SEC Proposal for U.S. Transition to IFRS Reporting

Introduction

This essay examines the SEC's proposed Work Plan for transitioning International Financial Reporting Standards (IFRS) into the U.S. financial reporting system. The paper presents arguments in favor of convergence based on the benefits it offers to American companies operating in an increasingly globalized economy.

History of Convergence Efforts

The history of convergence efforts for IFRS reporting includes several important milestones. In October 2002, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) issued a memorandum of understanding (MOU) known as the Norwalk Agreement. This agreement marked an important step toward formalizing their commitment to converging U.S. and international accounting standards (FASB, 2002).

The agreement describes the efforts of both boards to propose changes to U.S. and international accounting standards that reflect common solutions to "certain specifically identified differences" (FASB, 2002, para. 2). By eliminating these differences, the boards expected to improve the comparability of financial statements across national jurisdictions. FASB Chairman Robert Herz described the FASB's commitment to "working toward the goal of producing high-quality reporting standards worldwide to support healthy global capital markets" (FASB, 2002, para. 3). In a similar vein, IASB Chairman Sir David Tweedie emphasized the importance of convergence so that "the world's capital markets will have a set of global standards that investors can trust" (FASB, 2002, para. 3).

In February 2006, the FASB and IASB issued another MOU, A Roadmap for Convergence between IFRSs and US GAAP 2006–2008. The memorandum describes their intention to develop a new common standard rather than merely attempt to eliminate differences between existing standards — an approach expected to result in improved financial information reported to investors. The boards also planned to replace weaker standards with stronger ones. The memorandum included a list of short-term convergence topics that both boards planned to address for completion by 2008 (FASB, 2006).

In August 2008, the SEC proposed a roadmap that could lead to the use of IFRS by U.S. issuers beginning in 2014. With the growing integration of the world's capital markets, two-thirds of U.S. investors owned securities issued by foreign companies that reported financial information using IFRS. At that time, more than 100 countries around the world — including all of Europe — required or permitted IFRS reporting. Of those countries, approximately 85 required IFRS reporting for all domestic listed companies (SEC, 2008).

The IASB and FASB issued a progress report in 2011 detailing recent achievements toward convergence. The report described five completed projects, prioritized three others plus insurance accounting, and extended the timetable for remaining priority convergence projects to be completed in the second half of 2011. The U.S. insurance standard was targeted for completion in the first half of 2012 (FASB, 2011).

The Proposed Work Plan sets forth a possible framework for achieving the goal of establishing a single set of high-quality, globally accepted accounting standards. The Plan would also provide for a U.S. issuer complying with U.S. GAAP to be in a position to assert compliance with IFRS as issued by the IASB (SEC, 2011).

Analysis of the Proposed Work Plan

The Work Plan discusses two primary approaches to incorporating IFRS into companies' reporting requirements: the convergence approach and the endorsement approach. Under the convergence approach, jurisdictions do not adopt IFRS as issued by the IASB. Rather, they maintain their local standards and attempt to converge those bodies of standards with IFRS over time. The People's Republic of China uses the convergence approach (SEC, 2011).

Under the endorsement approach, jurisdictions incorporate individual IFRSs into their local body of standards. Countries within the European Union (EU) follow a form of the endorsement approach (SEC, 2011).

A third possible incorporation approach, referred to as condorsement, is a variation of the endorsement approach. This treatment would share characteristics of the incorporation approaches used by other jurisdictions that have incorporated or are incorporating IFRS into their financial reporting systems, except that during the transitional period the framework would employ aspects of the convergence approach to handle existing differences between IFRS and U.S. GAAP over a period of perhaps five to seven years (SEC, 2011).

Because the SEC believes it will be important for the U.S. to continue its active involvement in the international accounting arena, the FASB would remain the standard-setting body responsible for promoting U.S. GAAP under the proposed framework. The Work Plan sets forth several possible scenarios in which the FASB would participate in IASB standard setting (SEC, 2011).

The SEC would maintain its oversight of the FASB if IFRS is incorporated into the U.S. financial reporting system. SEC staff would monitor international standard-setting developments to evaluate the implications of changes to IFRS on the Commission's existing rules and regulations (SEC, 2011).

The Work Plan also discusses a transition strategy that borrows heavily from the convergence approach. The FASB would develop a transition plan allowing U.S. constituents to plan appropriately for implementation within a reasonable timeframe. The initial incorporation could be handled through a transition of individual IFRSs organized into one of three categories. One of the highest priorities of the transition plan would be identifying ways to minimize the potential impact on U.S. constituents while still providing useful information to investors (SEC, 2011).

The Work Plan further discusses the potential benefits of the framework. The framework supports a flexible transition strategy that is better able to respond to and be tailored to the needs of U.S. constituents than other mechanisms for incorporation. It also provides for gradual implementation of IFRS, thereby avoiding the costs of an all-at-once approach. Moreover, potentially greater investor protection is available through FASB endorsement than through direct incorporation of IFRS. The framework also allows for retaining U.S. GAAP as the basis of financial reporting for U.S. issuers, mitigating the complexities of changing all existing references to U.S. GAAP (SEC, 2011).

Conclusion

This paper examined the history of convergence efforts in recent years and reviewed the Proposed Work Plan submitted for public comments and input. The Plan, as presented, offers several benefits for U.S. companies. With the increasing expansion of globalization and the need to compete internationally, companies are likely to find themselves required to use IFRS reporting — whether for subsidiaries, parent companies, or to satisfy the expectations of prospective foreign investors. The Proposed Work Plan provides for transitioning to IFRS reporting with minimum cost and disruption. Of course, as can happen with any plan still in development, the actual implementation of convergence may ultimately vary from what has been presented to date.