NEW YORK - A little-known provision in international financial reporting standards (IFRS) could require mutual funds to consolidate and report the financials of the companies they invest in, if they own a controlling interest across all of their individual funds.
Under U.S. Generally Accepted Accounting Principles (GAAP), investment companies like mutual funds, private equity holders and venture capital organizations, are exempted from consolidation requirements and allowed to account for their holdings separately in each fund at fair value.
Regulators in the U.S. and abroad are working with the International Accounting Standards Board to sort out this IAS 27 issue and others in the next year as the U.S. moves toward adopting IFRS, the internationally accepted set of high-quality standards for financial accounting that 117 countries have already adopted or approved.
"The IASB is sympathetic to this issue, but historically they have not issued industry-specific standards," said Paul Munter, a partner and IFRS national professional practice leader at KPMG. "Folks in the industry see it as a big issue, and I expect it will receive more attention as we move closer to convergence."
Because of its broad, international reach, the IASB is intentionally trying to avoid issuing industry-specific guidance to IFRS, but as major issues like this arise, investment companies and other U.S. firms that haven't yet begun to make the switch to IFRS are being urged to wait for more guidance before they proceed.
The London-based IASB and the Norwalk, Conn.-based Financial Accounting Standards Board held a joint meeting late last month to discuss ways to reconcile their differences. Last month's meeting went so well, the two boards are planning to meet more regularly.
The chairmen of the two boards detailed some of their convergence efforts a few days later in New York at a joint conference of the American Institute of Certified Public Accountants and the International Accounting Standards Committee Foundation.
"Changes may be in store," said Sir David Tweedie, chairman of the IASB. "Both boards are committed to having a single standard. By the end of next year, hopefully we will have a common classification standard."
The exploding growth of globalization in recent years has bolstered the need for a common reporting language that everyone can comprehend, he said.
"Having standards that people understand increases investment, especially greater cross-border investment," Tweedie said, and it's expensive and time-consuming for multinational companies to report in a myriad of different standards.
If countries are going to adopt IFRS, they need to adopt all of it, he said. National endorsements of IFRS can create the urge to tinker and politicize the standards, leading to variations, time delays and additional costs, he said.
"If you have arbitrage between two different types of accounting, you're never quite sure what you're getting," he said. "If we have different wording on these standards, people will start to interpret them differently. If you keep asking for guidance and interpretations, you're going to get rules."
Many people have speculated that a move from the rules-based U.S. GAAP to the principles-based IFRS will open the floodgates to litigation in the U.S.
"We are a litigious society. We need the protection of rules," said Michael Young, a partner with Willkie Farr & Gallagher LLP, referring to the current rules-based standards of GAAP, compared to the principles-based approach of IFRS. "There is a risk of liability as we move to a principles-based system because you open yourself up to second guessing. There is an inclination for firms to interpret ambiguous accounting standards in order to make an extra penny. Then other firms will follow suit."
"This creates a systematic problem, in that rules lead to more rules," Young continued. "There are ways to get around rules. Rules feed on themselves, and in time, rules may become counterintuitive."
Principles-based reporting is intentionally broad to avoid the creation of rules, he said.
"When you have sharp edges, you can aim for the edges," Young said. "When you're working with a principle, the edges are fuzzy, so you need to aim for the center."
Having rules makes enforcement easier, but conforming to the rules does not necessarily get you off the hook, he said.
"There has been an insatiable demand for guidance details," said FASB Chairman Robert Herz. "Jurisdictions want to adopt IFRS, but they don't want to have to change twice."
The Securities and Exchange Commission has been extremely busy dealing with last year's global financial crisis, but commissioners and staff members have indicated that the SEC has resumed work on the roadmap it published last year.
"Turning back to the roadmap will be a priority," said SEC Chief Accountant James Kroeker. "Convergence efforts could and should continue without a roadmap from the SEC. I don't think an absence of decision [on the roadmap] should impede efforts. There will be follow-up on the roadmap this fall."
The SEC's roadmap tentatively sets IFRS adoption to take effect in 2014, but regulators have allowed the largest companies to early adopt IFRS by 2010. So much could change before 2014-including the adoption year itself-that most firms are taking a pass on the early adoption option.
"Many companies are very hesitant to adopt in 2010 if they're not sure what the SEC will do in 2011," said Margaret Smyth, vice president and controller of United Technologies Corp. "People are taking a wait-and-see approach."
Kroeker said the SEC is committed to transparency and investor protection, and added that any new standards must not portray an artificial level of stability, mask real market volatility, cover a lack of adequate risk management or favor one business over another.
"The FASB and the IASB do not agree on every issue, such as consolidation, lease accounting and fair value," Kroeker said.
"Fair value is in the eye of the beholder," said Paul Volcker, chairman of the President's Economic Recovery Advisory Board and former chairman of the Federal Reserve.
"Fair-value accounting standards need to be reevaluated," he said. "An accounting standard that's appropriate for trading might not be suitable for other areas."
The two boards are working together on enhancements to both sets of standards and plan to come out with fully converged standards by the end of 2010, Tweedie said.
(c) 2009 Money Management Executive and SourceMedia, Inc. All Rights Reserved.