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IFRS and you: what are the implications of the European accounting revolution?

Article Excerpt
IN SEPTEMBER 2002, the Parliament and Council of the European Union (EU) introduced the biggest change to financial reporting in Europe in 30 years. They approved a new Accounting Regulation that would require all EU-listed companies to follow International Financial Reporting Standards (IFRS) in their consolidated financial statements as of 2005. This decision is now affecting thousands of companies in all 28 countries of the European Economic Area (EEA), including the 25 EU countries plus Norway, Iceland, and Liechtenstein. The compelling reason for this Regulation was the need to develop an integrated financial services market in the EU. Ultimately the change to IFRS will lead to transparency in financial statements, which should increase market efficiency, reduce the cost of raising capital, and thereby eliminate barriers to cross-border trading.

The new EU legislation has resulted in rapid change in financial reporting across the world. As of January 10, 2006, accounting firm Deloitte Touche Tohmatsu reported, 70 countries require and 25 countries permit listed companies to use IFRS for domestic reporting. As IFRS become the prevailing global accounting standard, their impact on U.S. generally accepted accounting principles (U.S. GAAP), U.S. companies, and capital markets will increase.

NEW APPROACH TO ACCOUNTING HARMONIZATION

The EU includes countries with extremely diverse economies. Even highly industrialized member states, such as Germany and the U.K., provide sharp contrasts in style and orientation when it comes to their accounting and financial reporting practices. In the late 1970s and 1980s, the quality of the financial information published by European companies increased considerably from implementing the EU Accounting Directives that were designed to align accounting requirements in Europe. But the Directives are broad guidelines and allow many options, so they didn't bring sufficient quality and uniformity of financial reporting within the EU.

In the 1990s, growing competition and globalization pushed EU companies to seek capital abroad. But international capital markets didn't accept financial statements prepared on the basis of the Accounting Directives. Consequently, many multinational companies in Europe had to prepare a second set of financial statements using either U.S. GAAP or International Accounting Standards (IAS) promulgated by the International Accounting Standards Committee (IASC) based in London. In the U.S., the Securities & Exchange Commission (SEC) accepts reports prepared under foreign accounting standards but requires a reconciliation of the company's net income and stockholders' equity to its net income and equity under U.S. GAAP. This costly requirement involves almost as much work as converting to a full set of U.S. GAAP statements.

Under these circumstances the European Commission, in consultation with the member states, started to develop a new accounting strategy in 1995. They considered five possible alternatives:

Mutual recognition agreement with the United States. Since the financial statements prepared by U.S. companies under U.S. GAAP were already recognized in all member states, the European Commission was in a weak bargaining position and spurred little interest in the U.S. for this initiative.

Exclusion of EU multinationals from the scope of applying the Accounting Directives. The Commission couldn't accept this option because most companies would probably choose U.S. GAAP. It was unacceptable that a foreign standards setter, over which the EU had no influence, would determine the financial reporting practices of large European companies.

An update of the Accounting Directives. Since member states implement Directives by incorporating them into national law, this solution was unworkable because of difficulties in achieving consensus among member states.

Creation of the European Accounting Standards Board. Establishing the pan-European standards-setting body was...

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