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Goodbye GAAP

It's time to start preparing for the arrival of international accounting standards.
Sarah Johnson, CFO Magazine
April 1, 2008

One of the densest thickets of generally accepted accounting principles is revenue recognition. By one tally, more than 160 pieces of authoritative literature relate to how and when companies record revenue. Now, however, U.S. and international accounting authorities are taking a scythe to the rules. They will mow down "broad swaths" of GAAP, says Robert Herz, chairman of the Financial Accounting Standards Board, en route to producing a single set of global accounting guidelines for revenue recognition.

This slash-and-burn approach is a sign of things to come. For the past five years, FASB and the International Accounting Standards Board (IASB) have been working to merge U.S. accounting rules with international financial reporting standards (IFRS). But this so-called convergence is shaping up to be more of a takeover than a merger of equals — many who favor a single global standard hope to wipe out GAAP altogether.

Experts at the Big Four accounting firms say a Securities and Exchange Commission mandate for all U.S. publicly traded companies to use IFRS is inevitable. The SEC does plan to release a road map in late spring for transitioning U.S. public companies to the international standards, but it has not yet said whether adopting IFRS will be mandatory. Still, many SEC watchers expect the agency to eventually scrap GAAP.

"If I'm reading the tea leaves right, it's not a question of if but when," says Jeffrey Keefer, CFO of chemical giant DuPont. Large U.S. companies could start using IFRS instead of GAAP in three years, say accounting firms and finance chiefs, while a mandatory conversion could take effect in five years. Auditors urge CFOs to keep a weather eye on the IFRS movement. "It's going to be bigger than anybody expects," says Gary Illiano, a partner at Grant Thornton. Adds Deloitte & Touche partner Joel Osnoss: "From the smallest public companies to the largest, everyone should at least be thinking about what the potential of this will be."

Large Benefits
Audit firms and multinationals have been pressuring the SEC to keep the global-standards movement on the fast track ever since the end of 2007, when the agency began allowing foreign companies to submit their IFRS-prepared filings without reconciling them to GAAP. That effectively blessed IFRS as high-quality, notes Margaret Smyth, vice president and controller of United Technologies Corp., some of whose international subsidiaries use the global standards. "If it's good enough for the SEC, I would think it's good enough for most people," she says.

And good enough especially for large multinationals, whose CFOs are tired of using more than one accounting system for regulatory purposes here and abroad. "It's really not cost efficient to maintain two sets of books on different standards," says Richard Fearon, CFO of Cleveland-based Eaton Corp., which has manufacturing sites in 30 countries.

To eliminate the extra work of adhering to U.S. GAAP as well as to other countries' accounting rules, Fearon would consider using consolidated global accounting rules. But he has reservations. For one, the current form of IFRS is too principles-based for his taste; he would prefer more specificity in the rules, à la GAAP. Also, he believes the global standards have spawned too many variants among the more than 100 countries that use IFRS-based standards (see Insight, "One Standard, Many Laws").

Still, Fearon's 2008 agenda includes an investigation into the differences between GAAP and IFRS, particularly how the changes in revenue recognition, taxation, and hedge accounting would affect his balance sheet and income statement. Fearon isn't alone: finance departments at other multinationals, such as PepsiCo and Procter & Gamble, are conducting similar internal studies.

Another possible benefit from IFRS is better-looking financial statements. More often than not, a company's earnings are higher under the international standards, according to a recent study of 129 IFRS-GAAP reconciliation reports of foreign companies (see "Showing a Better Side" at the end of this article). Daimler AG, for one, reported higher revenues, net income, and earnings per share (by 68 cents) when it reported its financial results under IFRS for the first time in April 2007. Without the reconciliation reports, "no one will know why foreign company XYZ typically has a better return on equity than [U.S.] company ABC under GAAP," says Jack Ciesielski, publisher of The Analyst's Accounting Observer.

Costly Conversion
For smaller U.S. businesses, especially those with no foreign subsidiaries or competitors, the benefits of convergence aren't so clear. "The question, obviously, for the companies that don't have international operations right now is, How do you justify it?" says Christine DiFabio, vice president of technical activities for Financial Executives International (FEI). "It's going to be expensive."

How expensive? The large accounting firms won't estimate how much it would cost companies to convert from GAAP to IFRS, but they acknowledge it won't be cheap. "It's too difficult to put down any kind of range," says Illiano. Kenneth Nielsen Goldmann, partner and managing director of capital-markets services for auditor JH Cohn, says it would be "extremely costly." Procter & Gamble hasn't pinned down an exact number, but expects a conversion project would cost tens of millions of dollars, according to comptroller of corporate accounting Mick Homan.


U.S. companies can get a better idea of the cost from their European counterparts. The Institute of Chartered Accountants in England and Wales estimates that European companies with revenue between 500 million euros and 5 billion euros spent 0.05 percent of their revenue in their first year of switching from their local GAAP to IFRS.

As for timing, auditors estimate that installing a new, IFRS-based accounting system will take U.S. companies 18 to 24 months to complete. During that period companies will have to evaluate their entire financial infrastructure — from which departments will be affected to who will need training on a new accounting language to relationships with outside groups that are used to GAAP, including bondholders, banks, and credit-rating agencies.

For the Greater Good?
Despite the cost and effort required, IFRS supporters maintain that CFOs should warm to convergence for the greater good of financial reporting.

"It would be a disservice for companies to sit back and not do anything," says DiFabio of FEI. A single set of worldwide accounting standards, the thinking goes, would result in more-comparable financial statements across industries and borders, and maintain U.S. companies' status as competitive global players. "A global set of standards will improve consistency among regulators, capital markets, and the investment community," DuPont's Keefer says.

Keefer's enthusiasm isn't widely shared among finance executives, according to surveys by auditing firms. The majority of finance executives trained in U.S. GAAP are reluctant to let it go, the firms report. According to a fall Deloitte & Touche poll of 300 companies (ranging in annual-revenue size from under $100 million to more than $10 billion), only about 20 percent of CFOs would consider adopting IFRS if given the choice.

"I don't see a lot of U.S. filers adopting it unless they have substantial foreign operations dominating their overall business that are already using IFRS," says Tim Mammen, CFO of IPG Photonics, a Massachusetts-based manufacturer of high-power fiber lasers and amplifiers with facilities in Germany, Russia, and Italy. He is skeptical of the idea that GAAP could one day disappear from the U.S. accounting landscape.

Others are taking a more active role in the convergence process, in hopes of influencing regulators. For example, Smyth of United Technologies told the SEC that inventory accounting that eliminates LIFO (last in, first out) accounting could be a deal breaker in whether her company would adopt IFRS. International standards bar the use of LIFO accounting, which confers sizable tax benefits to users like United Technologies. "We obviously are not going to switch to IFRS if it means cutting a big check to the IRS," says Smyth. Sooner or later, though, United Technologies will have to switch.

The European Experience
Advocates for early adoption of IFRS say companies could make the switch in three years, a projection based largely on the experience of European companies. For their 2005 consolidated financials, all 7,000 of the European Union's listed corporations switched from their home-country GAAP to IFRS. They had nearly four years to plan for the change. To ease investors into the new system, companies tucked a narrative in their 2003 filings on how IFRS would affect their future financials, followed by another report quantifying their forecast of the changes under IFRS. Last, they did away with their local GAAP when putting together their 2005 statements.

In 2003, Daimler launched a four-year project for converting to IFRS that included crafting internal guidelines for applying IFRS, assessing how the new rules would affect its performance measures, and making changes to its technology systems. (Companies like Daimler that were listed on a U.S. stock exchange were given two additional years to switch accounting rules.) The auto giant trained more than 3,000 employees for the conversion, including those in accounting, controlling, treasury, investor relations, and tax.

The EU's smaller companies, with less exposure to IFRS, took longer to respond to the mandate. Many didn't get serious until the year before filings were due. "People don't want to address [changes] until they become imminent," Illiano says. "No amount of browbeating on the part of accountants was able to overcome that [reluctance], so there was a bit of a fire drill toward the [deadline for] implementation."

Still, there's something to be said for taking a wait-and-see approach and letting the standard-setters continue to work on convergence, which has at least another five years to go. (Difficult projects lie ahead for FASB and the IASB, including revenue recognition, accounting for pensions and leases, and financial-statement presentation.) "The more similar the standards are, the fewer differences there are and the less work it will be for U.S. companies when it comes time to convert," says Danita Ostling, a partner and Americas IFRS leader at Ernst & Young.

Nor should U.S. companies contemplating a changeover act in haste if the SEC gives the go-ahead. They risk wasting time if they provide detailed training for their finance teams too early and the knowledge then atrophies before it can be put into practice. SEC staffers learned that the hard way when they underwent extensive IFRS training twice before embarking on a review of foreign companies' IFRS filings, according to Carol Stacey, former chief accountant of the SEC's Division of Corporation Finance. The anticipated flood of such filings materialized much later than expected, when EU companies began meeting IFRS requirements.


One advantage U.S. accountants could have over Europe's experience is GAAP itself. It is apparently much easier to transition from a more prescriptive set of standards to one that allows more judgment. "The differences tend to be idiosyncrasies, which makes it easier to switch from GAAP to IFRS than the other way around," says John Ramsay, CFO of Syngenta, a Switzerland-based agribusiness that uses IFRS and was filing GAAP reconciliation reports until this year.

It Never Stood a Chance
Accounting experts wax nostalgic about the days when the concept of converged accounting standards was first introduced. Initially, the expectation was that rulemakers would take the best aspects of GAAP and IFRS to create the highest-quality standards possible — no matter how long it took. "We seem to have lost patience somewhere along the line," says Charles Niemeier, a member of the Public Company Accounting Oversight Board.

The truth is that U.S. GAAP never stood a chance of prevailing as the global standard, according to Herz. "We do have the best reporting system, but the rest of the world will not accept it," he says. "It's too detailed for them."

If the rulemakers have given up on GAAP, then timing is the major issue facing the SEC. Institutional investors and analysts have criticized the commission for what they consider its premature allowance of IFRS for foreign companies, before those standards are fully converged with GAAP. They're wary of letting U.S. companies adopt IFRS within three to five years, as has been projected. In response, SEC chairman Christopher Cox has said that GAAP will stick around for many years.

IFRS is much less voluminous than GAAP, lacking the incrustations that GAAP has acquired through years of interpretation. Accounting experts will simultaneously praise the international rules for their brevity and deride them for giving companies too much leeway. That discrepancy could undercut the comparability that regulators tout as a benefit of IFRS. Under the footnote-lite international rules, "you don't really know what the differences [between companies] are," says H. David Sherman, an accounting professor at Northeastern University and a former SEC academic fellow.

Indeed, opinions are split over whether convergence has progressed to the point that both standards are interchangeable today. Says Grant Thornton's Illiano, "If you think that the accounting standards in the U.S. and the accounting standards in IFRS are going to match up word for word, they're never going to get there."

Sarah Johnson is a senior writer at CFO.


Not If, But When

2001: The International Accounting Standards Board (IASB) is established to work on international financial reporting standards (IFRS).

2002: U.S. and international standard-setters issue the Norwalk Agreement to make their current rules compatible.

2002: The European Union (EU) announces its member states must use IFRS for their 2005 financial statements.

2005: SEC chief accountant Donald Nicolaisen releases a road map for allowing IFRS filings without GAAP reconciliation for foreign firms by 2009 (or earlier).

2006: The IASB and FASB agree to work on all major projects jointly.

2007: In April, President Bush announces IFRS will be recognized in the United States within two years as part of an agreement with the EU. In November, the SEC makes that prediction a reality.

2008: The SEC will vote on a proposal mapping out a timeline for moving U.S. companies to IFRS.

2009: The IASB will end its moratorium for when companies need to adopt its new accounting standards. The board had frozen its rules while more countries adopted IFRS.

2011: The earliest that accounting firms and U.S. multinationals estimate large U.S. companies could begin to use IFRS rather than GAAP. Canadian, Indian, and Japanese companies are slated to begin using the global standards.

2013: The earliest projection by accounting firms for mandating that U.S. companies convert their financials to IFRS, with 2015 being the first year smaller companies could follow suit.


Switching Systems

Accounting experts say companies should start thinking now about whether to use international financial reporting standards (IFRS) instead of U.S. GAAP, so they could act quickly if given the option. Their advice:


Some companies whose 2006 earnings declined when their IFRS statements were reconciled with GAAP


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