On February 25, 2010, the Securities and Exchange Commission (SEC) released a formal Commission Statement in Support of Convergence and Global Accounting Standards.
I never got around to reacting. Today (March 29, 2010), Ed Ketz publishes his reaction, “The Iffiness of IFRS” at SmartPros. It’s better than anything I can write (anything Ed writes is always going to be better than anything I can ever write, just take it for truth). For those of you new to The Summa, Professor Ketz is a charter member of the group of IFRS critics.
For years, Ketz has railed (Merriam-Webster: to revile or scold in harsh, insolent, or abusive language) at the corporate practice of financial reporting. He has repeatedly said that the number one problem is that corporations simply don’t follow the rules. If ever they were all to be in a general state of compliance, then we could talk about about the structure of accounting standards. But first, we need compliance. Generally speaking, he favors specific accounting rules that permit no wiggle room. Such rules make it easier to crack down on wrong-doers.
Professor Ketz’s latest editorial is “The Iffiness of IFRS.” He responds to the SEC and suggests several issues that still need to be worked out before IFRS adoption. Although the context for his remarks is opposing IFRS adoption, he believes the biggest problem with the proposed transition is:
… whether IFRS statements can be audited and what will happen in the courtroom after a firm experiences severe declines in its stock price.
Ketz concludes with:
… I again marvel at the rush to IFRS. The benefits do not appear to match or exceed the costs of the adoption.
Here’s what Professor Ketz says in, “The Iffiness of IFRS.” He mentions six issues that should give the SEC cause to slow down or reverse its rush to IFRS.
These concerns question whether IFRS is the Holy Grail it is portrayed to be primarily because of various implementation and administrative issues. Let’s turn to these issues.
First, the SEC says that IFRS must be sufficiently developed to apply the system to the U.S. reporting system. The SEC then indicates there are concerns with respect to the comprehensiveness, the auditability and enforceability, and the consistent and high-quality application of IFRS. The SEC staff notes that commentators have criticized IFRS because they allow savvy managers significant wiggle room to manipulate accounting numbers and disclosures and thwart efforts by auditors to perform high-quality audits. Indeed, some wonder whether principles-based annual reports are even capable of being audited. Another issue raised by the SEC is whether standards will be uniformly enforced around the globe—the answer is of course not. The real questions are how divergent will this enforceability be and what will be its significance.
In just a few words, Ketz summarizes the reasons for his opposition to IFRS. First, IFRS is not designed to produce the types of information that American investors can use in evaluating their investments. Second, IFRS will make it easier for corporate managers to manipulate their financial statements. Third, auditors will not be able to check corporate manipulative practices. Fourth, legal systems around the world will evolve GAAP to fit the requirements of that country. IFRS will never be uniformly adopted or enforced around the world.
Second, the SEC probes the independence of the IASB, especially since much of its operating funds comes from corporate donations. Do you think that maybe, just maybe, corporate donors want something in return? Whether the board is free from undue influence won’t require much research since economic theory posits that managers have huge incentives to gain control over the IASB. As an aside, many have criticized the FASB for moving at the pace of a tortoise. Do they realize that the IASB will make the FASB seem like a hare?
Here, Ketz predicts that IASB will be more lobbyist friendly that the FASB. That’s hardly good news for investors.
Third, will investors understand IFRS? The SEC staff promises to empirically assess the current knowledge of investors about the IFRS. I wouldn’t waste the resources. Except for institutional investors, the answer is they don’t understand IFRS, and they won’t have any incentives to learn until the change is imminent. More importantly, as the costs for learning IFRS are large, we probably shouldn’t worry about investors. Let them depend on the skills and independence of financial statement researchers and analysts.
Ketz makes a good point here. Investors won’t understand IFRS-based financial statements. I agree. I also think that professors won’t be able to understand or teach IFRS. More good news to corporations massaging their financial statements.
Fourth, IFRS could have unknown effects in areas other than investments, the domain of the SEC. For example, financial statements are used by industry and anti-trust regulators and federal and state taxing agencies. Will an adoption of IFRS have a perverse effect on national and state policies?
Good catch, Professor Ketz. Yes, I agree there will be unintended consequences to IFRS adoption. In other words, we simply can’t predict all the difficulties that will eventually arise.
Fifth, the SEC speculates about the impact of adopting IFRS on issuers, including changes to accounting information systems, implications for contracts that depend on accounting numbers, and concerns about corporate governance. My short response is that it’s about time the SEC started thinking about these issues. It is fairly clear to me that the adoption of IFRS will require many issuers to keep dual systems for several years. Annual reports are utilized for too many things to move wholly to IFRS. In turn this will add to the costs of adoption and to its complexity.
Sixth, the SEC mentions human capital readiness. Except for the Big Four and some of the largest corporations, is anybody ready for the transition? If the IASB opened up its data base and supplied users with free training materials, then maybe managers and analysts and accountants could prepare themselves for the transition—unless the banking industry or Congress decides to introduce new and worse problems for the business community.
If the SEC is serious about making a reasoned decision about IFRS in 2011, then they should evaluate Professor Ketz’s concerns and have second thoughts.
Debit and credit – – David Albrecht