Globally comparable accounts - so near but so far

Globally comparable accounts - so near but so far

By: Rose Orlik | May 24, 2011

INTERNATIONAL FINANCIAL Reporting Standards may soon converge with US GAAP, and several other countries are following suit. The comparability of accounts should rise as a result, but legal, cultural and regulatory differences could hinder this noble ambition.

Trying to shoehorn uniform standards into non-uniform regulatory frameworks will undoubtedly give rise to hiccups, and David Larsen, managing director of fair value at US firm Duff & Phelps, has argued converged standards will not necessarily generate converged results.

US companies are prone to preparing accounts with national regulators in mind and undertaking financial reporting with a view to winning over audit inspectors. In the past, some companies became fixated on last transacted prices - the cost of buying or selling outside the price of the asset exchanged - as they thought it would be a key focus of US oversight board the PCAOB.

Real or perceived regulatory pressure could hinder comparable financial reporting, and investor pressure may work in a similar way. Companies feel the effects of investor displeasure almost immediately, and if their accounts do not meet with approval, the desire to please those holding the purse strings could outweigh fears of a regulatory wrist-slap.

In the same vein, companies without overseas operations or investors have less impetus to produce internationally comparable accounts. In the US, the availability of domestic finance is so widespread that businesses need never look beyond their shores, and the risk of deterring would-be financers through IFRS-divergent accounts is minimal.

Regulators are in place to ensure this does not occur, but there are instances where their input could lead companies to stray from comparable accounts. For example, national laws sometimes give rise, necessarily, to local differences in standards. Bob Garnett, chairman of the IFRS Interpretation Committee (IFRIC), said such variances are inevitable but potentially useful. He gave the example of income tax, but IFRS critics claim there are other, less IASB-accepted instances where domestic laws warp financial reporting. Pensions are one example where there are still options within the standards, and these can lead to accounts with low comparability.

The principles-based nature of IFRS means there will often be more than one possible interpretation reflected in accounts. In these cases, pressure from anxious preparers can push national regulators into issuing guidance, and this could lead to divergence. Rick Martin, vice-president of technical accounting at Pluris Valuation Advisors, said: "Companies demand bright lines - we'll migrate towards rules inevitably as users want clarity and consistency."

Garnett accepted that regulators can and will publish guidance on a fact- and company-specific basis, but said it must be clear that "these are not for generalisation", suggesting European regulators are most supportive of this agenda. Problems could arise if heavyweight regulators - such as the US Securities and Exchange Commission - issue rulings, as this might sway application in other nations and thereby affect comparability.

Several countries are currently tussling with the IASB and IFRIC over the interpretation of standards, and India is one example where serious challenges remain. However, supporters of IFRS as a conduit to globally comparable accounts say it is a process every new signatory goes through, and these teething troubles will eventually be ironed out.

Ruth Picker, global IFRS leader at Ernst & Young, was on the Australian Accounting Standards Board when it transitioned to IFRS. "We went through the same process; we challenged all the new requirements for a while, but then we realised it was counter-productive. Boards will try for a time to flex their muscles - it's all part of the transition."

Bob Garnett also highlighted the Australian case, saying the add-ons national standard setters initially imposed actually disadvantaged local business. "Companies were not comparable with peer competitors, and this held them back; the IFRS variations were unpopular, and eventually the board adopted the unaltered global standards."

This fits with the argument that no matter where they are located, it is in companies' interest to produce comparable financial reports. This, after all, is the primary purpose of IFRS, and multinationals should therefore go to great lengths in their quest for comparability.

Regulators, too, agree not to issue divergent guidance when they sign up to the global standards, though this commitment is frequently tested. If company accounts stray too far, regulators could come under pressure from legislators worried about the effect on international investment and the wider economy, effectively forcing them to tow the party line.

Changing companies' internal reporting mechanisms to reflect external requirements may be conducive to comparable accounts, and Garnett said this process is already under way. He suggested the queries directed to IFRIC - of which there are between 50 and 60 a year - often stem from users seeking reassurance that their new reporting system is compliant, and are easily dealt with.

Of those that do require further IFRIC consideration, many come from emerging economies where local conditions and challenges have few precedents among early adopters of IFRS. Garnett said on this basis, such problems will inevitably dwindle as more countries adopt the global standards and become confident in their application.

This is the central argument of those who see the final goal of universally comparable accounts as achievable. Mark Vaessen, KPMG's global IFRS network leader, said the big issues are generally accepted, and it is down in the detail where national interests seek to transfer the flavour of their old accounting standards to the global standards.

US convergence may be the litmus test, as the most powerful country in the world will soon decide whether IFRS is fit for purpose and how it should be applied. Japan and India have yet to sign up to full IFRS, and these major economies could yet balk at IASB-approved practices.

Ultimately, the proof is in the pudding. There is no denying that IFRS is far from generating exactly comparable accounts the world over, but equally, evidence suggests that divergence lessens with time and practice. However, the process of moving towards global convergence will soon be supplanted by widespread IFRS use; this will be the ultimate trial, and it will quickly become apparent whether the standards are fit for purpose.

In the next ten years, we will see whether it really is possible to extract picture-perfect accounts from companies as diverse and geographically removed as can be, or whether the global standard setting process has been an exercise in futility.