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The overseer of a coming accounting revolution opines on U.S. companies' inevitable, eventual shift to IFRS.
Tim Reason, CFO Magazine
September 1, 2008
(This is an expanded version of the interview that appeared in the September issue of CFO.) Make no mistake: the International Accounting Standards Board is poised to become the world's accounting-standards setter. When its chairman, Sir David Tweedie, spoke with CFO in late July, rumors were swirling that the Securities and Exchange Commission was about to release a timetable for U.S. companies to adopt international financial reporting standards (IFRS). That would put an end to the accounting principles used in this country since the end of the Great Depression (and set, in their modern form, since 1975 by the Financial Accounting Standards Board). Instead, companies from every developed economy in the world would report their financial results according to standards set by a multinational IASB based in London. To assuage fears that such an organization could become a supranational lawmaker answerable to no one, IASB's parent organization has begun to create its own overseer, a global monitoring group made up of regulators around the world, including the SEC. Meanwhile, Tweedie and his U.S. counterpart are rushing to replace some of America's most critical accounting standards, accelerating what was once called "convergence" but which now looks a lot more like conversion.
Some 112 countries now use IFRS, with Korea, India, Japan, Canada, and Brazil set to start by 2011 or sooner. That's quite a success for a seven-year-old organization.
It really has spread very rapidly. Far more quickly than we were expecting, to be honest. There is one major economy still standing out, and that is the United States. Of course, for six years now we have been working with FASB to bring our standards closer together. The United States — that is, the SEC and FASB — actually wrote our objective, before we were even formed, to create one single set of high-quality standards. Both organizations have really pressed to get there, so I think it will happen.
Meaning that the United States will switch?
Clearly it would be a massive cost savings for multinational companies, so that pressure is there in the United States. Also, if your competitors are being judged under IFRS, people start to wonder about the differences between your reporting and theirs. The markets would like everyone to be the same.
Do you have any idea if, as rumored, the SEC will choose 2013 as the date for U.S. adoption?
I literally don't know. I wouldn't be able to tell you if I did, but I don't.
It almost seems as though companies in America don't think this is really going to happen. Do you get any sense that U.S. companies are engaged in IFRS?
It's quite interesting. We have been quite well observed by Europe and others, and we find the letters are coming in even as we are debating. That tends not to happen, FASB tells us, in the United States. Once FASB starts issuing draft standards, the letters start to come.
But I suspect that will change in the United States. And that's not a bad thing, because if we've got a big flaw in a proposal, the sooner we hear about it the better. Once the SEC says something [about a date for U.S. adoption of IFRS], then I suspect attention from the United States will focus very much more on us.
What should U.S. CFOs know about IFRS?
During the next three years, FASB and the IASB will make some major changes to financial reporting. So CFOs really want to get engaged, especially in the next 12 months, because that's when the discussion papers and early exposure drafts will come out. And we want the right answer; we don't want to do something stupid. So please, please tell us what you think of what we're doing. Even if the date for the U.S. is not crystal clear, my view is that before too long, the U.S. will make the decision to go to IFRS. So don't take a chance. Don't have these standards hit you and then say, "Oh my goodness, we should have said what we think." Now's the time.
A July New York Times article said some critics worry that IFRS would "put American investors at the mercy of overseas regulators who enforce weaker rules and may treat investment losses as a low priority." How do you respond?
It is absolute nonsense. The SEC is going to look at the accounts that are coming in. Countries around the world aren't just going to throw away their own accounting standards if they think we are bringing out standards that aren't very good. We have been looking at disclosures on IFRS and U.S. GAAP, and, actually, you get far more disclosure under IFRS.
Will U.S. adoption be followed by a moratorium on new accounting standards, like the four-year moratorium put in place after the European Union adopted IFRS in 2005?
We really want to try to do that if we can. We had quite a problem in 2001, because Europe didn't consult us about switching over. It just picked 2005, which forced us to do a sort of cut-and-paste [on many standards]. We didn't finish that until March 2004. That gave Europe only nine months before it started. The United States won't have to go through that. But we do believe, with people putting in all the new systems [required by a change to IFRS], the last thing they want is another series of changes.
You're now working with FASB to accelerate some long-term — and pretty major — accounting convergence projects and finish them by June 2011. Why that date?
When we first agreed to converge U.S. GAAP and IFRS in 2002, there were 10 areas where we felt that both our standards were pretty poor. The target date for writing new ones was 2012 or 2013.
If we took a theoretical date of 2013 — and it is theoretical — for the United States to adopt IFRS, plus a year to get ready, as Europe more or less had, that puts us at 2011. Combined with the number of countries that are adopting in 2011, it really became clear that people didn't want us constantly producing standards in 2012 or 2013.
If we want to get the all-singing, all-dancing standard, we could spend another couple of years. But if we want the 80 percent standard, this will make one heck of a difference. All the bells and whistles can be done afterward.
What will we likely see, for example, with regard to financial statement presentation?
That will make quite a big difference, because U.S. accounts and international accounts will look the same. There will be new features the analysts will love, such as reconciliation from the cash- flow statement to the income statement, showing the effects of fair value changes. We are talking about this to CFOs today around the world, and some of them are quite excited about that. They said this will answer a lot of questions that are asked by analysts.
How will that project help soothe existing fears about the volatility that fair value introduces into financial statements?
We should separate items such as financing, investing, operating in the income statement, and we should show the assets involved clearly in the balance sheet.
We should also relate...the income statement to the cash-flow statement. So you can see what is cash, what is simply accruals, and what is valuations. That would have shown most of Enron's income was fair value, and FAS 157 would have shown you most of that was their models. That's why IASB is doing [its own version] of FAS 157.
Aren't there some differences between FASB and IASB's definition of fair value, particularly in terms of financial instruments?
Our financial instruments standard is not so different--it's just phrased differently.
We have perhaps been unfairly accused of having more fair value than FASB because the old IASC--and we never bothered correcting it--scattered the term "fair value" around the standards. We've got to go back to our standards and take out the term fair value when we don't mean it.
The only part where fair value comes in a bit more in IFRS is we allow the revaluations of properties. And that is quite useful, because it shows the financial strength of the organization. When you think about building companies and land banks--they could be holding a field for 30 years which is rocketing in value, and suddenly they sell it, and in comes the profit in year 30. An asset stripper who is wise could take over that company for much less and just sell off the fields.
What do you say to the criticism of FAS 157 and the idea that fair-value accounting in general exacerbated the subprime woes of the banks?
Basically, the standards didn't fail.
There undoubtedly was a problem with the valuations. Part of that was the drying up of the markets [that banks used to get values]. The big banks had a plan B--they switched to modeling. The smaller banks were starting from scratch, and they were really struggling. And that wasn't surprising, because this hadn't happened before. And there was a panic.
So what we've discovered is that we need to lay out the process of how you go about doing a valuation in that situation.
We've heard all the flack about pro-cyclicality. I think it was very telling that the Japanese finance minister said that the one lesson from the Japanese banking crisis in the 1990s was that further transparency would have allowed the problem to be dealt with earlier. Fair value has forced this crisis right out, whereas in Japan it bubbled along for 10 years and stagnated the economy.
As far as [FAS 157's valuation hierarchy], that has proved very popular in the financial statements. We've noticed even some of our IFRS companies have used it. I think the markets like it. I think we will bring that in even before we bring in an equivalent of FAS 157.
You've also accelerated the leasing project. Will you still be able to address what you've often said are serious problems there?
That project was going to address lessor and lessee accounting, but most of the problems are in the lessee accounting, so we decided that is the priority. In 2006, the leasing industry was a $634 billion industry--that's excluding property leases. And most of that is off balance sheet.
Yet, what is a lease? It's people committing to pay so much for so many years to get the use of an asset. Well, we think that is a liability. As does FASB. And we should bring that on balance sheet.
So what we're really talking about is, maybe we should get rid of the distinction between operating and finance leases. We could probably do that in three years. It will be tough, and some people might not like it so much. But nonetheless, that will make a massive difference.
The SEC will be part of a new monitoring group overseeing IASB. Will that heighten European fears about American influence over accounting standards?
It's quite interesting, but when I come to the States, there's a fear that international standards are going to be influenced by the Europeans. So it depends where you are coming from.
We are trying to make it crystal clear that that is not going to be the case. When IASB was set up, there were six North Americans on the board, and they were setting standards for Europe. There should be a board of 16--four from Europe, four from North America, four from Asia/Oceana, one from Latin America, one from Africa, and two from anywhere.
The monitoring group is [also] quite cleverly constructed. I think it is pretty well scattered to make sure there is no region going to dominate. Have a fair say? Yes. Dominate? No.