Thursday, January 14, 2010

Why IFRS Adoption will Slow Down in the U.S.

Recent political battles in Europe over IFRS may have slowed the timeline on progress of adoption of an IFRS road map in the U.S.

Reports suggest that the International Accounting Standards Board is in turmoil over the independence of standard-setters among other issues. With the U.S. watching on the sidelines, conflicting signals are being sent and questions are being asked about what the rush is toward adoption of IFRS in the U.S.—if the IASB, which sets IFRS standards, can’t agree on things, why would the U.S. buy in?

Politics won’t go away if and when the U.S. buys in to IFRS. The U.S. will not submit to the whims of accounting standards controlled by Europe, especially with the French government recently refusing to adopt certain IFRS standards affecting financial institutions. That is why the SEC has called for certainty about governance and funding before it sets a firm adoption date for IFRS.

In a recent article, Alfred M. King, vice chairman of Marshall & Stevens, a financial valuation and consulting practice cited six IFRS myths—a bit too late for Canadians, who are on track to adopt in 2011, and Australia and Europe, who have already adopted.

What follows below is Mr. King's article.


No. 1: IFRS will improve U.S. accounting. I have yet to see any proof that financial reporting by U.S. companies will be improved if we substitute IFRS for GAAP. However one slices it, accounting is an artificial construct. That GAAP and IFRS are different is self-evident. That IFRS is superior to GAAP is an assertion, not a proven hypothesis. The principal argument of proponents is that IFRS is "principles-based" while GAAP is "rules-based."

Who says principles are better than rules? If IFRS is so superior, shouldn't it produce better economic outcomes? Few people would support the thesis that the U.S. economy somehow suffers in comparison to countries that use IFRS - our capital markets are larger and stronger.

If IFRS is superior, economic data do not make that case. That leads us to principles versus rules.

No. 2: IFRS is principles-based while GAAP is rules-based. Why do we have rules-based accounting in the U.S.? Because auditors want certainty against the threat of lawsuits. The proponents of IFRS have not asserted that the legal system in our country will be modified to prohibit class-action lawsuits against accounting firms. Until or unless the legal system changes, auditors need the protection they get when they follow accounting "rules."

Further, every observer with deep IFRS experience says the same thing: Whenever an IFRS accounting issue arises, the usual response is, "What does GAAP say?" In other words, IFRS itself defers to GAAP as being intellectually superior.

No. 3: To be competitive, U.S. companies must adopt IFRS. This assertion sounds good, but it's only a sound bite. There is not a shred of evidence either that accounting under GAAP is a hindrance or that there would be any positive change in economic performance were IFRS to become the dominant accounting system in the U.S. The track record of the countries in the EU, however, does suggest a high probability of economic decline.

IFRS usage worldwide might make the task of security analysts easier, but within both GAAP and IFRS there are still significant differences among companies in the same industry. That adoption of IFRS will suddenly make accounting differences disappear flies in the face of experience over the last 75 years.

No. 4: To be a good international citizen we cannot continue to be the only country with GAAP. Hogwash. This could easily be turned upside down by an assertion that IFRS users would be better citizens were they to adopt GAAP. After all, the U.S. accounts for a substantial portion of global GDP. Perhaps the economic health of many European firms is worsened by IFRS. Indeed, they might be better off with a more robust accounting system, i.e., GAAP.

No. 5: We are going to do it sooner or later, so why not start now? This sounds like the used-car salesman who says, "If you don't buy this beauty (wreck?) today, you'll be left behind tomorrow."

Implicit in this concept is that convergence will happen because of some innate superiority in IFRS. The real issue is that proponents fear a public debate with knowledgeable opponents of this bad idea. Advocates say that the faster the U.S. gets on board, the sooner we will see the "benefits" of IFRS. But what are those benefits?

No. 6: The upfront costs of conversion or convergence will be more than offset by future savings. That there would be substantial cost in converting to IFRS is a given. To companies, that cost would represent cash outlays to auditors and consultants. No wonder the major firms support IFRS. They see tons of revenue awaiting them.

The costs to companies are real and tangible. The future savings are speculative and opaque. Will companies spend less time on internal controls and financial reporting if IFRS replaces GAAP? If that is the case, let IFRS proponents prove the case. Not assert it - prove it.

Much more likely is that the cost to companies of developing and disseminating financial information under IFRS will be about the same as it is today, once the initial conversion costs are past. So where will these savings come from? Maybe, like the current health care debate, the Congressional Budget Office could "score" a conversion to IFRS. Skepticism abounds that the Obama administration's estimate of cost savings from its health care proposals will ever come to pass. Will Medicare really be reduced by $400 or $500 billion?

It is possible that IFRS can generate savings. But where the savings will come from, and whether anyone other than consultants and accounting firms will actually gain, appear to be well-kept secrets.

KING'S CONCLUSIONS--Mr. King's conclusions are set out below.

There appears to be a rush to judgment to dump GAAP and embrace IFRS. But once we see who benefits from such a change, the case for IFRS becomes much weaker.

It is up to IFRS supporters to lay out a detailed explanation of all the costs and to quantify all the benefits. Hiding behind generalizations such as we must be good corporate world citizens or principles are better than rules does not provide rigorous support to offset the known costs that switching to IFRS would entail.


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George said...

You're absolutely correct. IFRS is going to be a huge bonanza for trial lawyers and it will force all but the smallest tax preparation firms to merge or fold, because their liability will go through the roof once the switchover occurs. The Big 4 loves this. But IFRS is horrible for other reasons as well -- these "principles" have been invented for use in small countries where inflation is sometimes very high. Consequently, fixed assets are always marked to market. This makes the balance sheet more accurate at a glance, but also incredibly difficult to go through the financials and figure out where the cash is going.

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