In Search of a New Financial Order
May 1 2005 by Chief Executive
Consistent, comparable and understandable financial information is the lifeblood of commerce and investing. Despite growing globalization, national borders still restrict financial reporting. Financial reports produced by companies domiciled in various countries contain financial statements based on very different accounting standards. Multinational companies operating or raising capital must maintain multiple accounting records and financial reports, and international investors and financial analysts must grapple to understand them.
The added costs from having to use this complex hodgepodge of financial information can run in the tens of millions of dollars annually. In the international arena, they can act as a barrier to forming and allocating capital efficiently. Thus, there are growing demands for the development of a single set of high quality international accounting standards.
Presently, there are two sets of accounting standards that are accepted for international use€¦quot;the U.S. Generally Accepted Accounting Principles (GAAP) and the International Financial Reporting Standards (IFRS) issued by the London-based International Accounting Standards Board (IASB). Foreign subsidiaries of U.S. multinationals use U.S. GAAP. Many foreign companies, attracted to our capital markets, have either adopted U.S. GAAP or reconcile their financial information with SEC requirements. However, IFRS is rapidly gaining acceptance as 70 countries around the world already use it, and all listed companies in the European Union must adopt it starting this year.
One way to get a single set of international accounting standards would be by fiat with governments and securities regulators mandating that either U.S. GAAP or IFRS (but not both) be used. But international politics makes that extremely unlikely.
Another path might be to allow companies to use either U.S. GAAP or IFRS. The marketplace would eventually determine which one prevails. But many informed observers believe this would only add to confusion and costs. Instead, most capital markets participants have gravitated to the idea of “international convergence” between U.S. GAAP and IFRS as the best solution.
And so it is that we at the U.S. Financial Accounting Standards Board (FASB), together with our counterparts at the IASB, have embarked on a systematic program to converge standards. This is a daunting task, since there are literally hundreds of areas of difference between our standards. Convergence necessitates compromises, but these will be difficult to achieve. This is particularly understandable in the post Sarbanes-Oxley era in the U.S. with its many changes in financial reporting.
We must avoid achieving convergence for its own sake and develop high quality converged standards that also improve the current state of financial reporting here and around the world. Our process must be careful, thorough and open, allowing participants sufficient time to adjust.
Much has been achieved already in converging our standards. Modifications have been made in accounting for business combinations. There has been progress in changing standards for tabulating “share-based payments,” despite attempts by some parties in the U.S. to delay or overturn accounting for employee stock options. Overall, the IASB has amended many of its standards, and, to a lesser degree, we in the FASB have modified some of our own. We currently are working together in other major areas, including revenue recognition and reporting on financial performance.
Convergence will occur slowly but steadily. There will be short-term “pain” for just about everyone. We hope, however, that you as chief executive officers agree that this effort promises significant long-term “gain” in the form of better, less costly and more comparable and consistent financial information. We very much welcome your support and participation in this important endeavor.
Robert H. Herz is chairman of the Financial Accounting Standards Board.