Closing the GAAP

International standards are ready to fly. But will convergence between the US and the world cause delays? By all accounts – well, by most accounts – it's a done deal. After years of planning, the world is heading toward convergence of accounting standards, with most industrialized countries already pledged to commit by 2007 at the latest.

If standards convergence sounds like a yawn, it isn't. The benefits for stakeholders are enormous, ranging from the obvious (not having to pay to produce two or more sets of numbers for instance, Swiss pharmaceutical giant Roche Group, which operates in more than 100 countries, once estimated it could save about $100 million annually if it produced just one set of books) to ones much more substantial, such as enabling investors to make apples-to- apples financial comparisons of companies regardless of where they are based.

Just how close are international standards to becoming a reality? Very. “Already there's a whole body of international standards; these are very real,” says Tricia O'Malley, a board member of the London-based International Accounting Standards Board (IASB), which started up in April, 2001 and is charged with spearheading international accounting standard-setting efforts.

The more interesting question, says O'Malley, who is the IASB's liaison with Canadian accounting professionals and with the Canadian Accounting Standards Board (CASB), is: how close are we to converged international standards? “The answer is we're more so than many people would have believed possible only a year or two ago. Recent accounting scandals have reminded investors of how important transparent financial reporting really is to strong capital markets. In turn, investor demands have galvanized standard-setters worldwide: we're getting into initiatives that otherwise might have taken years to launch.”

According to GAAP Convergence 2002, a report produced by the world's six largest accounting firms (and available through the International Forum on Accountancy Development's website, www.ifad.net), “significant progress is being made toward achieving the vision of a single worldwide language of financial reporting, notably for listed companies.” Of the 59 countries surveyed, 95% say that they have adopted international standards or expect to; of those, 39% have a formal plan to adopt or to converge – including Canada. Just as important, both Financial Accounting Standards Board (FASB) and the IASB say that the convergence of US GAAP and of international standards is a primary objective of both boards.

With the adoption of international standards, “investors and other stakeholders will be able to compare like with like,” notes Frits Bolkestein, European commissioner and directorate general for the Internal Market. “It will help European firms to compete on equal terms when raising capital on world markets.” Others see the same kind of benefits. “By drawing on the best of US GAAP, international and other national standards, the world's capital markets will have a set of global accounting standards that investors can trust,” says IASB chair Sir David Tweedie.

Paul Volcker, former chair of the US Federal Reserve Board and chair of the IASC Foundation – he tried to craft a survival strategy for Arthur Andersen is equally supportive. “The rapid development of global financial markets has greatly reinforced the desirability of indeed, it now demands – international consistency in accounting standards and auditing approaches,” he says.

Canadian accounting authorities deserve significant credit for the successful move toward a single set of standards. The CASB has been a booster ever since discussions began in the early 1970s about creating the IASB's predecessor, London-based International Standards Accounting Committee (IASC), which was launched initially to help emerging market countries create reporting standards. And Canadian support has remained strong as industrialized countries have recognized that in an integrated world economy their companies, too, must report using the same standards regardless of where they are headquartered.

Paul Cherry, chairman of the CASB in Toronto, points to Canada's historic interest in the resolving of international issues through multilateral agencies as part of the reason for its strong backing of both the IASC and IASB. “I think we're kindred spirits in terms of our approach internationally as a culture,” says Cherry. “In addition, we've never been quite as rules-driven or as oriented to precision as they are in the US, so working internationally has been a more comfortable fit for us. We've always seen the international arena and its forums as giving us considerable influence in the US because they've been at the same table. It has been very fruitful for us over the years rather than working only through bilateral negotiations. Being part of the IASB gives us an excellent arena to build consensus and more influence than our size alone would suggest.” And O'Malley agrees. “I think Canada has always had strong ties to the UK tradition of doing things,” she says. “At the same time, because we've always had a huge economic pull to the US, working with multilateral groups has been one way to distance ourselves and maintain independence. We don't have a lot of direct influence with the United States but, historically, we have tended to punch above our weight in international forums.”

Of course, the need for a one-size-fits-all approach has been reinforced as individual accounting authorities have taken on complex topics in recent years (business combinations, pension accounting, derivatives, stock options and the now-infamous special purpose entities, for example) and ended up with differing treatments for them.

The bottom line: accounting standard-setters realize the world simply cannot afford the inefficiencies of even two significantly different standard-setting systems, particularly if those variances impede the flow of capital worldwide, slow or kill investment decisions, help mask accounting irregularities or impede the release of accurate financial information. “If you can reduce the cost of capital worldwide by even a few basis points, that's an enormous amount of money,” says IASB board member Tony Cope.

Hold the convergence champagne

So why not break out the convergence champagne and celebrate a new international standard-setting organization brought about with remarkably little rancor for a major multilateral effort? There are plenty of reasons. The IASB is still in its infancy, little more than two years old. Currently there are some completed international standards on its books that don't need major improvements or changes before more accounting professionals worldwide buy into them; these improvement efforts are ongoing. Standards that will cover some of the most important yet contentious global accounting concerns (those regarding business combinations, for instance, financial instruments, stock options and performance reporting) are in the developmental, writing or rewriting stages, while others such as leases and extractive industries are just getting on the radar screen. Many of them are a year or two away from being finalized.

Since the news of Enron broke, US accounting professionals have been distracted by the many corporate scandals that have come to the fore, which have left less time for focusing on international standards issues. More important, the US Securities and Exchange Commission was ambivalent about the IASC but is somewhat more enthusiastic about the IASB and international standards, although the movement toward convergence has been praised in several speeches over the past three or four years by a steady stream of senior SEC officials. The SEC's concern is it does not want to endorse international standards if they will corrupt the integrity of US capital markets. That could happen if international standards allow into the United States companies whose numbers are more difficult to decipher, unclear or harder to verify than those of companies headquartered in the US. In short, the SEC wants international accounting standards to be as strong or as stringent as those written with US GAAP.

“The problem is that the SEC is deeply suspicious about international standards that don't have a lot of detailed guidance,” says O'Malley. “It's afraid that people will use those to do bad things. To the extent that people make judgment calls under international standards, the SEC will insist on reconciliation. The SEC wants to make sure these are being applied in the right spirit.”

Finally, US corporate accounting woes have led the FASB to reconsider what has been a growing, strong penchant for writing a rule that would cover just about every accounting eventuality or scenario that might present itself. The growth in such rules has been well-intentioned. It is meant to protect auditors, accountants, firms themselves and others afraid of being sued in the litigious environment of the US. Nevertheless, critics say the explosion of rules – and lawyers trying to find loopholes in them – can be blamed for recent accounting fiascos. Thus, the FASB is considering stripping back the number of rules it writes, getting back to a more principles-based approach – exactly the sort utilized now by the IASB and other national accounting standard-setters, such as Canada's. But will a more princi\ples-based effort south of the border fly in the face of the SEC's reservations about less stringent accounting requirements?

In Canada, accounting professionals seem relatively unconcerned about the “principles versus rules” debate. Accounting professionals everywhere agree that getting the SEC on board as quickly as possible is crucial if international standards are ever going to be effective worldwide.” Ultimately, yes, the SEC will accept international standards,” says O'Malley. “I just don't think over the long haul we can continue to have global capital markets where people are reporting widely different numbers depending on how they're doing their reporting. But when is the SEC going to decide that we are close enough to no longer require reconciliation for those using its markets?” asks O'Malley. “Everyone would like this to happen sooner rather than later.”

Presently, there's no effective enforcement agency or mechanism that can police a world operating under IASB standards; few national enforcement agencies have the powers of the SEC or are considered as effective. Without agreed-upon global means of enforcing IASB rules, but, the SEC is unlikely to sign on.

Another reason it is too early for a convergence celebration is the IASB can only take on so many accounting issues at any one time; its staff size is limited, so as it writes new international standards, updates or improves existing ones, it is joint venturing these new rules or rewriting specific rules with the help of a single national standard-setter that sometimes takes the lead. Perhaps more important, the CASB is taking the lead role in the conceptual framework project for measurements – essentially answering what measurement objectives should be. “What should be the objective of a measurement in financial statements when you first recognize an asset or liability or when you change its measurement?” asks O'Malley. “When other accounting standards tell you to recognize something or change it, what should the objective of the measurement be? Accounting standard-setters keep stubbing their toes on this issue because all of the conceptual frameworks in place have a great big gaping hole regarding this question. Accounting uses a lot of different measurements (fair value, historical costs, as examples) but provides no guidance as to which to choose. Usually when you acquire something, fair value or historical cost are the same. But it doesn't tell you when you measure something what the objective should be. What should go into the cost of something when you've built it yourself or you are in the process of doing so? Should you capitalize interest over the building of an asset?

“These are the kinds of issues we're getting at and it's incredibly interesting,” she says. “I think some of this will really help us clarify some of the muddles we've gotten ourselves into and allow us to get rid of some of the ongoing GAAP differences. Because in order to get rid of those differences, you have to answer what the relevant attribute of an asset or liability is that you're trying to measure.”

There's also a broad swath of countries that think of accounting standards as a tool to determine taxable income. That mindset is preventing acceptance of IASB's work. “The tax-driven nature of the national accounting regime was identified as an obstacle to convergence in almost half the countries surveyed,” the Convergence 2002 study says. “Financial statements prepared in accordance with [international standards] are intended primarily to serve the needs of the capital markets, which may differ significantly from the needs of the tax authorities.”

Finally, there are nitty-gritty problems that are slowing the process down as well. For instance, a significant number of foreign language translations of the standards must be approved by IASB, according to the convergence study. Currently, translations are available in about 70% of the countries that have signed on to use them, but the IASB has not approved all of those. Also, training worldwide is available in only 80% of countries pledged to using the standards, says the study. Nevertheless, about one-third of those countries where training is now taking place was concerned that training remains limited, or offered by only a few universities within those countries.

Canada: effectively working with the US

Canada is in a unique position to help shape the move toward international standards in a way that may bring SEC endorsement sooner than later. It may have a particularly urgent need to push the US along as quickly as it can as well, given that its economy and that of the US is so tightly intertwined. As is so often the case, it's forced to walk a tightrope between US and international views and needs. “I would say the move toward international standards is a beneficial development; however, because of the close link between the US and Canadian economies, if there's a choice between US and international standards and the two aren't converging then what you've got to do is move more toward the US standards,” says Axel Thesberg, managing partner of professional standards and risk management at KPMG in Toronto. He points out that, generally speaking, the CASB has been moving its standards in alignment with those of the US for some time – without copying the growing number of rules required in the US. “Most of the US and Canadian differences have been addressed so that they're more consistent with those in the States. That's not the case in every situation for instance, in accounting for joint venturing, where there is a significant difference between the two countries.”

“I think that for quite some time we've had a dual-track approach to attempt to converge as much as possible with the US while at the same time keeping a close eye with regard to the international front,” says Gary Entwistle, an associate professor of accounting at the University of Saskachewan in Saskatoon. “Even now we have very much to maintain that approach.”

Influencing the US positively is on Cherry's mind. Canada is not afraid to be cutting edge on accounting issues so it can have an impact on decisions made both in the US and abroad. One example of where it can do this is in stock options. “We're certainly hoping we'll have a major influence on the SEC, FASB and others involved with standard-setting in the US,” says Cherry. “For instance, we were the first standard-setter to call for stock options being expensed, and now we want to work with the Americans and international board to get one answer. So we believe we do have an opportunity to influence the FASB and vice versa. For instance, we have deliberately positioned our approach to be closer to the US on financial instruments.”

O'Malley says Canada may be able to assuage the SEC's concerns about the IASB standards; meanwhile, according to Cherry, concerns about “rules versus principles” ultimately may not have much influence on convergence. “We have had a special relationship with the SEC for a very long time,” says O'Malley. “There are more Canadian foreign private issuers than from the rest of the world combined doing business in the US so we work very closely.” One sign of the special relationship is the creation of the Multijurisdictional Disclosure System, created more than a decade ago between the US and Canada. “It's a mutual reliance system that allows qualifying public companies in Canada to file in the US, based on Canadian regulatory review,” says O'Malley. “So the SEC will rely on reviews by the provincial securities commissions rather than doing it themselves, and that has been very successful.”

Cherry thinks the flap over rules versus principles is much ado about nothing. “The whole debate is very overblown,” he says. “The US has very well-principled standards; it always has had for the most part, although it's true it has taken them to a lower level of detail.

“The truth is if you're not very comfortable with something it's not going to be effective,” Cherry says. “The US environment is very litigious and it always will be. People are concerned about their liability, and the US is fixated on having problems answered in black and white. I'm running around endlessly saying we're principles-based yet I'm creating a derivatives package that isn't very short. To some extent I think that people who yearn for less volume of material are a little naive.”

In fact, the SEC may not be as difficult to bring into the fold as some think. Last December the SEC's acting chief accountant, Jackson M. Day, sounded virtually like a cheerleader for the IASB. “During the past 12 months, the accounting profession in the US has been significantly challenged and changed,” Day said. “At the same time, momentum is building overseas towards creating a global financial reporting infrastructure, which would also be a tremendous change. Perhaps the most significant of these international developments is the adoption of International Accounting Standards (IAS) by at least 15 different countries around the world. The European Union, Australian, and Russian public companies, among others, will be required to use IAS in the next few years. For example, 7,000 companies in the EU will be required to adopt IAS by 2005. That's right 7,000 companies in the EU alone. Both American and international accounting standards have been criticized over the past couple of years. [International standards] have been criticized for being incomplete, too full of optionality, and lacking sufficient details to ensure comparable, consistent, and appropriate implementation. Conversely, US standards have been criticized for being overly detailed and complex and containing on/off switch rules that worship the form and not the substance of the transactions. And both sets of standards have been criticized for their use and proposed use of fair value measurements without providing the necessary implem\entation guidance and when the relevance of fair value as a measurement basis has been questioned. What is needed is balance. Balance between the mixture of principles and rules. Balance in the level of detail of implementation guidance. And balance between relevance and reliability. Standard-setters around the world have plenty of work ahead.”

Cherry doesn't see the SEC keeping a wait-and-see approach forever. “They've put a huge investment into this, tens of thousands of hours since the mid-1980s,” he says. “I can't see them standing back from that. The international standards are strong and I think that the pressure is going to be on them, coming from multinational companies, to get rid of all the differences.”

The view that the SEC is overly concerned about soft international standards may be overblown as well. Even before the IASB's creation, some SEC staff were suggesting selected IASC standards were of higher quality than those of GAAP. “SEC staff has done substantial work with respect to IASC standards, both directly and through the International Organization of Securities Commissions,” noted former SEC chief accountant Lynn E. Turner at the March 2000 European FASB-SEC financial reporting conference in Frankfurt. “There are areas, like accounting for intangibles, where [SEC] staff has significant concerns about the quality of information produced by applying the IASC standards. But those people also know that there are places, for example, in the area of business combinations, where many argue the IASC has provided better guidance than US GAAP.

“Some have suggested that the SEC is asking…questions to look for excuses to criticize the IASC standards. That is not the case. The issues raised … are real ones that we have to deal with in formulating any rule proposal that affects the current filing requirements for foreign issuers.

“The first step in promoting convergence of accounting standards is developing a body of standards that are internationally accepted. However, convergence will not be realized until those standards are rigorously interpreted and applied. This means settling for nothing less than full compliance. The bottom line is compliance matters.”

Internationally, securities regulators are aware of the SEC's concerns about the need for effective informational transparency, regulation and enforcement and are taking helpful steps. For instance, IOSCO has endorsed a memorandum of understanding concerning the exchange of information and cooperation among securities regulators and it has an observer at the IASB's advisory council. In its final communique at the end of its 2002 annual meeting, IOSCO said that, “looking ahead…IOSCO encourages the IASB and national standard-setters to work cooperatively and expeditiously to achieve convergence in order to facilitate cross- border offerings and listings and encourages regulators to address the broader issues of consistent interpretation, application and enforcement.”

The Paris-based Committee of European Securities Regulators, launched in April 2001, may take the lead in developing an enforcement mechanism that could ultimately be adopted by IOSCO.

Still how to police international standards appears to be a long- term issue that has yet to grab the attention of the IASCO fully. “Currently, countries such as Canada, the UK and Japan have efforts under way to introduce or improve minimum standards for audit quality assurance and to strengthen auditor independence,” says Day. “China had issued guidance related to professional ethics. And, the committee of European securities regulators has issued for comment a draft statement of principles on enforcement.”

Many accounting professionals believe all of these developments are coming none too soon. The IASB is already rushing to get its standards in place so they can be ready for publicly traded European companies that will have to report their numbers using those standards in 2005. Many companies are indicating they want at least a year, and possibly more time, to have the standards in hand, digest them and adapt their accounting and other internal systems.

“I think the IASB has already done a lot,” notes Cherry. “It has a standard in place regarding how to use its standards for the first time, and that's important for all the European companies now thinking about the change.

“This is a massive chore for the IASB and the companies involved to do this all in one fell swoop. The companies are saying they need some breathing room, that if they're going to do this, they need a period where the IASB isn't putting out any new rules. This is unbelievable if you remember that the IASB has only been around a couple of years.”

Canada's influence may actually grow in international standard- setting as the total number of national standard-setters decreases. “When you look at the standard-setting community globally there are only about a half-dozen that are really comprehensive,” says Cherry. “You have the US, Canada, [Australia, Britain). The fact is convergence means that the total number of full-fledged standard- setters is diminishing and their role is changing in the UK and elsewhere. The UK board is redefining its mandate, the Australians and those in New Zealand are all cutting back, and that gives us greater opportunity to influence things because we intend to keep a strong standard-setting body of our own throughout the convergence process.”

Meanwhile, expect Canada to continue offering comfort, and perhaps a good example, if the FASB does move toward a more principles-based approach and the SEC buys it.

O'Malley says that the US can't expect to have it both ways in the rules-versus-principles debate. “Reasonable people can very legitimately arrive at different conclusions using the same set of facts,” she says. “You can't then go to one of those parties and say, 'You came up with a different conclusion – we're going to shoot you for doing so.' ”

The bottom line; standard-setters realize that the world simply cannot afford the inefficiencies of even two significantly different standard-setting systems

Canada is not afraid of being cutting edge on accounting issues. It can have an impact on decisions being made in the US and abroad. One example is in stock options

Lawrence Richter Quinn is a freelance writer based in Washington DC..
Copyright Canadian Institute of Chartered Accountants Aug 2003.

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