The Pandora’s Box of international accounting standards
[Second of two parts]
In my last article, I explained some of the differences between US Generally Accepted Accounting Principles (GAAP) and the desire by top regulators to move to an international standard.
Given up for dead when President Obama entered office and SEC Chief Mary Shapiro originally said she would not held to her predecessor's commitment to adopting the standards, the tide recently turned when the newly appointed SEC Chief Accountant James Kroeker said adopting international standards would be one of his priorities.
Here's why U.S. companies should follow what's happening and potentially be concerned about the standards: They could cause companies here to prepare a new set of financials, adding a whole new layer of costs. The standards could make reporting more complex, not less; and finally, they could lead to more litigation.
The International Financial Reporting Standards are still being developed by the International Accounting Standards Board, which has 15 members from all over the world and includes U.S. representation. As the Board works through each issue, it seeks comments on its proposals from all interested parties. In the end, the U.S. regulatory bodies - mainly the SEC and the Financial Accounting Standards Board - will have to adopt the new international rules.
Dangers of international standards
Although the international standards are still being proposed, there are a couple aspects that I am concerned about. In my last article, I used the accounting for leases as an example of how international standards do away with "bright line" standards that clearly mandate how you record leases on balance sheets.
Rather than depend on a quantifiable rule, international standards require more judgment. That means that how something is accounted for can be more open to interpretation. In the worst case scenario, that could lead to pressure from management on auditors and internal financial executives to obscure the true financial picture from investors, lenders and other stakeholders. That in turn could lead to more litigation risk from anyone who is unhappy with how public companies are reporting their numbers. Let's not forget that the U.S. is more litigious than the rest of the world. International standards could invite more lawsuits.
Here's another example of a change from international adoption: Last-in, first-out inventory accounting is used by certain manufacturers to reduce their tax liability, but the tax code says you can only use it for your taxes if you use it on your financial statements as well. International standards don't allow LIFO, meaning you can't use it for GAAP financial statements and therefore couldn't use them for tax reporting. It could be quite a costly item for some companies, especially manufacturers.
Lastly, adopting new financial statements will require a costly, albeit one-time adjustment of a company's reporting system. It's another layer of expense that small public companies already struggle with in filing SEC financials.
The chairman of the IASB, Sir David Tweedy, recently called for the U.S. to get on board the international standards train. Leaders at the latest G-20 meeting said the same.
What the Madoff scandal did was to move us away from international standards because they were perceived as being judgment-based, while the U.S. was based on rules. A lot of people looked at international standards and say if we're having trouble here, going to a more relaxed set of accounting standards doesn't make a lot of sense.
U.S. companies should make their voices heard by commenting on the international process, the FASB and SEC's comment windows and to congressional representatives. If they don't, they could end up with more expenses, more complications and more headaches of accessing vital public markets.
International Accounting Standards Board
IFRS open to comment