02 May 2005 00:01 [Source: ICB Americas]
The US took a step closer in allowing foreign companies to sell securities in the US without first having to revise or reconcile their financial statements, paving the way for increased cross-border filings.
Following a meeting between Securities and Exchange Commission (SEC) chairman William Donaldson and European Union (EU) Market Commissioner Charles McCreevy, the SEC late last month released a roadmap of actions it would have to take to determine whether to eliminate the requirement for companies that follow International Financial Reporting Standards (IFRSs) and that file financial reports with the SEC to reconcile their reports to US GAAP (generally accepted accounting principles). The SEC hopes to decide by 2009 at the latest.
“This is a significant and positive development,” says D.J. Gannon, partner at Deloitte & Touche LLP and leader of the firm’s IFRS Center of Excellence for the Americas. “All companies that have cross-border filing requirements and use IFRSs should benefit from these efforts, including European companies. Ultimately, we’re talking about eliminating differences not only in financial reporting standards but also in regulatory rules. Therefore, companies will be able to file a single financial statement that would be acceptable for use in multiple jurisdictions.”
US-based publicly traded companies are required to follow US GAAP for financial reporting, which prior to the adoption of IFRS by the EU, was the “de facto global standard for financial reporting,” says Gannon. However, that changed with the EU’s adoption of IFRSs, which require that all companies domiciled in the EU with publicly traded shares on a European exchange to use IFRSs for their financial reporting by December 31, 2005. A limited number of companies meeting certain criteria are permitted an extension until 2007. EU member states may allow companies to defer their adoption of IFRSs until year 2007 if a company is listed both in the EU and on a non-EU exchange and currently uses internationally accepted standards as its primary accounting standards, or if a company has only publicly traded debt securities.
The EU’s adoption of IFRSs affects some 7,000 European companies, including non-European multinationals with reporting requirements overseas. Outside the EU, an increasing number of South American countries are also requiring the use of IFRSs and some countries, notably Japan, have voluntarily moved to IFRSs.
Companies that use IFRSs and want to list on US exchanges must reconcile their financial reporting to US GAAP. The move by the SEC last month details a schedule under which the SEC will work to decide whether to remove the reconciliation requirement.
“Not needing to prepare US GAAP financial standards will certainly eliminate one barrier to foreign companies entering the US capital markets,” says Andreas Ohl, partner in the transaction services group at PricewaterhouseCoopers (PwC).
“It should be easier to trade securities in all markets as the listing requirements converge,” says Deloitte’s Gannon. “This would be the case for European companies trading in the US. But US companies also should benefit as well as the convergence between financial standards provides for greater comparability among companies in the global marketplace.”
There are roughly 1,200 foreign private issuers that now file with the SEC, which includes 500 from Canada, which is not moving to IFRSs in 2005, says the SEC. Of the remaining 700 foreign private issuers, roughly 40 percent now prepare their financial statements using IFRSs. The SEC says it expects the number of foreign private issuers that use IFRSs to increase to roughly 300 for 2005 and to almost 400 by 2007, the end of the phase-in period for certain companies’ transition to reporting under IFRSs.
In moving to eliminate the reconciliation requirements, the SEC took a pre-emptive strike in thwarting off the EU imposing additional requirements for US-based companies that list on Europe’s exchanges. The EU is currently examining whether US companies listed in the EU should be allowed to continue to file their financial reports under US accounting standards.
“US-based companies that now list on European stock markets are able to do so without additional financial reporting re-quirements,” says Deloitte’s Gannon. “However, the SEC has required foreign companies to reconcile to US GAAP, and now with the adoption of IFRSs in the EU, the SEC has the opportunity to provide some relief in filing requirements. If it hadn’t moved toward that goal or eventually moved to that goal, there would be a risk that the EU may impose reconciliation requirements to IFRSs for US-based companies that list on European exchanges.”
Aside from opening US capital markets, the possible elimination of the US GAAP reconciliation requirement offers several other benefits to European companies. “It relieves them of the cost and effort of preparing two sets of accounts,” explains PwC’s Ohl. “More importantly, it eliminates the need to explain increasingly arcane differences between US GAAP and IFRSs. While US GAAP and IFRSs are converging on the principles level, there are many differences in the details. For example, there are dozens of nuance differences between the two stock-based compensation standards.”
The International Accounting Standards Board is responsible for IFRSs, and the Financial Accounting Standards Board for US GAAP. The two bodies began the task of convergence in 2002 to remove a variety of individual differences between US GAAP and IFRSs.
“There is tremendous upside to convergence of financial reporting standards,” says Deloitte’s Gannon. “It is simply easier to have to comply with a single set of standards versus multiple sets of different standards.”
However, although the conceptual acceptance of equivalence between US GAAP and IFRSs is not an issue, the actual application and enforcement may prove to be more challenging. “It has proven more difficult to actually converge standards than what may have been the original expectation, but the standard-setters and regulators are working through those issues,” says Gannon. “Another challenge will be to see how regulators can work together to avoid differing interpretations of the same standard in different jurisdictions. This is probably the biggest challenge that exists.”
Others agree. “A convergence on principles but not on details results in differences that only people who have really studied the standards are aware of,” says PwC’s Ohl. “These differences can often be significant in terms of their impact on key financial metrics. It can be difficult for management to explain to the market how two apparently similar standards can in some cases produce dramatically different results.”
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