CONVERTING TO IFRS:
A U.S. PERSPECTIVE
Robert D. Strahota
Assistant Director, Office of International Affairs
U.S. Securities and Exchange Commission
Russian Corporate Governance Roundtable
Moscow
November 11-12, 2004
As a matter of policy, the Commission disclaims responsibility for any private publications or
statements by any of its employees. The views expressed are those of the speaker and do not
necessarily reflect the views of the Commission, individual commissioners or the speaker’s
colleagues on the staff of the Commission.
This Presentation Covers:
1. Principal steps that have been taken in the U.S. to
facilitate the development and use of international
financial reporting standards (IFRS), including
conversion issues that may be of relevance to other
countries planning to adopt IFRS
2. U.S. efforts to foster high quality, internationally
acceptable accounting and auditing standards
3. Some thoughts on where we are in the process
SEC and International Financial Reporting Standards
SEC continues to work directly and through the International
Organization of Securities Commissions (IOSCO) to encourage the
adoption and use of high quality IFRS
Observed meetings of the former IASC
Supported 2000 IOSCO resolution re use of 30 core
international accounting standards (IAS) in cross border
offerings and listings
Participates in accounting standards improvement projects
Involved in restructuring and creation of IASB
Observes standards-setting and interpretation work of new IASB
SEC has already accepted use of IFRS by foreign companies with
reconciliation to U.S. GAAP
SEC has already accepted three IAS without reconciliation; IAS
No. 7 (cash flow statements), No. 22 (business combinations) and
No. 21 (operations in hyperinflationary economies)
Foreign Companies’ Conversion to IFRS
Less than 50 of 1200+ foreign companies now use IFRS in their
SEC reports
All of the six Russian companies subject to SEC filing
requirements have elected to prepare their financial statements
using U.S. GAAP
Per a September 2003 EU regulation, IFRS will be required
effective January 1, 2005 for approximately 7,000 EU companies,
including approximately 450 EU companies that file reports with
the SEC
Many other jurisdictions also are converting to IFRS as of this date
To accommodate IFRS conversion for foreign companies that file
SEC reports, the SEC issued proposals in February 2004 that would
permit filing of two instead of three years of IFRS financial
statements in the first annual report filed by a foreign issuer in
accordance with IFRS
SEC Proposals re Conversion to IFRS
Proposals would apply to companies adopting IFRS for the first time, and no
later than calendar 2007
Proposals would require a company must to state unreservedly and explicitly
that its general-purpose financial statements comply with IFRS; the audited
financial statements may not be subject to any qualification relating to the
application of IFRS.
If IFRS are used, reconciliation to US GAAP would still be required
All audited financial statements filed with SEC must be audited in accordance
with U.S. generally accepted auditing standards (which now means auditing
standards of the PCAOB) (U.S. GAAS), and U.S. independence rules apply
SEC staff will review the expanded universe of IFRS-based reports in
considering future acceptance of IFRS reporting without US GAAP
reconciliation
Key Issues Relating to Conversion
The SEC proposals, IFRS and CESR guidance identify several key
issues raised by conversion, although there is not complete
agreement regarding resolution
IFRS give rise to a new basis of accountability and would require
disclosure regarding reconciliation of IFRS balance sheet and
income statement information to previous GAAP information
To provide at least three years of comparable data, the SEC
proposals would require companies presenting only two years of
IFRS financial statements in the transition year report to include a
note to the audited financial statements which presents three years’
US-GAAP condensed balance sheet and income statement data
without any required footnote explanation.
Key Issues Relating to Conversion - continued
Interim financial statements during the first year of IFRS
Foreign companies are not required to file interim financial reports with
the SEC, but if interim financial information were required, e.g., in an
offering document because of the age of audited financial statements,
SEC proposals would require comparative interim period information in
accordance with or reconciled to U.S. GAAP
CESR guidance would not preclude use of previous GAAP for interim
financial statements but indicates a preference for reporting on the basis
of IAS 34 or IAS/IFRS recognition and measurement principles that will
be used for year-end IFRS financial statements
SEC proposals would require MD&A to focus on the IFRS financial
statements, would prohibit side-by side comparisons of IFRS and previous
GAAP information and would require cautionary language where previous
GAAP information is used; CESR guidance would permit side-by-side
comparisons with explanatory reconciliation
Effect of EU Conversion to IFRS on Non –EU Companies
EU regulation requiring conversion to IFRS provides that EU
member states to exempt non-EU companies from IFRS
requirements up to 2007 in the case of:
Companies that are listed both in EU and on a non-EU exchange and are
using another set of internationally accepted standards
Companies that have only publicly-traded debt securities
In light of the 2007 deadline, on June 29, 2004 EC issued a
mandate to CESR to assess the equivalence with IFRS of U.S.
GAAP, as well as Canadian and Japanese standards CESR-Fin, a
standing committee of CESR, will direct the work and report to
CESR
Resolution of this issue will affect the attractiveness of EU
markets; e.g., Eurobonds
SEC-CESR Cooperation Will Improve International
Coordination in Implementing and Enforcing Use of IFRS
2004 Memorandum of Understanding between CESR and the
SEC provides for consultation and cooperation on a wide range
of issues affecting the organizations’ constituencies
IFRIC will be responsible for issuing IFRS interpretations but
individual country regulators do not relinquish their authority to
interpret and enforce IFRS
It is expected that potential conflicts regarding interpretation and
enforcement of IFRS will minimized by SEC-CESR
consultation, and also by consultation within IOSCO
IOSCO Initiatives Regarding the Financial Reporting
Process and Its Oversight
May 2000 IOSCO resolution recommending that IOSCO members
permit the use of 30 core IAS, supplemented by reconciliation,
disclosure and interpretation, for cross border offerings and listings
In light of the many changes that have been made in the core IAS as
well as adoption of new standards, an updated IOSCO resolution is
being prepared to support IFRS as a whole, support IASB’s
independence, and explain IOSCO’s role vis a vis IFRS and the
IASB
In February 2004, the IOSCO Technical Committee approved a
Regulatory Interpretations of IFRS Project with the goal of
encouraging cooperation and consultation among IOSCO members
in the application and interpretation of IFRS. IOSCO Standing
Committee 1 is to develop a consultation to be circulated to all
IOSCO members regarding this project
IOSCO’s Position on Auditor Oversight
IOSCO’s October 2003 Statement of the Technical
Committee regarding Principles of Oversight reflects
international consensus that within each jurisdiction auditors,
auditing standards, independence, ethical standards and
quality control procedures, should be
subject to oversight by a regulatory body that “acts and is
seen to act in the public interest” and that
disciplinary processes carried out or overseen by a
independent body that is not under the control of the
auditing profession
SEC-PCAOB oversight of the auditing profession
is one (not the only) model for auditor oversight
PCAOB is a non-profit organization whose five board members are appointed by
the SEC after consultation with the Chairman of the Federal Reserve Board and
Secretary of the Treasury; no more than two board members may come from the
auditing profession
PCAOB has authority to establish audit standards, related attestation standards,
and independence quality control and ethics standards to be used by registered
public accounting firms in audits of public companies’ financial statements filed
with SEC
PCAOB has comprehensive authority to inspect, investigate, require reports,
testimony and documents from, and sanction registered public accounting firms
and associated persons for violations of SOX, securities laws and professional
standards, including failure to reasonably supervise associated persons and failure
to cooperate with an investigation
SEC’s oversight authority includes: authority to approve and amend Board Rules;
notice of Board investigations; authority to inspect and sanction the Board,
including censure and removal of members; review of Board disciplinary actions;
and oversight of the Board’s budget and funding process
Prospects for SEC Acceptance of IFRS Without U.S.
GAAP Reconciliation
The SEC Concept Release, issued in February 2000, requested
comment on issues relating to quality of the standards,
interpretation, application, auditing, and enforcement
Importance of a global financial reporting infrastructure was
emphasized, including:
A comprehensive body of standards
High quality of these standards, including:
• Consistency
• Transparency
• Full disclosure
Rigorous interpretation and application of the standards
Assessment of the financial reporting infrastructure includes
auditing and enforcement issues
International regulatory cooperation is critical
SEC Concept Release Aftermath
Comment letters expressed a variety of views
Accounting convergence work underway holds out tremendous
potential for investors and companies seeking to allocate and
raise capital on a global basis
Adoption of IFRS to occur in European Union and some other
countries should provide answers to some of the questions raised
in the concept release
SEC staff currently considering steps that would need to be
taken to eliminate reconciliation from IFRS to U.S. GAAP
No specific timetable has been adopted.
Convergence of Accounting Standards
IASB and FASB October 2002 MOU re convergence of IFRS and U.S. GAAP
Convergence is being implemented in several ways, including:
Short term efforts focused on discrete areas where it is possible to readily
identify the best standard
An IASB representative at the FASB
Joint projects on major, fundamental areas
Longer term research, studies and projects to come
Consideration of convergence potential in all FASB decisions
Convergence dialogue has identified the need for a single conceptual framework
(a longer-term project now underway)
Unfortunately, convergence can be affected by politics; e.g. EU acceptance of
IAS 39 and 32, now compromised, and U.S. accounting for stock options, now
deferred for six months
SEC fully supports convergence efforts and believes the focus should be on
developing high quality standards. It does not view convergence as a “one way
street” and is prepared to accept convergence from a U.S. GAAP standard to a
better IFRS, but SEC also opposes “lowest common denominator” convergence
SEC Chief Accountant Donald T. Nicolaisen
recently stated:
“In order to realize the benefits of truly
international financial reporting, we need
convergence in all areas --- accounting, auditing
and disclosures.”
Where Are We in the Process?
Progress in all three of these areas is encouraging
The global infrastructure for IFRS is substantially in place in light of IASB’s
reorganization and related efforts underway to coordinate interpretation and
enforcement of IFRS
The EU’s decision to use IOSCO’s Nonfinancial Disclosure Standards as the
base level for disclosure in the EU’s Prospectus Directive and the SEC’s
earlier adoption of these standards has contributed substantially to their
international acceptance
While encouraging, progress regarding the global infrastructure for auditing
standards is not complete. IFAC is not a body independent of the auditing
profession and efforts to establish a Public Interest Oversight Board overlay
are ongoing
There much less consensus over what constitutes high quality, international
acceptable auditing standards and what changes need to made in current
International Standards of Auditing
The Sarbanes-Oxley (SOX) Response to Auditing Failures in
the U.S. Has Significantly Changed U.S. Auditing Standards
On May 27, 2003, the SEC implemented Section 404 of SOX by requiring
domestic and foreign issuers to include in their annual reports a management report
on internal control over financial reporting, Among other things, the report must
include:
Management’s assessment of the effectiveness of the internal control as of the
end of the last fiscal year (any material weaknesses must be disclosed and if
they exist, management cannot conclude that internal control is effective)
A statement that the issuer’s independent accountants have issued an attestation
report on management’s assessment
SOX also required the PCAOB to adopt rules that will require the independent
auditor to describe in its audit report the scope of its testing of the internal control
structure and procedures of the company, and to present (in such report or in a
separate report):
The findings of the auditor from such testing
An evaluation whether the internal control structure and procedures achieve
substantially the principal internal accounting control requirements of the
Securities Exchange Act of 1934
Changes in U.S. Auditing Standards
The new internal control audit requirement differs from the independent auditor’s
existing obligation under U.S. GAAS to evaluate internal controls of the company
for purposes of planning the scope of the audit; e.g., the requirement envisions that
the internal control evaluation would encompass an evaluation of the effectiveness
of a company’s audit committee
This requirement is in addition to the independent auditor’s obligation under SOX to
attest to management’s report and assessment of the internal control structure and
procedures for financial reporting
This new requirement has been characterized as a “sea change” and as “a
breakthrough that requires an integrated approach to the audit process”. See PCAOB
Standard No. 2 on audits of internal controls over financial reporting
Because this change in U.S. practice is so new and has yet to gain international
acceptance, it suggests a scenario whereby any U.S. acceptance of IFRS is likely to
still require adherence to U.S. GAAS, as now prescribed by the PCAOB
Thank you
Questions?