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October 6, 2009

Wake up America, IFRS is coming

The global impact of US isolation on accounting standards demands stakeholder education, according to William Kowals, a partner at Nexia International firm JH Cohn. As every capital market embraces IFRS, US business leaders must get to grips with the implications or risk being left behind in the global marketplace.

Every major capital market is moving towards IFRS. Driven by the globalisation of the capital markets and the need for enhanced comparability of financial statements, IFRS is clearly here to stay.

The Securities and Exchange Commission (SEC) has issued its proposed road map for the adoption of IFRS by US registrants but they have yet to fully commit to IFRS.

US-domiciled businesses do not function in a vacuum and the co-existence of different accounting platforms has far-reaching implications for thousands of businesses globally. It affects everything from business practices to valuations, IT and systems, internal controls, key performance indicators, reward structures, disclosures, and investor relations – with major resource implications.

The divergence of IFRS and US accounting standards and its impact on business practices demand the attention not only of CFOs and finance teams in US-based entities with an international presence, but for a whole range of other stakeholders around the world. Customers, vendors, employees and sources of finance for these companies require greater insight into how these differences can impact business practices.

Divergence

IFRS as issued by the International Accounting Standards Board (IASB) has the momentum of worldwide adoption. Although the SEC has issued its proposed road map, many reporting entities have chosen to ignore, at least for the present time, the differences between IFRS and US GAAP.

These differences include, but are not limited to, revenue recognition, fair value accounting, accounting for leases and share-based compensation, all of which can significantly impact business practices.

According to the US Council Foundation, there are over 2,200 US multinational parent companies with a majority interest in a foreign entity. These companies have approximately 24,000 foreign affiliates, which have to report in their home country GAAP or IFRS, with implications at the parent level.

Further, there are approximately 11,000 US entities with a minority stake in one or more non-US entities. Additionally, there are the more than 9,000 entities around the world which own close to 12,000 US entities. Again, all of these entities have to report under GAAP and/or IFRS in their home country, and this can have a significant impact at the US entity level.

Furthermore, there are over 800 foreign companies listed on US exchanges and over 200 US entities listed on foreign exchanges.

IFRS is also highly relevant to US domiciled businesses seeking capital or targeting foreign acquisitions, or those that are targets for acquisition by foreign domiciled businesses.

Who is affected?

CFOs and finance teams, together with their advisers, will shoulder the largest burden in determining how IFRS might impact accounting and reporting systems, debt covenants, budgeting, acquisitions and contingent consideration (earn-outs), leases and tax planning. The basis of accounting that will be employed will be critical when negotiating agreements that give consideration to future financial results (for example, debt covenants, contingent rentals, contingent consideration in an acquisition and employee incentive compensation). Management needs to be aware that existing agreements may require renegotiation, which may also require the attention of legal advisers.

But the ramifications go far beyond finance departments and the need for training and new systems to capture the necessary financial accounting and information for reporting under IFRS.

Owners and boards of directors should be aware that the basis of accounting used in financial statements could have an impact on business valuations. Significant differences in reported revenues, net income, net assets, and net worth can arise, potentially impacting a valuation.

Audit committees need to be aware that an orderly transition to IFRS will require modifications to accounting policies, IT systems, business processes and internal controls. They should be discussing the implementation plans for adopting IFRS, if and when required, with their CEOs and CFOs. They should also be aware of any local statutory IFRS financial reporting requirements and related costs.

CEOs and strategic management teams may need to rethink key performance indicators, such as those which may affect loan covenants or employee compensation, if a different basis of accounting is contemplated for use. Further, these stakeholders may need to consider certain commercially sensitive disclosures that may be required by IFRS.

Companies may also need to consider that standard revenue arrangements created to allow for revenue recognition under US GAAP could significantly impact the way an entity goes to market. They may also need to rethink compensation arrangements, both cash incentive compensation and share-based compensation arrangements.

Nexia International member firms have extensive experience in the implementation and conversion to IFRS and ongoing financial reporting under IFRS in those jurisdictions where IFRS is now a well-established legal requirement for certain entities (as in the EU) or where accounting practice is substantially the same as IFRS (for example, Hong Kong, New Zealand, Australia and Singapore).

William Kowals

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