BUSINESS INSIGHTS | SPRING 2011 EFFECT

The End Is Near: IFRS Convergence

by Mike Westervelt

Despite what Mayan predictions say, we don’t know for sure the world is coming to an end in 2012. However, certain changes in the financial world are absolutely on their way, and we must be prepared. These changes won’t require the stockpiling of canned goods, paper, or backup versions of your spreadsheet software, but they will require preparation.

What does international convergence mean?

The Financial Accounting Standards Board (FASB) believes that the ultimate goal of convergence to International Financial Reporting Standards (IFRS) is a single set of international accounting standards companies worldwide will use for both domestic and cross-border financial reporting. FASB and the International Accounting Standards Board (IASB) are both committed to this goal.

Specific convergence issues

In 2006, FASB and IASB reached an agreement that outlined the specific standards they expected to combine. Exposure drafts (preliminary drafts released for public comment) have already been issued for many of these projects.

These drafts address the following topics:

• Consolidations—FASB has a working model based on reporting entity and variable interest entity concepts that will work internationally. IASB still needs to issue an exposure draft more in line with FASB.
• Derecognition of transferred financial assets—FASB has a working model; IASB is still deliberating.
• Financial instruments—FASB and IASB models for financial instruments are very different. IASB prefers amortized costs for all liabilities, while FASB prefers a presumption of fair value with amortized cost exceptions. Convergence of this standard will be challenging.
• Financial statement presentation—The proposed model will affect the organization and presentation of information in the financial statements. The balance sheet, income statement, and cash flows statement will be organized into five sections: business (two subsections: operating and investing), financing, income taxes, discontinued operations, and equity. Combining this standard has been more challenging than originally expected.
• Financial instruments with characteristics of equity—This standard deals with liability versus equity. FASB and IASB are in the process of developing a working model.
• Leases—The exposure draft proposes a “right-of-use” model be considered when accounting for leases. This means an organization leasing an asset would account for it by recording an asset for the lease term and a liability for lease payments (similar to the capital lease model under current standards). This would require more leases recorded on an organization’s balance sheet.
• Fair value measurement—FASB has a working model; IASB still needs to issue an exposure draft.
• Revenue recognition—This exposure draft was developed to provide a comprehensive framework concerning when to recognize revenue, amounts to be recognized, and presentation and disclosure. This standard will significantly impact all industries and replace previously issued industry-specific guidance.
• Post-employment benefits—This standard will eliminate off-balance sheet reporting.

Constituent concerns

Constituents of both FASB and IASB voiced their concerns about not having adequate time to review, evaluate, and respond to the exposure drafts. Based on this feedback, the boards issued a combined report in June 2010 explaining that the rollout of certain projects will be slowed to no more than three exposure draft releases per quarter. All of these projects are still expected to be completed by the end of 2011.

Is it really coming to an end?

For those whose business plans abruptly end in 2012, convergence may not matter. However, if your future looks beyond the end of recorded time, careful planning will make a big difference in how your organization ultimately adjusts to the changes. Though these standards may not go into effect for small and medium-sized (non-public) companies until 2014, being part of the review and approval process for these exposure drafts allows you to share your insights and potentially influence the revisions. Participating will also force you to thoroughly understand the relevant issues long before they are final.

Plotting your organization’s convergence course

Would you jump into your car on a cross country trip to an unfamiliar destination without bringing your GPS or looking at a map? Even if you do your research and decide on the best route, you are still likely to encounter unforeseen difficulties due to weather, road construction, or traffic. Preparing beforehand allows you to adapt to uncertain conditions while still progressing toward your goal. By reviewing the issues and educating yourself on convergence topics, it will be easier to map out a course to convergence.

A larger organization will typically have more complex issues to address, so their leaders should start this process sooner. A smaller company may have fewer issues to wrestle with, but they also have fewer resources to devote to convergence. By having a deliberate plan from the start, your journey will be more cost effective, and your organization will be more capable of fully embracing the new reporting standards when they are issued.

A general map of the convergence process might include the following points:

• Understand, participate in, and influence the exposure drafts.
• Consider current systems and what resources might need to be added in the future.
• Identify technical accounting differences.
• Train internal staff.

IFRS and the real world

Though the new standards may still feel like a distant dream, some companies are already looking forward to them. Ron Paquette, CFO of Hubner Manufacturing Corporation, an international manufacturer located in South Carolina, says, “I see convergence to IFRS as a good thing … Hubner is a multinational company with subsidiaries throughout the world. The resources needed to keep each location in compliance with local regulatory and financial reporting requirements are significant. Despite some upfront planning and training expenses, I think we’ll benefit from lower financial reporting and tax compliance costs following our convergence to IFRS.”

Although not all businesses have multiple locations in different countries, a uniform standard will be useful if expanding overseas is on your horizon. And the hurdles for doing business in a different country will appear significantly less daunting when compliance standards are the same.

We live in a dynamic business environment, and our success will be determined by our ability to adapt and compete in a global market. So, in short, IFRS convergence is coming, and the sooner you understand and embrace it, the more fit for the future your company will be.