Big Shift in Accounting Rules Nears

U.S. execs welcome the clarity of the SEC's new timetable for switching from GAAP to international standards. But adopting new ways won't be easy or inexpensive

Searching for what he called a "lingua franca" of financial statements, Securities & Exchange Commission Chairman Christopher Cox announced on Aug. 27 a road map by which U.S. companies may report their numbers using international accounting rules beginning in 2009. The convergence of the U.S. rules, known by the acronym GAAP, for "Generally Accepted Accounting Principles," and international ones has been inching along for more than a decade. But the specific timetable laid out by the SEC's new proposal, which will be open for comment until a final vote in 60 days, gives the process added certainty.

That came as a relief to many companies and audit firms that are looking for a clear direction. "What I've heard consistently from my clients is, 'We just need to know,'" says Todd Markus, vice-president for accounting, finance, and enterprise governance at the New York financial consulting firm Accretive Solutions.

Under the SEC's proposal, the very largest U.S. companies, approximately 110 in all, could be eligible to file their 2009 statements using the international standard. Smaller companies could phase in after that. The SEC would keep track of the experience of those early adopters as well as continue to study the companies in Europe and elsewhere that already use the global rules. By 2011 the commission would make a final determination as to whether all companies would have to switch. All U.S. companies could be using the standard in 2014.

FASB Seeks Harmony

The Financial Accounting Standards Board (FASB), which writes GAAP, has already been trying to harmonize its major rules with the global standards. But there are still many areas where there is no common ground, says Danita Ostling, a partner at accounting giant Ernst & Young. And that's what the SEC's move would fix. "There remain a number of differences in the details, and the devil is in the details," says Ostling. "Having two different standard-setting bodies working over time isn't a sustainable model."

Clearly for investors, having all companies report on the same basis is a good thing. Years ago most countries had their own reporting systems. Their dramatic differences were made clear in the early 1990s when Daimler-Benz (DAI) adopted GAAP, famously erasing all the domestically reported profits of the automaker, leaving it with a loss.

Much has changed since then. As Cox noted, more than 100 countries, including all of Europe, use the common international standard. In all, companies based in those countries represent 35% of global market capitalization, compared with 28% for the U.S. market.

Consumer Advocates Miffed

Not everyone is happy with the proposal. Barbara Roper, director of investor protection for the Consumer Federation of America, argues that the move may not result in uniform reporting at all. In a statement issued after the SEC meeting, Roper argued that the SEC's move "promises a long detour through accounting chaos on its way to eventual uniformity." The international standard's lack of clarity and uniform application, she said, particularly in the areas of revenue recognition, business combinations, and accounting for illiquid investments, could well mean "that promised uniformity may be more mirage than reality."

For major U.S. companies with global operations, the benefits of switching are obvious. They already keep multiple sets of books and will be able to simplify without having to learn a whole new standard.

Domestically focused companies will incur big costs in adopting new rules, with uncertain benefits. However, E&Y's Ostling argues that even U.S.-centric corporations will benefit from bigger companies going before them and working out the kinks. Markus notes that many companies, whatever their marketplace, chafe under the highly detailed U.S. rules and would prefer the opportunity to move toward the "principles-based" style the international accounting standard embraces. U.S. GAAP rules historically have been much more specific, with bright lines drawn on matters such as the reporting of income from stakes in other businesses.

GAAP Seen as Inflexible

Some companies complain those inflexible boundaries force them into accounting that often doesn't make economic sense. In the worst case, they can lead to embarrassing restatements. Such restatements soared in the years after the Sarbanes-Oxley accounting reform legislation was signed into law in July 2002 and only fell for the first time in 2007, according to a study by Compliance Week.

But for some industries, particularly financial firms, translating reports into the new financial language may not be so easy. Some experts worry that could leave room for shenanigans. Financial firms will be highly affected by the international standards for fair-value disclosure, for instance, which govern how they document hedges and encompass other compliance requirements. A 2008 survey by the American Institute of Certified Public Accountants found that most members believe it will take three to five years to prepare for the move.

Washington has been generally supportive of the idea. Federal Reserve Chairman Ben Bernanke and U.S. Treasury Secretary Henry Paulson have both come out for merging the standards. But not everyone is enthused. Senator Jack Reed, the Rhode Island Democrat who chairs the securities and investments subcommittee of the Senate Banking Committee, has criticized U.S. regulators for not being tough enough. He has opposed adoption of international standards on the grounds that regulation will become even more lax.

Controversy About Financing

Another topic of controversy has been the method by which the International Accounting Standards Board (IASB) is financed. Presumably, U.S. officials and investors would like to see it entirely funded, as FASB is now, by a standard levy on public companies. The IASB now has some mandated funding from companies using the international standards, but much of its budget still comes from voluntary donations from a small number of large U.S. companies and the big audit firms. Critics say that can give companies and auditors too much influence at the expense of investors.

All of the big accounting firms quickly came out in favor of the SEC's road map. But some experts wonder whether auditors will be able to so quickly abandon their old ways in favor of a new path. "U.S. auditors have grown up knowing, loving U.S. GAAP," says Markus. "Can they wipe all that clean? That's going to be a struggle for everyone."

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