An IFRS Primer
International Financial Reporting Standards (IFRS) is essentially the set of standards created by the International Accounting Standards Board (IASB). IFRS is a principles-based set of standards rather than a rules-based one. The current IFRS standards are far less detailed – with little industry-specific guidance – than the current U.S. generally accepted accounting principles (GAAP). Since 2003, the IASB and the Financial Accounting Standards Board (FASB) have indicated that convergence of their separate standards to one global set of accounting standards is necessary. Convergence hopes to create a one-world approach to facilitate cross-border capital markets.
Recent statistics indicate that more than 120 countries worldwide permit or require the use of IFRS in its public company filings. More than 90 of these countries have fully conformed to IFRS as promulgated by the IASB by including an acknowledgement statement in their respective audit reports.
Currently, the U.S. direction rests with the Securities and Exchange Commission (SEC). The SEC has also expressed support for one set of global standards. In November 2008, the SEC released a roadmap for determining whether it would ultimately approve IFRS as an acceptable method of accounting for its listed companies. One key milestone in the plan is that the SEC would determine in 2011 (based upon progress reports) whether to proceed with the incorporation of IFRS or not. In November 2011, the SEC issued two staff papers: one geared toward comparing IFRS and GAAP, aside from the current convergence projects, and the other focusing on possible methods of incorporating IFRS into the U.S. system.
In December 2011, SEC Chief Accountant James Kroeker spoke at the annual American Institute of CPAs conference indicating that the SEC needed additional time to evaluate its findings. There was no firm date given from the SEC as to when it would make a decision, only that both boards need to ensure that future convergence projects are in the best interest of the registrants.
While major projects, such as revenue recognition, leases and financial instruments, have been or will be tackled by the FASB and the IASB with respect to differences, there are still several areas where GAAP and IFRS differ. First, under IFRS the conceptual framework is the highest level for authoritative guidance; as for GAAP, the conceptual framework is not included in the codification and therefore not deemed to be authoritative. Other areas that differ are the definitions of assets and liabilities – more specifically the use of the word “probable” in the U.S. definition. While the differences are small, they can give rise to different depictions of companies’ financial performances.
Key remaining differences for assets are:
- Inventory – IFRS allows the use of impairment reversals, while GAAP does not. Last-In First-Out is not an acceptable inventory method under IFRS, while it remains acceptable under GAAP. Inventory is valued at the lower of cost or market for GAAP and the lower of cost or net realizable value for IFRS.
- Intangible Assets – IFRS allows for impairment reversal in certain circumstances; GAAP does not.
- Goodwill – Measuring for impairments for IFRS uses a one-step method; GAAP still uses a two-step method.
- Property, Plant and Equipment – IFRS allows for impairment reversal of fixed assets; GAAP does not. IFRS also requires companies to view its fixed assets at a more componentized level; GAAP does not.
- Deferred Taxes – IFRS requires all deferred tax assets to be classified as noncurrent, whereas GAAP allows the split between current and noncurrent. Additionally, under IFRS there is no deferred tax asset set-up if there is a corresponding valuation allowance to offset it. The net deferred tax asset is what is ultimately recognized.
Key remaining differences for liabilities are:
- Definition – GAAP uses the term “probable,” whereas IFRS uses the term “more likely than not.” On the surface, they appear to be the same thing. However, people do have varying definitions of these when they are applied in everyday situations.
- Debt Covenants – If debt covenant violations are not cured before year-end under IFRS, the corresponding liability is classified as current; under GAAP the company has the ability to obtain a waiver subsequent to year-end, but before the financial statements are issued, in order for the violation to be cured.
- Taxes – The concept of “uncertain tax positions” is not a term that is readily defined under IFRS.
Other key differences:
- Research and Development Costs – Under IFRS, there is an opportunity to capitalize costs if certain bogeys are met.
- Correction of an Error – Under IFRS, the correction of an error is handled in the opening equity of the earliest period presented. Under GAAP, the company would present the prior period financials where the error first occurred.
- Going Concern – Under IFRS, the going concern concept is for a period defined as for the foreseeable future; GAAP is generally 12 months from the balance sheet date or 12 months from the date the financial statements are released.
- Interim Reporting – Generally, IFRS views each interim period as a discrete period; GAAP views them as a component of the annual report.
- Joint Ventures – GAAP uses the equity method for reporting activity under joint ventures; IFRS further breaks down these arrangements into joint ventures and joint operations. Joint ventures would be under the equity method, and joint operations would be under the proportionate consolidation method.
There are also several administrative items (authoritative board, board funding) that need to be reconciled prior to any IFRS convergence or endorsement in the U.S. The above is not an all-inclusive list of differences, just a sampling of what tasks are ahead as the FASB and IASB continue to refine their plan. This also shows what financial statement preparers and users need to be aware of. The thought of converging, endorsing or even condorsing is something we all need to think about now and not leave it for the last minute.