In a world recovering from corporate scandal, fraudulent financial reporting, and economic decline, the value of common ground is obvious. Having a single, global set of high-quality accounting standards would benefit investors and reduce the administrative costs of accessing capital markets around the world. The 25 members of the EU, being confronted with a hodgepodge of differing accounting standards, took no exception to this view and issued a regulation requiring most European stockexchange listed companies to prepare their consolidated financial statements using the IFRS that they decided to endorse for 2005 (the balance by 2007). This means that one set of standards will be acceptable in more than 100 jurisdictions - a revolution in the truest sense of the word.

Taking the Lead

Every revolution needs a standard bearer to guide the troops into battle. In 2000, the International Accounting Standards Committee became the IASB and positioned itself as the global accounting standard setter. The restructured board is a full-time, independent body responsible for setting international accounting standards, including IFRS. Its members are chosen for their acumen and expertise in accounting, and the board operates with due process. The board's goal, as explained by Chairman Sir David Tweedie, former head of the UK Accounting Standards Board, is to boost transparency by having a single set of high-quality standards for companies worldwide.

To prepare for 2005, the IASB has had an ambitious program of improving its existing standards, such as Property, Plant, and Equipment, and issuing new standards to "plug the holes" in other areas, such as Share-based Payments. By December 2003, the IASB had revised over a dozen standards, and in March 2004 the board issued five new ones. This flurry of effort was needed to ensure that a "stable platform" of IFRS that was as robust as possible could be adopted by so many listed entities in 2005.

Across the Atlantic

The IASB also has been working on several projects with its U.S. counterpart, the Financial Accounting Standards Board (FASB). The boards have decided to coordinate their agendas so that any major project that one board takes up will also be taken up by the other. The business combinations project - the project to improve quality and address international convergence on the accounting for business combinations - is an example of such a project. In addition, the two boards have been working on "short-term convergence," addressing the differences that can be resolved in a relatively short time, not by rethinking the issue entirely, but by looking at the two existing models and picking the better one. Many of the IASB's recent amendments to standards are an example of this convergence. Similarly, the FASB has issued four exposure drafts that would change U.S. Generally Accepted Accounting Principles (U.S. GAAP) in certain areas to conform to IFRS. Also, the two boards are working on joint projects to address revenue recognition and business combinations (Phase II).

Clearly, the prospect for convergence between U.S. GAAP and IFRS looks promising. The question that remains, however, is whether the U.S. Securities and Exchange Commission (SEC) will allow foreign registrants to use IFRS in filings with the SEC without reconciliation to U.S. GAAP. In the past, the SEC has justified this insistence with the assertion that U.S. GAAP provides more accurate information and better protection to investors because of its much more complete and detailed set of rules, limiting the discretion and judgment management can exercise in preparing the numbers and disclosures in the annual report. Taken as a whole, U.S. GAAP is seen as the most detailed and comprehensive body of accounting in the world. However, convergence with IFRS is moving opinion against reconciliation for foreign registrants.

The prospect of convergence, together with the disparity of foreign listings on U.S. exchanges when compared to foreign listings on non-U.S. exchanges, has caused investors, the New York Stock Exchange (NYSE), and Nasdaq to begin lobbying the SEC aggressively to permit foreign companies to list on those exchanges using IFRS, without reconciliation to U.S. GAAP. The SEC has exhibited caution in doing so, indicating that even when accounting standards are fully converged, the rigor of application of those standards will still be dependent upon accountants and auditors in every jurisdiction around the world. If the application varies, the benefit of having converged standards will be lost.

Fortunately, there are forces at play to reduce the chances of that occurring. The IASB has increased its resource allocation to its interpretive body, the International Financial Reporting Interpretations Committee. In addition, the major accounting firms have taken up the challenge, developing a core of IFRS technical experts, training people in IFRS, and actively supporting consistent application of the standards.

Regulators also have a vital role to play. They are responsible for the enforcement of accounting standards. The standardsetting process cannot always move as quickly as the capital markets, which means that there will almost always be accounting issues that companies are dealing with that the standard setters have not yet identified or addressed. Here, companies' auditors need to exercise well-founded judgment regarding the interpretation of complex and unique accounting issues that are not specifically addressed in the accounting standards. Clear support among the auditors, regulators, and standard setters is required.

The Committee of European Securities Regulators (CESR) has been working to ensure that regulators work together to achieve consistent application in interpreting accounting standards in the different jurisdictions. CESR recently released Enforcement Standard No. 2 to address the issue.

Many believe that under the IASB's "principles-based" approach, the standard setters and regulators may not need to provide the same level of detailed interpretations required under U.S. GAAP, where more detailed rules are the norm. Substance should prevail over form. This may be true, but consider the lesson from leases: Under U.S. GAAP, one of the criteria for determining whether a lease is a capital lease is that the present value of the minimum lease payments must be at least 90 percent of the property's fair market value. To get around this issue, an entire industry of lease-structuring specialists has emerged to create lease arrangements in which the minimum lease payments amount to 89.9 percent of fair market value.

The FASB and the sec have responded to such attempts by issuing many pronouncements and interpretations. Under IFRS, the requirement is that at the inception of the lease, the present value of the minimum lease payments must amount to at least "substantially all" of the fair value of the leased asset. Clearly, IFRS eliminates the 89.9 percent phenomenon, right? Think again: What is the likelihood that regulators in Europe, the United States, Australia, and South Africa will all interpret 89.9 percent to mean "substantially all"? And what about 80 percent or 75 percent? This is but one of the many tough issues the IASB and the FASB are considering in their move to a single set of global accounting standards.

For now, it appears that full acceptance of IFRS in U.S. markets, without reconciliation to U.S. GAAP, will require a continuing effort to close the gaps in accounting standards, as well as regulatory convergence. The work that has already been done to close the gaps is commendable, but regulatory convergence may be more difficult to achieve. Many believe this will happen; however, the big uncertainty is just how long it will take.

The challenges of 2005

In the United States, the international convergence of accounting standards has not yet had a significant impact on companies reporting under U.S. GAAP. Across the Atlantic, however, finance and other staff of listed companies in the EU have been reaching for the headache tablets - 2005 is now less than a month away.

For the vast majority of finance directors, the adoption of IFRS is not a matter of a few expanded disclosures and some "topside" adjustments applied during the consolidation process. The standards represent a new mindset - one that must be embedded in the company's day-to-day activities so that IFRS become part of "business as usual." The move to IFRS changes the primary basis of accounting for many companies, so the differences are vast and pervasive. Accounting for business combinations, consolidation issues, derivatives, and other financial instruments at fair value on the balance sheet - to name but a few - are proving to have extensive financial and system consequences.

But the issue is not limited to 2005. IFRS requires at least one year of comparative information. Companies already should have started to redraw spreadsheets, revise forecasts, and implement system changes and other changes for the 2004 comparatives - a massive logistical exercise. Throw the U.S. Sarbanes-Oxley Act of 2002 into the pot for sec registrants, and you may have created the "perfect storm."

So how up to speed are these European companies? A survey conducted by PricewaterhouseCoopers (PwC) in May 2004 revealed that the vast majority of the 310 companies polled still had a lot of work to do to make the change to IFRS. More worryingly, only 20 percent of those companies had focused on communicating changes to the market.

CESR has issued a wake-up call to finance directors, asking them to provide markets with appropriate information in a phased process. CESR urged companies to provide details of the key accounting differences between IFRS and the previous set of standards, a timetable of the transition, and an explanation of what impact the changes will have on their business. The lack of response from businesses to this recommendation has caused great concern among European regulators.

Impact on internal auditing

The adoption of IFRS is presenting interesting and somewhat out-of-the-ordinary challenges to the internal audit functions of the many listed companies in the EU. It combines aspects of internal auditing that vary across the spectrum of its annual activities, from human resources to more technical accounting policy and change control matters. Although such implementation projects are quite exhaustive by nature, a logical and structured internal audit approach that is consistent with key project success factors can add real value.

It is imperative that the internal audit function is included in the implementation project team from inception. This will ensure that internal auditing is suitably positioned to audit the controls over the implementation project from a preimplementation perspective. The benefits of such an approach are that potential control issues are addressed early and that these issues are identified and corrected before an external audit assessment of the systems.

The absence of adequate and appropriate skills in the implementation of IFRS will spell disaster. As such, internal auditing may well consider a skills assessment of the IFRS project team to be the perfect starting point. This assessment calls for some introspection and extends well beyond the obvious. It may include checking the adequacy of internal audit staff skill sets, the geographical distribution of implementation staff between head office and other sites, and the IFRS knowledge of staff- including the board - to inform strategy and operations within an organization. The complexities within IFRS, both from a technical and practical application perspective - need to be understood, as failure to do so may result in the misstatement of earnings or net worth.

According to the aforementioned PwC survey, the lack of trained personnel is a significant debilitating factor in IFRS conversions. Internal auditing has a role in assessing the quality and sufficiency of training material prior to rollout.

The assimilation of management and reporting information, as well as new software system implementations associated with IFRS, should be of interest to the internal audit function, with internal auditing focusing its efforts on issues such as the quality of management/financial reporting information and systems/data change control. This should be coupled with internal auditing's focus on controls over IFRS-specific issues, such as the impact of comparative year reporting requirements, monitoring mechanisms that identify changes in standards as and when they occur, and reconciliations between IFRS and U.S. GAAP for SEC registrants.

Although there is no established benchmark against which to measure the value of a good communication strategy in an IFRS context, it is clear that the principles of effective corporate governance should not be substituted in this regard. Consequently, internal auditing should review IFRS communications to ascertain whether they are structured in a fair and honest way so as not to mislead investors, illustrate changes to country-specific generally accepted accounting practice transparently, and are distributed timely regardless of whether or not they lend themselves to negative financial analysis in a traditional context.

Two concepts should become apparent immediately when considering internal auditing's role in IFRS implementations. First, there is a critical role that an organization's internal audit function must fulfill to uphold the controls surrounding IFRS implementation. And second, IFRS implementation necessitates the involvement of a full array of skills from the internal audit function. The challenge is clearly on.

NICHOLAS GANZ, a director in PwCs Global Capital Markets Group (GCMG) based in South Africa; COENRAAD RICHARDSON, a manager in the New York-based GCMG; and AVENDTH TILAKDARI, a PwC associate director based in South Africa, contributed to this article.

To comment on this article, e-mail the authors at avanwyk@theiia.org.

-- Van Wyk, Anton B; Taylor, David G; Jackson, Russell A