INTERNATIONAL ACCOUNTING

Transcription

1 FRF BRIEFING INTERNATIONAL ACCOUNTING Key policy issues as at June 2010 SUMMARY The accounting standards (International Financial Reporting Standards, IFRS) set by the International Accounting Standards Board (IASB) now underpin accounting in over 100 countries around the world, with several major economies due to make the transition to IFRS over the next few years. In this Financial Reporting Faculty briefing, we: underline the importance of support for global accounting standards in general and for IFRS in particular; explain the benefits and risks associated with efforts to converge IFRS and US standards, and the importance of a positive decision by the US Securities and Exchange Commission (SEC) in 2011 on the use of IFRS by US companies; comment on the merits of the IASB approach to the reform of accounting for financial instruments and the importance of early endorsement of the new IASB standard on financial instruments (IFRS 9) for use in Europe; and recognise the need for ongoing debate and reform of IASB governance, whilst warning of the dangers of seeking a more direct role for regulators and more emphasis on regulatory concerns. SUPPORT FOR IFRS ICAEW believes strongly in the benefits to investors and business of truly international standards, and has been a persistent champion of the creation of a single set of high quality global accounting standards and their application by publicly traded and other companies around the world. In our view the establishment of a single set of globally accepted accounting standards will increase the efficiency and competitiveness of global capital markets by enhancing transparency and comparability in financial reporting. The achievements of the IASB since its establishment in 2001 now means that this objective is

2 tantalisingly close to realisation, although, as explained below, there continues to be a significant risk that momentum will be lost. We made a significant contribution to the successful adoption of IFRS by UK listed companies in 2005, and our expertise in this area was reflected in the selection of ICAEW by the European Commission (EC) to deliver a comprehensive study in 2007 covering all aspects of first time application of IFRS by European Union (EU) member states. In 2008 ICAEW was also commissioned by the United Nations to prepare a follow-up report on the UK experience of IFRS implementation, which was presented in Geneva in October Our study for the EC drew attention to certain shortcomings in IFRS, such as gaps in IFRS literature dealing with insurance accounting, and the challenges involved - for regulators, preparers and auditors - in migrating in some cases to a more principles-based accounting environment requiring the greater use of professional judgement. Our assessment of the move to IFRS was, nonetheless, a favourable one: we reported an absence of any general loss of confidence in financial reporting and the general view of stakeholders that IFRS implementation had been a positive development for EU financial reporting, with an overall improvement in the quality of financial statements, improved comparability across borders and signs of improved capital market efficiency. The shortcomings and challenges identified in our study are, to some degree, still being addressed, and new challenges have arisen linked to the financial crisis. However, our assessment remains broadly positive, and anecdotal evidence and subsequent reports of European regulators - neither of which to date point to unforeseen problems with IFRS reporting or with the quality or consistency of enforcement - have done nothing to change this. While some improvements have been necessary, these have tended to affect only a small minority of IFRS reporters, and in general IFRS has proved robust when stress-tested during the very difficult economic conditions experienced in recent times. Our continuing support for the IASB and its standards is not offered lightly, or unconditionally. It is set firmly in the context of what we see as the fundamental aims of standard setting: the development of accounting standards that are high quality and neutral, providing the foundation for transparent and comparable financial statements that improve investor confidence in the reliability and transparency of published information. To that end we believe firmly that accounting standards should only be issued by an independent standard setter with an appropriate mandate and level of technical expertise, following transparent due process and making decisions solely in the public interest, and more specifically to protect the interests of investors. We note - and welcome - the support of the G20 for these broad principles, and it is against these fundamentals that we comment below on some of the current concerns regarding IFRS reporting. CONVERGENCE BETWEEN IASB AND FASB STANDARDS Much of the IASB work programme since 2005 has been aimed at narrowing the differences between IFRS and US GAAP under a Memorandum of Understanding between the IASB and the US standard setter, the FASB. The success of this programme is crucial for eventual adoption of IFRS in the US in accordance with the Roadmap published in 2008 by the SEC for the potential use by US issuers of financial statements prepared in accordance with IFRS. An SEC decision is expected in 2011, following completion of a detailed work plan announced in February The importance of a positive decision can scarcely be overstated. With the right political will in the US, the EU and elsewhere, we believe that the goal of a single set of standards applied across all the major capital markets could be achieved in the next three to five years. It is critical that momentum is maintained, and there is some

3 disappointment that the current cautious approach of the SEC - whilst understandable in many respects - does not offer the much-needed certainty required by US companies and the many jurisdictions still in the process of making final decisions about switching to IFRS reporting. The prima facie case for the convergence strategy has been bolstered by recent economic events, which have clearly illustrated the increasing use of IFRS by issuers in the global capital markets and the interdependencies of capital markets worldwide, as recognised by recent G20 meetings. Scrutiny of financial instruments accounting under US GAAP and IFRS has highlighted the importance of comparability in corporate reporting by major organisations, and hence in the consistency of the underlying reporting requirements. Differences between standards - even relatively small differences in detail - caused difficulty for regulators, investors and other users of reported financial information trying to understand global issues and to formulate an effective and internationally-coordinated response to the crisis. The convergence project s progress is closely monitored and scrutinised across the world. The G20 leaders at the 2009 summit in Pittsburgh, US, asked the standard setters to redouble their efforts to complete the convergence project by the target deadline of June The convergence programme has however run into difficulty in recent months, as discussed below in relation to financial instruments. In June 2010 the FASB and IASB issued a joint statement saying that they are in the process of developing a modified strategy for convergence of their two sets of accounting standards. Whilst the deadline for completing the convergence initiative should not slip significantly, ICAEW supports this review. It is important that the drive towards one set of standards across the world does not compromise the quality of international standards, or cause unnecessary regulatory burdens for business. The FASB/IASB progress report for the first quarter of 2010 set out a timetable for document publication that was simply too ambitious given the need to ensure that stakeholders had sufficient opportunity and resources to consider the many complex proposals expected. Whatever changes are made, everyone with a stake in high quality IFRS financial reporting is braced for an unparalleled outpouring from the standard-setters in the coming months. The challenge for the UK and other IFRS jurisdictions around the world is to ensure that the final push for IFRS/US GAAP convergence, important though it is, does not damage the quality of international standards. By the same token, there should be no wavering by the IASB from its central mission of ensuring that investors in global capital markets get the high quality and transparent financial information they deserve. After whatever the outcome of the convergence programme and the SEC s deliberations - there is a widespread view in the UK and elsewhere that there needs to be a change in focus at IASB from convergence with US GAAP to post-implementation reviews and a small number of major projects crucial for the long-term improvement of financial reporting. Convergence in future - whether to US or any other national GAAP - should invariably play second fiddle to the overriding objective of setting robust, understandable and high quality standards. FINANCIAL INSTRUMENTS The issue posing the greatest challenge to the convergence agenda is financial instruments accounting. The IASB is working through a three-stage reform of its standard, a staged approach that was a pragmatic response to urgent requests from the EU during the financial crisis that certain specific items be dealt with immediately to improve financial instruments accounting and that amendments be issued before the end of 2009, so they could be applied for 31 December 2009 year ends. The three phases are classification and measurement (which

4 has already resulted in a new standard, IFRS 9), impairment (currently out for consultation), and hedge accounting. In May 2010 the FASB finally published its own long-awaited proposed standard, incorporating all of the areas covered in the three IASB projects. ICAEW will go through the FASB proposals in detail and share our thoughts in due course. However, there are some immediate concerns; the proposals seem complex and potentially confusing in parts, and the major differences in classification and measurement between the FASB and IASB approaches raise questions about how likely it is that the two boards will be to find common ground and agree on one standard. There is a common view in the UK and beyond, moreover, that the approach in IFRS 9 on classification and measurement is much to be preferred over the FASB approach, which requires greater use of fair value accounting. A major study by PwC published in June 2010 concludes that the majority of investment professionals around the world do not support the fair value model for financial instruments put forward by the US standard setter. Respondents thought that the so-called 'mixed measurement model' favoured by the IASB better reflects the underlying business and economic reasons for holding a financial instrument, ie it adopts the business model-based mixed measurement approach favoured in Europe. From a political standpoint, IFRS 9 also responded to the demands of the G20 for change to financial instruments accounting by the end of New IASB standards cannot be used in Europe until they have been legally endorsed, and there was strong support in the UK for early endorsement of IFRS 9 to allow companies to apply the new requirements before the mandatory application date set out in the standard of This was seen as necessary, in part, to avoid non-endorsement putting European companies that wished to adopt IFRS 9 early at a competitive disadvantage, and would have sent a strong signal of support for IFRS as global standards and for the decision of the IASB to retain a mixed measurement approach in financial instruments accounting. In November 2009 the European Commission, in conjunction with the Accounting Regulatory Committee (which represents the views of Member State governments), decided to defer a decision on endorsement. This decision, in some ways, was an understandable one. A new College of Commissioners was in the process of taking office and a new European Parliament was only elected last summer. It is also fair to say that the timetable set for the IASB was ambitious. Nonetheless, we have concerns that deferred endorsement of IFRS 9 could hinder the drive towards global standards. In particular, we are keen to avoid a potential outcome of a three fold system of US GAAP, IFRS and Euro GAAP for an indefinite period. Whilst early endorsement is no longer a realistic objective, we are keen to ensure that all stakeholders, including EU policy-makers, get behind the efforts of the IASB to meet G20 and European calls to improve IAS 39, and take all possible steps to ensure that the final, complete standard is rapidly approved for use in Europe, without delay and - critically - without amendment. IASB GOVERNANCE Much of the criticism of the IASB from European institutions in particular continues to be couched in terms of accountability and due process. We recognise that the ongoing process of debate and reform of governance issues are key to the success of the IASB and to wider acceptance of its legitimacy as a global standard setter. The importance of achieving an appropriate and widely-respected governance

5 structure for the IASC Foundation as the IASB increasingly assumes a global role of profound economic significance should not be underestimated. However, steps have been taken to improve the governance structure of the IASB, with a period of public consultation that ended on 30 November A Monitoring Board now provides a link to organisations that set the regulatory requirements for listed companies (including the European Commission), with a mandate inter alia to approve nominations of the 22 Trustees of the IFRS Foundation who oversee the activities of the IASB. It is often not at all clear what specific changes critics are seeking to IASB constitutional arrangements, beyond adding to the membership or responsibilities of the Monitoring Board. All in all, we have no major objections to the updated Constitution, although we have called for the effectiveness of a number of recent changes to be reviewed at an early date (for example regarding the impact on the IASB Board s operational effectiveness of the recent increase in its size - which we did not support). On the contrary, we have major concerns about one common feature of calls for further reform since the onset of the global financial crisis, namely introducing into the standard setting process a more direct role for regulators and more emphasis on regulatory interests. Banking and other regulators are important stakeholders in the financial reporting process, but often have a distinct focus, not necessarily aligned with the interests of investors - the primary users of annual financial statements under the IASB conceptual framework. It is the quality and transparency of financial reporting for investors that is of paramount importance, subject only to cost: benefit considerations. Regulators should have no particular influence over the determination of the detailed requirements of accounting standards for general purpose financial reporting. Whilst it is desirable in principle for regulators to use GAAP financial information as their initial point of reference, they tend to have the power to obtain any extra information needed to supplement or adjust the published financial statements. In some cases they may not, but that does not mean financial reporting should be regarded as a proxy. Whilst we welcome the establishment of the Monitoring Board and the efforts of the IASB to liaise more closely with regulators on technical issues, financial stability and prudential supervision should always be delivered principally through regulatory regimes. Any attempt in the light of the financial crisis to align regulatory and financial reporting objectives very closely runs the risk of deep and lasting damage to the capital markets. IASB DUE PROCESS Regular and inclusive dialogue with constituents is a hallmark of an effective and credible standard setting process. Despite some continuing criticism of IASB due process, it is generally transparent and compares favourably with the due process of major national standard setters and regulators. We welcome recent, significant improvements in IASB due process arrangements and procedures and in particular the highly effective outreach undertaken in 2009 in the context of the reform of the principal standard on financial instruments accounting, IAS 39 (which lead to the publication of the new standard, IFRS 9, in November 2009). This should provide a model for future IASB due process in relation to controversial proposals. Whilst we believe that the process of review and improvement must continue to ensure that IASB due process is seen as the embodiment of best practice in global standard setting, we do not think that any further fundamental changes are required at this time. Adding new mandatory layers of due process may have a negative impact on operational effectiveness, although we recognise that there are areas - such as the use of advisory groups and field

6 testing - where the effectiveness of current arrangements continues to be variable and should be kept under review. One key aspect of the due process undertaken prior to the publication in November 2009 of IFRS 9 was a greater willingness of the IASB to re-deliberate proposals which attracted significant adverse comment. There should be no turning back on this point. The Board has in the past been roundly criticised for its perceived unwillingness to reconsider decisions in such circumstances, especially where the staff concluded that no new substantive arguments had been raised by constituents. A widespread lack of support for proposals, whilst not a reason in itself not to proceed, should be seen to result in a process of reflection, further field testing and engagement with concerned stakeholders. Finally in this context, the recent decision to require the IASB Board to expose its agenda priorities to periodic public consultation should be noted. This is a change that ICAEW and many other stakeholders have long called for, and although some have called for an annual (rather than triennial) consultation process, the move is an important step forward towards addressing stakeholder concerns. For further information contact: Dr Nigel Sleigh-Johnson, Head of Financial Reporting Faculty (nigel.sleighjohnson@icaew.com); +44 (0) ) As a world-class professional accountancy body, the ICAEW provides leadership and practical support to over 134,000 members in more than 160 countries, working with governments, regulators and industry to maintain the highest standards. Our members provide financial knowledge and guidance based on the highest technical and ethical standards. They are trained to challenge people and organisations to think and act differently, to provide clarity and rigour, and so help create and sustain prosperity. The ICAEW ensures these skills are constantly developed, recognised and valued. Because of us, people can do business with confidence. Chartered Accountants Hall T +44 (0) Moorgate Place, London F +44 (0) icaew.com E frfac@icaew.com