Who pays under uniform global accounting rules?
When investors examine a company before a stock buy, how do they know they can trust the books? The U.S. Securities and Exchange Commission mandates that companies report their numbers using Generally Accepted Accounting Principles to further its missions of promoting investor protection and market integrity. Since some two-thirds of U.S. investors own securities issued by foreign companies, the SEC has flirted with the notion of abandoning homegrown GAAP in favor of International Financial Reporting Standards.
When investors examine a company before a stock buy, how do they know they can trust the books? The U.S. Securities and Exchange Commission mandates that companies report their numbers using Generally Accepted Accounting Principles to further its missions of promoting investor protection and market integrity.
Since some two-thirds of U.S. investors own securities issued by foreign companies, the SEC has flirted with the notion of abandoning homegrown GAAP in favor of International Financial Reporting Standards. Would requiring use of international standards in the U.S. be a boon for investors and businesses in this country? Probably not, says Maria Wieczynska, an accountancy assistant professor at the W. P. Carey School of Business.
Wieczynska studied how mandatory use of IFRS impacted the business community in five European countries. According to her, the switch can pay off well for big global accounting firms. The rest of us face dubious benefit.
A matter of principle
What’s the difference between GAAP and IFRS? The big split is a matter of principles.
“
U.S. standards are generally more rules-based. They’re very prescriptive,” explains Wieczynska. She says the reason for this is the stringent regulatory environment in the U.S. as well as the litigious character of market players. “People get sued often, and so do businesses. In order to defend themselves, businesses need to have rules in place that they followed so they can say this is what we did and this is why we did it.”
But, Wieczynska notes, international standards are more principles-based. “What that means is there’s a lot more room for judgment,” she says. “Things are not as clear-cut. Auditors and managers have to decide how to apply the standards.” Would a manager’s or auditor’s interpretation of the rules be considered appropriate by a U.S. regulator or judge? Maybe not, she says.
Along with the differing use of principles between U.S. and international standards, there are a few different rules in IFRS that might make U.S. companies balk. One is the way companies can account for the original prices of their inventory. Internationally, organizations must measure the cost of inventory according to its actual cost or average cost. In the U.S., companies can use the most recent price of the inventory, even if that price is higher than what the firm paid for the inventory originally. That shrinks profit on the books, as well as tax liability.
“Companies use this rule to save billions,” Wieczynska notes. “It doesn’t make economic sense” for a tax authority, she adds. “International standards don’t allow it.”
Making a case
What prompted Wieczynska to start looking at international standards in the first place? When SEC officials first published a roadmap for IFRS adoption in the U.S., officials said the move was designed to help investors compare corporate financial information more easily. Published in 2008, this roadmap called for some U.S. companies to start using the international standards as early as 2014. In the press release announcing the move, then SEC Chair Christopher Fox said, “An international language of disclosure and transparency is a goal worth pursuing on behalf of investors who seek comparable financial information to make well-informed investment decisions.”
He added: "The increasing worldwide acceptance of financial reporting using IFRS, and U.S. investors' increasing ownership of securities issued by foreign companies that report financial information using IFRS, have led the commission to propose this cautious and careful plan.”
Wieczynska might consider “worldwide acceptance” of IRFS to be a questionable view. Among her research projects is one where she examined compliance with the European Union’s mandatory use of IFRS for some firms. The mandate covered only the largest firms that fit a certain subset of characteristics, she explains. “Firms that didn’t have those specific characteristics didn’t have to adopt IFRS. They could have, but they didn’t have to,” she says. “Then, on top of that, some countries within the European Union offered additional options for adopting IFRS” … or not.
In her study, Wieczynska found the result of this flexible approach was that four years after the EU mandated adoption, nearly 18 percent of the companies weren’t using the international standards. Some 42 percent of those non-adopters presented consolidated financial statements, which was one of the conditions requiring IFRS use according to the EU mandate.
“If other countries are not adopting IFRS fully, why should we?” Wieczynska asks.
Even more important, she questions the appropriateness of international standards for U.S. companies. “The way that capital markets evolve over time reflects the culture and institutions in a country,” She says. “Our standards have grown up over many decades in the U.S., reflecting our legal environment, our regulations and our investors’ needs. While these other standards have been created with the nice idea of one-size-fits-all, it’s not necessarily the case on a global scale.”
Finally, Wieczynska wonders if U.S. investors actually would be better off with a switch to international accounting standards. She notes the U.S. is the world’s largest capital market, and investors “would have to learn how to interpret these standards” if the U.S. adopted them. Auditors and accountants would face a learning curve, too. “There’s a cost involved in switching,” she says.
Chunk of change
So, who would benefit most from a switch from GAAP to international standards? According to Wieczynska’s research, it’s the global auditing firms — the largest accounting firms in the world — that stand to make a chunk of money from the standards change.
This is evident in Wieczynska’s study of audit-firm switching in five European nations after mandatory adoption of IFRS. The nations studied were the U.K., Poland, Germany, Italy and Spain. Wieczynska defined large global accounting firms as the Big Four —PricewaterhouseCoopers LLP, KPMG, Ernst & Young and Deloitte Touche Tohmatsu — as well as two large international firms: BDO and Grant Thornton LLP.
“Client firms that were using small, domestic accounting firms were more likely to switch to those big firms when their country went with international standards,” Wieczynska says. She also saw increases in consulting fees paid out as client companies scrambled to get their accounting systems ready for IFRS. Those fees went to the big guys, too. She thinks client firms figured that it was “better to use brand name firms than some unknown auditor with questionable IFRS knowledge.”
Smaller firms that acquired knowledge of international standards did regain clients over time, Wieczynska found. Still, her studies prompt her to consider the threat of oligopoly and the potential price fixing that could result when just a few firms dominate a market. “We used to have the Big Eight. Now we have the Big Four. Do we want these four firms to increase audit market concentration even more?”
Wieczynska isn’t the only accountancy expert who questions the benefit of international standards for U.S. issuers. When the SEC first published its 2008 roadmap for adoption of IFRS, the research committee of the American Accounting Association said, “We therefore recommend that the SEC conduct a more thorough analysis of the costs to issuers, investors and markets of a transition to IFRS — and perhaps more importantly — a thorough analysis of the potential benefits to issuers, investors and markets.”
Fast forward to 2014, and the current SEC leadership is stepping back from IFRS adoption, but the accounting world isn’t necessarily walking away from the idea of global standards. As it turns out, the organizations responsible for IFRS and GAAP have been working together to minimize some of the differences in the two sets of standards. Wieczynska says a new, jointly created standard on revenue recognition is expected to be issued by the two accounting boards this year.
“Maybe the U.S. won’t need to adopt the whole set of international standards, but rather we could move as close to IFRS as possible,” she says. “We would get the benefit of being comparable with the international community without losing all the good things we have in our own standards.”
Bottom line
• The SEC has flirted with the notion of mandating International Financial Reporting Standards instead of the U.S. Generally Accepted Accounting Principles to protect investors.
• Assistant professor of accountancy Maria Wieczynska questions whether such a move would serve its purpose.
• According to her, the U.S. has more stringent regulations than other countries, as well as a litigious culture that makes our current, rules-based standards more fitting than the principles-based international standards.
• Her research also has found that even in the European Union, where IFRS are mandated for some firms, international standards aren’t universally applied.
• In addition, when countries switch to IFRS, Wieczynska found that smaller, local accounting firms lose clients to large global auditing firms.
• Citing the risk of oligopoly, this accountancy expert favors a blending of the two standards rather than replacement of GAAP with IFRS in the U.S.
U.S. standards are generally more rules-based. They’re very prescriptive,” explains Wieczynska. She says the reason for this is the stringent regulatory environment in the U.S. as well as the litigious character of market players. “People get sued often, and so do businesses. In order to defend themselves, businesses need to have rules in place that they followed so they can say this is what we did and this is why we did it.”
But, Wieczynska notes, international standards are more principles-based. “What that means is there’s a lot more room for judgment,” she says. “Things are not as clear-cut. Auditors and managers have to decide how to apply the standards.” Would a manager’s or auditor’s interpretation of the rules be considered appropriate by a U.S. regulator or judge? Maybe not, she says.
Along with the differing use of principles between U.S. and international standards, there are a few different rules in IFRS that might make U.S. companies balk. One is the way companies can account for the original prices of their inventory. Internationally, organizations must measure the cost of inventory according to its actual cost or average cost. In the U.S., companies can use the most recent price of the inventory, even if that price is higher than what the firm paid for the inventory originally. That shrinks profit on the books, as well as tax liability.
“Companies use this rule to save billions,” Wieczynska notes. “It doesn’t make economic sense” for a tax authority, she adds. “International standards don’t allow it.”
Making a case
What prompted Wieczynska to start looking at international standards in the first place? When SEC officials first published a roadmap for IFRS adoption in the U.S., officials said the move was designed to help investors compare corporate financial information more easily. Published in 2008, this roadmap called for some U.S. companies to start using the international standards as early as 2014. In the press release announcing the move, then SEC Chair Christopher Fox said, “An international language of disclosure and transparency is a goal worth pursuing on behalf of investors who seek comparable financial information to make well-informed investment decisions.”
He added: "The increasing worldwide acceptance of financial reporting using IFRS, and U.S. investors' increasing ownership of securities issued by foreign companies that report financial information using IFRS, have led the commission to propose this cautious and careful plan.”
Wieczynska might consider “worldwide acceptance” of IRFS to be a questionable view. Among her research projects is one where she examined compliance with the European Union’s mandatory use of IFRS for some firms. The mandate covered only the largest firms that fit a certain subset of characteristics, she explains. “Firms that didn’t have those specific characteristics didn’t have to adopt IFRS. They could have, but they didn’t have to,” she says. “Then, on top of that, some countries within the European Union offered additional options for adopting IFRS” … or not.
In her study, Wieczynska found the result of this flexible approach was that four years after the EU mandated adoption, nearly 18 percent of the companies weren’t using the international standards. Some 42 percent of those non-adopters presented consolidated financial statements, which was one of the conditions requiring IFRS use according to the EU mandate.
“If other countries are not adopting IFRS fully, why should we?” Wieczynska asks.
Even more important, she questions the appropriateness of international standards for U.S. companies. “The way that capital markets evolve over time reflects the culture and institutions in a country,” She says. “Our standards have grown up over many decades in the U.S., reflecting our legal environment, our regulations and our investors’ needs. While these other standards have been created with the nice idea of one-size-fits-all, it’s not necessarily the case on a global scale.”
Finally, Wieczynska wonders if U.S. investors actually would be better off with a switch to international accounting standards. She notes the U.S. is the world’s largest capital market, and investors “would have to learn how to interpret these standards” if the U.S. adopted them. Auditors and accountants would face a learning curve, too. “There’s a cost involved in switching,” she says.
Chunk of change
So, who would benefit most from a switch from GAAP to international standards? According to Wieczynska’s research, it’s the global auditing firms — the largest accounting firms in the world — that stand to make a chunk of money from the standards change.
This is evident in Wieczynska’s study of audit-firm switching in five European nations after mandatory adoption of IFRS. The nations studied were the U.K., Poland, Germany, Italy and Spain. Wieczynska defined large global accounting firms as the Big Four —PricewaterhouseCoopers LLP, KPMG, Ernst & Young and Deloitte Touche Tohmatsu — as well as two large international firms: BDO and Grant Thornton LLP.
“Client firms that were using small, domestic accounting firms were more likely to switch to those big firms when their country went with international standards,” Wieczynska says. She also saw increases in consulting fees paid out as client companies scrambled to get their accounting systems ready for IFRS. Those fees went to the big guys, too. She thinks client firms figured that it was “better to use brand name firms than some unknown auditor with questionable IFRS knowledge.”
Smaller firms that acquired knowledge of international standards did regain clients over time, Wieczynska found. Still, her studies prompt her to consider the threat of oligopoly and the potential price fixing that could result when just a few firms dominate a market. “We used to have the Big Eight. Now we have the Big Four. Do we want these four firms to increase audit market concentration even more?”
Wieczynska isn’t the only accountancy expert who questions the benefit of international standards for U.S. issuers. When the SEC first published its 2008 roadmap for adoption of IFRS, the research committee of the American Accounting Association said, “We therefore recommend that the SEC conduct a more thorough analysis of the costs to issuers, investors and markets of a transition to IFRS — and perhaps more importantly — a thorough analysis of the potential benefits to issuers, investors and markets.”
Fast forward to 2014, and the current SEC leadership is stepping back from IFRS adoption, but the accounting world isn’t necessarily walking away from the idea of global standards. As it turns out, the organizations responsible for IFRS and GAAP have been working together to minimize some of the differences in the two sets of standards. Wieczynska says a new, jointly created standard on revenue recognition is expected to be issued by the two accounting boards this year.
“Maybe the U.S. won’t need to adopt the whole set of international standards, but rather we could move as close to IFRS as possible,” she says. “We would get the benefit of being comparable with the international community without losing all the good things we have in our own standards.”
Bottom line
• The SEC has flirted with the notion of mandating International Financial Reporting Standards instead of the U.S. Generally Accepted Accounting Principles to protect investors.
• Assistant professor of accountancy Maria Wieczynska questions whether such a move would serve its purpose.
• According to her, the U.S. has more stringent regulations than other countries, as well as a litigious culture that makes our current, rules-based standards more fitting than the principles-based international standards.
• Her research also has found that even in the European Union, where IFRS are mandated for some firms, international standards aren’t universally applied.
• In addition, when countries switch to IFRS, Wieczynska found that smaller, local accounting firms lose clients to large global auditing firms.
• Citing the risk of oligopoly, this accountancy expert favors a blending of the two standards rather than replacement of GAAP with IFRS in the U.S.
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