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If you're like me, you read financial statements and wonder if you've been had. Call me a cynic, but I'm always wondering how the numbers have been moved around to hide the bad news.
That is supposed to change—but not without potential chaos. Corporate America is just now starting to prepare itself for a new dawn in financial reporting. Today I moderated a panel at Town Hall Los Angeles on the potential transition by US companies from US GAAP to International Financial Reporting Standards (IFRS).
It is possible companies will start reporting under IFRS beginning in 2014, meaning they have to be transitioning by 2012. Seems like a long time away. It's not. Brent Woodford of Disney [DIS
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] calls it "a nightmare."
Rosalind Tyson of the SEC says the commission will be releasing "at any moment" its proposed roadmap for the transition, opening it up to public comment, before making a final decision on whether to go toward IFRS by 2011. Why switch at all?
Well, in a global economy, more than a hundred countries already use IFRS, and that number is growing. No country is moving to US GAAP. IFRS is supposed to be simpler, easier, more transparent, and provide a more accurate picture of a company's health. Total IFRS instructions take up 2,500 pages, versus 25,000 for GAAP.
Multinational companies will save money only having to use one system. And, hey, under IFRS, profit numbers are often higher, so that initial year-over-year comparison during the transition will look great!
But there are concerns. IFRS is based on "standards", while GAAP is based on "rules." This means IFRS requires more judgment on the part of accountants, and that could lead to inconsistent interpretations, and more lawsuits. A Moody's study of the 30 largest European companies it rates claims that "finding the true level of debt can be like searching for a black cat in a dark room."
Then there will be the cost of transitioning to a new system, and one of the thorniest issues may be renegotiating contracts and covenants originally agreed to based on GAAP reporting. Brent Woodford says he wouldn't be surprised if the transition to IFRS eventually costs his company "double digit millions of dollars."
What happens when a US company disagrees with an IFRS standard? Some European countries have reportedly ignored certain IFRS standards and not been called to account. More importantly, what happens if the SEC disagrees with an IFRS standard? Hmmm. A financial version of the Kyoto Protocol?
But a move toward IFRS seems inevitable, and it may not be a bad thing. Beyond the convenience of everyone in the world reporting in the same format, IFRS is supposed to give investors a better picture of a company's true finances. While GAAP seems easier for accountants, because you just have to follow the rules and plug in numbers mechanically, sometimes those rules and numbers can be manipulated. The hope of IFRS is that by adhering to principles, not rules, a more truthful picture will emerge.
For example, Ian Eddleston of Ernst & Young says look at the way companies account for a depreciating asset. Company A buys a building for $10 million, which it expects to own for 30 years. It will depreciate that asset over 30 years under GAAP. But under IFRS, different parts of a building depreciate at a different rate. The roof depreciates faster than the walls, for example. Company A would have to segment those areas and depreciate them individually. A lot more work, but a more honest assessment of the asset.
Bill Sullivan, of the legal firm Paul Hastings, says it may be easier to defend companies against shareholders or the SEC under IFRS. This, despite the conventional wisdom that it might be easier to defend under GAAP, where accountants can just say they were following rules. "It will all come down to disclosure," Sullivan says. Financial statements will be filled with explanations of how a firm came to its conclusions, and, perhaps, it will be easier to convince juries that you were acting in "good faith" in trying to follow a standard, versus a hard and fast rule.
All this means more work for accountants and corporate lawyers. The SEC's Rosalind Tyson joked, "Maybe this is the way out of the financial crisis!"
A lot is still up in the air. Brent Woodford is on the fence over whether going to IFRS is a good thing. At the moment he says his company, like others in this downturn, is more focused on getting people "to buy our products" than worrying about a new accounting system. And while there may be much angst over the work ahead, and a reluctance to commit too much money having been burned jumping in early on Sarbanes-Oxley, Rosalind Tyson of the SEC says the concerns may be overblown. "Everyone remember Y2K?" she asked. What a non-event that turned out to be.
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