Global Business

Small-Biz IFRS: Sarbox Deja Vu

For the smallest of public corporations, is it a savvy business move to take a wait-and-see attitude — or just a case of procrastination?
Marie LeoneAugust 29, 2008

If experience guides their actions, smaller U.S. companies probably won’t do much to prepare for a transition to international financial reporting standards. They’ve been through this drill before — in 2002 when the Securities and Exchange Commission issued the Sarbanes-Oxley Act rules — and this time, the SEC proposal is not yet a foregone conclusion.

On Wednesday, the SEC announced that sometime soon it would be issuing a proposed “roadmap” to move American companies off of U.S. accounting rules and onto IFRS, the standards currently being used by more than 100 countries. The proposal includes a phased approach to the transition, starting with the largest corporations being given the choice to test out IFRS beginning with 2010 financial statements, and ending with adoption of IFRS by the smallest public companies by 2016.

But the move to IFRS is contingent on the progress companies make reaching several milestones laid out by the SEC in its timetable, and the regulator has decided to wait until 2011 before it decides whether to implement the timetable and mandate IFRS for U.S. companies. As a result, smaller companies may just sit tight and wait.

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“I think the deadline is probably further out than most people expected,” said Jay Hanson, national director of accounting, McGladrey & Pullen, noting that participants at the last SEC roundtable on the subject, held in June, batted around 2013 as an adoption deadline. “I’m not sure the SEC moved the ball along very far” with this most recent announcement, added Hanson. “My fear, with the date out so far, is that [IFRS] will be out of sight, out of mind,” especially as the timeline relates to smaller companies.

“I think there is going to be a tendency among smaller companies to postpone the inevitable and not spend resources now,” said J.H. Cohn partner Kenneth Nielsen Goldmann. Those corporations “will be drawing on their experience with Section 404″ of Sarbox,” adds the audit partner.

He points out that small companies — those with a market capitalization of less than $75 million — were granted compliance extensions with regard to Section 404(a), the internal controls rule, and they still don’t have to comply with Section 404(b), the rule that requires larger companies to provide an auditor attestation report. There are about 5,000 smaller public companies that fit into the Section 404(b) exemption category, according to the SEC.

Goldmann, whose clients are mainly small and mid-size companies with revenues in the $10 million to $1 billion range, reckons that companies will take a risk-based approach to IFRS, which is how they dealt with 404 “in the end.” His feeling is that CFOs will first identify the greatest differences between IFRS and U.S. generally accepted accounting principles with respect to their companies, and then plan how to approach the transition.

But procrastination may pay off for smaller companies, mainly because both U.S. GAAP and IFRS literature will be “evolving” over the next few years as the two standard-setting groups — the Financial Accounting Standards Board and the International Accounting Standards Board — work to iron out differences in the rules. In fact, the SEC’s chief accountant Conrad Hewitt noted at Wednesday’s meeting that FASB and IASB are getting ready to release a revised agenda of major projects and priorities for the next few years.

What’s more, inaction may also result from the perception that the roadmap may not survive a new SEC chairman, opined Hanson. Indeed, following November’s presidential election, a new commander-in-chief will likely appoint a new commission chairman.

If larger companies take the IFRS plunge, smaller counterparts will be watching intently for trouble spots that may apply to them. One problem area will be inventory accounting, specifically the tax implications associated with the last-in-first-out method. LIFO is used in the U.S. to defer taxes, but not allowed under IFRS, and that could hurt some smaller companies that are motivated to save every dollar they can, posits Goldmann. He expects to see several letters to the SEC on the LIFO issue during the 60-day comment period that is slated to start after the roadmap proposal appears in the Federal Register.

Snags related to the differences between reporting income for accounting purposes and reporting income to the Internal Revenue Service will also emerge in the transition to IFRS. “There is a whole set of U.S. standards and rules that govern how to account for those differences,” remarked Hanson. For example, the U.S. rules for dealing with uncertain tax positions (FAS 109 and FIN 48) are well established, while companion IFRS rules are still evolving and so far not headed in the same direction.

The fundamental difference is that under U.S. GAAP a company uses a threshold measure of “more than 50 percent likely” that a tax position will pass muster with the IRS to record the tax benefit. In that way, the company is not evaluating every tax position on its books, just the more tenuous assumptions. In contrast, the IFRS rule seems to be evolving in a different direction, forcing companies to test most, if not all, tax positions before claiming a deduction. That includes mundane deductions like office expenses, for example.

Another trouble spot will be renegotiating debt agreements, says Hanson, as companies will have to find out if their lenders will accept IFRS, or whether they will have to submit financial statements in both IFRS and U.S. GAAP.

Training in-house staff to apply IFRS properly will also pose problems for smaller companies that are constrained by small staffs and limited money to spend on training. “The best trainers are very busy and demand a high premium,” asserts Hanson. Meanwhile, under Sarbox, auditors are not allowed to recommend accounting strategies and tactics to clients — they can only assess them — so companies will have to hire accounting consulting firms to help them make the transition.

In general, Goldmann says he was happy with the SEC’s proposed timeline, since he expects that it would take smaller companies at least five years to prepare for the transition. That’s important, since he thinks there is little doubt the SEC will mandate IFRS in 2011, noting that most of his firm’s clients engage in some kind of international business, whether that’s selling into the global market or using foreign manufacturers for goods sold in the United States. That’s a big change from 15 years ago, when few smaller companies focused on worldwide markets. In the end, Goldmann predicts that “IFRS is here to stay.”

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