The Accounting Onion

Let the "Condorsement" Games Begin

The SEC has finally conceded that its efforts to adopt IFRS have failed. Damage control has begun in earnest, but the ship is still taking on water.

The SEC took a tentative poke at the problem last May with the publication of a Staff Paper, Exploring a Possible Method of Incorporation (with emphasis, supposedly, on "exploring"). Once upon a future time, the staff fantasized, it will be possible that financial statements prepared in accordance with U.S. GAAP will simultaneously comply with IFRS as issued by the IASB. Known informally as 'condorsement', the paper describes the staff's wishful thinking in the form of three "convergence" phases and a final "endorsement" phase.

Convergence Phase I — Would somehow complete the few surviving MoU convergence projects by the end of this year, but even those have since been shot full of enough holes to push the timeline out by at least another year. The SEC will not acknowledge this, but everyone pretty much agrees that the decade-long effort to converge U. S. GAAP and IFRS has been marked by many more failures than successes.

Convergence Phases II and III — Would take an additional 5 to 7 years and require the FASB to formulate plans for merging active IFRS projects into U. S. GAAP. If FASB-style "due process" can't get it all done, someone is supposed to be able to figure out a way to pick up all the pieces.

Endorsement — Simple math combined with the most obvious lessons learned from recent history leads to the inescapable conclusion that the "endorsement" phase can't even begin for at least another decade. At that point, the FASB is supposed to get hog tied; it will not be allowed to do anything except for figuring out how to fit new IFRSs into the GAAP codification.

The Staff Paper Fizzles instead of Sizzles

Except for the Big Four (I'll be getting to that later) and perhaps a few large companies, the Staff Paper has gone over like a lead balloon. To start, the handpicked investor panel at July's SEC Roundtable on IFRS provided only tepid encouragement, and the smaller public companies panel could barely be held back from strangling the SEC staff; all they saw in IFRS was a lot of incremental cost and zero incremental benefit. Other federal regulators exercised political restraint, but the representative of the state boards of accountancy condemned the SEC's for its foolhardy quest for a holy grail -- which not everyone believes is so holy -- in no uncertain terms.

It is quite possible that the failure of the Roundtable to drum up support for IFRS adoption may have also moved the IASB itself to go negative shortly thereafter. In an August 3 public conference call discussing the IASB's agenda, Ian Mackintosh, vice chairman of the IASB, was asked whether the IASB will continue to develop projects jointly with the FASB. With surprising frankness, he sent a strong signal that our favored nation status could be revoked:

"It depends on what decision is made in the United States on adoption, or convergence, or incorporation of IFRS. I would have thought … that we would continue to work jointly with FASB on those four major projects I mentioned before. But I wouldn't have thought … that we would work jointly with them on new projects. I think we are in a situation where we have a global constituency; every country has its right to a place in the process."

In some respects, all Mackintosh has done is echo the sentiments expressed some months ago by EU Commissioner Charlie McGreevy and the IASB's John Smith, as they attempted to ratchet up the pressure on the U.S. to abandon GAAP – lest it forfeit any future say on IFRS. But, whatever the motivation, Mackintosh is clearly not happy with the SEC's condorsement fantasy; and to add insult to injury, apparently, the SEC failed to consult with the IASB beforehand. Perhaps Mackintosh chose to inflict public humiliation on the SEC as payback for the slight.

The Big Four Tries to Pick up the Pieces

Given the Roundtable bashing and the Mackintosh lashing, the SEC may not have been at all surprised by E&Y's recent defection from the IFRS adoption bandwagon, as expressed in their belated comment letter on the Staff Paper:

"Ideally, we would like to see a single set of high-quality accounting standards used throughout the world, including the US, without modification. However, we unfortunately are not convinced this worthy goal can be practically achieved at this time. … Few nations are willing to sacrifice their accounting standard-setting sovereignty, particularly for issues they view as important to their local capital markets and economies. We doubt constituents in the US will be more willing to make this sacrifice. Therefore, some form of endorsement process seems necessary and the creation of a 'US flavor of IFRS' inevitable. [italics supplied]

There's that word "inevitable" again!

"Inevitable" means that something will undoubtedly come to pass, doesn't it? E&Y used to say that IFRS adoption is inevitable; and now they would have the SEC believe that a mutually exclusive proposition, namely a "US Flavor of IFRS", is the new "inevitable." I'm not surprised by the tactic, but I could certainly have wished for somewhat more inventive rhetoric to digest.

Of course, that's not the only curious statement in the comment letter:

"Although we support the approach described in the Staff Paper, we believe it is unlikely that method would allow US issuers (following a transition period) to assert compliance with IFRS as issued by the IASB." [italics supplied]

On the one hand, it's a relief to finally see the day when even E&Y has conceded that IFRS adoption is a virtual impossibility; but on the other hand, E&Y is also saying that the SEC should proceed as if IFRS adoption were to actually take place!

Methinks the method to E&Y's madness lies in their latest policy recommendations. First, E&Y would still like to see the FASB hog tied:

"[W]e hope the FASB would make changes to its legacy standards only to converge with IFRS."

Second:

"We would support voluntary adoption of IFRS as issued by the IASB by US issuers."

Essentially, this latter recommendation, which quite predictably has now been echoed by the AICPA, repudiates the one and only rationale that has ever been proffered for adoption of IFRS: comparability of financial statements. Now, E&Y and the AICPA are saying 'pick a number.' If a free choice between IFRS and GAAP by foreign private issuers (FPIs) does not harm investor interests, they say, then it would also be appropriate to give domestic issuers the same freedom to choose.

Obviously, I think they're wrong. To begin with, the option given to FPIs to file financial statements in accordance with IFRS without a reconciliation to U.S. GAAP was highly controversial decision made during the Christopher Cox era. It cavalierly brushed aside the fact that it was strenuously opposed by investor interests. But even more important to evaluating E&Y's latest proposal, it has been established for decades that the criteria for FPI rulemaking are fundamentally different from those for domestic issuers.

Whereas disclosure adequacy is generally the paramount concern, the SEC has long recognized that FPIs are a special case. If the SEC were to impose the same disclosure requirements on FPIs, it could discourage many FPIs from offering their securities to U.S. issuers. That would harm investors, because they would be deprived of an opportunity to invest in foreign companies while enjoying the broad regulatory protections and lower costs afforded by U.S. markets.

Thus, if there was any rationale to allowing FPIs to choose between IFRS and U.S. GAAP, it was to accommodate the FPIs. And the fact remains that whatever the outcome, the decision to accomodate them ran the risk of lowering investor protections. Although E&Y and the AICPA would have us believe otherwise, none of this has anything to do with whether domestic issuers should be given a choice between IFRS and U.S. GAAP. 

I have, as you might have suspected, many other concerns with E&Y's recommendations:

• As Jack Cieselski pointed out in his early comment letter on the Staff Paper, the FASB will be prevented from adding items to its agenda that are of particular concern to U.S. investors. Is E&Y thinking that its voice counts for more at the IASB than at the FASB? The IASB independence problems are well known, and entirely consistent with that self-serving scenario.
• Getting back to the comments of the IASB vice chair, the 'condorsement' strategy that E&Y would like to see the SEC implement must be anethema to at least some IASB members. I imagine they are torn between taking our money, and telling us to take a hike. The EU wants to drive the bus, and China and India also want their say. But, are they ready to pay for the gas?
• How will accounting education (and the CPA exam) be affected if IFRS is merely optional? By the way things are headed, students eventually would have to master three sets of rules – public company U.S. GAAP, private company U.S. GAAP, and IFRS. I'm all for studying comparative accounting systems, but having to be tested on three systems will perforce crowd out real learning in favor of committing details to memory.
• The hundreds of FPIs, which include some of the largest banks in the world, are probably shaking in their boots, contemplating a condorsement plan where the U.S. would require of its domestic issuers compliance with IFRS plus additional disclosures. Instead of IFRS becoming the only game in town, it would once again look like the weaker of two regimes.  When will we finally get the message that the EU doesn't want us in their sand box?
• The courts have recently set the bar a lot higher for SEC-generated cost-benefit analysis in support of any new rulemaking. If the SEC had continued down the path of ultimately requiring adoption of IFRS, would they be capable of conjuring up a cost-benefit analysis that could actually survive a legal challenge? Methinks condorsement was cooked up in part to achieve de facto convergence without additional SEC rulemaking.

In summary, all I can say is, 'here we go again.'

I'm Not the Only One Dissing the SEC's IFRS Fixation

Every time I write a post, I might receive a couple of non-spam comments, and perhaps a few more private emails intended for my eyes only. Most of the feedback is positive, and even encouraging. Nonetheless, I am by nature particularly sensitive to negative feedback, even when delivered in a kindly and constructive manner.

For example, Edith Orenstein thinks I jumped the gun with my assertion that the "fix is in," on the forthcoming SEC Roundtable on IFRS; and Lane suggested that my arguments lack force when I predicted that some panelists would be shills. These comments came even prior to my most irrascible rant on the Roundtable after it took place. In some ways, this post is a response to Edith and Lane: I know that my comments are often unkind and liberally dosed with irreverence and sarcasm; but in my defense, I am not the only one out there letting their frustration with the SEC's IFRS fixation hang out.  Consequently, even in my most untethered moments, it feels kinda OK to know that I'm in pretty decent company:*

Lynn Turner, a former SEC chief accountant no less, circulated this email bearing the incendiary subject line "Stacked Deck":

"I find it interesting that so many credit rating agencies are given slots at the SEC IFRS roundtable when they were the very ones who so shafted investors. And Jonas who was at one of them, now at Morgan Stanley, and who was head of the AA national office is another one of the participants.

Take a look at the panelists on the small-company panel. Bank of the West isn't a public company – it's owned by BNP Paribas. Cuisine Solutions has a subsidiary in France – sort of unusual for a small U.S. company. Viropharma has a European unit. Tandy Leather has operations in Canada and the UK. Are you seeing a pattern here? They specifically aren't having as panelists the kind of strictly domestic small public company that wouldn't benefit from IFRS."

And in a subsequent email:

"The SEC so stacked this deck it is beyond one's imagination as to why they would expect anyone outside their 4 walls would see this as anything short of the typical Washington DC contrived outcome."

Jack Ciesielski, former member of FASAC, AcSEC, EITF and author of one of the most highly respected publications for financial statement analysts, described the upcoming Roundtable as a "railroad job." And he also wrote a must-read comment letter on the SEC staff's paper, "Exploring a Possible Method of Incorporation." Like Gaylen Hansen's remarks from the Roundtable, all of Jack's criticisms are quite devastating, but the one from Jack that resonates with me for its originality and the vividness of the example is the following:

"If the FASB is barred from starting projects independently of the IASB, how are American investors best served? There could be financial reporting issues that are unique to our country, that would never be addressed by the IASB - simply because they are not a problem in the rest of the world.

An example may help make the point. In the United States, many … are troubled by what they consider to be excessive executive compensation. There is only a limited amount of information available annually regarding executive compensation. More comprehensive information about all of a firm's human capital costs (not just executives' compensation), directly displayed in financial statements on a quarterly basis, would be useful for investors to help them assess the value of pay packages on which they vote annually. … There's no cohesive model or set of disclosures for reporting pay information. What gets measured, gets managed - and since there's not much reporting of pay information to investors, it's likely not to be managed too well.

It's a uniquely American problem, not shared elsewhere in the world. The FASB should undertake a project for improving investor information in this area - but it would be barred from doing so under condorsement, unless the IASB deemed it necessary. That's not likely to happen unless it became a problem elsewhere in the world. Is it fair to ask American investors to wait until an American issue that may be resolved by better accounting and disclosure is a problem in the rest of the world? In a word: No." [ first line bold in original, bold italics supplied]

Professors Ed Ketz and Anthony Catanach (Grumpy Old Accountants blog) evidence even less restraint in venting their frustration than yours truly. The title of their latest blog post, "IFRS is for Criminals" is more than sufficient evidence for that.

Floyd Norris, NYT columnist, trenchantly observed that, if the SEC were to follow through on its "condorsement" idea, many "flavors" of accounting would be the result for many years – if not indefinitely. The drive for IFRS to eventually replace U.S. GAAP increasingly appears to be coming from large companies who would like the SEC to give them the option to report using IFRS, just like many of their counterparts overseas.

But, I enjoyed Floyd's column the most for his one-liner response to the latest lobbying by IASB chair Hans Hoogervorst for the EU to endorse its latest pronouncement on the accounting for loan losses. Hoogervorst said straight out that the rule should appeal to the European Commission because it gives banks the free option to ignore economic reality, e.g., Greek bonds trading at junk debt levels:

"But it may not appeal as much to those who rely on financial statements, and would prefer to know when a bank's loans go bad. As a sales pitch, 'Adopt our rules and you won't have any losses' does not sound like a promotion for a superior set of accounting standards." [emphasis supplied]

Gosh, I wish I had written that!

Some say that the same sorts of political machinations are at work on U.S. GAAP. Even granting that point today (which I don't), imagine how things will look if more countried created an EU-like infrastructure for the purpose of lobbying the IASB for just the right IFRS standard to incorporate into its own system. The EU, the US, China, Japan and a hundred other smaller economies would be 'on board' with IFRS, but the IASB chair's head would have to be on a swivel in order to fend off each and every attack from increasing numbers of 'incoporators', 'endorsers', 'advisory groups', etc. The IASB will, in effect, devolve to something awfully akin to its early beginnings when the IASC (the IASB's predecessor) worked as a 90-person committee.

The only "standards" or "principles" back then were that there were none. A new era of balkanized accounting jurisdictions could put the IASB right back to where it started.

-------------------------

*Some of the comments made were in private correspondence with me. In every case I received permission to reproduce them here.

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.

 

SEC IFRS Roundtable Agenda and Panelists are Announced: Even Worse News than I Expected

This is a short follow-up to yesterday's post on the upcoming SEC Roundtable on International Financial Reporting Standards.

As I feared, the agenda is not even on the same planet as the core questions, indicating ever more strongly that the fix is in. Of the panelists, I know two of them (good things), and know a little something about one other (a bad thing).

Of the two panelists I know, the more outspoken is Gaylen Hansen, director at large of the National Association of State Boards of Accountancy (NASBA) and partner at accounting firm EKS&H. Gaylen was the first, even before the SEC, to go public with an analysis of the constituent feedback from the SEC's Roadmap proposal. He did it at a NASBA convention, and I wrote about it here:

"The problem for … IFRS supporters is that the data is so darn unequivocal against the IFRS Roadmap proposal that any errors due to small sample size would have to be tsunami-sized in order to reverse the results. Public companies disfavor the Roadmap by a margin of exactly 2:1; and the public companies that express "strong" opposition to the Roadmap proposal outnumber all supporters, however strong, by exactly 1.5:1. Perhaps even more damning to the Roadmap proposal is that not a single investor group expresses "strong" support, and the overwhelming majority want to tear it up." [Just to be clear, I am quoting myself.]

I'm guessing that the SEC felt they had no choice but to ask NASBA to provide a panelist, and bless NASBA's little hearts, they picked Gaylen. I know he has a lot to say about IFRS, and for me, the only drama remaining is whether he will actually be given a chance to say it.

I Don't Know this Guy, But I Think I Know What He's Going to Say…

The panelist I know of by reputation only is Bill Yeates, partner at Hein & Associates. The SEC's brief description of him doesn't mention that he is a past member of both the SEC Regulations and Professional Prace Executive Committees for the Center for Audit Quality (CAQ). For that reason alone, I suspect that he was handpicked by the AICPA, and will as a matter of course shill for them.

Mr. Yeates is on the "smaller public companies" panel, and I find it amazing that the SEC refuses to recognize that CPAs have a built-in conflict of interest on any IFRS policy question. Moreover, regardless of the size of the issuer, the SEC should be focusing on the financial statement user, and not the financial statement supplier. How are these panelists supposed to tell us about "…financial statement users and their needs," as listed in the agenda, if not one is actually a financial statement user?

The Token Investor Issues

Here are the issues that the first panel, entitled "Investor Understanding and Knowledge of IFRS" are supposed to address:

• U.S. investors' current knowledge of IFRS and preparedness for potential incorporation
• How and when U.S. investors educate themselves on changes in accounting standards
• Extent, logistics, and timing necessary to undertake changes to improve investor understanding of IFRS
• Potential methods of incorporation

These topics aren't even on the same planet with the core questions that the SEC has been avoiding for years (I know, I'm repeating myself):

• Do investors perceive that IFRS gives them higher quality information than U.S. GAAP?
• Is there any hope that financial statements will become more comparable across issuers over time by continuing to work with IFRS?

And, please tell me how this handpicked panel, which purportedly can represent investors' interests in the IFRS policy decision, is competent to evaluate the "potential methods of incorporation"?

* * * * * * *

And, tell me again why, two years after the Roadmap proposal's comment letters were tabulated and analyzed we are still wasting time on this? It should be said that a couple of commenters to my blog post on Gaylen's analysis found fault because one form or another of non-response bias could have skewed the results. There is a lot of validity to that, but there are ways to investigate the degree to which non-response bias accounted for the findings. The SEC has had two years to follow up on the comments from the Roadmap proposal, but of course, they have done nothing – because, I'm thinking they were thinking that they couldn't control the results.

A "roundtable," on the other hand, can be controlled. Even though it may not be possible to handpick each panelist, a watered-down agenda with very little time for each panelist to say their peace is likely to do the trick.

An earlier version of this post incorrectly stated that Bill Yeates is a CAQ board member.  I regret the error and apologize to Mr. Yeates.

No News from the SEC on its IFRS Roundtable is Bad News

I'm looking forward to the SEC's July 7^th IFRS Roundtable like surgery without anesthetic. Perhaps the SEC feels much the same, as notification was only posted to its public calendar of upcoming events within the last day or two – absent an agenda and list of participants.

In an attempt to fill in the blanks before writing this post, I called Christopher White in the Office of the Chief Accountant for more information. His voicemail was extremely friendly, but equally unhelpful. It turns out that even though there are only three more working days between now and the Roundatable (announced 10 weeks ago), the agenda is still a work in progress and the panelist roster has yet to be finalized even.

The Fix Must Be In

All of the past SEC actions, spins, jumps and procrastinations are consistent with my expectation that the Roundtable is being carefully orchestrated to achieve one specific end: to yield a message that will justify the deals and commitments already consummated out of the public view. The only remaining question is whether the Roundtable can shroud these arrangements with some modicum of legitimacy; or at the very least a large dose of white noise.

The white noise outcome may be the best the SEC can hope for since, try as they have, not a shred of empirical support for further association with IFRS in any shape or form, has been marshaled. Most poignantly, the SEC staff's first (and last) progress report fully eight months ago said almost nothing, except for sheepishly admitting that glowing reports of hook-line-and-sinker IFRS adoption is not nearly so widespread as the IASB's propaganda would have us believe. Moreover, the subsequent departure of India and Japan from the IFRS Adoption Express only further confirm a more sobering reality on the ground.

Since the staff's progress report, the SEC staff has hardly uttered a peep, despite solemn pledges of in-depth investigation on an impossibly wide range of controversial topics. Perhaps the Commission is hoping that hyping the Roundtable will cover over the absence for public scrutiny of hard work and hard thinking from its staff.

Starting from the time when the SEC tried to be dismissive of the overwhelmingly negative feedback, from even large issuers, on the initial IFRS adoption proposal, it has become ever clearer with time that the one thing the SEC does not care to receive from the Roundtable event is real feedback on the core strategic propositions. Even if the panelists selected* turn out to be slightly more open-minded and honest than the shills I expect them to be, I am concerned that they won't have more than a glimmer of a chance to respond to strategic questions like, "Why should we do this?"

Count on, instead, a numbing series of tactical questions like, "How should we do this?" That's the only way that I can think of for the SEC to divert attention from the fact that benefits from adopting IFRS are mere speculation without empirical or theoretical foundation. If, for example, you think the debate is still about 'principles' versus 'rules' in accounting, you need to think again. For an effective debunking of this tired old nonsense, you should read George Washington law professor Lawrence Cunningham's 82-page paper, "A Prescription to Retire the Rhetoric of "Principles-Based Systems in Corporate Law, Securities Regulation, and Accounting." Please.

Trying my best not to gag as I write this, these are the types of questions of the panelists that I expect will dominate the as-yet-to-be-published agenda:

• How would IFRS adoption affect your organization?
• How is GAAP used in your industry?
• What is the impact that a change in accounting standards will have on your industry? (If you don't know, then make something up!)
• How should (i.e., not if) the transition to IFRS take place?

 

The Hard Questions that Won't be Asked

Sovereignty – If the IASB is allowed to set the agenda and take first crack at writing a standard under an "endorsement" strategy for continued association with IFRS, what are the risks? In particular does the U.S. risk a race to lowest-common-denominator accounting standards? Why wouldn't investors be better protected by a competitive standard-setting strategy instead of a merely cooperative strategy with the ultimate goal of producing a monopoly?

My favorite case study is India and its accounting for the foreign exchange effects on foreign-currency denominated debt. They are adamant that foreign exchange losses on freestanding debt denominated in a foreign currency should be eligible for deferral. For U.S. issuers, that approach harkens back to the stone ages of pre-FASB financial reporting. With that in mind, how could the U.S. take IASB rule-making seriously should it deign to make some sort of concession to India? This is not a hypothetical: India has every expectation that the IASB will take up that case once U.S. GAAP considerations are at long last moved off center stage.

What is there to converge with, anyway? – The hyperbole about IFRS adoption throughout the world has been intense and unrelenting. Yet, the SEC staff admits that very few countries have adopted IFRS as issued by IASB. Ironically, U.S. GAAP is probably closer to IFRS than the versions in use by the majority of those countries which have already adopted to some degree or another.

Also, the SEC's staff ad lib proposal from just a few weeks ago would provide for US carve-outs with an "endorsement" approach. They are saying that the differences would be few and far-between, sort of like the SEC's involvement with the FASB. However, in reality the SEC really meddles a great deal with the FASB. It has issued hundreds of Staff Accounting Bulletins and Financial Reporting Releases, and a huge Financial Reporting Manual (351 pages); and importantly, it retains veto authority over private sector standards setters. Will the FASB have that same power with IFRS? The only that happens is if we adopt a US version of IFRS and not as issued by IASB. Linking agendas in this manner could further bog down improvement agendas and will do more to constrain, rather than advance, development of timely and high quality financial reporting developments

Will Comparability and Cost Savings Really Occur? – The attraction of IFRS adoption for investors was supposed to be worldwide comparability; and to that end the SEC originally stuck to its guns and demanded pure IFRS in accordance with IASB in exchange for removing the reconciliation requirement a few years ago for foreign private issuers. Yet, hypocritically, the SEC now purports to prefer a US-flavor of IFRS for domestic filers (while foreign private issuers will continue to file pure IFRS financial statements. This is because the SEC cannot transfer the authority to set accounting standards to anyone else. In effect then, we have come full circle back to a lack of comparability due to multiple versions of standards. Heretofore, it had been possible to state that all U.S. listed companies were 'comparable' at least insofar that all of them reported income as per U.S. GAAP. That is no longer happening, and will never happen again if any of the paths currently being contemplated is taken.

Public Confidence in IFRS – I received a request just this morning from a reporter, from one of the premier business publications, who is trying to investigate how IFRS adoption would affect smaller public companies. He asked me for names of sources he could contact, because he couldn't come up with any himself. The problem has been that the issue he wants to report on has barely been considered:

"[Sources are] nearly impossible to find. There's been almost no public opposition to IFRS from small companies that I've been able to find. The groups that might be representing small businesses' interests here, like the US Chamber of Commerce and the National Federation of Independent Businesses, haven't done anything. … And there have been virtually no comment letters from small companies on convergence and IFRS.

The sentiment I'm getting is that this issue just isn't on small companies' radar screens as yet – they've got enough to do just to keep their heads above water financially, deal with the impact of Dodd-Frank, etc. I suspect, though, that this is very much going to be an issue for small companies – we just haven't seen it yet." [italics supplied]

Here we are on the cusp of a momentus decision, and the impact on smaller reporting companies remains a mystery. Isn't that one of the things the SEC has supposed to have been looking at this year? (Where is that darn progress report from the SEC staff!?)

There is also a huge issue with trust because, of the most strident voices, the public doesn't know whom to believe. The problem is that the loudest IFRS cheerleaders are doing their best to cash in as they speak. The AICPA is already selling IFRS certifications, and Big 4 partners have vested themselves in accumulating expertise in something that now has to be "sold." To my view, the credibility of virtually everyone hawking IFRS adoption has been auctioned off for big bucks.

Any notion of receiving a balanced view from veteran regulators is also laughable. The most prominent, including Paul Volcker, Harvey Goldschmidt and Ray Glauber have long been captured through their status as IASB Foundation Chairs or Trustees at one time or another.

Other – I could go on, but I'm running out of time and space, so I'll just leave you with these additional thoughts:

• The issues of IASB independence and lack of uniform (or practically non-existent) enforceability throughout the world.
• What about the cost? When is the SEC going to do a realistic study?
• How is the U.S. going to fund the IASB, and is that a political reality?
• Is there any substance over form to the IASB's Monitoring Board? It was supposed to solve the governance issues but I can't see that the U.S. will have any more influence than just one vote of many. Conclusion: it's just there for appearances sake.

* * * * * * *

I'll be dragging myself to the computer next week to watch the Roundtable on the web (three hours earlier in AZ!), but like I said, I sure ain't lookin' forward to it. Here's hoping that there are at least a couple of panelists who haven't either been bought or brainwashed.

 --------------------------------------------

*I responded to the SEC's request for panelist nominations. The SEC has not responded to my email.

A Brief Exchange with an IASB Member on Hedge Accounting

A reader of my post on the CFA Institute's critique of the IASB's hedge accounting exposure draft suggested that I write to the two members of the IASB, Patrick Finnegan and Patricia McConnell, who had a close association with the Institute prior to joining the IASB. So, I did, and Pat Finnegan was kind enough to respond. This post is based on our very brief correspondence.

Why Would I Do Such a Thing?

Writing to the board members was a departure from my modus operandi, which is to limit my sources to what I happen to read as I pursue my nerdy interests, plus other items brought to my attention by readers and others. I simply don't have time to do much more than that. But, in this case, I couldn't resist reaching out to IASB members. Here's why:

• Pat Finnegan was associated with the CFA Institute until relatively recently, and presumably he helped determine, and advocated for, the Institute's positions on financial reporting issues. (Pat McConnell's direct association with the Institute was longer ago.) Hence, I was looking for an explanation of the inconsistency between Finnegan's present endorsement of the hedging ED and the present disagreements on practically all aspects of the ED expressed by his previous employer. Moreover, these disagreements involve core conceptual issues that go beyond hedge accounting (e.g., fair value, comprehensive income, management intent, etc.) 
• The ED also contains a dissenting view, which the CFA Institute supports, and which IASB members could have joined. It happens to have been written by another U.S. member, John Smith, who is reputedly the most informed and technically capable board member when it comes to financial instruments accounting.
• The utter passivity of the SEC with respect to the actual substance of "convergence" of financial reporting standards suggests that it may be using the votes of the IASB "investor" members as justification for remaining on the sidelines.  Finnegan and McConnell must be aware of the significant influence they have, especially as the SEC approaches closure on its own IFRS policy questions; and for this reason alone, providing greater transparency of their views is the right thing for them to do.*

I Got Criticized, but I Didn't Get an Answer to My Question

In my email, I asked only one question: "Given your former intimate connection with CFA Institute, I would like to ask you whether you agree with their comment letter; and if you disagree, kindly explain why."

And, here is Pat Finnegan's response in its entirety:

 

Dear Tom,

Many thanks for your email, and for sharing your recent posting on our work to reform hedge accounting. I am on your distribution list and read your posting last week.

 You will not be surprised to learn that I do not agree with your assessment of our extensive due process as a 'political circus'. I suspect that most of the 250 or so respondents to the Hedge Accounting consultation would also disagree with your assessment. 

It also seems odd to substantiate your arguments based on just two comment letters. If you are interested in investor views, why ignore, for example, the Investment Management Association (whose members manage over £3 trillion of assets) that broadly supports our proposals? There are a range of views expressed in the comment letters received – some supportive, others offering constructive criticism, which is the whole point of having such an extensive due process.

I understand from my colleague Pat McConnell that you have sent her a similar request for opinion. I am copying her on this reply.

The board is planning to discuss the staff's analysis of comment letters and outreach visits during the next several weeks.  Those discussions will inform the Board's decision making (including my own) before determining how to proceed. I believe the key questions and observations raised in the CFA Institute's letter will be addressed during those discussions. I invite you to listen and if you would like to discuss our tentative decisions as we proceed, please do not hesitate to contact us.

Best,
Pat

I am flattered that Pat reads my blog, and I hope he understands why I singled him out. I am going to respond to his concerns, below. But first, I must note that he has declined to respond to my request: to have an explanation for the inconsistency of his vote with the positions of his previous employer.

As to my inferences from only one comment letter and an analysis by E&Y, I should first point out that I have been following the IASB's "due process" for some time. I invite Pat to read my post on the revisions made to IAS 23 (interest costs), and tell me that "political circus" is not a better descriptor than "due process" for the way in which those revisions were made. But, more directly to his point, if that IMA comment letter is the best that Pat could come up with for investor input that I overlooked, then I clearly did not miss very much.

The CFA Institute's letter that I discussed contains almost 40 pages of solid analysis, including numerous reasoned and detailed responses to specific questions that the IASB asked commenters to address. In stark contrast, the IMA's letter is two pages in total, with barely more than one page of substantive comments. The IMA letter contains no responses to the specific questions in the ED, and it provides no explanations for why investors should be supportive of the IASB's proposals. The CFA Institute's letter, on the other hand, is thorough not just for its depth and breadth, but for its lucid explanation as to why the ED is inimical to investor interests.

Hedge accounting is the poster child for rules-based accounting.  It owes its existence to a highly-politicized process in the first place that made an explicit exception to principles-based accounting. But, even if the ED were actually principles-based, how should one weigh the IMA's two-page letter from an organization representing members that manage over £3 trillion of assets with the Institute's letter and its 100,000 members? Evidently, Pat Finnegan thinks the IMA letter is significant in comparison to the Institute's, but I disagree. A staff analysis of comment letters that could consider the IMA's contribution to be in the same ballpark as the CFA Institute's is precisely the kind of "political circus" I had in mind when writing my post that Pat disagrees with.

As to what the receipt of 250 comment letters actually says about "constituents'" perceptions of due process, unlike Pat, I don't see that it says much of anything. For example, commenters could be just as cynical as I am, and still find it in their interests to register their views. And, I wouldn't be surprised if that's the way the signers and drafters of the CFA Institute's letter regard the process – they have no real choice except to participate in a charade.

The IASB would do well to commission an independent survey of "constituents" (most especially, investors, academics and journalists) for their perceptions of the efficacy of the Board's "due process." That such a survey has not already been conducted is, in and of itself, telling. 

* * * * * * *

Unfortunately, accounting reform is turning out just like banking reform: politics and influence, as opposed to economics and principles, are the deciding factors. I see only political reasons for Pat Finnegan and Pat McConnell to decline to explain their votes on the hedging ED. And, the IASB's analysis of comment letters on their hedge accounting ED, under the name of "due process," can be nothing more than pretense.

-------------------------------

*In a previous version of this post I incorrectly stated that hedge accounting was not discussed at the IASB's most recent meeting.  I apologize for the error.  

IFRS Adoption is Dead! (I Think)

Way back in November 2008 when Christopher Cox was calling the tune, the SEC issued its proposed "Roadmap" for achieving a "single set of globally accepted accounting standards." That was the point at which the IFRS-adoption-is-inevitable" pot banging reached deafening levels. Thankfully, however, it has been mostly downhill from there:

• Both boards and their staffs have racked up many vacations' worth of frequent flyer miles in their efforts to "converge" U.S. GAAP with IFRS; but there has been little else to show for it, leaving a trail of abandoned, stalled, half-done and half-baked projects in their wake.
• The Financial Accounting Foundation (which has no legitimate claim to power since Sarbanes-Oxley funded the FASB from issuers' fees) first shrunk the FASB and then re-expanded it, in a series of futile gambits to grease the IFRS adoption skids, but to no avail.
• In February 2010, after months of virtual silence, the SEC issued a statement reiterating and defending its commitment to a single set of global accounting standards, and committing its staff to a putatively rigorous examination of that possibility. Six months later, the Staff issued what was clearly a hastily cobbled together report right at the only deadline to which it had been committed (end of October 2010). It is now almost seven months hence, and not another peep from the Staff has been heard.

But, only a couple of months after that clearly embarrassing report – both for the admission that precious few countries have fully adopted IFRS and given up their sovereignty over accounting standards, and for its vacuity otherwise – the SEC seems to have switched to face-saving mode. I mean that in two respects.

First, the SEC has sat on the sidelines for far too long, and far too often. If progress on the Memorandum of Understanding (MOU) between the FASB and IFRS to converge of their accounting standards is so important to the process of moving to a single set of accounting standards, why has the SEC chosen to be so passive during that process, practically abdicating its role by stating that a converged standard would presumably be a "high quality" standard? Sarbanes-Oxley does not permit the PCAOB to issue a new auditing standard without explicit SEC approval. If the same were required for FASB/IFRS accounting standards, you can bet that the Commission, and hopefully even individual commissioners, would be staking out their positions well in advance, instead of sitting on the fence while issues are interminably batted back and forth by the boards and its "constituencies."

Second, the political hold on global accounting standards seems to emanate from the G-20, which (for its own political purposes) has called for converged accounting standards to happen post haste. The notion of outright IFRS adoption may have become passé, especially as it has become widely known and acknowledged that so few countries are actually doing it; but the Obama administration, perhaps with good reason, does not want to be seen as the dissenter on this issue, particularly if it is relying on cooperation on other issues that could be more important to the U.S.

Face-saving mode was effectively launched by Deputy Chief Accountant Paul Beswick in a speech last December, as he described a hybrid convergence and endorsement approach, which with evident impish pleasure he dubbed, "condorsement."

Beswick – "[A] new set of priorities would be established where the FASB would work to converge existing U.S. GAAP to IFRS over a period of time for standards that are not on the IASB's agenda." [emphasis supplied]

Me – This is tantamount to re-visiting all of the many topics for which convergence was already given the old college try and failed. Bad idea.

Beswick – "At the same time, the FASB would have a process where they would consider new standards issued by the IASB for incorporation into U.S. GAAP … However, criteria would need to be established for [incorporation] – for example whether incorporation of a given standard is in the interests of U.S. investors or the U.S. capital markets." [emphasis supplied]

Me – In concept, "incorporation" doesn't sound so terrible, perhaps because I'm still trying to stop the ringing in my ears brought on by the pot bangers. But, I object to any suggestion that the U.S. should be reduced to seeking converged standards instead of superior standards. The whole notion of convergence rests on the presumption that it can be expected to result in enhanced comparability, and I think that presumption has already been demonstrated to be specious. Attaining convergence is never going to be any sort of valid rationalization for failing to promote a better standard than IFRS has offered.

And so it came to be a few weeks ago that the SEC announced that it would be hosting public roundtables this coming July on the question of "incorporating IFRS" [italics supplied] into U.S. GAAP. If "incorporation" is going to mean what Beswick said it means, I might be able to live with that outcome, so long as it doesn't mean that the SEC stays off the hook in determining any of the substantive issues – such as "whether incorporation of a given standard is in the best interest of investors," or whether a different standard would serve U.S. investors better.

So, I say let the "incorporation" discussions begin! But, whatever the outcome, the one thing that has to change is the SEC's passivity with regard to standards setting.  And, let's start now: if "incorporation" is what the SEC is really down to, why wait until July or later to inform the accounting standards setters that their convergence MOU is hereby rendered null and void?

Hedge Accounting: Convergence Crunch Time

If you want to appreciate the political circus masquerading as "due process" in accounting standards setting, I recommend that you read two recent documents. The first one is the CFA Institute's stinging 39-page comment letter* on the IASB's hedge accounting exposure draft:

"We do not find investors calling for a standard which allows broader and more liberal application of hedge accounting and which permits its use to alter the IASB's classification and measurement of financial instruments. Rather, our research indicates that users find hedge accounting and disclosures to be confusing, difficult to understand and low in quality. We would be interested to hear how the IASB's outreach to users allows them to conclude that this proposal will benefit users." [Emphasis supplied.]*

And second, this equally-detailed publication from Ernst & Young, which hit the internet at about the same time:

"Among the proposals issued by the … [Boards] … to amend financial instruments accounting, the hedge accounting sections were the most favorably received. Both Boards heard support from constituents for attempting to make hedge accounting easier to accomplish with changes that constituents found substantial and helpful."

That much is all you need to get the sense that preparers, as represented by EY's clients, are clearly talking past investors, as represented by the CFA Institute. If you need more evidence, search for the word "users" or "investors" in EY's 26-page document. You'll find "users" once, but not in any relevant context to the point I am making. What you will find is a lot of support for the IASB from EY, buttressed by this kind of client cheerleading: "hedgers like", "valuable to many industries", "entities typically want to match", "many banks and financial institutions have long wanted", "entities … would benefit", etc.

Ask yourself whose views should carry more weight at the IASB (or FASB): the prestigious CFA Institute, which represents more than 100,000 investment professionals worldwide, and whose stated purpose is to advocate for investor protections; or EY – and its clients? Next, ask yourself whose views are actually weighted more by the IASB (or FASB)?

Case closed.

Whither Hedge Accounting – and Convergence?

The FASB has also issued its own discussion paper, Selected Issues about Hedge Accounting, but they are substantially different. While the FASB has proposed incremental liberalizations of their existing approach to hedge accounting, the IASB took a clean sheet of paper – and has drawn a picture of what accounting standards would look like if the U.S. would kindly step aside.

I want to be clear at the outset that if I had my way, there would be no such thing as hedge accounting, and I believe many investors share my preferences. If the probability is 1/x that reasoning life forms reside on another planet, the probability of their adopting more complex hedge accounting standards than ours is 1/x². Hedge accounting is already ridiculous enough; and with that introduction, I present but a taste of the Institute's many concerns with the IASB's further plumbing of the depths:

• Absence of investor primacy – The Institute believes that most investors would prefer broader application of fair value and increased rigor around the permissibility of hedge accounting, not the opposite which is being proposed. The IASB has done nothing to demonstrate how their proposal would benefit investors. If investor primacy no longer exists at the IASB, then it should say so. Moreover, increased use of fair value accounting, which the CFA Institute has consistently recommended, would reduce any "need" for hedging accounting, yet the IASB is proposing to expand hedge accounting, a dubious and anomalous concept. (My strong sense is that, consistent with my own views, the Institute would eschew hedge accounting altogether if it could get the Boards to agree.)

   

• Lack of conceptual basis – The foundation of the ED is a new concept of risk management strategy that is only vaguely specified, and has no foundation in either economics or the conceptual framework definitions of assets and liabilities. Moreover, the ED has been so broadly written and so removed from any conceptual framework that there seems to be no way it can be adequately policed for abuses. Investors would benefit more from the disclosures of the risks that are not hedged, than the (inadequate and vaguely-specified) disclosures of risks that are purportedly being managed.

   

• More ways to management earnings – Especially because of the failure of the financial statement presentation project, the notion of accounting treatments being driven by management intent has become discredited, so now we are being sold other amorphous concepts like "risk management strategy" which really means 'more choices for management.' Global accounting standards are being promoted under the premise that enhanced comparability will be the result. But, no one can seriously argue that the IASB's ED will move comparability anywhere but on a serious jag in the wrong direction.

   

• Hedge effectiveness threshold lowered – Like the FASB, the IASB is eliminating the requirement to assess hedge effectiveness quantitatively. But, the IASB's new criteria is much more amorphous: to minimize ineffectiveness, and to be "unbiased and other than accidental offsetting" – whatever that means. Relatedly, retrospective assessment of ineffectiveness would no longer be required.

   

• Increased use of "other comprehensive income" – OCI has yet to be defined for any other purpose, yet this "principles-based" hedge accounting proposal would run all hedging gains and losses through OCI.

   

• Held to maturity positions can be hedged – Although these will be re-named when IFRS 9 becomes effective, measurement based on amortized costs only makes sense if management is indifferent to changes in the fair value of their investments. Permitting hedge accounting of these investments means exactly the opposite – that management is not indifferent to price changes, which was what had been asserted to allow amortized cost accounting. What a farce!

   

• Derivatives can hedge other derivatives – Don't like the bet you made on a commodities future contract anymore – and don't want to recognize a loss when you sell it? Under the proposal, you can construct a hedged item out of your anticipated purchase of the commodity and your under-water forward contract (which had been designated as a hedge in order to put the gains and losses in OCI). All you would have to do is to find an offsetting derivative that better suits your new view of price movements, and now the gains and losses on both derivatives can be thrown into OCI.

   

• The ability to hedge a portion of an item – This is where the games start to get really interesting.  There is no restriction that requires that the identified hedge portion be unrelated to the unhedged portion.  So, management could identify a portion (such as the copper component of insulated wire) and describe the hedged portion as a perfect offset of the derivative. Even though the "risk management strategy" may be questionable, who is going to question it? And, there need never be any ineffectiveness to report in net income.

 

• The new concept of "net nil positions" – Which in effect says that when assets and liabilities (which may include derivatives) net to zero, both sides are hedged items – and voila all restrictions on what qualifies as a hedging instrument are swept away, because the asset and liability positions qualify as hedged items.   The fair value option and its restrictions (elected only at inception, irrevocable, gains and losses through net income) are circumvented.  Even better (or worse, depending on your point of view), it could be that all aspects of IFRS 9 classifications can be "managed" with the right financial engineering.

   

• Cash instruments to be used as hedging instruments — Currently under US GAAP, cash instruments (such as debt instruments) may be used to hedge the net investment in a foreign subsidiary whose functional currency is the local currency (an utterly stupid concept to begin with) or a firm commitment denominated in foreign currency. Under the proposal, cash instruments that are measured at fair value through net income could be designated in various kinds of hedging relationships. That means, of course, that the gains and losses on those cash instruments would flow through OCI instead of net income.

The Institute has many other gripes, and a lot of it has to do with process; i.e., timeframe, risks, etc. But, I think I have given you enough to convey the impression that the most prestigious association of investment professionals in the world is trying to tell you that the IASB's ED is a HORRIBLE HORRIBLE document. Yet, politics being what they are, there will doubtless be a lot of pressure put upon the FASB to come as close as they can to the IASB's madness as it re-deliberates its own more modest discussion paper.

Who Are These Guys Anyway?

In understanding where the notions in the IASB's ED come from, it is important to remember that circumstances essentially forced the IASC (IASB's predecessor) to swallow US-style hedging accounting with one big bite. Basically, the IASB was thrust from relative obscurity into international prominence when, in 1995, the International Organization of Securities Commissions (IOSCO) tasked the IASC with establishing a set of high-quality accounting standards, within five years, covering all of the core topics IOSCO specified.

Of these core topics, financial instruments proved to be the gnarliest; plus everyone knew that the final arbiter of high quality was to be the US, where FAS 133 was published in 1998. By then, time was running out on the IASC, and an international consensus on hedge accounting was nowhere at hand. In desperation, the IASC essentially made a carbon copy of U.S. financial instruments accounting and dubbed it IAS 39.

I can't say for sure why the IASB has so sharply tacked away from the FASB on hedge accounting at the eleventh hour of the current convergence project. But, it is clear that the Europeans hated IAS 39 from its inception during that eleventh hour of the IOSCO "core standards" project 12 years ago. With the hedge accounting ED, either the EU is trying to tell the US to take a hike, or they realize that the promise of a "stable platform" for accounting standards would effectively wed them to US-style hedge accounting rules forevermore — unless they make a bold move within the convergence timeframe.

In bringing the EY document to my attention, Bob Jensen wrote:

"There's an old saying when cable companies are bringing fiber to households: 'The last mile costs more than all the other miles.'"

To which I will add a sports adage: Crunch time is when you learn the most about your teammates.

Hedge accounting is crunch time for the SEC.

Speaking of IFRS

You may have noticed the advertisement on my website for the Core Concerns Conference in Chicago this June, sponsored by CFO.com. I will be attending all three days of the conference, and I would welcome the chance to meet and share ideas with any Accounting Onion readers in attendance.

You might also be interested in two other things about that conference. First, if you click on the ad on my website to register, you will receive a $300 discount off the standard registration fee.

Second, and apropos to this post, the conference will feature a panel discussion entitled "One Global Accounting Standard — IFRS in America." The panelists are:

• Paul Cherry, Chairman, Standards Advisory Council, IASB; Former Chairman, Canadian Accounting Standards Board
• Brian Fiedler, VP Finance, Canadian Tire
• Christian Leuz, University of Chicago's Booth School of Business
• William Hildebrand, Financial Accounting Standards Board (FASB) Practice Fellow
• Jack Klingler, Director of Accounting Research and IFRS Implementation, Alcoa, Inc.

You can count on me to use the opportunity to ask questions, and I hope to see you there!

__________

* This document was provided to me via email from a member of the CFA Institute. Since neither the IASB nor the Institute has posted it on the internet as of the time of this writing, I am taking the liberty of posting it to my own website. I just wanted you to know that this is where the link will take you.

"Convergence Flaws" v. Convergence Spin

I recently read the transcripts of two recent speeches on the question of the future of IFRS in the US.  They are as different as two speeches could be on this topic.

As one might expect, the adopt-IFRS-or-the-sky-will-fall speech emanated from David Tweedie, the IASB Chair. It should also come as no surprise that he gave it in a protective bubble: a meeting of the freest-spending corporate lobbying group in Washington – the U.S. Chamber of Commerce. To those tone-deaf-to-investors ears, Tweedie must have sounded like a Bach chorale. But, I wonder how many of those Dodd-Frank and fair value bashers actually understand (or care) that GAAP and IFRS will be far from converged even after the frantic race to the bottom on leasing, financial instruments and revenue recognition has been declared fini in just a few months. Here's a quick list off the top of my head of projects that were abandoned, never fully addressed or mutilated by "convergence" (feel free to add your own):

• Impairment of long-lived assets
• Research and development costs
• Borrowing costs
• Pensions
• Financial statement presentation, statement of cash flows and disclosures
• Contingent liabilities
• Business combinations
• Joint ventures
• Oil and gas accounting
• Agriculture
• Goodwill impairment

I wonder how many of Tweedie's audience understand (or care) that rigorous SEC enforcement of IFRS with only 'soft-touch' enforcement elsewhere in the world will only make us out to be chumps.

Or, that the loss of sovereignty to set our own accounting rules should be antithetical to practically everything else the conservative Chamber has lobbied and stands for. From their anti-regulatory free-market standpoint, there is no valid reason why the U.S. should be colluding with the IASB on accounting standards. Instead, U.S. regulators should be pushed to compete against the IASB with constant improvements toward the highest quality financial reporting standards in the world.

Or, that Tweedie's latest "now or never" gambit sounds more like a desperate suitor whose love interest has finally discovered his true callow nature. There is absolutely no valid reason for the U.S. to be rushed into determining the long-term status of IFRS in the U.S.

"In talking with many investors over the past few years, and during the darkest days of the financial crisis, not one has ever said to me, 'What we need is to move to international accounting standards.'"

That's from the other speech, "Convergence Flaws," by Wall Street Journal columnist David Reilly.

Reilly has been following the IASB and IFRS convergence for a number of years and, and while he does not address any of the technical issues (like incomplete convergence and mutilated standards), he and I end up at the same place: there doesn't seem to be much good that can come out of U.S. adoption of IFRS, or even further efforts at convergence.

Enforcement problems – One of Reilly's more interesting observations comes from drawing an analogy between common accounting standards and a common currency. Like others, he attributes much of the Euro's problems to the absence of political unification.

"Without a common political view, there is no real way to enforce measures needed to guarantee the structure and credibility of the currency – witness how even years before Greece nearly imploded, countries such as France flouted some measures that all euro-zone countries had agreed to follow, with little to no consequences.

Similarly, a common accounting system needs a common enforcement system. Having the most intelligently crafted rules means nothing if companies feel they can simply ignore them without fear of any meaningful consequence. … Does anyone think for a moment that rules will be as consistently enforced in Russia as they are in, say, London? And it's worth noting that there isn't even a single securities regulator within the European Union." [italics added]

Moreover, Reilly scoffs at the notion that auditors are capable of taking up the slack, or that a global securities regulator, as suggested by John Mack, former chairman and CEO of Morgan Stanley, is politically workable.

Whom Should Capital Markets Serve? –Reilly explains that it is hard to come to converged accounting standards if one's view as to whom capital markets regulation should serve differs: investors, issuers (in the name of capital formation), or even authoritarian political regimes (in the name of political stability):

"It's hard to see that countries with such differing views will strive for standards that put investors first or will abide by an accounting outcome if it conflicts with a national objective.

Consider that Greece has admitting [sic] to fudging numbers about its national accounts. What then makes us think it wouldn't hesitate to twist corporate accounting rules? France has often intervened in markets to promote the interests of national champions and has already shown a willingness to politicize and pressure the IASB. And let's not pretend the Chinese communist party would hesitate to twist the accounting if it suited the needs of the politburo."

And, Why are We Going to Do This? – Even apart from cost considerations, Reilly says that if there were ever a time for U.S. adoption of IFRS, it has come and gone:

"[The push for IFRS adoption] came at a time when there was much debate about the competitiveness of U.S. capital markets. The argument went that burdensome regulation was going to push capital markets activity to London and Hong Kong. To counter that threat, the argument went, we needed to embrace the kind of light-touch, principles-based regulation and standards setting seen in London.

Today, we know better. A lack of regulation and regulatory will, not too much of it, was a large contributor to the financial crisis that brought our economy and markets to their knees. London, by the way, has since repudiated the light-touch approach."

Reilly, of course, wasn't speaking to the U.S. Chamber of Commerce choral society. He spoke at a meeting of accounting academics – the functional equivalent of a herd of cats. In other words, he spoke to people with an open mind, and without marching orders from the corporate elite.

I wonder how well David Tweedie's speech would have gone over after David Reilly's?