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.
First, the SEC has clearly communicated that the less standard-level convergence between U.S. GAAP and IFRS is attained, the less the SEC will be inclined to even consider a switch from one to the other. Thus, a mandate to switch from U.S. GAAP to a substantially dissimilar set of standards would be directionally inconsistent with the position the SEC has taken on this matter.
Second, the SEC is simply not stupid enough to saddle U.S. companies with avoidable costs while we remain in the shadow of the global financial crisis. The SEC and its staff have their strengths and weaknesses, but in my experience, their weaknesses do not include a lack of intelligence. The political fallout for the SEC would be devastating at a time they can ill afford more negative attention.
Third, and most significantly, for the SEC to order a switch from future U.S. GAAP to future IFRS despite substantial differences between those sets of standards, the SEC would have to conclude that FASB and its standard-setting predecessors completely failed to get U.S. GAAP “right.” That would be despite nearly eight decades of trying and in light of the commission’s staunch support during that time. Repudiating its traditional support for U.S. GAAP and FASB cannot be imagined as a first-choice course of action for the SEC.
CFOs of public U.S. companies can stop worrying about the worst-case scenario regarding IFRS. That possibility does not deserve attention beyond a very minimal contingency plan. At the same time, it is essential for CFOs of both public and private U.S. companies to prepare for the profound changes to U.S. GAAP that the standard-level convergence efforts of FASB and the IASB have already started to produce. And, as I will examine in my next column, it is also time for U.S. CFOs to shift from being passive reactors to changes in financial reporting standards to being active shapers of the future of financial reporting in the United States.
Contributor Bruce Pounder is president of Leveraged Logic and is the immediate past chair of 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.”