The Language of Business is Changing: Do You Speak IFRS?

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What attorneys need to know
In November 2008, the Securities and Exchange Commission (SEC) released a proposed roadmap outlining milestones that, if achieved by 2011, could lead to the mandatory transition to International Financial Reporting Standards (IFRS) starting in fiscal years ending on or after December 31, 2014. It also outlines additional criteria that would allow certain other issuers to elect to use IFRS as early as 2009. The roadmap follows previous action by the SEC in December 2007, when they amended rules to allow foreign private issuers to file financial statements under IFRS without a reconciliation to U.S. Generally Accepted Accounting Principles (U.S. GAAP).

IFRS is a comprehensive, globally accepted set of accounting standards utilizing a principles-based approach with a greater emphasis on interpretation and application of those principles, aiming at best reflecting the economic substance of transactions. It is a less extensive body of literature than U.S. GAAP with limited industry guidance and less detailed application guidance.

• IFRS totals approximately 2,330 pages
  • If you printed out both sets of standards
    • The IFRS stack would rise to just above your ankles
    • The U.S. GAAP stack would be several feet over your head

IFRS requires a much greater exercise of judgment, supported by contemporaneous analysis and documentation. In other words, if you were driving to the beach, U.S. GAAP would likely give you a map and turn-by-turn directions to the lifeguard stand, while IFRS would likely give you a compass and point you in the general direction of the sand.

Today, more than 100 countries permit or require IFRS for listed companies, with more than 40 percent of the Global Fortune 500 using IFRS. Stock exchanges in the 85 countries that require IFRS comprise 35 percent of the global market capitalization, compared to 25 percent of the global market capitalization held by U.S. exchanges ₁.

The European Union requirement for member countries to use IFRS began in 2005 and several major countries have plans to adopt or converge to IFRS in the very near future, including: Brazil (2010); Canada, India, Japan, and South Korea (2011). A recent Deloitte survey of over 200 finance professionals showed that if given the choice, 42 percent would consider adopting IFRS before 2014.

There are over 200 key differences between the standards. Examples of pervasive differences are the lack of ‘bright-line’ rules under IFRS, such as when accounting for leases, and IFRS revenue recognition guidance being significantly less extensive than U.S. GAAP, which can pose many challenges as revenue recognition is the number one financial statement fraud risk ₂.

The time is now for companies, and the attorneys that serve them, to understand the impact of IFRS.

How will IFRS impact law firms and attorneys?
The transition to IFRS in the U.S. will have wide-reaching consequences for corporate clients, and the accounting and legal professions as well. Continued interaction between counsel and accountants at various stages of transition, implementation, and subsequent monitoring will be essential to ensure a successful outcome. This could be particularly critical given the pervasive impact across companies, including finance and accounting processes, controls, internal reporting, tax structures, treasury management, compensation arrangements, and contracting, among others. Several areas of your practice may be impacted as follows:

• Corporate attorneys that serve management and boards should already be involved in IFRS discussions or plan on doing so in the near future. Strong documentation, policies, procedures, and protocols will be necessary to ensure consistent and uniform application of IFRS across organizations to reduce the risk of litigation based upon the application of principles, and use of management’s judgments and estimates
  
• Attorneys involved in drafting contracts with accounting provisions will need to consider the impact of IFRS on earn-outs, credit agreements, purchase agreements, sales contracts, and bonus plans, among others, as the key drivers of these, such as reported earnings, may differ under IFRS
  • Contracts drafted to support specific accounting results for leases, derivatives, and securitizations will have to be carefully analyzed, as the requirements will change
  • Additionally, contracts with existing U.S. GAAP or local GAAP provisions, such as debt covenants or income-sharing arrangements, would need to be recalculated if they included earnings before interest, taxes, depreciation and amortization (EBITDA) or other earnings-based calculation
  • Furthermore, volatility of earnings as a result of greater fair value reporting under IFRS could trigger “material adverse change” provisions in contracts
  • Finally, contracts with “frozen GAAP” provisions, where financial statements are required to be prepared applying the same GAAP used at the time the initial agreement was entered into, would need to be assessed if transitioning from one accounting method to another in order to avoid maintaining two sets of books and records
• Merger and Acquisition (M&A) attorneys may witness an increase in cross-border transactions or an increasing number of deals where IFRS is the predominant prescribed accounting method. In addition, the structure of business transactions may be impacted by the difference in classification of debt versus equity under IFRS
• White-collar defense and corporate investigation attorneys may see a shift in cases to IFRS-based regulatory proceedings or disputes. The level of documentation to support management’s judgments and estimates employed to support their reasoning may be key in these cases
• Accountants and malpractice attorneys will need to prepare themselves for the change in the way audits are performed under IFRS and the requisite new auditing methodologies and processes
• Tax attorneys and accountants will need to work with their clients to strategize and reorganize tax structures that may be significantly impacted by IFRS

A PDF of this information is provided for your convenience below. 

Related content
Resource: IFRS Resource Library

_{1 August 27, 2008 speech by SEC Chairman Christopher Cox.
2 According to the Deloitte Forensic Center Study, "Ten Things About Financial Statement Fraud," June 2007}

_{This publication contains general information only and Deloitte Financial Advisory Services LLP, Deloitte LLP and related entities are not, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.}

_{Deloitte Financial Advisory Services LLP, Deloitte LLP and related entities shall not be responsible for any loss sustained by any person who relies on this publication.}

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