A new era in accounting?

"For many, many years, foreign companies have felt it was worth the cost and effort (to use two accounting standards) because there was no other game in town. Now there are other games," securities lawyer Lola Miranda Hale says.


In the battle to set accounting standards for companies across the globe, the United States appears to have lost. More than 100 countries, including Russia, those in the European Union, and soon Canada, have adopted or agreed to adopt the rules set by the London-based International Accounting Standards Board, a group established just seven years ago.
In doing so, they have rejected generally accepted accounting principles, the standard this country has been using for decades. And now that the world has shown a preference for international financial reporting standards, or IFRS, the big question is if, or maybe when, the United States will do the same.

Accountants who read the Securities and Exchange Commission's actions like tea leaves believe the agency will either allow or require public companies to switch as soon as 2011. Doing so would represent a seismic shift in the otherwise staid world of accounting.

"The capital markets don't respect political borders these days," says Benjamin Resch, a partner with Deloitte & Touche LLP in Chicago. "And IFRS is increasingly the language they speak."

The two methods have significant differences, especially when it comes to reporting revenue, valuing assets and accounting for lease agreements — all of which can lead to dramatic changes on balance sheets and income statements. Depending on the company and industry, those using IFRS may see a boost in their bottom line. Others may end up with a higher tax bill.

MICKEY MOUSE MATH

In many ways, the international standards create a different picture of a company's financial position, one based more on current market value than on historic costs. While that view may appeal to investors, it can be complicated to produce because it often requires estimating the market value of assets for which a market does not exist.

U.S. accountants aren't trained that way. They analyze value according to cost. Thus accounting for Walt Disney Co. is based on the purchase price of its parks and property — not on the value of Mickey Mouse, one of Disney's greatest assets.

It's nearly impossible to say which method would show U.S. companies' financial statements in the clearest or brightest light. Both systems are complicated and have rules that are stricter on some issues and more lenient on others.

Still, there are lots of good reasons for the United States to consider a switch. U.S. financial statements would be more readily comparable to foreign companies', making American companies more attractive to overseas investors.

It may also make U.S. capital markets more attractive to foreign companies because they wouldn't have to spend the money to prepare their financial statements twice: once using IFRS for their country and again using generally accepted accounting principles in the United States.

"In order for the U.S. markets to stay competitive, they really need to convert," says Joseph Schulte, a partner in the Chicago office of Ernst & Young LLP.

Many experts think the change will occur in the next three to five years. The biggest clue came in November, when the SEC announced a major rule change that would allow foreign companies to register to issue stock in the United States without reconciling their financial statements with GAAP.

"I think (the SEC was) concerned about marketshare," says Lola Miranda Hale, a securities lawyer with Epstein Becker & Green P.C. in Chicago. "For many, many years, foreign companies have felt it was worth the cost and effort because there was no other game in town. Now there are other games."

Those other games include AIM, the London Stock Exchange's international market for smaller, growing companies that was founded in 1995 and has more flexible rules for listing, and stock markets in burgeoning economies like Brazil, she says.

LEARNING CURVE

It's only a matter of time before U.S. multinationals that already report results to foreign regulators using IFRS demand the right to use the same method here. In letters to the SEC, companies like Morgan Stanley already have recommended using IFRS to "make financial results of companies across the globe more transparent and reliable."

The change, whether voluntary or required, will create a massive learning curve for corporations, accountants, accounting students and faculty. A March survey by Chicago-based accounting firm Grant Thornton LLP found only 19% of U.S. chief financial officers and senior comptrollers questioned had experience preparing financial statements using IFRS, which requires significant adjustments in how a company collects and analyzes financial information on everything from incentive plans to debt contracts. But perhaps the biggest challenge of all will be at the SEC, which is charged with enforcement.

"There will be a significant transition while we see that . . . infrastructure built up," says Christian Leuz, a professor of accounting at the University of Chicago's Graduate School of Business. "This is where the concern is."

To illustrate some of the most significant differences between GAAP and IFRS, Crain's asked four accountants to explain how four fictional companies would change their reporting as a result of the switch. The four companies are in industries common to Chicago: manufacturing, consumer products, financial services and software development. Each industry faces unique challenges and benefits from using IFRS. With change in the air, it's not too early for Chicago companies to start evaluating how their accounting systems would need to adapt.