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        Robert Kugel's Analyst Perspectives

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        What’s the Rush in Adopting IFRS?

        I have commented before on the movement to adopt International Financial Reporting Standards (IFRS) by the United States to replace US-GAAP (Generally Accepted Accounting Principles). Most recently I discussed the drive to harmonize the significant differences between US-GAAP and IFRS on revenue recognition and lease accounting. To those who are interested in but not intimately involved with the subject, I suspect the current situation is a bit confusing, since there are multiple groups involved in the discussions on how best to proceed, each with its own agenda. The full adoption issue remains in flux, but let me weigh in the matter.

        I have long supported IFRS, largely because over the past three decades I have watched US-GAAP become increasingly unwieldy as the Financial Accounting Standards Board (FASB), the group that administers US-GAAP, has made it much more of a rules-based, rather than principles-based, accounting standard. Although the rules are well-intentioned, in several areas (such as revenue recognition) they have become increasingly complex and, to my mind, do not necessarily promote transparency. In an effort to be conservative, companies can understate their economic performance, which allows some investors (usually professionals) to gain an advantage because they can see through the distortions produced by the accounting rules. And it’s not that difficult for companies to slip up and require a restatement, as the recent example with JDA Software made clear.

        Lately, though, I’ve been having second thoughts. Some of the arguments for the United States adopting IFRS are so overstated that I want to reject them on rational grounds. This offsets a suspicion that advocates for retaining US-GAAP are mainly attempting to retain their administrative power. In the end, though, I think that the SEC got it exactly right in advocating following a path of condorsement, which will converge US-GAAP and IFRS without formally adopting it for the near term while endorsing the ultimate adoption of IFRS at some time farther out. I agree that adopting IFRS is a worthy objective, but what’s the hurry?

        The main argument for the U.S. adopting IFRS immediately is that in global financial markets it’s essential for all countries to use the same standard to ensure comparability of financial statements. This sounds reasonable, especially to those who aren’t accountants. Yet the reality is that today the overall differences between practices in the U.S. and IFRS are not especially great. For example, when global software company SAP shifted to IFRS from US-GAAP, only relatively small differences between the two approaches emerged in the years when it was reporting results in parallel. (SAP minimized differences by electing to largely follow US-GAAP revenue recognition methods.) In some industries (those affected by the differences in revenue recognition and the treatment of leases, for example) there can be meaningful differences. However, if the United States retains US-GAAP but the two systems converge on key differences, I expect that in most cases the gaps between what would be reported using either standard would be slight. Moreover, once the major areas of difference between US-GAAP and IFRS have converged, the argument that the two systems will not offer comparable results becomes specious. Indeed, IFRS is based far more on principles than US-GAAP is, and that approach creates the potential for a similar lack of strict comparability between two companies that use IFRS, even in the same industry.

        I have another concern with the U.S. adopting IFRS: The eXtensible Business Reporting Language (XBRL) taxonomy in IFRS is less rich than the one developed for US-GAAP. As things stand, I believe adoption of IFRS by the U.S. would leave investors worse off in this respect. While the International Accounting Standards Board (IASB) talks a good game, I fear it will be many years before the IFRS taxonomy will become as rich in its descriptive capabilities as the US-GAAP version. The IASB views taxonomy-building as being tightly linked to standard-setting, and therefore requiring careful vetting and review. In my judgment, this is at odds with the nature of XBRL taxonomies, which are designed to be loosely coupled and dynamic. Inevitably, a more limited IASB taxonomy would lead to a considerable increase in the use of extensions and a corresponding reduction in financial statement comparability when using XBRL. This would diminish the value of XBRL in communicating financial results.

        There is long-term value in the United States adopting IFRS, mainly because it will shift the accounting standard back to a principles-based approach from today’s rules-based regime. But I don’t see a great deal of value in rushing this migration if the main rationale is to achieve greater comparability, and even less if it means diminishing the value of the nascent use of XBRL for financial statement analysis and reporting.

        Regards,

        Robert Kugel – SVP Research

        Authors:

        Robert Kugel
        Executive Director, Business Research

        Robert Kugel leads business software research for Ventana Research, now part of ISG. His team covers technology and applications spanning front- and back-office enterprise functions, and he personally runs the Office of Finance area of expertise. Rob is a CFA charter holder and a published author and thought leader on integrated business planning (IBP).

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