The Accounting Onion

Goodwill Impairment: I Love a Charade (Re-posted)

Kind readers:  To the best of my knowledge, the first version of this post was not picked up by the software that magically distributes it to my email subscribers; therefore, I am re-posting it for them. I apologize to anyone who has received duplicate notices. 

I have written about initial recognition of goodwill on numerous occasions. I suppose it might be less bothersome if goodwill had the good grace to sit and stay like a good dog on the balance sheet at its opening 'value'; but alas, such is not the case. Not even close.

Goodwill impairment tests chew up good money, and as I am about to describe, they screw up the accounting for just about everything else. Even in the best of circumstances (by which I mean that goodwill could actually be something more than a garbage can for overpayments, mis-measurements and measurement exceptions) the goodwill impairment test is a ludicrous charade.

To Illustrate

Let's start with a simple set of made-up facts, albeit loosely based on a real situation as described to me. The teller of the tale attended a business combinations workshop that I had recently led:

Acquiror Company purchased 100% of the outstanding shares of Target, a consulting company for $1,000. None of Target's liabilities were assumed; the only asset eligible for recognition other than goodwill was a customer-related intangible, with a fair value of $400 million and an expected economic life of 8 years. Therefore, goodwill was initially "measured" (the FASB's misleading term, not mine) at $600 million (=$1,000-$400). Why such a high amount for goodwill? Acquiror viewed Target's assembled workforce to be its most valuable asset, which may not be recognized separately under GAAP (or IFRS).

One-year later, negative events associated with the recession significantly diminished Target's prospects. Principally, the value of the previously recognized customer related intangibles declined significantly; however, their remaining expected economic life still has seven years to run. (The remaining expected economic life of the asset is not particularly relevant to my analysis to follow, but there it is, anyway.)

U.S. GAAP requires that the customer-related intangible be tested for impairment before the goodwill is tested. To make a long story mercifully short, one first assigns the current carrying amount to the smallest cash-generating unit (CGU) for which cash flows can be reasonably attributed. Acquiror determines the CGU to be Target itself, and then determines the expected undiscounted cash flows to be just slightly greater than $350 million (which is the carrying amount of the CGU. Thus, no impairment of the customer-related intangible is recognized, even though its value is surely far below the carrying amount.

Now, it's on to the goodwill; and for the FAS 142 cognoscenti among you, we shall stipulate that Target constitutes a "reporting unit." Cutting to the chase again, GAAP requires that the current fair value of Target be compared to its carrying amount. Let's say that the fair value of Target is determined to be $300 million. Since that's less than Target's carrying amount of $950 million (=$350 + $600), Acquiror must launch itself through the gauntlet of the goodwill impairment test, known as "Step 2."

Step 2 requires Acquiror to pretend that it purchased Target today for its fair value, and to figure out what goodwill would be recorded at today, should that impossible fantasy somehow be the reality. So, let's see: assuming a purchase price of $300 million and a fair value for the customer related intangible of $200 million, the "implied fair value of goodwill" (another fabricated and misleading term to add to one's collection) comes to $100 million.

Thus, a "goodwill impairment" of $500 million (=$600 - $100) must be recorded, even though everyone and their brothers and sisters all know that it is the customer-related intangible that is deep underwater. Acquiror's management knows that the customer-related intangible is worth $200 million less than the amount reported on the consolidated financial statements, but investors don't know that. All they see is a writedown to goodwill; which everyone and their brothers and sisters dismiss as merely the result of an arbitrary recalculation of an arbitrary calculation.

So now you know why issuers don't complain too much about goodwill impairment accounting, even though the charade by which it is calculated can be a gigantic pain in the tuchas. It's just one more line of defense for hiding information about real impairments on any kind of long-lived asset other than goodwill that you can imagine. Nothing actually re-measured, only goodwill actually lost.

Is IFRS Any Better?

No. It's worse and with no prospects of improvement anywhere close to being on the horizon. Unless management elects to separately estimate the "recoverable amount" (higher of net fair value and "value in use"), then all of the goodwill and customer-related intangibles carrying amounts are thrown into the CGU bucket. If the CGU's fair value is less than its total carrying amount, then you will always write down goodwill before you touch any of the other long-lived assets.

Although in this case the GAAP and IFRS answer would be identical, the difference is that under GAAP there is at least some chance that non-goodwill assets would be stated at a more realistic value for them. Moreover, the SEC has demonstrated its awareness of the anomaly and willingness to hold a registrant's feet to the fire. For example, here is one case of an SEC comment letter to a company expressing its incredulity that goodwill was written down while miraculously preserving the carrying amounts of its non-goodwill assets:

Taking into consideration the circumstances that caused you to recognize an impairment charge on the Birmingham market goodwill, tell us whether you first tested your long-lived assets … If you did test your long-lived assets for impairment, explain to us in why an impairment charge was not recognized. If you have not tested your long-lived assets for impairment explain to us why not. Please also tell us how you group your long-lived assets for purposes of testing your long-lived assets for impairment …. [Letter from the SEC to Cox Radio, Inc., dated July 17, 2006]

Don't Worry, Be Happy

Small wonder that goodwill and long-lived asset impairment is not on the rush-rush 2011 convergence agenda, or even anytime thereafter. The financial crisis has clearly demonstrated, asset impairment accounting is a sacred cow that may only be approached in circumstances involving extreme unction. Not very long ago, it was hard enough for the FASB to push through any sort of consistent impairment standard for long-lived assets. Now, with the EU already threatening to jump ship on financial instrument impairment, the only choice the Boards have is to pretend that the shortcomings of impairment standards are not a high priority, not to mention the gaping inconsistencies within and between IFRS and GAAP.

I love a charade.

The FASB's Mission Incomprehensible

I had believed that one of the few positives that would come out of the wave of accounting scandals that broke at the beginning of the just-completed decade would be a general awareness of the critical role that financial reporting and its regulation plays in the functioning of large economies. There certainly seems to be more in-depth coverage in business periodicals, but little else. For example, I was appalled at how little coverage my hometown paper, the Arizona Republic gave to the SEC investigation of Phoenix-based Apollo Group's revenue recognition policies.

But, the NYT's Paul Krugman soothed my feelings more than a little in his last column of 2009 (which incidentally was at the top of the Times' 'most emailed' list for about a week:

"For as the decade began, there was an overwhelming sense of economic triumphalism in America's business and political establishments, a belief that we — more than anyone else in the world — knew what we were doing.

Let me quote from a speech that Lawrence Summers, then deputy Treasury secretary (and now the Obama administration's top economist), gave in 1999. 'If you ask why the American financial system succeeds,' he said, 'at least my reading of the history would be that there is no innovation more important than that of generally accepted accounting principles: it means that every investor gets to see information presented on a comparable basis; that there is discipline on company managements in the way they report and monitor their activities.' And he went on to declare that there is 'an ongoing process that really is what makes our capital market work and work as stably as it does.'

So here's what Mr. Summers — and, to be fair, just about everyone in a policy-making position at the time — believed in 1999: America has honest corporate accounting; this lets investors make good decisions, and also forces management to behave responsibly; and the result is a stable, well-functioning financial system.

What percentage of all this turned out to be true? Zero." [my emphasis]

And this assessment comes from a guy who has repeatedly displayed a soft spot for financial regulation. Considering the sheer size of diversity of Krugman's audience, it is a devastating indictment that should make the FASB's ears ring.

It All Begins with a Mission Statement

My dear wife, Jane, had a long and distinguished career as an information systems consultant; and her engagements usually began with an in-depth examination of the client's mission statement. Thusly is writ the first sentence of the FASB's:

"The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information. …"

 

Jane has very patiently explained to me on multiple occasions the purpose of a mission statement, and what it should say about an organization. I have to confess, however, that my mind doesn't work on that level. But, I did absorb enough to know that one's mission should be clearly stated and universally understood.

I have studied accounting intensely for more than thirty years, and I don't understand the FASB's mission statement. The only substantive indication I can glean from it is a clear intent to be unclear, thereby rendering the processes in place for setting accounting standards as muddled as the standards themselves. Aside from just being able to state that one does indeed have a mission statement, its only apparent use to the FASB is as a sort of blank check to throw a bone whenever it wants to whomever it wants.

Of course, methinks it should be quite easy to write a sensible and comprehensible mission statement. I offer this one, which I threw together in about 15 minutes, just to kickoff the rest of this conversation with myself.

The mission of the FASB is to establish and revise standards of financial accounting and reporting that significantly improve the usefulness of financial statement information to current and potential investors. Recognizing that significant improvements are urgently needed in numerous aspects of accounting and financial reporting, the Board is to continually evaluate the pace of change, and whether its short- and long-term goals are appropriate considering the current informational needs of investors.

The Board also gives due consideration to the feedback from non-investor stakeholders – principally auditors, preparers, attorneys and other finance professionals – to the extent that such feedback provides relevant information regarding cost and feasibility of a proposed change to standards. However, the evaluation of a proposed standard's effect on relevance and reliability, is to be made independent of feedback from non-investor stakeholders.

Now, that's a mission statement I hope Jane would be proud to read. It's a clear a set of marching orders that identifies the organization's 'customers', what to produce, and how to produce it.

Convergence: Mission Impossible

Convergence with IFRS could be the clearest and most timely example of how a true mission statement would direct the FASB goals and processes; there should be general agreement that standards production efforts over the past decade have been focused on attaining convergence with International Financial Reporting Standards. Yet, convergence is neither a necessary nor a sufficient condition for producing significant improvements to the quality of accounting and financial reporting.  As such, according to my own view of what the FASB's mission should be, it is a non-core activity. Indeed, a decade's worth of "zero," as Paul Krugman would have it, must perforce lead one to conclude that convergence has been a prime sourcesof standards production inefficiencies.

I could cite any number of examples of counterproductive behavior resulting from convergence fixation, not the least of which would be the current idiotic "debate" over fair value for financial instruments. But I cannot possibly do any better than Dennis Beresford, erstwhile FASB chair, in a recent posting to the AECM listserv (frequented by about 700 academics and other interesting people):

"But what I find most interesting about the recent decision for the Boards to start meeting every month and to complete the converge plan by 2011 is that these are projects that have begged for a solution for decades in some cases and now they will supposedly be finished in two years. The consolidation project, for example, was added to the FASB's agenda in 1982 and the Board has never been able to operationalize a definition of 'control.' But somehow the joint efforts of FASB and IASB will now solve that issue in 24 months, including all of the normal due process.

 

And the IASB has just issued an exposure draft on financial instruments impairment and other issues. One 'feature' of that ED is that loan losses will be accounted for using an expected loss model rather than the incurred loss model we have in SFAS 5. This means that companies will have to predict future losses over the lives of loans and not just record what has already happened. Some of the old timers on this list may recall that one of the main reasons the FASB issued SFAS 5 was to eliminate the practice of accruing "catastrophe losses" in advance. In other words, casualty insurance companies that previously priced policies and accrued for a portion of expected future losses for floods, hurricanes, etc. could no longer do so. The new IASB exposure draft deals with with [sic] loan collections and not casualty losses but the principle is the same and applying it would move us back to the pre-SFAS 5 accounting. Is that progress? More importantly, is that something that is capable of being accomplished before the end of 2011?" [italics supplied by me]

Here we have yet another devastating indictment of the process that has dominated standard setting for the past decade. Some convergence has been achieved, but far short of a reasonable goal, even if one were to believe that convergence, in and of itself, were a valid goal to embrace. Just one implication of Denny's comments is that the legacy of the FASB's fixation on convergence could be the entire world ending up with German-style hidden reserves all over again. (I can't resist pointing out that I am writing this while on a plane heading to Frankfurt!)

Convergence has been the tail wagging the dog of high quality accounting standards. The FASB could be much better by starting 2010 with a reconsideration of its mission statement, instead of a head-over-heels run to a finish line – precisely situated at the edge of a cliff.

And Our IFRS Survey Says…

This is the first of a series to discuss the results of our IFRS opinion survey. The idea for a survey originated with yours truly, and I was moved to do so (more like propellled with outrage) by the ersatz pro-IFRS "research" coming out of the Big Four and the AICPA propaganda machines. I also decided to seek a collaborator from the ranks of academia through the AECM listserv, and I consider myself very fortunate that Pat Walters, herself an IFRS proponent, volunteered to work with me. Pat's association with this effort should lend, at the absolute minimum, a semblance of balance; which is, ironically, completely absent from published views of the Big Four and their shills.

But, thankfully, I can report that not all CPAs have behaved like pigs at the trough. We owe a huge debt of gratitude to Gaylen Hansen, who has provided us with a clear-eyed compilation of the response letters to the SEC's Roadmap proposal; and to Grant Thornton for their survey, which was published as we were conducting ours. GT asked a question of import ("Ideally, who should set U.S. accounting standards?") properly, and received proper responses from CFOs and senior comptrollers in return. GT reports that only 18% of more than 800 respondents from public companies are of the opinion that the IASB should be setting accounting standards for U.S. companies.

Full Disclosure and Caveats

We received a total of 289 responses. We can't beat GT on sheer number of responses, but we did ask a broader set of questions regarding the perceived relationships between IFRS and GAAP: (1) quality differences; (2) costs and benefits of IFRS adoption; and (3) how the SEC should act on its Roadmap proposal. You can view all of our response data in a spreadsheet format here, and the text of the online questionnaire here. Twenty-seven responses came from non-U.S. residents and 13 from students. Our analysis excludes these two groups, and the tabulation at the end of this post breaks down the respondents we analyzed by all of their occupations.

Before we proceed to the major takeaways from our survey, two further caveats are in order.

First, we sure were hoping to generate a larger number of responses. GT excepted though, our level of participation is well within the range of other "studies" conducted by the IFRS proponents, including the number of comment letters received by the SEC in response to the Cox-instigated Roadmap Proposal. We left our survey open for three weeks; the SEC's comment period extended for months.  

Second, one should always take with a grain of salt unsolicited responses, as opposed to a random sample. But, no study that we are aware of has employed a more open self-selection process than ours. For example, I was solicited for Deloitte's survey apparently because I subscribed to one of their IFRS information services; if that was Deloitte's only method for soliciting responses, the self-selection bias therefrom is self-evident.

The Major Takeaways from Our Survey

As with GT, we asked for opinions regarding IFRS adoption; and our results were very similar to theirs:

My initial interpretation was that 71% of respondents do not agree with the proposition that IFRS should replace U.S. GAAP. Pat pointed out that this may be somewhat of an overstatement—since we don't know why 16% of respondents "neither agree nor disagree." Those respondents, according to Pat, could very well be indifferent to the prospect of IFRS adoption. My own take on that is: if one took the trouble to take the survey and to answer the question, then indifference would not be the most likely sentiment being expressed. Nevertheless, Pat and I agree to this interpretation:  respondents who disagreed with the proposition outnumbered those who agreed by a margin of about 5:3. Anyway you look at it, especially in light of GT's results, it should give the SEC pause before proposing to supplant the FASB with the IASB.  That's as mildly as I can put it.

When I took a closer look at the answers to this question, I was not surprised to see that the frequency distribution of responses from Fortune 500 companies and the Big Four appeared to be negatively correlated with all of the other occupations. To evaluate their impact on the full results, I decided to disaggregate each question by three subgroups: (1) Fortune 500 + Big 4; (2) academics; and (3) everyone else. The chart below repeats the results from above and adds these subgroups:

 

See that tall blue bar on the left? That's Big 4 and Fortune 500 money talking. Notice also that academics (the ascetic purists J), are the least inclined to adopt IFRS (as indicated by the short green bar on the left).

Given these results, it should come as no surprise that a significant majority of respondents do not believe that the benefits to investors of IFRS adoption would exceed the costs of conversion:

77% of all US respondents do not believe that benefits to investors will exceed the cost of conversion. Indeed, although a majority of the Fortune 500 accountants and Big Four auditors believe that the SEC should adopt IFRS, only 44% believe that the benefits to investors would exceed the cost of adoption. Figure that one out.

The bottom-line question we asked pertain to how the US should approach adoption of, or convergence, to IFRS:

These results are, admittedly, somewhat difficult to interpret with precision, but they clearly indicate that few respondents would like to see IFRS adopted before 2014. Moreover, 54% of respondents (including the Fortune 500 and Big 4) would either prefer not to adopt IFRS, or to adopt it starting with 2020 at the earliest. Although an in-depth analysis of the "other" category of responses was not undertaken, my brief analysis strongly indicates that a comfortable majority of the "other" responses more closely resemble those who stated a specific preference to either delay in IFRS adoption beyond 2020, or to abandon IFRS altogether.  If you don't believe me, you can look at the data for yourself.

And, as one might expect, the Fortune 500 accountants and Big Four auditors were strongly in favor of relatively fast-paced IFRS adoption, although it must be said that less than 10% favored adoption by 2012-2013. But, take those folks out, and you have even less interest among respondents for adopting IFRS anytime soon … or ever.

Act II

Thus far, I have discussed the results of only three of the ten questions that we asked about IFRS vs. U.S. GAAP. I promise you, more drama is to come. Also, Pat has agreed to write a guest post with the working title, "How the Survey Result Informs an IFRS Proponent." I'm sincerely looking forward to that.

Announcing Our IFRS Survey!

This is a brief announcement of an online IFRS survey that I have prepared with Pat Walters of Fordham University. 

I invited Pat to collaborate with me because we have divergent views on the questions being asked.  Thus, I hope that together we have achieved a modicum of balance in the survey's design--particularly in the phrasing of the questions and response choices offered.  There are only 12 multiple-choice questions, and afterwards, I cordially invtie you to express your own opinions regarding its design by posting a comment to this blog post. 

We are also trying to reach many more stakeholders than any other survey has reached to-date on the IFRS adoption/convergence question.  To that end, we hope you will choose to email the link at the bottom of this post to anyone else whom you think might have an interest in taking it.

Pat and I thank you in advance for clicking here to take the survey, or by pasting this ugly link in your web browser:

http://www.surveymonkey.com/s.aspx?sm=pF0E3UgdSV_2bHMQvdAnXv8w_3d_3d

IFRS Adoption Critics: More Silent Majority than Vocal Minority

Given my public record of opposition to IFRS adoption, you might be surprised to know that I have taught courses on IFRS for over ten years, beginning in Switzerland and the UK. If anybody is interested, I will be presenting a two-day IFRS/GAAP comparison courses in Chicago and Vegas this November; and I gladly collaborate on the delivery of those courses with representatives of two Big Four firms.

I try to stay away from blatant self-promotion in the body of a blog post, but I wanted to make the point that I am not an IFRS newbie, and have thought about the problems of which I blog for years. I also strongly believe that certain aspects of IFRS are much stronger than U.S. GAAP.

The larger point, however, is that I actually do have a significant stake in IFRS adoption; yet, for reasons only a psychiatrist might be capable of explaining, I persist in my financially self-destructive rants.

Imagine you're my shrink. As I lie on your couch, I tell you that my attitudes toward IFRS adoption are rooted in my childhood. (Surprise!) Both my parents fled from Nazi Germany, but my Dad was involuntarily detoured in a Nuremberg prison and Dachau concentration camp before managing to finally extricate himself from miscreants' clutches.

After immigrating via the UK to the USA, Dad soon thereafter entered the military (he was drafted after first volunteering and being turned away). He was returned to Germany on D-Day +30 as a POW interrogator. It's a long and unique story, which late in life he wrote about in a book that I posted on line.

Obviously (I try not to use that word very much), my dad's perspectives on life were shaped by these experiences. As to their effect on me, his bitterness rarely came to the surface, except indirectly when he was motivated to speak out against some proximate injustice. Dad was non-violent in actions and manner, but his words were sharp and he didn't give a hoot what others thought of his pithiness and directness. He was only self-conscious about his thick German accent (think Henry Kissinger). Also, I'm sure that his "attitude" and accent did not help his career aspirations at AT&T. Anyway, I think that is the font of my self-destructive outspokenness.

I bring this up now, as I am about to present you with a quote from a kindred spirit, and former Big Four auditor, who shall remain nameless; his nom de email is SuperHeater, and I have no idea what that is supposed to mean, but I have a pretty good idea that his brief turn as a Big Four auditor shaped his perspectives. Here's an excerpt from one of his war stories:

"I knew I needed to leave [the Big Four firm I was working for] after about three months. I had questioned a client (politely) about how they arrived at a $90,000 bad debt reserve on an A/R balance of $10,000,000 for unsecured receivables where the aging detail showed items 500 days old. I was told by the assistant controller that the 'CFO knows our customers, and knows what invoices they'll pay.'

The in-charge senior associate told me, 'I don't care if it's adequate, I care that it's there'- so much for adequate audit evidence and professional skepticism.

The following day I was summoned to meet with the partner on the job (who happened to be the HR partner) in order to be told 'the client had a complaint,' but offered no details. As the client was a trucking company that financed their equipment and was surely trying not to violate the current asset requirement of their debt instruments I suppose that's not hard to figure out. I'd like to say that was my only eye-opening experience, but it wasn't. There were screaming 'seniors' and days when testing exceptions were explained away with 'this appears to be a one-off transaction, P/f/p' rather than expanding the test sample as indicated by the audit plan."

I don't receive many substantive comments on my posts, (roughly two per post), but they are about 95 percent supportive. (BTW, those who have chosen to express their disagreement with my points of view are invariably respectful.) Thus, I want to at least surmise that SuperHeater's sentiments (with certain colorful features omitted) are generally in the same direction as those of a large proportion of my readers. In addition, the comments about how the market for auditing staff will shift after IFRS adoption is a fresh perspective for me.

"Having spent an unpleasant year at KPMG as an older, nontraditional hire and observed their methods and now currently employed at an enterprise where Deloitte is an IT contractor, I remain convinced that the only people who think IFRS adoption (either wholesale, convergence or some other method) is desirable are the Big 4, major transnational corporations and the SEC.

Additionally, the cheerleaders' affection for IFRS has absolutely nothing to do with any intrinsic superior quality, simplicity, brevity or any other (supposed but immeasurable) attribute of IFRS; it's about the ease and profitability of the cheerleaders' enterprises. The transnationals have a similar perspective; the SEC is a study in "regulatory capture", with its bureaucrats giving speeches and missing the likes of Enron, Worldcom, Adelphia & Madoff.

However, the leader of the pack is the Big Four. Like most modern propagandists, they furiously release marketing information disguised as objective technical analysis. I personally think the IFRS' "ordained clergy" are easily identified by the use of the word "robust." We are supposed defer to the presumed expertise of Big 4 partners and senior managers about the arcana of accountancy-especially when they use nebulous language and speak with the authority of historicity with constant references to IFRS as "inevitable."

For years the Big 4 have envied their clients who outsource their production to places like India, China, and other lands, where there's plenty of high intellects looking for opportunity. As the birthrate has fallen in America, it has been harder to represent the typical associate's position as something more glamorous than the fraternity hazing it resembles. The Big 4 have copied the outsourcing on their IT side, where there's no credentialing impediments; but on the attest side – well, that's different. Sure, you can staff an office full of staff and senior associates from other countries; language barriers don't matter that much when you don't speak to the client that much. Also, we know they'll work like the dickens because they're working for permanent US residency and having family half a world away creates less desire for time off.

However, when you get to be a manager, you need to have that CPA-and the exam is hard. Harder still, when you don't speak English, let alone when you have to learn a new book of rules. Do away with GAAP, you do away with the need to comb among potential US born associates with their tender egos, high debt loads and social and esteem needs. Once we're on IFRS, the Big Four becomes a truly global enterprise; picking off bright minds from lands of less opportunity-obtaining a deep inventory of intellectual capital at distress sale prices. Perhaps at the Big Four, the "A" in CPA stands for arbitrageur. I suppose it's a losing battle, because in the end, some very deep and mercenary pockets are driving this surrender of US commercial sovereignty. Now we know why Mr. Niemeier was passed over for the CA job."

The supporters of IFRS adoption have long-dismissed detractors like myself, Charles Niemeier and SuperHeater as comprising nothing more than a "vocal minority." The tepid-to-hostile feedback on the Roadmap should have put that libel to bed, but the recent remarks of chief accountant Kroeker and SEC chair Schapiro indicate that they are willing and able to follow Christopher Cox's oft-repeated example of plowing straight through reasoning critics behind nothing more than a blast of hot air.

I'll soon be posting a link to an online survey of attitudes towards IFRS adoption. Whatever the truth is, I want it to be more clearly evident.

First Missive from the New Chief Accountant: Get Ready to Roll with IFRS

It came as no surprise that SEC Chief Accountant James Kroeker's first public foray, since Mary Schapiro deigned to remove "Acting" from his title, was to announce that the IFRS Roadmap has once again become a priority at the SEC. That should please his former employer, Deloitte, one of the Big Four IFRS Cheerleaders. To give you some indication of the goal-oriented culture from whence Kroeker came, here's a couple of examples from recent "surveys" Deloitte has been peddling.

In 2008, Deloitte asked financial professional what they thought were the benefits and costs of IFRS adoption. That sounds reasonable, but the next logical question appears to have been intentionally left off: which was whether respondents perceived that the benefits of IFRS adoption might not exceed the costs.

And, here's a sample question from a survey I received in my email this month:

In your view, what should the IASB's and FASB's approach be to convergence?

• Extend a comprehensive convergence plan over the next 5-10 years
• Achieve as much convergence as possible between now and 2011, and then focus on IFRS conversion at that point
• Wind down convergence efforts at this time, and support IFRS conversion
• Not sure

"Not sure"? What if you're "sure" or just pretty "sure"; but your answer is not one of the three that Deloitte is willing to tabulate? What if, heaven forefend, you are really "sure" that further convergence efforts would be a waste of time and money?

Answer to my questions: Should you dare opine that IFRS adoption is of no benefit, Deloitte doesn't want to have to acknowledge that gazillions of other like you perchance exist amongst the public, whose interests Deloitte has an ethical obligation to serve. These were not surveys; they were charades. They were put together to serve special interests – at the expense of the investors that Mr. Kroeker now is supposed to be working to protect.

Thus far, the text of Kroeker's remarks have yet to appear, as is customarily the case, on the SEC's website. Consequently, my comments will be based on press coverage from the following sources: CFO.com, Reuters and WebCPA.

Be Very Afraid … of a "Race to the Bottom"

Some people took IFRS adoption for dead, but Kroeker came to say that it has returned to becoming a priority at the SEC, in part because the financial crisis may have underscored its importance. It appears, for example, that without a single authority over standards, the U.S. and Europe may get caught up in a "race to the bottom" to set accounting standards most favorable to banks and to the detriment of investors.

While it is true that the EU has made its fears that lower-quality accounting standards in the U.S. will cause its banks competitive harm, more recent events don't comport with a race-to-the-bottom scenario. The FASB (as I have written here) is proposing that all loans should be fair valued. The FASB is clearing saying to the IASB, 'You can take the low road if you want, but we'll take the high road.' (By the way, there's no way that the IASB will follow the FASB's lead on this. If Sir David Tweedy so much as dreamed of requiring fair value for loans, he'd call up Charlie McCreevy the very next morning to apologize.)

Nonetheless, I do concede that, in the absence of SEC intervention, a race to the bottom is at least theoretically possible. But, for at least two pretty obvious reasons, that possibility is remote, if not downright silly to contemplate.

First, as a general matter, it is not clear that competition among jurisdictions inevitably results in a race to the bottom. As one of many possible counterexamples, consider the development of the state laws governing corporations. The Delaware laws are regarded by many to be least restrictive; however, many corporations choose to register elsewhere. There are two lessons from this that I can think of: (1) there is not necessarily one set of rules to suit all tastes; and (2) the stability and longevity of our system of corporate laws indicates that multiple law givers are preferable to giving the federal government a monopoly on that role. Thus, notwithstanding the 99 other reasons (okay, 10) I can think of, it is far from clear that granting a worldwide monopoly to the IASB is the most efficient thing to do.

Second, and this is the biggie, whatever Kroeker might fear about incentives of standard setters to debase their own coinage, his job, whether he likes it or not, is fundamentally to prevent a race to the bottom from even getting past the starting line. Various securities laws clearly state the authority of the SEC to set accounting standards for public companies. It must be said, however, that the SEC has published its policy that, for the most part, has left standard setting to the FASB. (For the rule wonks amongst you, that would be Section 101 of the codified Financial Reporting Releases.) Kroeker weakly assures us that the SEC will always be active in interpreting accounting standards adopted by SEC registrants, but the SEC historically has done much more than that – by judiciously picking its moments to pre-empt or outright reject FASB pronouncements.

Given Kroeker's own stated preference for uniformity in bank accounting and his own view of its significance in the global financial order, no opportunity could be more ripe than for the SEC to take the initiative on loan accounting. All Kroeker need simply do is to endorse the FASB's proposal to measure all loans at fair value, and counsel the IASB that they should get with the program. That oughta eliminate any fears of an accounting standards race-to-the-bottom.

But, alas, world peace is a more likely scenario; fair value for loans doesn't fly in the EU, so it surely cannot fly with Kroeker's former colleagues at Deloitte. Who wouldn't prefer to know what Kroeker's thinks about loan accounting than the Roadmap? But it's a steady diet of Roadmap that we will surely be force fed in the months to come.

Saying So Doesn't Make it So

As was sadly the case when Christopher Cox was SEC chair, I found nothing in Kroeker's remarks to indicate that he cares much about citing evidence in support of his ideology. Take these accounts:

• Reuters – "Kroeker … said … that in the more than 200 comment letters the SEC has received on the proposal, it was 'resoundingly clear' that people agree there should be a single set of global high-quality accounting standards…"
  
• WebCPA – A single set of global accounting standards is "…like motherhood and apple pie."

Given, as I reported here, that the overwhelming majority of investor responses to the Roadmap proposal want to tear it up, I don't know where he comes up with this stuff. And, don't forget about Deloitte's paranoia about even broaching the question in its "surveys." (By the way, Wayne Carnall, former PwC partner, and chief accountant of the Division of Corporation Finance had characterized the response rate as a pittance, and now Kroeker is spinning 180 degrees away from that.)

Ironically, Kroeker delivered his remarks before a meeting convened by the New York State Society of CPAs. It was there that another candidate for chief accountant, Charles Niemeier, trashed the whole notion of IFRS adoption for what it was: a full-employment act for the current chief accountants' former colleagues.

Not only were Kroeker's and Niemeier's positions as different as black and white, but the quality of their inputs and reasoning couldn't be more starkly contrasted. Niemeier's inspiration clearly sprang from a foundation of cited broad-based analyses produced by published rigorous, peer-reviewed, independent research. The source of Kroeker's remarks apparently came from nothing more than his own wishful thinking.

Emergency Post: Chief Accountant Candidates Could be Down to Just Two

My practice has been to post about once per week, and I had completed my latest less than a day ago. I'm coming back at you so quickly, because Bloomberg News has just come out with this:

"Securities and Exchange Commission Chairman Mary Schapiro settled on two finalists to be chief accountant, acting director James Kroeker and Baltimore money manager Jack Ciesielski, people familiar with the matter said.

Kroeker, a former Deloitte & Touche LLP partner and acting chief since January, and Ciesielski, who has defended mark-to- market accounting, met with commissioners this month to discuss their interest in the job, said the people who declined to be identified before an announcement …" Continued in article.

With the passage of time, it seems increasingly less likely that the next Chief Accountant will come from the Big Four; it would break a string of the last six in a row (more or less, I think). Especially given the records of the most recent guys in charge, I think that most would agree that it's time for a change in emphasis.   

Appointing Jack Ciesielski, a wise and straight-shooting investor advocate, would send a strong signal from the SEC that the voices of special interests would be muted henceforth. But, if Kroeker is promoted to be the permanent big cheese as an appeasement to the Big Four, it will look to much like Chair Schapiro lacked the gumption to face down a special-interest juggernaut. After all, Kroeker's only bona fides as an investor advocate are his leadership of a recent fair value study that chafed the chops of the banking industry big time. Other than that, the public pretty much knows only of his Big Four acculturation (and the inevitable accompanying baggage), and that he was appointed to deputy chief by the best imitation of a paperweight ever to hold the title of chief accountant.

Bonus Coverage

This morning, I merely smiled to myself at the audacity of two missives (missiles?) from PwC that came across from two very different sources. Now, after the sobering news from Bloomberg, not so much. These guys are nothing, if not tenacious.

First, there was a letter to academics directing them in no uncertain terms to include appropriate IFRS-related materials in the courses—else, their students would be deemed insufficiently programmed to serve as audit highly paid drones according to PwC's new hiring hiring criteria:

"PwC believes it is important for our new hires to have sufficient knowledge and skills about IFRS to transition easily into our practice. Therefore, we will include IFRS in the basis for making decisions about an applicant's level of technical and professional skills and knowledge. Starting in Fall 2009, we will expect that applicants will have used our learning opportunities or other means…"  [italics supplied]

Bob Jensen, a retired academic and former American Accounting Association Educator of the Year called the letter in remarks on the AECM listserv an "insult to the academy of accounting educators." ... " and "I've always admired PwC.  But I can only hope that they lose some terrific accounting graduates because of this Orwellian Big Bully strategy." 

Ditto from me, and sad to say some faculty seem all too willingly to line up and salute the flag.  About a year ago, I asked a first-year assistant professor at a smaller university, that was extremely proud of its record of placing students with the Big Four, why they were looking to add an entire course on IFRS to their curriculum.  Her answer was simple, yet devoid of any trace of irony or regret: "It's our job to give the Big Four what it wants."

Second, revisionist history continues in PwC's latest IFRS First newsletter: 

"Due to a new administration, ongoing economic issues, and responses to the proposed roadmap, there is some uncertainty around the final timetable for adoption of IFRS in the US. However, the responses to the Proposed Roadmap indicate that there still is strong support for a single set of global accounting standards. [LOL] We remain confident that:

The SEC is interested in moving forward with IFRS
The SEC will continue to approach the change with a thoughtful, measured process
The SEC will ultimately propose a revised roadmap
Adoption of IFRS in the US is inevitable " [italics supplied]

Has anybody else noticed that the mantra of "single set of high-quality global accounting standards" has been truncated to exclude that pesky 'high-quality' part?  The marching orders to all who have been captured by the Big Four's largesse is becoming more and more pointed:  'Forget quality. Forget convergence. Get with the IFRS program … or no more soup for you!'

If Mary Schapiro doesn't take a strong stand for investors on the chief accountant appointment, then  "inevitable" will become sooner than you can say PricewaterhouseCoopers.'

Which SEC Roadmap Comments Matter, and What They are Saying

A couple of commenters on the last post found fault with my assertion that the "low" response from issuers on the SEC's IFRS Roadmap proposal is pretty much a non-issue. For example, commenter Andy argues that self-selection bias may well exist because only "... those who feel strongly against or for, will make their views known."

I do agree with Andy in general, and there is strong empirical evidence to support that sort of tendency in some circumstances.* But, I don't agree that it is the phenomena that operates on issuer response rates to an SEC proposal such as the Roadmap.  I consider only the following four factors to affect the decision of an issuer's CEO to submit a comment letter: (1) one's stake in each potential outcome; (2) the subjective probabilities of each potential outcome; (3) the costs of commenting; and (4) the subjective probability that a comment letter can favorably influence the SEC's decision.

Thus, strong opinions are not enough – and perhaps irrelevant – to move a CEO to speak out on the Roadmap. The issuers who determined that investing in a comment letter was worthwhile did so.  For whatever reasons a lot didn't, but it is unlikely that it was systematically related to the 'strength' or substance of their opinion.

Moreover, the third and fourth factors, above, indicate that if the comment submission rate is judged insufficient, the Cox-lead SEC should bear some of the responsibility for that. For example, the cost of commenting is influenced by the ease of doing so. I, for one, wasted a full day out of my life to draft one, and then abandoned the project out of frustration. It took just too much effort to respond to all of the niggling questions, and I felt that anything that didn't fit the particular and numerous questions the SEC was asking would not even be classified, much less read.

With regard to the fourth factor, above, it certainly didn't help that the Cox SEC all but threw in the dust bin the strident and numerous criticisms of their proposal to eliminate the IFRS-to-GAAP reconciliation requirement. The saber rattling by the EU, and the relentless lobbying and PR by the Big Four doesn't help either, as they only lend credence to the proposition that bigger fish will have the ultimate say.

Moreover, issuer comments are in my view, a sideshow compared to investors.  If the SEC largely ignores them, that's how it should be. For example, let's take a look at an excerpt from Wal-Mart's response:

"For a global company like ours, [the benefits of IFRS adoption] include standardized reporting systems, efficiency in accounting training, and efficiency of financial statement review. However, these benefits are limited to the extent that various government and regulatory bodies in countries we operate in adopt IFRS as issued by the IASB for all oftheir reporting requirements. Failure to achieve this consistency in reporting standards minimizes or eliminatesany benefits. At the present time, we do not see any other significant benefits to offset the expected costs in adopting IFRS." [italics supplied]

Is Wal-Mart providing an honest assessment of the costs and benefits of IFRS, or do they have a hidden agenda? I haven't looked at Wal-Mart's financials in a few years, but in the years I did, I was amazed at how steady was their growth rate, and their profit margins were like a steady drum beat year after year. Wal-Mart, being in a very straightforward business with short cash cycles and tending to grow without a lot of M&A activity, probably doesn't face a lot of thorny accounting issues where GAAP and IFRS are significantly different. Except for one: asset impairment, where (as I have written here) IFRS can create more earnings volatility than GAAP. I suspect that avoiding the IFRS long-lived asset impairment standard could be their real agenda.

So, the long and short of it is that we can argue about whether the issuer response rate is low, but the SEC shouldn't be paying much attention to issuer comments anyway – except, perhaps, to help them divine what the costs of IFRS conversion to issuers might be. Evaluating the potential for IFRS to improve the quality of information provided to investors should be the purview of investors and others with financial reporting expertise, and who have no obvious axe to grind (academics, for instance).

And what of the auditors' strongly pro-IFRS comments?  I believe they actually have a role in the process, but not the one they have chosen.  I am reminded of a comment made by the irascible college basketball coach, Bob Knight. When asked about his position on a proposal to reduce the time on the 'shot clock' from 45 to 35 seconds, he said something like, "I don't care if you make it 5 seconds! We're good enough to play that game, too; and if somebody is dumb enough to thnk that the best basketball team will win that way, that's their problem."

What I mean to say is that the only thing I want to know from the auditors is akin to Bob Knight's shot clock response.  In switching from IFRS to GAAP will auditing practices and the reliability of an auditor's report be affected?   The Big Four never features (or perhaps even deigns to answer) those kinds of questions, because they are self-evident and non-self-serving: auditing procedures should not change very much, but the reliability of the auditor's report will decline due to greater reliance on management's judgment.

I'll readily admit that everyone is supposed to have a hidden agenda (except me), but with that caveat, I'll close with a selection of what I believe are some of the more revealing comments on the Roadmap proposal by a few of the organizations which, one might say, should hold 'super votes.'**

In summary, while the FAF and the FASB continue to support strongly the ultimate goal of a single set of high‐quality global accounting standards as part of a global financial reporting system, in our view, additional study is needed to better identify, understand, and evaluate the strengths, weaknesses, costs, and benefits of possible approaches the U.S. should take in moving toward that goal. – FASB

Until a single set of standards that produce such a result [high quality standards] exists, with a demonstrated record of compliance andenforcement, we believe it is premature and unwise to move away from U.S. GAAP… [W]e have seriousdoubts as to whether the proposed roadmap, as currently envisioned, will tangibly benefit investors' interests…In our view, the proposal fails to provide sufficient support as to why it presents a better course of action than the current on‐going convergence efforts… – Investors Technical Advisory Committee, FASB

[L]ittle existing research directly addresses whether U.S. investors, issuers, and markets would benefit fromimplementation of IFRS in the U.S. … We recommend further analysis of the costs and benefits of a mandated transition to IFRS for U.S.issuers, investors, and markets. – American Accounting Association, International Accounting Section

In our opinion, converting to IFRS is a solution without an underlying problem. In fact, we have never heard aninvestor in our company, any stock analyst covering Marriott, or any lender with which we do business in theUnited States or abroad suggest to us that they would prefer we report our results in IFRS. – Marriott

We believe that the costs to convert to IFRS will be extraordinary. The total cost to convert to IFRS is extremelychallenging to capture since it involves both quantifiable cash costs, as well as the cost that the distraction andreallocation of resources will cause to businesses. – McDonald's

Amen.

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*See, for example, Richard J. Cebula, "Strong Presidential Approval or Disapproval Influencing the Expected Benefits of Voting and the Voter Participation Rate," Atlantic Economic Journal, (2005)33:159-167.

**Extracted from a document of excerpts presented to members of NASBA

The Comments on the SEC Roadmap are Clear: Make a U-Turn

There are some definite signs that Mary Schapiro is getting closer to naming her Chief Accountant. For example, I received an email from Denny Beresford, former FASB chair, who was left with the impression from a reporter that an announcement would be coming this week. Indeed, because of recent events I'll be discussing in this post, I'm inclined to believe that it will indeed come to pass.

The Chief Accountant appointment will clearly be setting the tone for the debate on the IFRS Roadmap proposal. But I am also getting strong vibes that, this time around, the many negative comment letters in response to the proposal will be a significant factor in the SEC's deliberations —as opposed to Christopher Cox's tone deaf handling of the elimination of the IFRS-to-GAAP reconciliation requirement. Because of that, the IFRS supporters are spinning the comment letters like crazy.

Most recently, CFO.com reported on remarks emanating from Wayne Carnall, Chief Accountant of the SEC's Division of Corporation Finance. He is generally seen to be an IFRS adoption proponent, and rumored to be a candidate for the Chief Accountant in the Office of the Chief Accountant -- yes, I know it's confusing, because he is already a 'chief accountant.' There are, to the best of my knowledge at least four positions at the SEC bearing the title of Chief Accountant. There's one each in the functional divisions of enforcement, corporation finance, investment management; plus the"Chief Accountant to the Commission" with one's own staff to serve the Commission as its principal advisor on accounting and auditing matters. That's the seat of power that everyone covets, and it's the one that has lacked a permanent possessor since Mary Schapiro took over from Cox's gang.

Anyways, Wayne is reported to have expressed his disappointment that so few public companies have even bothered to express their views on the Roadmap proposal:

"A total of 240 letters were received, about half of them from registrants. Cornall [sic] called that level of response 'disappointing.'

'Only about 1% of the companies in the United States that would be impacted by this change, if we were to adopt it, decided to comment. I thought that was a surprisingly low number,' he said.

He noted that a pair of FASB staff positions issued in March on what he called a 'relatively small, narrow item' — valuing assets in illiquid markets — got 700 comments in a 15-day comment period. 'Yet on a proposal to change the reporting framework in the United States we got 120 comments" from public companies during a 120-day comment period."

Wayne seems to be implying that nothing of significance can be inferred from such a low (in his judgment) response rate. He might have a point if the responses were equivocal, but that's simply not the case.

I read only a few of the comment letters, but I know of at least one person who read them all. That would be Gaylen Hansen, a partner in a Colorado CPA firm, and self-described detractor of IFRS adoption in the U.S. Among other high profile national service positions that Gaylen holds, he is chair of the Strategic Initiatives Committee of the National Association of State Boards of Accountancy (NASBA). The data on roadmap proposal comments displayed here is straight from his presentation at recent NASBA regional meetings (video, here):*

The problem for Wayne and other 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.

Not even the AICPA, an IFRS adoption cheerleader for years, can spin a very positive message out of the comment letters, but eschewing all references to actual data, spin fast and furiously they did with something they call an "analysis":

"While many expressed support for the goal of high-quality globally accepted accounting standards, the request for comments produced numerous critics of the SEC's proposed roadmap.  Commentators had serious concerns about the cost of adoption, the benefits of adoption compared to convergence, and whether IFRS were in fact as good as or better than U.S. GAAP. ….

While in the minority, some U.S. registrants generally supported the roadmap and mandatory adoption in the near term. [i.e., the majority voted "nay"] These organizations noted the benefits of global comparability, increased transparency, decreased cost of global financial reporting and the belief that converged standards would fall short of the benefits accruing from use of one global set of accounting standards. …

Responses from investor groups were mixed." [emphasis supplied]---

"Mixed"? While they were relatively few in number, it's safe to say that the major U.S. investor groups one normally expects to weigh in on accounting standards did so here. I suppose one would be technically accurate to state that investors were not unanimous in their strong opposition to the Roadmap proposal, but saying that 'most were strongly opposed' could only be an understatement. (Sometimes, I wonder if the AICPA outsources its communications department to the National Rifle Association.)

Even so, the AICPA's spin is not nearly as blatantly disingenuous as PwC's recent press release:

"Despite uncertainty about timing of the move to International Financial Reporting Standards (IFRS) in the United States, PricewaterhouseCoopers (PwC) maintains that the adoption of IFRS in the U.S. is inevitable [emphasis supplied], and that there is still overwhelming support for a single set of global accounting standards.

We expect steadily increasing convergence activity followed by eventual conversion to IFRS. …

Additionally, all U.S. businesses will face an unprecedented wave of U.S. GAAP changes, influenced by - and, in many instances, conforming to IFRS - over the next several years."

Having to make an explicit choice between the Big Four, and now, practically everyone else, is a scenario that a new SEC chair would certainly like to avoid so fresh out of the box. But, so far, Mary Schapiro appears to be handling it brilliantly: by waiting for IFRS to self-destruct.

"Inevitable"?  Not even close to that anymore.  'Implosion' more aptly describes what is now occuring, with almost shocking rapidity. On the overseas front, Charlie McGreevy of the EU and the European Federation of Accountants (FEE) have been applying countervailing pressure on the IASB to de-link itself from U.S. GAAP -- else the EU is threatening to part company with the IASB. It's a highly credible threat, and it would leave the IASB with little more than the Asian powers, Australia and a gaggle of third worlders no capital markets of their own to speak of.

On the embattled U.S. front, the FASB, without a breath of mention of convergence, has announced its intention to require that all financial assets, including loans, would have to be presented at fair value on the balance sheet. To abandon McCreevy's beloved 'amortized cost' accounting for loans investments in debt instruments would certainly be a bridge too far for EU regulators; and most encouraging to moí, the FASB by this action may finally be tacitly admitting that convergence is holding them back from making urgently needed changes to accounting standards that have contributed to the recent bout of financial havoc.

So, at this rate, the long-awaited appointment of a Chief Accountant may turn out to be an anti-climax -- which is just the way Mary Schapiro would like it.

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

* Gaylen's tabulation of the Roadmap comment letters excludes the Big Four, AICPA and others with an obvious pecuniary interest, foreign companies, foreign accountancy groups, foreign companies currently using IFRS, students and responses that defied classification.

Spinning "Convergence"

"Converge" from Merriam-Webster's Online Dictionary:

1. to tend or move toward one point or another: come together: meet

2. to come together and unite in a common interest or focus

3. to approach a limit as the number of terms increases without limit

Now that it has become abundantly clear that convergence of IFRS and U.S. GAAP is not likely to happen, the proponents of IFRS adoption in the U.S. are trying to downplay its importance, and spinning what convergence is supposed to mean. That stratagem should come as no surprise to those who have observed the numerous instances where immutable plain English words have been misappropriated by accounting standards to serve as terms of art no more artful than Dickens' Artful Dodger.* (For some examples I have posted, see here, here and here.)

I have been meaning to write about the notion of convergence and its implications for some time now, but I was having trouble organizing my thoughts until I read D.J. Gannon's article, The IFRS Convergence Quandary.  Gannon is a Deloitte & Touche partner and as far as I can tell, he is his firm's point person on issues related to the SEC Roadmap.  (As Gannon seems to be singing in unison with the Big Four chorus, I hope that my criticisms are not taken to be a personal attack, but simply as a convenient point of reference.)

"Let's start with what convergence is. Convergence is designed to bring U.S. GAAP and IFRS closer together. The focus is on having similar general principles. Many have misinterpreted convergence as meaning the development of the same or "identical" standards. The reality is that convergence never really contemplated "identical" standards.

In fact, the FASB and IASB have acknowledged that doing so is too difficult to accomplish. This is evident in the boards' recently issued business combinations standards that contain differences in certain requirements. And, based on the boards' current thinking on topics such as consolidations and leasing, differences likely will exist in future converged standards."

I would like to suggest that a reading of very plain language in the Boards' 2008 joint progress reporton the Memorandum of Understanding between the FASB and the IASB indicates a very different view of "convergence":

"Convergence of accounting standards can best be achieved through the development of high quality, common standards over time." [italics supplied]

In other words, both Boards have stated that convergence was intended for GAAP and IFRS to actually meet, and not merely come "closer together." The distinction is crucial, because, by claiming that "convergence" has a meaning that is not in the ordinary-folks dictionary, proponents of IFRS adoption now seem to be trying to find excuses for a lack of progress on convergence—and more important, the increasingly dysfunctional relationships between prime movers at the IASB.  I also can't resist pointing out that the phrase "differences likely will exist in future converged standards" makes no sense without some special meaning for convergence, which neither appears to have been contemplated by the MOU nor accomodated by the dictionary definition of "converge."

As to what the FASB and IASB have "acknowledged" regarding their convergence efforts, the alleged facts are that IASB representatives sat in Norwalk as the FASB determined to finalize their new business combination standards (FAS 141(R) and FAS 160). Those envoys reportedly gave assurances that the areas in which the FASB was sticking its neck out would be adopted by the IASB as well. In essence, the IASB reneged on its assurances; and that's as close to an 'acknowledgement' that I am aware of.

Convergence Has Reached the End of the Road -- Now What?

Actually, D. J. Gannon and I do agree on one thing. We both believe that convergence has probably gone as far as it can go. Our differences concern the question of what to do next. Gannon thinks that the U.S. should be ready for IFRS adoption:

"…[Y]ou only have to look at the recent events surrounding the current financial crisis. What historically have been seemingly harmless differences between U.S. GAAP and IFRS now are the source of much politicization.

Take, for example, the issue of when companies can change the classification of financial assets, which in turn impacts the measurement of these items. Prior to last year, the "technical differences" on classification between U.S. GAAP and IFRS were never considered a significant issue in practice. However, the financial crisis put the IASB under tremendous pressure to conform IFRS to arguably a "lesser-quality" answer under U.S. GAAP. This is only one example of literally hundreds of differences between U.S. GAAP and IFRS that likely will never be addressed by convergence."

Actually, it was the EU (not the "financial crisis") that put the IASB under "tremendous pressure," and just as the FASB responded to the U.S. Congress, the IASB caved. I see nothing compelling about this particular case, but that's not my main point. I find it curious that of the "literally hundreds of differences" that could have been picked, Gannon happened to pick one whose lessons are obscured by anomalous constraints imposed by inefficient banking regulations. Just because Congress and the EU want to shoot the messengers, that doesn't mean the U.S. should appoint a new messenger who will no doubt be harder to shoot the next time Congress wants to engage in that distasteful exercise.  

Also, my wandering mind wants to liken the relationship between the FASB and the IASB, as set out in the 2002 MOU, to a crumbling marriage. Both spouses have made some very poor choices in the past and it's as if one spouse is desperately imploring the other to stay together despite a tumultuous past together. "Everything could be just like it was when we first fell in love if we started a family—just like we were planning when we got engaged!" (sob, sob)

Whoa. I say divorce now rather than take a crazy risk like having kids. And, don't think further counseling is the answer either. As Gannon points out, there are "literally hundreds" of irreconcilable differences. Maybe none of those little tics and peeves matter by themselves, but collectively they're sure to drive the whole family nuts.

In case you don't get it from my cutsey troubled marriage analogy, let me spell it out for you.  Adopting IFRS any time soon will require a giant leap of faith that is not at all warranted by past actions. 

What Exactly is the Problem that IFRS Adoption Will Solve?

I learned from a colleague some years ago that the way to resolve a turf battle is to ask the power grabber to describe precisely what the problem is they are trying to solve, and how their solution solves that problem. 

Gannon's opening statement lays out that problem, insofar as IFRS adoption proponents would have the rest of us see it:  

"One thing most everyone in the financial reporting community can agree on is the need for a single set of high-quality globally accepted accounting standards."

Let's start with the presumption that IFRS is "high-quality." I see that as the biggest reason why the arguments of IFRS adoption proponents are not persuasive to skeptics such as myself. To my way of thinking, the one thing that most everyone in the financial reporting community really should finally admit is that IFRS is deeply flawed, and U.S. GAAP is no better.

In far too many respects that belie any pretense of quality, IFRS merely apes GAAP. The GAAP standards that have wrought the savings and loan crisis, the pension crisis, the thousands of pages of hedge accounting rules, hidden executive compensation costs, and now the worldwide financial crisis are converged all right. They're converged at a point barely above lousy.  In short, we will certainly be no closer to high quality accounting standards by adopting IFRS.

As to the advantages of having a "single set" of standards, it would certainly be desirable for all financial statements to spring from a single set of high-quality accounting standards, but we are worlds away from that utopia.   Indeed, dysfunction is beginning to take over the IASB's most prized relationship, the EU.  Charley McGreevy is grumbling that the IASB may not be able to be satisfy the financial reporting needs of the EU, so it remains a distinct worst-case scenario that the U.S. could adopt IFRS just as the EU is trashing it.

But let's ignore that, and assume that we do end up with a single set of accounting standards, albeit badly in need of improvement.  In that case, I predict that, with the U.S. voice muted, the chances will only increase that broken financial reporting standards will stay broken. I still have high hopes that better financial reporting standards can be obtained, but getting them is much more likely to spring from competition between standard setters than cooperation. In all things capitalistic, competition breeds excellence; and cooperation is the fuel for a race to the bottom.

In summary, failure to converge may be a "quandary" for IFRS adoption proponents.  Should we stop convergence efforts and set the stage for adoption?  "Absolutely," they say.  "Damn the risks and costs... full speed ahead (towards higher consulting fees)!"  But for me, the whole notion of convergence is, and always has been, nothing more than propaganda.

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*"He was a snub-nosed, flat-browed, common-faced boy enough; and as dirty a juvenile as one would wish to see; but he had about him all the airs and manners of a man." (Oliver Twist)