Robert D. Strahota

1
CONVERTING TO IFRS A U.S. PERSPECTIVE

• Robert D. Strahota
• Assistant Director, Office of International
  Affairs
• U.S. Securities and Exchange Commission
• Russian Corporate Governance Roundtable
• Moscow
• November 11-12, 2004
• As a matter of policy, the Commission disclaims
  responsibility for any private publications or
  statements by any of its employees. The views
  expressed are those of the speaker and do not
  necessarily reflect the views of the Commission,
  individual commissioners or the speakers
  colleagues on the staff of the Commission.

2
This Presentation Covers

• Principal steps that have been taken in the U.S.
  to facilitate the development and use of
  international financial reporting standards
  (IFRS), including conversion issues that may be
  of relevance to other countries planning to adopt
  IFRS
• U.S. efforts to foster high quality,
  internationally acceptable accounting and
  auditing standards
• Some thoughts on where we are in the process

3
SEC and International Financial Reporting
Standards

• SEC continues to work directly and through the
  International Organization of Securities
  Commissions (IOSCO) to encourage the adoption and
  use of high quality IFRS
• Observed meetings of the former IASC
• Supported 2000 IOSCO resolution re use of 30 core
  international accounting standards (IAS) in cross
  border offerings and listings
• Participates in accounting standards improvement
  projects
• Involved in restructuring and creation of IASB
• Observes standards-setting and interpretation
  work of new IASB
• SEC has already accepted use of IFRS by foreign
  companies with reconciliation to U.S. GAAP
• SEC has already accepted three IAS without
  reconciliation IAS No. 7 (cash flow statements),
  No. 22 (business combinations) and No. 21
  (operations in hyperinflationary economies)

4
Foreign Companies Conversion to IFRS

• Less than 50 of 1200 foreign companies now use
  IFRS in their SEC reports
• All of the six Russian companies subject to SEC
  filing requirements have elected to prepare their
  financial statements using U.S. GAAP
• Per a September 2003 EU regulation, IFRS will be
  required effective January 1, 2005 for
  approximately 7,000 EU companies, including
  approximately 450 EU companies that file reports
  with the SEC
• Many other jurisdictions also are converting to
  IFRS as of this date
• To accommodate IFRS conversion for foreign
  companies that file SEC reports, the SEC issued
  proposals in February 2004 that would permit
  filing of two instead of three years of IFRS
  financial statements in the first annual report
  filed by a foreign issuer in accordance with IFRS

5
SEC Proposals re Conversion to IFRS

• Proposals would apply to companies adopting IFRS
  for the first time, and no later than calendar
  2007
• Proposals would require a company must to state
  unreservedly and explicitly that its
  general-purpose financial statements comply with
  IFRS the audited financial statements may not be
  subject to any qualification relating to the
  application of IFRS.
• If IFRS are used, reconciliation to US GAAP would
  still be required
• All audited financial statements filed with SEC
  must be audited in accordance with U.S. generally
  accepted auditing standards (which now means
  auditing standards of the PCAOB) (U.S. GAAS), and
  U.S. independence rules apply
• SEC staff will review the expanded universe of
  IFRS-based reports in considering future
  acceptance of IFRS reporting without US GAAP
  reconciliation

6
Key Issues Relating to Conversion

• The SEC proposals, IFRS and CESR guidance
  identify several key issues raised by conversion,
  although there is not complete agreement
  regarding resolution
• IFRS give rise to a new basis of accountability
  and would require disclosure regarding
  reconciliation of IFRS balance sheet and income
  statement information to previous GAAP
  information
• To provide at least three years of comparable
  data, the SEC proposals would require companies
  presenting only two years of IFRS financial
  statements in the transition year report to
  include a note to the audited financial
  statements which presents three years US-GAAP
  condensed balance sheet and income statement data
  without any required footnote explanation.

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Key Issues Relating to Conversion - continued

• Interim financial statements during the first
  year of IFRS
• Foreign companies are not required to file
  interim financial reports with the SEC, but if
  interim financial information were required,
  e.g., in an offering document because of the age
  of audited financial statements, SEC proposals
  would require comparative interim period
  information in accordance with or reconciled to
  U.S. GAAP
• CESR guidance would not preclude use of previous
  GAAP for interim financial statements but
  indicates a preference for reporting on the basis
  of IAS 34 or IAS/IFRS recognition and measurement
  principles that will be used for year-end IFRS
  financial statements
• SEC proposals would require MDA to focus on the
  IFRS financial statements, would prohibit side-by
  side comparisons of IFRS and previous GAAP
  information and would require cautionary language
  where previous GAAP information is used CESR
  guidance would permit side-by-side comparisons
  with explanatory reconciliation

8
Effect of EU Conversion to IFRS on Non EU
Companies

• EU regulation requiring conversion to IFRS
  provides that EU member states to exempt non-EU
  companies from IFRS requirements up to 2007 in
  the case of
• Companies that are listed both in EU and on a
  non-EU exchange and are using another set of
  internationally accepted standards
• Companies that have only publicly-traded debt
  securities
• In light of the 2007 deadline, on June 29, 2004
  EC issued a mandate to CESR to assess the
  equivalence with IFRS of U.S. GAAP, as well as
  Canadian and Japanese standards CESR-Fin, a
  standing committee of CESR, will direct the work
  and report to CESR
• Resolution of this issue will affect the
  attractiveness of EU markets e.g., Eurobonds

9
SEC-CESR Cooperation Will Improve International
Coordination in Implementing and Enforcing Use of
IFRS

• 2004 Memorandum of Understanding between CESR and
  the SEC provides for consultation and cooperation
  on a wide range of issues affecting the
  organizations constituencies
• IFRIC will be responsible for issuing IFRS
  interpretations but individual country regulators
  do not relinquish their authority to interpret
  and enforce IFRS
• It is expected that potential conflicts regarding
  interpretation and enforcement of IFRS will
  minimized by SEC-CESR consultation, and also by
  consultation within IOSCO

10
IOSCO Initiatives Regarding the Financial
Reporting Process and Its Oversight

• May 2000 IOSCO resolution recommending that IOSCO
  members permit the use of 30 core IAS,
  supplemented by reconciliation, disclosure and
  interpretation, for cross border offerings and
  listings
• In light of the many changes that have been made
  in the core IAS as well as adoption of new
  standards, an updated IOSCO resolution is being
  prepared to support IFRS as a whole, support
  IASBs independence, and explain IOSCOs role vis
  a vis IFRS and the IASB
• In February 2004, the IOSCO Technical Committee
  approved a Regulatory Interpretations of IFRS
  Project with the goal of encouraging cooperation
  and consultation among IOSCO members in the
  application and interpretation of IFRS. IOSCO
  Standing Committee 1 is to develop a consultation
  to be circulated to all IOSCO members regarding
  this project

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IOSCOs Position on Auditor Oversight

• IOSCOs October 2003 Statement of the Technical
  Committee regarding Principles of Oversight
  reflects international consensus that within each
  jurisdiction auditors, auditing standards,
  independence, ethical standards and quality
  control procedures, should be
• subject to oversight by a regulatory body that
  acts and is seen to act in the public interest
  and that
• disciplinary processes carried out or overseen by
  a independent body that is not under the control
  of the auditing profession

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SEC-PCAOB oversight of the auditing profession is
one (not the only) model for auditor oversight

• PCAOB is a non-profit organization whose five
  board members are appointed by the SEC after
  consultation with the Chairman of the Federal
  Reserve Board and Secretary of the Treasury no
  more than two board members may come from the
  auditing profession
• PCAOB has authority to establish audit standards,
  related attestation standards, and independence
  quality control and ethics standards to be used
  by registered public accounting firms in audits
  of public companies financial statements filed
  with SEC
• PCAOB has comprehensive authority to inspect,
  investigate, require reports, testimony and
  documents from, and sanction registered public
  accounting firms and associated persons for
  violations of SOX, securities laws and
  professional standards, including failure to
  reasonably supervise associated persons and
  failure to cooperate with an investigation
• SECs oversight authority includes authority to
  approve and amend Board Rules notice of Board
  investigations authority to inspect and sanction
  the Board, including censure and removal of
  members review of Board disciplinary actions
  and oversight of the Boards budget and funding
  process

13
Prospects for SEC Acceptance of IFRS Without U.S.
GAAP Reconciliation

• The SEC Concept Release, issued in February 2000,
  requested comment on issues relating to quality
  of the standards, interpretation, application,
  auditing, and enforcement
• Importance of a global financial reporting
  infrastructure was emphasized, including
• A comprehensive body of standards
• High quality of these standards, including
• Consistency
• Transparency
• Full disclosure
• Rigorous interpretation and application of the
  standards
• Assessment of the financial reporting
  infrastructure includes auditing and enforcement
  issues
• International regulatory cooperation is critical

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SEC Concept Release Aftermath

• Comment letters expressed a variety of views
• Accounting convergence work underway holds out
  tremendous potential for investors and companies
  seeking to allocate and raise capital on a global
  basis
• Adoption of IFRS to occur in European Union and
  some other countries should provide answers to
  some of the questions raised in the concept
  release
• SEC staff currently considering steps that would
  need to be taken to eliminate reconciliation from
  IFRS to U.S. GAAP
• No specific timetable has been adopted.

15
Convergence of Accounting Standards

• IASB and FASB October 2002 MOU re convergence of
  IFRS and U.S. GAAP
• Convergence is being implemented in several ways,
  including
• Short term efforts focused on discrete areas
  where it is possible to readily identify the best
  standard
• An IASB representative at the FASB
• Joint projects on major, fundamental areas
• Longer term research, studies and projects to
  come
• Consideration of convergence potential in all
  FASB decisions
• Convergence dialogue has identified the need for
  a single conceptual framework (a longer-term
  project now underway)
• Unfortunately, convergence can be affected by
  politics e.g. EU acceptance of IAS 39 and 32,
  now compromised, and U.S. accounting for stock
  options, now deferred for six months
• SEC fully supports convergence efforts and
  believes the focus should be on developing high
  quality standards. It does not view convergence
  as a one way street and is prepared to accept
  convergence from a U.S. GAAP standard to a better
  IFRS, but SEC also opposes lowest common
  denominator convergence

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SEC Chief Accountant Donald T. Nicolaisen
recently statedIn order to realize the
benefits of truly international financial
reporting, we need convergence in all areas ---
accounting, auditing and disclosures.
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Where Are We in the Process?

• Progress in all three of these areas is
  encouraging
• The global infrastructure for IFRS is
  substantially in place in light of IASBs
  reorganization and related efforts underway to
  coordinate interpretation and enforcement of IFRS
• The EUs decision to use IOSCOs Nonfinancial
  Disclosure Standards as the base level for
  disclosure in the EUs Prospectus Directive and
  the SECs earlier adoption of these standards has
  contributed substantially to their international
  acceptance
• While encouraging, progress regarding the global
  infrastructure for auditing standards is not
  complete. IFAC is not a body independent of the
  auditing profession and efforts to establish a
  Public Interest Oversight Board overlay are
  ongoing
• There much less consensus over what constitutes
  high quality, international acceptable auditing
  standards and what changes need to made in
  current International Standards of Auditing

18
The Sarbanes-Oxley (SOX) Response to Auditing
Failures in the U.S. Has Significantly Changed
U.S. Auditing Standards

• On May 27, 2003, the SEC implemented Section 404
  of SOX by requiring domestic and foreign issuers
  to include in their annual reports a management
  report on internal control over financial
  reporting, Among other things, the report must
  include
• Managements assessment of the effectiveness of
  the internal control as of the end of the last
  fiscal year (any material weaknesses must be
  disclosed and if they exist, management cannot
  conclude that internal control is effective)
• A statement that the issuers independent
  accountants have issued an attestation report on
  managements assessment
• SOX also required the PCAOB to adopt rules that
  will require the independent auditor to describe
  in its audit report the scope of its testing of
  the internal control structure and procedures of
  the company, and to present (in such report or in
  a separate report)
• The findings of the auditor from such testing
• An evaluation whether the internal control
  structure and procedures achieve substantially
  the principal internal accounting control
  requirements of the Securities Exchange Act of
  1934

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Changes in U.S. Auditing Standards

• The new internal control audit requirement
  differs from the independent auditors existing
  obligation under U.S. GAAS to evaluate internal
  controls of the company for purposes of planning
  the scope of the audit e.g., the requirement
  envisions that the internal control evaluation
  would encompass an evaluation of the
  effectiveness of a companys audit committee
• This requirement is in addition to the
  independent auditors obligation under SOX to
  attest to managements report and assessment of
  the internal control structure and procedures for
  financial reporting
• This new requirement has been characterized as a
  sea change and as a breakthrough that requires
  an integrated approach to the audit process. See
  PCAOB Standard No. 2 on audits of internal
  controls over financial reporting
• Because this change in U.S. practice is so new
  and has yet to gain international acceptance, it
  suggests a scenario whereby any U.S. acceptance
  of IFRS is likely to still require adherence to
  U.S. GAAS, as now prescribed by the PCAOB

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Thank you

• Questions?