From a small northwestern observatory…

Finance and economics generally focused on real estate

International Financial Reporting Standards

with 2 comments

I know I’m sounding like an overly technical geek on these subjects, but as we know from the recent (current?) economic malaise, seemingly back-page issues can have major impacts on large segments of the economy.

Buried deep inside Friday’s issue of the Wall Street Journal (OK, page C1, but that’s pretty deep) was news that the SEC will once again delay implementation of the International Financial Reporting Standards (“IFRS”) for U.S. regulated businesses (from a practical standpoint, essentially all of them).  For those who aren’t up on their accounting theory, U.S. accounting standards — generally referred to as “Generally Accepted Accounting Practices” or “GAAP” for short — have been developed over time from essentially three sources:  “best practices” which have evolved literally over the centuries, pronouncements of the Financial Accounting Standards Board, or “FASB”, and its predecessors, and adaptations to conform with U.S. tax practice.  IFSR is more of a top-down approach, and governs accounting practices pretty much anywhere in the developed world EXCEPT for the U.S.   (One might argue, and with some validity, that recent accounting problems among Chinese businesses reveal real problem with IFRS compliance, and one wouldn’t be altogether wrong.  That’s a topic for a different day, though.)

American businesses dealing in global commerce (as nearly all big ones do, now-a-days) have been anxious for a unifying accounting paradigm for many years.  Indeed, the differences between IFRS and GAAP are significant, and in fact adoption of IFRS in the U.S. may cost many businesses quite a bit in tax penalties, since IFRS doesn’t recognize certain tax avoidance strategies (e.g. — last-in-first-out inventory accounting) that are common in the U.S.  Nonetheless, American businesses are willing to suffer the tax pain in order to get a common accounting language globally.

From an accounting perspective, this delay by the SEC is a royal pain in the neck, but that too is a topic for another day.  The reason I bring it up today is the implicit impact on real estate appraisal standards.  I’ve noted, with some interest, that appraisal standards are increasingly derivative of accounting practices.  Back when America’s Uniform Standards of Professional Appraisal Practice (“USPAP”) was developed, accountants could barely care about appraisal standards.  Today, a close examination of the International Valuation Standards Council (IVS) reveals a substantial degree of input from the accounting and banking fields, much more than we saw 25-ish years ago when USPAP was first codified.

In my own observation, this SEC delay gives the appraisal profession another year or so to decide if they want a top-down or bottoms-up approach to appraisal standards in the U.S.  Do appraisers want to be driving the truck or riding in the back?  I’ve observed that the three constituent “regulatory” bodies (the professional organizations, such as the Appraisal Institute and RICS, the Appraisal Foundation, and the state and federal regulators) seem to be of three different minds on the subject.  The constituent bodies seem to be more proactive and ready to move forward with IVS adoption.  The Foundation seems to have been constantly playing damage control in the past couple of years over the mortgage market meltdown and the resultant sturm-and-drang from the Federal regulatory bodies.  None of those regulatory bodies seemed to have a dog in this hunt, so haven’t appeared to care.  I will say, however, that proposed changes to USPAP 2014, which are currently being circulated in draft form, are very forward-looking, albeit with baby steps.

Finally, state regulators are almost 100% reactive.  Some are very good at reacting, and some are very bad.  Currently, they are all overwhelmed with the double-whammy of very real budget cuts and very real appraisal standards violations problems emanating from the mortgage market meltdown.  As such, a major paradigm shift in appraisal standards will be difficult for them to swallow.

This all seems to be back-page stuff, but in fact these issues have very real implications for the way “business does business”, particularly in the real estate valuation world.  We’ll keep you posted.

Written by johnkilpatrick

July 8, 2012 at 4:43 am

2 Responses

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  1. Thanks for the article you posted at the USPAP LinkedIn site. I appraise public utility companies. The large ones are audited by SOX CPA’s. Thus, one knows they are adhering to GAAP, but small companies do not adhere to GAAP. They have their own unique ways of not reporting what I am looking for. However, many small companies do deal with banks who think in terms of GAAP. Thus, through the back door, those small companies do report in some manner that mimics GAAP.

    However, one glaring weakness with GAAP is related to reporting leases. We in WV used to appraise airlines. We would ask for original cost information on their aircrafts. They would point out that they deal with operational leases. They did not own the aircrafts. So, we would go round-robin to get at the original cost information on those aircrafts.

    Then, WV passed legislation where we would only value airlines based on 5% of the original cost information on their aircrafts. We have had no problem with airlines in providing that original cost information.

    So, I am inclined that I would like IFRS to bring sunlight to what goes on with operational leases. Then, since banks are big-time entities, I am inclined to have banks gear their accounting to accounting theory rather than rules. However, from the USPAP discussions, it seems real-estate appraisers, banks, and Frank-Dodd rules are completely tying us up in red-tape rules that keep us from doing sale transactions on real-estate. Do all of these rules prevent us from moving to IFRS? What is the possibility of IFRS over-riding all of the gobbedy-goop rules and letting us adhere to sound accounting theory understanding?

    Please advise. Thanks.

    Scott McNeil, Tax Analyst II
    Property Tax Division
    Ph: (304)558-0769
    Email: Scott.H.McNeil@wv.gov

    H. Scott McNeil

    July 12, 2012 at 10:48 am

  2. Scott —

    Thanks for the comments. The short answer, unfortunately, is that IFRS will simply replace one set of complex rules with another, somewhat different set. I concur that lease accounting has always been problematic under GAAP, but I can’t speak to whether or not this will change much under IFRS. In some ways, IFRS provides broader lattitude for financial reporting, but in other ways prohibits certain practices which are economically unsupported (i.e. — LIFO inventory accounting).

    Thers is, however, a substantial divergence between GAAP and IFRS on lease accounting (also on revenue recognition and accounting for financial instruments). PriceWaterhouse Coopers has a publication on IFRS versus GAAP which you may want to read — info for ordering can be accessed by clicking here.

    Best wishes,

    John

    johnkilpatrick

    July 12, 2012 at 11:11 am


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