Spring 09 - International Accounting Standards Are Coming

For the last several years, the Securities and Exchange Commission (SEC) has promoted the convergence of the Generally Accepted Accounting Principles used in the United States (U.S. GAAP) into the International Financial Reporting Standards (IFRS), which are already used in more than 100 countries worldwide.

Last August, the SEC proposed a timetable by which all U.S. public companies will be required to adopt IFRS between 2014 and 2016 depending on each registrant’s market capitalization. While there has been some talk that the new SEC commissioner might consider a delay in that process, most pundits seem to agree that IFRS convergence is coming and is only a matter of time. 

Private, “non-publicly accountable” companies will likely face a similar transition sooner or later, since lenders and investors prize consistency of reporting across the globe as a primary reason for converging to a single set of accounting standards in the first place.  In fact, a separate set of standards for these companies is expected to be issued in June of this year and those standards are expected to be significantly less onerous than current IFRS.

Fundamental ChangeThis process will constitute a fundamental change because IFRS, though similar to U.S. GAAP in some ways, diverges in important aspects. Some of the most critical differences are as follows:

  • Principles Over Rules — U.S. accounting standards are based on sharply defined rules — many more than are applied in the standards used in other countries. The method of accounting for a transaction is typically unambiguous and straightforward, once the appropriate rule is applied. 

    IFRS, by contrast, provides fewer detailed rules to account for transactions. Instead, it is based on accounting concepts and therefore relies more on the judgment of accountants and auditors to reflect a transaction’s substance and relationship to economic realities, and to treat it consistently with other transactions.

  • LIFO “Dying on the Vine?” — The last in, first out (LIFO) inventory method permitted under U.S. GAAP can deliver significant tax savings to manufacturers and distributors in times of inflation. But LIFO isn’t recognized under IFRS.  But, this may not necessarily sound a death-knell for LIFO and the tax benefits it creates.  Stay tuned for further developments.

  • Revaluation to Fair Value — Under current U.S. GAAP, companies may not revalue their long-term fixed and intangible assets to fair value on a regular basis. However, IFRS permits a company to elect either a cost model or a revaluation model and apply it to an entire class of assets. Under a revaluation model, assets are revalued to fair value on a regular basis.

  • Impairment Losses — When an asset’s carrying value exceeds its fair value, U.S. GAAP recognizes an impairment loss. (Fair value is calculated as the sum of future undiscounted cash flows to be derived from the asset.) Under IFRS, a company recognizes an impairment loss if an asset’s carrying value exceeds the higher of: 1) its fair value minus the costs of selling it, or 2) its value in use (based on the discounted present value of future cash flows).

    While U.S. GAAP prohibits reversal of an impairment loss, IFRS permits reversal, except for goodwill losses, up to the new recoverable amount, but may not exceed the original carrying amount.

  • Classification of Leases — While U.S. GAAP provides bright-line tests for determining whether a lease is an operating or capital lease, current IFRS takes into account the “essence of the transaction.” This is determined by such factors as whether the lease term is a “major part” of the asset’s economic life, and whether the present value of the minimum lease payments represent “substantially all” of the asset’s fair value.
     
  • Classification of Debt Subject to Loan Covenant Violations — U.S. GAAP allows such debt to be presented as a non-current liability if the lender provides a debt covenant waiver prior to the issuance of financial statements. IFRS allows the debt to be presented as a non-current liability only if the lender provides a debt covenant waiver prior to the balance sheet date. Otherwise, it must be presented as a current liability.

Relevance TodayIFRS will require a host of new choices, procedures and technology. While the SEC’s goal of implementation taking place between 2014 and 2016 seems a long way off, U.S. manufacturers and distributors should begin to get a big-picture understanding of IFRS and its implications today. In particular, companies that do business abroad will find themselves encountering the “convergence” movement long before an actual shift to IFRS in the U.S.  Further, there has been a significant convergence effort underway between the U.S. and International rule makers for several years, and there is an expectation that, whether the SEC were to proceed with adoption of IFRS or not, GAAP and IFRS may have few, if any, differences by the time such adoption is required anyway.  That means a lot of changes coming in the next several years in any event.

Our firm is keeping a very close eye on developments in this important area, and can help you understand the IFRS transition, its pace and its meaning and impact on your company. Please contact us for assistance.

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Manufacturing / Distribution Advisor is produced quarterly by Bober Markey Fedorovich’s Manufacturing / Distribution Services Team.  If you would like additional information about the services that we provide to manufacturers and wholesale distributors, please contact James E. Merklin, CPA, CFF, CFE, M.Acc. or Cindy S. Johnson, CPA, CIT at 330.762.9785. 

 

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