International accounting harmonization: Developing a ... - Science Direct

International accounting harmonization: Developing a single world standard F. Robert Buchanan Doctoral Student in Management, University of Texas at Arlington ([email protected])

Decision makers recognize the need to understand financial documents with transparency and clarity. So accounting rules are in the process of converging to a single international standard. This involves two dominant formats: the US GAAP and the International Financial Reporting Standards. A sports comparison in professional football is the American style of a highly detailed rulebook that is structured like a legal system, while the International Football Association operates with less than half as many rules, leaving referees great latitude in making judgments on the field. In accounting, the primary question is determining how much detail is necessary.

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ow that Europe has fully established its own currency, the international competitiveness of that region is intensifying, particularly in relation to the United States. Asia and other regions are also working to pool their influences. Affected by this competitive pressure are the preeminence of the dollar, the US stock markets, efforts to attract money from investors all over the globe, and the underlying systems for acquiring and deploying capital resources. A multitude of accounting systems exist, creating difficulty in comparing financial reports in different countries. The need for clarity in accounting is acute. So an organization called the International Accounting Standards Board (IASB) has been working for more than ten years with the goal of creating global accounting convergence by establishing standards for the world’s capital markets. Known as the International Accounting Standards Committee until it was renamed in 2001, the IASB is the counterpart to America’s Financial Accounting Standards Board (FASB). The United States operates under accounting standards called Generally Accepted Accounting Principles (GAAP). To be listed on US stock exchanges for the purpose of accessing the world’s biggest capital markets, international companies have been required to restate their financial reports according to US GAAP, without regard to the cost or difficulty of doing so. Yet, as significant as this issue is, it only comes to public attention occasionally. Investors became aware of the international GAAP issue in 1993 as they anxiously awaited the opportunity to purchase shares of Daimler-Benz on the New York Stock Exchange. Starting in May, company accountants in Stuttgart worked nights and weekends, seven days a week, for the October listing. Then came the final announcement: Having just told German investors that the company had made a profit of DM615 million, Daimler had to turn around and inform investors in the US that the company had lost DM1.839 billion during the same year. Was Daimler-Benz making money or losing money? This took some of the sparkle off the Daimler deal, and the excitement never fully returned; investors on both sides of the Atlantic are bitter and contentious, even today. 61

Nevertheless, US GAAP continued earning respect and international legitimacy until the scrutiny following the bankruptcy filing of Enron in 2001—the 11th largest in the Fortune 500 list of publicly traded firms and one of the largest bankruptcies in history. Accounting practices were alleged to have played a significant role in the collapse. The IASB commissioner stated that the rules of US GAAP featured prominently enough to cast doubt on the validity of the system. This came at a critical time in the decision process in the EU as well as the United States toward allowing companies certain latitude in selecting International Financial Reporting Standards (IFRS; known as IAS, or International Accounting Standards, until June 2002) versus other forms of local and US GAAP.

This article discusses the harmonization of international accounting standards in light of three specific areas: (1) a comparison of US GAAP to IFRS, especially IAS 39, the specific rules that relate to financial instruments for evaluation by investors; (2) a discussion of corporate fraud, particularly the Enron debacle, pursued in the context of how either GAAP or IFRS might furnish safeguards; and (3) a general review of historic and regional issues that may or may not make it possible to fully standardize accounting practices to achieve the uniformity that is intended. Finally, implications of international accounting standards harmonization are discussed, including the long-term impact on managers and investors.

Figure 1 Important differences between IFRS and US GAAP The significance of the differences summarized below will vary with respect to individual companies, depending on such factors as the nature of the company's operations, the industry in which it operates, and the accounting policy choices it has made. Reference to the underlying accounting standards and any relevant national regulations is essential in understanding the specific differences. IAS

Area of difference

IFRS

US GAAP

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Minimum liability recognition under defined benefit plans

No minimum liability requirement

At a minimum, the unfunded accumulated benefit obligation is recognized

27

Basis of consolidation policy

Control (look to governance and risk and benefits)

Majority voting rights

27

Special purpose entities

Consolidate if controlled; generally follow the same principles for commercial entities in determining whether or not control exists

Consolidate if certain criteria are not met; generally look to whether or not the SPE has a sufficient level of equity “at risk”

27

Impact of different accounting policies or reporting dates of parent and subsidiaries

Must conform accounting policies and reporting dates; if not practical, must adjust for any significant differences in policy and subsequent transactions or events

No requirement to conform reporting dates or accounting policies; need not adjust for any significant differences in policy or subsequent transactions or events

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Classification of convertible debt

Split the instrument between its liability and equity components

Classify the entire instrument as a liability

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Development costs

Capitalize, if certain criteria are met

Expense

39

Change in value of non-trading investment

Recognize either in net profit or loss or in equity (with recycling)*

Recognize in equity (with recycling)

39

Hedge of a firm commitment

Cash flow hedge*

Fair value hedge

39

Use of partial-term hedges

Permitted

Prohibited

39

Use of qualifying SPEs

Prohibited

Allowed

*This topic is currently being addressed as part of IASB’s Amendments to IAS 39 Project. Source: Deloitte Touche Tohmatsu, IAS Plus

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Business Horizons / May-June 2003

Comparison of US GAAP to IFRS

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ne of the fundamental differences between IFRS and US GAAP (outlined in some detail in Figure 1) is the degree of specificity in reporting procedures dictated by each group of standards. There seems to be a distinct cultural dimension. For example, America likes highly detailed rules, much like in its approach to sports. The International Football Federation has less than half as many rules as America’s NFL, reflecting a clear preference for letting officials on the field make determinations in the course of the game; in contrast, the action in an NFL game is stopped seemingly every few seconds to refer to rules that are written like a law book. Americans love complex rules at both work and play. According to Coopers & Lybrand (1995), IFRS does not prescribe narrowly defined rules, leaving more room for interpretation by the accountants preparing the reports. The auditing professional is called upon to make judgments that focus on the economic substance of transactions. Studies by Schultz and Lopez (2001) have shown that compliance with a rigid set of narrowly articulated rules does not necessarily guarantee economic relevance of the resulting data. However, some analysts feel that IFRS allows too many alternatives due to its reduced specificity. Comparability between financial statements of different firms is compromised when a transaction can be treated in ways that are inconsistent. IAS 39, “Financial Instruments: Recognition and Measurement,” is a standard that covers significant amounts of the financial reporting used by investors. Having taken the IASB nearly ten years to develop, it includes accounting procedures for conventional assets and liabilities such as cash, trade receivables and payables, investments in debt and equity securities, and notes, bonds, and loans payable. It also includes accounting rules for derivatives as well as futures, forwards, swaps, and options contracts. Guidance on accounting for financial instruments is contained primarily in a previous document, IAS 32, “Financial Instruments: Disclosure and Presentation (1998).” Other documents that influence IAS 39 issued by the Standing Interpretations Committee of the IASB are SIC Interpretation 5, “Classification of Financial Instruments—Contingent Settlement Provisions,” and SIC Interpretation 12, “Consolidation—Special Purpose Entities.” IAS 39 was developed with US GAAP as a base. The IASB tried to take the basic approaches of US GAAP and codify them in a format compatible with other IASB standards. This was a daunting task because in addition to compatibility was the goal of having far less detail than its American counterpart. US GAAP has developed over many years to its current huge volume and complexity of standards

International accounting harmonization: Developing a single world standard

and practices. Detailed guidance exists for specifically defined instruments and individualized industries. The procedures are at times inconsistent between industries, and some financial instruments are not addressed at all. Included in the US documents are FASB statements, interpretations, and technical bulletins as well as SEC staff accounting bulletins and other directives. Practitioner guidance comes from the American Institute of CPAs’ audit and accounting guides, statements of position, practice bulletins, and regulatory reporting requirements. Recent US standards, such as FASB Statements No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and No. 133, Accounting for Derivative Instruments and Hedging Activities, are broader in scope than many of the older written standards. The US standards have specifically addressed a great many of the issues that arise in financial accounting, while the IASB’s more general approach allows individual reporting choices to be made in applying the standards. Among significant general differences noted by Porter and Traficanti (1999) and Deloitte Touche Tohmatsu (2002) are: ● Some financial instruments that would be classified as liabilities under IFRS would be classified as equity under US GAAP. ● IFRS standards require the issuer of a compound instrument that contains both liability and equity components (such as convertible debt) to account separately for its debt and equity components. US GAAP precludes that separate accounting in most circumstances. ● IFRS standards have trading, available-for-sale, or heldto-maturity classifications that apply to all types of financial assets. Under US GAAP, those classifications apply only to securities. As a result, measurement of certain financial assets, as detailed in Figure 2, would differ depending on whether IFRS or US GAAP was followed. ● The US GAAP distinction between sales and secured borrowings is different from that in IAS 39. As a result, many asset transfers that would qualify for sale accounting treatment under IAS 39 would not qualify under US GAAP, and some asset transfers that would not qualify for sale accounting treatment under IAS 39 would qualify under US GAAP. ● Sale and leaseback accounting, as in removing an asset through sale but continuing to use it through a leaseback contract, is highly specified in US GAAP, particularly for transactions involving real estate. IFRS furnishes only generalized guidance. ● Companies with defined benefit pension plans have a financial liability exposure. Under US GAAP, the company must at the very least recognize its unfunded accumulated benefit obligation. With IFRS there is no 63

Figure 2 Classification and measurement for financial assets under IAS 39 IAS 39 category of financial asset

Description

Measurement basis

Originated loans and receivables

Loans and receivables created by an enterprise by providing money, goods, or services directly to the debtor

Amortized cost, subject to impairment recognition

Held-to-maturity investments

Fixed maturity investments that the enterprise intends and is able to hold to maturity

Amortized cost, subject to impairment recognition

Available for sale financial assets— normal case

Includes: • Fixed maturity investments that the enterprise either does not intend or is unable to hold to maturity • Equity investments with a quoted market price • Equity investments with no quoted market price but able to estimate fair value

Fair value; enterprise has a one-time, enterprise-wide choice of reporting changes in fair value in (a) net profit or loss or (b) equity until the asset is sold or otherwise disposed of, at which time the cumulative gain or loss is reported in net profit or loss.

Available for sale financial assets— unusual case

Equity investments with no quoted market price and the enterprise is unable to estimate fair value

Cost subject to impairment recognition

Financial assets held for trading

Financial assets acquired for the purpose of generating a profit from short-term fluctuations in price; includes all derivative assets and liabilities

Fair value, changes in fair value in net profit or loss

Source: Deloitte Touche Tohmatsu, IAS Plus

minimum liability disclosure requirement, potentially allowing the concealment of a firm’s pension liability.

perform calculations and make their own adjustments to the income statement in order to see the actual earnings.

The differences in actual results are substantial but not consistent. For example, in 1999 Nokia reconciled its IFRS financial statements to US GAAP and had an identical net income. Hoechst reported virtually identical net income in 1998 under GAAP and IFRS, but in 1997 its GAAP income was 75 percent less than that using IFRS. For BHP Billiton and Novartis, US GAAP net income in 1999 was about 80 percent of their IFRS income.

International standards are taking an opposite approach when it comes to securitized transactions. IFRS will not allow this type of transaction; for example, loans or credit card balances that are assets cannot be stated as a sale and removed from the balance sheet because of continued risk exposure to the firm. Stock options are an area of contention, relative to goods or services that are secured by such and not reported on income statements. This continues to be permissible in US GAAP, whereas the IASB has not fully decided on it.

Financial assets can be measured and reported in numerous ways around the world, creating unwelcome surprises for investors when losses occur. For example, some companies recognize assets at cost, others at the lower of cost or market, still others at fair market value. Daimler has stopped publicly releasing results calculated according to German regulations (although it provided this information to German authorities), and now reports using only GAAP. In response to current events, the IASB is taking a leadership stance in requiring that stock options be fully expensed in financial statements. Analysts are urging the FASB to follow suit. The FASB currently requires that the value of outstanding stock options be disclosed in the footnotes of financial statements, requiring investors to

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The IASB has an interesting approach to a class of assets called “held-to-maturity investments.” These are typically debt securities and mandatorily redeemable preferred shares that are not intended to be disposed of. Because this classification depends on management intent rather than objective evidence, IAS 39 imposes a somewhat punitive burden. If an enterprise actually sells a held-to-maturity investment other than in a circumstance that could not be anticipated or in insignificant amounts, all of its other held-to-maturity investments must be reclassified as available-for-sale, which are measured at fair value. (See Figure 2 for categories and measurements.) For available-for-sale


financial assets that are remeasured to fair value, a firm will have a single, company-wide option to adopt one or the other of the following accounting policies:

has all of its planes on lease? A balance sheet that presents an airline without any aircraft is clearly not a faithful representation of economic reality.

● recognize fair value changes in net profit or loss for the period ● recognize the fair value changes directly in equity until the financial asset is sold, at which time the realized gain or loss is reported in net profit or loss Hedge accounting is allowed under IAS 39 in specific circumstances. The hedging relationship must be clearly defined, measurable, and actually effective. Offsetting effects on net profit or loss has to be recognized symmetrically.

Corporate corruption issues

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European companies have until 2005 to implement IAS 39. Approximately 300 European companies that already use US GAAP exclusively have until 2007 to adapt to the new system. The vast majority of about 6,700 companies across Europe report in their national local GAAP. Africa, Australia, and a number of former Soviet republics have agreed to adopt IFRS. Stock markets that accept financial statements of foreign listed companies in IFRS without any additional reconciliation include the London, Zurich, Frankfort, Luxembourg, Hong Kong, Thailand, Malaysia, Amsterdam, and Rome stock exchanges. IAS 39 strictly forbids recognition of anticipated future revenues that are in any way speculative. Accountants would ignore any non-contractual aspects of financial instruments, such as future deposits by depositors and projected purchases by credit card customers in valuation of a financial instrument. A bank is not allowed to assume renewals of time deposits, and credit card companies are not permitted to assume any additional purchases. Off-balance-sheet financing is not allowed under IAS 39. For reporting purposes, a firm is deemed to be in control of a financial asset or liability as long as it has the right to sell or pledge the asset, or to reacquire it, unless the asset is readily available on the open market. The FASB is taking action on special-purpose entities (SPEs) that have been the vehicle for corporate fraud in America. The intent is not to restrict the use of SPEs but to improve financial reporting by involved firms. We can expect to see more assets, liabilities, and results of SPE activities consolidated into financial statements of parent firms that create the entities and are the primary beneficiaries. This effectively removes advantages that deception would provide and, as such, makes SPEs useful only if their intent is legitimate. IFRS is considerably more restrictive in the use of SPEs. Both the IFRS and FASB are concerned about other items that could be removed or omitted from financial statements, obscuring the extent of a company’s true assets and liabilities. Operating leases are typically not reported as either an asset or a liability. What about an airline that


nron is not unique in recent history for having blatantly endeavored to defraud investors. Sunbeam, Cendant, and Waste Management, Inc. notably engaged in clear-cut fraud. Those companies, however, were not forced into bankruptcy when their shenanigans came to light. In its simplest accounting explanation, Enron was hiding billions of dollars of debt by using off-balance-sheet financing. The purpose was to convince the marketplace to pay no attention to the associated risks. The firm was actually responsible for the debt of partnerships and special purpose entities that turned out to be controlled by Enron, various convoluted subsidiaries of Enron, or one of its principals, such as Andrew Fastow, the CFO. In order to be in compliance with the SEC and procedures of the FASB, the liabilities in question, along with the assets and costs, need not be consolidated into the financial statements if the parent firm does not control 51 percent of the voting rights of the off-balance-sheet affiliate. Enron’s meltdown began when it filed Form 8-K to restate results for 1997 through 2000, admitting that three of its affiliated partnerships should have been consolidated after all. No reason is required or given in the document. Analysts suggest that other investors in these particular partnerships might have been Enron employees, a violation of rule compliance. In 1999, when Enron was flying high (along with the rest of the market), company officials boasted about their use of leverage. Many analysts, consultants, academics, and journalists agreed, holding up Enron as an award-winning example to follow. In bragging about hiding the debt associated with the acquisition of three New Jersey power plants from Cogen Technologies in 1999, Fastow said, “We accessed $1.5 billion in capital but expanded the Enron balance sheet by only $65 million.” He also insisted, “We’ve completely segregated these assets, so if something were to happen here, given the high leverage, it would not be able to come back at Enron.” As investigators have tried to ascertain exactly what went on in Fastow’s financial black box, the marketplace has been punishing the stock of other companies that use offbalance-sheet debt. El Paso Corp., another Houston company that owns natural gas pipelines, consolidated $2 billion in off-balance-sheet financing in the wake of the Enron debacle. Its press release said, “It has become clear that the market now expects energy companies to maintain lower leverage and more simplified balance sheets.”

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The response by the US government is a congressional scrutiny of how financial and commodity markets are regulated, in addition to examining the inadequacy of federal protection of employee retirement accounts. At a minimum, we can expect to see new standards for disclosure of off-balance-sheet liabilities. A key proposal to the FASB is to tighten the definition of when affiliates need not be consolidated into financial statements. The SEC plans to close certain loopholes in its disclosure requirements. One salient point is the definition of material information, since Enron’s auditors at Arthur Andersen accepted the company’s claims that much of its off-balance-sheet activities need not be disclosed because the amounts at stake were small enough to be considered immaterial. On a related topic, many people are suggesting it would be prudent to eliminate a huge potential conflict of interest by banning accounting firms from furnishing consulting services to clients they audit. (In 2000, Arthur Andersen billed Enron $27 million for consulting services, compared with $25 million for audit work.) The Enron debacle, though having drawn great attention in the IFRS dialogue, is not an indicator of any fundamental accounting or regulatory system failure. Rather, it is a case of corrupt management that was seeking technicalities behind which to perpetrate investor fraud. It appears that its primary infraction, nondisclosure of off-balance sheet financing, might be more clearly prohibited under IFRS. That, however, would not necessarily have precluded them from other fraudulent tactics under the international system, because the IFRS is generally less structured than US GAAP and more interpretive latitude is available to corporate accountants.

Influence of history and region

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ctivities arising from systems with legal traditions based on Roman law (also known as code law) are quite different from the conceptual framework that comes from common law. Roman law, as used in Germany and France, depends on civil codes, highly detailed and comprehensive, with little room for interpretation. In a common law system such as the UK and the US, accounting standards are more general and are supplemented by the input and governance of professional organizations. This creates inherent challenges in harmonizing international accounting standards, due to cultural and systematic differences. Typically in a Roman law or code law country, the role of the professional accountant is to implement highly prescriptive and detailed legal requirements. This could be contrasted with the UK, where presentations of “a true and

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fair view” of a company’s financial position and results will depend heavily on the judgment of the accountant as an independent professional. Gray (1988) postulates that Roman law systems would favor less flexibility and a more conservative approach. The development of IFRS is much to the credit of accounting professionals in the UK, who

The Enron debacle, though having drawn great attention in the IFRS dialogue, is not an indicator of any fundamental accounting or regulatory system failure. Rather, it is a case of corrupt management seeking technicalities behind which to perpetrate investor fraud. have taken a leadership role in gradually convincing Roman law countries that a common law format is viable. This has been facilitated by the experience of European firms using US GAAP methods to tap US capital markets that would prefer a much simpler rulebook. Japan differs from the Asian-colonial countries of Singapore and Hong Kong, whose systems were initiated by the British Empire. Japanese favor high levels of uniformity and statutory control. They favor secrecy and are not comfortable with Western concepts of disclosure and transparency. Politics are injected into the accounting system as needed. For example, at the beginning of the Japanese banking crisis the government informed banks that they need not recognize loan losses because the public might lose confidence in the banking system. In capturing broad differences in institutional structure, researchers may partition countries into the “shareholderfocused” group or “Anglo-American cluster,” which includes the US, the UK, Canada, and Australia. By examining environmental measures that include legal systems and the relationships between business enterprises and sources of capital, one can see these market-oriented systems as emphasizing the needs of investors. France, Germany, and Japan are members of the “continental” group, also known as the “bank-dominated Business Horizons / May-June 2003

economies” or “code law cluster.” Traditionally, banks and governments have been dominant in directing the use and evaluation of accounting information. High uniformity of accounting procedures is preferred over flexibility. Homogeneity is assumed within each cluster, and between-cluster countries are considered to be dichotomous with respect to bank-oriented vs. market-oriented financial systems, public vs. private sector accounting standard-setting, and degree of importance of auditing.

Arguments in favor of harmonization

A

The same divisions are present in defining the two institutional structures into two legal styles: common law and code law. An empirical study by Ball et al., cited in Pownall and Schipper (1999), has shown significant differences in the factors of accounting practices between common law and code law countries. The structure of this study was seven countries divided into the two groups. Regressions of net income per share were deflated by share price on annual return per share, and again deflated by price in order to capture the extent to which annual earnings reflect actual market share pricing movements during the fiscal year. This was interpreted by the researchers to measure the timeliness of accounting earnings. Hypotheses relating to differences in timeliness reflected group-specific differences in the use of accounting earnings. Inferences relating to to timeliness between code law and common law countries were based on comparisons of R-squared statistics from the regressions of earnings on returns. The researchers concluded that if international harmonization of financial reporting is to converge into a single system, common law is more appropriate because of the arm’s-length transaction process most typical of it, which is “shareholder focused.” Shareholders use earnings to determine share value and compensate managers, while in “stakeholder-focused” economies (code law countries) “earnings are used more for determining current payouts to government (via taxation), to shareholders (via dividends), and to managers and employees (via wages and bonuses).” As a further endorsement of the common law concept, cross-border transaction participants are likely to be unrelated and at arm’s length from one another, rather than related to the firm and its managers. Another very interesting result of the study is the suggestion that accounting earnings in common law countries are more conservative than reported earnings in code law countries, arising out of the arm’s-length relationship between contracting parties (managers and shareholders). This adds to the degree of difficulty in comparing financial statements from different legal traditions, due to information asymmetry. Reviewing the results of earnings suggests that bad news is incorporated more slowly and good news more quickly in code law than in common law countries.


study conducted by Whittington (2000) compared a steel company in France to one in the UK over an 11-year interval from 1988 to 1998. Each company used GAAP in its own country and restated its earnings to US GAAP for investor purposes. None of the differences between methods was decisive enough to make any inferences. The US and UK GAAP were the most closely aligned and the French GAAP appeared slightly more conservative, although other studies have indicated GAAP to be somewhat more conservative in the US than in France. As such, GAAP between US, UK, and France may not differ significantly. Earlier studies by Weetman and Gray and Weetman et al. (cited by Whittington) had concluded that US GAAP is generally more conservative than UK GAAP. Another study by Dumontier and Labelle (cited by Pownall and Schipper) found that in 117 publicly traded firms in the years 1981–1990, French GAAP earnings were no less value-relevant than were those of US or UK GAAP earnings. Coopers & Lybrand conducted extensive research on casespecific reconciliations of IFRS to US GAAP. They concluded that the belief in lower standards as a result of IFRS financial reporting is erroneous. Their studies did not reveal material differences, and they emphasize that in looking for areas of difference between US GAAP and IFRS it is important to bear in mind that there are often differences in the application of the same domestic accounting standards between US companies. Volcker (2002) believes that a single set of international accounting standards would minimize compliance costs for companies and also assist enforcement. The current practice for foreign firms that desire access to US markets is to use US GAAP reporting. Their alternative is to file a report with the SEC that reconciles their local statements to US GAAP. A recommendation by Schwartz (2001) that has merit calls for an international standard that approximates US GAAP to be supplemented as needed with the use of an additional disclosure for remaining differences in measurement, recognition, or disclosures that are material. This furnishes an acceptable level of transparency without the burdensome accounting conversion processes that currently take place. The overall need for accounting harmonization is fueled by globalization. While the US capital markets have been dominant, investors are interested in the broadest possible access. The forces of accounting harmonization involve companies and investors that are fully committed to an international standard. This is supported by the longterm efforts of a considerable array of accounting professionals, particularly the IASB.

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Arguments against harmonization

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erhaps the most pervasive resistance to acceptance of IFRS is the pressure exerted by the United States. Certainly there is justification for the US GAAP preference, based on the large portion of international capital that flows through American markets. But the US is known for a heavy-handed style. Europeans see the US pulling strings behind the scenes, particularly in the SEC’s influence in the appointment of IASB trustees. The current chairman is none other than Paul Volcker, former chairman of the Board of Governors of the US Federal Reserve System. The European Community has wanted the IASB to have wider geographical representation in order to balance the American influence somewhat. Form 20-F is an accounting reconciliation of foreign financial statements to US GAAP that is filed with the SEC. Many non-US firms file this document. Analysis by Pownall and Schipper shows the differences to be large in magnitude from the original accounting standards used, although the differences are not in any consistent direction. This indicates that the application of different accounting systems to a common set of events and transactions could produce essentially noncomparable reports. Hence, it may be inappropriate to impose uniform accounting standards because of cross-jurisdictional institutional differences. Some regulators and standard setters may find it preferable to maintain at least some countryspecific reporting that can capture qualitative, institutiondriven differences in events that seem superficially similar. Reconciliations can be additionally furnished for firms that choose to report in numerous jurisdictions. Another part of the problem is the previously mentioned lack of specificity in the IFRS model. Schultz and Lopez found that when international accounting rules allow for significant discretion in application, de facto uniformity among nations is unlikely to result. This impairs the utility of the harmonization effort. In inviting comments for a 2003 discussion, FASB Chairman Robert Herz (2002) stated, Many believe that moving to broader, more principles-based accounting standards such as those used in other parts of the world would facilitate better reporting in the US. Others, however, are concerned that a principles-based approach could reduce the comparability of financial information and leave too much room for judgment by companies and auditors. Dzinkowski (2000) suggests that firms could suffer negative effects from adopting non-local GAAP, in relation to local tax liabilities they have shielded themselves from

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through careful use of their existing accounting standards. These amounts could be quite substantial. Costs and assets may be stated in any number of different ways, according to local custom. The fear of excessive transparency is of legitimate concern to a firm. Barth, Clinch, and Shibano (1999) assert that local firms could also experience a decrease in domestic trading volume after harmonizing to an international standard due to a decrease in domestic price informativeness. Domestic investors would experience an expertise acquisition deficit as they delay or decline an education in interpreting the unfamiliar reporting formats. If the international standard is less stringent than US GAAP, it could place American companies at a disadvantage in competing for a pool of international funds. This would be caused primarily by the higher level of transparency that appears in US standards of accounting than that required of firms from other countries, offering those firms a competitive advantage. At the same time, foreign firms, if able to do business on US stock exchanges without full US GAAP compliance, will not have any reason or desire to perform accounting conversions. Said Malcolm Cheetham of Novartis, a Swiss pharmaceuticals company: In completing our US listing we had to go through the costly exercise of making a bridge to US GAAP. It introduced a lot of complications in acquisition accounting. It didn’t result in our share price moving at all, and I don’t see that it was of any real value to the business community. (Dzinkowski 2000)

Into the future

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he past 20 years have seen increasingly creative attempts by companies to avoid showing various assets and liabilities on their balance sheets by using transactions that may obscure the economic substance of their financial position. There will always be loopholes to be exploited by corrupt managers in any country or company. It is a matter of opinion to what extent the United States dominates in corrupt accounting practices, but it has assuredly not cornered the market. US GAAP is already more restrictive overall and more detailed than IFRS. Cairns (2000) points out that it would be much easier for a US GAAP company to be in compliance with the IFRS than for a company that reports in IFRS to claim compliance with US GAAP. In the case of the Enron fiasco, IFRS would have prohibited the particular accounting procedures that misled investors. However, that cannot create the assumption that the company would have been unable to find any loopholes under IFRS with which to perpetrate fraud.


As Paul Volcker told Congress, “A new profession of financial engineering has emerged which exercises astonishing ingenuity in finding methods to circumvent established accounting conventions and tax regulations.” This would not be one of America’s proudest exports. He also noted, The accounting profession is facing increasing challenges in responding to the growing complexity of business and finance, which features seemingly endless varieties of securitizations, multiplying offbalance-sheet entities, and diabolically complicated abstruse derivatives. This is a trend that will continue. Along with this complexity, at least in the United States, there has been a certain amount of erosion of professional, managerial, and ethical standards, as well as internal company safeguards. Compliance, enforcement, and jurisdiction are among many issues that will need to be worked out. An export of American litigiousness would be an unhappy addition to the international community.

Compliance, enforcement, and jurisdiction are among many issues that will need to be worked out. An export of American litigiousness would be an unhappy addition to the international community. A possible future prediction is that accounting system harmonization will add to the international movement of executives and managers as local business practices become less preeminent in favor of global business strategy. Management skills will become ever more transferable. The high compensation of American managers will also take place globally, though not to the lofty extent seen in America in the recent past. This will be contingent on the skill and value brought to the firm. The pay scales will be a shock in some places that have not had significant management compensation disparities into the top levels. The rapid terminations of these highly paid managers will also come as a surprise in some countries and cultures that have featured employment stability. Over the next 25 years, these pay disparities between top and middle management will shift downward as the knowledge base becomes more generalized. International accounting harmonization: Developing a single world standard

University curricula will become less regionally focused as accounting professors deal with the standardized systems. Needs and opportunities for academic research will become clearer as scholars apply their analysis to challenges that are more universal and pervasive. For example, how does the homogenization of accounting and finance affect political risk? Foreign exchange risk? Market risk? Does risk increase or decrease? Homogenization of accounting practices will assist in the consolidations of large businesses on a global basis. Mergers on the scale of Daimler and Chrysler, British Petroleum and Mobil, will increase exponentially. Harmonization will assist executives in evaluating investments and acquisitions in totally different economies. This trend is well established with media giants, oil companies, and automobile manufacturers, to name just a few. We can expect to see retailers and telecommunications the next in line to go the same way. Access to capital markets will be facilitated by accounting standards homogenization, for the benefit of both investors and firms. The sophistication level of investors around the world will increase. Stock market exchanges will have larger volumes in all markets as American investors shop overseas and international investors become active in their own markets as well as the US markets. The timing is perfect for the maturity and power of the Internet, with global investors able to access information and conduct transactions at low cost and high speed. Boundaries and time zones are inconsequential on the Net. Anyone with a computer and a phone line can have tremendous access to information. The burden associated with being a public company is going to produce a divergence in management and strategy between public and private companies. The lure of big capital is often later lamented and regretted as companies sacrifice their privacy and self-governance in favor of raising money. International managers need to understand the strategic disadvantage this can create in their particular competitive environment. Managers are going to find that they are furnishing transparency in ways they do not desire. We can expect to see subsequent restructuring trends as companies rush into the capital markets and then later move toward reprivatization to regain confidentiality after the firm has been built out. This may be an evolutionary trend over the next 25 years. We know from history that the growth of business globalization is much higher than the overall growth in world business volume. More effort is expended in chasing the same pool of money. This is counterproductive to the intent of moving beyond domestic markets. Companies see global capital markets with similar hopes of accessing higher volumes by reaching beyond borders. This has been a spectacular failure for some firms, most notably Daimler-Benz, whose launch on the New York Stock 69

Exchange was a dismal experience, and the results of which are partially obscured by its adventuring into the Chrysler acquisition. One of the many possibilities that arise from transparency and comparability of financial statements and the resulting inflow from foreign investors is the opportunity perhaps to raise money globally but grow the business domestically, on home turf in familiar markets. It is somewhat of a reverse globalization concept: global input rather than global output. This gives a firm more funding to use toward its core competency.

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ike it or not, the evolution of international accounting standards harmonization is inevitably tilted toward a strong resemblance to US GAAP. In addition to the pressures exerted by the SEC and the FASB, there is the undeniable pull of the US mega-markets. Europeans have strong faith in their future potential, but the current reality is not characterized by Americans scrambling to get into European capital markets. The spotlight remains on the United States. ❍

References and selected bibliography Barth, Mary E., Greg Clinch, and Toshi Shibano. 1999. International accounting harmonization and global equity markets. Journal of Accounting and Economics 26/1-3 (January): 201-235. Cairns, David. 2000. Waving a different flag. Accountancy 126/ 1,285 (September): 105-107. Colvin, Geoffrey. 2002. Sick of scandal? Blame football. Fortune (22 July): 44. Coopers & Lybrand. 1995. International accounting standards versus U.S.-GAAP reporting: Empirical evidence based on case studies. Cincinnati: South-Western College Publishing. Deloitte Touche Tohmatsu. 2002. International accounting standards: A guide to preparing accounts. London: ABG Professional Information. Dzinkowski, Ramona. 2000. The world according to US GAAP. CA Magazine 133/10 (December): 26-31.

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Fechner, Harry H.E., and Alan Kilgore. 1994. The influence of cultural factors on accounting practice. International Journal of Accounting 29/3: 265-277. Fink, Ronald. 2002. Beyond Enron. CFO 18/2 (April): 34-42. Gray, S.J. 1988. Towards a theory of cultural influence on the development of accounting systems internationally. Abacus 24/1 (March): 1-15. Guerrera, Francesco, and Peter Norman. 2002. Call to scrap US rules on accounting in wake of Enron. Financial Times (21 February): 1. Herz, Robert. 2002. FASB Press Release PDF 13k. @ www. iasplus.com/pastnews/2002oct.htm (October). Kroll, Karen M. 1997. Closing the GAAP? Industry Week (3 November): 61+. International standard on financial instruments. 1999. Management Accounting 77/4 (April): 11-13. Pacter, Paul. 1998. International accounting standards. CPA Journal 68/7 (July): 14-21. Porter, T., and R. Traficanti. 1999. Comparative analysis of IAS 32 (1998), financial instruments: Disclosure and presentation, and IAS 39 (1998), financial instruments: Recognition and measurement, and related US GAAP. In Carrie Bloomer (ed.), The IASC-U.S. Comparison Project: A Report on the Similarities and Differences Between IASC Standards and U.S. GAAP (137138). Norwalk, CT: Financial Accounting Standards Board. Pownall, Grace, and Katherine Schipper. 1999. Implications of accounting research for the SEC’s consideration of international accounting standards for U.S. securities offerings. Accounting Horizons 13/3 (September): 259-280. Radebaugh, Lee H., and Sidney J. Gray. 1997. International accounting and multinational enterprises (4th ed). New York: Wiley. Schultz, Joseph J., Jr., and Thomas J. Lopez. 2001. The impact of national influence on accounting estimates: Implications for international accounting standard-setters. International Journal of Accounting 36/3 (September): 271-290. Schwartz, Don. 2001. What price global standards? CPA Journal 71/5 (May): 40-48. Tweedie, David. 2002. Speech to United States Congress (14 February). Volcker, Paul. 2002. Speech to United States Congress (14 February). Whittington, Mark. 2000. Problems in comparing financial performance across international boundaries: A case study approach. International Journal of Accounting 35/3 (September): 399-413.
