A single set of global accounting standards, rules to be followed by any public company as it reports annual operating results, has become the Holy Grail of Accounting. In today’s world, these rules are embodied in International Financial Reporting Standards. Unfortunately for many good but unwitting people, advocating the U.S. adoption of IFRS is a fool’s errand. To more fully understand the ramifications of this statement let’s turn to the dictionary for a basic frame of reference.
Grail [greyl] –noun (from dictionary.com)
- Also called Holy Grail. a cup or chalice that in medieval legend was associated with unusual powers, esp. the regeneration of life and, later, Christian purity, and was much sought after by medieval knights: identified with the cup used at the Last Supper and given to Joseph of Arimathea.
- Informal. any greatly desired and sought-after objective; ultimate ideal or reward.
Can we adapt the word’s definition to fit into the context of accounting? You beta.
Holy Grail [greyl] of Accounting –noun (The Summa)
- Universally adopted set of global accounting standards that in modern urban legend is associated with unusual powers, esp. perfect transparency in corporate financial disclosure, universal comparability, ethical business purity, optimal investor returns, cross national and international economic stability, and is much sought after by various economists, politicians, governmental regulators, large audit firms and executives of large multinational corporations.
- A greatly desired and sought-after objective; ultimate ideal or reward.
- Accounting ideal that is unsupported by any accounting theory.
The Holy Grail of Accounting is what is known as a fool’s errand.
Fool’s errand –noun (from dictionary.com)
- A completely absurd, pointless, or useless errand.
The American Heritage Dictionary defines a fool’s errand as a fruitless mission or undertaking.
Let me say it again, so no one can possibly misunderstand: The United States quest to join in a single set of global accounting standards (either by convergence or by adoption of IFRS) is a fool’s errand–completely absurd, pointless and useless.
I am not a killjoy. I think that accounting standards must exist in at least some form for a local capital market. Why? If there was only one company in a local capital market, its manager would have to provide feedback to investors in what we have come to call financial statements. If the manager didn’t, there wouldn’t be many investors (perhaps none at all). The company manager would have to disclose how he/she computed the numbers on its financial statements, else no one would invest in it. He/she would quickly discover that providing investors the information they want would return more invested capital, as would securing an independent audit of the financial statements. There are many details I won’t go into, such as incentives for the company manager to resist providing investors with financial information, so eventually there is a compromise between manager and investor preferences.
Add a few companies, and pretty soon many of them are copying the accounting methods from the most popular (i.e., successful) company, so the wheel does not need to be continually reinvented.
Eventually, a company performs poorly enough to provide an insufficient return, no return at all, or else go bankrupt. It is likely (probable) that financial statements will be intentionally misstated so as to prolong the day of reckoning, for it is economically rational for company managers to do so. However, the bad news always come out in the end. Then investors will cry foul (we didn’t see it coming), and government steps in to fix things.
Government regulation of its national capital market is inevitable. Although economic instability can bring a new government to power, economic stability will keep it there. The creation of accounting standards is a necessary step because government regulates with rules and enforcement.
The design of accounting rules depends upon many factors, such as history, societal norms, economic forces, legal system, taxation and culture, to name a few. Around the world, we have seen government regulation of each country’s capital market produce three types of accounting standards design: (1) protect investors, (2) protect corporate interests, (3) provide information for taxation. Everything is keyed around the power and authority of the government, as it is the government performing the regulation.
The success of government regulation of accounting standards and the resulting corporate compliance is dependent upon several factors. Chief among them is that accounting standards for a country must properly be set to balance investor interests for more complete information against corporate management interests for less disclosure. If a government’s regulatory scheme gets this right, then compliance is enhanced because societal norms reinforce incentives to comply and enforcement is efficient and effective. If government regulation gets this wrong, then compliance is problematic, as is enforcement.
One national capital market and one government leads to one set of accounting standards. Multiply as needed for all the market-government couplings.
The U.S. system of capital market regulation has been less effective because (1) the government has delegated the task of creating accounting standards to a private organization that is not charged with striking a balance between corporate and investor interests (see Acevedo’s work), and (2) the government does not directly enforce accounting standards, relying instead upon independent auditors (see Peterson’s work).
Now the U.S. is converging toward a single set of global accounting standards. What makes this a fool’s errand is there exists no reason for it. No one has explained what benefits exist that outweigh the need for regulation on a country by country basis.
I understand that the partners of some of the largest auditing firms will get rich, as will certain regulators that facilitate the convergence (such as David Tweedie, Mary Schapiro and James Kroeker).
What I don’t understand is why a move to a more independent private accounting setting organization with increased reliance on large audit firms will produce more effective government regulation when such actions in the past have resulted in less effective government regulation.
Dr. Raymond Ball in his very popular paper, “International Financial Reporting Standards (IFRS): Pros and Cons for Investor,” discusses these very issues.
Professor Ball explains why it is natural and expected that accounting standards differ: (1) From one country to another, there are significant differences in users and the information they desire, differences in companies and their industries, differences in countries and their cultures. It has never been shown that a unique set of standards can exist for all. (2) From one country to another, government imposed rules are political solutions to circumstances in that country, and cannot be interpreted as optimizing all public interest (only a public interest).
Despite claims that there now exists a single global capital market, Dr. Ball says that simply isn’t so. “The fundamental reason for being sceptical about uniformity of implementation in practice is that the incentives of preparers (managers) and enforcers (auditors, courts, regulators, boards, block shareholders, politicians, analysts, rating agencies, the press) remain primarily local.”
Is the only purpose of this convergence to enrich certain individuals at the expense of the vast majority of citizens of the affected economies? It seems so. That’s why it is a fool’s errand.
The next worldwide economic crash starts with the implementation of the holy grail of accounting.
Debit and credit – David Albrecht