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2011: The Year of Sweeping Accounting Changes

2011 may become one of the most significant years in the history of accounting. The activities of several different organizations, including the Securities and Exchange Commission (SEC), the Financial Accounting Standards Board (FASB), and the International Accounting Standards Board (IASB) are poised to create an upheaval unlike any that’s been seen in recent years. While it’s unlikely that the expected changes will need to be implemented this year, those affected, including accounting and finance professionals, business owners, investors and others, will need to begin to devote significant attention to these issues in order to understand their impact. 

IFRS Adoption

First and foremost on the list of changes is the potential adoption of the International Financial Reporting Standards, or IFRS. The SEC has been studying the possibility of further incorporating IFRS into the U.S. financial reporting system since 2008. The issue was temporarily derailed in 2009 due to the credit crisis, but the SEC issued a revised work plan in early 2010 that established a goal of making public its decision about IFRS in 2011. That decision is expected in the latter part of the year.

Currently, public companies in the United States are required by the SEC to prepare their financial statements using U.S. generally accepted accounting principles (GAAP). IFRS is the international counterpart to U.S. GAAP and is used in more than 100 countries around the world. The globalization of trade and credit markets has heightened the issue of whether the United States should join the ranks of the European Union and other large economies that already use IFRS. At this time, the SEC has not publicly disclosed whether it’s in favor of a change to IFRS, how a change to the international standards would be accomplished, and over what time frame. However, it’s widely believed that, should the SEC require public companies to begin using IFRS, a minimum three-to-four year adoption period would be necessary to implement the change.

It’s important to note that any decision would only affect public companies that file financial statements with the SEC. However, should public companies begin to follow IFRS, it’s expected that other nonpublic companies may adopt the international standards, especially those that compete directly with public companies for customers, vendors, and financing. 

Lease Accounting

Leasing has been and continues to be one of the most common forms of financing for real estate, equipment, and other assets. There are many advantages to leasing, including the ability for lessees to only commit to using an asset for a limited period of time along with the reduced cash outlays at the inception of a lease when compared with asset purchases. The accounting rules governing leases have also led to their popularity with some entities. Under current U.S. GAAP, leases can be structured as “off-balance sheet” contracts whereby no assets and liabilities are initially recognized and the rent payments are simply expensed when paid in future periods. However, this off-balance sheet treatment has attracted the attention of regulators and accounting standard setters, many of whom believe that all lease contracts should result in assets and liabilities being recorded by lessees.

As part of a project being undertaken by the FASB and the IASB, a new lease standard has been proposed that would require assets and liabilities to be recognized for all lease arrangements, effectively eliminating the off-balance sheet advantages under the current approach. For companies that use leasing as a significant form of financing, the new standard could create significant changes to their financial statements, in particular by increasing the amount of recorded liabilities. This could result in higher leverage measures, such as the debt-to-equity ratio.

The new lease standard is expected to be issued in late 2011. A timetable for implementation has not yet been decided; however, many companies have said that they may need an extended period of time to gather the necessary information to adopt the new guidance. 

Revenue Recognition

The accounting rules for revenue recognition are extremely complex, at times contradictory, and a challenge for financial statement preparers, users, and auditors. This is a reflection of the importance placed on the revenue line item in financial statements and the number of different standards issued throughout the years to address issues such as multiple-element contracts and industry-specific matters, such as software, utilities, and construction contracts. The FASB and the IASB are attempting to eliminate much of the complexity and confusion by issuing a new standard that creates a uniform revenue recognition model that will apply to nearly all industries.

The proposed model takes a contract-based view of revenue recognition by requiring companies to recognize assets and liabilities related to the various rights and obligations they have in contracts with customers. Revenue and expenses are then recognized based on the changes in those rights and obligations as goods and services are provided to customers. The proposed model would introduce only modest changes for certain entities such as manufacturing companies, whereas other entities, such as technology companies, contractors, and others could see significant changes to their financial statements.

Similar to the new lease accounting standard, the proposed revenue recognition guidance is expected to be finalized in late 2011, with no decisions yet on an implementation timetable.

Now Is the Time to Begin to Plan

Significant changes to accounting standards are expected to make 2011 one of the more memorable years in recent history. Now is the time for organizations to begin to assess the potential impact of the changes, which have the possibility of touching nearly all entities that prepare financial statements. Plante & Moran will continue to be at the forefront of these issues and provide updates within the Universal Advisor as they arise.

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David Grubb

877.622.2257, x33745