One Standard, Many Laws

When he wanted to reprint U.S. accounting standards in a textbook he was writing, Lawrence Cunningham, a professor of accounting and law at George Washington University, was told he would have to pay. That's because the Financial Accounting Standards Board holds copyright to its pronouncements — everything from statements to interpretations to technical bulletins — and sells them in bound volumes. According to the Financial Accounting Foundation, which oversees FASB, the board earns $17 million a year from sales of such tomes and other products.

Eventually, Cunningham agreed to pay $3,000 for the rights to republish the standards in question. Had he sought instead to reprint International Financial Reporting Standards (IFRS), which are used by much of the rest of the world, he could have done so without paying a cent. Mark Byatt, a spokesperson for the International Accounting Standards Board (IASB), notes that the text of IFRS must be written into the law of each country that adopts the standards. "In most countries the text of law is freely available," says Byatt, "so we waive copyright for the bare standards in each adopting country to allow this to happen."

This contrast between proprietary and free highlights a fundamental difference between U.S. GAAP and other countries' accounting standards — and is one of several reasons that convergence may be more complicated than people think. In the United States, accounting is governed by a common-law system modeled after that of Great Britain. Rules are created independently, function as best practices, and are enforced through litigation. They can be copyrighted and sold.

But many countries, including Germany, France, Italy, Belgium, and Spain, are governed by code (or civil) law, and hence much of Europe (as well as Asia) uses a code-law system of accounting. Code laws, dating back from when they were still literally etched in stone, were always intended to be free.

The distinction between code-law and common-law accounting systems might seem academic, but it has real-world ramifications. Academics and accountants generally agree that common-law systems are better, because they are more efficient, created by experts, and less likely to be compromised. Whenever the Securities and Exchange Commission or Congress attempts to influence accounting rules, purists complain they are becoming "codified" and thus tainted.

The distinction is also important for the world's push toward a single, global set of accounting standards. IFRS are rooted in common law, but many of the countries adopting them traditionally use code law, with their governments creating and enforcing accounting rules. Will IFRS survive intact as they are adopted by code-law countries, or will they morph into a number of different, even contradictory, country-specific versions?

Why Common Is Superior
Popularity aside, among the benefits of the growing acceptance of IFRS is that common-law standards are supposed to be top quality. Those who favor accounting systems based on common rather than code law contend they produce timelier financial information and make companies more efficient, because of the threat of lawsuits from shareholders or regulators. The threat of shareholder litigation encourages more-timely loss recognition published in financial statements, says Ray Ball, a professor of accounting at the University of Chicago Graduate School of Business. Hence, managers become more attuned to decreases in expected future cash flows, says Ball, making them more likely to shift investments and strategies to make the company more efficient.

Code-law accounting systems, by comparison, are less market-oriented and rely more on private information. The accounting code is written by the government, which also levies penalties for violations. Code-law standards give managers more wiggle room to make accounting estimates while leaving policing and punishment to the government.

Like GAAP, IFRS are based on common-law standards, created by the IASB. While European code-law countries have expressed concern that adopting IFRS best practices effectively allows outsiders to make their laws, the subjectivity of enforcement might be the undoing of accounting's convergence goal. Ball notes that Europe's policies on enforcement vary by country, and that places such as Italy give their companies plenty of leeway when it comes to accounting.

"Implementation is the Achilles' heel of IFRS," says Ball. "There are overwhelming reasons to expect IFRS to be uneven around the world." Without perfectly integrated markets, attempts to regulate international accounting standards could become heavily politicized and contentious, as a one-size set of standards might not fit everyone's needs.

Most recently, common law and code law clashed last year when the European Union created a "carve-out" in IFRS to change a rule about hedge accounting. Code law prevailed and the carve-out was kept. The EU has also considered toying with a rule on business-segment reporting. Such changes have created fears that the ideal of a universal reporting standard could unravel. Last year James Leisenring, an IASB member, called carve-outs the biggest threat to convergence and said, "Our mission fails completely if that's tolerated and allowed to continue."

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