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For many multinational corporations, January 1, 2005, marks the dawn of a new financial era. That’s when sweeping accounting regulations affecting Europe, Australia, and a handful of other nations will require use of International Financial Reporting Standards (IFRS). Pressure to revamp the system has been building for some time. For more than a decade, proposed changes to the process of financial reporting culminating in these new rules have been front and center for the London-based International Accounting Standards Board (IASB). In recent years, the fires of fundamental change were fanned by the accounting controversies of the past few years, many of them in the United States. While the move to the new accounting standards has been gradual, their adoption will inevitably change the way business is conducted worldwide. In fact, it’s nothing short of a revolution in global accounting. The impact in Europe alone will be significant. IFRS affects 7,000 business entities immediately. More than 300 of these companies also have shares listed in the U.S. As the formal inception date looms, what’s at stake for corporations, and what do directors and officers need to know about IFRS to assist them in making the easiest possible transition? IFRS won’t require a crash course from Harvard Business School to master its complexities. But some education is essential. Executives and board members should know whether their company, or any of its consolidated subsidiaries are subject to the new regulations. They should be sure that they grasp the substance and nuance of IFRS, so that they can understand fully, for example, the accounting ramifications of a joint venture or merger abroad or a possible takeover action by a foreign entity. In fact, most U.S. board members are likely to first encounter IFRS once their foreign subsidiaries come under the dictate of the new rules. One of the biggest advantages of IFRS is the unifying simplicity of a structure based on shared reporting concepts. In Europe alone, the 25 members of the European Union have traditionally had their own ideas about accounting standards. But IFRS will bring a consistent set of standards and should render the financial reporting process less difficult for all involved parties. Starting January 1, E.U. companies will lose the option of using national standards, including U.S. GAAP (generally accepted accounting principles), for listing purposes on European stock exchanges. However, E.U. member states may permit companies to defer adoption of IFRS until 2007 if their shares currently trade on a U.S. stock exchange and they use U.S. GAAP. E.U. member states also are deciding whether to require or permit the use of IFRS for statutory reporting purposes, such as the disclosures that corporations must make to government authorities. Not everyone is on board. Some nations will absorb IFRS later in the decade. Others intend, for now, to retain their current GAAP. But most countries will probably follow the European lead, adopting IFRS outright as their national standards. Some countries, most notably the United States and Japan, are planning to converge with IFRS over time. The changes to global accounting standards aren’t simply a case of streamlining regulations. There are substantive differences between IFRS and country GAAP — essentially, the accounting standards in the United States. Broadly, the differences fall into three categories: the foundation of each standard, the ability to make choices within the framework, and the level of specificity demanded. Perhaps the most fundamental difference between U.S. GAAP and IFRS is the underlying basis of the standards. Some accounting standards, including U.S. GAAP, are more “rule-based.” They rely on strict requirements. That’s not the case with IFRS, which is a more “concept-based” system. Rule-based standards are built upon very specific requirements, sometimes involving strict quantitative measures. These rules generally are easier to apply and enforce than concept-based standards. On the other hand, they’re more vulnerable to circumvention by those who might seek to manipulate accounting results. Much of the complexity attached to U.S. GAAP comes from the reliance on detailed regulations. Prescriptive rules can encourage companies to concentrate on “letter of the law” compliance. Often, that can result in financial statements that don’t capture the economic substance of a company’s activities. Concept-based standards follow overarching principles. To apply them, understanding the economics that underlie a transaction or event is essential. Concept-based standards are qualitative and adapt more readily to differing environments — a real plus in an era of increasingly multinational business activity. IFRS relies on a higher degree of professional judgment, which can make effective enforcement more of a challenge. But they are easier to comprehend, and the process overall lends itself to greater transparency. And transparency benefits everyone involved — executives, corporate boards, and audit committees alike. A second point that separates IFRS from U.S. GAAP is the ability of financial officers to make choices. U.S. GAAP generally allows for fewer options in setting accounting policies. (Both standards, though, require that once a company chooses an accounting policy, it must stick to it.) For example, under U.S. GAAP, accounting costs — primarily interest — generally are capitalized and treated as a balance sheet asset. Under IFRS, borrowing costs can be expensed or capitalized. Another example is accounting for investments in joint ventures. In the U.S., the lone option is the equity method — generally the simpler option, reducing reporting to a one-line item on the balance sheet. The international standard permits use of either the equity method or proportionate consolidation, which allows for a more itemized and detailed accounting of assets, liabilities, and expenses. Finally, the third point of contrast is the specificity of the two standards. Standards built on rules, like U.S. GAAP, will be more specific than those built on concepts. IFRS places an enormous amount of weight on managerial judgment. It’s critical that officers, directors, and their accountants agree that the spirit as well as the letter of the standard be satisfied. Consider the classification of a lease — whether it should be listed as an on- or off-balance sheet transaction. This is an issue of great importance to companies, especially in the wake of recent financial scandals involving off-balance sheet transactions. Under U.S. GAAP, certain quantitative rules determine the classification of a lease. If the length of the lease exceeds 75 percent of an asset’s useful life, for instance, it must be shown as an on-balance sheet transaction. Below 75 percent, the lease must be listed as an off-balance sheet transaction, assuming other tests are also met. IFRS calls for review of many of the same items used in determining lease classification — such as the length of the lease compared to the life of the leased asset — but without the quantitative rules. IFRS mandates that companies examine all of the terms of the lease and make a collective judgment as to classification. For officers and directors — especially audit committee members — IFRS requires a slightly different approach to understanding financial statements. Instead of the check-the-box mind-set encouraged by U.S. GAAP, IFRS demands that board members use more discretion and judgment in assessing the company’s accounting. Simply put, the audit committee must apply a kind of “reasonableness” test: Does the financial reporting make sense? Does it reflect the underlying economics of the transactions that the company has engaged in? How does the reporting compare to that of other companies that assemble financial reports under similar circumstances? In the absence of specific rules in the preparation of financial statements, it’s critical that all participants concur that accounting done under international standards conforms to the spirit of the law. The challenge for regulators, companies, and auditors is making sure that consistency exists within the conceptual parameters of the IFRS. While it will likely be some years before IFRS is adopted completely in the U.S., momentum is growing. The adoption of IFRS around the world is a fundamental shift that won’t be easily reversed. The payoff for these big changes will be more transparent, accurate financial reporting that is based on globally consistent standards. For boards and audit committees, that’s good news. D.J. Gannon is a partner with Deloitte & Touche LLP and leader of the firm’s IFRS Centre of Excellence for the Americas.

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