Transatlantic Accounting Divide: A Critique of IFRS to US GAAP Migration for FTSE PLCs

For a FTSE PLC contemplating delisting from the London Stock Exchange (LSE) and relisting on a major US exchange like Nasdaq or NYSE, the journey is fraught with strategic, operational and most notably accounting complexities. The shift from International Financial Reporting Standards (IFRS) to US Generally Accepted Accounting Principles (US GAAP) represents a monumental undertaking, demanding meticulous planning and significant investment. While the allure of the US capital markets – deeper liquidity, higher valuations and access to a broader investor base – can be compelling, the transition to US GAAP presents a considerable hurdle that warrants detailed critique. Having completed a 7+ of these type of conversion programmes, these my thoughts.

The Fundamental Dichotomy: Principles vs. Rules

At the heart of the IFRS to US GAAP conversion lies a philosophical divergence: IFRS is largely principles-based, offering a flexible framework that requires professional judgment in application, while US GAAP is predominantly rules-based, characterised by detailed, prescriptive guidance. This fundamental difference permeates every aspect of financial reporting, creating a myriad of disparities that necessitate extensive reconciliation and re-evaluation.

A few Key Areas of Divergence and their Critical Impact²:

Inventory Valuation (LIFO Prohibition):

The prohibition of LIFO under IFRS means that any FTSE PLC currently using LIFO for inventory valuation (unlikely for a UK company, but a theoretical point for comparative purposes) would face a significant restatement. More broadly, the non-reversal of inventory write-downs under US GAAP (compared to IFRS's allowance for reversals if market value recovers) can lead to more conservative inventory valuations and potentially depressed reported profits during market upturns.

Property, Plant, and Equipment (PPE) Revaluation:

This is a major area of impact. A FTSE PLC with significant Property development or other long-lived assets that have appreciated in value under IFRS's revaluation model will see a substantial reduction in reported asset values on their US GAAP balance sheet. This can negatively impact financial ratios, borrowing capacity and investor perception of the company's underlying asset base.

Research and Development (R&D) Costs:

For technology or innovation-driven FTSE PLCs, this difference can significantly alter profitability. Capitalising development costs under IFRS can boost reported assets and net income in the short term. The move to US GAAP would necessitate expensing these costs, potentially leading to a material reduction in reported earnings and a more volatile profit trajectory, that could concern US investors accustomed to different R&D accounting practices.

Leases:

While convergence has reduced major differences here, nuances remain, particularly in the classification of leases (finance vs. operating under US GAAP, or "right-of-use" asset and lease liability under IFRS). The precise application of criteria for lease classification and subsequent measurement can still lead to adjustments and the transition will require a thorough re-evaluation of all lease contracts. Including where applicable ARO’s.

Goodwill Impairment:

While both frameworks aim to ensure goodwill is not overstated, the multi-step US GAAP approach can be more complex and time-consuming. Differences in cash-generating unit definitions and valuation methodologies can lead to varying impairment charges, potentially impacting reported equity and earnings.

Revenue Recognition (IFRS 15 vs. ASC 606):

Both standards are largely converged around the five-step model, subtle differences in application guidance, particularly regarding variable consideration, principal-versus-agent considerations, collectability and contract modifications, can still lead to different timing and amounts of revenue recognition. Companies must meticulously review their contracts and revenue streams to ensure compliance with the more prescriptive US GAAP requirements.

 

The Costs and Burdens of Conversion: A Hefty Toll

The conversion from IFRS to US GAAP is not merely an accounting exercise; it is a profound organisational shift with substantial costs and resource implications. For instance:

• The need to restate historical financial statements (typically three years) to US GAAP requires extensive data re-collection, recalculation and audit. This is a highly resource-intensive and costly process, involving financial accounting work.

• Existing enterprise resource planning (ERP) systems and financial reporting software may need significant upgrades or replacements to handle US GAAP-specific requirements and data points.

• Engaging external consultants with valuation repertoire will be required to manage and work the conversion².

• During the transition period, direct year-on-year comparability of financial results can be challenging, potentially confusing investors and analysts. The conversion process diverts significant management attention and resources away from core business operations and strategic initiatives.

• US GAAP often mandates more extensive and detailed disclosures than IFRS, particularly for certain industries or complex transactions. This increases the burden on finance teams and demands a robust internal control environment.

• Lastly, listing on Nasdaq or NYSE means subjecting the company to the rigorous oversight of the US Securities and Exchange Commission (SEC) and the Sarbanes-Oxley Act (SOX)¹. This entails significant compliance costs related to internal controls over financial reporting (ICFR) and public company accounting oversight board (PCAOB) audits.

 

Implications of Delisting from the LSE:

While the focus is on the US GAAP transition, the act of delisting from the LSE carries its own set of implications, where it removes the company from the immediate purview of UK and European investors and analysts, potentially reducing local liquidity and name recognition.

Importantly, LSE-listed companies benefit from specific protections under UK Listing Rules, including notifications for material developments and certain transactions. These protections will cease to apply, although the company will remain a public limited company and subject to the Takeover Code. Some companies delist to reduce the administrative burden, complexity and costs associated with maintaining an LSE listing, especially if liquidity and trading volumes are low.

The Allure of the US Market: Pain Worth the Gain?

Despite the formidable challenges, the move to US exchanges and US GAAP is often driven by strategic imperatives, where US markets generally offer greater liquidity and a broader base of institutional and retail investors, potentially leading to higher valuations and easier access to capital for growth and acquisitions.

Moreover, certain sectors, particularly technology and biotech, tend to command higher valuations in the US compared to Europe. For companies with predominantly US peers, switching to US GAAP allows for more direct and meaningful comparisons, which can aid analyst coverage and investor understanding. Groups with significant US operations exposure or US expansion plans, aligning their financial reporting with US standards can streamline internal processes and investor relations.

A Calculated Risk, Not a Casual Leap of Faith

The decision for a FTSE PLC to delist from the LSE and relist on a US exchange, necessitates a full IFRS to US GAAP conversion, with an element of strategic gamble. While the potential rewards in terms of capital access and valuation can be significant, the accounting transition itself is a massive undertaking. It demands not only a deep understanding of the technical differences between the two accounting frameworks but also a comprehensive assessment of the associated financial, operational and reputational costs.

For a FTSE PLC to successfully navigate this transatlantic accounting divide a thorough due diligence is needed, where a detailed gap analysis between IFRS and US GAAP will help identify all material differences and their quantitative impact. Significant commitment to engage expert technical advisors and valuation specialists (with both  IFRS and US expertise) to the conversion programme, especially when internal personnel are focused on BAU.

Investor relations will need to work very closely with conversion champions to clearly articulate the reasons for the transition, the expected impact on financial reporting and the long-term strategic benefits to maintain investor confidence. Not forgetting also strengthen internal controls for the heightened scrutiny and compliance demands of the SEC and SOX.

The move from IFRS to US GAAP for a FTSE PLC is not a casual accounting tweak for the faint hearted but a fundamental shift in financial identity. Sure, it is a calculated risk that, if managed meticulously, can unlock significant opportunities in one of the world's largest capital markets. However, underestimating the complexities and costs of this accounting migration could derail even the most promising transatlantic ambitions.²

Dee Singh Kothari is a senior partner in Kothari Partners

¹ Emerging Growth Company: (revenues less than $1,2bil and not a large accelerated filer (i.e. public float of less than $700milion).

SOX 404 (a): Management to assess and report on the effectiveness of the company's internal controls over financial reporting.

SOX 404 (b): External auditors to attest to, and report on, the assessment made by management under Section 404(a).

Jobs Act 5 yr Exemption: It would generally exempt a new public company from compliance with section 404(b) for the first 5 years it is a public company as long as it does not exceed certain market capitalisation or revenue thresholds.

Transition exemption Yr1: The final rules provide all newly public companies with a transition period that prevents them from having to comply with the Section 404 requirements in the first annual report that they file after becoming an Exchange Act reporting company. 

² Contact Kothari Partners for a free confidential discussion on how we can help with your challenges.

At Kothari Partners, our approach is to help our clients understand their current situation, identify the value and decide on the scope, vision and set of strategies for what they could achieve for their business. We help plan their implementation and support them and deliver the solution/ change needed, so it is properly and permanently embedded in their organisation.

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