I was recently consulted on an unusual accounting and a related audit reporting question raised on behalf of a practitioner’s public client, which was contemplating converting its financial statements from an IFRS to a U.S. GAAP basis. Apparently, the client believed reporting on a U.S. GAAP basis would broaden its access to U.S. capital markets.
The Accounting Question
There is no authoritative U.S. standard, and little nonauthoritative guidance, available that relates directly to the accounting question raised above, except in the opposite direction (which is the prevalent form of conversion), that is, from U.S. GAAP to IFRS (primarily IFRS 1, First-time Adoption of International Financial Reporting Standards).
A nonauthoritative 2017 publication by the AICPA’s Center for Plain English Accounting (CPEA), “Common Questions About Special Purpose Frameworks” (https://bit.ly/44LtaZ5), points out that IFRS does not constitute a “special purpose framework” (for which nonauthoritative guidance cited below does exist); this is “due to the AICPA designating the International Accounting Standards Board (IASB) as the body to establish professional standards with respect to international financial accounting and reporting principles. This results in IFRS … being considered generally accepted accounting principles.” For that reason, the CPEA goes on to quote the AICPA’s (also nonauthoritative) Technical Questions and Answers (TPA), sections 9150.32–.33, issued in 2014, which read in part as follows:
Authoritative literature [in the U.S.] does not address accounting for a change in accounting basis [since] FASB ASC 250 provides guidance [only] for reporting accounting changes within the same basis [emphasis added]. …
[T]he situation described above is considered to be a change in accounting basis rather than an accounting change.
When only current year financial statements are presented, it [nevertheless] is common practice to present the effect of the change in the accounting basis by showing beginning retained earnings as previously reported with an adjustment to convert to the new basis. Although not as common in practice, precedent also exists for either showing opening retained earnings on the new basis or showing the effects of the change as a cumulative-effect adjustment in the income statement.
However, if comparative financial statements are presented, the prior year(s) should be restated and presented under the basis to which the company has changed. Restatement is necessary to ensure comparability with all periods presented.
Presumably, because the stated subject of TPA 9150.32–.33 is “special purpose frameworks,” since IFRS is not included in the definition thereof, since the question is about a change in accounting basis, and because there is no authoritative guidance directly on the question, the guidance in the TPA is not intended to (but it may, in fact) be useful if applied by analogy equally to such a change.
The most direct and, therefore, most useful nonauthoritative guidance (albeit brief and, therefore, highly limited) that I was able to find is a 380-page Deloitte publication from 2020, “U.S. GAAP and IFRS Standards: Understanding the Differences” (https://bit.ly/3YijceY), which states similarly in its preface that “First-time adoption, converting to U.S. GAAP is typically more complex than converting to IFRS Standards as U.S. GAAP does not include specific guidance on first-time adoption unlike that available under IFRS Standards.” Section 1 of the Deloitte paper states as follows:
Entities should review all historic transactions since their inception to determine whether the accounting for such transactions would have been different had U.S. GAAP been applied. This can be extremely challenging particularly where standards have changed over time and the subsequent standards cannot be early adopted. For example, it is necessary to consider all historic business combinations and whether there should be any amounts (goodwill, fair value adjustments to long-lived assets) that should be included in the opening balance sheet.
Adopters generally use full retrospective application unless the transitional provisions in specific guidance require otherwise. Whereas the key principle of IFRS 1 is to apply retrospectively all standards effective as of the reporting date of the entity’s first IFRS financial statements (with some exceptions and exemptions), U.S. GAAP requires the application of the standard effective as of the transaction date and apply new or changes in accounting policies in accordance with the respective transition requirements of each standard. [The previous sentence refers to any retroactive adoption of any U.S. (i.e., FASB) standard and not specifically to a basis conversion from IFRS.] Therefore, entities should review all historic transactions since their inception to determine whether the accounting for such transactions would have been different had U.S. GAAP been applied and such differences would still be present at the start of the period for which U.S. GAAP financial information is presented. …
For long established companies converting to U.S. GAAP, it may be necessary to refer back to the previous [i.e., pre-Codification] accounting hierarchy and original pronouncements (as amended) to determine the appropriate accounting for a particular transaction; this will likely be most common for historic business combinations where the acquired assets and liabilities are still recorded on the entity’s balance sheet and the accounting for that business combination may have been different under IFRS standards compared to U.S. GAAP.
Adding to the complexity of converting to U.S. GAAP, there are other elements such as (1) the existence of (a) different effective dates, (b) transition approaches, and (c) guidance for public and non-public entities; (2) regulators such as the SEC requiring under certain circumstances comparative information for more than one year; and (3) specific industry guidance, amongst others, that an entity needs to factor in. From a process perspective, a first-time U.S. GAAP adopter must look at the U.S. GAAP that was effective when the historical transactions occurred to determine if there is a difference other than the currently existing differences between IFRS and U.S. GAAP.
As noted above, first-time adoption of U.S. GAAP is complex, and entities may need to use significant judgment in any conversion process. Furthermore, consultation with qualified professional advisers is recommended. I advised that an informal telephone conversation with SEC staff might be productive as a first step prior considering to any formal, written communication with the Office of the Chief Accountant, which is generally a longer process. A search for examples among SEC filings might also be wise.
The Reporting Question
Because this discussion is written from the point of view of a successor auditor, I believe the example of a paragraph to be added to the audit report on the current year provided in the PCAOB Staff Q&A “Adjustments to Prior-Period Financial Statements Audited by a Predecessor Auditor,” (2006, https://bit.ly/3DAagZ2, A5, pp. 6-7) would be substantially appropriate for reporting by a successor following such a conversion—except that the conversion should not be characterized anywhere in the report as a “change in accounting” because it is excluded from the definition of that term in ASC 250. (Such characterization may be followed in its initial occurrence by, “from International Financial Reporting Standards to generally accepted accounting principles in the United States,” and, if applicable, “and the related currency translation.”) Rather, the conversion should be described in the report as a “change in accounting basis,” because that term would presumably apply even though the term “special purpose framework” does not. Note that the old reference to AU section 508 contained in the PCAOB Q&A has since been superseded, without modification, by AS 3101. (To a certain extent, similar guidance would be applied to a continuing auditor.)
However, as I wrote in my May 2017 column, “Reporting on Restatement Adjustments after an Auditor Change” (https://bit.ly/44NUjul): “the PCAOB staff believes that successor reporting on restatement adjustments (without a full re-audit) is not a freely unrestricted option.” This article goes on to summarize the 2006 PCAOB guidance as follows:
[Use of this practice] is subject to auditor judgments about certain qualifying conditions deemed necessary to enable the successor auditor to form an opinion that the adjustments are appropriate and have been properly applied. These conditions, which must be evaluated and documented by the reporting successor, are set forth and explained in Q4 (pp. 4-6) of the Q&A. … Relevant considerations are—
- ▪ the extent and pervasiveness of the adjustments,
- ▪ the reason for the adjustments, and
- ▪ the extent of cooperation expected from the predecessor.
In addition, a successor auditor is cautioned to consider whether any evidence was observed in the process of auditing restatement adjustments which indicates a risk that the prior-period financial statements are materially misstated in other respects, and whether a full re-audit of the prior year financial statements may therefore be necessary.
Therefore, because of the complexities of the conversion process cited in the Deloitte paper, extreme caution by a successor firm is warranted before it accepts this responsibility. The SEC staff’s views on a successor auditor’s report when the prior-period financial statements have been restated, consistent with the relevant PCAOB guidance, are briefly set forth in its Financial Reporting Manual (sections 4830.2-.6, https://bit.ly/3QCI7IL).
In my opinion, a successor who nevertheless agrees to audit the retrospective adjustments for a conversion to U.S. GAAP would report a critical audit matter (CAM) that discusses the challenges of auditing the conversion restatement adjustments (which would also set forth that there is no authoritative U.S. GAAP guiding the transition accounting) and briefly explains how it was done. In addition to the extra paragraph illustrated in A5 of the PCAOB’s 2006 Staff Q&A referred to above, an explanatory paragraph disclosing the restatement might also be included separately. However, according to PCAOB Staff Guidance issued in 2019, “Implementation of Critical Audit Matters: The Basics” (https://bit.ly/3ssuldX), an auditor is “not expected” to include an emphasis paragraph for the same matter as is reported in a CAM.