Market Trends

SEC Proposal to Allow Early Adoption of International Accounting Standards

September 5, 2008

by Mike Antich - Also by this author

By Mike Antich

Last week, on Aug. 27, the Securities and Exchange Commission (SEC) raisedthe possibility that some U.S.publicly traded companies will be able to use international accounting standards(IAS) next year and may require all U.S. companies switch to IAS between 2014-2016. TheSEC commissioners voted unanimously to release the proposal for a 60-daycomment period. If approved, the SEC estimates 110 companies in 30 industries wouldbe eligible to use IAS for fiscal years ending after Dec. 15, 2009. Only thetop 20 companies in each industry would be eligible, based on marketcapitalization and whether their largest foreign competitors use IAS.

Efforts to developinternational accounting standards were started in 1973 by the International AccountingStandards Board (IASB). Today, nearly 100 countries require or allow companiesto prepare financial statements using IAS. The U.S.uses Generally Accepted Accounting Principles (GAAP); however, there is agrowing movement for the adopt the IAS rules where there are differences between the two rules. Thisprocess has been called “convergence.” Currently, accounting standards vary betweenthe U.S.and countries that use IAS, such as the European Union nations, making comparisonof corporate financial statements difficult. For multinational companies,compliance with a single set of accounting standards would be a majorimprovement to the current multiplicity of national standards and would promisesignificant cost savings, among other benefits. These multinationals have toldthe SEC that allowing IAS in the U.S. would also bring efficiencies sincemany of their non-U.S. subsidiaries already use international accounting standards.

It is estimated that U.Scompanies would require two to three years to make the switch to IAS, withsmaller businesses needing more time. The SEC said it would consider requiringlarge U.S.companies to switch to international accounting standards for 2014 financialstatements, with mid-size companies required to switch in 2015, and small companiesto switch in 2016. Under this so-called“road map,” a final decision on adoption would be made by the SEC in 2011.

IAS Impact on Fleet Leasing in the U.S.

Fleet leasing is one facet of fleet management that will be impactedby international accounting standards. Lease accounting is governed byFinancial Accounting Standard (FAS) 13 in the U.S. and by IAS 17 elsewhere. One of the maindifferences between these two rules is that FAS 13 treats typical open-endleases as operating (off-balance sheet) leases, while IAS 17 treats them ascapital (on-balance sheet) leases. IAS17 allows closed-end leases to be treated as operating leases. Currently, the IASB and the U.S. FinancialAccounting Standards Board (FASB) are working on a project – known as the LeaseAccounting for Lessees Project – to align these two rules. “All indications arethat the new rules will require all leases to be capitalized, regardless ofwhether they are open- or closed-end. In fact, the SEC has stated that convergenceon such issues is likely to be a ‘gating’ factor to moving to internationalaccounting standards,” said Dan Frank, vice president and general manager forFour Wheels at Wheels Inc. “Thus, regardlessof whether companies move to international standards or continue to use U.S.GAAP, it is probable that all leases will need to be capitalized sometime inthe 2011-2016 timeframe." Exactly howthe leases will be capitalized, including accounting for renewal options, contingentrents, and residual guarantees, is still open for discussion by the standardsboards.

“I think it is highly unlikely the SECdecision will have any material impact on fleet leasing in the U.S.,”said Jim Frank, president & CEO of Wheels Inc. “The vast majority of ourclients lease for the financial, administrative, and service benefits a fleetmanagement company can provide and not merely for off-balance sheetaccounting. The biggest change will bein the reporting requirements that will be associated with accounting for acapitalized lease rather than simply an expense. Most lessors should be readyto assist their clients with this to make it as seamless as possible. Since all leases will ultimately be treatedthe same, we don’t expect a large change in demand for open- versus closed-endleases.”

George Kilroy, president& CEO of PHH Arval says the recent SEC decision could impact fundingdecisions at some companies. “If early adoption means adopting current IAS 17lease accounting, it could mean many of the leases in the fleet industry thatare treated as operating leases would have to be capitalized. That may impactsome companies’ decision as to whether to lease or not, or to change leasestructure,” said Kilroy.

Other Considerations and Implications

Many in the fleet industry expect the SEC to endorse IAS 17, but withmodifications that will result from the Lease Accounting for LesseesProject.

There are also other implications to the adoption ofIAS 17. “We’ll have to watch this closely, given the current state ofthe credit markets and, for some companies, the growing importance offinancial ratios to their ability to access funds,” said Kilroy.

According to Jim Frank, this issue is likely to be addressed by the enormity of the overall change to IAS.  “When companies switch over to international accounting standards, lenders, accountants, analysts, and investors are all going to need to adjust their measurements and ratios to accommodate the new reporting.  Many of them already add back the off-balance sheet items today.”

Others view the implications of the convergence between FASB and IASB as still uncertain. “The interpretation of open-end leases will likely change in some form or fashion. Whether these new interpretations will lead some fleets to choose to vary their ownership versus open-end lease versus closed-end lease is unknown,” said Rick Fletcher, strategic marketing manager for GE Capital Solutions Fleet Services. “Financial reporting treatment is only one of many factors to consider when making fleet decisions. The question will become how important operating lease treatment is to companies. In today’s sophisticated financial markets, with increased focus on underwriting standards, off- versus on-balance sheet accounting will likely be viewed similarly by capital markets. Therefore, many believe the impact of the change will be minimal, but only time will tell.”

Wholesale Change to U.S. Accounting Rules

If the international accounting standards are eventually adopted, the result will be wholesale change in U.S. accounting rules. While FASB and IASB are working to bring convergence between accounting rules, there still remain differences between the two.

Not everyone is happy with the possible convergence between FASB and IASB standards. “I do not like the idea of the U.S. losing control over accounting rules because the IASB is not as accessible as the FASB has been to the fleet leasing industry,” said Bill Bosco, president of Leasing 101 in Suffern, N.Y. “IASB has such a vast base of interested parties that it seems they listen to no one, and it seems the political processes around the world have allowed some cases where large, influential companies get special treatment.”

Let me know what you think.
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