In my previous column, I noted that U.S. CFOs have been wasting time and money in anticipation of an event that will not happen. Specifically, U.S. companies will not be forced to switch from using U.S. generally accepted accounting principles (GAAP), as we know GAAP today, to using international financial reporting standards (IFRS), as we know IFRS today.
I also noted that most U.S. CFOs are unprepared for several related phenomena that will happen and that, in many cases, are already under way. Topping that list are the profound changes to U.S. GAAP and IFRS that will result from the ongoing efforts of the U.S. Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) to improve and converge their respective standards. Most of the boards’ work is focused on developing common standards that will be very different from existing standards.
Beyond these few certainties, there are many uncertainties associated with IFRS, especially from a U.S. perspective. Here’s how U.S. CFOs can plan intelligently for the future despite all of the unknowns.
First, financial executives should identify key areas of uncertainty — those areas for which different actual outcomes would have significantly different consequences. It’s also important to identify relationships among areas of uncertainty, including how outcomes might influence each other or be influenced by common factors.
While different companies will reach different conclusions regarding their key areas of IFRS uncertainty, the companies I’ve worked with have most frequently identified the following four key uncertainties:
• the degree to which standard-level convergence between U.S. GAAP and IFRS will be attained;
• the degree of uniformity in other countries’ adoption, interpretation, and application of IFRS;
• the decision of the U.S. Securities and Exchange Commission (SEC) with regard to the use of future IFRS by public U.S. companies; and
• whether the private-company standard-setting process will remain closely coupled to the public-company standard-setting process in the United States.
What Are the Possibilities?
For planning purposes, there’s a big difference between not knowing what will happen and not knowing what might happen. The CFO who can imagine a reasonably complete and realistic set of possible future scenarios can plan effectively. So let’s examine the possible outcomes for each of the four key areas of uncertainty identified above.
Standard-level convergence between U.S. GAAP and IFRS is very much a matter of degree. Currently, at the standard level, IFRS and U.S. GAAP exhibit a large number of similarities — and a much larger number of differences. The two sets of standards will surely become more similar over time, and eventually they could end up identical to each other. But given the outcomes and pace of the FASB and IASB convergence efforts to date, it’s understandable that many, if not most, of the boards’ constituents have serious doubts that perfect convergence will be achieved anytime soon — if ever.
With regard to the degree of standard-level convergence between U.S. GAAP and IFRS, there are three broad possibilities: (1) minimal convergence at the standard level; (2) standard-level convergence that is substantial (e.g., on major issues) but incomplete; and (3) substantially complete standard-level convergence.
Uniformity of IFRS use throughout the world also is largely a matter of degree. At one end of the spectrum, IFRS as issued by the IASB, without variation, could widely be seen as the only rational choice for countries to adopt and enforce. At the opposite end of the spectrum, IFRS as issued by the IASB might be considered only a “starting point” subject to legislative or other endorsement, with few countries using IFRS in its “pure” form.
As for the SEC’s decision regarding the use of future IFRS by its domestic registrants, the SEC might (1) reject the use of future IFRS by domestic registrants, (2) allow domestic registrants to choose between future U.S. GAAP and future IFRS, or (3) require domestic registrants to use future IFRS.
Finally, the private-company standard-setting process in the United States might remain closely coupled with the public-company standard-setting process as it is now, possibly with some exceptions for private companies built into future standards. But we may also see the creation of a separate standard-setting infrastructure and process specific to the United States (as we have seen recently in Canada), or we may embrace the country-neutral standard-setting infrastructure and process for “non-publicly accountable entities” that has already been created by the IASB.
Once alternative possible outcomes are identified for each key area of uncertainty, there are several planning techniques that can be used. These include scenario planning, risk analysis, and proactive influence. Here’s a “crash course” on how these three techniques work individually and together.
Scenario planning is useful when a company’s managers don’t know (or can’t agree on) the probabilities associated with possible future scenarios. This technique involves planning a response to each possible scenario without focusing on how likely each is to happen. No time or effort is wasted trying to “handicap” future events or distinguish more- from less-likely possibilities. Managers tend to embrace scenario planning once they realize that their best guesses about the future often turn out to be wrong. While the specific probabilities of future possibilities are often hazy, the planning implications of each possibility are often quite clear. Therefore, it’s generally feasible to develop plans for each alternative possibility. The plans don’t have to be detailed, but collectively they should cover all of the possibilities identified.
The primary value of scenario planning is that it helps companies anticipate and prepare for a wide variety of future possibilities. It can also increase the confidence of executives in their ability to handle whatever may come.
Risk analysis differs from scenario planning in that it assumes that the probabilities associated with each identified possible future scenario are determinable. Planners who use risk analysis invest time and effort in figuring the odds, individually and jointly, of the various possible outcomes in key areas of uncertainty. It doesn’t have to be complicated — relative probabilities work just fine. For example, here are the outcomes that well-informed U.S. executives usually conclude are most likely to occur in the next five years:
• At the standard level, future U.S. GAAP and future IFRS will be significantly — but only partially — converged.
• Country-to-country variations in the adoption, interpretation, and application of IFRS will persist.
• The SEC will allow U.S. registrants to choose between future U.S. GAAP and future IFRS.
• In the United States, the private-company standard-setting process will remain closely coupled with the public-company standard-setting process.
The point of this example isn’t for each company to reach the same conclusions. Rather, the example illustrates that conclusions such as these can form the basis for detailed plans. Once detailed plans are created for one or more highly-probable scenarios, those plans are used to supplement the less-detailed plans developed with scenario planning. By combining scenario planning and risk analysis, managers are ready for anything — and most ready for what they think is most likely to happen.
Proactive-influence planning differs dramatically from the preceding two techniques. Scenario planning and risk analysis assume that there is little or nothing a company can do to influence what actually happens in each key area of uncertainty. But proactive influence assumes that a company can, at least to some degree, influence what happens in the future.
In short, this technique is about determining which possible future scenario would most benefit a company’s stakeholders, and then developing a plan of action to increase the likelihood of it happening. For example, CFOs can participate in the standard-setting processes of FASB and the IASB, as well as the rule-making process of the SEC.
By following the three-pronged planning approach I’ve described, U.S. CFOs can exercise exactly the kind of leadership that is needed in the financial-reporting supply chain today.
Contributor Bruce Pounder is president of Leveraged Logic and chairs the Small Business Financial and Regulatory Affairs Committee of the Institute of Management Accountants (IMA). He is also the lead developer and presenter for the Webcast series “This Week in Accounting.”