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C C O U N T I N G

& A U D I T international accounting

I N G

Planning Ahead for IFRS 1

Initial Adoption of IFRS by U.S. Companies
By Joseph M. Langmead and Jalal Soroosh

n November 14, 2008, the SEC issued its proposed road map addressing when and under what circumstances U.S. public companies might be permitted or required to adopt International Financial Reporting Standards (IFRS) when preparing their financial statements with the SEC. The road map does not include a fixed IFRS adoption date as such. Rather, it states that adoption of IFRS will be considered in 2011 in light of stated conditions at that time. It also provides an option for early adoption by a defined set of companies. While the adoption of IFRS by U.S. public companies likely will, if it comes to pass, occur over several years, the opportunity for some public companies may arrive soon. For all others, the time for planning such a transition is now. The differences and similarities between IFRS and U.S. GAAP have been covered extensively. (For example, see International Financial Reporting Standards: The Road Ahead, by Joseph M. Langmead and Jalal Soroosh, The CPA Journal, March 2009; Dual Reporting Under U.S. GAAP and IFRS, by Francesco Bellandi, The CPA Journal, December 2007; and Shaking Up Financial Statement Presentation, by Guy McClain and Andrew J. McLelland, Journal of Accountancy, November 2008.) The discussion below will instead explore several of the important technical and practical considerations for a U.S. public company adopting IFRS for the first time. The focus is on the issues deriving from applicable accounting standards regarding initial adoption.

Emergence of IFRS for U.S. Companies

IFRS is a comprehensive set of accounting standards promulgated by the

International Accounting Standards Board (IASB). In December 2007, in a step which surprised many, the SEC eliminated the requirement for many foreign company filers using IFRS to provide supplemental information on a U.S. GAAP basis. One important reason behind the SECs proposed road map is that IFRS has become the de facto international accounting language, used (or scheduled to be used) in more than 100 countries. Because comparability between companies is highly valued by both investors and the SEC, and because U.S. GAAP has not achieved similar acceptance around the world, the SEC sees IFRS as the logical next step. The momentum in this direction has been assisted by the convergence efforts under-

taken by the FASB and the IASB over the past several years. The two standards setters have been working from a common agenda to eliminate as many differences as possible between them over time. The SEC, however, appears to consider the matter more urgent than the gradual convergence process would allow. The many current differences between the two sets of standards are a significant consideration when a U.S. company adopts IFRS initially. Much progress has been made to reduce the differences between U.S. GAAP and IFRS, and several major remaining ones are on track for convergence in the near term. Nevertheless, a reasonably large company approaching the switch to IFRS might
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identify 10 or more such differences which are material and which may require important changes to its information systems as well as to compensation arrangements, debt covenants, income tax decisions, and a variety of other aspects of its business. All of these dimensions are important and require substantial lead time in a transition to IFRS, usually within an overall project management framework. The technical and practical accounting considerations associated with the initial adoption of IFRS can, by themselves, influence the timing and timetable of a conversion, especially in a period where adoption is optional and the timing is flexible, as may be the case for a number of public companies (the SEC estimates 110) as soon as the road map is adopted. Even in the later phase of implementation, where the timing will depend upon the size of the company (2014 for the largest public companies; 2016 for the smallest), these adoption-related accounting considerations

can influence how early one should start making important measurements. In some cases, analysis may indicate that some action should be taken as early as this year.

Accounting and Reporting Framework for Initial Adoption

IFRS 1, First-time Adoption of International Financial Reporting Standards, was issued by the IASB in 2003 and has since been amended (most recently on July 23, 2009). It establishes the provisions that govern companies when adopting IFRS. The standard provides a number of practical provisions to ease the burden of such a transition and contains exceptions to what might otherwise be the full retroactive application of IFRS. There are two related considerations in any adoption of a new accounting model: Identifying the operative effective date of the change, and Implementing any retroactive (retrospective in IFRS 1) features required by

the change (including how many prior periods are to be presented). IFRS 1 provides that a first reporting date be established at the end of the period in which IFRS is adopted. It then defines a transition date as the beginning of the earliest period whose financial statement information is required for comparative purposes in the year of adoption. It prescribes that opening balance sheet measurements under IFRS be made at the transition date and that IFRS be consistently applied from then to the first reporting date based on IFRS standards in effect at the first reporting date, even though standards may have changed between those dates. The period between those dates is generally two years under IFRS 1, and the SEC accepted this two-year standard when many European companies first adopted IFRS in 2005. But for U.S. companies, based on the proposed road map, the SEC will likely require three years and further clarify that adoption must take place only as of the end of a fiscal year.

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Thus period in IFRS 1 means year and the transition date is the beginning of the three-year period ending with the first reporting date (which is the year-end date as of which IFRS is first adopted). This three-year period must reflect a consistent application of IFRS, as if the standards in effect at the end of the current fiscal year were in effect throughout the period. Similarly, subject to defined exceptions discussed below, the three-year period begins its measurements with an opening balance sheet (statement of financial position) composed of assets and liabilities measured in conformity with IFRS in effect at the end of the three-year period. This consistency provision applies for new adopters, even though individual IFRS standards may have become effective between the transition date and the first reporting date, and even though some IFRS standards include special transitional guidance which might depart from full retroactivity. A further element of this framework is that the financial statement form and classification requirements of IFRS be in full effect for all periods on the basis of IFRS requirements at the first reporting date. Exhibit 1 provides examples capturing these key provisions.

Given this framework, a host of implementation issues arise. The opening balance sheet requirement in particular reinforces the basic challenge that differences between IFRS and U.S. GAAP that remain unconverged at the end of the year of adoption must be measured and adjusted consistently not only for all three years presented but for all transactions and events in earlier years which have residual effects on the opening balance sheet. Such a challenge can be formidable for many companies, and IFRS 1 contains two strategies for reducing the magnitude of the challenge. The first is noted above: IFRS 1 removes the problem that IFRS itself has been changing over time by identifying a single date (the first reporting date) as of which IFRS standards are identified and applied to all earlier transactions and events. Note that this does not alter the fact that U.S. GAAP has also been changing over time. The second strategy IFRS 1 employs is to make exceptions to full retroactivity for more complex categories of transactions. These exceptions, particularly the optional ones, are integrated into IFRS 1 in recognition that any conversion or adoption to a new basis of accounting presents practical challenges when applying new stan-

dards retroactively. By reviewing these exceptions from the standpoint of a U.S. company, one can address the more significant accounting challenges inherent in first-time adoption.

Exceptions to Full Retroactivity

Implicit in the three-year retroactive requirement is that all transactions preceding this period must also be remeasured using those standards, at least to the extent of the residual effects of those earlier transactions on the transition date balance sheet. The challenge of having many current differences between U.S. GAAP and IFRS is increased when considering that U.S. GAAP and IFRS were even less converged in earlier years than at present. In an effort to make the transition to IFRS less onerous, the IASB included additional provisions in IFRS 1 to reduce the practical burdens of retroactive application. These include both optional and mandatory exceptions to the general principle that the opening transition date balance sheet should reflect all standards in effect at the first reporting date. Each of these exceptions represents a potentially important element in a U.S. companys strategy regarding when and how to adopt IFRS initially.

EXHIBIT 1 Identifying Operative Dates

Example A: Company A is a calendar-year U.S. company and is required by the SEC to adopt IFRS in 2014. First reporting date: December 31, 2014 Transition date: January 1, 2012 Required financial statements: As of and for each of the years in the three-year period ending December 31, 2014, plus balance sheet at January 1, 2012 Basis of accounting: IFRS as in effect at December 31, 2014, applied as though in effect consistently for all periods, including before 2012 (subject to exceptions discussed). Example B: Company B is a U.S. company with a June 30 year-end and is permitted by the SEC to adopt IFRS as early as 2010 and elects to do so beginning July 1, 2010. First reporting date: June 30, 2011 Transition date: July 1, 2008 Required financial statements: As of and for each of the years in the three-year period ending June 30, 2011, plus balance sheet at July 1, 2008 Basis of accounting: IFRS as in effect at June 30, 2011, applied as though in effect consistently for all periods, including before July 2008 (subject to exceptions).

Optional Exceptions
In the interests of practicality, IFRS 1 specifies 15 available, but not required, exceptions (exemptions) from the general principle that the transition date opening balance sheet should reflect the same accounting principles as those employed throughout the initial three-year period ending with the first reporting date. Some are less relevant to U.S. companies than others and are discussed and summarized below. Users should read IFRS 1 completely for further details and possible exceptions. Business combinations. Business combinations are potentially the most onerous and complex accounting category involved in any retroactive application. IFRS 1 provides no exception to the requirement that all periods presented (probably three years for U.S. companies) should reflect consistent application of IFRS in effect at the end of the period. That requirement thus includes all business combinations consummated within that three-year period. IFRS provides an exception, however, for business combinations consummated
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tized amounts under IFRS. Retroactive restatement to include the cumulative effects of such differences on the transition opening balance sheet (and subsequent periods) can be onerous and expensive. IFRS 1 permits initial adopters of IFRS the option of considering all unamortized actuarial gains and losses as having been realized as of the transition date as long as this option is applied to all such plans. A company and its actuaries can then apply a deferral and amortization strategy for new actuarial gains and losses in line with IFRS methodology. Foreign currency translation adjustment. The cumulative foreign currency translation adjustment related to foreign operations and activities (a separate component of equity) may be eliminated at the transition date as long as it is eliminated for all such operations and activities

(reset to zero). All subsequent translation adjustments are measured and accounted for in line with IFRS thereafter, including each of the years in the three-year period immediately prior to the first reporting date. This is a useful option when other cumulative IFRS adjustments made at the transition date have effects on foreign assets and liabilities that are difficult to measure or where the detailed application of IFRS to foreign currency translation before the transition date would have differed from U.S. GAAP. Compound financial instruments. IFRS (IAS 32) requires that financial instruments that have both debt and equity features (e.g., convertible debt) be accounted for in two separate parts, with the amount allocated to equity persisting even if the instrument is not converted and the debt is

EXHIBIT 2 Business Combination Examples

Example A: Company A is a calendar-year U.S. company and is required by the SEC to adopt IFRS in 2014. It consummated a major business combination on May 15, 2005 and plans to restate its accounting for that combination consistent with IFRS. First reporting date: December 31, 2014 Transition date: January 1, 2012 Required financial statements: As of and for each of the years in the three-year period ending December 31, 2014, plus the balance sheet at January 1, 2012. Basis of accounting: IFRS as in effect at December 31, 2014, applied as though in effect consistently for all periods, including before 2012 (subject to exceptions discussed) Accounting for business combinations: All business combinations consummated after May 14, 2005, must be restated using IFRS in effect at December 31, 2014 (with the effects of the restatements reflected in the January 1, 2012, balance sheet for combinations consummated between May 15, 2005, and December 31, 2011). Example B: Company B is a U.S. company with a June 30 year-end and is permitted by the SEC to adopt IFRS as early as 2010 and elects to do so beginning July 1, 2010. It has consummated a number of business combinations over the years but does not wish to restate any more of them than are required. First reporting date: June 30, 2011 Transition date: July 1, 2008 Required financial statements: As of and for each of the years in the three-year period ending June 30, 2011 plus balance sheet at July 1, 2008 Basis of accounting: IFRS as in effect at June 30, 2011, applied as though in effect consistently for all periods, including pre-July 2008 (subject to exceptions discussed). Accounting for business combinations: All business combinations consummated after June 30, 2008, must be restated using IFRS in effect at June 30, 2011.

fully paid off. IFRS 1 allows this provision to be ignored for all such cases where the debt has been fully paid off as of the transition date. Thereafter, the IFRS bifurcation requirement applies, including during the three-year period immediately prior to the first reporting date. Certain affiliates. The effects of adopting IFRS at the transition date can be different if a subsidiary or other specified affiliate has adopted IFRS earlier. Similarly, if a U.S. company adopting IFRS is a subsidiary or specified affiliate of a parent who has already adopted IFRS, certain other options apply. Certain financial assets and liabilities. U.S. GAAP and IFRS require that certain defined financial assets be classified as available for sale (subject to mark-to-market accounting through other comprehensive income, a separate component of shareholders equity) or trading (subject to mark-to-market accounting through the income statement). Certain financial liabilities can similarly be designated as subject to mark-to-market accounting through the income statement. IFRS 1 allows a one-time opportunity, as of the transition date, to redesignate assets as available for sale and assets and liabilities as subject to mark-to-market accounting through the income statement, irrespective of their earlier designations under U.S. GAAP, subject to specific conditions. Because these IFRS classifications are virtually identical to those under U.S. GAAP, it would likely be difficult to justify the use of this option except for items not previously marked-to-market under U.S. GAAP. Certain share-based compensation. SFAS 123(R), Share-based Payments, requires a fair value accounting approach for share-based compensation awards that is generally similar to IFRS 2. One would thus expect IFRS to require restatement for any awards prior to the 2005 effective date of SFAS 123(R), but IFRS 1 provides an optional exception to the restatement requirement for any awards that have fully vested prior to the transition date. In all these cases, and for other optional exceptions not discussed here (due to their limited relevance and in light of recent convergence efforts), a thorough reading of IFRS standards is warranted in any actual conversion situation. Electing any one
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of these optional elections does not require electing any of the others.

Mandatory Exceptions
IFRS 1 recognizes that certain kinds of retroactive or retrospective changes made along with a change from one accounting model to another can have negative effects and rob such a transition of important credibility and objectivity. IFRS 1 thus specifies a set of core accounting judgments that should not be revisited as part of an initial retroactive adoption of IFRS. In broad terms, these include the more typical instances where estimates and judgments are required by management, such as credit loss allowances, warranty obligations, and other contingent liability exposures. In these cases, a company adopting IFRS is prohibited from employing any information which became available subsequent to the original estimates as long as management employed all of the relevant information available at the time of the original estimate. Recordable amounts for contingent liabilities can sometimes be different under IFRS due to different methodologies and thresholds. Such differences must still be applied retroactively but only by employing information available at the time of the original estimates. In a similar vein, both IFRS and U.S. GAAP contain documentation and designation requirements to support various forms of hedge accounting. These are generally applicable at the initiation of a hedge, making the use of hindsight problematic. Thus, IFRS 1 generally prohibits any retroactive designations. Only designations documented as having been made on a timely basis at the initiation of a transaction can be employed in the retroactive application of IFRS. Since U.S. GAAP has reasonably stringent requirements regarding timely designation, the effect of this prohibition simply precludes the use of hindsight to achieve hedge accounting where it was not already applicable under U.S. GAAP.

GAAP usually required a one-time cumulative catch-up adjustment in the year of change without restatement of earlier periods. Like U.S. GAAP, when a new IFRS standard is finalized, its effective date may be in the future but an option for earlier adoption is often available and encouraged. Companies adopting IFRS should consider early adoption if it is advantageous. The attractions may include not only the actual accounting effects of the new standards, but also the avoidance of future restatements. IFRS 1 allows for such early adoption of newer standards in connection with initial adoption as long as the newer standards are applied consistently across all periods presented, as well as in the transition date balance sheet. If more than one newer standard is available for early adoption at the first reporting date, a decision to adopt one early does not trigger the early adoption of others. These considerations alone can influence the selection of a first reporting date for companies where IFRS adoption is optional.

posal, may adopt IFRS earlier than 2014. A prudent approach would be to assume that U.S. GAAP information will need to be compiled alongside IFRS information through 2014. Regarding disclosures in general, IFRS has its own set of required disclosures which can be more extensive in some areas than U.S. GAAP. A U.S. company considering its IFRS conversion strategy and timing should include this within its planning.

Preparing for Change

The discussion above has focused on the particular accounting and reporting implications at the time of the first adoption of IFRS and thus excludes discussion of the many other dimensions of such a significant change in a companys basis of accounting. Other relevant subjects include the remaining not-yet-converged differences between IFRS and U.S. GAAP and the substantial organizational impact, including the education and training implications, the importance of knowledgeable commitments from the board of directors and senior management, the changes to information systems and business processes, and the need for an effective overall project management structure. Perhaps just as important is the degree to which management will be challenged to use more judgment in applying accounting standards, because IFRS remains generally less rules-based and more principles-based than U.S. GAAP, an attribute that is lauded by some and criticized by others. Most importantly, every U.S. public company should carefully consider the technical accounting implications of the initial adoption of IFRS, including the particular options available in IFRS 1, and, for those companies that may be eligible to adopt IFRS early, the considerations for selecting the year in which to adopt. Joseph M. Langmead, STD, MBA, CPA, is an executive in residence at the Sellinger School of Business and Management, Loyola University Maryland, Baltimore. Jalal Soroosh, PhD, CMA, is a professor of accounting at the Sellinger School of Business and Management, Loyola University Maryland, Baltimore.

Required Disclosures in Initial Adoption

As noted above, IFRS 1 requires the measurement of a transition date opening balance sheet (opening IFRS statement of financial position) to capture the full cumulative retroactive effects of the application of IFRS up to the beginning (transition date) of the comparative periods (three years) required to be presented in the year of adoption (the end of which is the first reporting date). The plain language of IFRS 1 seems to require the actual presentation of this opening balance sheet in the year of adoption. Even if this awkward requirement were to be waived by the SEC for U.S. companies, such a balance sheet, at least in summarized form, may be useful in the notes to meet the disclosure requirements of IFRS 1 regarding the various financial statement effects of the conversion to IFRS and a related required reconciliation of total shareholders equity at the transition date. IFRS 1 also requires reconciliation of key financial statement amounts (shareholders equity and comprehensive income) from the preceding years U.S. GAAP statements to the corresponding IFRS amounts. The SECs road map requires more elaborate U.S. GAAP disclosures, particularly for those companies that, under the pro-

Prospective Changes in IFRS at the First Reporting Date

As a result of convergence efforts, both U.S. GAAP and IFRS now provide that changes in accounting principle, particularly those required by a new accounting standard, be implemented retroactively for all periods presented. Formerly, U.S.
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