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SEC Stepping Back from the GAAP? Acceptance of IFRS Accounting Could Pose Challenges


Globalization may be coming in baby steps. In the effort to move to a single, universal financial reporting standard, the Securities and Exchange Commission voted unanimously last month to open for public comment a proposal to allow U.S. companies-including investment companies-to use International Financial Reporting Standards (IFRS) for their SEC filings, rather than U.S. Generally Accepted Accounting Principles (GAAP).

The Commission also voted at its July 25 meeting to eliminate the requirement that foreign issuers that already prepare financial statements according to IFRS provide a second version to the SEC, which reconciles those existing statements with U.S. GAAP. It effectively creates a two-system regime.

"As issuers and investors increasingly look beyond our borders for opportunities to invest and raise capital, it is critical that the financial information they use to make their decisions be accurate and timely," said SEC Chairman Christopher Cox.

"Among the different obstacles that must be overcome in making financial decisions are the different ways in which financial information can be reported," he said.

IFRS is already accepted in 100 countries, and was mandated for members of the European Union in 2005.

Commissioner Roel Campos noted the increase in the number of filings that the SEC has received that adhere to IFRS. There were 100 IFRS filings in 2006, compared to "just a few" in 2005, he said.

Cox stressed that eliminating the requirement that IFRS filers also produce GAAP-compliant documents will reduce the cost for those issuers. Increased costs could make listing in the U.S. less attractive, he said, and drive issuers to other markets.

For fund companies, the acceptance of IFRS, and migration away from U.S. GAAP standards, poses questions on two fronts. First, for funds that have foreign holdings, portfolio managers will be faced with the prospect of valuing holdings that report in two different ways, which could present valuation and selection challenges. Furthermore, managers must have a mechanism for accounting for these differences in their own accounting software and systems.

Secondly, fund companies must consider what a universal shift to IFRS would mean for their own reporting and whether it would present a competitive advantage when wooing overseas investors.

Right now, IFRS is unlikely to make a difference to non-U.S. investors, even if it has been adopted as the preferred reporting standard in their home countries, said Brian Gallagher, an investment management partner with Deloitte & Touche.

"Foreign investors are accustomed to using financial statements prepared under U.S. GAAP," Gallagher said. Conversely, offshore products that use the international accounting standards typically offer U.S. investors supplementary disclosures that they have come to expect under U.S. GAAP, he said.

Whether U.S. issuers will become accustomed to IFRS soon is a different story.

"Universities in the United States have not started teaching it," said SEC Chief Accountant Conrad Hewitt. "There is not even a textbook that has been written as such yet," he said. Before IFRS-or a later incarnation of it-becomes the global standard, it would have to be incorporated into certified public accounting exams, among other professional certifications, he said.

Commissioner Annette Nazareth suggested that the Commission consider waiting before allowing U.S. companies to trade GAAP for IFRS accounting until regulators have more experience with the filings of foreign issuers already using it.

When it comes to foreign issuers already using IFRS, fund portfolio managers face another problem: reconciling two different standards used by companies in one fund.

The number of companies this applied to could increase if the SEC allows domestic companies to use IFRS. The companies most likely to do so would be large corporations with entities or operations overseas, Hewitt said.

SEC Director of Investment Management John White said that such a shift is unlikely to happen quickly, since those companies would need a chief financial officer, accounting staff and a comptroller who really understood the system.

"I don't think you would have a system that says, This is how it computes in U.S. GAAP' and you hit a button," said Gallagher.

Existing fund accounting systems will have to be modified to either note the differences within foreign companies' financials, or provide a way to account for differences between standards through the footnotes, and ensure that what information is provided is comparable across all holdings.

"It will take some effort, but I don't think it means throwing out the old system," said Gallagher.

As for funds themselves switching to IFRS, Gallagher said that even if it is allowed, it is unlikely. Under IFRS, companies that have a controlling interest in another company are required to incorporate the financials of the company they control into their own reporting. For mutual funds and private equity funds, this is especially problematic. If a fund, for example, held a controlling interest in an automobile company, the fund would be required to incorporate the automobile company's capital costs and sales into their own filings. "It's almost nonsensical," said Gallagher.

What makes more sense, he said, is to continue using GAAP and wait until the two systems finally morph into one, blended and truly global standard.

"People are encouraging that migration," said Gallagher.

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