Weighty, complex, costly … The conversion to International Financial Reporting Standards (IFRS) has certainly represented all of these things for some European companies. However, with the IFRS train running at full steam as more countries and companies start to apply these new accounting rules, valuable lessons surely can be learned from Europe by later adopters. With Europe acting as the “IFRS guinea pig,” U.S. companies potentially converting to IFRS in the future should review the European experience and take note of the sometimes costly mistakes that some companies have endured.

However, it is not expected that all the IFRS convergence issues facing the U.S. will be the same as in Europe. For instance, one of the biggest issues that European companies faced at the time was the conversion of their current U.S. GAAP (Generally Accepted Accounting Principles) to the full weight of international standards (roughly 2,500 pages). One of the biggest issues for U.S. companies may be the conversion of GAAP (roughly 25,000 pages) to the relatively light weight of International Standards. IFRS is a principles-based set of accounting standards with limited application guidance; the move away from the predominantly rules-based approach of GAAP will inevitably lead to a lack of consistency of interpretation if appropriate training of finance directors and accounting professionals hasn’t occurred.

Project Management

When there was only 18 months to go until conversion of European companies to IFRS in 2005, only 55 percent of companies interviewed (according to a survey conducted by Mazars LLP, of 425 European list and non-listed companies in different European countries) had a specific internal project established. With the date of transition to IFRS being effectively two years prior to the reporting date, this meant that the majority of European companies were left reacting to IFRS, as opposed to proactively structuring their business to lessen the impact that IFRS would have.

The resistance to change, the pessimism about the advantages of IFRS and the cost of changing, deterred many companies in Europe from starting the conversion process in a timely method. Meeting these issues head on will reduce the fears of conversion and make the process smoother. Certainly many larger European companies who took a project management approach to conversion avoided last-minute surprises common among those entities who favored a “big bang” approach.

Preliminary Impact Assessment

On the surface, many of the IFRS accounting standards may appear closely matched with GAAP. This is certainly true for the more recent accounting standards like SFAS 141r, which was prepared as a joint convergence project between the FASB (Financial Accounting And Reporting Standards) and the IASB (International Accounting Standards Board); however small differences and options available under one set of standards and not the other can have a large impact on the financial statement themselves and on the time and resources needed to capture the requisite data.

Let’s look at two small examples:

1. Internal development costs meeting IFRS criteria must be capitalized and amortized as opposed to being expensed. The level of manpower needed in some companies for this one accounting difference, may disrupt the entire timeline of implementation.

2. An option is included in GAAP for companies to use LIFO (a historical method of recording the value of inventory in which a firm records the last units purchased as the first units sold) to manage inventories. Under IFRS, the use of LIFO is prohibited. Therefore companies that had elected this option under GAAP will need to consider the financial statement and tax impact of adopting an IFRS-compliant inventory method.

Subtle GAAP differences may also have major implications. One such standard that typifies this is IAS 12 “Income taxes.” The European experience of the impact of IFRS on tax varied from one country to another. The application of IAS 12 was viewed in Europe as one of the most complex standards to apply (together with areas on financial instruments and business combinations). Many differences in the detail to U.S. standards will again mean this is likely to be a challenging area for companies to address. One hopes that over the next few years many of these minor but important GAAP differences will be eliminated by FASB/IASB projects.

Undertaking a preliminary IFRS impact assessment enables the company to identify the principal issues created by the transition to IFRS and highlights the key implications on the company’s systems and resources. At this early stage one can then assess whether any external assistance is required and whether a detailed project plan is needed for smooth implementation. Some of the most common external support that is required surrounds project management, independent valuations and impairment reviews, actuarial services and specialist accounting technical opinions.

First-Time Adoption of IFRS

To assist first-time adopters of IFRS, the IASB issued IFRS 1 ”First-time adoption of International Financial Reporting Standards.” This accounting standard is essential reading for the prospective adopter because it discloses certain exemptions that are available to first-time adopters; these exemptions in many instances counter the general requirement to have full retrospective application of accounting standards.

First-time adoption of IFRS gives companies a one-time opportunity to completely reassess and change their accounting policies. Certain IFRS allow choices of measurement rules, therefore a company in transition needs to weigh the alternative approaches carefully in order to select the most appropriate choices for them as these will have to be applied on a consistent basis going forward.

One example of accounting policy choice is the accounting for investment properties, where a company can elect to carry these investment properties at cost or at fair value, with movements in that value going through the income statement.

IFRS 1 certainly reduces the burden of transitioning to IFRS. However, it does not negate the responsibilities on management to have a full set of IFRS accounting policies because it does not aid comparability with diverse companies opting for different choices.

Divergence in Interpretation

Listed European companies were at a distinct disadvantage in that they were the first batch of companies to adopt IFRS; there were often no model disclosures to follow or indications on how specific industries were applying standards. This left “room for improvement” in many companies’ first-year’s IFRS financial statements.

At least the U.S. now has a large enough supply of comparable European companies with IFRS financials that are available and can be used for an indication of the presentation requirements expected in a set of IFRS financial statements.

IAS 8 “Accounting policies, changes in accounting estimates and errors,” contains a hierarchy of resources to be consulted where IFRS guidance is considered to be inadequate or missing in dealing with certain situations. Part of the hierarchy is the allowance to consult other GAAPs for accounting guidance. Caution should be taken in these circumstances; the user who is familiar with a rules-based accounting system such as GAAP may infer that much is missing from IFRS, when in fact this is not the case. In the majority of situations, an accounting principle exists covering the circumstance and management needs to exercise judgment in developing an appropriate accounting policy. The natural tendency to default to GAAP should be resisted in the vast majority of cases.

Conclusion

While application of IFRS in the U.S. may seem some time away at the moment, it is nevertheless on its way and companies need to put it on their Boardroom agenda. The adoption of IFRS in the U.S. is the single most significant change in financial reporting ever and it shouldn’t be considered lightly.

Steven Brice, is a technical partner in the financial reporting advisory group for Mazars in the U.K. You can reach him for European IFRS. Brice is currently Chairman of the Technical Committee of the London Society of Chartered Accountants (LSCA) and Deputy-President of the London Society. He contributes regularly to financial reporting debates and is also an experienced lecturer on a wide variety of topics including IAS39. Remi Forgeas is an audit and assurance partner for Mazars in the U.S. The views expressed in this article are the author’s own.