As I have explained in prior columns, there are three techniques that enable CFOs to plan intelligently for the future despite the many unknowns associated with the use of International Financial Reporting Standards (IFRS) in the United States. This month’s column provides an example of one of the techniques, risk analysis, which involves assessing the likelihood of possible outcomes in key areas of uncertainty.
Risk analysis is informed by the scenario-planning technique (which I covered in detail in my previous column) and informs the proactive-influence technique (which I will cover in detail next time). Usually risk analysis is conducted to identify outcomes that are highly probable because companies should prepare for such outcomes. But risk analysis can also be done to identify outcomes that are highly improbable so that companies do not waste time and effort preparing for them.
Focusing on the Worst-Case Scenario
For obvious reasons, one of the most significant probability assessments made in the risk-analysis process is that of the “worst-case” scenario. From the perspective of public U.S. companies, the worst-case scenario regarding IFRS would be if the Securities and Exchange Commission were to require its domestic registrants to switch from using future U.S. Generally Accepted Accounting Principles (GAAP) to future IFRS without substantial standard-level convergence having been attained between the two sets of rules. So what chance does this worst-case scenario have of actually happening?
A risk-analysis exercise can rarely answer such a question with “27%” or some other precise figure. Risk analysis does, however, enable company managers to characterize the likelihood of possible outcomes in broad but useful ways. In particular, an informed risk assessment of the worst-case scenario regarding IFRS in the United States indicates that it is highly improbable.
Analyzing the Risk
One factor limiting the likelihood of the worst-case scenario is that the degree of future standard-level convergence between U.S. GAAP and IFRS is itself uncertain. In short, an extreme outcome on standard-level convergence — in either direction — is possible but unlikely. To presume that the Financial Accounting Standards Board and the International Accounting Standards Board will fail to achieve substantial standard-level convergence is as unrealistic as presuming that there will never be issues on which the boards agree to disagree. Neither board is willing to change its standards merely for the sake of agreement, but both are heavily invested in the convergence process.
Other factors relevant to this situation relate to what the SEC might decide if FASB and the IASB somehow fail to attain substantial standard-level convergence between U.S. GAAP and IFRS. There are three specific reasons that, in the absence of substantial standard-level convergence, a switch to IFRS for public U.S. companies has no significant likelihood of occurring.