Some obstacles to global financial reporting comparability and convergence at a high level of quality part1

Some obstacles to global financial reporting comparability and convergence at a high level of quality

part1

Now that we are beyond 2005, it is time to take stock of the ongoing efforts of standard setters, companies,auditors, and regulators to promote the continued improvement of worldwide financial reporting and to discuss some of the challenges and obstacles that lie ahead.

The issues I would like to discuss are two: comparability and convergence.

1. Comparability

‘Comparability’ is a very difficult notion to understand even within a country, let alone globally. We have not really had much literature that helps us understand what is meant by comparability—when we have it, and when we do not. The view originating in the United States and now cited widely is that comparability is achieved by assuring that ‘like things look alike, and unlike things look different’ (Trueblood, 1966, p. 189).

But in accounting what are ‘things’? And how do we perceive and identify ‘like’ and ‘unlike’ things? Accounting is an artefact, not articles of furniture or draperies. I will elaborate on this difficulty in the course of my remarks.

Since 2005, when the IAS regulation of 2002 went into effect, some 8000 listed companies in the European Union (EU) are now preparing their consolidated financial statements by the use of International Financial Reporting Standards (IFRS).1 Scores of other countries around the world have also signed on to IFRS. I think it is a widely shared opinion that there has suddenly been a very great increase in global comparability in relation to what we had before, namely, every country using its own national standards, which differed considerably from country to country.

Nevertheless, I would like to strike a note of caution that future progress in enhancing comparability may be difficult to achieve and that one needs to be concerned about the future course of convergence across international borders.

I am going to discuss four cultures in the first part of my presentation, as follows:


The business and financial culture
The accounting culture
The auditing culture
The regulatory culture

These cultures differ from one country to the next, and this is one of the factors that could impede or interfere with promoting genuine worldwide comparability.

1.1. Business and financial culture

First, with respect to the business and financial culture, there are certain differences across countries in the way business is conducted and in their supporting financial markets. For example, because of incentives and disincentives in the income tax law and other laws, business transactions are often designed differently in different countries. In the USA, partly because of tax benefits, it is commonplace in certain industries to raise financing through long-term leases.

Therefore, if you were to board an airliner of a US carrier (e.g. American Airlines, Delta Airlines, Continental Airlines), it is almost 100% certain that the plane would not be owned by the airline company. Instead, it would be owned by financial institutions that lease them to the airline company, and, in the vast majority of cases, the aircraft do not appear on the balance sheet of the operating company. This practice of omitting major tangible operating resources from the balance sheet is also found in a number of other important industries in the USA (see Weil, 2004), and this is one of the reasons for a considerable lack of comparability even within my country, let alone between my country and others.

Further, executive compensation packages are composed differently in different countries. In my country,and increasingly in other countries, employee share options and other share plans have become a major part of the compensation packages of executives and of many other employees as well. How we account for these various forms of share compensation compared to how we account for a salary and a cash bonus will determine whether we have comparability across countries because of the different ways in which we compensate executives and other employees. Pension schemes and other retirement plan arrangements are also affected by the way business is done in different countries. In some countries, post-retirement benefits,including those for health care, are administered and paid by the Government, while in others they are the responsibility of the employer.

Then there are different business customs and corporate structures. For example, in Japan and Korea, the keiretsu and chaebol, respectively, represent networks of companies with interlocking relationships, where it is not clear who the holding company is, if indeed there is a holding company. Therefore, one may raise the question whether a standard on consolidated financial statements in its application in Japan and Korea would produce anything like comparability with countries that have a clear hierarchical relationship between subsidiaries and the ultimate parent or holding company. An identical standard in such circumstances would do little more than accentuate the differences between the countries’ different way of structuring inter corporate enterprise.

There is also the issue of public vs private ownership of enterprise, including related party transactions.

Even today, one reads in the news about EADS producing airliners through its Airbus subsidiary and of the French and German governments’ intrusive involvement in their operations compared to Boeing, which manufactures airliners in the USA without any Government involvement in its operations. This can produce accounting non-comparability and, at the same time, present some tricky auditing problems.

We can also mention what might be called deep vs shallow asset pricing markets.

Fair value is becoming more prominent in International Accounting Standards (IAS) and IFRS, raised by the International Accounting Standards Board (IASB), as well as by the Financial Accounting Standards Board (FASB) in its standards, including such accounting issues as measuring impairment losses and revaluing property, plant, and equipment as well as valuing investment properties and biological assets (including forestry, orchards, livestock, and crops). There must be asset pricing markets that provide these values, but it is likely that, in the great majority of countries adopting IFRS, the asset pricing markets are not sufficiently deep to provide the necessary data with which to revalue many of the assets reliably. This means that companies in these countries would have to turn to synthetic approaches, like using fair value models or basing estimates on the prices of similar assets, which may produce results that, some would argue, are not truly comparable to those in other countries, where there are adequate asset pricing markets to value such assets directly.

Moreover, one sees differences among countries in the vibrancy and centrality of their equity capital markets.

Prior to the middle of the 1990s, in many countries on the European continent and on other continents, large companies did not depend primarily on the equity capital markets for long-term financing. Instead, they relied on banks, on the State, and on family sources; hence, financial reporting did not have to take into account the information needs of equity investors. Beginning in the 1990s and into the current decade, the equity capital markets have begun to expand and become more vital in numerous countries on the European continent and around the world. Yet it is arguable that old habits of reluctant financial disclosure die out slowly.

Numerous other countries have relied for many years on equity capital markets for long-term financing, and they have been well accustomed to providing extensive and candid financial disclosures. This history or tradition of thinking proactively about how much disclosure a company must give to equity capital suppliers is relatively young in some countries and relatively older in others. It may take some time before executives in the former change their mentality on such questions as the extent and informativeness of financial disclosure, and there could thus be a disinclination in some countries to disclose information that in other countries has been routinely disclosed. How soon will these executives begin to tailor the candour of their financial disclosures to a regime of active suppliers of equity capital?

With reference to the degree of sophistication of financial analysts and financial journalists, in some countries selected newspapers and magazines report companies’ financial results credibly and with discernment, and they draw attention to developments at the IASB and the national standard setter. In other countries, it is hard to find any articles in the financial press on these matters at all. The articles in the news media may be brief, and they may not reflect much understanding of the subject. And the financial analysts themselves may not be all that well informed about accounting. This can be a significant variable from country to country. The degree to which potential and actual investors are served well by financial writers and analysts in quite a few countries may be extremely low. All of this bears on how comparably financial statements inform interested parties in some countries in relation to others.

Some examples may be useful here. In a number of Asian and South Pacific countries that have signed on to IFRS, companies and their auditors do not say that IFRS are being used in financial statements. Instead, the companies say they are using national accounting standards, even though they might correspond with IFRS.

In the auditor’s report, the reference is to the national standards, not to IFRS. Financial analysts and other readers of financial statements, especially from overseas, need to be aware that, in those countries, the national accounting standards are congruent with, or may be nearly the same as, IFRS. Will they know that? The countries to which I refer are Hong Kong, the Philippines, Australia, and New Zealand. So the central issue is whether domestic and foreign financial analysts, as well as the financial journalists, truly understand what is going on in such countries. In other countries, such as India, Pakistan, Malaysia, and Thailand, companies’ and auditors’ references are also to national accounting standards, but these standards differ significantly from IFRS, or their pace of adoption of IFRS is lagging well behind (Pacter, 2005, pp. 79–81). This diversity in the use of referents to national accounting standards hardly promotes international comparability. I will refer in Section 2.5 to a proposed revision of IAS 1 which is intended to deal with this problem of detecting differences between IFRS and jurisdictional variations of IFRS.

To Be Continued