Accounting Standards

Standards Convergence: The Movement Toward International Accounting Standards

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In three years, as many as 150 countries could be using IFRS, according to the Chief Accountant of the SEC.

The integration of European capital markets and the rapid growth of China's economy and capital markets have increased the pressure to merge the various accounting standards of the world into one cohesive accounting standard -- a movement known in the accounting world as convergence.  Perhaps no one has examined and monitored the convergence issue more than Bruce Pounder, CMA, President of Leveraged Logic, an educational products and services consulting firm in Asheville, North Carolina and author of The Convergence Guidebook.   

CreditPulse had the opportunity to sit down with Mr. Pounder at the recent Institute of Management Accountants (IMA) Annual Conference & Exhibition in Tampa, Florida.  Read below as one of the foremost experts on the impending convergence between U.S. GAAP and International Financial Reporting Standards (IFRS) provides insight on what will likely be the biggest change in accounting standards and reporting since the Securities and Exchange Act of 1934. 

Exclusive question and answer session with Bruce Pounder, CMA, President of Leveraged Logic:

CreditPulse: What effect will convergence have on accounting standards?

Pounder: The standards themselves will change.  There will be different standards for revenue recognition for example, different standards for lease accounting, different ways of presenting the financial statements.  Additionally, there will be different ways in which reporting entities communicate to stake holders, investors, creditors, regulators, analysts, and so forth, and credit rating agencies.  The communication that comes out of reporting entities will be different quantitatively, the numbers will change, and qualitatively, the statement will look different. 

CreditPulse: You said the numbers will change.  Isn't that a concern for the people that are driving this change?

Pounder: Not really.  It is expected that the numbers will change.  The justification is that they are higher quality numbers.  They're better numbers.  Not better from the standpoint that they are more favorable to the investor, but they are more faithful representations and more relevant to the needs of the financial statement users. 

CreditPulse: You mentioned that convergence is a migration away from rules-based standards toward principles-based standards.  A Russian attendee at the conference made the point that when her company tried the principles approach of IFRS they couldn't figure out how to achieve them because they didn't have rules. 

IMA Photo
"If you're using U.S. GAAP now, buckle
your seat belts," was Pounder's message
at the IMA conference in Tampa in June.

Pounder:  Right now both U.S. GAAP and IFRS are principles-based.  Both are also rules-based.  Principles-based and rules-based are not the opposites that many think.  I look at them as two independent dimensions.  A set of standards can be more or less principles-based and at the same time it can be more or less rules-based -- two real independent dimensions.  Right now in U.S. GAAP we have a set of standards that is very principles-based and it is VERY rules-based.  IFRS is principles-based, it also has a lot of rules, it's just not as rules based as U.S. GAAP.  So there's a clear difference in the quantity of rules and the character of the rules in IFRS.  As we converge, a lot of people ask, where are we going to end up?  Are we going to end up with more rules like US GAAP or less rules like IFRS?  I believe long, long term, we'll end up somewhere in the middle.  And the reason is as much as the FASB and the IASB actually want to get rid of as many of the rules they have right now, as many rules as possible.  It is the auditor community, the preparer community and regulators who want the ability to point to rules in order to determine compliance and consistency in the application of principles. 

CreditPulse: How is the change toward a common international standard being received by U.S. standard setters?

Pounder: FASB is 100% moving towards it aggressively.  SEC 100% moving towards it aggressively.  AICPA 100% moving towards it aggressively. 

CreditPulse: Isn't that surprising?

Pounder: It is surprising to a lot of people.  That's going to be an eye-opener for a lot of people. 

CreditPulse: Why do you think they are moving toward what is essentially a migration away from their own standards?

Pounder: The question that comes up is aren't they (FASB, SEC, AICPA) signing their own death certificate?  It is surprising to hear that they are the biggest proponents for this.  I think they are doing it ultimately to fulfill their mission.  In the case of the FASB, it's basically to serve the needs of users of financial reporting - investors, creditors, analysts, credit-rating agencies and so forth.  And they understand fundamentally there should not be differences from country to country in what constitutes proper accounting.  They ultimately realize that generally accepted in the United States is almost an oxymoron.  Generally accepted, should be generally accepted period.  And to the extent that country-specific differences exist in accounting standards somebody, and maybe even everybody, doesn't have the accounting right. 

CreditPulse: What effect will convergence have on the NYSE and Nasdaq?

Pounder: They are looking primarily to the SEC to say ok what can public companies do or not do.  But the individual stock exchanges have actually for their own purposes begun to accept, and the Nasdaq is a good example of this, statements prepared using IFRS.  But the stock exchanges are ultimately going to say well we know these listed companies have to comply with SEC regulations so they are not going to get to far ahead of the SEC in this area.

CreditPulse: Who in the United States opposes convergence?

Pounder: There are two groups: One is the preparers who say it's going to be hard work for us and maybe it won't add any value.  So there is a perception that this is just a lot more busy work for people who are already way to busy and they are not really convinced that it's going to have value.  And for certain companies they may be absolutely right.  This may just be a forced change which really does not improve anything for certain entities.  But for a lot of entities there will be improvement.  For every entity it will be a lot more work.

The second group of concern is from investors and users.  There are a lot of investors right now, particularly the high-end institutional investors, who say we're not sure we're going to get better numbers out of this.  Now this is not speaking for the whole investor community but there are certain vocal members of that investor community who are saying we're not convinced we are going to get better information. So that's where you see the opposition come from - from the preparers, from certain segments of the investor community. 

CreditPulse: Two significant groups.

Pounder: Two very significant groups in the financial reporting supply chain.  Auditors, by and large, are very, very favorably inclined towards convergence and IFRS.  Particularly the big global firms.  These folks, the top six global auditing firms, have come out and said we are 100% in favor of convergence. 

CreditPulse: Earlier you cited labor and cost as a reason for support among the Big Four auditing firms...  

Pounder: ...and that, I believe is a key motivation for their support of global standards.  You won't hear it come out of their mouths, but I believe it is a key factor because anybody looking from the outside starts to realize that is a benefit, a key benefit, for those firms.

CreditPulse: How influential have the Big Four been in this change taking place?

Pounder: I think they have been fairly influential and I don't know if that's a good thing because I believe they are operating under some faulty assumptions about who should change and how soon.  I believe they are coming from the perspective that IFRS as we know it today would be good for every U.S. company to switch to.  I don't concur with that but I believe that is the underlying message of the Big Four and I believe that that message has been put out by the Big Four and other auditing firms to support their ultimate goal of having a global supply of low cost talent.  You can't blame them because that is the business that they are in, of wanting to mange their costs downward for their single biggest cost.  But by the same token, if they are coming out and trying to encourage people to do something that will serve the interests of those firms without really being transparent about why, I have a problem with that.

CreditPulse:  How will new international standards be enforced?

Pounder: In the United States for public companies that falls squarely in the lap of the SEC.  Other countries don't have an SEC necessarily.  Canada is an interesting situation.  They have a series of provincial securities regulators, they do not have a national securities regulator.  So as you see Canada switch to IFRS then you have a dozen or so provincial regulators that are grappling independently with the issues of enforcement rather than a single national regulator.  Some countries don't have anything like the SEC at all.  And therefore there are certain risks associated with reporting in those countries even though ostensibly they would be using the same standards, there are risks associated with the fact that there is nobody there to really require the enforcement of consistent interpretation of those standards.  And the capital markets will factor that in.  But it is never better for us to be using different standards.  It doesn't solve every problem to use the same standards but it is never better for different standards to be used.

CreditPulse:  The importance of enforcement was apparent in the accounting scandals that occurred at the turn of the century.  The rules were there but some chose to ignore them.  Those companies were, in the end, held accountable.  What assurance will investors have that that same level of accountability will exist under IFRS?

Pounder: I think the good thing is that we have, at least in the United States, and growing throughout the world, a greater awareness of the importance of internal controls over financial reporting.  Thanks to Sarbanes-Oxley, thanks to a lot of things that have happened in the wake of Enron, Worldcom and so forth.  Companies in the United States and throughout the world now understand why having strong internal controls over financial reporting is important.  The beauty is that good control is neutral with respect to the actual financial reporting standards themselves.  So good control for a company that uses U.S. GAAP is good control for a company that uses IFRS and vice versa.  So even though the actual standards of financial reporting might change, the internal control principles and practices are identical.  And if we have good internal control now for a company that uses GAAP that's still going to be good internal control for a company that uses IFRS.  A company that doesn't have good internal control right now, regardless of what standards they are using, they don't have good internal control.   It's really a control issue rather than a standards issue. 

One thing that did come up though is there is a risk as a company makes a major transition such as changing from U.S. GAAP to IFRS that there will be potential to introduce new weaknesses in their internal controls.  They might have things running very well right now for their internal controls using U.S. GAAP but when they switch those standards all of a sudden they are dropping back in a lot of ways that may raise a control issue such as are your people really qualified, do your people have the knowledge, skills and abilities to perform their jobs under a different set of standards?  Now apples to apples, if the people were just as qualified under IFRS as U.S. GAAP there would be no change in the quality of your internal control.  But if you make that transition there is a risk that you could introduce new weaknesses because you don't know as much about what you are going to as you know about what you are coming from.  There is that possibility.  But the control principles and practices don't change.

CreditPulse:  Getting back to the enforcement again.  We know the difference in standards and controls between public and private companies in the United States.  With a lot of the rules going away, won't it have an impact on internal controls?

Pounder: It can.  And again that sort of shift can introduce the risk of new weaknesses if the people who are actually making the judgments based on the principles instead of just following the rule book, if those people are not equipped to make sound professional judgments starting only from a set of principles or starting with fewer rules, let's put it that way, they are not equipped mentally or skill wise to step up to essentially doing what rules had done for them previously, you could be introducing new weaknesses in your internal control.  And that's why it always gets back to training, education, making sure your staff has the competencies to operate in a different standards regime.

CreditPulse: Where do you see the SEC ending up in all of this?

Pounder: Very quickly and I'm talking about a matter of months they will propose that U.S. companies be allowed to use IFRS instead of U.S. GAAP for financial statements filed with the SEC.  Longer term the SEC has made it very clear that they want to require all public companies to use the same set of global standards.

CreditPulse: Do you ever see the majority of U.S. companies using IFRS and, if so, when?

Pounder: I do not see it happening if public companies simply have the option to use IFRS or not.  That optional period in all likelihood is going to come to and end x years in the future at which point public companies will be required to use whatever converged standards we have at that point.  If all public companies go that route will private companies go the same route?  At this point I'm not handicapping but private companies could say well if public companies use IFRS or whatever standards they use we are just going to do the same thing because we cannot deal with having multiple standards.  You have to have two college curriculums, you have to have big and little auditors who can handle each set and it's just too complex probably for the U.S. accounting profession to handle two different sets of standards, public versus private. 

U.S. private companies might say here is our chance, we're tired of having U.S. GAAP dominated by the needs and expectations of public companies so we're going to do to U.S. GAAP what the IASB did to IFRS in making a small, light version just for private companies.  A U.S. GAAP for private companies could happen, but then private companies would realize we're going to have to pay for this somehow.  Right now FASB is funded primarily by public companies.  Private companies don't have to pay a dime to have that set of standards and if you put the burden on them financially they might say oh we'd rather to go to this set of free standards over here that we don't have to pay for, which would be full IFRS or whatever converged standards there are or that variant like I was waving around this morning [in his session], a specific standard created by a global country-neutral body specifically for private entities.

CreditPulse: When do you see convergence taking place?

Pounder: It's a continuous process.  It's not really an event it's not really a kind of a threshold type of event, it's a continuous process.  I don't know if we will ever say we are done with convergence because there are always going to be instances, and we are seeing it in Europe already, for a company or a country to say we need an exception that applies to us.  And that is counter to the whole concept of convergence.  But it's already started to happen in Europe.  They're saying we need an exception, we have a handful of French banks over here that don't like these paragraphs in this international standard so the European Union has literally carved that out of the legal statutory requirements for European listed companies.  And that is completely counter to the idea of convergence because now there is a European version of international standards.  We don't want that to happen in every country because then we are right back where we started.  So there is a lot of pressure on Europe to say don't do that.  And there is a lot of pressure on countries coming into the IFRS camp to say don't do that, don't do what Europe did.  Don't have your own variation otherwise it defeats the whole point. 

CreditPulse: Has a date been set as a target for convergence?

Pounder: Not for the United States.  The countries in Europe are already down that path.  Canada for example, January 1, 2011 is the date on which listed and other publicly accountable companies in Canada must start reporting on IFRS. 

CreditPulse: How have the large multinational European companies responded to convergence?

Pounder: They made the switch.  It was not easy, but they made it in a fairly short timeframe.  Damler, BASF classic examples of companies that participate actively in the U.S. capital markets.  They said our statutory requirements in the country where we are domiciled have now changed to force us to file with regulators in Europe using IFRS.  What they did in the Unites States, Damler again a good example, was they satisfied their SEC requirements by providing a reconciliation of their IFRS statements to U.S. GAAP but in November the SEC said you don't have to do the reconciliation anymore.  It was a challenge for them to go from German GAAP and all this other stuff and essentially from U.S. GAAP because they hewed very closely to that simply for reporting purposes in the U.S.  But they said we are changing our standards.  They changed to IFRS.  They grumbled but they did it just like thousands of other European companies.

CreditPulse: Yesterday you mentioned China in discussing IFRS.  What is China's role in convergence? 

Pounder: China has publicly said that they will have a set of financial reporting standards for public enterprises in China that will be closely aligned in the short term with IFRS.  Longer term they are being a little bit more coy about their future.  Most observers would say it's because they want a greater say in the standard setting process than they have now.  They have virtually no say right now in the setting of IFRS.  They think, hey we're big, we've got a lot going on here, we have a large and rapidly growing capital market, we have all kinds of things going on, we need a say in the standards setting process.  I believe if China gets a say in the standards setting process that they perceive is proportionate to what they want then they are going to be completely in the fold of global convergence just like other countries.  But I think they are holding out for a greater say in the standards setting process. 

CreditPulse: How would you rate China's accounting standards now?

Pounder: They are very closely aligned with IFRS.  They just haven't had much experience running those standards or enforcing those standards.  But they haven't had decades of experience applying those standards, so it's all very new to them. 

CreditPulse: What ability has China shown to look at the path that Europe and the U.S. previously blazed in accounting standards?

Pounder: They are very much interested in getting education and training for their growing professional community.  Do they think ultimately they're going to want to end up with something that looks like U.S. GAAP, I think they don't.  Do they want something that addresses some unique political things in China like the prevalence of government owned or government sponsored enterprises much more so than we have in the rest of the world, yes, they are going to want to see standards that relate more specifically to their political environment.  Nobody else has bothered to think about putting standards into IFRS or U.S. GAAP that would address the political situation in China.  And China's saying those sort of standards belong in whatever standards we end up with because that's our political and legal reality.

CreditPulse: Do you see that as a major challenge?

Pounder: It's a very big challenge.  But China has a growing economic clout that they have no inhibitions against using to get what they want.  So I believe that ultimately it will happen.