Verbal Clarity Could Ease IFRS Reporting

CFOs who report under IFRS could start breathing a little easier if the IASB follows through on creating better definitions.
Kathy HoffelderDecember 28, 2012

Distinguishing between debt and equity on a corporation’s balance sheet has been no easy task for CFOs and their staffs over the years. Financial instruments today can have features of both: a situation that can lead to misreporting and dire repercussions for senior management. But clearer definitions could make for easier accounting for U.S.-based multinationals that report under international financial reporting standards (IFRS).

The International Accounting Standards Board agreed last week with respondents from its public consultation (a study that reached out to industry professionals at all levels in more than 80 countries in 2011) that it needs to better clarify definitions of assets and liabilities for debt instruments. That, in turn, should help eliminate some uncertainty when accounting for assets and financial liabilities or nonfinancial liabilities (which can include land and equipment leases).

The respondents said “defining the nature of liabilities would advance IASB’s thinking on distinguishing between financial instruments that should be classified as equity and those instruments that should be classified as liabilities.”

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Many respondents said they consider clearer definitions of assets and liabilities to be a prerequisite for resolving a number of issues that participants have had in international financial reporting overall. Corporate executives and their accountants have routinely questioned the classification for such holdings as hybrid instruments or convertible bonds, for example, where the conversion option is classified as equity and the bond is classified as a liability, as well as what defines accounting treatment for hedging derivatives.

Salvatore Collemi, quality-control senior manager at accounting firm Rothstein Kass & Co., says a clear understanding of what is included in the IFRS for assets and liabilities would be a big help. “They do have to have better definitions for the CFO — or anybody else dealing with financial reporting — to make sure they understand what their boundaries are and what the rules are,” he says. By initiating the public consultation, Collemi says, the IASB is focusing on whether or not issuers of financial statements or corporate executives can apply the standards in practice.

More clarity over these and other definitions in the standard-setting process should help alleviate some problems CFOs at multinationals face when bumping up against two sets of accounting definitions in accordance with the IASB and the Financial Accounting Standards Board (FASB) in the United States if a U.S. corporation has a subsidiary abroad.

Aside from financial instruments, the lack of clarity in the definitions of other balance-sheet items has also kept CFOs and their staffs up at night. Accounting for revenue recognition, leases, and insurance contracts, in particular, has been hard because the IASB and FASB have not fully melded the IFRS with U.S. generally accepted accounting principles (GAAP) in those areas. The IASB study respondents also cited accounting for intangibles, such as intellectual property, as an area that is creating challenges during financial reporting.

Corporate accounting for trademarks or patents acquired in a merger become difficult during reporting time when the IFRS has one definition for intangibles and U.S. GAAP has another. Under U.S. GAAP, development costs for an intangible, for example, are expensed as “incurred,” while they are capitalized under the IFRS under such circumstances as when the technical and economic feasibility of a project can be shown.

Keith Peterka, a shareholder with Mayer Hoffman McCann, a national audit and attestation firm, says a big divide exists globally over the accounting definitions for intangibles. “If you look at the way we define intangibles here in the U.S., it’s well defined,” he says. “But in other parts of the world, you don’t have the intellectual-property protections.”

He blames some of that divide on cultural differences that make the convergence of definitions for intangibles hard, noting that because of that, the United States has sharper definitions for intellectual property than exist in other parts of the world.

Often a single word has been at the heart of differences between the IASB and FASB. A case in point is an IASB definition for investment entities, including firms that obtain funds from investors in exchange for professional-management services. The IASB staff has said that an entity should not be disqualified from investment-entity status only because it provides “substantive” investment-related services to third parties. FASB has a similar definition, but one that does not include the word substantive.

According to an Ernst & Young report issued last spring, the IASB word choice creates “uncertainty about what the IASB means,” since some firms meet the definition of an investment entity only when considering their third-party services, and under the current wording some firms may not qualify.

While more clarity in definitions should help in the financial-reporting process, respondents in the IASB study also recommended that the IASB make standard-setting and increased cost-benefit analysis priorities. Most respondents believe the IASB’s principles-based framework for setting standards is better than the rules-based standards typically applied under U.S. GAAP.

Rothstein Kass’s Collemi thinks the former will become the dominant system. “You are going to see U.S. GAAP is not the gold standard anymore,” he says. “IFRS is what is accepted in global capital markets.”