An Introduction to International Financial Reporting Standards
International Financial Reporting Standards (IFRS) are the collection of reporting standards developed by the International Accounting Standards Board (IASB). The IASB
is committed to developing “a single set of high quality, understandable and enforceable accounting standards to help participants in the world’s capital markets and other users make economic decisions.”
IFRS reporting is now required or permitted in nearly 100 countries, including the European Union and most of Asia Pacific. India, Japan, and Brazil plan to adopt or converge with IFRS over the next three years.
In the US, the Financial Accounting Standards Board (FASB) is working with the IASB to align US Generally Accepted Accounting Principles (GAAP) with IFRS reporting standards. The goal for both organizations is a single set of global standards for financial reporting of public companies listed anywhere in the world. The US Securities and Exchange Commission (SEC) has eliminated IFRS/US GAAP reconciliation requirements for foreign-owned filers, and published a preliminary timeline for US companies to adopt IFRS.
The SEC proposes that 2014 be the first year for USregistered companies to file their financial statements in an IFRS format. On this timetable, the current requirement for companies subject to SEC regulations in the US is to prepare opening balances plus the two most recent years of comparative statements, meaning that 2012 is the first year for which IFRS-formatted statements would need to be produced.
For companies that only operate in the US and have neither overseas subsidiaries nor a need to raise capital or debt in overseas markets, a more gradual approach to IFRS transition is under consideration. However, with multiple large economies and trading partners at various stages in the IFRS adoption process, domestic companies should begin to assess their business requirements over the next five years relative to IFRS deadlines. US firms should develop a timeline for internal adoption of IFRS accounting standards and the presentation of IFRS statements.
IFRS reporting encapsulates a principles-based framework, as opposed to the rules-based standards of US GAAP. Many US-based companies are comfortable with the financial certainty of a rules-based accounting system. Companies familiar with US GAAP should not be distracted by the debates about which system is inherently more or less complex or utilitarian. The fact remains that accounting standards conversion and dual reporting programs in the US are well underway. GAAP-based financial discipline must continue, as sound financial judgment and experience will be called upon to translate financial treatments in GAAP to their equivalents under IFRS.
Enterprise resource planning (ERP) technology will be a key enabler in the transition to IFRS, and for the financial consolidation and reporting process in particular. Companies should focus on the technology areas supporting IFRS transition: financial consolidation and reporting systems, the general ledger (GL), subledgers, and financial data entry systems. There are nearly 200 differences between IFRS and US GAAP accounting systems. However, most companies will find they will need to focus on somewhere between 10 and 40 differences in their own reporting requirements. These differences can be easily and cost-effectively compared, tested, and reconciled in a comprehensive ERP system. Epicor, a company dedicated to providing integrated enterprise software, offers one such ERP system. I will refer to the Epicor ERP system as an example for some of the points discussed in this document.
Early planning and adherence to best practices will provide a distinct advantage to all firms in the process of IFRS transition. Conversion benefits range from streamlined financial close, reconciliation, and reporting, to improved financial compliance in multiple markets. IFRS promotes the alignment of business objectives and financial reporting processes across a global enterprise. We’ll turn now to the business and systems processes involved in a smooth transition to IFRS.
Effectively Managing the Transition to IFRS
Although few in number, much has been made of the differences between the requirements of US GAAP-level reporting and IFRS, primarily focusing on the fact that the use of last-in-first-out (LIFO) inventory costing is precluded under International Accounting Standard 2
(IAS 2). Companies that use the LIFO costing methodology under US GAAP may experience different operating results as well as altered cash flows under the IFRS regime.
In addition, IFRS reporting standards require inventory to be carried at the lower of cost and net realizable value (NRV), while under US GAAP, inventory is carried at the lower of cost and market-based valuation. Under IFRS, a larger number of financial instruments will qualify as derivatives. For instance, instruments such as option and forward agreements to buy unlisted equity investments are accounted for as derivatives under IFRS, but not under US GAAP.
The well-managed European experience with IFRS transition is encouraging. In their 2005 consolidated financials, all 7,000 of the European Union’s listed corporations switched from their home-country GAAP to IFRS-based reporting. Each company had about four years to plan for this change. In order to inform their investors of the upcoming conversion, most of these companies added a discussion to their 2003 filings on how IFRS would affect their future statements, followed by a report quantifying their forecast of the impact of the expected changes. European companies ended their local GAAP reports in their 2005 financial statements.
IFRS reporting already affects a large number of US multinational companies through statutory or other reporting requirements in their foreign subsidiaries. Apart from the SEC’s role in guiding the formal domestic transition process, it is only a matter of time before IFRS reporting has a major impact on the remaining US companies. Financial consolidation and reporting for IFRS is an important and entirely manageable task for public companies.
IFRS transition should not be viewed as “another” huge business process reengineering program (as many business consultants have suggested), and it should not drain time and money from already tight budgets. Instead, with efficient planning, companies should focus on embedding IFRS requirements into their GL and subledger systems while gaining the benefits of simplified charts of account and improved reporting structures, and remove the headache of manual adjustments to financial consolidation and reporting. This approach will reduce the scope of updates to primary systems so that the focus is on consolidation rules and IFRS reporting formats.
Many US organizations will choose a phased standardsembedding process to convert their systems from US GAAP to IFRS. One of the keys to a smooth conversion is coordinating the transition to IFRS with the technology roadmap, planned systems deployments, and scheduled upgrades (e.g., IFRS components should be included when performing upgrades to the financial systems). IT coordination will help limit the time, budget, and human resources necessary for this transition.
Companies across Europe, Asia, and Australia have learned that, as with any project, effective planning and management allows enough time and resources for a smooth transition process, with critical tasks not being rushed, and progress not being hindered due to unforeseen gaps. This lowers the risk of errors and redundancies as well as the need to outsource more work than necessary.
Given the amount of time necessary to train staff on IFRS and adapt to changes in financial reporting practices, the time has come for US-based companies to start planning for IFRS transition. Early action (including the creation of an internal project team to assess the financial processes and systems required) allows companies to benefit from cost reduction during each phase, and to better control the scope of the implementation.