Client Alert
Foreign Private Issuers Preparing Financial Statements in Accordance with IFRS are No Longer Required to Reconcile to U.S. GAAP
April 17, 2008
On March 4, 2008, final rules adopted by the Securities and Exchange Commission (SEC) went into effect that eliminate the need for foreign private issuers who prepare financial statements in accordance with International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) to reconcile their financial statements to U.S. generally accepted accounting principles (U.S. GAAP).1 This significant change to foreign private issuer financial reporting requirements is a major step towards the SEC’s goal of having a single, global accounting standard.2
Background
Prior to March 4, 2008, the SEC required reporting foreign private issuers to provide a reconciliation of their financial statements to U.S. GAAP, regardless of the accounting standards on which the foreign private issuer statements were based. The rationale for the reconciliation requirement was that there did not exist a set of widely accepted, high-level, international accounting principles on which both issuers and investors could rely. Progressive globalization of the capital markets has stimulated the development of IFRS as issued by the IASB such that the SEC now feels comfortable relying on financial statements prepared in accordance with IFRS without the need for U.S. GAAP reconciliation. IFRS has achieved global acceptance outside of the U.S., with approximately 100 countries currently requiring or allowing the use of IFRS, with many more expected to do so in the coming years. Illustrating this trend, the European Union (EU) issued a directive to require all companies incorporated in an EU member state and whose securities are listed on an EU regulated market to use IFRS beginning with their 2005 financial year.3
Rationale for Eliminating the U.S. GAAP Reconciliation Requirement
The SEC had a two-fold rationale for eliminating the U.S. GAAP reconciliation requirement. On one hand, the SEC was confident that the accounting principles of IFRS as issued by the IASB were robust enough to provide investors with salient financial data from foreign private issuers. On the other hand, the SEC believed that accepting IFRS-based financial statements without U.S. GAAP reconciliation would expand capital market access by:
- encouraging more foreign private issuers to enter the U.S. public markets;
- causing more foreign private issuers to adopt IFRS; and
- promoting the gradual convergence of U.S. GAAP and IFRS.
New Rules4
The ability of foreign private issuers to omit U.S. GAAP reconciliation of their financial statements is limited to those issuers that (i) file on Form 20-F and (ii) prepare their financial statements in accordance with IFRS as issued by the IASB. Under amended Form 20-F, a foreign private issuer “is eligible to omit the reconciliation to U.S. GAAP if it states, unreservedly and explicitly in an appropriate note to the financial statements, that its financial statements are in compliance with IFRS as issued by the IASB. Also, the independent auditor must opine in its report that the financial statements comply with IFRS as issued by the IASB.”5 A foreign private issuer may also take advantage of the new reconciliation exemption if it uses a jurisdictional variation of IFRS but is also in compliance with IFRS as issued by the IASB (and it so states, and its auditor so opines).6
A foreign private issuer that submits financial statements in accordance with IFRS as issued by the IASB will be able to omit the reconciliation to U.S. GAAP for both its annual audited financial statements and its unaudited interim financial statements if the interim financial statements comply with IAS 34.
General Instruction G to Form 20-F provides for an accommodation which allows foreign private issuers in their first year of reporting under IFRS as issued by the IASB to file two years rather than three years of statements of income, changes in shareholders’ equity and cash flows. Although this accommodation was available to any foreign private issuer, it was originally intended for the benefit of EU-based companies transitioning to IFRS in accordance with the EU directive discussed above. As such, it was scheduled to expire after the first financial year starting on or after January 1, 2007, having expended its utility for such EU-based issuers, who had to adopt IFRS starting in financial year 2005. However, the SEC has now extended this accommodation indefinitely to accommodate the expected rise in filers who will use IFRS in the coming years as a result of reconciliation omission and the push for globalization of IFRS.
The SEC estimates that as of the effective date of these amendments, approximately 140 foreign private issuers were able to omit the U.S. GAAP reconciliation.7 The SEC’s analysis also indicates that significant cost savings will inure to the benefit of these issuers and that further benefits are expected from the increase in capital formation by foreign companies in the U.S. capital markets.
1. Release Nos. 33-8879; 34-57026; International Series Release No. 1306; File No. S7-13-07, Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation to U.S. GAAP (December 21, 2007), available at http://www.sec.gov/rules/final/2007/33-8879.pdf.
2.See Release No. 33-8831; 34-56217; IC-27924; File No. S7-20-07, Concept Release on Allowing U.S. Issuers to Prepare Financial Statements in Accordance with International Financial Reporting Standards (August 7, 2007), available at http://www.sec.gov/rules/concept/2007/33-8831.pdf.
3. Consistent with Form 20-F, IFRS and general usage outside the United States, the SEC uses the term “financial year” to refer to a fiscal year. See Instruction 2 to Item 3 of Form 20-F.
4. In addition to the amendments discussed in this section, the SEC also adopted various conforming amendments to rules, forms and regulations that ensure uniform application of the omission of U.S. GAAP reconciliation for foreign private issuers who file financial statements in accordance with IFRS as issued by the IASB.
5. Release Nos. 33-8879; 34-57026; page 30.
6. The EU has allowed a carve-out of IAS 39 relating to hedge accounting in its accepted IFRS standards. The SEC has allowed an accommodation for foreign private issuers who have utilized this IAS 39 carve-out in the past to omit U.S. GAAP reconciliation for their first two financial statements that end after November 15, 2007 if they are otherwise in compliance with IFRS as issued by the IASB.
7. Release Nos. 33-8879; 34-57026; page 82.
Read about recent SEC proposals relating to foreign private issuers:
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