Focus on Private Companies: Understanding the Latest IFRS Developments

Followed by over 100 countries, International Financial Reporting Standards (IFRS) are recognized as the worldwide equivalent to U.S. generally accepted accounting principles (GAAP). Nearly all major capital markets have either adopted the IFRS framework or are migrating towards that model within the next few years.

Since 2007, the Securities and Exchange Commission (SEC) has allowed certain foreign issuers to register their financial statements using IFRS without reconciling to U.S. GAAP. The SEC has also outlined a plan that could lead to a requirement for U.S. issuers to comply with IFRS as early as 2014. While the daunting challenge of adopting IFRS is clearly ahead for public companies, private organizations are at a crossroads.

One unique aspect of IRFS principles that may factor into this decision is a “simplified” version of the standards for private companies. IFRS policy makers recognize that private companies have fewer resources to dedicate to financial reporting and struggle justifying the cost of complying with complex accounting standards.

In addition, end-users of private company financial statements have different needs than those of a publicly traded enterprise. Private companies’ reports tend to focus more on short-term decision making and emphasize cash flows, liquidity and solvency more than the long-term perspective of their public company peers.

In response to these conditions, IFRS standard setters issued IFRS for Small and Medium-Sized Businesses (SMEs). These standards eliminate some the complexities in presentation and disclosure and simplify accounting for matters such as revenue recognition, goodwill, investments and income taxes. The result is a set of concept-based rules totaling approximately 250 pages compared to the thousands of pages companies face in complying with GAAP. For U.S. companies considering the transition to IFRS, these simplified rules are a viable option.

What impact does adoption of IFRS have on my business?

A move to IFRS will undoubtedly affect a company’s financial reporting systems. In addition to restructuring the chart of accounts and reporting models, finance executives will have to become familiar with the consolidation and measurement concepts contained in IFRS. These shifts will impact how financial executives gather data, prepare budgets and forecasts, and report results. The measurement changes can also potentially affect compensation plans and management objectives.

Existing contractors will also be heavily affected. Vendors would have to be informed of the change so that credit decisions could be made appropriately. In addition, lending arrangements often stipulate a basis for external reporting and determining compliance with covenants. The legal documents supporting these agreements would require amendments to permit a transition to IFRS.

The differences between GAAP and IFRS may also have an impact on corporate culture. While GAAP tends to include bright line tests centered on detailed rules, IFRS principles attempt to reflect the essence of transactions and tend to be more judgmental. Organizations will have to gain an understanding of how these judgments are made and how the principles are applied to specific situations. Management teams accustomed to having hard and fast rules on which they can “hang their hat” will have to undergo a fundamental change in their mindset.

Is IFRS right for my company?

Like any change that requires an investment of time and money, company executives should weigh the benefits of adopting IFRS with the potential costs (both monetary and opportunity costs). Some points to consider:

Benefits

• Simplified standards – IFRS for SME may lower the cost of compliance due to reduced complexity, particularly if a company is engaged in international business.
• Consistent reporting with foreign parent – Entities owned by foreign companies may eliminate GAAP to IFRS conversions, thereby easing consolidations of US based subsidiaries into parent organizations operating off shore.
• Greater access to global markets – Companies seeking capital may broaden their search to the wider international markets by presenting information in a format recognized by the international investing community.

Costs

• External – Conversion will likely require the purchase of new accounting software and systems in addition to hiring experts familiar with IFRS requirements. Legal and professional fees would also be incurred to address the impacts on existing contracts and agreements discussed above.
• Internal – Hiring new talent and training existing personnel will require time, effort and money.
• Tax implications – Currently, IFRS rules to not recognize last-in-first-out (LIFO) methods of valuing inventory. Conversions from LIFO to acceptable IFRS methods present one of the biggest hurdles because the accounting change frequently results in negative tax consequences. Congress is currently considering the repeal of LIFO methods for tax reporting however, further legislative action would be necessary to eliminate this barrier.

Depending on the size, complexity and expertise of a company’s staff and outside professionals, preliminary estimates indicate that a full IFRS conversion could run as much as one percent of revenues. Due to the significance of these costs, the decision to switch to the international reporting model should be considered carefully.

Moving Forward

While the path toward a conversion decision begins to take shape, private companies should monitor developments and begin their assessments now in order to avoid a hasty, reactive determination. In developing their analysis, the costs and benefits described above should be quantified to the extent possible and considered along with any intangible advantages or burdens.

Once the direction seems clear, firms should create a timetable of key milestones to serve as a roadmap to guide the process. Working back from the expected issuance date of the initial IFRS statements, the timetable should include programs to build awareness of the change and communicate with the parties expected to be impacted by conversion.

Conclusion

Adoption of the IFRS model requires a thoughtful analysis focused on providing stakeholders with the most relevant and reliable information possible. Developing an approach that considers the impacted parties and net benefits to an organization will clearly point the right direction and allow private companies to effectively meet their financial reporting needs.