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SEC Review of IFRS Making Progress

11.23.10

In a progress report released on Oct. 29, 2010, the SEC described its efforts towards achieving its objectives set forth in its Feb. 2010 work plan in connection with the SEC’s determination as to whether, when and how the current financial reporting system for U.S. issuers should be transitioned to a system incorporating International Financial Reporting Standards (“IFRS”).

Consistent with the Work Plan, the Progress Report addresses the SEC’s efforts in six areas, each of which the SEC determined was important in analyzing the switch to IFRS: 

1.         Sufficient development and application of IFRS for the U.S. domestic reporting system. 

The Work Plan indicated that the SEC would focus on the following to determine whether IFRS is sufficiently developed and applied to be the single set of globally accepted accounting standards for U.S. issuers: (1) the comprehensiveness of IFRS, (2) the auditability and enforceability of IFRS, and (3) the comparability of IFRS financial statements within and across jurisdictions.

The Progress Report demonstrates that the SEC is making steady progress in this area.  The report indicates that the SEC currently is identifying possible approaches of incorporating IFRS into the U.S. financial reporting system, analyzing how other jurisdictions do the same and considering how other jurisdictions deal with concerns related to the sovereignty of capital market regulators, national standard setters and other bodies responsible for setting accounting standards.  In furtherance of its work in this area, the SEC staff continues to research the financial reporting framework used in a sample of jurisdictions (which as a whole represent over 90 percent of word domestic product (GDP)), consider published reports of the World Bank and the Nations Conference on Trade and Development and review submissions by interested professional accounting organizations.

2.         The independence of standard setting for the benefit of investors.

As indicated in the Work Plan, to determine whether the international administrators of IFRS are sufficiently independent to support the independent development of account standards for the ultimate benefit of investors, the SEC is considering the following: (1) the oversight of the IFRS Foundation, (2) the composition of the IFRS Foundation and the International Accounting Standards Board (“IASB”), (3) the funding of the IFRS Foundation and (4) the IASB standard-setting process.        

The Progress Report indicates that not much progress has been made in this area of consideration.  Rather, the report states that, after the publication of the Work Plan, the Monitoring Board of the IFRS Foundation (which is the group that oversees the IFRS Foundation) committed to a review of the governance framework of both the Monitoring Board itself and the IFRS Foundation.  As indicated in the Progress Report, the Monitoring Board’s governance review will focus on several items that the SEC identified as important in determining whether the funding and governance structure of the IFRS Foundation and the IASB will be viewed favorably by the SEC.  Based on the expectation that the Monitoring Board will complete its review by the end of 2010, the Progress Report states that the SEC is expected to perform a significant portion of the work on this component in early 2011. 

That being said, the Progress Report provides the following preliminary observations regarding the funding (and by implication, the potential lack of independence) of the IFRS Foundation: (1) the IFRS Foundation has not obtained all of its necessary long-term mandatory funding commitments and that the IFRS Foundation has indicated that it could have an operating deficit for fiscal year 2010, (2) implementing a funding mechanism to allow the SEC to provide funding to the IFRS Foundation could potentially require Congressional action and (3) such an arrangement may be in conflict with relevant legislative history which appears to express a preference against mechanisms that could result in pressures on its standard setting, including funding through direct Congressional appropriations.

3.         Investor understanding and education regarding IFRS.

The Work Plan noted that the decision to incorporate IFRS into the financial reporting system for U.S. issuers would require consideration of the impact on investors.  As provided in the Progress Report, “the main benefits to investors of a single set of high-quality globally accepted accounting standards would be realized only if investors understand and have confidence in the basis for the reported results.”

The Progress Report indicates that the SEC is researching and analyzing the three components identified in the Work Plan regarding this category: (1) conducting research aimed at understanding U.S. investors’ current knowledge and preparedness for incorporation of IFRS, (2) gathering input from various investor groups to understand how investors educate themselves on changes to accounting standards and (3) considering the extent of, logistics for and estimated time necessary to undertake changes to improve investor understanding of IFRS.  The report notes that the SEC issued a request for public comment to aid in its evaluation of these three components (the comment period ended on Oct. 18, 2010).  The SEC is reviewing the input from the comment letters received and will consider whether further outreach would facilitate the SEC’s understanding of investors’ perspectives on these three components.

As a preliminary observation, the Progress Report states that initial feedback indicates the U.S. investor understanding and education regarding IFRS has begun to develop.

4.         Examination of the U.S. regulatory environment that would be affected by a change in accounting standards.

The Work Plan recognized that U.S. issuers commonly provide financial information to a wide variety of parties other than the SEC for different purposes and that the SEC did not have the authority to determine the provision and content of such information to other regulators.  Because these other regulators frequently rely on U.S. GAAP as a basis for their regulatory reporting regimes, the Work Plan provided that the SEC should consider the role of financial reporting in various regulatory regimes and how IFRS incorporation into the financial reporting system would affect issuers, investors, and others in those contexts and access the magnitude and logistics of changes that would be necessary for effective incorporation.

The Progress Report indicates that the SEC’s assessment of the transitional considerations for regulators primarily will be performed through outreach to the various affected parties.  The report states that these discussions have commenced with numerous regulators and will continue into 2011.

As a preliminary observation, the Progress Report indicates that the SEC has identified the prominence of “U.S. GAAP” references currently in U.S. laws, contractual documents, regulatory requirements and guidelines, and similar documents as a consistent area of concern and focus for many regulators.  As reported by the Progress Report, regulators have expressed that if U.S. GAAP is the mechanism used for incorporation of IFRS into the financial reporting system for U.S. issuers, then this would resolve a number of the more significant issues currently identified in the SEC’s outreach.

5.         The impact on issuers, both large and small, including changes to accounting systems, changes to contractual arrangements, corporate governance considerations and litigation contingencies.

            The Progress Report notes that the “[i]ncorporation of IFRS into the financial reporting system for U.S. issuers would significantly affect preparers of financial statements – the thousands of issuers that file reports with the Commission.”  The SEC identifies “the costs, efforts, and time involved for U.S. issuers with a move to IFRS and whether the benefits of such a move justify the costs” as an important consideration in its evaluation of IFRS.

            The Progress Report indicates that the SEC solicited public comment to aid it in evaluating several components of this category (the comment period ended on Oct. 18, 2010).  The SEC is analyzing the input from the comment letters received and determining the nature for further public input.

            That said, as a preliminary observation, the Progress Report indicates that based on discussions with issuers to date, the SEC understands that the extent and significance of differences in applicable accounting requirements and their effect on internal processes will vary among issuers.  The report also indicates that for multinational issuers with subsidiaries already utilizing IFRS, the SEC may need to consider whether there are any existing inconsistencies with applying IFRS from one jurisdiction to another.

6.         Human capital readiness.

The Work Plan acknowledged that transitional considerations related to the readiness of all parties involved in the financial reporting process, including investors, issuers, attorneys, auditors, regulators and educators must be considered to assess the magnitude and logistics of changes that would be necessary to incorporate IFRS into the financial reporting system.

To evaluate human capital readiness, the original Work Plan indicated that the SEC would consider the education and training of constituents and auditor capacity.  Among other things, the Progress Report states that the SEC plans on obtaining the perspectives of key stakeholders (such as market participants, academics, and members of selected professional organizations) and will meet with members of accounting firms (large, medium, and small size firms) to discuss these components.

The Progress Report notes that the SEC has determined that the assessment of this category is most efficiently conducted after it has progressed further on the Work Plan.

While the Progress Report indicates that some progress has been made in each of the above categories, the report makes clear that the SEC’s review continues in all of these areas.  The SEC anticipates completing its review in 2011. 

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