Accounting, as students are often told, is the language of business. Until recently, however, every country had its own dialect. Now Christopher Cox, the outgoing head of the U.S. Securities and Exchange Commission (SEC), has proposed that the U.S. give up its traditional rules and move to a common international standard.

The benefits of such a move, Cox argues, are that companies operating across borders would have to keep only one set of accounts, and investors would have an easier time comparing the outlook of companies in different countries. 

Under the proposal, within 10 years companies around the world would use a uniform language of accounting, a kind of bean counters’ Esperanto. That word refers to a universal common tongue developed in the late 19th century that some visionaries thought would connect the world’s diverse peoples. Instead, English became the global language—at least for purposes of trade, commerce, and science.

If the SEC’s Cox has his way, the path to accounting’s standardization will run in the opposite direction. Instead of an Americanization of accounting worldwide, U.S. companies will gradually move toward the rules formulated by the London-based International Accounting Standards Board (IASB). As the table shows, these are known as International Financial Reporting Standards, or IFRS. 

As AIER’s newly revised publication, How to Read a Financial Statement, explains, accounting standards define the rules governing how companies can report their profits (or losses).  Companies typically have a tendency to want to overstate their success. Higher reported earnings (profits) often lead to a rise in a company’s stock, and perhaps to performance bonuses for upper management as well.

The result is a game companies and regulators such as the SEC play. Within the rules, how rosy a picture can a company paint? For now-defunct Enron, the answer turned out to be, not that rosy: Bend accounting rules far enough, and people will go to jail. (The Enron story, incidentally, is given a chapter of its own in How to Read a Financial Statement, as is today’s subprime-mortgage financial meltdown.)

In any case, Cox’s proposal, if adopted, would represent both a rare move by the U.S. to align its laws with a world standard and an implicit admission that the U.S. approach—adhering to generally accepted accounting principles (GAAP)—has outlived its usefulness.

Some large multinational U.S. companies are already using the alternate rules. Under the Cox plan, about 100 now qualify to use only the international standards as of 2010. (For that matter, as this handbook on IFRS points out, since November 2007 foreign companies operating in the U.S. have been allowed to use the IFRS, not GAAP, in their filings with the SEC.) 

Other companies would have more time in making the transition. Indeed, one of the provisions of Cox’s proposed road map is that within a year or two, a study group should monitor the success of the project. The implication is that if things go badly, the shift to a single international standard could be scrapped.

On the other hand, if things go well, smaller companies would have up to eight years to make the move.

Apart from the one-time cost and general wear-and-tear of such a transition, there is also the matter of the new governance board’s independence. This gets down to funding. As the U.S. record shows, the authority of a financial accounting standards board depends on who pays the piper.  In general, if it is professional accountants, the standards will be weakened. Only when a standards setting board has its own money can it be expected to act independently.

What would such a shift mean? In the abstract, it would bring more emphasis on principles and less on rules. FASB’s 160-odd principles (more accurately rules) try to anticipate every different problem and prescribe a solution. By contrast, the IFRS standards are less specific and more conceptual. 

The distinction here is between the letter of the law and the spirit of the law. The spirit of the law is what the international guidelines try to codify, leaving it up to the auditors to decide whether a company has published its financial statements in good faith. The letter of the law is what FASB had tried to spell out in detail.

Practically speaking, it would also mean that companies’ reported profits would typically be higher than under GAAP. Still, whatever the confusion or obfuscation that might arise from the shift, the tendency toward an increase in reported profits under IFRS would likely be a one-time event for any given company. In subsequent years, a company’s profit comparisons would be standardized.   

None of this is set in stone.  Rather, Cox and the SEC have made the proposal, laid out a road map and timetable, and provided for interim monitoring to make sure that the transition remains feasible for smaller, more localized U.S. firms.

Given the ever-growing list of GAAP principles, however, the move to the IFRS would seem to offer a move toward greater simplicity and uniformity.  In sum, an alternative to GAAP is beginning to look like a good idea, and the IFRS may offer one. 

Share this article: