The proposed amendmentswould provide a one-time accommodation that would permit eligible “foreign private issuers” to include in their annualreportsand registration statements filed with the SEC, for their first year of reporting under IFRS, only two years of audited financial information prepared under IFRS, rather than three years of audited financial information ascurrently required. Furthermore, the amendments would require foreign registrants that change their basis of accounting to IFRS to provide disclosures regarding their reliance on any exceptions from IFRS. The most significant aspects of the SEC’s proposed amendments are discussed below.
Adoption of IFRS by foreign private issuers
Several countries in the EU and elsewhere throughout the world currently allow issuers to use IFRS for preparing financial statements required under locals ecurities regulations. In June 2002, the EU adopted a regulation requiring companies incorporated under the laws of a current or future member state, and whose securitiesare publicly traded within the EU, to prepare their consolidated financial statements for each financial year beginning on or after 1 January 2005 on the basis of IFRS. Other countries, such as Australia, have adopted similar requirements mandating the use of IFRS by public companies for all periods beginning after 1 January 2005.
To ease the burden of switching to these new accounting standards, IFRS generally require only two years offinancial statements to be included in the reports of companies adopting IFRS for the first time. Taking up this accommodation and factoring in the possibility that there may continue to be first time adopters of IFRS in years beyond 2005, the SEC’s proposed amendments would be available to foreign private issuers that adopt IFRS for the first time for a financial year that begins no later than 1 January 2007. The accommodation would not be available to a foreign private issuer that had previously published audited financial statements prepared under IFRS, either voluntarily or by mandate, or to an issuer adopting a set of accounting standards that includes deviations from or qualifications to IFRS.
Two-year disclosure accommodation
Under current SEC rules, foreign private issuers that file an annual reportor registration statement with the SEC generally must provide three years of audited statements of income, changes in shareholders’ equity and cash flows, and two years of audited balance sheets, prepared on a consistent basis of accounting. To facilitate the transition of foreign private issuers to IFRS, the SEC has proposed amending Form 20-F to allow foreign private issuers that adopt IFRS for the first time to file only two years of audited financial statements prepared under IFRS. As previously mentioned, this accommodation would only be available to foreign private issuers that adopt IFRS for the first time for a financial year beginning no later than 1 January 2007.
Selected financial data
Form 20-F generally requires the presentation of, in addition to audited financial statements, five years of selected financial data. Under the SEC’s proposed amendments, foreign private issuers adopting IFRS for the first time would be required to provide only two years of selected financial data based on IFRS. Nonetheless, the SEC would continue to require disclosure of five years of selected financial data prepared under US generally accepted accounting principles (US GAAP) or under previously used non-US GAAP reconciled to US GAAP, subject to exceptions historically granted by the SEC.
Additional disclosure items in Form 20-F
The SEC proposes to amend the required disclosure in Form 20- F regarding the issuer’s business and market risks by explicitly requiring that the disclosure refer to financial information prepared under IFRS and not the issuer’s previous GAAP or US GAAP.
The proposed amendments to Form 20-F would also instruct management to focus on financial statements for the past two financial years prepared under IFRS, including the corresponding US GAAP reconciliation, when preparing the narrative disclosure of the issuer’s operating and financial review and prospects. This section would need to explain any differences between IFRS and US GAAP that are not otherwise discussed in the US GAAP reconciliation and to the extent the issuer believes it necessary for a clear understanding of the financial statements as a whole.
Interim period disclosure in registration statements
Under current SEC rules, a foreign private issuer may be required to include interim period financial statements in a registration statement or prospectus if a prescribed period of time has elapsed between the end of the last audited financial year and the date of the document. Under these current rules, if a foreign private issuer is required to provide interim period financial statements for the year in which it is making the transition to IFRS, it will also be required to present comparative unaudited interim period financial statements for the previous year, prepared under the generally accepted accounting principles previously used by the issuer (Previous GAAP). Moreover, any published interim period financial statements prepared in accordance with IFRS must be included, along with appropriate and prominent disclosure regarding the lack of comparability between the IFRS and non-IFRS financial statements.
Under these circumstances, a foreign private issuer may be required to maintain its accounts in accordance with Previous GAAP and IFRS and to publish two separate sets of interim period financial statements during the year of transition to IFRS. Recognising that this approach under current SEC requirements may place additional burdens on foreign private issuers and cause uncertainty among investors, the SEC has sought comment on alternative approaches.
US GAAP reconciliation
The proposed amendments would not eliminate the requirement that foreign private issuers reconcile their financial statements to US GAAP. Moreover, the reconciliation must still be audited and included as a note to the audited financial statements prepared under IFRS.
Under the proposed amendments, issuers that supply only two years of financial statements prepared in accordance with IFRS would be required to present audited condensed US GAAP financial information for the three most recent fiscal years (including condensed US GAAP income statements and balance sheets, but not notes to this information or statements of changes to shareholders’ equity). This condensed US GAAP financial information would not be required of foreign private issuers filing initial registration statements with the SEC.
Financial information prepared under previous GAAP
In addition to financial information prepared under IFRS, foreign private issuers may elect to include or refer to financial information prepared in accordance with Previous GAAP, including a third year of financial statements not required by IFRS during the transition period. If an issuer includes or incorporates by reference such additional information in its annual reports, registration statements or prospectuses, the SEC proposes that the issuer must also include or incorporate narrative disclosure of the issuer’s operating and financial review and prospects for the reporting periods covered by such financial information. Moreover, the issuer would be required to insert appropriate cautionary language to the effect that the filing contains financial information that is not directly comparable to the financial information based on IFRS.
Additional disclosure
There are certain elective and mandatory exceptions to IFRS available to a foreign private issuer adopting IFRS for the first time. An issuer may elect not to comply with IFRS with respect to items such as business combinations, fair value or revaluation as deemed cost, and employee benefits. Retroactive application of IFRS is prohibited with respect to derecognition of financial instruments and financial liabilities, hedge accounting, and information to be used in preparing IFRS estimates. Under the SEC’s proposal, any issuer relying on any of these exceptions to IFRS would be required to provide a detailed discussion of each exception used and the circumstances that gave rise to its use.
Consistent with IFRS transition rules, a first-time adopter would also have to include in filings with the SEC a reconciliation between its Previous GAAP and IFRS that gives sufficient data to enable users to understand the material adjustments to the balance sheet and income statement and, if presented under Previous GAAP, the cash flow statement.
National exceptions to IFRS
While requiring general adoption of IFRS, the EU is considering allowing member states to apply for national exceptions to certain provisions. However, the SEC encourages companies to adopt IFRS without exceptions. As previously mentioned, only companies that provide financial statements that comply with IFRS without qualification will likely be eligible for the two-year disclosure accommodations described above.
Practical advice for foreign private issuers
The SEC’s proposed amendments have been open to public comment and may be modified before actual adoption. Nonetheless, foreign private issuers should consult with their US-qualified lawyers and take steps as necessary to address the following issues:
- The company should consider whether it would be eligible for the proposed two-year disclosure accommodation. If eligible, the company should consider whether and how to preserve eligibility. For example, should the company prepare financial statements under IFRS for the current financial year even if compliance is not yet required and would potentially make the company ineligible for the twoyear disclosure accommodations? If not eligible, it may be advisable to determine whether the company can and should take steps to become eligible (eg, by complying with IFRS without qualification)
- In preparing for compliance with IFRS, the company should take into account and plan as necessary for the various requirements that it may need to observe with respect to SEC filings in light of the proposed amendments, including:
- the inclusion of IFRS-US GAAP and IFRS-Previous GAAP reconciliations,
- adjustments to the narrative disclosure of the issuer’s operating and financial review and prospects in Form 20-F to provide for: analysis using financial information prepared under IFRS; explanation of important differences between US GAAP and IFRS not otherwise covered by the US GAAP reconciliation; inclusion of any necessary discussion for reporting periods covered by Previous GAAP financial information; and explanation of the use of any exceptions to IFRS, and
- the insertion of appropriate cautionary language regarding the lack of comparability between IFRS and non-IFRS financial information.
About the co-auther
Pedro Reyes is an associate in the US corporate finance group. Pedro joined the US corporate finance group in November 2003 and has experience working on matters relating to general securities and corporate law.