IFRS and Privately-Held Companies
Gregory J. Millman
the source for financial solutions
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financial executives international
Many have heard about something new, something different happening in the
realm of accounting, but few have a clear picture of what that is, or how it will
affect them.
In this well researched, concise report on international financial reporting
standards (IFRS), Greg Millman has provided the critical information that key
players will need to know as they begin the process of determining how and
when to respond to these important developments. This balanced presentation
provides perspectives from key constituents with important knowledge of the
areas you will need to consider in the near term, and beyond.
Gary Illiano
National Partner-in-Charge
International and Domestic Accounting
Grant Thornton LLP
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IFRS and Privately-Held Companies
TABLE OF CONTENTS
Purpose and Executive Summary
1
Research Methodology
2
What is IFRS?
Definition
Growing Acceptance of IFRS in the United States
Relevance to Private Companies in the United States
3
3
3
3
IFRS vs. IFRS for Private Entities
Why IFRS for Private Entities?
How Does IFRS for Private Entities Differ from Full IFRS
5
5
5
IFRS vs. GAAP: Implications for Private Companies
Principles vs. Rules
The LIFO Tax under IFRS
Other IFRS-GAAP Issues Important for Private Companies
7
7
7
9
The Banker’s Perspective
Mary Ann Lawrence, Key Bank
Dev Strischek, SunTrust
Mike Cain, Frost Bank
11
11
12
13
The Private Company Executive Perspective
George Beckwith, National Gypsum
William D. Koch, Development Dimensions International Inc.
Arthur Neis, Alliance Minerals North America LLC
Andy Thrower, Naviscent
14
14
15
16
17
Summary and Conclusion
19
About the Author and Financial Executives Research Foundation, Inc.
20
IFRS and Privately-Held Companies
Purpose
The purpose of this report is to give executives of private companies a
basic introduction to the implications of International Financial Reporting
Standards (IFRS). In November 2008, the SEC proposed a roadmap for
the use of IFRS by publicly held companies. Privately held companies are
not subject to SEC reporting requirements, but should be aware that IFRS
represent an alternative to GAAP that they may want to consider.
Unlike public companies, private companies face a choice not only
between GAAP and IFRS, but between full IFRS and IFRS for Private
Entities. Therefore, this report addresses both sets of standards insofar as
they may affect private companies. The report does not limit itself to
discussions of accounting differences, but discusses the impact of those
differences on financial reporting, tax reporting, the raising of capital, and
other activities.
Executive Summary
Here are the key findings of this report, based on interviews of bankers, financial
executives, and other experts:
•
Principles-based IFRS may supplant rules-based GAAP for public companies
in the United States by 2014, according to a roadmap proposed by the
Securities and Exchange Commission (SEC).
•
Although there will be no regulatory requirement that private companies adopt
IFRS, there are sound reasons for private companies to consider it.
•
There will soon be two options for private companies interested in adopting
IFRS: full IFRS and IFRS for Private Entities. Even if privately held,
companies that are accountable to the public because they issue publicly
traded debt securities, or have fiduciary responsibilities (such as banks and
mutual funds) must use full IFRS and follow the same rules as publicly held
companies. Private companies that are not accountable to the public may opt
for IFRS for Private Entities.
•
IFRS for Private Entities is expected to be approved in the first quarter of
2009. The AICPA already recognizes IFRS as a legitimate alternative to
GAAP. So private companies should be able to adopt either full IFRS or IFRS
for Private Entities as early as next year, if they choose.
•
For some companies, full IFRS or IFRS for Private Entities may offer clear
advantages, but for others, these methods may entail potentially steep tax
and audit costs.
•
IFRS for Private Entities represents the International Accounting Standards
Board’s attempt to, in its words, “provide a simplified, self-contained set of
accounting principles that are appropriate for smaller, non-listed companies.”
It could mean that private companies will have lower costs for financialstatement preparation and auditing.
•
•
•
•
However, neither full IFRS nor IFRS for Private Entities permits LIFO. This
means that under current U.S. tax law, companies on LIFO could face steep
tax penalties for adopting IFRS.
Many U.S. banks say they currently are not equipped to deal with IFRS. Their
credit analysts do not understand it, and their analytical software, credit ratios,
etc. do not address IFRS statements.
Most accountants in the United States have little or no training in IFRS.
Accounting schools have not prepared the profession for IFRS.
Although the IASB claims that IFRS for Private Entities represents a
simplification of full IFRS, critics say that the simplicity is only apparent, and
that private companies adopting the standard will still have to do much of the
measurement and reporting that is of little relevance or utility to the users of
their financial statements.
Research Methodology
This report is based on interviews with accounting professionals, policymakers, bankers,
private-company executives, and other experts. The interviews were conducted during
the second and third quarters of 2008. The intention was to identify the issues most
important for private companies, but not to compile an exhaustive catalog of accounting
treatments under U.S. GAAP, full IFRS, and IFRS for Private Entities. This report distills
what some of the leading authorities in private-company accounting have to say about
IFRS as it relates to private companies. It aims to reach a general-management
audience, and is not primarily addressed to accounting specialists.
As this report was going to press, the International Accounting Standards Board was in
the process of finalizing IFRS for Private Entities (formerly IFRS for Small and Medium
Enterprises). Although some outstanding issues would affect the details of reporting
under the new standard, their disposition would neither substantially alter the main
findings of this report, nor affect the interviewees’ concerns about the impact of IFRS
convergence on private companies.
2
What is IFRS?
Definition
International Financial Reporting Standards are issued by the International Accounting
Standards Board (IASB), a 14-member organization appointed by the trustees of the
International Accounting Standards Committee Foundation. The IASB defines its
mission as “to develop, in the public interest, a single set of high-quality, understandable
and international financial reporting standards (IFRS) for general-purpose financial
statements.”
Growing Acceptance of IFRS in the United States
In October 2002, the Financial Accounting Standards Board (FASB) of the United
States and the IASB announced a memorandum of understanding known as the
Norwalk Agreement. The memorandum was a step toward convergence of U.S.
generally accepted accounting principles (GAAP) with international standards.
Subsequently, the U.S. Securities and Exchange Commission (SEC) made several
decisions that led many to wonder whether IFRS might replace GAAP altogether. The
most notable of these decisions were:
•
November 15, 2007 – The SEC voted unanimously to eliminate the
requirement that foreign issuers of securities in the United States reconcile
their IFRS financial statements with GAAP, provided that they use IFRS as
adopted by the IASB, and not a local adaptation of IFRS.
•
August 27, 2008 – The SEC announced a plan to propose a roadmap for
adoption of IFRS by U.S. public companies. The roadmap would identify
conditions under which the SEC might permit or require public companies to
report using IFRS.
Relevance to Private Companies in the United States
Unlike most other jurisdictions, the United States does not require private companies to
provide general-purpose financial statements (or have those statements audited) as a
matter of course. Unless companies access the public capital markets, or operate in
certain regulated industries, they need not provide financial statements (other than tax
returns) to any government entity.
Thus, U.S. private companies do not and very likely will not face any regulatory
requirement that they prepare their financial statements in accordance with either GAAP
or IFRS.
That said, many private companies will sooner or later find themselves facing the
decision of whether to adopt IFRS. At present, although regulators do not require them
to prepare audited financial statements, other constituencies may. Thus, private
companies often prepare audited financial statements according to GAAP for bankers,
customers, suppliers, management and other constituencies.
The process of
convergence launched by the FASB and the IASB, and the roadmap defined by the
SEC, suggest that IFRS will not only influence but may even supplant GAAP for public
3
companies within the next decade. As IFRS becomes more widely accepted, and
possibly even required, as an accounting standard for publicly held companies, it should
behoove private companies to be aware of how they may or may not benefit from
adopting it.
IFRS offers clear advantages to many private companies in the United States. For
example, some U.S. private companies may have subsidiaries outside of the United
States that are already using IFRS to comply with the law in those jurisdictions. Such
companies could well find it simpler to adopt IFRS at the parent level than to reconcile
to U.S. GAAP. For these and other private companies, the transition to either full IFRS
or IFRS for Private Entities may – and we emphasize may -- mean simpler financial
statements and lower audit costs.
Yet IFRS may also impose new and onerous costs on some private companies. For
example, companies that use the last-in-first-out (LIFO) method may find that adopting
IFRS carries a steep tax penalty. Many of these companies have substantial LIFO
reserves. IFRS does not permit the use of LIFO (in contrast with GAAP). The U.S.
Internal Revenue Service requires companies to be consistent in their use of LIFO or
FIFO: that is, they must use the same method for tax reporting as they do for financial
reporting. Converting from LIFO to FIFO would mean a tax hit because the LIFO
reserves would become taxable. Some interviewees expect to see congressional or
regulatory relief to encourage companies to make the transition to IFRS. However, not
all interviewees expect relief. In fact, some suggest just the opposite – that the IFRS
transition could represent a stealth tax increase on businesses. There is some evidence
for the latter, pessimistic view: some Congressional members have proposed increasing
tax revenues by repealing LIFO.
The transition to IFRS will have unique consequences for government contractors
because of the regulatory environment in which they operate, notes William Keevan,
senior managing director of Kroll, Inc. He explains that virtually all government
contractors are subject to the "cost principles” in Part 31 of the Federal Acquisition
Regulation ("FAR") and most contractors are subject to the Cost Accounting Standards
("CAS") promulgated by the Cost Accounting Standards Board, which is part of the
Office of Federal Procurement Policy. The CAS set forth the rules contractors must
follow for measuring costs, assigning costs to accounting periods and allocating costs to
government contracts. The FAR cost principles determine whether a cost is or is not
reimbursable. Both the CAS and FAR cost principles incorporate GAAP to a certain
degree, while differing from GAAP in other respects. Adoption of IFRS may require that
costs and prices of contracts be adjusted. "Depending on how the regulators view these
accounting changes, contract costs and prices could be adjusted both upward and
downward, or only downward. Other complications are also likely to result," says
Keevan.
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Full IFRS vs. IFRS for Private Entities
Why IFRS for Private Entities?
There will soon be two separate sets of IFRSs. Full IFRS applies to public companies
and to private companies that are publicly accountable because they access the public
debt markets or hold assets as fiduciaries (such as banks, insurance companies,
securities broker/dealers, pension funds, mutual funds, investment banks, etc.).
However, in February 2007, the IASB published an exposure draft of a proposed IFRS
for Small and Medium-sized Entities. In May 2008, the board changed the title to IFRS
for Private Entities. Full IFRS fills approximately 2,700 pages. By contrast, the exposure
draft of IFRS for Private Entities was approximately 250 pages long.
The IASB explained:
Because full IFRSs were designed to meet the needs of equity investors in companies in public
capital markets, they cover a wide range of issues, contain a sizeable amount of implementation
guidance, and include disclosures appropriate for public companies. Users of the financial
statements of private entities do not have those needs, but rather are more focused on assessing
shorter-term cash flows, liquidity and solvency. Also, many private entities say that full IFRSs
impose a burden on them — a burden that has been growing as IFRSs have become more
detailed and more countries have begun to use them. Thus, in developing the proposed IFRS for
Private Entities, IASB’s twin goals were to meet user needs while balancing costs and benefits
from a preparer perspective.
(source: http://www.iasb.org/Current+Projects/IASB+Projects/Small+and+Mediumsized+Entities/Small+and+Medium-sized+Entities.htm)
The objective of the project is to develop a set of standards that meets the needs of
entities that are not publicly accountable but that do publish financial statements for
external users, including providers of capital, credit rating agencies, owners who are not
active in management, etc.
How Does IFRS for Private Entities Differ from Full IFRS?
Full IFRS applies to publicly accountable companies. The IASB claims to have made
five kinds of changes to full IFRS in order to develop a standard for private entities:
1. Topics deemed not relevant to private entities are eliminated.
2. Where full IFRS allow accounting policy options, IFRS for Private Entities
includes only the simpler option.
3. Many simplifications of the recognition and measurement principles that are in
full IFRS.
4. Many reductions in disclosures.
5. Simplified drafting.
The abbreviated, private-entity standard eliminates topics not relevant to most private
entities. Whereas full offers a choice of accounting treatment, IFRS for Private Entities
provides only the simple option. Recording and measurement is also simpler. For
5
example, there are only two categories of financial assets, instead of four, and private
entities are permitted to expense all research and development costs, instead of
capitalizing development after viability of the innovation. However, private entities may
choose to use the more complex accounting treatment by cross-referencing to full IFRS.
Yet critics say that the simplification apparent in IFRS for Private Entities is misleading.
Andy Thrower, former national chairman of the Standards Subcommittee of FEI’s
Committee on Private Companies, says, “Simplification is not there, and I don’t believe
that private companies will experience any meaningful difference between what’s in
IFRS for Private Entities and what they’re doing now.” Thrower says that IFRS for
Private Entities looks simple because it is a short, clearly written document – but still
requires private companies to do the same kind of extensive and expensive
measurement and disclosure required by U.S. GAAP.
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IFRS vs. GAAP: Implications for Private Companies
Principles vs. Rules
The acronym GAAP stands for "generally accepted accounting principles.” The word
“principles” is a bit misleading, because in practice, U.S. GAAP is a rulebook with more
than 20,000 pages of detailed prescriptions, industry-specific applications, variations,
exceptions, and provisions.
By contrast, even full IFRS is only about 2,700 pages long and, as mentioned above;
the simpler IFRS for Private Entities is only about one-tenth the length of full IFRS.
There is a cost to this simplicity: a greater range of variations in accounting practice.
Paul Pacter, director of standards for private entities, IASB, says, "Obviously, at 10
percent of the size of full IFRS, there are fewer issues covered in the private entities
standard, which will mean more diversity in practice than with full IFRS or U.S. GAAP."
A panel addressing a gathering of bankers at the Risk Management Association's
annual conference in October 2008 advised that two CPAs working with the same data
could produce quite different reports, both in accordance with IFRS. Consequently,
footnotes to financial statements will be indispensable to explain the preparer's logic
and provide context for users.
U.S. GAAP offers quite detailed and industry-specific rules for revenue recognition.
IFRS does not. The principle under IFRS is to recognize revenue when it is probable
that future economic benefits will flow to the entity and these benefits can be measured
reliably. Press reports suggest that, internationally, companies switching from their local
GAAP to IFRS have generally been able to report higher revenues. See, for example:
http://www.cfo.com/article.cfm/10919122/c_3395216
Even if IFRS is simple and clear now, some question how long it may remain so after its
adoption in the United States. More than one interviewee described IFRS as "GAAP 25
years ago,” and suggested litigiousness in the United States will lead inexorably to
detailed application guidance and blur the distinction between "principles" and "rules.”
Arthur Neis, president of Alliance Minerals North America LLC and a member of the
Standards Subcommittee of FEI's Committee on Private Companies, says, "We are
going back to the old days, when the auditors had to stand tall and individually take
responsibility and say, 'This fairly represents the entity'. They can no longer hide behind
page 892, paragraph 3."
The LIFO Tax under IFRS
LIFO (last-in-first-out) is a method of calculating the cost of goods sold that assumes the
last items to enter inventory are the first to be sold. The opposite of LIFO is FIFO (firstin-first-out), which assumes that the first items to enter inventory are the first sold. In
inflationary periods, LIFO accounting reports a higher cost of goods sold, and therefore
a lower net income. The opportunity to reduce tax liabilities by using LIFO was attractive
7
to many companies. The inflationary gains in the value of their inventory went not to the
bottom line, but to a special “LIFO reserve” account.
Over the years, those “LIFO reserves” have become quite substantial. In fact, in 2006,
the Senate Republican leadership proposed getting rid of LIFO in order to raise
revenues to pay for a $100 gas tax rebate for every American family. Associated
Equipment Distributors, a trade group, reported that, “Assuming a 35 percent tax rate,
LIFO repeal could mean an $870 million tax increase for AED members alone!” [Source:
http://www.aednet.org/government/aed-washington-insights.cfm?id=07/01/2006#ref2]
George Plesko, a professor at the University of Connecticut School of Business,
testified that according to the most recent data available at that time, the LIFO reserves
of U.S. publicly traded companies totaled $60 billion. He estimated that, assuming a 30percent tax rate, repealing LIFO could bring in $18 billion in tax revenues, before credits.
[Source: http://www.senate.gov/~finance/hearings/testimony/2005test/061306testgp.pdf].
Of course, financial statements of privately held companies are not publicly available,
and some critics disputed Plesko’s calculations for publicly held companies. A broad
coalition of trade associations and industry groups opposed the proposal to repeal LIFO,
and it did not move forward.
However, in 2007, U.S. House Ways and Means Committee Chairman Charles Rangel
of New York proposed a tax reform bill that included repeal of LIFO to raise an
estimated $107 billion over 10 years. A report by Credit Suisse indicated that basic
materials and energy companies would be particularly exposed. [Source:
http://emagazine.creditsuisse.com/index.cfm?fuseaction=OpenArticle&aoid=206991&lang=EN&coid=177883]
Under current U.S. tax law, private companies that use LIFO and have accumulated
substantial LIFO reserves would face a substantial tax penalty if they were to adopt
IFRS, which does not permit LIFO. George Beckwith, controller of National Gypsum,
says, “Many private companies are S-corporations and are very attuned to the tax
consequences of transactions. Giving up LIFO would be a big deal if it lands on the
owners’ personal tax return. They won’t be able to change their financial reporting
model if it’s going to cost them cash.”
There have been reports of meetings and discussions with IRS officials about this issue.
However, the requirement that companies be consistent in their use of LIFO or FIFO for
both financial and tax reporting is not a matter of regulatory interpretation, but of tax law.
Congressional action may be necessary to address it. Given the history of proposals to
repeal LIFO advanced by both Republican and Democratic legislators specifically in
order to raise tax revenues, it is far from certain that Congress would act to protect
companies from the tax impact of the IFRS transition.
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Other IFRS-GAAP Issues Important for Private Companies
Asked to note some of the differences between GAAP and IFRS, Paul Pacter, director
of standards for private entities at the International Accounting Standards Board,
indicated the following:
•
•
•
•
•
•
Investments in real estate: full IFRS allows fair-value reporting, i.e., revaluing
the investment at each reporting date. The change in value goes to the P&L.
Provisions, such as liabilities of uncertain amounts: in U.S. GAAP, when a
liability, such as a lawsuit, might have a range of possible outcomes,
accountants accrue the minimum and disclose the potential excess. Under
IFRS, accountants accrue the expected amount, which is a probabilityweighted estimate.
Borrowing costs: GAAP requires capitalization of borrowing costs relating to
construction of a long-lived asset, but under IFRS for Private Entities,
borrowers may either capitalize or expense these costs.
Research and development (R&D): GAAP expenses all R&D. Full IFRS
expenses research costs but capitalizes development costs, defined as those
costs incurred after the product is commercially viable. IFRS for Private
Entities follows the GAAP approach of simply expensing all R&D costs, but
allows the option of capitalizing development costs (with a cross-reference to
full IFRS).
Impairment: full IFRS requires calculating impairment based on the
discounted cash flows. U.S. GAAP, by contrast, does not require an
impairment calculation as long as the present value of future payments
equals or exceeds the carrying amount of the asset. Pacter offers the
example of a strip mall that is half empty. If gross expected rental payments
equal or exceed the carrying amount, there is no need to calculate
impairment under U.S. GAAP, but there is under IFRS.
Income taxes: IFRS requires accrual of deferred taxes on non-deductible
goodwill; U.S. GAAP may or may not. IFRS also requires accrual of deferred
tax on undistributed earnings of consolidated subsidiaries.
Companies may find their income statements more volatile under IFRS, says Karine
Benzacar, president of KnowledgePlus, a consulting firm based in Toronto. She
explains, “Reported income tends to be higher under IFRS but also tends to be a lot
more volatile. Under current Canadian or U.S. GAAP, when there is asset impairment,
the asset gets written down but not back up. Under IFRS, if circumstances change, the
asset will have to be written up.” She notes that IFRS also requires disclosure of
constructive obligations. “If a company has an expectation that it will make a payment, it
has to disclose that in its financials. For example, suppose a company promises publicly
to clean up an oil spill, even if it doesn’t have to by law. Since it has made a public
announcement, it’s expected to incur those expenses. Under IFRS, it’s required to show
that liability in the financials.”
Banks are the primary source of capital for privately held companies, and IFRS is
stricter than GAAP with respect to waivers of covenant issues. Mary Ann Lawrence,
9
senior vice president, credit risk review, at Key Bank, says that under U.S. GAAP, a
company technically in default on a covenant at the end of a reporting period can go
back to the bank and ask for a waiver. If the waiver is granted, the company need not
report the default as a current liability. However, under IFRS, if the company has not
already obtained a waiver before the end of the period, it must report the liability as
current. “The large companies have financial staffs that can project and track these
issues. But a lot of small, private companies will run into a real problem with this
because they don’t realize they’re in default until the accountants do the books. Now
they’ll be in default, not just technically, but really in default, and that’s a big distinction
in the banking world,” she says.
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The Banker’s Perspective
This section of the report presents reflections on IFRS by bankers who provide capital
to privately held companies.
Mary Ann Lawrence
Senior Vice President, Credit Risk Review
Key Bank
We’re a large enough bank that we do public companies, but we also do a lot of private
companies, and we get the entire gamut of small-enterprise statements. I think most
people don’t know and don’t realize the effect of accounting convergence. It means,
number one, everybody will have to be retrained and, number two, covenants are going
to have to be rewritten and models to rate credit redone. Anything that relies on
accounting data is going to have to be redone.
It is going to be a massive change and will cost lots of money. Banks will need training
for credit analysts and new software to get financial statements and ratios. They will
have to rethink what ratios are and what they really mean, so they can figure out how to
set covenant levels. It will be a brave new world for a whole bunch of people, not just
the banks but also the bank regulators. It will be a big cost to the economy, and given
the current conditions, I’m not sure we have the extra economic power to provide the
training necessary. It’s a hidden cost that people don’t think about.
There’s no place to get really good training. The schools are not teaching IFRS.
Academics will not start making changes in academic programs until there is clear
guidance from the SEC for large companies and some guidance on what will happen
with private companies.
Lenders are not actually so concerned about what the rules are, but we want consistent
application of those rules, so that when we’re looking at statements for two companies
we can make an informed decision. Frequent changes in GAAP have hurt the
consistency of accounting for private companies. I’m not saying accountants are not
doing the right thing, but there are many changes, and not a lot of lead time, so
accountants aren’t always up-to-date. If you’re a sole practitioner accountant doing
primarily small private companies, you depend on continuing education to keep you
abreast of the latest changes.
The foundation of a principles-based system is that the accountant is a professional and
understands the principles. I can see, in our litigious society, the legal system having a
field day. So I think it will morph into more rules. The reason many people think IFRS is
more principles- than rules-based is that IFRS hasn’t been around long enough. When
IFRS has been around as long as GAAP, you’ll see the same volumes of interpretations
and rules. It’s a cultural thing.
11
I think there is going to have to be some kind of governing body in this country to
oversee accounting for private companies. Who it should be is an interesting question.
One could make an argument that it should be some new group that is an
amalgamation of the FASB and the AICPA, a group that could speak both for the
profession and for users.
Dev Strischek
Senior Vice President and Senior Credit Policy Officer
SunTrust
We bankers are always a little bit reserved when it comes to changes in accounting,
and particularly a change as large as this one is going to be.
IFRS has been totally focused on global publicly traded companies. The puzzle is how
in the world you can focus only on a few thousand globally traded companies and put
off until tomorrow the vast majority of corporations. My first thought is there’s an equity
analyst focus on IFRS, which seems to ignore the vast majority of corporations in the
United States. The second interesting item is that most companies would report an
increase in income under IFRS. Given that most privately held companies generally try
to avoid paying additional taxes, they are not going to be very excited about that.
Third, consider IFRS a Trojan horse for fair-value accounting: now your income
statement is reflecting not just the cost and revenues associated with products or
services you have sold, but also changes in value from time period to time period. Is
that what we really want? Fourth, IFRS does not permit LIFO accounting, but many auto
dealers and manufacturers use LIFO, so suddenly they have to push out their LIFO
reserves into their income statements. It’s an incredibly embarrassing time to show
higher income when you probably don’t have the cash flow to pay the taxes. A fifth item
is that under IFRS, all leases would be treated as capital leases; there will be no offbalance-sheet operating leases. But for tax purposes they’re likely to continue to permit
operating leases, so you have another deferred item popping up on balance sheets.
In banking we’ll accommodate just about anything. Many of our borrowers provide us
with cash-based accounting that is not GAAP, or with tax statements.
The amount of effort necessary to get onto a fair-value basis is big. For example, if you
have an airplane, you can’t just have a value for the plane, but you have to break it
down into component parts. And how do you value nonfinancial assets anyway?
The SEC itself seems to have slowed down its embrace of IFRS because of the
financial crisis. If you were to look at the tenor of SEC pronouncements and guidance
three or four months ago, IFRS was the way we were going to go. Now, in the financial
crisis, fair value begins to look a little more challenging to implement. We in banking are
grateful for the rethinking.
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Mike Cain
Senior Executive Vice President
Frost Bank
It will really come down to cost-benefit. From my perspective, I get no real benefit. Most
of our customers are middle-market companies with total sales from $1 million to $100
million. We have a few that do business internationally, but very few have reporting
entities that are on IFRS. So in terms of making their accounting life easier, IFRS isn’t
really a factor. Most of these business users do not provide financial information to
international grantors of credit but instead use letters of credit. So the biggest downside
I see is that private companies are going to have to change their accounting with no
benefit. The private sector is left with the cost of changing systems, familiarizing the
internal staff with the new approach, working with preparers, and so on. Maybe there’s
an undefined long-term benefit, but most of our clients are looking at today’s cost and
revenue and aren’t too worried about two years from now.
The LIFO issue will have a huge impact on private companies. Large numbers of our
customers have a LIFO position, and I can think of several whose LIFO reserve is as
big as their net worth. It was done that way for tax reasons. Although their profits have
looked smaller, their cash flows have been better because of the tax subsidy they’ve
gotten for LIFO accounting. From a practical standpoint, that’s probably the biggest
direct cost.
We have a financial analytic software package that serves us well, but it would not
necessarily deal with a new basis of accounting. The system is not really going to map.
An updated version of that will cost half a million bucks, plus who knows how many
more dollars in training costs and reeducation. Those are the negatives.
Most of the private companies I deal with perceive that accounting, whether it’s U.S.
GAAP or IFRS, is really built for public companies and not for private companies. I’m
seeing a lot of statements these days that have opinions with qualifications or
exceptions from GAAP. Ten years ago that would have been the kiss of death, but now
it’s fairly commonplace.
IFRS for Private Entities may be a middle ground, possibly a bit too light for a lot of our
customers, but there are probably a lot for whom it would fit well.
For us, cash flow is obviously paramount. Verification of numbers is important. But for
most of the people we deal with, the more esoteric things like derivatives and fair-value
accounting are not issues.
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The Private Company Executive Perspective
This section of the report presents reflections on IFRS by executives of privately held
companies and preparers of financial statements. Each of these executives is a
member of the Standards Subcommittee of FEI’s Committee on Private Companies.
George Beckwith
Controller
National Gypsum
Private companies need to know that IFRS is not completely different. It’s not as if you
change how you record receivables and payables and basic expenses. The main
differences are things that private companies would find to be favorable. It’s much more
principles-based and focused on general-purpose financial statements, unlike GAAP,
which has evolved to be a special-purpose financial statement. For example, there
might be special-purpose financial statements made up just for a regulator. Utility
regulators require a utility to list and account for assets differently; bank regulators
require different disclosures from energy regulators. GAAP has moved [accounting] to
be almost exclusively for publicly traded companies. IFRS takes it back to being what
the general person wants to see. Many of the frustrations private companies have come
from the fact that everybody has to play by the public-company rules; other than filing a
10-k and following proxy rules, private companies have the same disclosure
requirements.
IFRS is much more principles-based. That’s certainly a benefit. GAAP requires a $20or $50-million dollar construction company to go through with its auditors all the
disclosures that would be required for some obscure thing that doesn’t really apply to it.
Getting away from that is going to be a big benefit to private companies.
I think it would make our financial information more understandable to our owners and
our creditors. We would have fewer carve-outs for debt covenants and so forth. Today
we back out a lot of FASB accounting that banks and owners say is not relevant to them
as users. We would have fewer of those. We’d have a better look into the financials of
the organization. From an internal perspective, the preparer would find it simpler. I think
our audit fees would go down.
We hope to adopt it, but we have roadblocks in our way. Like many others, we would
like to see LIFO addressed. LIFO doesn’t have any good accounting theory behind it;
it’s much more of a tax theory. It’s not as if it’s good financial reporting to use LIFO.
IFRS does not allow it. But many public and private companies are more attuned to the
tax consequences of transactions. They won’t want to change their financial reporting
model if it’s going to cost them cash.
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William D. (Bill) Koch
Vice President and CFO
Development Dimensions International Inc.
The train is moving to convergence: either jump on or get run over. I don’t know what’s
going to happen with U.S. standards, but they’re going to converge at some point in
time.
We’re a human resources consulting firm focusing on three things: 1) employee
selection, 2) leadership development, and 3) execution of corporate strategy. We’re
about 50/50 U.S. and non-U.S., with a lot of pass-through subsidiaries. Many, if not
most, jurisdictions use IFRS or a variant. We consolidate using U.S. GAAP at
headquarters, and it turns out that for us, it’s close to being the same. There are some
special cases where the rules are different. But when we did an analysis of IFRS for
Private Entities a year ago, we walked away saying we’d move to that someday. We’d
have to do some work, but the fact that the rules wouldn’t be changing every three
weeks was very appealing. CFOs don’t generate business value by spending time on
accounting pronouncements; not one of my customers has asked me about what our
position is on fair value, FIN 48 or FIN anything else.
Owners of private companies are generally significant percentage owners, not minority
shareholders. They’re involved, know what’s going on in the business, and are much
more interested in cash flow than valuation. Analysts of public companies are looking
for a piece of differential value that, when the world catches on, will drive up the price.
It’s a totally different motivation. We run a pretty simple business – you have to get your
cost to be nine when you sell for 10. If I were czar of all Russia, I’d issue cash-flow
statements. But we have to capitalize R&D software development and amortize it,
because from a valuation standpoint it’s supposed to be better. We don’t manage our
business that way. It’s one of the things we put up with because that’s what GAAP says
you must do, but we don’t need that kind of profitless bookkeeping.
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Arthur Neis
President, Alliance Minerals North America LLC
Member of the IASB Working Group for Small and Medium-sized Enterprise
Financial Reporting and of the FEI Standards Subcommittee
The logic is pretty clear and compelling. We have in IFRS a set of standards, not rules,
which can be applied rationally. The AICPA has said that IFRS is a recognized set of
standards on which auditors can opine. Bank agreements that specifically reference
GAAP are beginning to reference IFRS. IFRS seems to be very well field-tested and
easily implemented, and the lenders have gone along, recognizing that private
companies are different from public companies.
In preparing IFRS for Private Entities, we started with all of the accounting and reporting
principles for any given area and asked ourselves which of those accounting and
reporting principles applied only to public entities. We eliminated a large percentage of
the principles, and delineated the key accounting and reporting principles that apply to
private entities.
It seems to me that almost everyone in the world of business has a concept of the
fundamentals of accounting and financial reporting. The problem is that we have
deviated down the path of innumerable rules and nuances that were specific to
situations and weren’t relevant to operating management. But every business person
has been through at least a few courses at a business school and has had a basic
introduction to financial reporting. IFRS for Private Entities is contained in 250 pages,
and anybody can read that, understand it, take it away and hang on to it.
We’re going back to the old days, when the auditor had to stand tall and individually
take responsibility and say, ‘This fairly represents the entity.’ They can no longer hide
behind page 892, paragraph 3. That’s where we were 50 years ago when I got into
business. I got lectures on how my personal financial strength was dependent on my
integrity and my auditing. The same applies to all preparers/CFOs.
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Andy Thrower
Partner, Naviscent
If I’m a small company on the European continent, I’m required by law to have financial
statements audited and filed. Here in the United States, I’m not required to have that,
but in the event I go out to seek capital, debt or equity financing, the party that may be
willing to invest or lend may require me to have a set of audited financial statements. So
it’s a market-based determination here in the United States.
A database of the Risk Management Association lists 150,000 private companies.
About 30,000 to 40,000 issue audited statements. Another 30,000 to 40,000 issue
statements according to GAAP, and the rest either say they are tax-based, othercomprehensive based, or else don’t disclose. So there are many more private
companies issuing GAAP statements than public ones.
If the AICPA says it will now accept IFRS for Private Entities, but the banks don’t want it,
then there isn’t a demand. The preponderance of support for GAAP is market-driven,
and by market I basically mean custom and tradition. We could end up adopting IFRS
for Private Entities, or we could end up doing nothing.
It appears to be a simpler version and perhaps a less costly option for U.S. companies,
as it excludes some of those things that private-company users say are irrelevant. But
my opinion is that IFRS for Private Entities is basically designed for companies with 50
employees, and I think it is still too complicated for the small company that needs GAAP
statements only because it needs a bank loan.
IFRS for Private Entities gives the impression of being simpler because there are fewer
pages and it reads nicely. But some things are summarized by cross reference to full
IFRS. That makes IFRS for Private Entities a lot smaller, but it does not take away the
requirement. At some point, it may state a principle identical to full IFRS or GAAP, but
leave out the implementation guidance. That doesn’t mean you don’t have to implement
it or report it; the fact that IFRS for Private Entities doesn’t tell you how doesn’t mean
you don’t have to do it.
The debate over GAAP for private companies has been around for a while, but now that
we have convergence, it raises again whether it’s a convenient opportunity for private
companies to do something different. We have had a lot of standards in recent years
based less on accounting transactions and more on economic events. That adds a
degree of difficulty for private companies. With no transaction, they have to hire an
appraiser. Then the banker says I don’t need that information; if I need to know the
value of your fixed assets, I’ll hire an appraiser.
17
In 2005, the AICPA published the Private Company Financial Reporting Task Force
Report. The report identified 12 GAAP requirements that were “low either in relevance
or usefulness” for private companies. However, when the IASB issued its final exposure
draft of IFRS for Private Entities, it included all 12. **
We’ll continue to hear the same complaint: that the information satisfies the needs of
investors and potential investors, but not of users of financial statements of private
companies, who are primarily bank lenders. I don’t see any improvements. Moreover, in
this country there is an insatiable demand for implementation guidance, interpretation of
standards, etc. You won’t change the U.S. cultural and legal environment. When we
adopt IFRS, a void will be created, and somebody will step in and write rules and
implementation guidance because our culture will require that. Then private companies,
as long as they’re in the system, will be pulled along, and it will be business as usual.
Just because somebody puts out a principles-based standard on leases doesn’t mean
my auditors are going to be comfortable. Legal exposures remain the same, secondguessing remains the same, so the idea that we’ll magically drop all of these detail
demands…you tell me – how in the world could that possibly happen?
**Note: in an article now under consideration for publication by The CPA Journal, Andy
Thrower details the problematic standards and their treatment under IFRS for Private
Entities.
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Summary and Conclusion
IFRS for Private Entities will offer privately held companies an alternative to GAAP.
Principles-based rather than rules-based, this alternative promises to be simpler and
more straightforward than GAAP. The IASB has also committed to put changes on a
timetable, so the first release of IFRS for Private Entities will be unchanged for at least
two years. Companies frustrated with the complexity of GAAP and the frequent changes
from the FASB may find IFRS for Private Entities preferable. However, tax issues will be
a deterrent for companies that use LIFO to calculate the cost of goods sold.
Executives of private companies seem more receptive than bankers to the prospect of
IFRS for Private Entities. Bank credit analysts do not, for the most part, have training or
expertise in IFRS. Banks will need to upgrade software and human resources in order
to cope with the change. Although bankers are decidedly unenthusiastic about making
these investments, bankers who spoke on the subject for this report indicated that they
would accommodate borrowers who opt to make the switch.
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About the Author
Gregory J. Millman is a contributing editor to Financial Executive magazine and editor of IFRS Reporter
(http://www.ifrsreporter.com ). He has also written for Forbes, Barrons, the Wall Street Journal, The
Washington Post, and numerous other periodicals. He is the author of books of financial journalism
including The Floating Battlefield: Corporate Strategies in the Currency Wars; The Vandals’ Crown: How
Rebel Currency Traders Overthrew the World’s Central Banks, and The Day Traders: the Untold Story of
the Extreme Investors and How They Changed Wall Street Forever. His most recent book is
Homeschooling: A Family’s Journey.
Prior to making a career shift to journalism, he worked in banking, consulting, and project finance in China.
He earned an MBA at the Olin School and a Master of Arts (Asian Studies) from Washington University in
St. Louis. He may be reached at gregmillman@gmail.com or by phone at (732) 926-1225.
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