On October 29, Paul Miller spoke before the annual meeting of the National Association of State Boards of Accountancy about politics and standard-setting. This column presents an excerpt that describes the misguided political effort directed at convincing U.S. authorities and accountants that international standards were both a good idea and inevitable. It shows they were neither.
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A ROSY VISION?
With regard to international standards, I have to confess that the hypothetical idea of a single set of standards sounds terrific. If the obstacles could be overcome, there would be only one set to learn and apply everywhere. It would also be great if applying these standards would automatically make all financial statements comparable all over the world.
Alas, reality is quite different. Thus, it is baffling that so many people bought into that optimistic rosy vision. I'm afraid many of them pursued this idea after placing their own self-interest ahead of the public interest.
I want to point out that the real issue that the Securities and Exchange Commission was considering was not the choice between GAAP and International Financial Reporting Standards. It was actually about deciding whether the Financial Accounting Standards Board or the International Accounting Standards Board will do a better job of promoting progress in financial reporting. It was, in fact, a decision about which system is more capable of promoting truth-telling and other American interests. That choice is much more complicated.
Congratulations to NASBA's leadership in early 2009 for its response to the SEC's request for comment on its so-called Roadmap. Their letter explained with some strength that going in that direction for U.S. public companies would divide the profession into those who worked with U.S. GAAP and others who worked with IFRS. While that view was certainly helpful, it did not fully address all the arguments.
For example, one pressure for international standards came from frequent claims that many other countries had adopted IFRS. Advocates said that the U.S. had better get with it or we would be left out. The IASB itself began to interfere with our domestic politics by chastising the SEC for not adopting. They even made threats that we would lose seats on the board and be cut off from shaping future standards. All the while, though, the people at the IASB knew that managers of American corporations and accounting firms were, and still are, financing the board's annual budget with large donations.
Another high-sounding claim is that IFRS are superior to GAAP because they're principles-based, not rules-based. Superficially, that idea sounds really good. In fact, it's not so good at all.
We also watched when FASB and the IASB established the Norwalk Agreement in September 2002 and then signed a Memo of Understanding in which they promised to work together to produce converged standards and to get it done by 2011. It turns out this amazing idea of friendly international cooperation was oversold.
Finally, almost everyone seemed to think that making the change would be as simple as persuading only three SEC commissioners to vote "aye." Just how hard could that be? A whole lot harder than anyone ever thought.
The regulatory context? Standards can improve practice only in the context of a strong regulatory system. What good does it do to have standards if no agency is empowered to investigate whether they have been complied with? What good is it if no agency is given jurisdiction and empowered to sanction those who don't comply? What good are standards for protecting investors if they don't have recourse to recover damages in a legitimate justice system? It turns out that such protections generally do not exist outside the U.S. to the same extent they do here. In many places, they do not exist at all.
The unarguable conclusion is that international standards just won't work as promised unless and until the world's regulatory systems are far more trustworthy.
International comparability? Financial statement comparability can come about if and only if the standards cause truly relevant and reliable information to be reported. In fact, comparability is not produced when everyone complies with today's compromised and outdated standards. Of course, financial statements are not now uniformly prepared even under GAAP or IFRS because the standards are political, obsolete and full of discretionary choices. As a result, those who used this argument had to make a huge assumption that is not supported by the facts.
It turns out that international comparability is a pipedream that's like a beauty contestant's hope to rid the world of hunger, war, crime and disease.
An unstoppable tide? With regard to the worldwide groundswell, virtually only smaller and weaker countries with no significant capital markets have fully endorsed IFRS. Stronger countries have carved out the offending parts they don't like. That would surely be true in the U.S. as well.
For example, much has been said about the fact that LIFO isn't allowed under IFRS. Suppose for a brief second that the SEC could endorse the IASB and IFRS and tried to leave the LIFO prohibition intact. There is no way the commission could get away with doing that because it would create billions upon billions of new real tax liabilities as older, lower costs flowed onto income statements. The SEC simply does not have a legislative mandate to impose taxes on its registrants.
In summary, there is no good reason to rush to join a unified international community of IFRS adopters that doesn't actually exist.
Principles-based standards? The only reason someone would claim that IFRS are principles-based is because the only kind of consensus the IASB members are able to reach are relatively easy agreements in principle that lack concrete substance, like the two sides in a labor dispute who agree they don't want a strike. More than anyone, NASBA members know that our rules-based system is essential for providing a clear legal basis for going after offenders.
In addition, I find that it's mostly managers who cite the principles-based approach as attractive, probably because it gives them more leeway to polish their financial images. As long as managers treat standards as creating maximums, instead of providing guidance for going beyond the minimum requirements, this claim must be disregarded.
Joint convergence? As far as the Norwalk Agreement is concerned, I don't believe anybody was paying full attention when it was signed. Here's what I mean. Sarbanes-Oxley was enacted on July 30, 2002. It includes provisions intended to make FASB financially independent by eliminating its need for corporate contributions. Specifically, Section 109 empowers the SEC to approve FASB's budget and the Public Company Accounting Oversight Board to fund it through a fee assessed on U.S. public companies.
Only 50 days later, FASB members ironically bound themselves at the hip with the IASB, even though that board did and still does depend on contributions from American corporations. This agreement effectively nullified the Sarbanes-Oxley provision and once again made FASB vulnerable to charity from the regulated parties!
So, one more time, we see that something that sounds good turns out to be unsound. I am not surprised that this convergence experiment failed because it was doomed from the beginning.
Flipping a switch? The idea that the SEC could just flip a switch and embrace the IASB is completely misguided. For one thing, as NASBA pointed out nearly four years ago, the SEC's jurisdiction is limited to public companies. For another, its legislative mandate is to regulate U.S. securities markets for the protection and benefit of American citizens. For still another, GAAP accounting is woven into the tapestry of countless contracts and taxing systems. There would be an immense cost in taking GAAP out and putting IFRS in its place. As someone once said to me, "Changing accounting standards would be almost as hard as going to the metric system. But at least we would all be better off if we did go metric."
In sum, it just isn't clear that any benefits would follow from adopting the IASB as our accounting standard-setter.
Who would adopt whom? Here is the clincher. It turns out that the real reason the SEC cannot embrace the IASB as the designated standard-setter is that the IASB would never stand for it!
You'll recall that Section 109 of Sarbanes-Oxley requires the SEC to fully fund the designated board. What you also need to understand is the little-noted Section 108 that requires the designated body to have "the capacity to assist" the SEC in implementing Section 13(b) of the 1934 Securities Act. Among other things, this provision makes it clear that the board assists the commission and that the commission has oversight authority over the board.