Wednesday, March 31, 2010

Contrary Opinions on IFRS

J. Edward Ketz is a professor at Pennsylvania State University. He wrote an interesting article recently on the U.S. approach to IFRS.

On February 24, the SEC issued its "Statement in Support of Convergence and Global Accounting Standards." Curiously, while the SEC did indeed affirm its "strong commitment" to IFRS, it may have unwittingly given voice to the concerns of dissidents. Finally!

The report begins with a documentation of the SEC’s commitment to a set of high-quality accounting standards. Quite naturally, this history includes a discussion of its own report on a principles-based accounting system. The reader should recall that this previous study merely provides a list of unproven assertions about principles-based accounting, including greater comparability for investors and lowered costs of capital for corporations. Rather than providing evidence, the SEC merely enumerates these articles of faith.

At least this time around the SEC adopted a go-slow policy and hoped that the IASB would improve its IFRS in six areas. These concerns question whether IFRS is the Holy Grail it is portrayed to be primarily because of various implementation and administrative issues. Let’s turn to these issues.

First, the SEC says that IFRS must be sufficiently developed to apply the system to the U.S. reporting system. The SEC then indicates there are concerns with respect to the comprehensiveness, the auditability and enforceability, and the consistent and high-quality application of IFRS. The SEC staff notes that commentators have criticized IFRS because they allow savvy managers significant wiggle room to manipulate accounting numbers and disclosures and thwart efforts by auditors to perform high-quality audits. Indeed, some wonder whether principles-based annual reports are even capable of being audited. Another issue raised by the SEC is whether standards will be uniformly enforced around the globe—the answer is of course not. The real questions are how divergent will this enforceability be and what will be its significance.

Second, the SEC probes the independence of the IASB, especially since much of its operating funds comes from corporate donations. Do you think that maybe, just maybe, corporate donors want something in return? Whether the board is free from undue influence won’t require much research since economic theory posits that managers have huge incentives to gain control over the IASB. As an aside, many have criticized the FASB for moving at the pace of a tortoise. Do they realize that the IASB will make the FASB seem like a hare?

Third, will investors understand IFRS? The SEC staff promises to empirically assess the current knowledge of investors about the IFRS. I wouldn’t waste the resources. Except for institutional investors, the answer is they don’t understand IFRS, and they won’t have any incentives to learn until the change is imminent. More importantly, as the costs for learning IFRS are large, we probably shouldn’t worry about investors. Let them depend on the skills and independence of financial statement researchers and analysts.

Fourth, IFRS could have unknown effects in areas other than investments, the domain of the SEC. For example, financial statements are used by industry and anti-trust regulators and federal and state taxing agencies. Will an adoption of IFRS have a perverse effect on national and state policies?

Fifth, the SEC speculates about the impact of adopting IFRS on issuers, including changes to accounting information systems, implications for contracts that depend on accounting numbers, and concerns about corporate governance. My short response is that it’s about time the SEC started thinking about these issues. It is fairly clear to me that the adoption of IFRS will require many issuers to keep dual systems for several years. Annual reports are utilized for too many things to move wholly to IFRS. In turn this will add to the costs of adoption and to its complexity.

Sixth, the SEC mentions human capital readiness. Except for the Big Four and some of the largest corporations, is anybody ready for the transition? If the IASB opened up its data base and supplied users with free training materials, then maybe managers and analysts and accountants could prepare themselves for the transition—unless the banking industry or Congress decides to introduce new and worse problems for the business community.

As I survey this list, I again marvel at the rush to IFRS. The benefits do not appear to match or exceed the costs of the adoption. Nonetheless, I suppose we shall find ourselves employing IFRS within a decade. Hopefully this pause by the SEC will address some of the most glaring challenges.

Of all the issues listed, the most important is this: whether IFRS statements can be audited and what will happen in the courtroom after a firm experiences severe declines in its stock price. I predict that principles-based accounting will become rules as judges and juries fill in the details left out by the accounting profession and create accounting case law. And then where will the benefit be?

Wednesday, March 10, 2010

KPMG Survey: IFRS Glass Half Full or Half Empty?

  • Survey shows 49 percent of execs want early IFRS adoption
  • Another 50 percent don't think the U.S. should adopt at all
  • Majority of executives want greater clarity from SEC
About half of U.S. executives would like to be able to move to international accounting sooner rather than later even though U.S. regulators have not made a formal decision to mandate a switch, according to a new survey on Tuesday.

However another half of American business executives (presumably the other half) are not convinced the US should adopt international accounting standards, at all.

In a survey of 2,500 executives by accounting firm KPMG LLP [KPMG.UL], 49 percent said they would like the option to adopt IFRS, which are already used in more than 100 countries, before 2015, if the U.S. does plan to formally make the switch.

KPMG completed the survey completed only two days after the SEC's announcement, found the majority would also like greater clarity on the SEC's IFRS plans.

About 59 percent of the executives polled said a potential move to IFRS in 2015 or 2016 would give their companies enough time to prepare for the change.

Only 15 percent of those polled said that it would not be enough time, and 25 percent said they would be unsure of the impact of a switch.

The questions were asked during a web seminar two days after SEC Chairman Mary Schapiro, said she would delay a final decision on US adoption until 2011, and companies would not be permitted to begin using the rules until at least 2015.

However, almost half of respondents, 49%, said they would like the ability to adopt IFRS earlier before the SEC’s 2015 timetable.

KPMG said that while some uncertainty remains, companies are not slowing their IFRS conversion activities. Only 18 percent of respondents said they will delay their IFRS plans based on the SEC’s February 24 announcement.

Thursday, March 4, 2010

"Can’t-Shoot-Straight SEC" Gets it Right on IFRS

Article from Bloomberg by David Reilly

Can’t-Shoot-Straight SEC Gets This Call Right: David Reilly

Bloomberg-- Every now and then the much-maligned Securities and Exchange Commission gets it right. That was the case this week when it adroitly tapped the brakes on a drive to require U.S. publicly traded companies to adopt international accounting rules.

In doing so, SEC Chairman Mary Schapiro embraced the dream of a global financial language, yet kept the hug loose enough that the agency can ensure such a change isn’t a foregone conclusion or happens on someone else’s timetable.

That was vital because the stakes are so high -- a decision to switch the U.S. accounting system, or not, will affect every investor as well as companies throughout the U.S.

Yet a basic question about international standards remains unanswered. Would it be foolish to adhere to a supposedly uniform, global accounting system when countries don’t consistently enforce rules and have opposing views of the purpose of financial markets themselves?

If Greece is openly admitting to fudging numbers on a national level, you can bet it and others wouldn’t hesitate to twist corporate accounting rules. And let’s not pretend the Chinese communist party is ever going to put the interests of investors over those of the politburo.

That being the case, it’s not clear any common accounting language would really offer investors the kind of comparability they’d hope for.

Until the SEC can provide investors and Congress, which is sure to weigh in at some point, with an answer to how it will deal with that fundamental flaw, the agency would be crazy to rush to switch.

No Rush

That’s why the go-slower approach advocated by the SEC on Feb. 24 was justified. The commission said it would wait until at least the middle of next year to make a decision on whether the U.S. should switch to international rules.

The agency also clarified what it wants to know or see happen before making that decision. Among other steps, it said U.S. and international rules should be more closely aligned and international standards setters should be independent and investor-oriented.

While those conditions weren’t cast in stone, they give the SEC room to further postpone a decision. And, if a switchover took place, the SEC wouldn’t require it until at least 2015.

This contrasts with the more rushed approach to international rules undertaken when Christopher Cox chaired the commission from August 2005 to January 2009.

Making Comparisons Easier

Let’s step back, though. Publicly traded U.S. companies report results according to generally accepted accounting principles set by the Connecticut-based Financial Accounting Standards Board. They are enforced by the SEC. Around the world, many countries have their own accounting regimes.

In a global market, having numerous accounting systems becomes costly for both companies and investors, who can’t easily compare companies in different countries.

A decade ago, an effort was launched to create a set of international standards. This got a huge boost when the European Union required all its publicly traded companies from 2005 to use those rules, which are set by the London-based International Accounting Standards Board.

The hope was always that the U.S. would eventually join in, and the FASB and IASB have been working to converge their standards with that goal in mind.

As it considers a next step, though, the SEC has to weigh just how independent an international body can be and whether a switchover from U.S. rules is in the best interest of U.S. investors. Not all countries share the U.S. view that markets are meant to serve investors.

The SEC’s Dilemma

And political pressure on the IASB, particularly from the EU, has grown recently. Not that politics isn’t an issue in the U.S.: Congress last year browbeat the FASB into easing mark-to- market rules so banks wouldn’t have to recognize losses quickly.

Yet political pressure is an even greater concern at the IASB, given that it is setting rules for use in more than 100 countries. Among them are widely differing views on how accounting rules should be crafted, their fundamental purpose and how they should be enforced.

This leaves the SEC with a dilemma, if it chooses to go international.

It could accept a system that offers uniformity only through United Nations-style consensus. That would mean watered- down rules that sometimes force investor interests to take a back seat to political concerns.

Or the agency will have to insist that different countries and regions may tailor international rules to their own situations. This would result in a global accounting language that has regional and national dialects.

Melding Together

So rules may be comparable, yet not effective, or not that comparable yet more robust.

If dialects become the norm, why not let the FASB and IASB continue melding their rules over a longer period of time? At some point, the rules will be so similar that a costly system switch won’t be needed.

That route has hazards, since the rulemakers may diverge, rather than converge, on key standards. It may also lead other countries to say the U.S. shouldn’t have much say in international rules. The big fear is that staying on the sidelines too long may put U.S. markets at a competitive disadvantage.

Those are risks the SEC should take. With the economy in tatters, financial regulation in flux and investors still jittery, the SEC shouldn’t foist massive change onto markets unless we know what we’re really getting into.

Until then, it makes sense for the U.S. to go it slow and alone for at least a while more.

David Reilly is a Bloomberg News columnist. The opinions expressed are his own.)