By Renee Ford, CPA

Status of IFRS Adoption in U.S. and Abroad

Following its announcement in late 2010 to render a decision on U.S. adoption of International Financial Reporting Standards (IFRS) in the next year, the Securities Exchange Commission (SEC) has continued to consider whether an adoption or endorsement of IFRS for U.S. listed companies would be in the best interests of U.S. investors and markets.  To that point, the SEC has issued three Staff Papers in 2011,the first of which proposes a gradual approach in which the Financial Accounting Standards Board (FASB) would continue its joint projects with the International Accounting Standards Board (IASB) until the two sets of standards are essentially converged, followed by an evaluation and an endorsement of future standards issued by the IASB on a case-by-case basis. In November of 2011, two additional Staff Papers were issued–a comparison of U.S. GAAP and IFRS undertaken to determine areas where IFRS provides no guidance or less guidance than U.S. GAAP, and also a study of IFRS in practice involving the analysis of financial statements for 183 companies reporting under IFRS. The results of these two studies have only clarified that significant differences between the two sets of standards, both literally and in practice, continue to be significant in spite of convergence efforts completed and still in progress, and that further consideration of whether IFRS is sufficiently developed will be needed. In December 2011, the SEC indicated that a decision on how to incorporate IFRS into the U.S. reporting system is still “months away,” thus will not meet its 2011 deadline.Investment companies were excluded from the SEC’s roadmap to IFRS issued in 2008, which initially allowed early adoption of IFRS for some issuers. The exclusion was primarily due to views in the U.S. investment industry that the information most relevant to fund investors would be lost in a transition to a single set of accounting standards. The unique characteristics of investment funds demand an industry-specific reporting model not currently provided by IFRS. Many believe that the application of IFRS to investment companies will result in less meaningful reporting and less transparency, and for regulated funds a conflict with the existing requirements of Regulation S-X. Moreover, the primary advantage of a transition to IFRS in any industry is to enhance comparability of financial information between U.S. and non-U.S. companies. With the limitations of U.S. laws on investments in foreign funds as well as U.S. tax rules that discourage foreign investment in U.S. funds, cross-border offering of fund shares is limited, thus diminishing the need for such comparability in this industry.

IFRS in the investment industry has been met with similar resistance in Europe. Both the European Funds and Asset Management Association and the International Funds Association have issued statements to the effect that IFRS is not sufficiently focused on the needs of investors or the unique aspects of an investment company. In fact, many European jurisdictions are still allowing local standards to be used by investment funds. Although all listed companies in the European Union are now required to report under IFRS, member states can decide whether to mandate IFRS for regulated investment funds. The UK, Germany, France, and Luxembourg all allow local GAAP for regulated funds, although the Irish Funds Industry Association recently proposed that IFRS for Investment Companies be developed in response to a recent exposure draft by the UK Accounting Standards Board that would require all Irish funds to report under IFRS. Outside of the U.S. and Europe, use of IFRS in the investment industry is most commonly seen in certain offshore jurisdictions where there are no local standards, such as Cayman Islands, Bermuda, and British Virgin Islands.

IASB - FASB Convergence Efforts

Where investment companies are concerned, recent joint projects of the IASB and FASB have substantially converged many of the relevant standards. The significant changes to fair value measurements and disclosures that were introduced with FASB Statement No. 157, Fair Value Measurements (SFAS 157) were followed by amendments to IFRS 7, Financial Instruments: Disclosures, that called for similar, if not identical, disclosure requirements and the use of the fair value hierarchy. IFRS 9, Financial Instruments, which replaced IAS 39, Financial Instruments: Recognition and Measurement, dealing with financial instruments, narrowed the gap on classification of financial instruments by requiring them to be classified based on an entity’s business model and initially valued at fair value, resulting in most cases in a single classification for investment entities – "at fair value through profit and loss." Still in proposal stage with the comment period ending in January 2012, IASB Exposure Draft 10 addresses amendments to IFRS 10, Consolidated Financial Statements, and IFRS 12, Disclosure of Interest in Other Entities, that will eliminate perhaps one of the most problematic issues in applying IFRS to investment funds by defining what constitutes an "investment entity" and then scoping out of the consolidation requirements of IAS 27, Consolidated Financial Statements, an investment entity’s controlling interests in investee funds. While this has been an issue most commonly encountered with master-feeder structures due to the fact that a feeder fund or multiple feeder funds more often than not own 100% of the related master fund, it has also been a frequent issue for private equity funds reporting under IFRS.

IFRS 13, Fair Value Measurement, is effective in 2013 and sets out a single framework for measuring fair value and disclosing such measurements. The FASB’s Accounting Standards Update 2011-04, Amendments to Achieve Fair Value Measurement and Disclosure Requirements in US GAAP and IFRS, will be effective in 2012 and will eliminate from a U.S. GAAP perspective some of the key differences between the two sets of standards as they pertain to fair value. Most significant to investment companies, the U.S. update brings a significant increase in the quantitative and qualitative disclosure requirements of unobservable inputs used to value investments in level 3 of the fair value hierarchy. For publicly traded funds, sensitivity analyses will now be required for these unobservable inputs, a requirement for all funds public or private under IFRS.

Key Differences

The lack of an industry-specific reporting model, as discussed above, is perhaps the most pervasive barrier to widespread acceptance of IFRS among investment entities. However, even after significant convergence efforts in the area of accounting and classification of financial instruments and fair value measurement and disclosures, some key differences remain that are unattractive to the investment industry. Most notably, the extensive risk disclosures for financial instruments required under IFRS 7 are seen as burdensome to prepare and of little value to the typical investor, particularly where sensitivity analyses are required even for nonpublic entities. Another key difference is that the practical expedient allowed under U.S. GAAP for measuring investments in funds that report net asset value is not provided for under IFRS, thus creating a higher volume of level 3 fair value measurements to evaluate and disclose. On the other hand, some of the information believed to be most important to investors, such as financial highlights, portfolio of investments, and the breakdown of realized and unrealized gain or loss, is not currently required by IFRS. In most cases, net assets are required to be classified as liabilities under IFRS, thus there is no "equity" component and no requirement for a statement of changes in net assets.

What U.S. Fund Managers Should Consider Now

While it appears unlikely that public or private investment companies in the U.S. will be required to report under IFRS in the near term, certain questions warrant consideration earlier than later. Will you be required anytime soon to report under IFRS by your investors? This scenario could arise, for example, where a fund has investors who are funds themselves who report under IFRS. Similarly, are your competitors offering funds to investors who report under IFRS? Does your current administrator have the infrastructure and expertise to provide IFRS reporting should the need arise? The accumulation of data needed to prepare certain of the disclosures required under IFRS, particularly the risk disclosures and related sensitivity analyses, will likely require changes in the way certain data is captured on a day to day basis. Those in the industry should stay alert for any significant movement by the SEC on adoption or endorsement of IFRS generally, as the effects on private companies including those in the investment industry will quickly follow. Awareness and advance preparation for upcoming convergence measures and maintaining a contemporaneous plan of approach to address the gaps between reporting requirements under U.S. GAAP and IFRS would minimize the challenges that a full conversion to IFRS would present down the road.

Contact the Decosimo Financial Services Group

Decosimo is a PCAOB-registered firm, and our Financial Services Group provides tax, audit and advisory services to hundreds of investment companies both in the U.S. and offshore. Our financial services professionals are eager to provide you with the information you need to navigate the continuing changes in accounting standards affecting investment companies.

Karl Jordan, CPA | Domestic and International Principal
Marshall Harvey, CPA, CPE | Assurance Principal
Renee Ford, CPA | Assurance Principal
Brad East, CPA, ABV | Assurance Principal

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