Global leaders have recognised that stabilising the economy requires globally harmonised accounting standards. But that harmonisation is proving difficult, not least because governments resist their loss of sovereignty, leading accounting standards setter Ian Mackintosh told a recent Manchester Business School seminar. Dr Jodie Moll reports.
Since the onset of the global financial crisis in 2008, the world’s leaders have set about stabilising the economic system in a bid to prevent a repetition. Banks have been recapitalised and required to increase their holdings of capital. Central banks have pumped extra money into the system, while also cutting interest rates. In addition, the G20 has pushed governments to improve their management of their nations’ finances.
Another key element of the systemic reforms has been to improve accounting standards, to make the financial reporting of both major corporations and governments more transparent. In this way, lending and investment decisions will improve and policy-makers should have better information about underlying problems in the financing of nations and corporations.
At the heart of the efforts to improve accounting standards has been the drive to harmonise them internationally, so investors know all corporations and all governments are reporting their finances in the same way, making their accounts easier to compare. This job is being undertaken by the International Accounting Standards Board (IASB). But the IASB is finding international harmonisation to be difficult and it remains far from complete.
The rewards on offer for harmisation are substantial and the journey is worthwhile, Ian Mackintosh, Vice Chairman of the IASB told a seminar at the Manchester Business School.
“National differences in financial reporting impede the efficient allocation of capital by adding unnecessary risk and cost to investors”, he explained.
But the IASB has faced substantial obstacles in its efforts to achieve globally harmonised accounting standards.
Three issues in particular have hindered the efforts of the IASB. First, governments must accept a loss of sovereignty if there is to be international harmonisation. “If you want the benefit of global accounting standards, then you need to accept the cost, which is for each country to agree to stick to the internationally agreed standard and to resist the temptation to tinker with standards,” Mr Mackintosh explained. “A failure to adopt a global standard, or a decision to amend or add to that global standard means it simply isn’t a global standard any more.”
The second challenge relates to the structure of the IASB itself. The IASB operates as a private sector body working in the public interest. Members of the IASB serve as independent experts, coming from 16 different nations and with diverse professional backgrounds. But sometimes those involved are unable to leave their national identities behind.
“The presentation of national positions for bargaining and the consensus-driven nature of their decision-making will often result in standards that represent the lowest common denominator of international agreement, or that provide substantial latitude to jurisdictions in how those standards are implemented,” said Mr Mackintosh. “Neither of these are characteristics of a high quality, international accounting standard.”
The IASB is acutely aware of this problem and has responded by improving its standard setting processes. For instance, in 2007, six years after the IASB was established, its trustees introduced a requirement to conduct a post-implementation review of new standards and major amendments. In 2011 the trustees introduced the three-yearly public ‘Agenda Consultation’. And in 2012 the standard-setting process was modified to place greater emphasis on the research phase of the process.
The third challenge has been the multitude of various cultural preferences, business practices and accounting traditions that exist in different jurisdictions. These cannot all stay in place if there is to be agreement on a single, globally consistent way of describing financial performance and an entity’s financial position.
Mr Mackintosh reflected that the process of trying to balance competing viewpoints often leads to some interest groups being unhappy with the outcome, as was the case with the 2010 decision to replace the concept of ‘prudence’ with ‘neutrality’ in the ‘Conceptual Framework’.
Supporters of retaining the concept of prudence argued that by removing it, companies were less likely to act prudently, leading to increased and reckless risk-taking. For instance, the UK reporting watchdog, the FRC, argued in a response to the IASB that such concepts should not be removed from the conceptual framework. It argued that greater clarity reduced the risk of “undesirable interpretations” and that “apparent agreement may mask significant underlying differences”.
Yet International Financial Reporting Standards (IFRS) already prohibited many imprudent practices. For example, the IASB requires inventory to be recorded at the lower of cost or net realisable value. And guarantees and warranties are recorded as liabilities under IFRS, even when a claim has not been made under them and the company may not need to make a payment under them. Such exercises of caution suggests that the concept of prudence is embedded in the IASB standards.
But it is only through compromise that harmonisation will ultimately be achieved.