As regulators work to converge U.S. Generally Accepted Accounting Principles (GAAP) with International Financial Reporting Standards (IFRS), several key differences remain, most notably the different measurement attributes of financial liabilities, the timing and approaches to projects and the difference between fair value and amortized costs.
Under GAAP, investment companies like mutual funds, private equity holders and venture capital organizations are exempted from certain consolidation requirements and are allowed to account for separate fund holdings at fair value.
No such exemptions currently exist under IFRS, though fair value concerns are being featured prominently in convergence discussions, and the U.S. has been adapting its rules on fair value to increase its international appeal.
The London-based, International Accounting Standards Board (IASB) and the Norwalk, Conn.-based Financial Accounting Standards Board (FASB) are in the process of addressing many of these issues and have issued joint statements reaffirming their commitment to achieving convergence of U.S. GAAP and IFRS.
These international collaboration efforts to craft a single set of global accounting standards are moving along at a speedy pace, and with a little luck, the global economy will be well on its way to recovery when the time comes to implement these changes in a few years.
"The recent developments in the global economy demonstrate the need to improve accounting standards in order to assure transparency to investors," said SEC Commissioner Elisse Walter. "I applaud the ambitious timeline that accounting standard setters have laid out to revise the standards in question. I believe that we should move forward with further incorporating IFRS into the U.S. capital markets if, and only if, it is the right thing to do for U.S. investors."
The IASB is intentionally trying to avoid issuing industry-specific guidance to IFRS in order to maintain its broad, international reach, but as major issues like this arise, investment companies and other U.S. firms that haven't yet made the switch to IFRS are being urged to wait for more guidance before they proceed.
Fair Value is Key
"Fair value is recognized as a key concept," said Ken Owens, a partner at PricewaterhouseCoopers. While most people say GAAP is based on rules and IFRS is based on principles, the reality is that there is a wide spectrum of rules and principles in both plans, he said.
IFRS does not have a strong standard for governing fair value measurements, but fair value is so important to the U.S. that many experts predict the IASB will adopt something similar to GAAP's Financial Accounting Standard No. 157, also known as FAS 157, to handle financial statements and disclosures. FAS 157 is currently undergoing major changes to bring it more in line with IFRS.
In fact, the name has already changed to Accounting Standards Codification Topic 820, Fair Value Measurements and Disclosures, or "Topic 820" for short.
"Most of you will embrace Topic 820, as it will expedite filing," said Michael Patanella, a partner at Grant Thornton LLP.
Patanella said the new hierarchy of fair value begins with Level 1 assets, commonly quoted at market prices, followed by Level 2, which considers other observable inputs such as broker quotes and private investments in public equity. Level 3 is where it gets tricky, he said, and it's no wonder this level has received the most attention.
Level 3 assets come from hard-to-value places like private equity, distressed debt and complex derivatives, Patanella said.
"Before FAS 157, there were many different definitions of fair value," said Marni Pankin, a partner at the New York accounting firm Marcum LLP. "There was very little guidance and a lot of inconsistencies. FAS 157 didn't change the way we fair-valued investments, but it increased disclosure. The real purpose [of Topic 820] should be to define fair value and establish a framework for values so we have consistency."
Pankin said there are several proposed updates to subtopic 820-10 that involve sensitivity analysis and transfers in and out of Levels 1 and 2.
"Everybody was OK with the Level 1 market, but what happens when a market becomes inactive?" she asked. "As GAAP converges with IFRS, this may come back."
FASB officials say the changes will improve comparability of financial reporting internationally, as IFRS requires similar disclosures about transfers between levels. The changes to Topic 820 apply to interim and annual reporting periods ending after Dec. 15, 2009.
The IASB is currently working on IFRS 9, which is based on how an entity manages its financial instruments and the contractual cash flow characteristics of the financial assets, the IASB said on its website.
"IFRS 9 uses a single approach to determine whether a financial asset is measured at amortized cost or fair value, replacing the many different rules in IAS 39," the IASB said. "The new standard also requires a single impairment method to be used, replacing the many different impairment methods in IAS 39. Thus, IFRS 9 improves comparability and makes financial statements easier to understand for investors and other users."
Rush to Finish
While a lot of extra convergence goals were added on after the financial crisis, planners are already seeing progress moving along, said Mary Tokar, global head of KPMG's International Financial Reporting Group.
"There's a lot at risk if they don't deliver before the change in the board," Tokar said, noting that the IASB is scheduled to replace a number of board seats soon. If they can't make significant progress before this turnover, "the delay won't be months but years," she said.
Tokar called the IASB's agenda "aggressive," and said they have been receiving a lot of pressure from regulators to get the U.S. on board by 2013.
While support for global convergence is still strong, she said this support could waver if it takes too long and countries that have already adopted IFRS are required to make continual changes.
"I'm concerned about how much change the system can take," Tokar said. "Can the IASB sustain this pace? I'm worried about change fatigue. I wouldn't be surprised if one or two things slipped, but the IASB is so determined, most of the slippage is already out."
The next joint meeting between the FASB and IASB will be Tuesday, Jan. 5, and will cover insurance contracts and lease projects.
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