Global Business

Global Standards: Jilted at the Altar?

Despite glowing words for International Financial Reporting Standards, Securities and Exchange Commission Chairman Christopher Cox seems no closer ...
David KatzAugust 5, 2008

A word of advice to those holding their breaths until the Securities and Exchange Commission issues a deadline for U.S. companies to convert from the use of generally accepted accounting principles to international financial reporting standards: exhale.

To judge from the views expressed on Tuesday by SEC Chairman Christopher Cox and other participants in a roundtable held by the commission to assess how well IFRS has performed in the current financial crisis, the possibility of the SEC making such announcement in the next week or so—as many have been expecting—seems remote.

A catchword of late is that it’s no longer a matter of “if” U.S. regulators will adopt IFRS; it’s a matter of when. Speaking at a press conference immediately preceding the roundtable, Cox said, however, “that the question we’re now asking ourselves is, how does [a conversion to a single set of accounting standards] fit in over the longer term, and will U.S. companies ultimately be using IFRS instead of U.S. GAAP?”

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That sounds a bit more like “if.” Indeed, Cox appears to have his hands full with other matters over the next few months, making a launch of a definitive wholesale conversion of U.S. accounting standards by Corporate America seem a bit further away than it once did. Cox after all, must break in a trio of new commissioners: Luis Aguilar and Troy Paredes, whom the chairman swore in last Thursday and Friday, and Elise Walter, who assumed her post in mid-July. Also on his very full plate, as he told reporters, were initiatives on naked short-selling, SEC registration, and municipal-securities rulemaking, along with consideration of the 25 recommendations just submitted by the commission’s advisory committee on financial reporting.

Another indication that some more deliberation may be at hand was the abundant criticism leveled at IFRS during the roundtable, including some by those thought to be its best supporters. Investors, for example, have been the biggest proponents of global accounting convergence, contending that a single set of standards makes for more transparent and comparable financial reporting. Jeffrey Mahoney, general counsel of the Council of Institutional Investors, said, however, that at least six conditions should be met by the International Accounting Standards Board, which issues the global standards, before U.S. companies switch to IFRS.

Declaring that there was “some disagreement in the investor community” about when U.S. companies should be allowed to IFRS, Mahoney said that the following questions have yet to be resolved.

•Do international standards produce the same quality of reporting as U.S. GAAP does?

•Would the application and enforcement of international standards in the United States be as rigorous as they are in the case of U.S. GAAP?

•Does IASB have an adequate and stable source of funding that’s not dependent on private donors?

Does IASB have enough full-time, technically capable, and independent staff members?

Does IASB pay the most attention to the views of customers of financial reports–that is, investors?

Does IASB have a structure, process, and adequate governmental support to keep its standards work from “being overridden by political processes?”

Other panelists expressed mixed feelings about the relative youthfulness of IASB—it’s only been in existence since 2001—and the scant guidance it’s provided in comparison with the Financial Accounting Standards Board. Some of course contend that because IFRS is a more “principles-based” system than rules-riddled GAAP it’s much easier for investors to understand.

But the relative lack of guidance has made the application of IFRS, at least in its first go-round, more complex for companies than that of U.S. GAAP, according to some issuers. “I would say IFRS is not easier to apply,” said Charlotte Jones, a managing director and global head of accounting policy at Deutsche Bank, referring specifically to the bank’s reporting on special-purpose entities. “It comes from the fact that IFRS is not as mature as GAAP, [that it] doesn’t have a track record.”

Another speaker, Roger Harrington, vice president of group accounts at BP plc, agreed that conversion “takes time to settle, and it takes find answers to certain questions.” However, he added, “the benefit of converting now is that a lot of those questions have been aired” and consensuses have emerged on how to interpret various standards in countries like the United Kingdom, which have already switched from a local form if GAAP to IFRS.

Since the petroleum giant converted to IFRS in 2005, using the international standards has provided “help in communicating with investors, Harrington said. But although BP hasn’t had challenges in making the transition, there have been significant accounting hurdles.

One particular challenge: Unlike U.S. GAAP, IFRS doesn’t allow companies to use the last-in, first-out (LIFO) method of inventory accounting. Instead, BP now uses the first-in, first out (FIFO) method. This can mean that in highly volatile markets—like the current one for oil—”we experience a mismatch through our income statement between the selling prices of products and crude oil, and the associated cost of sales.” Under FIFO, for instance, products the company made in much lower-priced markets would now be reported as having sold at a much higher price.

Deutsche Bank, which moved from reporting in U.S. GAAP to reporting in IFRS at beginning of 2007, went through its own conversion process mainly during 2006. The conversion involved the consolidation of an additional 200 SPEs onto the bank’s corporate balance sheet.

That’s because, under IFRS, the bank couldn’t treat most of them as the off-balance-sheet, Qualified Special Purpose Entities that it could treat them as under GAAP. The bank’s accountants found during the conversion that not having “the specific rules that could give you a very clear ‘yes’ or ‘no’ answer under U.S. GAAP required us to step back and look at the entity as an entirety,” Jones said.

Achieving that “holistic” view was “more difficult, more work,” she said. “But on balance it gives you a more realistic answer of what’s going on.”

For his part, Cox seemed to feel that IFRS had passed an important test. “In the financial services sector, IFRS worked well during the subprime crisis–at least as well, perhaps better than U.S GAAP. It kept SPES on the balance sheet to a far greater extent than U.S. GAAP, which made it possible to structure QSPEs to keep them off the balance sheet,” he said. Despite the glowing send-off, however, the commissioner seemed no closer to shooting the starting pistol to launch the conversion to IFRS.