Global Accounting

California CPA magazine: June 2008

Q&A with IASB Member Mary Barth Sheds Light on Accounting Reg Convergence

For Stanford University professor Mary Barth, being a member of the International Accounting Standards Board means the world is her office. With IASB headquarters in London, and the board’s charge spanning the entire globe, her modus operandi is not something most of us are familiar with. However, her job—shaping global accounting standards—is something all CPAs should be familiar with.

Convergence of the global market is moving forward and now is the time to get educated on what that could mean. In that spirit, California CPA spoke with the well-traveled professor to get a status check of international convergence.

Q: What are some of the challenges in moving toward convergence?
There are many. A key one is to avoid the natural temptation to adapt, rather than adopt, IFRS. That is, avoid the temptation to make some changes to the standards in particular jurisdictions. Several countries that have moved to IFRS have discovered that it is better to use the exact same standards than it is to make modifications. This is because it is unclear how investors and others interpret the modifications.

For example, Korea has decided that the best course of action is to simply adopt IFRS in its entirety—previous attempts to adapt them and adopt them piecemeal failed because investors did not believe the results were the same as IFRS.

When Australia adopted IFRS in 2005, it eliminated options in IFRS that it thought were less appropriate, believing that this would not interfere with Australian companies’ ability to assert compliance with IFRS and would promote consistency within Australia. They have since concluded that this was a mistake, and it is more important to be consistent with the rest of the world and they are in the process of reinstating the eliminated options.

The European Commission “carved out” a few paragraphs of IAS 39, which made the hedging requirements less rigorous. Even though only a few companies availed themselves of the carve-out (European firms are permitted to apply IFRS as issued by the IASB), this is now viewed as an unfortunate mistake. Hopefully, the European Commission will eliminate the carve-out. Having even slightly different standards opens the door to the risk that investors and others perceive them to be less rigorous and, thus, the resulting financial statements to be less credible.

Also, investors are coming to understand IFRS as issued by the IASB. Investors are becoming more and more global. Thus, they may not understand modifications made in particular jurisdictions, which creates information uncertainty and the need for investors to assess an information risk premium. The U.S. needs to resist this temptation, just as do other countries.

Q: What will the change to IFRS mean to those affected?
They will incur one-time costs of changing their financial reporting to comply with IFRS. Those costs are offset by the benefits of convergence and increased ability of financial statement users to understand their statements. No country can stand alone in this global world—not even the United States.

In the United States, there also are benefits to being able to apply more principles and fewer complex rules, which can reduce the chance of misapplying GAAP. Depending on the starting point, there also could be benefits from increased information quality. I have done research that confirms this.

One study shows that information in IFRS-based financial statements is higher quality (using a variety of metrics from academic literature) than the information in non-U.S. domestic standards-based information. Another study shows that IFRS-based information is of comparable quality to U.S. GAAP-based information for common-law countries such as Australia and the U.K. And yet another study shows that the European stock market reacted positively to events leading up to the European Commission’s decision to require IFRS for all publicly listed companies in 2005.

The reaction was positive for all groups of firms, but more positive for those with lower quality pre-adoption information environments. These findings indicate that investors perceived benefits associated both with convergence and with increased information quality.

Q: Given that we may be five or so years away from mandatory IFRS application in the United States, how urgent is it that companies stay informed and perhaps begin planning to change?  
There should be a sense of urgency. If regulators decide that five years is needed before mandatory adoption, it will be primarily because they believe it will take that long to prepare for it. Failing to start the preparation will just cause problems later. Companies need to determine how their accounting will change under IFRS, whether any of their contracts (such as bank loan covenants) need to be altered, get started training their people to understand IFRS, etc. Five years will fly by.

Companies need to be on the alert. They should begin to monitor and provide input into the IASB’s technical projects. This is not as onerous as it may seem, especially for companies that are doing this now for the FASB’s technical projects. Most of our major projects are conducted jointly with the FASB—but not all.

Q: How have you seen this move toward convergence play out over the years?
The spread of IFRS use over the last seven years has been nothing short of breathtaking. The global movement really started with the European Commission’s decision in 2002 to require IFRS for all listed companies in the European Union beginning in 2005.

Now, more than 100 countries use IFRS or have plans to adopt IFRS or base their standards on IFRS. Even Canada, that has long had a convergence plan with U.S. GAAP, has announced it will adopt IFRS in 2011.

The market is demanding convergence of financial reporting globally. The IASB is just trying to facilitate it. The IASB has no power to require any country or company to use IFRS. This is a country-by-country regulator or government decision. The evidence speaks for itself. Even the SEC now permits non-US registrants to use IFRS (as issued by the IASB) without reconciliation to U.S. GAAP.

It seems logical that it is only a matter of time (perhaps a short time) before they permit U.S. registrants to do the same. Why not?

Q: Putting on your educator hat, what needs to be done inside classrooms to prepare the CPAs of tomorrow when it comes to convergence?
Educators need to teach students about IFRS. The most productive way to do this would be to ensure students understand the conceptual framework underlying financial reporting.

The IASB and FASB frameworks are very similar, thus, focusing on teaching the framework sets the stage for the move to IFRS and is, in my view, the right way to think about U.S. GAAP.

The framework spells out the objective of financial reporting, the qualitative characteristics that financial reporting information should possess, the definitions of elements of financial statements (e.g., assets, liabilities, income, and expense), etc. Standards then specify principles that translate the concepts to particular types of transactions or arrangements. They then specify the rules companies need to apply to achieve those principles. The rules are implementation details and are the things most likely to differ between U.S. GAAP and IFRS.

So, if students understand the concepts and the principles, and that there are a variety of ways to implement the principles, they should be able to transition from one set of rules to the other.

There are a few differences in principles between U.S. GAAP and IFRS (one might think of revaluation of assets in this category, or using fair values for agriculture), but the similarities far outweigh the differences. The big differences are in the detailed rules.

Educators also need to teach students how to make judgments, and train them in the subject areas that underlie financial reporting—finance and economic theory, valuation, operations of markets, etc. They also need to teach students to adopt a global mindset.

Q: What are some lessons learned from those countries that have already moved to IFRS?
Prior to the 2005 adoption of IFRS in Europe, there was quite a bit of anxiety and skepticism. Many had concerns similar to those being voiced now in the United States.

The consensus seems to be that the transition was much smoother and less disruptive than most feared. This is particularly noteworthy because Europe was coming from a diverse set of domestic standards, many of which were quite different in perspective (let alone details) from IFRS.

U.S. GAAP is more similar in perspective to IFRS than these domestic standards. Thus, one might expect the transition in the United States to be even smoother. The challenge in the United States will be more about learning to be comfortable making more judgments and letting go of all the detailed rules than it is to apply new ones.

Q: How does convergence tie into XBRL for business reporting?
XBRL is a technology that facilitates analysis of financial reporting information. XBRL can only provide the information input into it. If that information is based on the same set of standards, then it will be comparable across companies and countries, thereby facilitating an apples-to-apples analysis. Without the same basis for the information, one can never be sure they are comparing apples-to-apples. Thus, with converged financial reporting, XBRL becomes an even more powerful tool.

Q: Where are we now in the convergence process, and what does the timeline look like from here?
Total convergence between IFRS and U.S. GAAP would take quite a while. The standard-setting processes of both the IASB and FASB involve extensive due process and deliberation. Thus, any changes take time to achieve.

The two boards agreed on a Memorandum of Understanding in 2006 that outlined the targets for convergence that needed to be made before the SEC staff would recommend to the SEC that it remove the reconciliation requirement for non-US registrants using IFRS. Those targets largely were met and the SEC has removed the reconciliation requirement. The two boards are in the process of updating the MoU to identify targets for convergence by 2011 to facilitate the adoption of IFRS in the countries that will adopt IFRS at that time or shortly afterwards.

Q: Why do California CPAs need to concern themselves with IFRS?
The world is moving to IFRS, with or without the United States. Already, non-U.S. companies are filing with the SEC financial statements based on IFRS without reconciliation to U.S. GAAP. Also, knowledge of IFRS is needed now.

Many U.S. companies (large and small) have non-U.S. subsidiaries. Many of these subsidiaries are now required or permitted to file their statutory reports using IFRS. So, even before the United States adopts IFRS, U.S. parent companies must know how to convert these IFRS-based financial statements to U.S. GAAP.
It is fruitless for Californians, or the United States, to ignore this trend or pretend it does not exist.

The question is when will the United States use global standards, not if. California has always been on the leading edge of progress and change. I would think that Californians would be among the first in the U.S. to acknowledge and participate in this global movement.

Q: What do CPAs, both in public and private practice, need to know about IFRS?
This is a huge question. The short answer is what they need to know about IFRS is the same as what they now know about U.S. GAAP. As a starting point, they need to know that IFRS are based on a conceptual framework that is quite similar to that of U.S. GAAP, but they rely more on companies exercising judgment in complying with the principles in the standards.

The principles are designed to have the financial statements reflect the underlying economics of what is going on in the company. There are many fewer detailed rules and bright lines in the standards. This means they are much less complex than U.S. GAAP. But, the benefit of reduced complexity comes at the cost of having to make judgments and not being able to depend on being told exactly how to do everything.

Are IFRS perfect? No. Like U.S. GAAP, they have evolved over time and contain some inconsistencies and complexities. That is why standard setting never seems to be done!

Q: How aware are CPAs about IFRS, and what can CalCPA do to raise that awareness?
CPAs are becoming more aware of IFRS, but probably not aware enough. CalCPA can help by getting the word out, offer CPE courses or hold conference sessions on IFRS—and even require California CPAs to know IFRS before licensing them to practice in California.

My understanding is that the AICPA is considering introducing some IFRS-based questions into the Uniform CPA Exam.

This is the best way to ensure CPAs are aware of IFRS. If knowledge of IFRS is required on the CPA Exam, then educators will be sure to teach it and students will be sure to learn it.