It's time to start preparing for the arrival of international accounting standards.
Sarah Johnson
April 1, 2008
One of the densest thickets of generally accepted accounting principles is revenue recognition. By one tally, more than 160 pieces of authoritative literature relate to how and when companies record revenue. Now, however, U.S. and international accounting authorities are taking a scythe to the rules. They will mow down "broad swaths" of GAAP, says Robert Herz, chairman of the Financial Accounting Standards Board, en route to producing a single set of global accounting guidelines for revenue recognition.
This slash-and-burn approach is a sign of things to come. For the past five years, FASB and the International Accounting Standards Board (IASB) have been working to merge U.S. accounting rules with international financial reporting standards (IFRS). But this so-called convergence is shaping up to be more of a takeover than a merger of equals — many who favor a single global standard hope to wipe out GAAP altogether.
Experts at the Big Four accounting firms say a Securities and Exchange Commission mandate for all U.S. publicly traded companies to use IFRS is inevitable. The SEC does plan to release a road map in late spring for transitioning U.S. public companies to the international standards, but it has not yet said whether adopting IFRS will be mandatory. Still, many SEC watchers expect the agency to eventually scrap GAAP.
"If I'm reading the tea leaves right, it's not a question of if but when," says Jeffrey Keefer, CFO of chemical giant DuPont. Large U.S. companies could start using IFRS instead of GAAP in three years, say accounting firms and finance chiefs, while a mandatory conversion could take effect in five years. Auditors urge CFOs to keep a weather eye on the IFRS movement. "It's going to be bigger than anybody expects," says Gary Illiano, a partner at Grant Thornton. Adds Deloitte & Touche partner Joel Osnoss: "From the smallest public companies to the largest, everyone should at least be thinking about what the potential of this will be."
Costly Conversion
For smaller U.S. businesses, especially those with no foreign subsidiaries or competitors, the benefits of convergence aren't so clear. "The question, obviously, for the companies that don't have international operations right now is, How do you justify it?" says Christine DiFabio, vice president of technical activities for Financial Executives International (FEI). "It's going to be expensive."
How expensive? The large accounting firms won't estimate how much it would cost companies to convert from GAAP to IFRS, but they acknowledge it won't be cheap. "It's too difficult to put down any kind of range," says Illiano. Kenneth Nielsen Goldmann, partner and managing director of capital-markets services for auditor JH Cohn, says it would be "extremely costly." Procter & Gamble hasn't pinned down an exact number, but expects a conversion project would cost tens of millions of dollars, according to comptroller of corporate accounting Mick Homan.
U.S. companies can get a better idea of the cost from their European counterparts. The Institute of Chartered Accountants in England and Wales estimates that European companies with revenue between 500 million euros and 5 billion euros spent 0.05 percent of their revenue in their first year of switching from their local GAAP to IFRS.
As for timing, auditors estimate that installing a new, IFRS-based accounting system will take U.S. companies 18 to 24 months to complete. During that period companies will have to evaluate their entire financial infrastructure — from which departments will be affected to who will need training on a new accounting language to relationships with outside groups that are used to GAAP, including bondholders, banks, and credit-rating agencies.
For the Greater Good?
Despite the cost and effort required, IFRS supporters maintain that CFOs should warm to convergence for the greater good of financial reporting.
"It would be a disservice for companies to sit back and not do anything," says DiFabio of FEI. A single set of worldwide accounting standards, the thinking goes, would result in more-comparable financial statements across industries and borders, and maintain U.S. companies' status as competitive global players. "A global set of standards will improve consistency among regulators, capital markets, and the investment community," DuPont's Keefer says.
Keefer's enthusiasm isn't widely shared among finance executives, according to surveys by auditing firms. The majority of finance executives trained in U.S. GAAP are reluctant to let it go, the firms report. According to a fall Deloitte & Touche poll of 300 companies (ranging in annual-revenue size from under $100 million to more than $10 billion), only about 20 percent of CFOs would consider adopting IFRS if given the choice.
"I don't see a lot of U.S. filers adopting it unless they have substantial foreign operations dominating their overall business that are already using IFRS," says Tim Mammen, CFO of IPG Photonics, a Massachusetts-based manufacturer of high-power fiber lasers and amplifiers with facilities in Germany, Russia, and Italy. He is skeptical of the idea that GAAP could one day disappear from the U.S. accounting landscape.
Others are taking a more active role in the convergence process, in hopes of influencing regulators. For example, Smyth of United Technologies told the SEC that inventory accounting that eliminates LIFO (last in, first out) accounting could be a deal breaker in whether her company would adopt IFRS. International standards bar the use of LIFO accounting, which confers sizable tax benefits to users like United Technologies. "We obviously are not going to switch to IFRS if it means cutting a big check to the IRS," says Smyth. Sooner or later, though, United Technologies will have to switch.
It Never Stood a Chance
Accounting experts wax nostalgic about the days when the concept of converged accounting standards was first introduced. Initially, the expectation was that rulemakers would take the best aspects of GAAP and IFRS to create the highest-quality standards possible — no matter how long it took. "We seem to have lost patience somewhere along the line," says Charles Niemeier, a member of the Public Company Accounting Oversight Board.
The truth is that U.S. GAAP never stood a chance of prevailing as the global standard, according to Herz. "We do have the best reporting system, but the rest of the world will not accept it," he says. "It's too detailed for them."
If the rulemakers have given up on GAAP, then timing is the major issue facing the SEC. Institutional investors and analysts have criticized the commission for what they consider its premature allowance of IFRS for foreign companies, before those standards are fully converged with GAAP. They're wary of letting U.S. companies adopt IFRS within three to five years, as has been projected. In response, SEC chairman Christopher Cox has said that GAAP will stick around for many years.
IFRS is much less voluminous than GAAP, lacking the incrustations that GAAP has acquired through years of interpretation. Accounting experts will simultaneously praise the international rules for their brevity and deride them for giving companies too much leeway. That discrepancy could undercut the comparability that regulators tout as a benefit of IFRS. Under the footnote-lite international rules, "you don't really know what the differences [between companies] are," says H. David Sherman, an accounting professor at Northeastern University and a former SEC academic fellow.
Indeed, opinions are split over whether convergence has progressed to the point that both standards are interchangeable today. Says Grant Thornton's Illiano, "If you think that the accounting standards in the U.S. and the accounting standards in IFRS are going to match up word for word, they're never going to get there."