Accounting for Financial Reform

April 7, 2010

Sir David Tweedie
, Chairman, International Accounting Standards Board (IASB)

Robert Herz
, Chairman, Financial Accounting Standards Board

Sir David Tweedie of the International Accounting Standards Board visited Japan Society to discuss progress in the development of international standards in accounting.

The IASB's aim "is to come up with one single set of high-quality global standards," Sir David said. "So it doesn't matter whether you have a transaction in Tokyo or Toronto--we should get the same answer. And if we don't, why don't we? Why don't we just pick the best way of accounting for a given situation?"

The Asian financial crisis of 1997-98 was a driving force for the creation of the IASB, he observed, as "companies' accounting standards completely failed in certain parts of Asia." Currently, International Financial Reporting Standards are used in 117 countries, including Europe and, for domestic markets, Japan, though the rule is new and thus far just a handful of Japanese companies have made the switch. China's system now has very few differences with IFRS, "and we are working to eliminate those." Israel switched to IFRS in 2008, Chile in 2009, and Brazil in 2010; Canada, India and Korea will do so in 2011. Japan's decision won't be made until 2012, but "when you speak to them... the answer is the decision is made--it's going to happen."

Cultural differences do have to be taken into account, he said. "Japan is a very unique culture," and "even in Europe, cultures are different. In Britain everything is permitted unless it's prohibited. In Germany it's the other way around. Everything is prohibited unless it's permitted. In the Netherlands everything is prohibited even if it is permitted. I know in France everything is permitted, especially when it's prohibited," he added to the amusement of the audience.

FASB Chairman Bob Herz, who presided at the event, was a founding member of the IASB, Sir David noted, "and his selection as Chairman of the FASB was not an accident. I think that was a very strong signal that the U.S. acknowledged international standards, wanted to have a major influence in international standards and also wanted America to move closer toward them."

Early efforts to address differences between the IFRS and U.S. GAAP made slow headway, he said. "We can converge until doomsday, but 17,500 pages doesn't converge well with 2,500, and people were getting fed up" with constant changes in the rules and with the reconciliations demanded of IFRS users that were listing in the U.S. The IASB and the SEC set out a roadmap towards creating new, joint standards on a dozen major items "where neither of our standards were particularly good." In September 2009, the G20 asked the IASB and FASB to "redouble its efforts" and to complete its standards and convergence program by June 2011. With so many countries switching to IFRS in 2011 and 2012, there's extra pressure to get the work done so companies don't have to change twice.

The new standard for business combinations is completed, and exposure drafts will be coming out in the next three months on revenue recognition, liability/equity, performance reporting and leases. "I often say one of my big ambitions is to fly in an aircraft that's actually on an airline's balance sheet," Sir David said dryly.

On pension accounting, "the U.S. runs ahead of us," he commented. U.S. GAAP does quite well at showing the impact of falling asset values and rising liabilities due to greater longevity; "we don't at present, but we will by June next year." By the end of 2010, there will be agreement on consolidation. "It's not simply the 50 percent plus one of equity; it's do you control? Now, what we just have to try to narrow down is when that is. Do you have to demonstrate it? Or is it just the fact that you can do it?"

On deal recognition, "we are not a million miles away from where you are here--we are just trying to make it clearer" and forestall a repeat of the Repo 105 fiasco, or at least "do our best to stop it as best we can," Sir David said. On financial instruments, "basically we only have two categories now: fair value for anything where you don't know what the cash flow is going to be, so it's equity, derivatives, exotics," and for debt or loans, where the company is collecting principal and interest, "you can keep it at cost," though some issues in this area remain to be resolved.

The provisions on OCI, other comprehensive income, are "what we call the Japanese amendment," he said. Where companies have cross holdings that aren't used for trading, "we don't want a gain of 30 or 40 years suddenly to be dumped in this year's profit when you sell them," so those amounts that would otherwise be included in P&L will be shown in OCI instead.

The IASB's exposure draft on impairment uses an expected loss model. Under this model, a lender in a region dependent on the oil industry wouldn't wait, in the event of a downturn in oil, until its borrowers had actually started to default on their mortgages, but would begin to provide for losses at an earlier point. FASB's approach is going to be "more of a look forward," and the two boards "will be doing quite a bit of outreach" once comments are received on the drafts.

"Both boards agree we want to try and write principles-based standards," Sir David said. "Show the core principle--what are you trying to do? Like leases, show the liability incurred by signing the lease contract and the right to the asset obtained thereby. That's what you're trying to do. Hopefully no inconsistencies, but judgment. We are not going to answer all of your questions. There's the standard, there's the objective, go for it. And so you'll find the interpretations coming out will be very, very few."

Two years after their effective date, the new standards will be subject to review. "The end goal of one single set of standards, which Bob has been a major champion of, and his board has been very supportive, is almost in our grasp. And this is probably the only time in a generation it will happen. If it blows apart at this stage it will take about 20-odd years to put it back again. So, that's why it's so important," Sir David concluded.


Moderator Bob Herz, Chairman of FASB, asked:

Beyond creating a global set of accounting standards, what other steps are preconditions for high-quality global reporting, and how do these dovetail with global regulatory efforts?

This is the $64,000 question, replied Sir David. "If we don't have good auditing this won't work," and "if the standards aren't enforced by regulators, if the auditors get overpowered and the regulators don't help them, it won't work either."

Audience members joined the Q&A:

My two kids are studying accounting right now in the U.S., and are not really learning IFRS. Faculty members don't know it, so they don't teach it. How will this be addressed?

The context of comparative accounting systems actually is being taught at many colleges; textbooks are in the works and the IFRS will be tested on the CPA exam starting in 2011, which will drive a lot of the process, Mr. Herz answered. Beyond this, "both the U.S. GAAP and the IFRS of today may be significantly changed by our efforts over the next year or so, so I think it's important for them less to learn all the detailed rules, but kind of understand the principles and concepts."

"People forget what Europe had to do," Sir Tweedie commented. "We didn't finish the first batch of standards until March 2004, and they started January 2005" and "managed pretty well."

Will IFRS end up treating loans on an accrual basis, or at mark-to-market or fair value?

A recent study using data from 1993 through 2009 found only a slight correlation between U.S. GAAP numbers and credit risk at banks (and none for regulatory capital numbers), "but it showed a six times more powerful correlation when you re-measured capital using fair values for all the financial instruments. So it's hard to ignore those kinds of results," though "implementation issues" remain, said Mr. Herz.

Sir David said, "Behind the scenes I can assure you there's a huge fight going on with the securities regulators versus the banking regulators over who's got control of accounts. And you'll see it appearing in statements by French politicians, 'Financial stability is a major objective of financial reporting.' We think it's transparency, and that's where a lot of the fight is going to be in the next few years--next few weeks, actually."

During the financial crisis there was a suggestion that the U.S. was pulling away from the IFRS effort, and even now, some have the impression that we are stalling. What are the odds that we're going to stay on target with the original plan?

"The G20 asked us to redouble our efforts," and the pace of face-to-face meetings, videoconferences and outreach to constituents is very much increased, Mr. Herz said.

In a principles-based system, how widely do the answers diverge when accountants come up with different answers for similar transactions? Very widely, or very narrowly? Is the system working?

"It's no different really than saying how long is this piece of machinery going to last," Sir Tweedie replied. "You may say it's 20 years, I might say it's 23. So, we will get slight differences."

"If you get 91 and I get 94, fine. We're in the same ballpark. If one of us gets 61, clearly the standard is not right and we would go back and fix it. And that tends to be what happens in the UK. If it comes out and people are all over the place, we move in pretty quickly, and then we have to tighten it--either make sure the principle is clearer, and we do that through our interpretations committee, but we don't tend to issue an interpretation. We will withdraw the paragraph and put another one in so it's clearer."

When IFRS, a new set of standards, is introduced into a national environment, there's initially a kind of "national flavor" to the outcomes, but this tends to narrow as time goes on, in part due to the influence of the international audit firms, in part to the regulators, in part to how the market looks at this, Mr. Herz said.

"For example, you get industry groups coming together and sort of saying, 'How will we deal with this so we can all be comparable,' and without us doing it they will say, 'We think this is a reasonable way to interpret that,' and they discuss with the audit firms, and practice just sort of takes care of it. So, we don't have to set the rules then. It's just done. Clearly if you find practice goes in two different directions, or we just don't accept the practice, you have to intervene. But normally that doesn't happen very often," Sir David concluded.

--Katherine Hyde
Topics:  Policy

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