Hitting the buffers?

Just how well is the accounting standards ‘convergence’ programme between Europe and the US progressing? asks Richard Aitken-Davies

The US Securities and Exchange Commission (SEC) has voted on a proposal to allow non-US companies to file their accounts using International Financial Reporting Standards (IFRS) without the requirement to reconcile them to US Generally Accepted Accounting Principles (GAAP). Now the SEC is looking to allow US companies the choice of IFRS or US GAAP. Just a few years ago this prospect seemed light years away.

Under the ‘road map’ agreed between the SEC and European Commission (EC), the EC will then confirm its recognition of US GAAP as equivalent for use in Europe. The plan includes a programme of short-term convergence amendments to IFRS to align them closer to US GAAP, and vice versa, together with continuing joint development projects for longer term improvements to standards. Milestones have been agreed by the two standard setters – the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) – which do not look too demanding.

By 2009 only one new converged standard – for business combinations – actually has to be completed. For other standards, the road map requires that either consultation documents on proposed changes should have been issued, or items should be part of an ‘active’ agenda. The SEC also has to be satisfied with the results of the 2005 transition to IFRS by European companies and their proper application of the standards. But there seems little here to stop the long-sought mutual recognition.

So where are the problems? They are most evident on the European side of the Atlantic, centring on both content and the revised IFRS endorsement process. The convergence project pointed to a number of US-imported changes to standards that had only just been adopted by European companies, the vast majority of which are not, and do not intend to be, listed in the US. They will bear the cost of change, but will not obviously benefit from the removal of US GAAP reconciliation requirement.

And if this was not a sufficient enough problem, the European Parliament has now shown increasing interest in the subject of accounting standards, most recently with the contentious IFRS 8, the first of the IASB’s short-term convergence standards, dealing with segmental reporting. In the UK, key investor bodies have expressed vociferous, but late, reservations to the relevant EU parliamentary committee over the perceived reduction in information this US import entails.

These investor groups owe the market an explanation for both the timing and nature of their objections. Why did they not raise these concerns sufficiently with the IASB in the consultative due process? If the segmental information in IFRS 8 satisfies the needs of the world’s largest capital market, why can’t it do so for Europe? Nonetheless, endorsement of IFRS 8 has now been suspended until the EC conducts an impact assessment and the Parliament votes on the subject this month.

Arguably, the real issue here is less about the merits or otherwise of IFRS 8, and more about the EU political process in action. Enduring resistance to the IASB itself, seen by many in Europe as lacking democratic legitimacy, has now led to the European Parliament securing a right to consider in detail each and every new IFRS or official interpretation. This oddly-named ‘comitology with scrutiny’ procedure represents a shift of power from the Commission to the Parliament, and could present a serious obstacle to the quick delivery of the EC/SEC road map.

There are several convergence matters which still have to go through this new procedure, and where opposition is already evident. These are: the amendments to IAS 23 requiring the capitalisation of interest costs in contrast to the current majority practice to expense these; ending proportional consolidation of joint ventures; and the new standard on business combinations.

The standard on business combinations, which are often the biggest transactions undertaken by companies, is the most important. The exposure draft of the revised standard was almost universally unpopular when it was issued for comment, and the IASB has been making amendments. The incomprehensible ‘full goodwill’ concept has been dropped, but the requirement for immediate write-off of transaction costs remains, as does the restatement requirement for pre-acquisition holdings to fair value in a step acquisition through profit and loss. There seems plenty for the European Parliament to get its teeth into here, and it appears to have the appetite.

Implications

What if this hardening attitude in Europe creates differences between the IFRS as issued by the IASB and an EU-endorsed version of IFRS? Initially, the reconciliation requirement would stay in place. The SEC has made clear that its road map only applies to IFRS as issued by the IASB.

But what would be the implications for the global accounting standards project? Progress would not stop, but it would probably slow down.

Many felt that the IASB did not adequately consult on the decisions on US GAAP convergence, which were fundamental to the direction of its work. The areas of achievement in US/IFRS convergence are precisely those areas which are generating opposition and resistance in Europe. This may in the end be resolved at the cost of delay and muscle-flexing between EU institutions. But it appears the IASB is going to have to allow more time for the new endorsement process in Europe.

However, the EU delays are probably indicative of a more extensive challenge for global standard setting. We may have to accept other jurisdictional delays and differences as the local consequences are digested and disputed.

We can only hope that the convergence and compliance consequences will be matters of timing because the benefits of a global code for accounting standards are compelling.

As IASB’s work has progressed, IFRS have been increasingly seen internationally as the basis for a comprehensive set of global standards. Arguably, the real gaps remaining are limited to SMEs, insurance and extractive industries.

Once these are satisfied, the burden of proof of the need for new standards or significant amendments falls on the IASB. It will have to consult more fully and justify its work programme, not just with the SEC and the EC, but with the worldwide constituency which faces costs and training pressures relating to translation, dissemination and implementation of these changes.

ACCA is committed to the concept of global accounting standards and to the work of the IASB. However, the pressure for fuller consultation and proper justification of further changes is irresistible and must be met if the present progress on convergence is to be maintained.

Richard Aitken-Davies is ACCA’s Deputy President.