International Accounting Standards Board chairman Hans Hoogervorst said that regardless of which way the Securities and Exchange Commission decides to go on supporting International Financial Reporting Standards, the main thing that is needed from the U.S. right now is “clarity.”
During a speech Friday at an IFRS Foundation conference in Melbourne, Australia, Hoogervorst took issue with two recently released papers from the SEC staff that found wide divergences in the way IFRS is applied by different multinational companies around the world and between IFRS and U.S. GAAP (see
“Whichever way the SEC goes, what is needed more than anything is clarity,” said Hoogervorst. “The transition to any new set of accounting standards is a major challenge. If a commitment is given, the IASB will carefully consider issues associated with transition in the United States, as we have for other jurisdictions throughout the world.”
Hoogervorst noted that he had “no privileged insight" regarding the SEC’s internal decision-making, but added that the “pace of events does appear to be picking up” and that the SEC has repeatedly said that it intends to make a determination this year regarding the possible incorporation of IFRS into the U.S. financial reporting system.
Hoogervorst acknowledged that there are many practical challenges facing the SEC in making the decision on whether or not to allow use of IFRS by U.S. companies. He added that the U.S. is the single largest and most liquid capital market in the world and already has developed its own sophisticated set of financial reporting standards over many decades.
However, he noted that the U.S. has already committed to supporting global accounting standards. “It is SEC policy, it is U.S. government policy, and it is the policy of the G20, in which the U.S. is a key player,” said Hoogervorst.
He discussed the two recent reports by the SEC staff of the issues related to U.S. adoption of IFRS, examining
“While this first paper concluded that the financial statements analyzed generally complied with IFRS, there were inconsistencies observed—mainly due to a lack of disclosure of accounting policies and how individual standards had been applied,” said Hoogervorst. “Indeed, this is a common finding for regulatory reviews. The Wall Street Journal noted the findings of this study were similar to a previous SEC study of Fortune 500 companies using U.S. GAAP. The problem of inconsistent application exists whether companies use IFRS or U.S. GAAP.”
Hoogervorst pointed out that standard-setters and securities regulators already know that they have to improve the consistency of application of IFRS, and the IFRS Foundation trustees want the IASB to play a more active role in application of the standards.
“However, the important point is this,” he added. “You can only work towards consistent application if you have one single language, and IFRS is the only candidate. Moreover, if the SEC is an active enforcer of IFRS for U.S. companies, as well as foreign private issuers, they will be in a position to drive consistency.”
As for the second SEC staff paper, which examined differences between IFRS and U.S. GAAP, Hoogervorst dismissed its significance, saying it “contains no major surprises.”
“The paper recognizes the tremendous progress that the boards have made in bringing IFRS and U.S. GAAP into alignment,” he said. “However, the paper also shows how quite a few differences remain, particularly in the detail. Many of these differences are not very important. But getting rid of them through a process of convergence could take up many, many years. This analysis makes me even more convinced that ongoing convergence is not the answer.”
He noted that in 2006, the SEC urged the IASB and the Financial Accounting Standards Board to stop eliminating narrow differences and focus on the big picture. “It is not in the best interests of investors in the U.S. or anywhere else in the world to spend another 10 years seeking to eliminate ever-smaller differences, which entail significant costs for change without much incremental benefit,” said Hoogervorst. “The convergence process has been extremely useful getting us to a point where IFRS and U.S. GAAP are much improved. These standards are now much closer together. In the long run, a dual decision-making process is a very unstable way to work. In practice, it can lead to diverged solutions or sub-optimal outcomes at the very end.”
He pointed out that the two boards had tried to achieve convergence on one project devoted to offsetting and only ended up further apart.
“The boards had to decide whether obligations between two parties should be netted in the balance sheet if the reporting entity can only offset these amounts only in times of stress, the U.S. approach, or must also be able to and will do so at all times, which is our approach,” he explained. “The difference can be as big as 40 percent of a bank’s balance sheet. We began with convergence and ended up with divergence. Obviously this was a very big disappointment. To many investors the balance sheet of many American banks will look much smaller than Asian and European banks that are equally leveraged. This is clearly not in the best interests of investors.”
Hoogervorst noted that the boards would inevitably have their disagreements. “The simple truth is that when you have two independent, highly competent boards, sometimes they will agree with each other, and other times they will not,” he said. “It’s not that one is right and the other wrong; they just reach different conclusions. The same would be true if I were to split my board in two and ask them to consider 10 projects. I doubt each smaller board would reach identical conclusions on all 10 projects, so convergence would require compromises to be made. Convergence therefore does not always result in the highest quality outcome. It has served its purpose, but now it is time to move on. Our international stakeholders have supported the current convergence process between the IASB and the FASB as a way to facilitate improvements in financial reporting and global adoption. At the same time, many have already indicated that they will not support an indefinite continuation.”
Nevertheless, Hoogervorst noted that the IASB has decided to re-open its IFRS 9 standards on financial instruments to achieve better convergence with U.S. standards, even though some companies have already begun adopting the latest standards, as they were allowed to do.
“There are still differences in our positions, but we’re not a million miles away,” he said. “At the same time, as our work on the insurance standard progressed, it became increasingly clear that we had problems with its interaction with IFRS 9. We gradually came to the conclusion that we could make a lot of progress on both these issues—insurance and convergence—by adapting IFRS 9 in a limited way. It was not an easy decision to make. Most importantly because we knew that our constituents that have already adopted might not be very happy. Also it is one thing to say changes are going to be limited, but in practice pressure for wider changes will undoubtedly be there. Nevertheless, the potential gains are so clear that we decided to go ahead. And you can rest assured that we will proceed with caution and limit any changes to those that are absolutely necessary.”
