Legal considerations in the proposed transition to International Financial Reporting Standards.

• Author: Heffes, Ellen M.
• Position: Financial reporting

A transition from financial reporting under United States generally accepted accounting principles to International Financial Reporting Standards raises significant legal issues that need to be considered by U.S. issuers. These include changes in financial-disclosure requirements and related litigation risks.

In the following IFRS section, Gerard G. Pecht and Seth D. Wexler, from the law firm of Fulbright & Jaworski LLP, highlight some basic legal issues for financial executives to focus on.

--IFRS Section Co-developers Cheryl Graziano, CPA, and Ellen M. Heffes

A transition to financial reporting under IFRS would require companies to change their public financial reporting from the more prescriptive, rules-based approach under U.S. GAAP to the principles-based approach under IFRS. Though U.S. issuers have thousands of pages of guidance and literature to wade through under U.S. GAAP, there is often relevant, rules-based guidance for a particular issue.

As contemplated by the draft SEC roadmap issued last November (for which comments were due April 20), transition to IFRS by 2014 for large, accelerated filers and 2016 for smaller public companies will require more judgment, as U.S. issuers will have to fill in the gaps where specific guidance does not exist under IFRS.

In the long-term, the new approach may give U.S. issuers flexibility and more discretion in their financial reporting.

From a legal perspective, however, U.S. issuers will have to modify their mindset (much like has been required with respect to disclosure of executive compensation) to focus on disclosure of the true substance of a transaction, while still addressing the litigation risks associated with any public disclosures.

Legal Impacts of IFRS on Transactional Issues

There are numerous ways in which differences between U.S. GAAP and IFRS may impact completed and future transactions. Many U.S. issuers have contractual agreements containing financial covenants that require certain performance criteria to be met or ratios to be maintained. The differences between IFRS and U.S. GAAP could affect compliance with those covenants.

In particular, a transition to IFRS could increase volatility in a U.S. issuer's earnings because, among other reasons, IFRS generally requires more fair-value accounting for assets and derivatives than U.S. GAAP. If this volatility causes the U.S. issuer's financial statements to reflect different results than under U.S. GAAP, that issuer could fail to...