Robert Kugel's Analyst Perspectives

The evolution from United States Generally Accepted Accounting Standards (US-GAAP) to International Financial Reporting Standards (IFRS) has been under way for more than a decade. I’ve commented on IFRS adoption before. It’s a hot topic for accountants and auditors because it goes to the heart of how companies keep their books.

Until now, most public companies have been more in a wait-and-see mode than a get-ready mode with respect to IFRS. The main reason is some critical differences been the two systems that appeared very difficult to reconcile. However, big changes are coming in revenue recognition and accounting for leases that aim at harmonizing US-GAAP and IFRS independent of (and therefore ahead of) a U.S. decision to fully adopt IFRS, which may be a long way off. As a result of these breakthroughs, public corporations will have to incorporate fundamental changes to their accounting and statutory consolidation processes earlier than they had been expecting. A further consequence I believe is that they will need to address the implications of these changes on their IT systems sooner rather than later.

Initially formulated in 1989, IFRS is currently required by 85 countries for external financial reporting. As adoption broadened, it seemed logical that the United States, too, should embrace IFRS, since capital markets are now global. Yet fundamental issues have complicated the move. For one, over the past 20 years US-GAAP has become more rules-based as opposed to IFRS’s more principles-based approach. Each system is guided by similar principles, yet there are important differences in practices and the specificity of the rules. Then, in December 2010, the U.S. Securities and Exchange Commission (SEC), which mandates accounting standards for publicly traded companies, indicated that while in principle it favors a single international accounting standard, the Commission would take a “condorsement” approach, which I covered in an earlier blog. In practice this means that, although there is no fixed date as yet for the one replacing the other in the U.S., a series of changes – some major – to US-GAAP will be implemented over the next several years, such as those noted above in revenue recognition and accounting for leases. The upshot is that rather waiting for some formal adoption date, which realistically will remain four or five years out, companies now will have to confront these changes piecemeal over the next several years.

Changes in accounting for revenue recognition and leases can have far-reaching impacts. For example, corporations will have to make changes to how they keep records (such as increasing the details kept for any leased asset), alter their thinking about buy-vs.-lease trade-offs and how they structure and record contracts (to optimize the timing of revenue recognition). Their IT systems for transactions, analytics and reporting may need considerable changes or even replacement. Some of the changes in accounting will mainly affect how data is reported, some the general ledger and subsidiary accounting systems (such as sales orders), others the statutory consolidation system and some a combination of all three. For most companies I expect there will be no single obvious approach. Trade-offs will need to be made. For example, they may have to decide between spending money to adapt existing systems or replace them sooner than intended to get added features or functional capabilities. It’s hard to provide useful generalizations here because the best decisions will depend on the company’s existing systems and the nature and requirements of the industry in which it operates.

For years software vendors and consultants have been beating the drums about the challenges to U.S. companies and their finance organizations posed by IFRS adoption. For years, most CFOs and senior finance executives have taken a skeptical approach to the need for immediate action. I used to think this was the right approach, but now I advise them to start thinking seriously about the best ways to adapt IT systems to the changes that are on the way.

Regards,

Robert Kugel CFA – SVP of Research