I can't cite chapter and verse for this, but experience tells me that there is a cardinal rule for IASB and FASB members that goes something like this: 'If you can't say something nice about board deliberations, then don't say anything at all.' Thus, I was surprised to read that IASB member James Leisenring recently made some more-than-bland comments in regard to the quality of the sausage spewing forth out of the IASB/FASB's high-speed grinders and packers.
But, before I continue, a caveat is in order. I was not in attendance when Leisenring made the remarks that are the subject of this post. After an arduous 15-minute search I am compelled to notify readers that my only source for his comments is a very brief news article credited to one Simon Brown and entitled, IASB Member Calls Lessor Accounting Discussions with FASB "Hopeless." The report was sent to me via email by a much-respected source, who must remain nameless. I have not even been able to discover the title of the publication in which Brown's article appeared.
According to Brown's report, Leisenring made colorful comments on three topics: leases, pensions, and a disagreement among IASB members as to what constitutes "high quality accounting standards" (which I will abbreviate to "HQAS"). As lease accounting holds a special place in my pet-peeve riddled heart, I'll have more to say about the lease accounting comments at a later time. The topic for this post will be restricted to the HQAS remark.
According to Brown:
"Leisenring also explained an interpretive disagreement he has with some IASB members regarding what is meant by 'high quality standards.' He said some consider high quality accounting standards can be standards that are unambiguous, such that a practitioner 'can't fail to comply with them.' An unambiguous standard, however, could still allow 'for implicit alternatives' to the standard, Leisenring argued. He did not offer an alternative model."
Actually, I can't say that I even know from Simon's account what Leisenring is specifically referring to. What grabbed my attention was simply that the IASB members are still trying to figure out for themselves what constitutes an HQAS, especially if it will be used as a benchmark against which to judge the results of IFFRS/GAAP convergence. I'm also surprised that the dialogue among the players seems to be: (1) strictly amongst the IASB members; and (2) apparently restricted to the compliance side of standards – as opposed to whether the numbers reported in the financial statements actually will mean anything.
Regarding the strictly intramural aspect of the discussion, I have noted previously that James Kroeker, SEC Chief Accountant has stated that the SEC would want to determine whether convergence has resulted in demonstrably higher quality accounting standards before moving further down the IFRS adoption path. Leaving aside my concern that "demonstrably higher" is neither very ambitious nor specific, the SEC's view of what HQAS means should count for something to the IASB, assuming they actually care about making a case for convergence.
Moreover, if there are some doubts as to what HQAS is, the SEC's view could have been attended to more closely at the outset of formal convergence efforts (October 2002); for surely the SEC had convergence in mind when they published their congressionally mandated (see the Sarbanes Oxley Act, Section 108(d)) report on the feasibility of "principles-based" accounting standards in August 2003. According to the SEC, the "objectives-oriented" standards they are looking for from a standard setter should possess the following qualities:
"Be based on an improved and consistently applied conceptual framework;
Clearly state the accounting objective of the standard;
Provide sufficient detail and structure so that the standard can be operationalized and applied on a consistent basis;
Minimize exceptions from the standard;
Avoid use of percentage tests ("bright-lines") that allow financial engineers to achieve technical compliance with the standard while evading the intent of the standard."
Now, seven years later, the SEC's battle plans have been subordinated by the din and desperation of convergence wars. Are any new standards from either board "based on an improved and consistently applied conceptual framework"? Obviously not, for nary a single alteration to any conceptual framework document has occurred in the last seven years. The existing definitions for assets and liabilities are like wooden ships sent to battle against nuclear submarines.
Does each new standard, or revised standard "clearly state the accounting objective"? In a strict compliance sense, the answer could be 'yes,' but otherwise not. Take IFRS 3R on business combinations:
"The objective of this IFRS is to improve the relevance, reliability and comparability of the information that a reporting entity provides in its financial statements about a business combination and its effects. To accomplish that, this IFRS … [establishes a bunch of new rules].
Fair enough, I suppose. But, every new IFRS should "improve relevance, reliability and comparability"—so what contribution to HQAS is there from from stating what should be the objective for all accounting standards? For example, the IASB has an outstanding exposure draft proposing to continue to give companies the option to fair value financial liabilities. "The objective of this statement is to diminish comparability and reliability by allowing companies to arbitrarily choose to measure some of their liabilities at fair value, and to measure the remainder of its liabilities according to the rules of this statement."
As to "minimize exceptions to the standard," why did the IASB propose to exclude insurance companies from the scope of its putatively "principles-based" revenue recognition exposure draft (at earlier stages of the project, insurance was not excluded); or to exclude extractive industries from its leasing ED; or, again in IFRS 3R, and without exposing it for comment, to give acquirors the option of measuring noncontrolling interests at historic cost instead of fair value?
A High Quality Recipe — If I May Be Allowed to Say So Myself
Up to this point, I have set aside my misgivings with the SEC's 2003 report, and especially the apparent lack of monitoring by the SEC to ensure that its recommendations were adopted. I wanted to focus first on my misgivings with the IASB/FASB convergence project as a producer of HQAS; for taken as a whole, the last seven years have done little more than to add filler and artificial coloring to the old sausage recipes. Now, finally, here is my very own recipe for making HQAS.
First and foremost, for there to be a higher quality accounting standard, there must be higher "earnings quality," defined as the strength of association between reported earnings and economic earnings. Higher earnings quality can, and must, be established from standard economic logic. For example, I believe that every post I have written in which I have suggested an alternative accounting standard has been based on a logical link between whatever I proposed and economic earnings. On the other hand, the Boards' leasing exposure drafts, for example, would fail this test; because, although all leases would be capitalized, the numbers put on the financial statements are arbitrarily determined.
Second, accounting should never be determined by management's intent, strategy, or even industry. An asset is an asset and a liability is a liability.
Third, do not twist perfectly clear English words into misleading terms of art. The lump left over from IFRS 3R's additions and subtractions is not "goodwill"; and multiplying an historic cost denominated in a foreign currency by a current exchange rate is not "translation." A balance sheet is not a statement of "financial position" (because of omitted economic assets and liabilities); and a statement of recognized revenues, expenses, gains is not an "income" statement. And, please don't refer to a liability or a contra-asset as a "provision" unless one is legally required to prefund a future obligation.
Fourth, if a standard must exclude certain transactions or industries from its scope, justification for a scope limitation should be based only on a comparison of the cost of producing information to its value. Why are derivatives contracts with physical settlement provisions ignored, but net-settled derivatives are recognized and measured at their fair values? Why should there be different revenue recognition rules for insurance companies than for companies that issue product warranties? I believe these are examples of political tradeoffs, as opposed to tradeoffs made with the interests of investors in mind and heart.
A recipe for high quality accounting standards doesn't have to be complicated. But, it's more like baking a cake than making sausage: if you skimp on key ingredients, it will fall flat.