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Companies’ contracts often, either explicitly or implicitly, require the use of U.S. GAAP or are based on current U.S. GAAP reporting. If IFRS were to be incorporated into the U.S. financial reporting system, U.S. issuers would be required to determine how their contracts could be impacted and how those impacts should be addressed. Accordingly, in executing the Work Plan, the Staff:

 Assessed the types and pervasiveness of contractual arrangements that would be affected by such incorporation and the manner in which they would be affected.

 Determined the costs, ability, plans, and estimated time required to address concerns regarding affected contractual arrangements.472

The Staff executed this aspect of the Work Plan primarily by outreach to issuers using the Issuer Comment Request, which solicited comment on several issues related to the potential impact of any incorporation of IFRS on issuers’ contracts, including:

 The extent and manner in which incorporating IFRS would be likely to affect the application, interpretation, or enforcement of contractual commercial

arrangements such as financing agreements, trust indentures, merger agreements, executive employment agreements, stock incentive plans, leases, franchise agreements, royalty agreements, preferred stock designations, or other commercial arrangements;

 How parties to such arrangements would most likely address the effects and whether an incorporation of IFRS would be treated differently than a change in an existing financial reporting standard under U.S. GAAP is treated today; and

 The extent to which any potential effects of incorporation could be mitigated by phased-in transition and, if so, the length of such transition.

The Staff also received insightful feedback at the SEC IFRS Roundtable and through comments on the 2011 May Staff Paper.

1. Types and Pervasiveness

Commenters identified the following two principal terms in contracts that may be affected by any incorporation of IFRS: (1) terms requiring delivery of financial statements prepared in accordance with U.S. GAAP; and (2) terms requiring that a company achieve or

472

maintain certain financial targets or ratios, the inputs for which are currently calculated using U.S. GAAP (and which may or may not explicitly state that U.S. GAAP is to be used).473

Commenters noted that these types of contractual terms could be found in the types of contracts identified in the Issuer Comment Request (and noted above) but also in sale/purchase agreements, hedging contracts, R&D collaboration agreements, employee compensation arrangements, and a significant number of additional types of contracts.474 The Staff believes that both the scope and the volume of the impacted contracts would be significant.

The Staff noted that some companies have anticipated the potential for change in

accounting standards (either due to normal course changes to U.S. GAAP or due to the potential incorporation of IFRS) by using so-called “frozen GAAP.” That is, the contract will specify the use of U.S. GAAP as it exists at the time the contract was signed. These contracts may also be impacted by incorporation of IFRS, but differently, as described below.

2. Effects on Issuers

To some extent, commenters described difficulties in determining how any incorporation of IFRS would impact their contractual arrangements. Commenters emphasized that the extent of the impact would depend, in part, on the progress of current efforts to converge U.S. GAAP and IFRS: the more successful the convergence process is now, the easier the transition to incorporate IFRS would be later.475 Commenters also pointed out that the incompleteness of the convergence process makes it difficult at this time to predict comprehensively and accurately the impact of a transition to IFRS.476

That said, however, the vast majority of commenters explained that companies will need to review all of their contracts to identify explicit or implicit references to U.S. GAAP and to determine how they will address those provisions that would be affected by any incorporation of IFRS.477 However, some commenters noted that companies already have in place (or should

473

See comment letters of American Institute of Certified Public Accountants; The Allstate Corporation; Beckman Coulter; Financial Executives International; FirstEnergy Corp.; The Institute of Chartered Accountants in England and Wales; Lincoln Financial Group; and URS Corporation on the Issuer Comment Request.

474

See, e.g., comment letters of American Council of Life Insurers; American Institute of Certified Public Accountants; Alcoa Inc.; The Allstate Corporation; Beckman Coulter; Chevron Corporation; Constellation Energy; FirstEnergy Corp.; Ford Motor Company; The Institute of Chartered Accountants in England and Wales; Institute of Management Accountants; KPMG LLP; Eli Lilly and Company; Lincoln Financial Group; Northrop Grumman; and URS Corporation on the Issuer Comment Request.

475

See comment letters of American Council of Life Insurers; American Institute of Certified Public Accountants; Alcoa Inc.; The Center for Audit Quality; Conrad Hewitt; and KPMG LLP on the Issuer Comment Request.

476

See comment letters of American Council of Life Insurers; U.S. Chamber of Commerce; Intel Corporation; and Lincoln Financial Group on the Issuer Comment Request.

477

See comment letters of American Council of Life Insurers; Association for Financial Professionals; Alcoa Inc.; The Allstate Corporation; BNY Mellon; The Center for Audit Quality; FirstEnergy Corp.; Institute of

Management Accountants; KPMG LLP; Eli Lilly and Company; Lincoln Financial Group; Northrop Grumman; and State Street Corporation on the Issuer Comment Request. See also comment letter of the American Institute of Certified Public Accountants on the Issuer Comment Request (noting that the amount of effort this would

have in place) mechanisms for assessing changes to contracts caused by changes to accounting standards, as these changes currently occur in the ordinary course.478 A transition to IFRS would involve an invocation of these same mechanisms—but the scope of the overall impact

assessment would be much more extensive.479

Commenters asserted that many of the contracts affected by any incorporation of IFRS may need to be renegotiated.480 The Staff understands that a contract renegotiation could be executed with relatively little effort (e.g., the parties may agree to substitute IFRS financial reports for U.S. GAAP reports),481 or renegotiations could be more complex and time-

consuming. For example, counterparties may attempt to renegotiate other issues, or agreements related to debt securities or other indebtedness may require a consent solicitation or tender offer, which would involve substantial time and cost, and which could be economically

disadvantageous based on market conditions.482

Several commenters expressed concerns regarding the possible incorporation of more principles-based accounting on the Federal Acquisition Regulation (“FAR”) system and

government contractors.483 Specifically, the FAR’s cost accounting standards (“CAS”) reference or incorporate U.S. GAAP in several aspects, but currently, it is unclear whether, and, if so, how the CAS would be transitioned to IFRS—whether the CAS would be modified to incorporate the relevant provisions of IFRS or whether affected issuers would need to maintain dual accounting records. Thus, commenters requested that the SEC work with the Department of Defense, National Aeronautics and Space Administration, and the General Services Administration to resolve the cost accounting issue concurrently with any incorporation of IFRS.484

require varies from company to company, with leasing companies, real estate management companies, and financial services companies likely having a large volume of contracts that need to be addressed).

478

See comment letters of The Center for Audit Quality and KPMG LLP on the Issuer Comment Request.

479

See comment letters of American Institute of Certified Public Accountants; The Allstate Corporation; The Center for Audit Quality; The Institute of Chartered Accountants in England and Wales; KPMG LLP; and Lincoln Financial Group on the Issuer Comment Request.

480

See comment letters of American Institute of Certified Public Accountants; Alcoa Inc.; The Allstate Corporation; Beckman Coulter; BNY Mellon; Chevron Corporation; Constellation Energy; Financial Executives International; FirstEnergy Corp.; Institute of Management Accountants; Lincoln Financial Group; Northrop Grumman; and State Street Corporation on the Issuer Comment Request. See also comment letter of Intel Corporation on the Issuer Comment Request (noting that it could not determine how many of its own contracts would need renegotiation because of uncertainty associated with ongoing standard setting in areas such as leasing and financial instruments with characteristics of equity).

481

See comment letters of FirstEnergy Corp. and Lincoln Financial Group on the Issuer Comment Request.

482

See comment letters of Alcoa Inc.; Beckman Coulter; Constellation Energy; FirstEnergy Corp.; Institute of Management Accountants; and Lincoln Financial Group on the Issuer Comment Request.

483

See comment letters of Aerospace Industries Association; Northrop Grumman; and URS Corporation on Issuer Comment Request.

484

See comment letters of Aerospace Industries Association and Northrop Grumman on the Issuer Comment Request.

Commenters acknowledged that not all contracts would need to be renegotiated specifically to incorporate IFRS. For example, contracts could be updated to reflect IFRS incorporation during their normal renewal cycles. A lengthier transition period, in general, would afford issuers increased flexibility in addressing contracts through this process. Finally, it is possible that a transition to IFRS would only immaterially impact contractual arrangements, requiring no action to be taken.485

Finally, for contracts containing frozen GAAP provisions, contractual counterparties would, in theory, not need to take any action to respond to any incorporation of IFRS. One commenter noted that issuers that have agreements with frozen GAAP currently would need to have processes in place to be able to report or assess compliance with contractual terms based on U.S. GAAP as it existed when it entered into the agreement.486 Any incorporation of IFRS would involve the use of these same processes—but the scope of the changes to be managed could be much different.487 For example, to the extent that current accounting systems must be significantly modified to incorporate IFRS, the maintenance of legacy accounting systems necessary to track frozen GAAP could become more costly (as would the alternative of calculating adjustments from IFRS to the frozen GAAP). As a result, companies may have incentives to renegotiate contracts containing metrics based on frozen GAAP upon any incorporation of IFRS as a means of avoiding additional costs.

The Staff understands that the burdens of incorporating IFRS into the financial reporting system for U.S. issuers could be mitigated if any such incorporation is accomplished by

amending the substance of U.S. GAAP to conform to IFRS by incorporating such standards into the Codification, while continuing to refer to the amended accounting standards as U.S.

GAAP.488 In some cases, however, this approach may result in the need to renegotiate the terms of the contract, particularly when the resulting accounting treatment is not favored nor

anticipated by the company or its counterparty.489 Although this approach to incorporation could be helpful, it would not be a substitute for comprehensive reviews of contracts. Commenters were nearly unanimous in noting that an appropriate transition period (comments centered on a five-year transition period) would be necessary to provide issuers sufficient time to complete their review of contracts, to determine how to respond, and to execute on those decisions (e.g., by conducting the required renegotiations).490

485

See comment letter of Intel Corporation on the Issuer Comment Request.

486

See comment letter of KPMG LLP on the Issuer Comment Request.

487

See id.

488

See comment letters of Alcoa Inc.; Conrad Hewitt; and BNY Mellon on the Issuer Comment Request.

489

See comment letter of Institute of Management Accountants on the Issuer Comment Request.

490

See comment letters of American Council of Life Insurers; Association for Financial Professionals; American Institute of Certified Public Accountants; Alcoa Inc.; Beckman Coulter; BNY Mellon; The Center for Audit Quality; U.S. Chamber of Commerce; Chevron Corporation; Constellation Energy; Financial Executives International; FirstEnergy Corp.; Institute of Management Accountants; KPMG LLP; Lincoln Financial Group; Northrop Grumman; State Street Corporation; and URS Corporation on the Issuer Comment Request.