Peeling away financial reporting issues one layer at a time

SEC IFRS Roundtable Debrief: March of the Zombies

If IFRS incorporation is supposed to be some fantastic opportunity for achieving one set of accounting standards worldwide, then why was no one at the SEC's Roundtable on IFRS jumping for joy at the prospect? You would think that someone, anyone, would have projected at least a modicum of excitement and energy in anticipation of great things to come.  Instead, try as I might, I couldn't eradicate the image from my mind ofa bunch of zombie CPAs chasing after me for five hours.  

I also take no joy in reminding everyone that I predicted that the Roundtable would amount to nothing more than blatant pretense and deception. If I do say so myself, my prediction was very close to hitting the bullseye. Where I missed, it was because, as hard as SEC Chief Accountant Kroeker as putative moderator tried to stifle/ignore them, there were some telling blows to the SEC's cause.  Unfortunately, they were spaced too far apart to score the knockout the SEC deserves.

 The "Investor" Panel

There were a number of panelists whom I think shouldn't have been there: present and former employees of rating agencies and Big Four partners. So, I found it supremely ironic that the most apt panelist, Gerry White as representative of the CFA Institute, made an early grab of the overall gold medal for shilling. It's an open secret that the Institute is pushing IFRS adoption in the U.S., because that's what its leadership perceives the non-US membership wants. The percentage of non-U.S. CFAs could be as high as 70%.

Gerry might could have stated that 'x% of U.S.-based CFAs in analyst positions strongly support convergence with IFRS'; but since he didn't, I expect that 'x' must be an embarrassingly low number. What he stated (according to my notes) was that the Institute's membership surveys showed "overwhelming" support for a single set of global accounting standards.

Of course, as any great shill is wont to do, White omitted some important qualifications to his statement that the SEC might at least pretend to be interested in knowing. Most critically, he didn't mention which accounting standards were supported by U.S.-based analysts. Although a majority of U.S. respondents to one of the Institute's surveys said that the global standard setter should be the IASB, it wasn't "overwhelming" – and the data is about 2 ½ years old. And, when you consider that only about one-half of CFAs actually work as research analysts or portfolio managers, the other CFAs (auditors, corporate accountants and corporate financial analysts) in the sample could have been the reason that the total responses tilted towards the IASB.

Another curious moment occurred when this panel appeared to have expressed a consensus view that the basis on which the financial statements are prepared matter very little, ostensibly because investment analysis is cash-flow focused. I find that to be a gross oversimplification, which might be explained by a ratings agency mindset of at least three of the panelists. My concern with such notions is that the SEC is on a scavenger hunt for any shred of evidence that will justify incorporation of IFRS into U.S. GAAP. In this case, the panelists are telling the SEC that accounting is only the starting point of an exercise in reverse engineering with the goal of producing estimates of future cash flows. Of course, any text on financial statement analysis, including Gerry White's co-authored book, will tell you that financial statement analysis is much more than that.

But, if those who take the cash flow view really believe it, then the solution to the IFRS v. GAAP problem is actually quite straightforward: require that financial statements are accompanied by detailed roll forwards of every balance sheet account. If this actually were to be a requirement, then all of my concerns regarding IFRS incorporation would dissolve. But, it won't, of course, simply because the proponents of IFRS incorporation are more interested in hiding the ball. I.e., not revealing to much about the way that earnings were manipulated through contrived 'principles.'

Finally, no investor expressed any concern whatsoever for the effect that conversion to IFRS could have on management decision making – and consequently shareholder value. The SEC has yet to express the slightest concern for the effect that changing the basis of accounting will have on decision making.

Why is that? Of all the potential costs of conversion to consider, skewed decision making relative to shareholder value creation may be the most significant by far. It is also the most difficult concern to minimize, for there is no doubt that fewer accounting rules will mean fewer restraints on managers to steal from the cookie jar. I fear not only those managers who would act with financial malice aforethought, but also about those in regulated industries or are simply fixated on earnings. Would European banks still be holding on to their Greek bonds, now worth something like 30 cents on the dollar, if they had been forced to mark their investments to market? No way. Even more fundamentally, would banks have been willing to expose themselves to the degree that they have to a Greek default if they knew those bonds would have to be marked to market? Same answer, and the same again for thousands of similar questions one could ask about the nexus between managerial decision making and financial reporting.

 

The "Smaller Public Companies" Panel

The first ray of sunshine (being the best disinfectant, of course) came from the smaller public companies panel when its members were asked whether incorporation of IFRS into U.S. GAAP would be a good idea. The consensus was virtually unanimous that it would cost them far too much money; and not only would the costs exceed any conceivable benefit, there wouldn't be any.

That took only about 10 minutes, and the rest of the time was spent on: 'OK, even if you don't think we should incorporate IFRS into U.S. GAAP, how should we do it?'

This, for me, was the nadir of the proceedings. A reasonable inference from the feedback from its handpicked panelists should have been something like this: at least half (very conservatively) of the public companies registered with the SEC must really want any and all talk of IFRS to go away ASAP. It was a full stop moment, but instead, the intrepid chief accountant forged on down his prepared list of questions as if he were utterly oblivious to the near universal condemnation of what he clearly hopes will be his legacy at the SEC.

 

The Regulators

The SEC was very lucky that Gaylen Hansen, the NASBA representative, was given the floor only as the zombie march was winding down. For, if the "investor" and "smaller public companies" panels were given the chance to digest and respond to his prepared remarks, a full zombie assault on civilization might have begun in earnest.

Basically, in about ten minutes, Gaylen shot down every stated reason and unsupported assertion for incorporating IFRS into GAAP into oblivion:

"International standards may be likened to the Holy Grail, worth searching for but only if you think there is a reasonable chance of finding it. In the meantime, there is a real risk of obsessing in the quest at the expense of more pressing and worthy goals. There are extremely high risks in the "condorsement" approach suggested by the Staff. We may not know for several decades whether it was a very bad idea and, if so, in time to recover." [emphasis supplied]

If you are interested enough in this topic to have read all the way to this point, then PLEASE click here to read Gaylen's remarks in their entirety. Here are just a few of his remarks (accompanied by parenthetical observations from yours truly):

  • The SEC owes it to the national interest to establish that IFRS itself is at least better than U.S. GAAP, if not far superior, to justify such a radical change with so many unknown (and uninvestigated) variables. (Of course, it can't be done. Moreover, the SEC's IFRS fixation has helped to improve IFRS, but it has done more to harm the quality of U.S. GAAP than to help it.)
  • The notion that one version of IFRS (i.e., the Holy Grail) has been gaining currency in the rest of the world is a myth. "It has been hyped that over 120 countries worldwide have adopted IFRS issued by the IASB. That is simply not true – carve-outs resulting in jurisdictional versions are legion … I have spoken to Canadians who have indicated some of their companies are not doing anything other than wrapping the IFRS name around Canadian GAAP. The same has been reported about France." (And, I have heard presentations from large Canadian companies reporting that conversion to IFRS was extremely costly, and without benefit.)
  • Let's face it, this is not about accounting, it's about politics. "[T]he original dream of comparability seems to have taken a back seat to the real agenda of some promoters…. I have read the 200 plus comment letters sent to the SEC on the 2007 Roadmap. Despite the spin of overwhelming support for global standards, there is actually substantial concern and much outright opposition."
  • "I have never had a lender or investor request international standards. I have never even heard of such pleas. On the contrary, the call for IFRS always seems to be from the suppliers [of financial statements], primarily large multinationals and international accounting firms."

* * * * *

I'm sure any negative reaction to the SEC's current thinking on IFRS was to the chief accountant and his staff like water off a duck's back.

Accordingly, and on this basis only, I am issuing my first stock tip to readers of this blog: buy Accenture. Or for that matter, any publicly traded consulting company that is surely gearing up to help U.S. companies make the costly "transition" to IFRS.

As for the companies that will be converting, buy puts.

 

2 Comments

  1. Reply K O'M July 11, 2011

    It seems a bit odd that the CFA Institute supports IFRS adoption, while at the same time it seems to trash the IASB’s proposals on the actual standards (witness the hedge accounting proposal). Could it be that they support change because it would increase demand for analysts?
    To me, the question of IFRS adoption comes down to whether the SEC is prepared to take the money that the FASB collects from issuers and send it off to London to an organization that it doesn’t have any direct authority over. “Condorsement” seems to suggest that they aren’t willing to do so, and instead envision the US adopting jurisdictional IFRS (going back on the SEC’s previous stated preference for IFRS as issued by the IASB), hoping that remaining US GAAP can make up for the deficiencies in IFRS.

  2. Reply RWOOD July 17, 2011

    As an American who teaches Financial Accounting at the college level in Vietnam, I spend more time than I care to explaining this situation to my students. Of course, adherence to either IFRS or GAAP would be a significant leap in the right direction here for most companies.
    From a global sense, it reminds me of the governmental efforts made to convert the US to the metric system. It is only some thirty years after the effort that I wish we had converted. The limitations of our system seem so obvious now.
    Perhaps the same can be said for this issue. It will become apparent when we are the only ones left using GAAP.

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