?A consequence of today’s increasingly global marketplace is the need for a common financial reporting language.


This is particularly true for the oil and gas industry, given its global nature and the significance of a few large companies spread between the U.S. and Europe. Of course, with the continuing emergence of large national oil companies, some of which are publicly traded or voluntarily publish their financial results, the need for global comparability within the industry is increasing.


Working towards the achievement of a common financial reporting language is the International Accounting Standards Board (IASB), an independent body responsible for developing and promoting a global set of financial reporting standards called IFRS (International Financial Reporting Standards).


Because IFRS provides the potential for a common financial-reporting language, it can result in financial reporting with greater comparability across borders, provide a consistent financial-reporting model for companies with global operations, and allow them to create common internal reporting systems that can lead to reduced costs.


A single global set of standards also would make it easier for investors to compare the financial statements of companies in the same industry domiciled in different countries.


The idea of a single set of globally accepted financial-reporting standards has become so compelling to governments and securities regulators, businesses and the accounting profession that many countries have jumped, or have made plans to jump, on the “IFRS bandwagon.”

Today, more than 100 countries either require or allow the use of IFRS for listed companies—among them the European Union countries, Australia and South Africa. Others scheduled to join in the next three years include Israel, Canada, South Korea, India, Japan, China and Brazil.


Now IFRS may be coming to the U.S.


For years, the SEC has been studying whether and, if so, how to move U.S.-listed companies to IFRS. In late August, the SEC agreed to issue a proposed “roadmap,” for which it is seeking public comment. This proposed roadmap would allow certain large U.S. public companies in industries composed mainly of IFRS-reporting entities to use IFRS as soon as in their 2009 financial statements. The proposed roadmap also will outline milestones for potential adoption of IFRS by all public companies and targets additional SEC rule-making in 2011. At that time the Commission could decide to require large accelerated filers to adopt IFRS for the calendar year 2014 financial statements, with additional companies being required to adopt IFRS in 2015 and 2016, depending on their size.


How challenging will it be to convert to IFRS? This answer will differ from company to company depending on the size and scope of its business. It is clear, however, that the conversion to IFRS is not just an accounting exercise. It can affect a company’s accounting policies, internal controls, cash management, IT services, contractual and compensation arrangements, and tax compliance—almost every area of its business operations.

Plan ahead
Instituting a company-wide assessment of the implications of converting to IFRS is something companies contemplating a conversion will need to do—the sooner the better. Based upon the experiences seen in the European Union when IFRS was mandated in 2005, successful conversions usually took between two and three years. Success required careful planning, board sponsorship and involvement of many people across the company.


How will IFRS change reported results? The answer to this question depends on a company’s specific transactions and events, its existing accounting policies, and the accounting policy elections it makes when adopting IFRS.


However, as a guide, the Analyst’s Accounting Observer looked at how financial-reporting results might change by reviewing the reconciliations between IFRS and U.S. GAAP for 130 foreign, private issuers for their 2006 financial statements, and this is what was found:
• About two-thirds of companies showed higher earnings under IFRS than U.S. GAAP; one-third showed lower earnings; only two showed earnings to be about the same.
• Slightly more than half showed greater equity under IFRS; only one company showed about the same equity under both.


What are the major differences between IFRS and U.S. GAAP for oil and gas companies? IFRS is much newer than U.S. GAAP. It is only about 10 years old as a comprehensive body of literature and has only been used widely since 2005, while U.S. GAAP has been in use roughly 60 years longer. IFRS standards comprise about 2,500 pages of text. U.S. GAAP comprises several times that amount. The difference is largely attributable to the fact that U.S. GAAP has more extensive implementation guidance and it also includes industry-specific guidance.


Because IFRS offers less implementation and industry-specific guidance, there are more situations that will require judgment by the preparer and auditor on the application of IFRS to a specific fact-pattern.


The IASB is currently working on its “Extractive Activities” project, which is scoped to address both the accounting for and disclosure of oil and gas (and other extractive) reserves. This project may result in an IFRS standard that is vastly different from those currently applied under U.S. GAAP. For example, the IASB is currently considering whether oil and gas reserves should be reported on the balance sheet at fair value or a similar type of measurement. The IASB expects to issue a discussion paper on this issue for the industry to react to near the end of this year, with a final standard still some way into the future—probably two to three years after the release of the discussion paper.


These are some of the significant differences between existing U.S. GAAP and IFRS:
Accounting for exploration and appraisal costs. Because IFRS does not currently have industry-specific guidance applicable to the extractive industries, the IASB issued IFRS 6 “Exploration for and Evaluation of Mineral Resources” to provide limited guidance on the application of accounting practices for exploration and evaluation expenditures, until it is able to complete a comprehensive project on accounting in the extractive industries.


s a result of that limited guidance, many companies reporting under IFRS have adopted accounting policies substantially consistent with the successful-efforts method of accounting under U.S. GAAP. For those companies utilizing the full-cost method under U.S. GAAP, a change to IFRS could result in substantially different results since the principles of IFRS generally are not consistent with some aspects of the full-cost method.


Reserves reporting. IFRS does not yet address disclosure of reserves and resources, although it is being addressed by the IASB project on extractive activities. In the meantime, U.S. companies should expect that they will be asked to continue to provide reserve information as currently reported, subject to potential changes that may result from the SEC’s current proposal on reserve definitions and reporting of reserves. Both the SEC and IASB are currently contemplating changes in reserve definitions and, while there is hope of convergence on the definition of oil and gas reserves, there is a chance that further differences between U.S. GAAP and IFRS will arise upon finalization of their respective reserve definitions.


The SEC has stated that it intends to discuss its reserve rule-making project with the IASB and work to harmonize the rules’ user effectiveness, but cautioned that the final SEC rules may be different than those issued by the IASB.


IFRS does not permit LIFO accounting. Under LIFO (last in, first out) accounting, the cost of inventory is measured using the earliest units extracted and refined with the last units extracted and refined being included in the cost of goods sold for the period. This method is widely used for downstream inventories under U.S. GAAP.


In times of increasing crude oil costs, such as in today’s environment, the most expensive inventory is expensed first, thereby deferring the payment of taxes. IFRS does not permit the use of LIFO. Considering recent commodity-price movements, this could affect the accounting for downstream inventory and the consequences for companies’ tax positions will need to be evaluated. The industry has had discussions with the U.S. IRS and other government bodies about this issue but it is uncertain what changes, if any, in tax laws and regulations may be made.


Asset-retirement obligations. Under IFRS, the liability for asset-retirement obligations will be more sensitive to changes in discount-rate assumptions as the entire recorded asset-retirement obligation is revalued for changes in assumed discount rates. Under U.S. GAAP, asset-retirement obligations are not remeasured for changes in assumed discount rates.


Impairment testing. Impairment provisions—not something that has been a significant issue in the industry in the current oil-price environment—would generally be more common under IFRS compared with U.S. GAAP. Under U.S. GAAP, a company assesses the recoverability of an amortizable or depreciable asset (or asset group) by first considering whether the undiscounted cash flows to be generated by using the asset are sufficient to recover the cost of the asset.


Under IFRS, an impairment loss is recorded when the book value of an asset (or cash-generating unit) exceeds the higher of the asset’s fair value less costs to sell or its “value in use” to the company. The value-in-use concept generally represents the entity-specific discounted cash flows attributable to the asset or cash-generating unit. In contrast to U.S. GAAP, impairment of depreciable or amortizable assets previously recognized under IFRS need to be reversed if circumstances subsequently change. This has the potential to result in greater income statement volatility under IFRS.

Devil in the details
Of course, there are many other differences. While IFRS and U.S. GAAP have converged to some extent and many accounting standards are very similar, even in converged standards the devil is often in the details. There are often some unexpected differences that arise.
The main objective of IFRS is to improve international comparability of financial reporting across jurisdictions. IFRS provides a framework for achieving this, but industries need to come together on a crossborder basis to discuss implementation issues to make the most of this opportunity.


This is what the power industry in Europe did to overcome the lack of industry guidance within IFRS. Power companies from across the region worked together to discuss practice issues that arose in the application of IFRS. Even though there wasn’t unanimous agreement on all issues, there was enough consensus developed so that the industry, as a unified group, could educate industry analysts on the industry’s application of IFRS.


IFRS implementation poses challenges to U.S. companies, but it is increasingly becoming the world’s preferred financial-reporting framework for listed companies. Adequate planning and project management will ensure a more efficient transition to the new global standards.

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