We begin by repeating this Feb. 24, 2010, quote from the American Institute of CPAs' Barry Melancon: "Our increasingly global economy makes it clear that the U.S. should move toward a single set of high-quality, globally accepted accounting standards for public companies."
After quoting it in our most recent column ("Be careful when you wish for high-quality global standards," May 10-23), we challenged the assumption that convergence is the path to high quality. We described 20 critically needed GAAP reforms that would make financial statements more useful to users for making rational decisions. Unfortunately, switching to International Financial Reporting Standards won't eliminate inferior practices and could even make them more difficult to correct.
This column describes how Melancon's claim that international uniformity would help the global economy is superficially attractive but unattainable.
IS UNIFORMITY A WORTHY GOAL?
The flawed assumptions underlying this argument for adopting IFRS hold that "a single set" of standards will produce uniformity and that uniformity is a good thing because it always creates comparability. Ah, if only life, and accounting, were that simple. Below, we discredit the false premises behind that proposition and explain the negatives of seeking uniformity without usefulness. Throughout, we challenge conventional wisdom and those who call for international standards without substantive reform.
UNIFORMITY ISN'T COMPARABILITY
The pivotal assumption that uniformity leads to comparability springs from information suppliers' self-serving rationalization for the easy way out, usually expressed by saying, "At least everyone is doing the same thing." That idea is totally simplistic because it ignores output content and quality. Uniformity produces comparability only when similar events and conditions are similarly and usefully described in statements. It isn't created merely by recording those similar events or conditions the same way. Here are two examples out of many:
Research and development. Under GAAP, R&D costs are expensed regardless of the results. Suppose three companies each spend $100 million on research and that one discovers nothing, the second gains knowledge worth $60 million, and the third discovers ideas worth $400 million. Comparability exists only if these divergent results are recognized in the statements; it is not achieved when the companies uniformly report $100 million of R&D expense and no asset.
Impairments. Carrying assets at cost unless they're impaired also impedes comparisons. Suppose two companies have similar land holdings that were each worth $50 million until recently, when they declined to $40 million because of an economic downturn. Further, one bought its property years ago for $22 million and the other paid the peak price of $50 million. Despite experiencing the same recent $10 million loss, the first reports its land at $22 million with no gain or loss, while the second reports its land at $40 million along with a $10 million impairment loss. The balance sheets misrepresent their identical situations and the income statements don't provide complete or comparable results. In fact, they conceal the ongoing ups and downs in market value.
These examples show that uniformity must be combined with usefulness to produce comparability.
IS IFRS UNIFORM?
Melancon's comment reflects the invalid assumption that IFRS is already uniformly applied throughout the world. That is just not true because most who are said to have adopted IFRS haven't really done so.
Here's a quote from the Feb. 19, 2009, letter sent by the National Association of State Boards of Accountancy to the Securities and Exchange Commission on the roadmap proposal: "Many of the more than 100 countries [that] have endorsed IFRS use only that portion of IFRS that is useful for their purposes. Some countries have adopted only a limited number of the standards. Countries that have adopted IFRS have made changes to the accounting standards promulgated by the [International Accounting Standards Board] in order to satisfy their local reporting needs. Such needs are influenced by substantial legal, cultural and environmental influences. As a result of such needs, jurisdictional variants of IFRS have become the norm and are likely to continue into the future. There is simply no assurance that all countries embracing IFRS will apply the standards in the same way to achieve comparability - the chief benefit argued for a single set of standards."
An e-mail from David Costello, NASBA's president and chief executive, added this point: "By our calculations, the countries which have accepted totally IFRS comprise about 4.5 percent of the world's GDP, roughly equivalent to that of our states of California and Georgia."
Bottom line, the world is not anywhere close to having "a single set of high-quality, globally accepted accounting standards." To imply that one will instantly spring into existence when the U.S. gives up on GAAP is either naive or manipulative.
NON-UNIFORM REGULATION?
Psychologists use the term "projection" to describe the tendency of people to believe that all others think and act the same way they do. (Consider how Marie Antoinette missed the point by suggesting that, like her, the peasants should just eat cake if they didn't have any bread.) However, education and thoughtful reflection on first-hand experience can allow people to comprehend that everyone's situation is not the same.
We make this point because vocal American advocates for IFRS seem to assume the rest of the world has regulatory and enforcement systems on the same order as the U.S. SEC. To the contrary, the SEC is the product of 75 years of hard work and millions upon millions of dollars. There are no other market regulators with its human, financial and political resources. Yet even it struggles to stay ahead of auditors and managers who deceive and defraud by bending and breaking GAAP.
Another jarring difference is that individual standards in IFRS take effect in the European Union only after a special Accounting Regulatory Committee recommends to the European Commission that it not reject a standard. Even if the commission approves, its action can be challenged by the European Parliament and/or the Council of the European Union, two political bodies. In contrast, new FASB standards automatically become GAAP unless the SEC acts to reject them. Thus, actually implementing uniform international standards is much more politically challenging than merely getting IASB members to agree. The consequence is bound to be watered-down, compromised standards.
We also gained insight from a person connected with a Big Four firm who explained that even though China has nominally adopted IFRS, its enforcement powers are applied only to Chinese accountants auditing Chinese companies' statements distributed in China. Counting China among the adopters strikes us as disingenuous.
We're certain that many more so-called adopters of IFRS have regulatory situations similar to China's, if not worse, such that investor protection is virtually nonexistent. If that isn't the case, we ask proponents of abandoning GAAP to bring forth facts and set us straight. In the meantime, we don't think it's wise for everyone to simply assume the rest of the world has fully capable and empowered agencies and processes standing ready to implement and enforce a converged set of accounting standards.
PRINCIPLES-BASED?
Many claim superiority for IFRS because they're principles-based. Although we debunked this myth in our Jan. 11, 2010, column ("It's principles and rules, not principles or rules"), we return to it to help readers think more critically about uniformity.
The idea behind principles-based standards is to give managers greater freedom to describe their unique situations and activities. However, that latitude is contrary to achieving uniformity through "a single set of high-quality, globally accepted accounting standards." For example, consider a well-known 64-year old principles-based standard from U.S. GAAP: Chapter 4 of ARB 43 tells managers to choose the inventory assumption that "under the circumstances, most clearly reflects periodic income." This politically expedient and open-ended standard makes both FIFO and LIFO acceptable, even though their results are clearly non-comparable. An example from IFRS appears for lease accounting, where capitalization is required when the lease term constitutes "the major part of the economic life of the asset." That conceptual guidance invites all sorts of non-uniform results.
Here is our message to the institute and others who encourage convergence without reform: You can't have it both ways. You cannot claim IFRS will help the global economy by providing uniform and comparable statements, while simultaneously advocating expanded acceptance of wide-open principles-based standards. That inconsistency just doesn't fly.
UNIFORMITY KILLS INNOVATION
Economists often talk about "unintended consequences" of laws or policies. For example, the Cash for Clunkers program was supposed to stimulate the moribund U.S. auto industry while clearing the streets of old vehicles. Instead, it boosted sales of fuel-efficient imports and made it much harder for lower-income drivers to find affordable cars.
We're inclined to think that the institute and those who influence its management are seeking the undeclared and socially undesirable consequence of avoiding increased risk for auditors by blocking innovative reporting standards that serve users' real needs. If authority were taken away from the independent and relatively nimble FASB and handed to the corporate-dependent and politically ponderous IASB, the process of reforming standards to produce high-quality reporting would be slowed to a snail's pace, and perhaps stopped dead in its tracks.
SERVING THE GLOBAL ECONOMY
If Melancon and those who persuaded him to throw the AICPA's weight behind replacing GAAP with IFRS really seek to serve the "increasingly global economy," they must replace their supply-driven mindset that seeks advantages for managers and accountants with a completely different one that seeks to satisfy currently unaddressed users' demands for useful information.
Alas, that would involve a massive paradigm shift that won't be accomplished without a brouhaha. It will require the SEC and others with genuine vision for serving statement users throughout the global economy to step forward and lead the way. Then, and only then, will the misbegotten drive toward uniformity for uniformity's sake be replaced with an inspired and genuine search for new standards that promote usefulness and comparability.
We now put on our steel helmets and flak jackets, retreat into our bunker, and otherwise prepare for bombastic assaults from those advocating convergence.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.
