Peeling away financial reporting issues one layer at a time

G-20 Conference Provides Cover for the SEC to Issue Its IFRS Roadmap

The trustees of the IASC Foundation (the oversight body of the IASB) have continued to blithely plug IFRS as if it were just an innocent bystander in the global financial crisis. Just days before the G-20 economic conference, the IASC Foundation sent a letter to President Bush, urging that the G-20 recognize that IASB should be the one to lead the "efforts to improve financial reporting … to ensure a globally coordinated approach." Of course, the trustees conveniently neglected to mention that it has long been the IASB's function to establish high quality financial reporting – lest anyone should closely examine its ongoing and recent neglect of investor interests, political machinations and prevarications.

In any case, the strategy seems to have paid off for the IASB, in large part because the G-20 utterly failed to develop any semblance of a strategy for resuscitating the global economy. The G-20's parting statement was a scant 12 pages; one page of introduction and recriminations, one page vaguely enumerating "actions to be taken" (don't you love the passive voice?), and 10 pages of proposed regulatory reforms to prevent bad stuff from ever happening again:

"Regulation is first and foremost the responsibility of national regulators who constitute the first line of defense against market instability. However, our financial markets are global in scope, therefore, intensified international cooperation among regulators and strengthening of international standards, where necessary, and their consistent implementation is necessary to protect against adverse cross-border, regional and global developments affecting international financial stability. Regulators must ensure that their actions support market discipline, avoid potentially adverse impacts on other countries, including regulatory arbitrage, and support competition, dynamism and innovation in the marketplace. Financial institutions must also bear their responsibility for the turmoil and should do their part to overcome it including by recognizing losses, improving disclosure and strengthening their governance and risk management practices." (para. 8)

In other words, competition among nations to attract capital shall be henceforth streng verboten; and if financial institutions don't suddenly get some religion, then … something.

Fluff and kerfuffle. If the U.S. hasn't learned its lesson from the harm already wrought by the absence of sensible capital markets regulation and accounting rules, then no amount of pledged international coordination, cooperation or centralization can save us from another financial tsunami. Why can't each nation, especially the U.S., be entrusted to act in their own best interests – to diagnose and correct its own policies, and provide a progress report one year hence?

Focusing on financial reporting regulations, the IASB has not been, and never will be the maker and keeper of high quality accounting standards. There is no reason to think that the U.S. can't go faster and further on its own. Nobody would let me, of course, but it wouldn't take me more than a week to accomplish 80% of the job. Here are a few of the changes that can get us well on the way to high-quality, investor-oriented accounting standards.

  • Do away with the held-to-maturity and available-for-sale investment categories (which the IASB still fiddles with as Rome burns). Financial institutions will no longer have any incentive to hold onto underwater investments solely because they can defer loss recognition. The concept of an "other than temporary" decline in market value is squishier and even sleazier than "pornography."
  • All financial assets and liabilities should be measured at fair value (or current replacement cost) with changes to earnings. recently reported that the Basel Committee is thinking about adjusting capital adequacy requirements to take into account fair value measurements. All I can say is that it's about time! Accounting standard setters have been kowtowing to financial regulators and banks since time immemorial, and in the process compromising the quality of accounting information provided to investors. Let the bank regulators adjust to fair value, and if they need any other measurements to effectively monitor bank capital, let them be required in addition to, and not in place of, fair value.
  • Do away with anything else in owners' equity except for the accumulated net proceeds from common stock issuances and earnings that were not paid out as dividends. Managers will no longer waste their time and shareholder money conjuring up complex financial instruments that do nothing except evade fair valuation for entity-issued instruments.
  • Do away with interest cost capitalization. Every investor wants to evaluate operating profitability separately from financing decisions.

Now, ask yourself why the SEC couldn't make these simple changes in very short order. Instead of a simple and straightforward approach to fixing GAAP, the G-20 conference provided the needed cover for the SEC to finally unveil its proposed rule, Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by U.S. Issuers, and the IASB scored a coup.

I'll take the above four bullet points over that 165-page albatross any day, and especially as a more appropriate and timely response to our financial crisis.

1 Comment

  1. Reply Policy Director November 18, 2008

    I really thought fairer minds would prevail in this debate. But, it seems that the march toward the devolution of our accounting standards will continue unabated. Now we just need someone to monitor and ensure the ongoing independence of the Big 4 who are key in promoting this proce$$. I assumed that was the SEC’s role (obstensibly, through the PCAOB). But wait, they are driving the changes. An so the cycle of self-conflicts and self-dealing continue unabated.

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