IFRS in the United States: Past, Present and Future
By Robert Garcia, CPA
The adoption of International Financial Reporting Standards (“IFRS”) has recently been a large accounting topic in the United States. IFRS would replace U.S. generally accepted accounting principles (“U.S. GAAP”) as the authoritative guidance of accounting transactions U.S. GAAP if it is adopted in the United States. The Securities and Exchange Commission (“SEC”) has proposed a roadmap to implement such a change that would start in 2014 and has said it would address the proposed roadmap this fall. IFRS was originally created in order to harmonize the different accounting standards throughout the world. IFRS has been compared to English being the worldwide language of business.
IFRS could be coming to the United States within the next decade. Over 100 countries throughout the world have already fully adopted IFRS or have converged their local accounting principles to mirror IFRS. The European Union, Australia, Hong Kong, New Zealand and South Africa are examples of regions that have already converged to IFRS. Countries currently in adoption include Canada, India, Japan, Brazil, and Mexico. There is growing pressure on the United States to fully adopt IFRS and move away from U.S. GAAP.
Currently, all U.S. public issuers and most private entities prepare their financial statements in accordance with U.S. GAAP. New accounting literature is issued by the Financial Accounting Standards Board (“FASB”). Until recently, U.S. GAAP was comprised of a mix of accounting literature prepared by different accounting bodies that had existed over the years. However, on July 1, 2009, the FASB combined all the accounting literature into a single source called the FASB Accounting Standards Codification. IFRS accounting literature is issued by the International Accounting Standards Board (“IASB”) which is headquartered in London.
The biggest difference between U.S. GAAP and IFRS is that U.S. GAAP is more rules-based while IFRS is more principles-based. What this means is that U.S. GAAP usually has specific guidance on how to treat specific accounting transactions while IFRS may only provide a framework on how to treat specific accounting transactions. There are approximately 17,000 pages of guidance under U.S. GAAP while IFRS contains approximately 3,000 pages. Using IFRS results in the notes to the financial statements being longer as more information must be disclosed to support a company’s accounting position. Other differences include, but are not limited to, the following under IFRS:
- Under IFRS, all financial statements must be presented in comparative format with the prior period. Single year financial statements are not allowed. While SEC registrants are already required to present comparative financial statements, US GAAP only encourages comparative financial statements but still allows for single-year presentation. [the SEC also requires this]
- For companies that do not expect to meet debt covenants, waivers must be granted prior to the fiscal year-end in order to still disclose debt as long-term. If a waiver is obtained after year-end, the debt must be disclosed as current debt, even though a waiver was granted. [isn’t this true under US GAAP too?]
- Special Purpose Entities (“SPE”) are consolidated if a relationship indicates that an entity controls the SPE. Under U.S. GAAP, an SPE is consolidated if an entity is the primary beneficiary of an SPE.
- Last-in First-Out (“LIFO”) inventory cost method is not allowed under IFRS.
- Under IFRS, impairment of long-lived assets (except goodwill) may be reversed in subsequent periods up to the initial carrying amount adjusted for depreciation.
- Gains or losses on sale/leaseback transactions are recognized immediately as long as the leaseback is not a capital lease. U.S. GAAP requires these gains/losses to be amortized over the life of the leaseback period.
- All deferred tax assets and liabilities are recognized as noncurrent on the balance sheet. U.S. GAAP allows certain tax assets and liabilities to be disclosed as current.
In October of 2002, the FASB and IASB agreed to the “Norwalk Agreement.” The Norwalk Agreement was the beginning of the U.S. GAAP/IFRS convergence project. The goal of the agreement was to remove differences between U.S. GAAP and IFRS so it would become easier for the United States to fully adopt IFRS in the future. Since that agreement was signed, several new accounting pronouncements have been issued by both entities. The FASB issued new accounting pronouncements that made U.S. GAAP more in line with IFRS and the IASB issued new accounting pronouncements that made IFRS more in line with U.S. GAAP. In the future, IFRS may actually be a hybrid of current U.S. GAAP and IFRS literature.
On November 14, 2008, SEC, lead by SEC Chairman Christopher Cox, issued its proposed roadmap for the potential use of financial statements prepared in accordance with IFRS by United States public issuers. Under the proposal, public issuers whose industry uses IFRS as the basis of financial reporting more than any other set of standards would be eligible to elect to use IFRS beginning with filings in 2010. The roadmap could eventually lead to the mandatory use of IFRS by U.S. public issuers starting in 2014.
On January 20, 2009, Mary L. Schapiro was appointed as the new SEC Chairman. Chairman Schapiro has expressed concerns of adopting IFRS at the current pace and her administration has mostly been silent on how it will proceed with the proposed roadmap issued by the Cox administration. However, after hearing no word on the proposed roadmap for several months, SEC Chief Accountant James Kroeker speaking at a conference on September 17, 2009 commented “Turning back to the roadmap will be an important priority for us this fall”. The next day Chairman Schapiro commented “I expect we will speak a little later this fall about what our expectations are with respect to IFRS”. IASB Chairman Sir David Tweedie has recently criticized how slowly the United States is responding to IFRS adoption and has publicly remarked the United States needs to commit by 2011 or the IASB may rethink the U.S. GAAP/IFRS convergence project. Chairman Tweedie has indicated the IASB is ready to move forward on its own projects to improve IFRS reporting instead of concentrating on U.S. GAAP/IFRS convergence.
There are several arguments for and against the adoption of IFRS in the United States. The biggest concerns for adoption are that the United States will lose control of setting accounting policies and that a principles-based accounting system could lead to an increase in accounting manipulation and an increase in lawsuits. The IASB has indicated it would allow more United States representation on its board once IFRS is adopted in the United States. Proponents of IFRS have indicated since IFRS requires more disclosure of accounting policies in the financial statements, the risk of accounting manipulation decreases. The proponents also state lawsuits would decrease since it is easier to defend financial statements prepared under a principles-based system instead of a rules-based system as it is easier to defend professional judgment.
Another concern for the United States is the cost of implementation. Since IFRS is a completely new accounting system, accountants and users of financial statements throughout the United States would have to be re-educated to understand the new rules, IT systems would need to be reconfigured to handle transactions under the new rules and there would be costs to renegotiate contracts or debt covenants that rely on a company’s financial statements.
The largest benefit seen for the United States would be increased investment from overseas since it would be easier for foreign investors to understand U.S. financials if they are in a uniform standard. Another benefit would be the decrease in translation costs for international companies. Currently, if a company with headquarters in the United States had subsidiaries throughout the world, that company would need to translate all those subsidiary financial statements into U.S. GAAP which requires the parent company to understand all the different local accounting principles its subsidiaries operate on. This translation amounts to time and money. If the parent company and all of its subsidiaries reported in IFRS, this translation cost would be eliminated.
More likely than not, it appears the SEC will eventually agree to adopt IFRS in the future. World capital markets are demanding a uniform set of accounting rules and the United States has become the largest hold-out up to this point. When IFRS is adopted in the United States, companies need to be proactive in understanding how the conversion will affect their business and plan for it. The biggest lesson from the European Union’s adoption of IFRS in 2005 was to not procrastinate. Several companies procrastinated in their IFRS conversion because they underestimated the changes they would need to implement in regards to training and IT systems. Due to the procrastination, companies had to pay more unnecessary costs in order to comply with IFRS before their financial statements were due by their regulatory authorities.
How IFRS implementation by U.S. public issuers will affect private entity accounting is unknown at this point. Market forces will most likely dictate where private accounting will proceed in the future, and this probably won’t occur until the SEC officially makes IFRS mandatory.
However, on July 9, 2009, the IASB published “International Financial Reporting Standards for Small and Medium-Sized Entities”. These new standards are meant for companies that publish general purpose financial statements for external users and do not have public accountability. These new standards were mainly developed for small and medium private companies and have greatly simplified and omitted several of the more complex topics not relevant to such companies. The amount of disclosures is also greatly reduced under these new rules. “IFRS for Small and Medium-Sized Entities” was published to be completely separate from IFRS. The new standards have already been adopted by the American Institute of Certified Public Accountants (AICPA) as an alternative for U.S. GAAP in the United States.
IFRS is changing the accounting world in the United States already. The most recent accounting literature issued by the FASB is to converge U.S. GAAP to be more in line with IFRS. The first steps of full implementation by the United States have already started and it appears the SEC may eventually require IFRS to be adopted. The most important aspect of this transition is for accounting personnel and financial statement users to understand what IFRS is and to keep up to date with IFRS updates so they will be ready for implementation.
Robert Garcia, CPA is a member of the Houston CPA Society and a Sr. Manager with the firm of Briggs & Veselka Co., Certified Public Accounts and Business Advisors with offices located in Bellaire, TX.
Houston Office Market: How Tenants Can Benefit in Today's Market
Stan Voelkel, CPA
Houston CPA Society
Real Estate Group
At midyear 2009, Houston's office market is feeling the effects of the sluggish economy and pervasive credit crunch. Following the high water mark in the fourth quarter of 2008, office fundamentals have softened significantly. The most pressing questions before us are how long will current conditions last and what can tenants do to benefit from this cycle?
A common misconception exists that real estate market cycles change slowly over extended periods of time, although this is not always the case. By examining two recent three-year periods in Houston's office market, for instance, we find that time lapsed does not dictate market changes. Instead, market changes are the result of a dynamic interplay of key factors specific to each period. From the first quarter 2003 to the fourth quarter 2005, Houston's CBD Class A office market remained fairly stable, with occupancy rates moving from 81% to 78.8% and rental rates from $23.11 to $21.19 per square foot. The next three years, however, tell a completely different story. Between the fourth quarter 2005 and the fourth quarter 2008, occupancy jumped from 78.8% to 91.1%, while average rental rates catapulted from $21.19 to $38.41 per sq. ft., marking a significant 81.3% increase. It should be noted that this increase in quoted rental rates does not take into account concessions – including free rent, tenant improvement packages and abated/discounted parking – offered by landlords. During 2006-2008, landlords all but eliminated free rent and abated/discounted parking, and also reduced tenant improvement packages by 50 percent. Tenants who were fortunate to sign a new lease or renew their existing lease in 2003 experienced strong sticker shock in 2008 when their landlords presented them with new lease proposals with very different terms. You are probably shaking your head in disbelief wondering what happened! Well, the short answer is OIL. Oil prices soared from $66 per barrel in 2006 to $145 in mid-2008. As oil companies aggressively expanded their businesses, accounting firms, law firms, insurance firms, and all other energy industry service providers went along for the ride.
Seeing how differently a market can perform over a three-year period, the question remains what does the future hold for today’s tenants in the market? Since the beginning of 2009, landlords have responded to the prevailing uncertainty in the real estate market by actively competing to attract solid, credit-worthy tenants to their buildings. The primary means of distinguishing themselves from the competition – i.e. other office building landlords – has been to increase lease concessions, including better rental rates, tenant improvement packages and abated/discounted parking charges. Typical concessions in today’s market includes 6-9 months of abated rent, turn-key build-out for tenant improvements, and 12-18 months of abated/discounted parking, depending on the lease term.
The single most important thing tenants can do to benefit from a flat market, is to choose to be represented by the best commercial broker available. An experienced, competent commercial broker is one who has excellent knowledge of current market conditions, is prepared with a comprehensive letter of intent covering all key business points, and is fully capable of negotiating from a position of leverage. A strong commercial broker will always work to create leverage for a client. Leverage is created when an existing landlord believes they are likely to lose you as a tenant. The cost to replace a tenant in any market is extremely expensive. When a tenant vacates space, landlords typically spend between $20-30 per square foot to provide tenant improvements to retrofit the space for a new tenant. This can represent a minimum of 3-9 months of lost rent for the landlord, not to mention the downtime after retrofitting while the space remains vacant. Losing a tenant is expensive for landlords!
Many office tenants have never used a representative broker and are not familiar with the services provided or how a tenant rep broker is compensated. Some tenants think they have to write a check to a broker when a deal is struck. On the contrary, a tenant rep broker is compensated in the same manner as a buyer's agent in a residential transaction. It is the seller or lessor who pays the tenant rep broker's fees, not the buyer or lessee. Many tenants feel they are saving a broker commission by working directly with a landlord. Landlords often suggest that if a tenant foregoes broker representation, the "saved" commission will be passed along to the tenant, but this is not the case. In reality, landlords may not want a tenant rep broker involved because this allows them to work directly with a tenant who is not knowledgeable about the market, and consequently, at a disadvantage in negotiating lease terms.
At the beginning of any lease transaction, brokers as well as tenants, receive the quoted building rental rates and standard concession package. However, only after a tenant rep broker has shown a tenant the various options available in the market and after careful analysis determined the most advantageous terms to the tenant, can true negotiations begin between a landlord and tenant.
Stanley H. Voelkel, II, CPA, vice president at Colliers International's Office Services Group in Houston. specializes in office tenant representation and has worked with a wide array of business entities, from corporations to small businesses, successfully representing firms across diverse industries.
Find Your Voice in 2009