March 2003

Convergence of IFRS and U.S. GAAP

By Paul Pacter

Things are moving so quickly in the evolving world of global accounting standards that IFRS may be unfamiliar. International Financial Reporting Standards (IFRS) is the new name for pronouncements of the International Accounting Standards Board (IASB). From 1973 to 2000, the IASB’s predecessor, the International Accounting Standards Committee, issued pronouncements known as International Accounting Standards (IAS). The movement toward IFRS (which now encompass IASs) as the worldwide accounting benchmark affects the environment in which all companies operate, including those in the United States.

For example, virtually all of the 7,000 publicly listed companies domiciled within the European Union are required by law to prepare their consolidated financial statements in accordance with IFRS by 2005. This requirement will affect the subsidiaries, associates, and joint ventures of those 7,000 entities, many of which are located in the United States. If the EU expands to include Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia, and Slovenia in May 2004 as proposed, listed companies in those 10 countries will also have to adopt IFRS in 2005. And some European countries will permit or require IFRS for non-listed companies, of which there are 5 million.

Proposals to require IFRS have been made by Australia (all companies, starting 2005) and New Zealand (listed companies, starting in 2007). When you add these new adopters, by 2005 IFRS will be required for reporting by some or all domestic listed companies in at least 60 countries, and permitted in another 21. An even larger number of countries will allow IFRS for foreign issuers.

In the United States, a foreign company registered with the SEC may submit IFRS or local GAAP financial statements, but a reconciliation of earnings and net assets to U.S. GAAP figures is required. In effect, companies are forced to keep two sets of books. In February 2000, the SEC issued a Concept Release, International Accounting Standards, inviting views on whether and how IAS might be permitted for foreign registrants, and possibly domestic registrants. The matter continues to be under study.

The movement to IFRS around the world will have a significant impact on the SEC, especially with regard to the Sarbanes-Oxley Act’s requirement for a review of all registrant filings at least once every three years. Roughly 1,400 foreign companies are listed with the SEC, approximately 40% of them from Europe. By 2005 there will be an additional 500 to 600 registrants filing IFRS statements as their primary financial statements. Currently, only about 50 foreign companies file IFRS financial statements with the SEC and reconcile to U.S. GAAP.

The Sarbanes-Oxley Act permits the SEC to look to a private-sector accounting standards setter, such as FASB, provided that the standards setter “considers, in adopting accounting principles … the extent to which international convergence on high-quality accounting standards is necessary or appropriate in the public interest and for the protection of investors.”

In October 2002, the IASB and FASB jointly issued a memorandum of understanding, formalizing their commitment to the convergence of U.S. and international accounting standards. The two boards presented the agreement to leading national standards setters at a two-day meeting in London. The boards agreed, as a matter of high priority, to—

Shortly thereafter, both FASB and the IASB added a number of projects relating to the above agreement to their agendas, including a short-term international convergence project with a target completion date of December 31, 2003, as well as several joint standards projects.

The Sidebar sets out some of the key differences between IFRS and U.S. GAAP, with a status note on what, if anything, is being done about each difference. Of course, the significance of these differences—and others not included in this list—will vary with respect to individual companies depending on such factors as the nature of the company’s operations, the industry in which it operates, and the accounting policy choices it has made. Reference to the underlying accounting standards and any relevant national regulations is essential in understanding the specific differences.

Paul Pacter is director, IAS Global Office, Deloitte Touche Tohmatsu, Hong Kong. He worked for many years for both FASB and the International Accounting Standards Committee.

Robert H. Colson, PhD, CPA
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