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An analysis of the content of Form 20-F U.S. GAAP reconciliation by foreign entities employing IFRS: is the SEC IFRS roadmap premature?
Abstract:
In 2007, the Securities and Exchange Commission (SEC) initiated perhaps the most aggressive actions over the past fifty years involving a relaxation of the rule(s) for certain foreign entities traded on United States (U.S.) stock exchanges. Until that time, all foreign entities were required to include a reconciliation to U.S. generally accepted accounting principles (U.S. GAAP) if the financial statements were not prepared in accordance with them. Faced with de-listings by foreign companies and their movement to foreign security exchanges, the SEC eliminated the requirement for firms that prepared their financial statements in accordance with International Financial Reporting Standards (IFRS) published by the International Accounting Standards Board (IASB). Although there was widespread support for this change, there is also criticism, especially concerning the amount of information loss for users of these statements. A second SEC action is the proposal to allow U.S. firms the choice to employ either U.S. GAAP or IFRS. Our study analyzed 2006 financial statements of foreign entities employing IFRS, which was the last year to require the reconciliation. We also analyzed the nature of the largest differences and determined whether there would be convergence between the two accounting systems in the foreseeable future that would eliminate them. Our findings lead us to conclude that before either of the SEC actions are warranted there should be more conformity in the areas of pensions and other post retirement benefits; financial instruments; and impairment, goodwill, and intangibles.

Subject:
Administrative agencies (Laws, regulations and rules)
Securities industry (Laws, regulations and rules)
Securities law (Interpretation and construction)
Authors:
McEnroe, John E.
Sullivan, Mark
Pub Date:
01/01/2011
Publication:
Name: Academy of Accounting and Financial Studies Journal Publisher: The DreamCatchers Group, LLC Audience: Academic Format: Magazine/Journal Subject: Business Copyright: COPYRIGHT 2011 The DreamCatchers Group, LLC ISSN: 1096-3685
Issue:
Date: Jan, 2011 Source Volume: 15 Source Issue: 1
Topic:
Event Code: 930 Government regulation; 940 Government regulation (cont); 980 Legal issues & crime Advertising Code: 94 Legal/Government Regulation Computer Subject: Securities industry; Government regulation
Product:
Product Code: 6200000 Securities & Commodities Services; 9108620 Securities & Commodities Regulatn NAICS Code: 523 Securities, Commodity Contracts, and Other Financial Investments and Related Activities; 92615 Regulation, Licensing, and Inspection of Miscellaneous Commercial Sectors SIC Code: 6211 Security brokers and dealers; 6289 Security & commodity services, not elsewhere classified
Organization:
Government Agency: United States. Securities and Exchange Commission
Geographic:
Geographic Scope: United States Geographic Code: 1USA United States
Accession Number:
256603224
Full Text:
INTRODUCTION

Until recently, all foreign entities that are traded on United States (U.S.) stock exchanges were required to include a reconciliation to U.S. generally accepted accounting principles (U.S. GAAP) if the financial statements were not prepared in accordance with U.S. GAAP. The firms provided this information on the Securities and Exchange Commission (SEC) Form 20-F. This is a very expensive exercise that cost some companies millions of dollars annually (Scannell and Reilly 2007a). This burden, in conjunction with the additional costs associated with Sarbanes-Oxley compliance, has led to many U.S. de-listings by foreign entities (Uhlfelder 2007).

In an effort to combat these de-listings, coupled with concerns that the U.S. financial markets are losing their competitive edge to London and Hong Kong (Scannell and Reilly 2007), the SEC proposed that certain foreign entities be allowed to file financial statements under either U.S. GAAP or under the English language version of International Financial Reporting Standards (IFRS) published by the International Accounting Standards Board (IASB) without reconciliation to U.S. GAAP (SEC 2007). On November 15, 2007, the SEC voted unanimously in favor of the proposal. On December 21, 2007, the SEC issued the final rule which was entered into the Federal Register on January 4, 2008 (SEC 2008a). The rule applies to financial statements ending after November 15, 2007.

The IFRS promulgations to be used in lieu of U.S. GAAP are referred to as "full" IFRS. An analysis of the comment letters by LaFon (2007) to the SEC proposal revealed that most of the commenters endorsed the proposal. A few opposed it, however, with the most vehement opposition originating from the Investors' Technical Advising Committee (ITAC), a body whose charge is to render technical advice to the Financial Accounting Standards Board (FASB) from an investor's perspective. In the letter, the Committee stated that it would like to see "concrete evidence" that U.S. GAAP and IFRS standards are "substantially equivalent" before the reconciliation requirement is eliminated. The Committee went on to state, "We suggest that the Commission undertake an evaluation of the IFRS/U.S. GAAP differences commonly found in the reconciliations, and periodically publicly disseminate and report upon such an inventory." (ITAC 2007, 2)

Given this background, our research, in part, is intended to accomplish this challenge. Another objective is to ascertain if the SEC roadmap for the adoption of IFRS is appropriate. As we will indicate in an ensuing section, the incoming SEC Chairperson is apprehensive about the proposed schedule. Our results should be of interest to financial statement users, especially financial analysts and accounting standard setters. Our paper begins with a discussion of the background of the topic, continues with a literature review and our research questions, and then our methodology, summary and conclusions.

BACKGROUND

The SEC first required listed foreign entities that did not employ U.S. GAAP to submit supplementary information in 1967. The instructions associated with Form 20-F did not specifically require a reconciliation, but rather, the financial statements, audit report, and other schedules that domestic issuers were required to file. Prior to 1967, the foreign entities only had to file a balance sheet and income statement, with no requirement for this information to be certified. In 1982 the Commission implemented the current reconciliation requirement (SEC 2007).

Although the Commission has required this information for the past twenty-five years, the agency has long advocated reducing differences in accounting principles between the U.S. and other countries in an effort to facilitate cross-border capital formation. In 1994, it accepted the cash flow statement prepared in accordance with International Accounting Standard No. 7 (IASB 2004b) without reconciliation.

In 1997, at the direction of Congress, the Commission examined the initiatives undertaken to develop "high-quality, comprehensive global accounting standards." (SEC 2007, 20) Towards that end, the SEC encouraged the International Accounting Standards Committee's (IASC) efforts to develop such standards that could be used for cross-border offerings. These standards would presumably reduce compliance costs and inefficiencies that exist under the current system.

Subsequently, in 2003, under a Congressional mandate contained in the Sarbanes-Oxley Act, the SEC released a study on the feasibility of a principles-based accounting system. Its conclusion was that the optimal approach would be based on objectives associated with a conceptual framework rather than relying solely on either principles or rules. This approach would also be used for the convergence of U.S. and international accounting standards. The FASB and the IASB have since established a formal plan for the convergence of U.S. GAAP and IFRS.

While the preceding discussion is of an optimistic tone, there are both very formidable obstacles and arguments involving both the elimination of the Form 20-F requirement and the acceptance of the international set of accounting standards as a substitute. The ensuing section includes a review of the literature that addresses these concerns and the research questions that they engender.

RELEVANT LITERATURE AND RESEARCH QUESTIONS

In addition to the new 20-F initiative, in 2007 the SEC issued a related recommendation that would allow U.S. companies to utilize IFRS as a basis for their financial reporting. (SEC 2008b) At that time some individuals suggested that allowing U.S. firms a choice between U.S. GAAP and international standards would be the end of U.S. GAAP. The reason given is that international rules are more principles based, and would allow companies more flexibility. In fact, Don Nicolaisen, a former SEC chief accountant responsible for developing the SEC's "road map" for the convergence of global accounting standards, stated that the SEC should eventually abandon U.S. GAAP and require the use of international rules. (Reilly 2007) However, in a recent study of 589 U.S. CFOs, only 14 per cent stated that they are very familiar with IFRS and fewer than 10 per cent stated that they are very likely to file under IFRS if given the choice. (Duke 2007)

John White, the SEC's director of corporate finance, argues that since foreign firms will have their choice of U.S. or IFRS reporting standards, U.S. entities should also be given the option: "We are asking a question. Why shouldn't we let a U.S. company choose?" However, Lynn Turner, form SEC chief accountant, states that this option will only work if the two sets of standards are comparable, and that "holes" currently exist in certain industries, especially insurance. Turner goes on to state that the two sets of accounting standards, "must result in comparable, consistent accounting across the universe of companies that have similar transactions." Arthur Levitt, the former SEC Chairman, is a long time proponent of one set of international standards, and also against the choice option, stating, "The menu, system, I believe, leads to earnings management and that should be avoided." (Greenberg 2007, B3)

On August 27, 2008, the SEC laid out its proposal to eventually require all U.S. companies to use IFRS. The proposal would allow some U.S. large multinationals to use IFRS for the financial statements for the year 2010. The SEC estimates that 110 U.S. companies would qualify (Scannel and Slater 2008, A1). This would represent approximately 2.5 trillion in U.S. market capitalization (Rodriguez, 2009). All U.S. companies would then be required to use IFRS in lieu of U.S. GAAP beginning in 2014. More recently, on November 14, 2008 the SEC released its "Roadmap" involving the use of IFRS and reiterated the 2014 date "... if it is in the public interest and for the protection of investors to do so." (SEC 2008b, 10) The Commission listed six "milestones" that should occur before the mandatory implementation of the IFRS. On February 3, 2009, the SEC extended the comment period which was scheduled to end on February 14, 2009 to April 20, 2009 (SEC, 2009).

Although some U.S. companies gave the proposal a "qualified welcome," there are still reservations and "issues to be worked out," according to one U.S. controller (Scannel and Slater 2008, A1). Barbara Roper, Director of Investor Protection at the Consumer Federation of America, stated that allowing some companies to use IFRS before others would impose a burden on investors to be familiar with both sets of rules. Furthermore, she stated that allowing them to choose which accounting model will establish a situation where "they'll choose the language that paints their financials in the rosiest light." (Scannel and Slater 2008, A12) Recently, Mary Schapiro, newly appointed Chairperson of the SEC indicated that she could delay the roadmap's transition to IFRS. Schapiro is worried about the high cost of the transition, which the SEC estimates to reach up to $32 million for some companies. She is also concerned about the independence of the IASB, and the "looser" nature of the IFRS principles-based standards. "I will take a deep breath and look at this entire area again careful and I will not necessarily feel bound by the existing roadmap that is out for public comment," she informed the U. S. Senate Banking Committee. (WEBCPA, 2009, 1)

In the U.S. there are famous cases where politicians became involved in the accounting standard-setting process to the extent that they succeeded in either aborting the proposed standard (the investment credit) or modifying it to their satisfaction (stock options). This same phenomenon also exists in the issuance of IFRS. Although the IASB promulgates the accounting standards, each country decides how to utilize them. Some countries adopt them verbatim; however, others modify them to some extent. In the case of the European Union (EU), each accounting standard must be approved by the European Parliament. The adopted standards are then referred to as "endorsed IFRS" (ITAC 2007, 3). One drawback of this EU review process is that there can be considerable lag time between the date that the IASB releases the standard and the date that the EU firms are required to use it. A more serious problem is that parliament can change the standard. This was the case of IAS 39 (IASB 2005d), which involved lobbying that extended to the level of the French president. Accordingly, in a "technical sense, Europe does not employ 'full' IFRS." (Hughes 2007a) However, the SEC insists that it will only accept "full" IFRS (SEC 2008a, 993), which could have potentially excluded the European Union countries and create a dispute between the U.S. and the European Union (Hughes 2007). The SEC reiterated its position and stated that the firm must explicitly state that the financial statements are in compliance with IFRS as issued by the IASB. Furthermore the independent auditor must provide an unqualified opinion as to this compliance (SEC 2007, 39; SEC 2008, 993).

As we mentioned previously, the ITAC released a comment letter that was very critical of the SEC proposal (ITAC 2007). Some of the committee's concerns are listed as verbatim bullet points below.

* We ... do not believe there is sufficient current symmetry between the IFRS literature and U.S. Generally Accepted Accounting Principles (GAAP) to warrant the elimination of the required reconciliation.

* While we would agree that progress has been made towards convergence of the two systems, it is not yet at the point where most reconciliations in SEC statements are labeled 'Not Applicable.

* If such a result were to occur, it would indicate the achievement of convergence- or at least a substantial harmonization, with the exception of items bearing inconsequential significance to investors (p.2).

* We would prefer to see concrete evidence that the two sets of standards are substantially equivalent before the reconciliation is eliminated. We suggest that the Commission undertake an evaluation of the IFRS/U.S. GAAP differences commonly found in the reconciliations, and periodically publicly disseminate and report upon such an inventory. We also suggest the development of a separate inventory of all the differences between the two sets of standards. The reconciliation requirement should be dropped only when the inventory of all identified differences has been satisfactorily resolved. "(p. 2)

* The differences among accounting standards are not our only concern. We are not yet certain that there is consistent auditing and enforcement of the application of IFRS. We understand that the international accounting firms currently assign highly experienced U.S. GAAP-trained practitioners to review the SEC filings of foreign issuers and the accuracy of the reconciliation as a matter of due course.....we view this process as critical in ensuring consistent application of accounting and auditing disciplines among international peers and the completeness of financial disclosures provided to U.S. investors. (p. 2) (The ITAC then suggested that the SEC compare the differences in the auditing and enforcement procedures between the IFRS and U.S. GAAP.)

* "While we respect the work of the IASB and its staff, we are concerned that the substance of the Proposed Rule is to recognize the IASB as a standard setter for purposes of the U.S. public capital markets, on virtually the same level as the FASB." (p.2)

Some other points in the letter referred to "the potential to inject a political, Euro-centric bias into standards set by the IASB" (p.3), the need for U.S. investors to learn IFRS, and the hindrance the proposal will have on the convergence process.

More recently, Charles Niemeier, a member of the Public Company Accounting Oversight Board (PCAOB) delivered a rather comprehensive address to the New York Society of CPAs in which he criticized both the elimination of the reconciliation requirement and the proposal to allow U.S. firms to employ IFRS. (Niemeier 2008) Some of his arguments echo the concerns of the IATC regarding the 20-F elimination. Niemeier avers that, based on the evidence he has reviewed, the reconciliation captured "value-relevant information" and that IFRS reporting has not yet resulted in convergence with, or comparability to U.S. GAAP." (Niemeyer 2008, 2) He stated that the move towards IFRS represented a capitulation. He summarized his position by quoting FASB Chairman Bob Herz, who stated, "We do have the best reporting system, but the rest of the world won't accept it." (Niemeier 2008, 2)

Niemeier also discussed (2008, 2) what he referred to as "myths" involving the adoption of IFRS, including that:

* IFRS are superior to U.S. GAAP because they are principles-based. Niemeier countered that IFRS are merely "younger" than U.S. GAAP and that over time it is likely to become more "rules-based". Furthermore, he warned that U.S. managers who employ IFRS for their flexibility will not have a defensible position if they mislead investors.

* Switching to IFRS will enhance financial reporting comparability. In a similar vein of the "Full IFRS Issue" discussed previously, Niemeier cited the case of certain French companies, who despite being required to employ IFRS, did so "in name only" and continued to use their home country standards for their financial reports, a term referred to by the French as "nostalgic accounting" and encouraged by local regulators.

* IFRS will strengthen investor protection in the U.S. Niemeier warned that the IFRS initiative would actually weaken regulatory enforcement by allowing more management discretion. Indeed, the Chairman of the International Accounting Standards Committee Foundation stated that stringent enforcement is unique to the U.S. and that "the SEC realizes that (its) attitude should change."

* The IASB's standard-setting process is protected from political and other influences. In this case, Niemeier cited Section 108 of Sarbanes-Oxley (SOX) that requires the SEC to determine that a private accounting standard-setter has satisfied certain criteria before it will recognize its accounting principles as U.S. GAAP. One of these is independent funding through, and the IASB's funding mechanism does not comply with the provisions of Section 108. Furthermore, although Niemeier states that although there is discussion about the structure of the IASB, much of it has "focused mainly on establishing mechanisms to give interested governments influence over the standard-setting." (Niemeier 2008, 3)

In a survey of individual investors, McEnroe and Sullivan (2006) found that over 85 percent agreed that foreign countries should be required to either employ U.S. GAAP or to reconcile to U.S. GAAP in order to be listed on U.S. stock exchanges. The respondents also perceived (80 percent) that if foreign firms were not required to comply with the Sarbanes-Oxley Act or U.S. GAAP to be listed on U.S. exchanges, that U.S. parties would be less inclined to invest their funds in such firms. Last, only 27 percent of the investors agreed that a coded stock symbol indicating compliance with international rather than U.S. GAAP should be sufficient for a foreign firm to be listed on a U.S. exchange.

Ucieda-Blanco and Osma (2004) studied the 20-F reconciliations to U.S. GAAP of firms using IASs over the period from 1995 to 2001. They found there to be an increasing number of adjustments being disclosed, but overall the materiality of the adjustments declined over this period. The most frequent adjustments were in the areas of expense capitalization, business combinations, assets revaluation, employee benefits, and stock compensation, although only asset revaluations and business combinations had a significant percentage of material adjustments. They concluded that although material adjustments still exist, U.S. GAAP and IASs appear to be converging.

In a more recent study, Henry et al. (2007) examined the 20-F reconciliations of 75 firms employing IFRS over the period from 2004-2006. They found evidence of convergence, although goodwill and pensions appeared to be the most dominant reconciliation areas. Their results also indicated that 28 percent of the firms had net income that was higher under IFRS than U.S. GAAP, while most of the firms reported lower stockholders' equity under IFRS as opposed to U.S. GAAP. They concluded that significant differences still exist and that given the potential for allowing U.S. firms to use IFRS, stakeholders should be aware of them.

Jack Ciesielski, an accountant and publisher of the Analysts' Accounting Observer, studied 137 foreign firms trading in the U.S. for 2006. He found that 63 percent of the companies had higher earnings under IFRS versus U.S. GAAP and that the median increase was 11.1 percent (Scannell and Slater 2008, A12).

RESEARCH METHOD

The previous two studies that have involved the differences between IFRS net income and shareholders' equity and their U.S. GAAP counterparts examined (1) the size of the gap, (2) whether one measure was systematically larger or smaller that the other, (3) if the gap was narrowing over time, and (4) the "value relevance" of the information provided by the information in the reconciliation using market-based tests. Our study extends the research by (1) determining the most significant adjustments reported for the year 2006, (2) examining the nature of the accounting standards that engendered those adjustments, and (3) projecting whether those adjustments are likely to continue to remain significant in the future.

We selected all the companies listed on the New York Stock Exchange that used an ADR (American Depositary Receipt) for the year ended December, 2006. From that group we selected all the companies that filed a Form 20-F reconciliation between International Financial Reporting Standards and U. S. GAAP. This exercise resulted in a total sample of 57 companies.

For each company, we scheduled all the reconciling items reported between U. S. GAAP and IFRS net income. Based on the similarity among the descriptive titles used by different companies, we combined some of the individual reconciling items. We then ranked the reconciling items based on frequency of occurrence and size of the item compared to the difference between IFRS and U. S. GAAP income. We decided to focus on those items that appeared as reconciling items on 20% or more of the companies selected. This process resulted in an in-depth examination of the following nine reconciling items:

Taxes--Deferred Taxes

Pensions and other post employment benefits

Financial Instruments

Minority Interest

Impairment, Goodwill, Intangibles

Business Combinations

Employee Compensation Costs

Capitalization

Amortization

Table 1 lists the reconciling items and ranks them by frequency of occurrence on 2006 20-F statements.

We then looked at (1) the explanations in Statement 20-F for the chosen reconciling items and companies, (2) the corresponding IFRS and SFAS standards for the individual reconciling items, and (3) the IASB and FASB agenda projects that are part of the convergence program. Based on this review, we believe that the following describes the most significant reconciling items as or December 2006 and the near term prospects for their reduction or elimination.

Taxes--Deferred Taxes

Reconciling items relating to deferred income tax allocation were the most frequently occurring issue. While the average difference as a percentage of net income was relatively low, in at least one case, the reconciling item was over ten times the net difference in IFRS vs. U. S. GAAP income (with other reconciling items offsetting this huge difference). Both the IASB (IAS 12: IASB 2004c) and the FASB (SFAS 109: FASB 1992) require the recognition of deferred tax assets and deferred tax liabilities resulting from differences in the reporting of income and the valuation of assets for financial and tax reporting.

There are a large number of differences, however, in the implementation of these standards. For example, it appears from an analysis of the 20-F of individual companies that some companies used different rates for computing taxes under IFRS than under U. S. GAAP based on the IFRS rule that "substantially enacted" rates should be used as opposed to the U. S. GAAP rule that an entity should not anticipate changes in future tax rates. Similarly, some companies reported tax differences associated with the fact that while both IFRS and U. S. GAAP call for the tax effects of items that are direct adjustments of stockholders' equity to be reflected in stockholders' equity or comprehensive income, U. S. GAAP requires that tax effects resulting from changes in rates must be reflected in operating income. Other companies reported differences based on different standards that apply as to whether a tax asset should be recognized and the different amounts of taxes that are required to be reported for share-based compensation schemes.

Even though these differences appear on the 20-F of a large number of companies and can be significant dollar amounts, they do not appear to reflect fundamental differences in the underlying companies. Nor do they appear to be the types of items that should be highlighted to users of financial statements. Furthermore, it does not appear likely that a company would choose to use IFRS or U. S. GAAP to "take advantage" of the differences in reporting for taxes. As a result, there appears to be a substantial opportunity for convergence of the two standards without losing important financial reporting information. The agenda for the convergence project calls for an exposure draft reconsidering IAS 12 (IASB 2004c) to be issued in 2008 and a new statement to be issued in 2009. This appears to be an important project because of the frequency of its occurrence as a reconciling item but it also appears that it is one area where convergence will be easily attained.

Pensions And Other Post Retirement Benefits

The second most frequent reconciling item was associated with pension and other postretirement benefits. Once again, the general accounting treatment is similar under both accounting regimes (Primarily IAS 19 (IAS 19: IASB 2004d) and SFASs 87, (FASB 1985a), 88, (FASB 1985b), 106, (FASB 1990), 132(R), (FASB 2003), and 158 (FASB 2006c). Both systems generally require that the costs associated with retirement benefits be recognized in the period which those benefits are earned by the employee rather than when they are paid.

Several of the companies that we reviewed had the pension costs associated with years prior to adopting IAS 19 (IASB 2004d). IFRS 1 allows those cost to be charged to equity while U. S. GAAP requires that these costs flow through the income statement. Other firms, however, had significant reconciling items associated with income from pension assets in some countries being directly reported on the income statement of sponsoring companies presumably because the funding vehicle was not sufficiently distinct from the sponsoring company. Other firms were subject to an IFRS limitation on the amount of prepaid pension costs which could be recognized in financial statements. Corresponding limits do not exist under U. S. GAAP.

These differences, while occurring less frequently than those related to deferred taxes, seem to be somewhat more consequential. The dollar amounts can be quite large as a percentage of reported income and, unlike the case of deferred taxes, it is easy to conceive that the management of a company might prefer one set of reporting standards over another to account for these costs. The different treatments provided for these types of cost may well significantly impair the ability of users to compare companies using different accounting standards. Permitting a company to choose its accounting standards might provide more accounting flexibility to management than many financial statement users would be comfortable with.

Post retirement benefits, including pensions, are an agenda item in the IASB/FASB convergence program. The current agenda (FASB 2008b) calls for an exposure draft in 2009 with a final IFRS in 2011. The significant differences in accounting for these costs will presumably continue to exist at least until that time and make the comparability of financial statements prepared under the different regimes quite problematic.

Financial Instruments

Almost half of the companies examined had reconciling items relating to financial instruments. While the average size and the range of differences are not as large as in the case of Pensions and Other Post Retirement Benefits, the textual description of the differences highlights a number of rather significant differences in the two accounting systems. IAS 32 (IASB 2005c) and 39 (IASB 2005d) and IFRS 7 (IASB 2005b) represent the primary guidance for the accounting for financial instruments under IFRS. U. S. GAAP has a number of separate standards dealing with topics related to financial instruments. SFAS 115 (FASB 1993b) and 133 (FASB 1993c) are arguably the primary authority while SFASs 114, (FASB 1993a) 140, (FASB 2000) 155, (FASB 2006a) 157 (FASB 2006b) and 158 (FASB2006c) deal with narrower issues. Both systems generally require fair value accounting but there appear to be quite significant differences permissible in the implementation of the standards.

Examples of significant difference that appeared in the analysis of 20-F include the following. Previously taken write-offs relating to certain investments were partially or fully reversed for a company reporting under IFRS while those reversals are not permitted under U. S. GAAP. Furthermore, certain assets were "derecognized" under IFRS standards whereas those amounts have to be retained on the balance sheet under U. S. GAAP. Some assets were reported as "available for sale" securities under IFRS but were required to be reported using the equity method for U. S. GAAP. Also, derivatives were categorized as hedges under IFRS where they did not qualify as such under U. S. GAAP.

These types of reconciling items represent significant differences in accounting under the two models and it is easy to conceive that management might have a preference for one method over the other. The accounting for financial instruments is similar to the accounting for pension and post retirement costs in the sense that quite significant differences exist and it is at least possible to visualize companies that would, if given the opportunity, choose one set of accounting principles over another in order to change the accounting presentation. Accordingly, this appears to be seems like a very significant area for concern and, while it is on the IAS's research agenda, no target date has been set for an exposure draft or new standard.

Minority Interest

An important reconciling item on the 2006 20-F's was labeled "Minority Interest." Perhaps the preferred term for this issue now is "Non-controlling Interest." Prior to the issuance of SFAS 160 (FASB 2008a) (effective for years beginning on or after December 15, 2008), U. S. GAAP generally treated non-controlling interest as an item separate from equity and income attributable to this interest was expensed in the computation of net income. IAS 27 (IASB 2008b) generally requires that non-controlling interest be included in equity and, therefore, there is no corresponding expense item in the income statement. It appears that almost all of the reconciling items on the 2006 statements were attributable to this issue. SFAS 160 (FASB 2008b) brought U. S. GAAP substantially in line with IFRS on this issue, so while the item was significant in 2006 reconciliations, our opinion is that it is unlikely to remain so in the future.

Impairment, Goodwill And Intangibles

While a number of companies had reconciling items classified as being related to the accounting for impairment and had separate reconciling items related to accounting for goodwill, in many other cases the issues were combined. Therefore, we have chosen to combine them as well. These items showed up on a large number of firms and frequently the amounts, as a percentage of the difference in income, were quite large. The U. S. GAAP rules governing these items are primarily in SFAS 142 (FASB 2001b) and 144 (FASB 2001c). The IAS rules are in IAS 36 (IASB 2004e) and 38 (IASB 2004f) as well as IFRS 3 (IASB 2008a).

With regard to impairment, two major issues appear to account for most of the reconciling items. First, unlike U. S. GAAP, IFRS permit the reversal of impairment losses under certain circumstances. Second, under U. S. GAAP, impairment losses are only triggered if undiscounted projected cash flows from an asset are below its carrying value. A number of firms took impairment losses for IFRS statements that could not be taken on U. S. GAAP statements.

With regard to goodwill and intangibles, the major reconciling items (ignoring impairment issues) appeared to be related to transitional issues. For example, one company converted to IFRS on January 1, 2004 and elected not to reinstate goodwill that had previously been written off under national accounting standards. Under U. S. GAAP that election is not available and the goodwill had to be reinstated. These differences, however, generally had a relatively small impact on the income statement.

The differences in the treatment of impairment of assets and the possible reversal of impairment losses seem to be the most consequential issues in this area. Differences caused by these items can be very large. It follows then that resolving these differences would be important in making the two accounting models more comparable; however, it appears that addressing impairment issues is not part of the IAS current agenda.

Business Combinations

U. S. GAAP (SFAS141: FASB 2001a) and IFRS rules (IFRS 3: IASB 2008a) are both based on the purchase method of accounting. For 2006, nevertheless, there were differences in implementation that resulted in the largest reconciling items between IFRS and U. S. GAAP.

Three items appeared to account for the major differences categorized under business combinations under the 20-F. First, restructuring costs incurred following the acquisition of a company (and therefore categorized under business combinations) are generally recognized earlier under IFRS than under U. S. GAAP. Second, as of 2006, IFRS reported the fair market value of the total net assets acquired in an acquisition while U. S. GAAP reported fair market value in proportion to the share of ownership acquired. Third, contingent consideration was typically treated as part of the purchase price under IFRS whereas under U. S. GAAP a company had to meet more stringent standards before contingent consideration could be included as part of the acquisition price.

Both standard setters have revised their GAAP in this area since 2006 with the new rules generally effective for 2009. These new rules appear to resolve most of the items that caused differences in 2006; therefore it appears that the substantial reconciling items for business combinations that appeared in 2006 are not likely to be significant in the future.

Employee Compensation Costs

Share-based payments are treated under IFRS (IFRS 2: IASB 2004a) in a manner substantially similar to the treatment required under SFAS 123(R) (FASB 2004). The main differences under compensation were related to severance costs and costs related to the discontinuance of benefit plans. The relevant U. S. GAAP rules are mainly in SFASs 88 (FASB 1985b) and 146 (FASB 2002) and the relevant IAS rules are primarily in IAS 19 (IASB 2004d). The general rules governing the recognition of liabilities also appear to have generated some differences.

Examples of typical reported differences include the following. One company recorded a severance pay obligation mandated under Italian law as a defined benefit plan for IFRS reporting but elected to report the present value of the termination obligation for U. S. GAAP. Another company recognized a liability for certain severance costs in 2004 for IFRS statements but that did not meet the standards for recognition until 2005 for U. S. GAAP.

Standing alone, these differences occurred fairly frequently in 2006 and some of the reconciling items were quite significant. When combined with the differing treatment of pensions and other post-retirement benefits, these two represent a very significant difference between U. S. GAAP and IFRS. Presumably these issues will be addressed in the review of IAS 19 (IASB 2004d) mentioned above and in the portion of the Conceptual Framework project dealing with the recognition of liabilities

Capitalization

Differences resulting from different capitalization rules occurred fairly frequently and many of them were quite substantial. The review of the reconciling items in the 20-F suggested that most of the items were associated with the capitalization of interest costs (IAS 23: IASB 2007) and SFAS 34 (FASB 1979) and the treatment of Research and Development Expenses (IAS 38: IASB 2004f) and SFAS 2 (FASB 1974).

In 2007, IAS 23 (IASB 2007) was revised to require the capitalization of interest costs for IFRS in a manner parallel to the rules of SFAS 34 (FASB 1979), so one of the major items for 2006 appears to have been eliminated. The differing treatment of Research and Development Expenditures does not appear to be on the agenda to be revisited. The 20-F's generally did not disaggregate R &D from other capitalization issues, so it is difficult to tell the size of the related adjustments. Even though it did appear in 2006 reconciliations, the circumstances under which R & D are capitalized for IFRS are quite restrictive, so it is at least arguable that these reconciling items will not be significant in the future.

Amortization

The rules governing the amortization of intangibles under IFRSs 38(IASB 2004f) and IFRS 3 (IASB 2008a) are substantially similar to U. S. GAAP: SFASs 141 (FASB 2001a) and 142 (FASB 2001b). In fact, although this is an item on the convergence agenda of the IAS and is the subject of research activity at the IASB, it does not appear to be a currently active agenda item.

The reconciliation items that appeared in 2006 appear to be primarily related to valuation issues for firms that changed from a national standard to IFRS. These transitions resulted in differing values for intangibles, including goodwill, and some of those differences result in different charges to income in 2006. The fact that the current practice seems to be so similar under the two accounting systems suggests that perhaps no further action should be taken. On the other hand, where these differences do occur, they can be extraordinarily large.

SUMMARY AND CONCLUSIONS

While substantial progress has been made in the convergence of U. S. GAAP with IFRS, some major differences existed in 2006 and appear to remain extant today, a situation which can have a very substantial impact on reporting income statement items. These differences will make comparing financial results for companies reporting under the two different accounting models quite difficult and could encourage some U. S. companies to adopt international standards solely for the different financial accounting alternatives that may be available. Based on our review, it seems that, at a minimum, there should be more conformity in the areas of pensions and other post retirement benefits; financial instruments; and impairment, goodwill, and intangibles before the U. S. companies are allowed to choose between U.S. GAAP and IFRS, as proposed by the SEC beginning in the year 2010. Furthermore, our findings lead us to agree with the Financial Reporting Committee of the American Accounting Association (AAA 2008a) that we do not support the SECs ruling that eliminates the U.S. GAAP-IFRS reconciliation requirement at this time. In addition, our results induce us to disagree with Financial Accounting Standards Committee of the AAA (AAA 2008b) which endorses the SEC proposal that supports the ruling and also recommends that U.S. firms also be allowed to choose between IFRS and U.S. GAAP. Finally, given that substantial differences between IFRS and GAAP remain, we feel that the SEC' roadmap to require all U. S. firms to adopt IFRS by 2014 is unwarranted without substantial progress on convergence in the areas we have noted.

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Table 1: 20-F Items Ranked by Frequency of Occurrence

Data Extracted from 57 Companies Reporting Using 20-F for 2006

                          Number of         Median           Mean
                       Times Appeared    Percentage *    Percentage *
                       as Reconciling
                            Item

Taxes, Deferred              49              7.1%             4.2%
Taxes

Pensions and other           37            -19.8%           -33.1%
post-employment
benefits

Financial                    24             -3.3%            -9.9%
Instruments

Minority Interest            23              0.2%             7.7%

Impairment **                21              1.0%            33.1%

Business                     18             -6.5%          -186.7%
Combination

Employee                     17             -1.8%           -18.7%
compensation costs

Capitalization               15             -7.5%           -29.8%

Amortization                 13            -14.8%           -62.1%

* Reconciling item as a percent of the absolute value of the
reported difference between income computed under U. S. GAAP and
income computed under IFRS.

** The descriptive information in the 20-F statements indicated that
sometimes the title impairment dealt with goodwill and intangibles
but other times it dealt with other impairments. The level of detail
in the 20-F did not permit recategorizing these items. The
discussion in the text combines these two items.
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