- Email: [email protected]
Development of Accounting Standards
C H A P T E R
30 Development of Accounting Standards S.A. Zeff Rice University, Houston, TX, USA
O U T L I N E United States
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United Kingdom, Canada, Australia, France, Germany, and Japan
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International Accounting Standards Board
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The history of the setting of accounting standards has centered mainly on the financial information that companies should provide to shareholders and to securities markets. Accounting standards are the norms of measurement that define the profitability of an enterprise, as shown in the income statement, and the amounts at which the assets and liabilities are carried in the balance sheet, and which is complemented by the cash flow statement. The standards encompass the financial disclosures that are to complement these financial statements. Because of the uncertainty inexorably surrounding the affairs of enterprise, the precise amount of its earnings (or profit or net income) for a financial year is unknowable. Alan Greenspan, a former Federal Reserve Board chairman, has said, “Unlike cash dividends, whose value is unambiguous, there is no unambiguously ‘correct’ value of earnings” (Greenspan, 2002: 3). Therefore, accounting standards are needed to assure the making of (1) reasonable judgments when estimating earnings, which are linked with (2) reasonable judgments when estimating the amounts at which assets and liabilities are to be stated. Because these judgments are inevitably subjective, accounting standards constitute the framework and criteria that are to be used when making them.
Conclusion Acknowledgment Glossary References
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The historical development of the accounting standardsetting process can probably best be told by focusing on the United States and then on the regime of international accounting standards (IAS). To be sure, one can also find interesting records of standard-setting experience in the United Kingdom, Canada, Australia, New Zealand, France, the Netherlands, South Africa, Spain, Norway, Germany, Japan, Mexico, and Argentina, among other countries, but the United States was the first country to set accounting standards and, as a model, it has probably had the greatest influence on other countries’ approaches and solutions. After taking up the history of the succession of United States standard setters, we offer a brief discussion of several of these other national standard setters.
UNITED STATES While accounting guidance was provided by the organized United States accounting profession as far back as 1917 and again in the early 1930s, a programmatic approach to providing such guidance on a regular basis was not implemented until 19391. In that year, the term ‘generally accepted accounting principles’ gained credence and came to be known as GAAP. The term
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The term ‘standard setting’ did not enter the accounting literature until the early 1970s. In the United States in earlier years, the terminology was ‘establishing accounting principles.’ Nonetheless, standard setting will be used herein.
Handbook of Key Global Financial Markets, Institutions, and Infrastructure http://dx.doi.org/10.1016/B978-0-12-397873-8.00047-5
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referred not just to principles but also to the methods of application, and it became the shorthand for ‘proper accounting practice.’ When judging the standards issued by the accounting profession, one must take cognizance of the fact that the Congress in 1933–34 delegated authority to determine publicly traded companies’ accounting practices to the newly created Securities and Exchange Commission (SEC). It was at the encouragement of the SEC that the American Institute of Accountants (AIA) empowered its Committee on Accounting Procedure (CAP) in 1939 to begin issuing accounting guidance, known as Accounting Research Bulletins. The 21 members of the CAP served on a part-time basis and were partners in audit firms (the Big Eight firms were always represented by one member each) complemented by a few accounting academics. Since then, although the SEC’s accounting staff have largely deferred to the CAP and its successors, they have nonetheless exercised a continuing and activist oversight of the development of its standards and have, on a number of occasions, actually preempted or overruled the standard setter. Until the 1970s, one of the major differences between the view of the SEC’s accounting staff and that of the standard setter was the former’s unwillingness to allow companies to use current values when they were higher than the historical cost of merchandise inventories and long-lived physical assets (see Zeff, 2007). Following the issue of more than 40 standards, the CAP was succeeded in 1959 by the Accounting Principles Board (APB), which was also a committee of the recently renamed American Institute of Certified Public Accountants (AICPA). The APB’s 18–21 members were, as before, part-time, composed of mostly partners in audit firms (again with full Big Eight representation) but with a small contingent of company financial executives and academics. It was assisted by a larger research staff than the CAP. The APB issued 31 Opinions during its 13-year tenure, and it was frequently embroiled in controversy. In 1973, the APB was succeeded by the Financial Accounting Standards Board (FASB), with seven fulltime members and a large technical and research staff. The FASB was overseen by a newly created Financial Accounting Foundation. It was thus independent of the accounting profession. Until 2003, the FASB was funded by voluntary donations from audit firms and companies in addition to the receipts from the sale of its publications. The Sarbanes–Oxley Act of 2002 required that, with SEC approval of its budget, the FASB instead be funded by a levy on publicly traded companies. The aim of this change in funding source was to diminish the influence of donors on the standard-setting process. Each of the successive standard setters in the United States has issued exposure drafts of proposed standards in order to obtain informed comment before promulgating a definitive standard. Being private-sector bodies, none of
them has possessed authority to require publicly traded companies to comply with its standards. Only the SEC possesses the legal authority to compel publicly traded companies, known as registrants, to follow (or not) the standard setter’s recommendations, and the SEC normally accepts its standards without conducting any public review or issuing a formal release. Unless the SEC were to modify any of the terms of a standard, it is assumed that it must be complied with by companies. Since the early 1980s, the SEC has allowed foreign registrants to use either their national GAAP or US GAAP in the preparation of financial statements in their filings with the Commission. When they use the former, the SEC requires them to reconcile their earnings and shareholders’ equity to the equivalent US GAAP figures, the object being to achieve a degree of comparability with companies using US GAAP. As will be noted below, in 2007 the SEC announced that foreign registrants using International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) need no longer present such a reconciliation. In addition, the APB published research studies, and the FASB early on put out discussion memoranda and has regularly held public hearings or round tables on major projects. The FASB’s meetings have been open to the public. Beginning in 1978, the FASB has issued a series of ‘concept statements,’ which constitute an explicit conceptual framework to guide its future standards on specific accounting topics. The conceptual framework itself has not been devoid of controversy. The long tradition of the series of standard setters has been to recommend accounting practices that they believe are technically sound and meet the needs of users of financial statements. Yet many of the standards have stirred controversy within the accounting profession and have on occasion provoked opposition by the preparers of financial statements, that is, the companies, as well as by organs of government (apart from the SEC). Once the standard-setting process acquired momentum and experience in the 1940s, 1950s, and 1960s, it became evident that philosophical differences existed among the Big Eight audit firms over how best to achieve comparability across companies. One of the major aims of accounting, or financial reporting, has been to facilitate the comparison of companies by users of financial statements. Some audit firms believed that comparability was best promoted by requiring all companies to use the same accounting methods, while others insisted that, as companies are inevitably different from one another, each company should be permitted, within limits, to choose the accounting methods that best reflect their individual circumstances (see Uniformity in Financial Accounting (1965) and Zeff (1984)). An issue underlying this difference is the suspicion by those in the former camp that to allow flexibility in this choice by companies
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UNITED STATES
is to enable them to ‘manage’ (or actually manipulate) their earnings and thus provide misleading information to the market. In this regard, the SEC has always argued that comparability is best achieved by reducing the diversity in accounting practice and thus, at the limit, to rid GAAP of alternative accounting methods. The SEC’s accounting staff has urged the standard setter to specify detailed rules for the application of its standards, so as to allow preparers less scope to interpret them as they might wish. Since 1975, the staff has also issued Staff Accounting Bulletins to set out its own views on proper accounting for filing companies. Another substantive accounting issue which has provoked controversy is whether footnote disclosure of accounting figures is an acceptable alternative to including them in the body of the financial statements. Empirical research has clearly demonstrated that disclosures are impounded in share prices even when presented outside the body of the financial statements, yet there has been an active debate among standard setters whether the disclosure of figures is equivalent to actually including them in the financial statements. Financial executives are especially protective of the financial statements, and they prefer ‘mere disclosure’ instead of allowing certain figures to affect earnings in the income statement or the amounts at which assets and liabilities are carried in the balance sheet. ‘Off-balance sheet financing’ is a beˆte noire to accountants, yet it has been enthusiastically pursued by company executives. The omission of most longterm, noncancellable leases from the balance sheets of lessees in certain industries, such as commercial airlines, has been regarded as nothing less than a scandal by accountants and users, but decidedly not by preparers (see Weil, 2004). In 2010, both the FASB and the IASB issued a joint exposure draft to remedy this omission. Since at least the late 1940s, accounting standard setters have come to realize that the availability of accounting options is often regarded by companies as a key element in their strategic decision making. The tightness or looseness of accounting standards, that is, how much flexibility they allow to companies in the choice of accounting methods, can be important in times of stress (see Revsine, 1991). When companies are engineering hostile takeovers or defending themselves against hostile takeovers, they frequently cite figures from their financial statements or from those of the other takeover party in an effort to sway shareholders to their side. When financial analysts’ earnings forecasts became commonplace in the 1970s, company executives came under pressure to meet the forecasts, else their share price might drop precipitately. Anticipating such circumstances, companies will insistently lobby the standard setter to preserve flexibility in accounting choice. In 1997, beginning with amazon.com, a number of companies began presenting a ‘pro forma,’ non-GAAP
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earnings figure, which was composed of their reported earnings with certain noncash, one-time charges, such as goodwill amortization and impairment losses, added back. The evident aim was to focus attention on a modified earnings figure that could better serve as a basis for predicting future earnings trends, yet the pro forma figure always was higher and never lower than the GAAP earnings. It has long been known that company executives – and especially banks and their regulators – prefer a smoothed trend of earnings. Earnings volatility is believed to frighten investors because it is difficult for them to forecast trends, and it encourages the inference that management is not in control of their company’s fortunes. All of these views about accounting held by company executives, together with their view that standard setters underestimate the cost of implementing new standards, help explain why the preparer sector aggressively lobbies the standard setter. When the standard setter seems to push ahead regardless of this lobbying, companies often turn to members of Congress to whose reelection campaigns they have contributed handsomely. Members of Congress, with rare exceptions, know and care nothing about accounting, but they do care about assuring financial support for their campaigns, and they will, when so invited, put pressure on the FASB, via the SEC. While Congress cannot require a private-sector standard setter, such as the FASB, to do one thing or another when issuing standards, it can order the SEC not to enforce certain FASB standards on publicly traded companies. The SEC is, after all, a creature of Congress, and Congress must approve its annual budget. As can be seen, therefore, the preparer sector can have strong views on accounting standards, because the standards can affect how they are perceived in the market and, indeed, how much of an earnings-based bonus its executives and other employees will receive. Accounting figures influence company behavior, because the market assesses the effectiveness of company performance by reference to those very figures. An analogy with sports is apt: the way you score a game determines the way the game is played. When the National Basketball Association adopted the three-point line for 1979–80 season, it changed player behavior. When the standard setter changes the scoring system known as accounting, it will very likely influence company behavior. As a result of these frequent ‘political’ pressures brought on the standard setter, some of the resulting standards represent compromises that dilute, sometimes significantly, the quality of financial information reported by companies. In addition, the SEC staff’s close monitoring of the standard setter, coupled with the highly litigious environment in the United States, has led to standards that are dense with detailed prescriptions on how to apply the standards. As noted above, the SEC’s
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accounting staff has historically believed that comparability is best achieved when companies are instructed in great detail how each standard is to be implemented. For their part, audit firms also prefer detailed standards, because they can rely on them to mount a stronger defense in court proceedings (see Revsine, 1991). There are both advantages and disadvantages for a private-sector standard setter when a securities market regulator uses its substantial power to oversee the setting of the standards and to command compliance by companies with the standards. On the positive side, it means that the standard setter’s will (except when the SEC disagrees) is converted into mandatory compliance by companies: its standards are consequential. On the negative side, the very force which the SEC brings to support full compliance with the standards stimulates countervailing efforts by powerful preparer groups to use maximum force to engage the support of key members of Congress. In such conflicts, the SEC is usually no match for the preparer sector. An example will help illustrate how government, not just companies, is motivated to press its ‘vested interest’ on the standard setter. In 1962, the Administration of President John F. Kennedy persuaded Congress to pass legislation establishing an ‘investment tax credit.’ It occurred in a weak economy and at a time of troubling unemployment, and the credit was intended to stimulate the economy. Under the terms of the credit, if companies were to invest in machinery and equipment, they could reduce their current year’s income tax bill by 10% of the cost of these assets, which could represent a sizable retention of cash. Before the credit went into effect, the APB began to debate how companies should account for the credit. Two schools of thought emerged. One school, favored by several of the Big Eight audit firms and by industry, was that the credit, being a reduction in the current year’s income tax bill, should be reflected in the current year’s earnings. The other school, favored by several of the other Big Eight firms and a slender majority of the APB, said that, no, a company cannot make a profit by buying. To them, the credit was a government subsidy which should be subtracted, for accounting purposes, from the acquisition cost of the assets. As with many accounting questions, it was a matter of timing: should the credit be reflected entirely in the current year’s earnings or gradually over the life of the assets via lower depreciation charges? The APB voted by the narrowest permitted majority, two-thirds, to adopt the latter interpretation, but several audit firms and representatives of industry complained directly to the SEC. Behind the scenes, it is understood that the Departments of Commerce and/or Treasury pressed the SEC that the deferral to future years of the credit’s effect on companies’ earnings would remove a major element of the Administration’s intended incentive for companies to
purchase capital goods, reduce unemployment, and thus stimulate the economy. Government wanted companies to see themselves as more profitable and therefore be more inclined to engage in such expansion. In the end, without giving reasons for its position, the SEC rebuffed the APB and announced that it would allow companies to use either interpretation in their financial statements (see Moonitz, 1966 and Zeff, 1972: 178–189). This represented a huge setback to the young APB, as its standard on the investment tax credit was its first important one to be issued. Eventually, after the economy recovered, the Congress terminated the credit. In 1971, the Administration of President Richard M. Nixon proposed reinstatement of the credit. The APB, recalling the earlier episode, proceeded to develop a standard that required the deferral of the credit’s accounting effect, after first securing the support of the SEC. Thereupon, the Treasury persuaded Congress to append a provision to the bill reinstating the credit that would allow companies to use any method of accounting for the credit they liked, thereby preempting the SEC. Accordingly, the APB called off its planned standard (see Zeff, 1972: 219–221). These episodes were a ‘wake-up call’ to the standard setter that ‘politics’ was a reality it had to face, like it or not. There have been other such lobbying pressures on the standard setter, usually emanating from the preparer sector, on accounting for business combinations (twice), the restructuring of troubled debt, oil and gas exploration (twice), marketable securities, employee share options (twice), and financial instruments (see Van Riper, 1994 and Zeff, 2010b). In the early 1990s, the FASB was given a foretaste of the pressure that the banking industry, representing preparers and regulators, can place on the standard setter. In 1990, SEC Chairman Richard C. Breeden argued that market value accounting should be used for marketable securities. In view of the SEC’s historical aversion to the upward revaluation of assets, this intervention by the SEC Chairman came as a surprise. Thus charged, in 1991 the FASB began considering a standard to move in the direction of market value accounting for such securities, with the unrealized profits and losses taken to earnings, when the banking industry, abetted by its regulators, certain members of Congress and the Secretary of the Treasury, launched a letter-writing campaign to oppose this initiative. In his own letter to the FASB, dated 24 March 1992, Treasury Secretary Nicholas F. Brady counseled that “This proposal could have serious, unintended effects on the availability of credit as well as on the stability of the financial system, and I strongly urge the FASB not to adopt it at this time.” In the end, the pressure from the banking industry led the FASB to devise an acceptable compromise: to partition most marketable equity and debt securities into two classes, ‘trading’ and ‘available-for-sale,’ and to account for
II. KEY MARKET, INSTITUTIONS, AND INFRASTRUCTURE IN GLOBAL FINANCE
UNITED KINGDOM, CANADA, AUSTRALIA, FRANCE, GERMANY, AND JAPAN
any marketable debt securities being ‘held to maturity’ at amortized historical cost. The company or bank owning the securities would determine which securities fit within each classification. The unrealized gains and losses accruing on available-for-sale securities, by far the larger category of the two equity securities groupings, would be lodged in shareholders’ equity and not taken to earnings until the securities were sold (see Johnson and Swieringa, 1996; Zeff, 2010b: 262). Perhaps the most celebrated recent case of ‘political’ intrusion occurred in the early 1990s over accounting for employee share options. In 1993, the FASB issued an exposure draft requiring that companies recognize an expense equal to the value of share options granted to employees during the year, based on the application of an option pricing model. Until then, companies had recognized no expense at all when granting such options, as the governing standard had been issued prior to the development of option pricing models in the 1970s. When the earlier standard was issued, it was not known how to estimate the options’ value. For many companies, especially those in the high tech community in Silicon Valley, California, such a standard would lead to a material reduction in their reported earnings, which might mean that, under pressure from shareholders at seeing the reduction in earnings because of an expense attributable to the options, companies might be forced to pull back on granting options or discontinue giving them altogether. Many of the high-growth companies in Silicon Valley and elsewhere in the country tended to compensate most of their employees entirely in share options in order to conserve their cash. Thus, the stakes were high. Executives and other employees were incensed at this threat to their livelihood. The FASB’s proposed standard galvanized the high tech companies around the country to press for Congressional relief. Members of Congress were quick to come to the rescue of the high tech entrepreneurial sector whose viability, as they understood it, was being imperiled by the FASB. They introduced numerous bills and resolutions to thwart the FASB (Zeff, 1997), and, finally, SEC Chairman Arthur Levitt, who feared that the controversy would bring down the FASB, counseled the standard setter to back off. Thus chastened, the FASB in 1995 issued a standard which exempted companies from a requirement to show the expense in their income statement and instead called for footnote disclosure of the options’ effect on current earnings, which, to companies, was ‘mere disclosure.’ Consequently, the threat to companies’ reported earnings in the income statement evaporated. It was an embarrassing episode for the FASB, and Levitt subsequently wrote that his advice to the FASB was “my single
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biggest mistake during my years of service” (Levitt and Dwyer, 2002: 11). In 2004, the FASB righted its ship and issued a principled standard on accounting for employee share options. As will be seen, the FASB’s success on this highly contested subject was facilitated by the lead taken by the IASB earlier that year by successfully issuing a standard, IFRS 2, which embodied the position that the FASB espoused in its 1993 exposure draft and was prevented from affirming in 1995. In March 2009, the FASB received another jolt from the banking industry, which pressed a Congressional subcommittee to order the Board to soften the adverse effects on earnings of its mark-to-market accounting for financial instruments. The subcommittee members gave the Board 3 weeks in which to make the changes, else Congress, they threatened, would intervene with legislation. It was evident that the banks were behind the move (Pulliam and McGinty, 2009). The FASB complied by the deadline (see Zeff, 2010b: p 265).
UNITED KINGDOM, CANADA, AUSTRALIA, FRANCE, GERMANY, AND JAPAN The Institute of Chartered Accountants in England and Wales (ICAEW) was the first United Kingdom accounting body to provide accounting guidance on a programmatic basis. From 1942 to 1969, it issued a series of Recommendations on Accounting Principles, but was reluctant to reduce the number of optional accounting methods in contentious areas2. From 1969 to 1990, the ICAEW, together with the other principal accounting bodies in the United Kingdom and Ireland, sponsored a part-time Accounting Standards (Steering) Committee (ASC), composed mostly of accounting practitioners, to give rather more definitive accounting guidance (see Rutherford, 2007). The ASC began issuing exposure drafts for public comment. The committee’s recommended standards did not take effect until they were approved by the several bodies’ governing councils. In 1990, a Financial Reporting Council, composed of representatives of the public interest in company financial reporting, was formed, which created under its wing the Accounting Standards Board (ASB). It was to set accounting standards which, under a companies act revision in 1989, required listed companies to adopt them or otherwise disclose the fact of their nonadoption. Thus, the ASB possessed much greater authority than its predecessor. The Chairman and Technical Director of the ASB were to be full-time, while the other seven or so members have been partners in audit firms, financial
The entire set of Recommendations has been published in Zeff (2010a).
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executives in companies, financial analysts, or academics. David (later Sir David) Tweedie chaired the ASB from its formation in 1990 until 2000, when he was chosen to chair the International Accounting Standards Committee (IASC, and then Board). In Canada, standard setting began in 1946 and has been continued over the decades by a series of committees of the Canadian Institute of Chartered Accountants (CICA). Until 1999, all of the standard-setting committee’s some 10–20 members were part-time, drawn mostly from audit firms and companies, with always one academic member and at least one user. Today, the CICA’s Accounting Standards Board (AcSB) has a full-time Chairman and seven or eight part-time members representing a variety of backgrounds. Since 1972, the CICA’s committee has set accounting standards for all Canadian companies under a grant of authority from the Canadian Securities Administrators and by Canadian companies and securities legislation. The committee has always played an active role in support of the IASC and in support of the IASB since 2001. Beginning in 2011, the AcSB is charged with incorporating IFRS into Canadian GAAP. In Australia, standard setting began in the 1960s and then accelerated in subsequent decades. Until 2001, the standard-setting committee or board has always been based within the accounting profession, in recent decades under the aegis of the private-sector Australian Accounting Research Foundation. Beginning in the late 1990s, the Australian Accounting Standards Board (AASB) was clothed with federal government authority to integrate IAS into Australian GAAP. In 2001, the AASB became a federal government agency with a full-time Chairman and a dozen part-time members, coming mostly from audit firms, companies, and government offices. The AASB’s current charge is to incorporate IFRS into Australian GAAP, and it collaborates, like other major national standard setters, with the IASB on the research support for standards projects. It has been an article of faith in the United Kingdom, Canada, and Australia, as well as in the United States, that the accounting standard setter should formulate and promulgate accounting standards that respond to the information needs of shareholders and investors in order to contribute to the effective working of the securities market. It has long been accepted that the standard setter should be insulated, as much as possible, from pressures to serve preparer interests and public policy interests that are not compatible with serving users’ needs. In France, Germany, and Japan, by contrast, accounting norms have been oriented not only to serving
investors but also to achieving other ends. In France, the accounting standard setter has always been a part of government. The original focus of the Conseil Supe´rieur de Comptabilite´, formed in 1947 (reconstituted in 1957 as the Conseil National de la Comptabilite´ (CNC)), was on the accounting standardization of all companies. When the Commission des Ope´rations de Bourse (COB)3, the stock exchange regulator, was set up in 1967, it redirected attention more towards financial reporting to investors of listed companies. Currently, the French standard setter, known as the Autorite´ des Normes Comptables (ANC) (which in 2009 replaced both the CNC and an oversight body, the Comite´ de la Re´glementation Comptable), is based within the Ministry of Economics, Industry and Employment (known informally as the Ministry of Finance). It is accepted that one of its roles is to serve as an instrument of public policy, which includes providing the securities market with the requisite financial information. In Germany, the Handelsgesetzbuch (HGB), the companies legislation, has prescribed the accounting framework and specific accounting norms, with a focus on the permissible payment of dividends. The law has in turn been interpreted by fiscal courts, because HGB accounts serve as the starting point for determining a company’s taxable income. In 1998, by which time Germany had begun to appreciate the importance of listed companies providing information for investors in the securities markets (see below), the government established the German Accounting Standards Board (GASB)4 (Deutsches Rechnungslegungs Standards Committee e.V.) which was recognized by the Ministry of Justice as the authority to achieve those ends. In 2010, the private-sector support for this standard-setting body seemed to have been withdrawn, but in May 2011 the Board was rejuvenated with a broader membership base. In Japan, since shortly after the Second World War, the Ministry of Finance has been advised on the development of accounting principles by a broadly based Business Accounting Deliberation Council, whose meetings the Ministry chairs. Then in 2001, major private-sector interests brought into being the Financial Accounting Standards Foundation, which in turn created the Accounting Standards Board of Japan (ASBJ) for the purpose of developing accounting standards oriented to serving the needs of investors in the securities market. The ASBJ proceeded to set accounting standards and then, in 2005, began to engage in mutual convergence with the IASB. In 2009, the Financial Services Agency, which had in 2000 succeeded the Ministry of Finance as the government body overseeing company financial
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In 2003, the COB was merged with two other agencies to become the Autorite´ des Marche´s Financiers.
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Today, the GASB is known in English as the Accounting Standards Committee of Germany.
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INTERNATIONAL ACCOUNTING STANDARDS BOARD
reporting, issued a roadmap towards the eventual required use by listed companies of IFRS.
INTERNATIONAL ACCOUNTING STANDARDS BOARD In 1973, accounting standards began to be set at the international level. In that year, the professional accounting bodies in the United Kingdom (jointly with Ireland), France, Germany, the Netherlands, Canada, the United States, Mexico, Japan, and Australia formed the IASC, which was based in London. Each country member sent a three-person delegation to the IASC Board. It was a part-time, private-sector undertaking, whose members were partners in audit firms, executives of companies or accounting institutes, financial analysts, and accounting academics. It had a slender research staff and relied on steering committees composed of other volunteers to draft the standards. Between 1973 and 2000, when its tenure ended, the IASC issued 41 standards as well as revisions of earlier standards, known as IAS.5 Like the FASB, it possessed no legal authority to impose its standards on anyone. The IASC’s first two dozen standards were mostly generic, providing for the use of alternative accounting methods, and calling for few disclosures. Yet the World Bank looked favorably on the initiative, and it began urging developing countries to adopt the IASC’s standards. No developed countries, especially those with active equity capital markets, adopted them. The IASC gradually evolved from 9 delegations to 16 in the 1990s and increased its technical support staff, and beginning in 1987 it caught the eye of the International Organization of Securities Commissions (IOSCO), which urged the IASC to improve the quality of its standards so that IOSCO might one day endorse them for use in crossborder listings in the major capital markets of the world. The IASC labored for more than 10 years to produce standards that could gain IOSCO’s endorsement, finally delivering them for IOSCO’s consideration at the end of 1998. Two years later, IOSCO endorsed them, but the endorsement had little practical effect on country decisions. The SEC has always been the dominant force in the IOSCO, and in the 1990s, as it became evident to the SEC that the IASC was maturing as a serious international standard setter, it began to press the IASC to restructure itself into a genuinely independent full-time body. There was a clash of philosophies as the IASC undertook to restructure itself. Continental European interests, especially the European Commission, wanted a large part-time body that was geographically representative of the countries that agreed to adopt the IASC’s standards.
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Yet the SEC made it clear that the FASB should be the model also for the IASC: a small, full-time, independent board with elaborate due process and a large research staff. To the SEC, technical accounting expertise was to be the prime criterion for membership on the restructured board. In the end, the IASC felt that it could not risk losing the support of the SEC because of the belief that no standards could be truly international without their acceptance in the United States. The SEC preferred a board of no more than seven, which was the size of the FASB, while continental European interests preferred a membership of 21. The IASC compromised at 14 members, of whom 12 were to be full-time and two part-time. Neither the professional accounting bodies nor the national standard setters would be sponsors of the board. Instead, an IASC Foundation (today called the IFRS Foundation) was formed, composed of a distinguished group of 19 trustees, chosen from around the world, which would oversee the new board. The trustees, who were chaired by Paul A. Volcker, would obtain funding for the board and would select its members. All of the relevant parties to the agreement approved the deal, and in early 2001, the restructured IASC was renamed the IASB. And its new standards were to be called IFRS. But what companies in what countries would be obliged to pay any attention to the restructured board’s standards? Prior to 2000, a number of Swiss and German companies, including Nestle´, Roche, Ciba-Geigy, Bayer, Hoechst, and Deutsche Bank, affirmed in their annual reports to shareholders that they complied with IAS in their consolidated financial statements, yet no country then required its listed companies to do so. At the same time, a number of continental European companies followed Daimler Benz’s lead and opted for US GAAP, including Veba and Deutsche Bank (which switched from IAS). In 1993, Daimler had become the first German multinational to list on the New York Stock Exchange and therefore reconcile to US GAAP in an SEC filing. For a while during the 1990s, IAS and US GAAP were in a kind of competition with each other in Europe. There were also important developments in the thinking of the European Commission. In 1995, the Commission began to look favorably on IAS and encouraged Member States to allow its use by companies. Then, in June 2000, to the surprise of most, the European Commission announced that, by 2005, it would expect that all of the some 7000 listed companies in the EU be required to use IAS in their consolidated financial statements. Other countries or jurisdictions, such as South Africa, Australia, New Zealand, and Hong Kong, began to take steps of their own in this direction, partly spurred on by the initiative in the EU. The European Commission
For histories of the IASC, see Kirsch (2006) and Camfferman and Zeff (2007).
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had concluded that its long-standing program of issuing Company Law Directives on accounting, which then had to be incorporated into legislation in each Member State, was too cumbersome and time-consuming to deal with the intricacies and fast-paced developments in accounting. Moreover, the European Commission had begun to appreciate that company law revision was not the major issue any more to occupy its attention. In view of a series of significant developments in Germany during the 1990s including the major banks’ redefinition of their role as the principal source of financing to the multinationals, as well as the massive Deutsche Telekom initial public offering in 1996, which proved that there was a large retail market for shares in Germany, the European Commission came to the realization that its focus should instead be on serving information needs in the securities markets. Further, in early 1997 the Neuer Markt was launched by the German Stock Exchange, which required that quoted companies use either IAS or US GAAP, and disallowed the use of German GAAP. It was unthinkable for the European Commission to call for the adoption of US GAAP. That left IAS as the only viable alternative, and the Commission seized it. In 2002, the EU approved the IAS Regulation, which gave legal force to the European Commission’s stated expectation about the mandatory use of IAS by EU listed companies. In order to convert a private-sector standard into a legal obligation for listed companies in the EU, it was necessary for the European Commission to ‘endorse’ the standard. It did so only after receiving advice at the ‘technical’ and ‘political’ levels. Technical advice, that is, whether the standard constitutes sound accounting, was to be conveyed by the newly created, private-sector European Financial Reporting Advisory Group (EFRAG), whose Technical Expert Group was composed of about a dozen accounting experts from within the EU. Political advice, that is, whether the standard is acceptable in the eyes of the Member State governments, was to be given by a newly established Accounting Regulatory Committee, whose members represented all of the governments. The formulation of these procedures represented a challenge to the European Commission, because it was without precedent for a rule or standard set in the private sector to become, in effect, EU law. The composition of the newly formed IASB was heavily Anglo-centric: of the 14 members, six came from the United States and Canada, two from the United Kingdom, and one each from Australia and South Africa. The remaining Board members, one each, came from France, Germany, Switzerland, and Japan. An elaborate system of due process, which eventually came to include
6
public roundtables on major projects, was put in place by the trustees. The Board’s meetings, other than those that dealt with purely administrative matters, were all to be held in public. From the outset, it became important for the IASB to engage in active convergence with the FASB so that their respective standards might become so similar to each other that, one day, the SEC would drop its reconciliation requirement for foreign companies listing in the United States and using IFRS in their financial statements. In October 2002, the FASB and IASB announced the Norwalk Agreement to affirm this relationship. In November 2007, to the surprise of many, the SEC dropped the reconciliation requirement for IFRS users, and it remains to be seen if, and when, the SEC allows or even requires domestic registrants to use IFRS. One of the Board’s initial agenda projects was on the contentious subject of accounting for employee share options. In early 2004, the IASB successfully issued a standard, IFRS 2, on the subject, and it was in effect the standard which the FASB had been prevented by political pressures from issuing back in 1995. The IASB had passed its first major test. The only criticism emanating from European preparers was that the IASB should not require EU companies to adopt a standard that would place them at a competitive disadvantage with companies reporting under US GAAP, which required only disclosure of the effect on earnings of the granting of share options to employees. Finally, in December 2004, notwithstanding a spate of political threats from members of Congress, the FASB succeeded in issuing its own standard, FAS 123R, to converge with IFRS 2. The Board also resolved to make improvements to 15 of the standards it inherited from the IASC, which included the two standards, IAS 32 and IAS 39, on accounting for financial instruments. The first major ‘political’ hurdle for the IASB arose in 2002, when the Board was proposing improvements to IAS 39, on the recognition and measurement of financial instruments6. IAS 39 had originally been issued in 1998, when all of the IASC standards were voluntary. At that time, the banking industry had only just become fully aware of the IASC’s potential significance. Its objections to the proposed IAS 39 were actually more fundamental than its relatively feeble protests might have suggested. In 2002–4, however, the revision of IAS 39 presented the industry with a new opportunity. The major French banks took the lead in a campaign against IAS 39, directed in particular at its hedge accounting provisions. At the same time, the European Central Bank stoutly opposed a provision that allowed financial liabilities to be written down, with a gain to be recognized in the income
For a recitation of the major political battles of the IASB involving financial instruments, see Zeff (2010b).
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INTERNATIONAL ACCOUNTING STANDARDS BOARD
statement, when interest rates had risen, even if the higher interest rate signified the debtor’s worsening credit rating. When the IASB refused to back down on these provisions, the European Commission took the unprecedented step of carving them out from the standard as part of its endorsement. Eventually, the carve-out on measuring financial liabilities at fair value was removed when the IASB modified its standard, but the hedging carve-out remains. It is used by perhaps two dozen banks in the EU. The drive by the major French banks to get their way on the hedging provision enlisted the support of French President Jacques Chirac. The big French banks have the ear of the government, and France knows how to work its will in the EU better than most other countries. Furthermore, the opposition to certain provisions in the revision of IAS 39, inspired mostly in France, made it evident that the French government never truly believed that an accounting standard setter should be ‘independent’ of government interests. In France, a view prevails in government and other circles that the setting of accounting standards should be an integral part of the setting of public policy. And if the banking industry is seen as ‘threatened’ by a proposed accounting standard, the standard setter should tailor the standard to the public interest as defined by government. This is not a view held solely by the French government. In the United States, members of Congress have, on a number of occasions after being petitioned by preparer interests, threatened legislative remedies when urging the FASB to reconsider proposed standards that were alleged by the preparers to work against their industry or against the welfare of the economy (see Zeff, 2010b). This conflict over the IASB’s independence erupted again in October 2008, in the throes of the economic and financial crisis. The major French banks, with the apparent support of the French government, pressed the European Commission to demand that the IASB make it possible for companies to reclassify debt securities from ‘trading’ to ‘held to maturity,’ retroactive to 1 July, so that, in the third quarter of 2008, banks could avoid showing a huge loss in their income statements because of plummeting securities prices. The banks claimed that US GAAP allowed such a reclassification and that IFRS should be similarly accommodating. The European Commission made it brutally clear to the IASB on 13 October that the IASB had just 24 hours in which to effectuate the change, else the Commission would itself modify the standard for required use in the EU, which could deal a fatal blow to the IASB as the effective standard setter in the Union. Sir David Tweedie confided that, faced with this threat, he came close to tendering his resignation as Chairman. In the end, the IASB bowed to the pressure and promptly approved the reclassification, but the Board and its trustees much resented this brazen
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intrusion into the standard-setting process. Although acceding to the reclassification, the IASB nonetheless imposed a disclosure requirement on companies and banks which would enable readers to know what the earnings would have been in the absence of the reclassification. There were other challenges that both the trustees and the IASB faced during their first ten years. But perhaps the most daunting and troubling challenge has been the increasingly strong hand of prudential regulators as a major force in standard setting, especially as applied to banks. In countries with strong equity capital markets, such as the United States, United Kingdom, Canada, and Australia, accounting standard setters have been historically charged with developing standards that promote transparency and relevant financial information for shareholders and investors in the securities market. And this has been given as the mission of the IASB, too. The interest of prudential regulators and of the banks as preparers, which is to dampen the volatility of bank earnings and capital and also not to depress capital to the point where the pace of lending is interdicted, had been pressed on the United States standard setter on two previous occasions, albeit with considerable force. Perhaps the best example was, as noted above, their opposition to the FASB’s considered proposal in 1992 that unrealized gains and losses on marketable securities, resulting from the changes in their market values, be reflected in the income statement. Also, as noted above, the IASB faced opposition from the major French banks and the European Central Bank over the extent of the use of hedge and fair value accounting in its revision of IAS 39 in 2002–4, culminating in the two carve-outs in the European Commission’s endorsement of the standard. In good economic times, the twin aims of promoting transparency in securities markets to suit investors and not driving down unduly the balance of capital to suit bank regulators may not be in conflict. But during the economic and financial crisis that began in 2008, the regulators’ aims have clashed. Moreover, the clash has been exacerbated by the regulators’ feared consequences of the use of fair value accounting for the procyclicality of bank earnings and capital, which has led G20 finance ministers and central bankers to challenge the propriety of the IASB’s requirement that fair value be applied so widely to bank accounting. One imagines that it is easier to persuade politicians of the need to assure stability of the banking system than the need to assure transparency in the securities markets. By 2010, the IASB announced to the world that more than 110 countries and other jurisdictions had adopted the required or permitted the use of IFRS by listed companies. Yet critics have pointed out that not all of the countries that claim to have adopted IFRS have really incorporated all of IFRS, without exceptions and without an inordinate delay, in their national GAAP.
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Universality of adoption does not come easily. Yet, by 2011 such jurisdictions as Australia, New Zealand, South Africa, Israel, Hong Kong, Brazil, and Canada had adopted IFRS as a requirement for listed companies, and others, such as Japan, Korea, and Mexico, were close to doing so. Whether the United States adopts is yet to be determined. In July 2011, Chairman Tweedie, whose 10-year term had expired, was succeeded by Hans Hoogervorst, who was the chairman of the Dutch securities regulator and a former Dutch Minister of Finance. Hoogervorst, whose background is not in accounting, will be assisted by the new Vice Chairman, Ian Mackintosh, who was chairman of the United Kingdom Accounting Standards Board.
SEE ALSO Key Market, Institutions, and Infrastructure in Global Finance: Earnings Quality; Fair Value and Accounting; Fair Value Accounting, Disclosure and Financial Stability.
CONCLUSION In the last few decades, standard setting has evolved from part-time to full-time operations, with Boards having larger staffs, increasingly open due process, and almost constant communication with interested and affected parties. Standard setting is much more challenging to get right at the international level because of the different business, accounting, auditing, and legal and regulatory cultures around the world, even among countries in the European Union. Furthermore, the standardsetting boards have had to face intensified interest and even organized lobbying on the part of preparers and governments on their proposed solutions, an influence which is magnified in difficult economic times. It has been the aim of this review to bring out these trends and developments.
Acknowledgment The author is grateful to Kees Camfferman for his comments and suggestions on an earlier draft.
Glossary FAS Statement of Financial Accounting Standards, issued by the Financial Accounting Standards Board.
References Camfferman, K., Zeff, S.A., 2007. Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973–2000. Oxford University Press, Oxford, UK. Greenspan, A., 2002. Corporate Governance, A Speech Delivered at the Stern School of Business. New York University, New York. 26 March. Available at http://www.federalreserve.gov/boarddocs/ speeches/2002/200203262/default.htm. Johnson, L.T., Swieringa, R.J., 1996. Anatomy of an agenda decision: Statement no. 115. Accounting Horizons 10 (2), 149–179. Kirsch, R.J., 2006. The International Accounting Standards Committee: A Political History. Wolters Kluwer (UK) Limited, UK. Levitt, A., Dwyer, P., 2002. Take on the Street. Pantheon, New York, NY. Moonitz, M., 1966. Some reflections on the investment credit experience. Journal of Accounting Research 4 (1), 47–61. Pulliam, S., McGinty, T., 2009. USA Inc.: Congress helped banks defang key rule. The Wall Street Journal A1, A14. Revsine, L., 1991. The selective financial misrepresentation hypothesis. Accounting Horizons 5 (4), 16–27. Rutherford, B.A., 2007. Financial Reporting in the UK: A History of the Accounting Standards Committee, 1969–90. Routledge, London, UK. Uniformity in Financial Accounting, 1965. Law and Contemporary Problems 30 (4). Van Riper, R., 1994. Setting Standards for Financial Reporting: FASB and the Struggle for Control of a Critical Process. Quorum Books, Westport, CT. Weil, J., 2004. How leases play a shadowy role in accounting. The Wall Street Journal 22 Sept. Zeff, S.A., 1972. Forging Accounting Principles in Five Countries: A History and an Analysis of Trends. Stipes Publishing Co., Champaign, IL. Zeff, S.A., 1984. Some junctures in the evolution of the process of establishing accounting principles in the U.S.A.: 1917 to 1972. The Accounting Review 59 (3), 447–468. Zeff, S.A., 1997. The U.S. senate votes on accounting for employee stock options. In: Zeff, S.A., Bala, G.D. (Eds.), Readings and Notes on Financial Accounting. 5th edition McGraw-Hill, New York, NY, pp. 507–517. Zeff, S.A., 2007. The SEC rules historical cost accounting: 1934 to the 1970s. Accounting and Business Research (International Accounting Policy Forum Issue) 49–62. Zeff, S.A. (Ed.), 2010a. Principles Before Standards: The ICAEW’s ‘N Series’ of Recommendations on Accounting Principles 1942–1969. ICAEW Financial Reporting Faculty, London, UK. Zeff, S.A., 2010b. Political lobbying on accounting standards – US, UK and international experience. Chapter 11. In: Nobes, C., Parker, R. (Eds.), Comparative International Accounting. 11th edn. Pearson Education, Harlow, Essex, UK, pp. 247–278.
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30 Development of Accounting Standards S.A. Zeff Rice University, Houston, TX, USA
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The history of the setting of accounting standards has centered mainly on the financial information that companies should provide to shareholders and to securities markets. Accounting standards are the norms of measurement that define the profitability of an enterprise, as shown in the income statement, and the amounts at which the assets and liabilities are carried in the balance sheet, and which is complemented by the cash flow statement. The standards encompass the financial disclosures that are to complement these financial statements. Because of the uncertainty inexorably surrounding the affairs of enterprise, the precise amount of its earnings (or profit or net income) for a financial year is unknowable. Alan Greenspan, a former Federal Reserve Board chairman, has said, “Unlike cash dividends, whose value is unambiguous, there is no unambiguously ‘correct’ value of earnings” (Greenspan, 2002: 3). Therefore, accounting standards are needed to assure the making of (1) reasonable judgments when estimating earnings, which are linked with (2) reasonable judgments when estimating the amounts at which assets and liabilities are to be stated. Because these judgments are inevitably subjective, accounting standards constitute the framework and criteria that are to be used when making them.
Conclusion Acknowledgment Glossary References
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The historical development of the accounting standardsetting process can probably best be told by focusing on the United States and then on the regime of international accounting standards (IAS). To be sure, one can also find interesting records of standard-setting experience in the United Kingdom, Canada, Australia, New Zealand, France, the Netherlands, South Africa, Spain, Norway, Germany, Japan, Mexico, and Argentina, among other countries, but the United States was the first country to set accounting standards and, as a model, it has probably had the greatest influence on other countries’ approaches and solutions. After taking up the history of the succession of United States standard setters, we offer a brief discussion of several of these other national standard setters.
UNITED STATES While accounting guidance was provided by the organized United States accounting profession as far back as 1917 and again in the early 1930s, a programmatic approach to providing such guidance on a regular basis was not implemented until 19391. In that year, the term ‘generally accepted accounting principles’ gained credence and came to be known as GAAP. The term
1
The term ‘standard setting’ did not enter the accounting literature until the early 1970s. In the United States in earlier years, the terminology was ‘establishing accounting principles.’ Nonetheless, standard setting will be used herein.
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referred not just to principles but also to the methods of application, and it became the shorthand for ‘proper accounting practice.’ When judging the standards issued by the accounting profession, one must take cognizance of the fact that the Congress in 1933–34 delegated authority to determine publicly traded companies’ accounting practices to the newly created Securities and Exchange Commission (SEC). It was at the encouragement of the SEC that the American Institute of Accountants (AIA) empowered its Committee on Accounting Procedure (CAP) in 1939 to begin issuing accounting guidance, known as Accounting Research Bulletins. The 21 members of the CAP served on a part-time basis and were partners in audit firms (the Big Eight firms were always represented by one member each) complemented by a few accounting academics. Since then, although the SEC’s accounting staff have largely deferred to the CAP and its successors, they have nonetheless exercised a continuing and activist oversight of the development of its standards and have, on a number of occasions, actually preempted or overruled the standard setter. Until the 1970s, one of the major differences between the view of the SEC’s accounting staff and that of the standard setter was the former’s unwillingness to allow companies to use current values when they were higher than the historical cost of merchandise inventories and long-lived physical assets (see Zeff, 2007). Following the issue of more than 40 standards, the CAP was succeeded in 1959 by the Accounting Principles Board (APB), which was also a committee of the recently renamed American Institute of Certified Public Accountants (AICPA). The APB’s 18–21 members were, as before, part-time, composed of mostly partners in audit firms (again with full Big Eight representation) but with a small contingent of company financial executives and academics. It was assisted by a larger research staff than the CAP. The APB issued 31 Opinions during its 13-year tenure, and it was frequently embroiled in controversy. In 1973, the APB was succeeded by the Financial Accounting Standards Board (FASB), with seven fulltime members and a large technical and research staff. The FASB was overseen by a newly created Financial Accounting Foundation. It was thus independent of the accounting profession. Until 2003, the FASB was funded by voluntary donations from audit firms and companies in addition to the receipts from the sale of its publications. The Sarbanes–Oxley Act of 2002 required that, with SEC approval of its budget, the FASB instead be funded by a levy on publicly traded companies. The aim of this change in funding source was to diminish the influence of donors on the standard-setting process. Each of the successive standard setters in the United States has issued exposure drafts of proposed standards in order to obtain informed comment before promulgating a definitive standard. Being private-sector bodies, none of
them has possessed authority to require publicly traded companies to comply with its standards. Only the SEC possesses the legal authority to compel publicly traded companies, known as registrants, to follow (or not) the standard setter’s recommendations, and the SEC normally accepts its standards without conducting any public review or issuing a formal release. Unless the SEC were to modify any of the terms of a standard, it is assumed that it must be complied with by companies. Since the early 1980s, the SEC has allowed foreign registrants to use either their national GAAP or US GAAP in the preparation of financial statements in their filings with the Commission. When they use the former, the SEC requires them to reconcile their earnings and shareholders’ equity to the equivalent US GAAP figures, the object being to achieve a degree of comparability with companies using US GAAP. As will be noted below, in 2007 the SEC announced that foreign registrants using International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board (IASB) need no longer present such a reconciliation. In addition, the APB published research studies, and the FASB early on put out discussion memoranda and has regularly held public hearings or round tables on major projects. The FASB’s meetings have been open to the public. Beginning in 1978, the FASB has issued a series of ‘concept statements,’ which constitute an explicit conceptual framework to guide its future standards on specific accounting topics. The conceptual framework itself has not been devoid of controversy. The long tradition of the series of standard setters has been to recommend accounting practices that they believe are technically sound and meet the needs of users of financial statements. Yet many of the standards have stirred controversy within the accounting profession and have on occasion provoked opposition by the preparers of financial statements, that is, the companies, as well as by organs of government (apart from the SEC). Once the standard-setting process acquired momentum and experience in the 1940s, 1950s, and 1960s, it became evident that philosophical differences existed among the Big Eight audit firms over how best to achieve comparability across companies. One of the major aims of accounting, or financial reporting, has been to facilitate the comparison of companies by users of financial statements. Some audit firms believed that comparability was best promoted by requiring all companies to use the same accounting methods, while others insisted that, as companies are inevitably different from one another, each company should be permitted, within limits, to choose the accounting methods that best reflect their individual circumstances (see Uniformity in Financial Accounting (1965) and Zeff (1984)). An issue underlying this difference is the suspicion by those in the former camp that to allow flexibility in this choice by companies
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is to enable them to ‘manage’ (or actually manipulate) their earnings and thus provide misleading information to the market. In this regard, the SEC has always argued that comparability is best achieved by reducing the diversity in accounting practice and thus, at the limit, to rid GAAP of alternative accounting methods. The SEC’s accounting staff has urged the standard setter to specify detailed rules for the application of its standards, so as to allow preparers less scope to interpret them as they might wish. Since 1975, the staff has also issued Staff Accounting Bulletins to set out its own views on proper accounting for filing companies. Another substantive accounting issue which has provoked controversy is whether footnote disclosure of accounting figures is an acceptable alternative to including them in the body of the financial statements. Empirical research has clearly demonstrated that disclosures are impounded in share prices even when presented outside the body of the financial statements, yet there has been an active debate among standard setters whether the disclosure of figures is equivalent to actually including them in the financial statements. Financial executives are especially protective of the financial statements, and they prefer ‘mere disclosure’ instead of allowing certain figures to affect earnings in the income statement or the amounts at which assets and liabilities are carried in the balance sheet. ‘Off-balance sheet financing’ is a beˆte noire to accountants, yet it has been enthusiastically pursued by company executives. The omission of most longterm, noncancellable leases from the balance sheets of lessees in certain industries, such as commercial airlines, has been regarded as nothing less than a scandal by accountants and users, but decidedly not by preparers (see Weil, 2004). In 2010, both the FASB and the IASB issued a joint exposure draft to remedy this omission. Since at least the late 1940s, accounting standard setters have come to realize that the availability of accounting options is often regarded by companies as a key element in their strategic decision making. The tightness or looseness of accounting standards, that is, how much flexibility they allow to companies in the choice of accounting methods, can be important in times of stress (see Revsine, 1991). When companies are engineering hostile takeovers or defending themselves against hostile takeovers, they frequently cite figures from their financial statements or from those of the other takeover party in an effort to sway shareholders to their side. When financial analysts’ earnings forecasts became commonplace in the 1970s, company executives came under pressure to meet the forecasts, else their share price might drop precipitately. Anticipating such circumstances, companies will insistently lobby the standard setter to preserve flexibility in accounting choice. In 1997, beginning with amazon.com, a number of companies began presenting a ‘pro forma,’ non-GAAP
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earnings figure, which was composed of their reported earnings with certain noncash, one-time charges, such as goodwill amortization and impairment losses, added back. The evident aim was to focus attention on a modified earnings figure that could better serve as a basis for predicting future earnings trends, yet the pro forma figure always was higher and never lower than the GAAP earnings. It has long been known that company executives – and especially banks and their regulators – prefer a smoothed trend of earnings. Earnings volatility is believed to frighten investors because it is difficult for them to forecast trends, and it encourages the inference that management is not in control of their company’s fortunes. All of these views about accounting held by company executives, together with their view that standard setters underestimate the cost of implementing new standards, help explain why the preparer sector aggressively lobbies the standard setter. When the standard setter seems to push ahead regardless of this lobbying, companies often turn to members of Congress to whose reelection campaigns they have contributed handsomely. Members of Congress, with rare exceptions, know and care nothing about accounting, but they do care about assuring financial support for their campaigns, and they will, when so invited, put pressure on the FASB, via the SEC. While Congress cannot require a private-sector standard setter, such as the FASB, to do one thing or another when issuing standards, it can order the SEC not to enforce certain FASB standards on publicly traded companies. The SEC is, after all, a creature of Congress, and Congress must approve its annual budget. As can be seen, therefore, the preparer sector can have strong views on accounting standards, because the standards can affect how they are perceived in the market and, indeed, how much of an earnings-based bonus its executives and other employees will receive. Accounting figures influence company behavior, because the market assesses the effectiveness of company performance by reference to those very figures. An analogy with sports is apt: the way you score a game determines the way the game is played. When the National Basketball Association adopted the three-point line for 1979–80 season, it changed player behavior. When the standard setter changes the scoring system known as accounting, it will very likely influence company behavior. As a result of these frequent ‘political’ pressures brought on the standard setter, some of the resulting standards represent compromises that dilute, sometimes significantly, the quality of financial information reported by companies. In addition, the SEC staff’s close monitoring of the standard setter, coupled with the highly litigious environment in the United States, has led to standards that are dense with detailed prescriptions on how to apply the standards. As noted above, the SEC’s
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accounting staff has historically believed that comparability is best achieved when companies are instructed in great detail how each standard is to be implemented. For their part, audit firms also prefer detailed standards, because they can rely on them to mount a stronger defense in court proceedings (see Revsine, 1991). There are both advantages and disadvantages for a private-sector standard setter when a securities market regulator uses its substantial power to oversee the setting of the standards and to command compliance by companies with the standards. On the positive side, it means that the standard setter’s will (except when the SEC disagrees) is converted into mandatory compliance by companies: its standards are consequential. On the negative side, the very force which the SEC brings to support full compliance with the standards stimulates countervailing efforts by powerful preparer groups to use maximum force to engage the support of key members of Congress. In such conflicts, the SEC is usually no match for the preparer sector. An example will help illustrate how government, not just companies, is motivated to press its ‘vested interest’ on the standard setter. In 1962, the Administration of President John F. Kennedy persuaded Congress to pass legislation establishing an ‘investment tax credit.’ It occurred in a weak economy and at a time of troubling unemployment, and the credit was intended to stimulate the economy. Under the terms of the credit, if companies were to invest in machinery and equipment, they could reduce their current year’s income tax bill by 10% of the cost of these assets, which could represent a sizable retention of cash. Before the credit went into effect, the APB began to debate how companies should account for the credit. Two schools of thought emerged. One school, favored by several of the Big Eight audit firms and by industry, was that the credit, being a reduction in the current year’s income tax bill, should be reflected in the current year’s earnings. The other school, favored by several of the other Big Eight firms and a slender majority of the APB, said that, no, a company cannot make a profit by buying. To them, the credit was a government subsidy which should be subtracted, for accounting purposes, from the acquisition cost of the assets. As with many accounting questions, it was a matter of timing: should the credit be reflected entirely in the current year’s earnings or gradually over the life of the assets via lower depreciation charges? The APB voted by the narrowest permitted majority, two-thirds, to adopt the latter interpretation, but several audit firms and representatives of industry complained directly to the SEC. Behind the scenes, it is understood that the Departments of Commerce and/or Treasury pressed the SEC that the deferral to future years of the credit’s effect on companies’ earnings would remove a major element of the Administration’s intended incentive for companies to
purchase capital goods, reduce unemployment, and thus stimulate the economy. Government wanted companies to see themselves as more profitable and therefore be more inclined to engage in such expansion. In the end, without giving reasons for its position, the SEC rebuffed the APB and announced that it would allow companies to use either interpretation in their financial statements (see Moonitz, 1966 and Zeff, 1972: 178–189). This represented a huge setback to the young APB, as its standard on the investment tax credit was its first important one to be issued. Eventually, after the economy recovered, the Congress terminated the credit. In 1971, the Administration of President Richard M. Nixon proposed reinstatement of the credit. The APB, recalling the earlier episode, proceeded to develop a standard that required the deferral of the credit’s accounting effect, after first securing the support of the SEC. Thereupon, the Treasury persuaded Congress to append a provision to the bill reinstating the credit that would allow companies to use any method of accounting for the credit they liked, thereby preempting the SEC. Accordingly, the APB called off its planned standard (see Zeff, 1972: 219–221). These episodes were a ‘wake-up call’ to the standard setter that ‘politics’ was a reality it had to face, like it or not. There have been other such lobbying pressures on the standard setter, usually emanating from the preparer sector, on accounting for business combinations (twice), the restructuring of troubled debt, oil and gas exploration (twice), marketable securities, employee share options (twice), and financial instruments (see Van Riper, 1994 and Zeff, 2010b). In the early 1990s, the FASB was given a foretaste of the pressure that the banking industry, representing preparers and regulators, can place on the standard setter. In 1990, SEC Chairman Richard C. Breeden argued that market value accounting should be used for marketable securities. In view of the SEC’s historical aversion to the upward revaluation of assets, this intervention by the SEC Chairman came as a surprise. Thus charged, in 1991 the FASB began considering a standard to move in the direction of market value accounting for such securities, with the unrealized profits and losses taken to earnings, when the banking industry, abetted by its regulators, certain members of Congress and the Secretary of the Treasury, launched a letter-writing campaign to oppose this initiative. In his own letter to the FASB, dated 24 March 1992, Treasury Secretary Nicholas F. Brady counseled that “This proposal could have serious, unintended effects on the availability of credit as well as on the stability of the financial system, and I strongly urge the FASB not to adopt it at this time.” In the end, the pressure from the banking industry led the FASB to devise an acceptable compromise: to partition most marketable equity and debt securities into two classes, ‘trading’ and ‘available-for-sale,’ and to account for
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UNITED KINGDOM, CANADA, AUSTRALIA, FRANCE, GERMANY, AND JAPAN
any marketable debt securities being ‘held to maturity’ at amortized historical cost. The company or bank owning the securities would determine which securities fit within each classification. The unrealized gains and losses accruing on available-for-sale securities, by far the larger category of the two equity securities groupings, would be lodged in shareholders’ equity and not taken to earnings until the securities were sold (see Johnson and Swieringa, 1996; Zeff, 2010b: 262). Perhaps the most celebrated recent case of ‘political’ intrusion occurred in the early 1990s over accounting for employee share options. In 1993, the FASB issued an exposure draft requiring that companies recognize an expense equal to the value of share options granted to employees during the year, based on the application of an option pricing model. Until then, companies had recognized no expense at all when granting such options, as the governing standard had been issued prior to the development of option pricing models in the 1970s. When the earlier standard was issued, it was not known how to estimate the options’ value. For many companies, especially those in the high tech community in Silicon Valley, California, such a standard would lead to a material reduction in their reported earnings, which might mean that, under pressure from shareholders at seeing the reduction in earnings because of an expense attributable to the options, companies might be forced to pull back on granting options or discontinue giving them altogether. Many of the high-growth companies in Silicon Valley and elsewhere in the country tended to compensate most of their employees entirely in share options in order to conserve their cash. Thus, the stakes were high. Executives and other employees were incensed at this threat to their livelihood. The FASB’s proposed standard galvanized the high tech companies around the country to press for Congressional relief. Members of Congress were quick to come to the rescue of the high tech entrepreneurial sector whose viability, as they understood it, was being imperiled by the FASB. They introduced numerous bills and resolutions to thwart the FASB (Zeff, 1997), and, finally, SEC Chairman Arthur Levitt, who feared that the controversy would bring down the FASB, counseled the standard setter to back off. Thus chastened, the FASB in 1995 issued a standard which exempted companies from a requirement to show the expense in their income statement and instead called for footnote disclosure of the options’ effect on current earnings, which, to companies, was ‘mere disclosure.’ Consequently, the threat to companies’ reported earnings in the income statement evaporated. It was an embarrassing episode for the FASB, and Levitt subsequently wrote that his advice to the FASB was “my single
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biggest mistake during my years of service” (Levitt and Dwyer, 2002: 11). In 2004, the FASB righted its ship and issued a principled standard on accounting for employee share options. As will be seen, the FASB’s success on this highly contested subject was facilitated by the lead taken by the IASB earlier that year by successfully issuing a standard, IFRS 2, which embodied the position that the FASB espoused in its 1993 exposure draft and was prevented from affirming in 1995. In March 2009, the FASB received another jolt from the banking industry, which pressed a Congressional subcommittee to order the Board to soften the adverse effects on earnings of its mark-to-market accounting for financial instruments. The subcommittee members gave the Board 3 weeks in which to make the changes, else Congress, they threatened, would intervene with legislation. It was evident that the banks were behind the move (Pulliam and McGinty, 2009). The FASB complied by the deadline (see Zeff, 2010b: p 265).
UNITED KINGDOM, CANADA, AUSTRALIA, FRANCE, GERMANY, AND JAPAN The Institute of Chartered Accountants in England and Wales (ICAEW) was the first United Kingdom accounting body to provide accounting guidance on a programmatic basis. From 1942 to 1969, it issued a series of Recommendations on Accounting Principles, but was reluctant to reduce the number of optional accounting methods in contentious areas2. From 1969 to 1990, the ICAEW, together with the other principal accounting bodies in the United Kingdom and Ireland, sponsored a part-time Accounting Standards (Steering) Committee (ASC), composed mostly of accounting practitioners, to give rather more definitive accounting guidance (see Rutherford, 2007). The ASC began issuing exposure drafts for public comment. The committee’s recommended standards did not take effect until they were approved by the several bodies’ governing councils. In 1990, a Financial Reporting Council, composed of representatives of the public interest in company financial reporting, was formed, which created under its wing the Accounting Standards Board (ASB). It was to set accounting standards which, under a companies act revision in 1989, required listed companies to adopt them or otherwise disclose the fact of their nonadoption. Thus, the ASB possessed much greater authority than its predecessor. The Chairman and Technical Director of the ASB were to be full-time, while the other seven or so members have been partners in audit firms, financial
The entire set of Recommendations has been published in Zeff (2010a).
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executives in companies, financial analysts, or academics. David (later Sir David) Tweedie chaired the ASB from its formation in 1990 until 2000, when he was chosen to chair the International Accounting Standards Committee (IASC, and then Board). In Canada, standard setting began in 1946 and has been continued over the decades by a series of committees of the Canadian Institute of Chartered Accountants (CICA). Until 1999, all of the standard-setting committee’s some 10–20 members were part-time, drawn mostly from audit firms and companies, with always one academic member and at least one user. Today, the CICA’s Accounting Standards Board (AcSB) has a full-time Chairman and seven or eight part-time members representing a variety of backgrounds. Since 1972, the CICA’s committee has set accounting standards for all Canadian companies under a grant of authority from the Canadian Securities Administrators and by Canadian companies and securities legislation. The committee has always played an active role in support of the IASC and in support of the IASB since 2001. Beginning in 2011, the AcSB is charged with incorporating IFRS into Canadian GAAP. In Australia, standard setting began in the 1960s and then accelerated in subsequent decades. Until 2001, the standard-setting committee or board has always been based within the accounting profession, in recent decades under the aegis of the private-sector Australian Accounting Research Foundation. Beginning in the late 1990s, the Australian Accounting Standards Board (AASB) was clothed with federal government authority to integrate IAS into Australian GAAP. In 2001, the AASB became a federal government agency with a full-time Chairman and a dozen part-time members, coming mostly from audit firms, companies, and government offices. The AASB’s current charge is to incorporate IFRS into Australian GAAP, and it collaborates, like other major national standard setters, with the IASB on the research support for standards projects. It has been an article of faith in the United Kingdom, Canada, and Australia, as well as in the United States, that the accounting standard setter should formulate and promulgate accounting standards that respond to the information needs of shareholders and investors in order to contribute to the effective working of the securities market. It has long been accepted that the standard setter should be insulated, as much as possible, from pressures to serve preparer interests and public policy interests that are not compatible with serving users’ needs. In France, Germany, and Japan, by contrast, accounting norms have been oriented not only to serving
investors but also to achieving other ends. In France, the accounting standard setter has always been a part of government. The original focus of the Conseil Supe´rieur de Comptabilite´, formed in 1947 (reconstituted in 1957 as the Conseil National de la Comptabilite´ (CNC)), was on the accounting standardization of all companies. When the Commission des Ope´rations de Bourse (COB)3, the stock exchange regulator, was set up in 1967, it redirected attention more towards financial reporting to investors of listed companies. Currently, the French standard setter, known as the Autorite´ des Normes Comptables (ANC) (which in 2009 replaced both the CNC and an oversight body, the Comite´ de la Re´glementation Comptable), is based within the Ministry of Economics, Industry and Employment (known informally as the Ministry of Finance). It is accepted that one of its roles is to serve as an instrument of public policy, which includes providing the securities market with the requisite financial information. In Germany, the Handelsgesetzbuch (HGB), the companies legislation, has prescribed the accounting framework and specific accounting norms, with a focus on the permissible payment of dividends. The law has in turn been interpreted by fiscal courts, because HGB accounts serve as the starting point for determining a company’s taxable income. In 1998, by which time Germany had begun to appreciate the importance of listed companies providing information for investors in the securities markets (see below), the government established the German Accounting Standards Board (GASB)4 (Deutsches Rechnungslegungs Standards Committee e.V.) which was recognized by the Ministry of Justice as the authority to achieve those ends. In 2010, the private-sector support for this standard-setting body seemed to have been withdrawn, but in May 2011 the Board was rejuvenated with a broader membership base. In Japan, since shortly after the Second World War, the Ministry of Finance has been advised on the development of accounting principles by a broadly based Business Accounting Deliberation Council, whose meetings the Ministry chairs. Then in 2001, major private-sector interests brought into being the Financial Accounting Standards Foundation, which in turn created the Accounting Standards Board of Japan (ASBJ) for the purpose of developing accounting standards oriented to serving the needs of investors in the securities market. The ASBJ proceeded to set accounting standards and then, in 2005, began to engage in mutual convergence with the IASB. In 2009, the Financial Services Agency, which had in 2000 succeeded the Ministry of Finance as the government body overseeing company financial
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In 2003, the COB was merged with two other agencies to become the Autorite´ des Marche´s Financiers.
4
Today, the GASB is known in English as the Accounting Standards Committee of Germany.
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INTERNATIONAL ACCOUNTING STANDARDS BOARD
reporting, issued a roadmap towards the eventual required use by listed companies of IFRS.
INTERNATIONAL ACCOUNTING STANDARDS BOARD In 1973, accounting standards began to be set at the international level. In that year, the professional accounting bodies in the United Kingdom (jointly with Ireland), France, Germany, the Netherlands, Canada, the United States, Mexico, Japan, and Australia formed the IASC, which was based in London. Each country member sent a three-person delegation to the IASC Board. It was a part-time, private-sector undertaking, whose members were partners in audit firms, executives of companies or accounting institutes, financial analysts, and accounting academics. It had a slender research staff and relied on steering committees composed of other volunteers to draft the standards. Between 1973 and 2000, when its tenure ended, the IASC issued 41 standards as well as revisions of earlier standards, known as IAS.5 Like the FASB, it possessed no legal authority to impose its standards on anyone. The IASC’s first two dozen standards were mostly generic, providing for the use of alternative accounting methods, and calling for few disclosures. Yet the World Bank looked favorably on the initiative, and it began urging developing countries to adopt the IASC’s standards. No developed countries, especially those with active equity capital markets, adopted them. The IASC gradually evolved from 9 delegations to 16 in the 1990s and increased its technical support staff, and beginning in 1987 it caught the eye of the International Organization of Securities Commissions (IOSCO), which urged the IASC to improve the quality of its standards so that IOSCO might one day endorse them for use in crossborder listings in the major capital markets of the world. The IASC labored for more than 10 years to produce standards that could gain IOSCO’s endorsement, finally delivering them for IOSCO’s consideration at the end of 1998. Two years later, IOSCO endorsed them, but the endorsement had little practical effect on country decisions. The SEC has always been the dominant force in the IOSCO, and in the 1990s, as it became evident to the SEC that the IASC was maturing as a serious international standard setter, it began to press the IASC to restructure itself into a genuinely independent full-time body. There was a clash of philosophies as the IASC undertook to restructure itself. Continental European interests, especially the European Commission, wanted a large part-time body that was geographically representative of the countries that agreed to adopt the IASC’s standards.
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Yet the SEC made it clear that the FASB should be the model also for the IASC: a small, full-time, independent board with elaborate due process and a large research staff. To the SEC, technical accounting expertise was to be the prime criterion for membership on the restructured board. In the end, the IASC felt that it could not risk losing the support of the SEC because of the belief that no standards could be truly international without their acceptance in the United States. The SEC preferred a board of no more than seven, which was the size of the FASB, while continental European interests preferred a membership of 21. The IASC compromised at 14 members, of whom 12 were to be full-time and two part-time. Neither the professional accounting bodies nor the national standard setters would be sponsors of the board. Instead, an IASC Foundation (today called the IFRS Foundation) was formed, composed of a distinguished group of 19 trustees, chosen from around the world, which would oversee the new board. The trustees, who were chaired by Paul A. Volcker, would obtain funding for the board and would select its members. All of the relevant parties to the agreement approved the deal, and in early 2001, the restructured IASC was renamed the IASB. And its new standards were to be called IFRS. But what companies in what countries would be obliged to pay any attention to the restructured board’s standards? Prior to 2000, a number of Swiss and German companies, including Nestle´, Roche, Ciba-Geigy, Bayer, Hoechst, and Deutsche Bank, affirmed in their annual reports to shareholders that they complied with IAS in their consolidated financial statements, yet no country then required its listed companies to do so. At the same time, a number of continental European companies followed Daimler Benz’s lead and opted for US GAAP, including Veba and Deutsche Bank (which switched from IAS). In 1993, Daimler had become the first German multinational to list on the New York Stock Exchange and therefore reconcile to US GAAP in an SEC filing. For a while during the 1990s, IAS and US GAAP were in a kind of competition with each other in Europe. There were also important developments in the thinking of the European Commission. In 1995, the Commission began to look favorably on IAS and encouraged Member States to allow its use by companies. Then, in June 2000, to the surprise of most, the European Commission announced that, by 2005, it would expect that all of the some 7000 listed companies in the EU be required to use IAS in their consolidated financial statements. Other countries or jurisdictions, such as South Africa, Australia, New Zealand, and Hong Kong, began to take steps of their own in this direction, partly spurred on by the initiative in the EU. The European Commission
For histories of the IASC, see Kirsch (2006) and Camfferman and Zeff (2007).
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had concluded that its long-standing program of issuing Company Law Directives on accounting, which then had to be incorporated into legislation in each Member State, was too cumbersome and time-consuming to deal with the intricacies and fast-paced developments in accounting. Moreover, the European Commission had begun to appreciate that company law revision was not the major issue any more to occupy its attention. In view of a series of significant developments in Germany during the 1990s including the major banks’ redefinition of their role as the principal source of financing to the multinationals, as well as the massive Deutsche Telekom initial public offering in 1996, which proved that there was a large retail market for shares in Germany, the European Commission came to the realization that its focus should instead be on serving information needs in the securities markets. Further, in early 1997 the Neuer Markt was launched by the German Stock Exchange, which required that quoted companies use either IAS or US GAAP, and disallowed the use of German GAAP. It was unthinkable for the European Commission to call for the adoption of US GAAP. That left IAS as the only viable alternative, and the Commission seized it. In 2002, the EU approved the IAS Regulation, which gave legal force to the European Commission’s stated expectation about the mandatory use of IAS by EU listed companies. In order to convert a private-sector standard into a legal obligation for listed companies in the EU, it was necessary for the European Commission to ‘endorse’ the standard. It did so only after receiving advice at the ‘technical’ and ‘political’ levels. Technical advice, that is, whether the standard constitutes sound accounting, was to be conveyed by the newly created, private-sector European Financial Reporting Advisory Group (EFRAG), whose Technical Expert Group was composed of about a dozen accounting experts from within the EU. Political advice, that is, whether the standard is acceptable in the eyes of the Member State governments, was to be given by a newly established Accounting Regulatory Committee, whose members represented all of the governments. The formulation of these procedures represented a challenge to the European Commission, because it was without precedent for a rule or standard set in the private sector to become, in effect, EU law. The composition of the newly formed IASB was heavily Anglo-centric: of the 14 members, six came from the United States and Canada, two from the United Kingdom, and one each from Australia and South Africa. The remaining Board members, one each, came from France, Germany, Switzerland, and Japan. An elaborate system of due process, which eventually came to include
6
public roundtables on major projects, was put in place by the trustees. The Board’s meetings, other than those that dealt with purely administrative matters, were all to be held in public. From the outset, it became important for the IASB to engage in active convergence with the FASB so that their respective standards might become so similar to each other that, one day, the SEC would drop its reconciliation requirement for foreign companies listing in the United States and using IFRS in their financial statements. In October 2002, the FASB and IASB announced the Norwalk Agreement to affirm this relationship. In November 2007, to the surprise of many, the SEC dropped the reconciliation requirement for IFRS users, and it remains to be seen if, and when, the SEC allows or even requires domestic registrants to use IFRS. One of the Board’s initial agenda projects was on the contentious subject of accounting for employee share options. In early 2004, the IASB successfully issued a standard, IFRS 2, on the subject, and it was in effect the standard which the FASB had been prevented by political pressures from issuing back in 1995. The IASB had passed its first major test. The only criticism emanating from European preparers was that the IASB should not require EU companies to adopt a standard that would place them at a competitive disadvantage with companies reporting under US GAAP, which required only disclosure of the effect on earnings of the granting of share options to employees. Finally, in December 2004, notwithstanding a spate of political threats from members of Congress, the FASB succeeded in issuing its own standard, FAS 123R, to converge with IFRS 2. The Board also resolved to make improvements to 15 of the standards it inherited from the IASC, which included the two standards, IAS 32 and IAS 39, on accounting for financial instruments. The first major ‘political’ hurdle for the IASB arose in 2002, when the Board was proposing improvements to IAS 39, on the recognition and measurement of financial instruments6. IAS 39 had originally been issued in 1998, when all of the IASC standards were voluntary. At that time, the banking industry had only just become fully aware of the IASC’s potential significance. Its objections to the proposed IAS 39 were actually more fundamental than its relatively feeble protests might have suggested. In 2002–4, however, the revision of IAS 39 presented the industry with a new opportunity. The major French banks took the lead in a campaign against IAS 39, directed in particular at its hedge accounting provisions. At the same time, the European Central Bank stoutly opposed a provision that allowed financial liabilities to be written down, with a gain to be recognized in the income
For a recitation of the major political battles of the IASB involving financial instruments, see Zeff (2010b).
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statement, when interest rates had risen, even if the higher interest rate signified the debtor’s worsening credit rating. When the IASB refused to back down on these provisions, the European Commission took the unprecedented step of carving them out from the standard as part of its endorsement. Eventually, the carve-out on measuring financial liabilities at fair value was removed when the IASB modified its standard, but the hedging carve-out remains. It is used by perhaps two dozen banks in the EU. The drive by the major French banks to get their way on the hedging provision enlisted the support of French President Jacques Chirac. The big French banks have the ear of the government, and France knows how to work its will in the EU better than most other countries. Furthermore, the opposition to certain provisions in the revision of IAS 39, inspired mostly in France, made it evident that the French government never truly believed that an accounting standard setter should be ‘independent’ of government interests. In France, a view prevails in government and other circles that the setting of accounting standards should be an integral part of the setting of public policy. And if the banking industry is seen as ‘threatened’ by a proposed accounting standard, the standard setter should tailor the standard to the public interest as defined by government. This is not a view held solely by the French government. In the United States, members of Congress have, on a number of occasions after being petitioned by preparer interests, threatened legislative remedies when urging the FASB to reconsider proposed standards that were alleged by the preparers to work against their industry or against the welfare of the economy (see Zeff, 2010b). This conflict over the IASB’s independence erupted again in October 2008, in the throes of the economic and financial crisis. The major French banks, with the apparent support of the French government, pressed the European Commission to demand that the IASB make it possible for companies to reclassify debt securities from ‘trading’ to ‘held to maturity,’ retroactive to 1 July, so that, in the third quarter of 2008, banks could avoid showing a huge loss in their income statements because of plummeting securities prices. The banks claimed that US GAAP allowed such a reclassification and that IFRS should be similarly accommodating. The European Commission made it brutally clear to the IASB on 13 October that the IASB had just 24 hours in which to effectuate the change, else the Commission would itself modify the standard for required use in the EU, which could deal a fatal blow to the IASB as the effective standard setter in the Union. Sir David Tweedie confided that, faced with this threat, he came close to tendering his resignation as Chairman. In the end, the IASB bowed to the pressure and promptly approved the reclassification, but the Board and its trustees much resented this brazen
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intrusion into the standard-setting process. Although acceding to the reclassification, the IASB nonetheless imposed a disclosure requirement on companies and banks which would enable readers to know what the earnings would have been in the absence of the reclassification. There were other challenges that both the trustees and the IASB faced during their first ten years. But perhaps the most daunting and troubling challenge has been the increasingly strong hand of prudential regulators as a major force in standard setting, especially as applied to banks. In countries with strong equity capital markets, such as the United States, United Kingdom, Canada, and Australia, accounting standard setters have been historically charged with developing standards that promote transparency and relevant financial information for shareholders and investors in the securities market. And this has been given as the mission of the IASB, too. The interest of prudential regulators and of the banks as preparers, which is to dampen the volatility of bank earnings and capital and also not to depress capital to the point where the pace of lending is interdicted, had been pressed on the United States standard setter on two previous occasions, albeit with considerable force. Perhaps the best example was, as noted above, their opposition to the FASB’s considered proposal in 1992 that unrealized gains and losses on marketable securities, resulting from the changes in their market values, be reflected in the income statement. Also, as noted above, the IASB faced opposition from the major French banks and the European Central Bank over the extent of the use of hedge and fair value accounting in its revision of IAS 39 in 2002–4, culminating in the two carve-outs in the European Commission’s endorsement of the standard. In good economic times, the twin aims of promoting transparency in securities markets to suit investors and not driving down unduly the balance of capital to suit bank regulators may not be in conflict. But during the economic and financial crisis that began in 2008, the regulators’ aims have clashed. Moreover, the clash has been exacerbated by the regulators’ feared consequences of the use of fair value accounting for the procyclicality of bank earnings and capital, which has led G20 finance ministers and central bankers to challenge the propriety of the IASB’s requirement that fair value be applied so widely to bank accounting. One imagines that it is easier to persuade politicians of the need to assure stability of the banking system than the need to assure transparency in the securities markets. By 2010, the IASB announced to the world that more than 110 countries and other jurisdictions had adopted the required or permitted the use of IFRS by listed companies. Yet critics have pointed out that not all of the countries that claim to have adopted IFRS have really incorporated all of IFRS, without exceptions and without an inordinate delay, in their national GAAP.
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Universality of adoption does not come easily. Yet, by 2011 such jurisdictions as Australia, New Zealand, South Africa, Israel, Hong Kong, Brazil, and Canada had adopted IFRS as a requirement for listed companies, and others, such as Japan, Korea, and Mexico, were close to doing so. Whether the United States adopts is yet to be determined. In July 2011, Chairman Tweedie, whose 10-year term had expired, was succeeded by Hans Hoogervorst, who was the chairman of the Dutch securities regulator and a former Dutch Minister of Finance. Hoogervorst, whose background is not in accounting, will be assisted by the new Vice Chairman, Ian Mackintosh, who was chairman of the United Kingdom Accounting Standards Board.
SEE ALSO Key Market, Institutions, and Infrastructure in Global Finance: Earnings Quality; Fair Value and Accounting; Fair Value Accounting, Disclosure and Financial Stability.
CONCLUSION In the last few decades, standard setting has evolved from part-time to full-time operations, with Boards having larger staffs, increasingly open due process, and almost constant communication with interested and affected parties. Standard setting is much more challenging to get right at the international level because of the different business, accounting, auditing, and legal and regulatory cultures around the world, even among countries in the European Union. Furthermore, the standardsetting boards have had to face intensified interest and even organized lobbying on the part of preparers and governments on their proposed solutions, an influence which is magnified in difficult economic times. It has been the aim of this review to bring out these trends and developments.
Acknowledgment The author is grateful to Kees Camfferman for his comments and suggestions on an earlier draft.
Glossary FAS Statement of Financial Accounting Standards, issued by the Financial Accounting Standards Board.
References Camfferman, K., Zeff, S.A., 2007. Financial Reporting and Global Capital Markets: A History of the International Accounting Standards Committee, 1973–2000. Oxford University Press, Oxford, UK. Greenspan, A., 2002. Corporate Governance, A Speech Delivered at the Stern School of Business. New York University, New York. 26 March. Available at http://www.federalreserve.gov/boarddocs/ speeches/2002/200203262/default.htm. Johnson, L.T., Swieringa, R.J., 1996. Anatomy of an agenda decision: Statement no. 115. Accounting Horizons 10 (2), 149–179. Kirsch, R.J., 2006. The International Accounting Standards Committee: A Political History. Wolters Kluwer (UK) Limited, UK. Levitt, A., Dwyer, P., 2002. Take on the Street. Pantheon, New York, NY. Moonitz, M., 1966. Some reflections on the investment credit experience. Journal of Accounting Research 4 (1), 47–61. Pulliam, S., McGinty, T., 2009. USA Inc.: Congress helped banks defang key rule. The Wall Street Journal A1, A14. Revsine, L., 1991. The selective financial misrepresentation hypothesis. Accounting Horizons 5 (4), 16–27. Rutherford, B.A., 2007. Financial Reporting in the UK: A History of the Accounting Standards Committee, 1969–90. Routledge, London, UK. Uniformity in Financial Accounting, 1965. Law and Contemporary Problems 30 (4). Van Riper, R., 1994. Setting Standards for Financial Reporting: FASB and the Struggle for Control of a Critical Process. Quorum Books, Westport, CT. Weil, J., 2004. How leases play a shadowy role in accounting. The Wall Street Journal 22 Sept. Zeff, S.A., 1972. Forging Accounting Principles in Five Countries: A History and an Analysis of Trends. Stipes Publishing Co., Champaign, IL. Zeff, S.A., 1984. Some junctures in the evolution of the process of establishing accounting principles in the U.S.A.: 1917 to 1972. The Accounting Review 59 (3), 447–468. Zeff, S.A., 1997. The U.S. senate votes on accounting for employee stock options. In: Zeff, S.A., Bala, G.D. (Eds.), Readings and Notes on Financial Accounting. 5th edition McGraw-Hill, New York, NY, pp. 507–517. Zeff, S.A., 2007. The SEC rules historical cost accounting: 1934 to the 1970s. Accounting and Business Research (International Accounting Policy Forum Issue) 49–62. Zeff, S.A. (Ed.), 2010a. Principles Before Standards: The ICAEW’s ‘N Series’ of Recommendations on Accounting Principles 1942–1969. ICAEW Financial Reporting Faculty, London, UK. Zeff, S.A., 2010b. Political lobbying on accounting standards – US, UK and international experience. Chapter 11. In: Nobes, C., Parker, R. (Eds.), Comparative International Accounting. 11th edn. Pearson Education, Harlow, Essex, UK, pp. 247–278.
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