Speaking in June at the SEC and Financial Reporting Institute Conference in Pasadena, Calif., Cox laid much of the blame on the IASB for what some are now calling the “divergence” of U.S. generally accepted accounting principles and international financial reporting standards. Declaring that he had “come to bury IFRS, not to praise them,” Cox charged that “IASB hasn’t shown much sensitivity to American criticisms of its proposals.”
More pointedly, Cox sketched out sharp behavioral differences between the European rulemakers and the American constituents of FASB. “On the few occasions when IASB members did appear at U.S. roundtables and meetings, they seemed aloof,” he said. “They simply weren’t accustomed to the more relaxed and supple interactions that FASB has been able to have with stakeholders over the years.”
The former SEC chair, who quit the agency during the nadir of the financial crisis, went so far as to psychoanalyze the international board members, citing “the IASB’s passive-aggressive response to the seeming U.S. indifference to the prospect of domestic use of IFRS.”
Those words seemed to get under the skin of the usually unflappable IASB chairman Hans Hoogervorst, who issued a statement suggesting that Cox was advocating an overly flexible approach to standard setting. “Former Chairman Cox has shifted his focus from a single set of high quality global standards to maintaining a national standard setter that is ‘supple’ when responding to domestic priorities and concerns,” he wrote. “We continue to believe that investors are best served by high quality globally comparable information, and that includes U.S. investors.”
In contrast to Cox, now a partner at law firm Bingham McCutchen, Hoogervorst feels the recent parting of the ways of IASB and FASB on two key standards—leasing and financial instruments—doesn’t represent a tragic end to the quest for a common global accounting language.
Instead, he sees the end of convergence as the termination of a more narrowly defined—and highly successful—project. “Convergence was a limited-scope project,” he wrote in an e-mail to CFO. Like any program, it’s had its successes, such as the converged standard on revenue recognition, and “some challenges,” especially the inability to come to agreement on how companies should report results involving their financial-instrument holdings, Hoogervorst wrote.
In fact, the IASB chairman refuses even to call the divergence between the two regulators “a philosophical parting.” If that were the case, “we would not have been able to achieve convergence in many standards. It points more to the structural fault with convergence, that two independent boards with different imperatives have a nasty habit of reaching different conclusions,” Hoogervorst wrote.
But for many U.S. constituents of financial reporting—standard setters, CFOs and other corporate executives, auditors, and investors—the end of convergence carries much more significance. The coming home to roost of certain unavoidable differences between America and the rest of the world seems to have led to a widespread conclusion that there can be no single correct way of accounting for corporate finance.
The New Realism
Call it the new realism. Like Hoogervorst, FASB chairman Russell Golden is quick to cite the many successes of the convergence effort, which began with the 2002 Norwalk Agreement (named for FASB’s Norwalk, Conn., headquarters). Under that agreement, FASB and the IASB signed a memorandum of understanding on the convergence of accounting standards.
The major goals on the agenda were to fix deficiencies in both U.S. GAAP and in IFRS, and eliminate certain differences between the two sets of standards. It was an ambitious agenda, and the pace of accomplishments was brisk, if sporadic. “Business combinations, noncontrolling interests, fair value measurements, borrowing costs, segment reporting, stock compensation, and nonmonetary exchanges are just some of the other areas where we’ve improved and aligned standards,” Golden said in a September e-mail to CFO.
Both Hoogervorst and Golden now seem to regard the joint standard on revenue recognition issued on May 28 as the crowning achievement of convergence, however. In the United States, the new standard, which starts becoming effective for annual reporting periods beginning after December 2016, will replace more than 200 ad hoc pronouncements on revenue recognition (see “Harder to Recognize,” April). “That guidance alone aligned a major area of financial reporting that affects all companies, institutions, and not-for-profit organizations worldwide,” the FASB head told CFO.
But failures in coming to terms on common standards for two major topics—leases and financial instruments—appear to have left the standard setters with a healthy appreciation of the obstacles they had tried for so long to overcome. (The boards also seem to be going their separate ways on accounting for insurance contracts, although that topic was not part of the original memorandum of understanding.) The recent divergence “requires us to recognize that differences in the cultural, business, legal, and regulatory environments in different jurisdictions inevitably will result in some differences in those standards,” wrote Golden.
Perhaps the clearest example of how such differences led to a breakdown in convergence is the leasing project. After a half decade of deliberations, having reached a fundamental agreement that leases longer than 12 months should be reported on corporate balance sheets, the two boards announced their decision at an August 27 joint meeting to approach lease reporting differently. The split boiled down to a disagreement about whether lessee accounting should follow a dual approach or a single one.
For its part, FASB decided on the dual approach. Under that method, there would be two types of leases: Type A, which would consist of mostly capital leases; and Type B, mostly operating leases. For both types of leases, companies would be required to recognize on their balance sheets the right to use the leased property or equipment and the interest on the lease payments.
The accounting difference between the two types of leases occurs on the income statement. For Type A leases, companies would have to report amortized payments for the right to use the asset separately from the lease-liability interest payments. For Type B leases, companies would only be required to recognize a single total lease expense.
By contrast, the IASB decided on a single approach, requiring lessees to account for all leases according to the Type A method.
Before the boards announced their decision on leasing, Cox observed that the dual approach represented an attempt by FASB to accommodate U.S. GAAP to IFRS ideas. “But despite this accommodation, something felt different to U.S. stakeholders. In the past, the FASB had been highly practical and sensitive to both costs and unwanted economic side effects [of a potentially converged standard]. Now, that sensitivity seemed to be giving way to the higher imperative of being sensitive to the IASB,” Cox said.
The Condorsement Compromise
All in all, it was quite a turnaround in attitude for the former SEC chairman, who during his tenure was a prime advocate of convergence, issuing in 2008 a “roadmap” that could lead to IFRS use by U.S. issuers starting in 2014. One reason that goal hasn’t been met was the lack of a strong convergence advocate like Cox at the agency, according to Emre Carr, a senior financial economist at the SEC from 2010 to 2012 who focused on how IFRS might be used in the United States.
After Cox left, the prospects for use of IFRS in the United States “clearly changed trajectory” toward divergence, says Carr, now a principal at Berkeley Research Group. “Since the SEC has the ultimate authority on what accounting we use, the SEC chairman favoring it or not has a big effect. I think that was one of the biggest things that altered course,” Carr says.
Cox’s successor at the SEC, Mary Schapiro, was less optimistic about the future prospects for the country’s use of IFRS, according to Carr. “There was a very, very strong expectation for Mary Schapiro to stand up and say, ‘In 2020, the U.S. will adopt IFRS,’ or something of that nature,” he says.
Because Schapiro wasn’t inclined to take that stance, the agency felt pressured to “give the IFRS community something without making tangible commitments,” Carr says. SEC staff members, including Carr, thus hatched the notion of “condorsement,” an ungainly amalgam of “convergence” and “endorsement.”
Under condorsement, FASB would continue to hold sway in this country over a convergence of U.S. GAAP and IFRS during a transition period of five to seven years. After that, FASB, which would work on the development of future IFRS, would choose whether to endorse the standards for use in the United States.
The Cost of Switching
At its core, condorsement was a last-ditch stab aimed at addressing what Carr sees as a fatal flaw in the U.S. side of the convergence plan: the price that domestic companies and auditors would have to pay for changing their reporting language from GAAP to IFRS. And while the goal here ultimately softened to adoption of a finite number of converged standards, in the early days of Cox’s advocacy the unspoken objective “was to adopt IFRS in the United States in some fashion,” he says.
The former SEC economist thinks that may have been an unrealistic aspiration because of the “huge switching cost” of wholesale IFRS adoption. The expense, he said, would have included that of companies and auditors changing their accounting systems and the alteration of a plethora of contracts.
To be sure, the boards’ decision to part ways generates its own costs for a host of U.S. companies. The schism on the issue of financial instruments, which formally began on July 24 when IASB issued its own standard (IFRS 9), could lead to substantial compliance and data-gathering expense for U.S.-based companies, says Lisa Filomia-Aktas, a partner with Ernst & Young and leader of the firm’s financial accounting advisory services.
At the very least, the financial instruments divergence creates compliance complications by imposing the possibility of two different effective dates on companies, creating a situation in which headquarters reports in GAAP and corporate subsidiaries report in IFRS. While the new IASB standard will go into effect on January 1, 2018, there’s no effective date for a FASB standard, which has yet to be completed.
Further, U.S. multinationals with large numbers of foreign subsidiaries that report in IFRS—40 or 50 isn’t uncommon, according to Filomia-Aktas—will have a big job on their hands with the transition to complying with the part of IFRS 9 that involves the classification and measurement of their holdings of debt and equity. “Because of the divergence on classification and measurement, in each country that I have to do IFRS reporting in, I have to have a whole separate process now to reevaluate and classify my financial instruments,” she says.
Under IFRS 9, for instance, companies will now have to do a “cash-flow characteristics test” of their financial instruments to gauge whether the cash flows generated by their investment portfolios consist solely of principal and interest. Such tasks will necessitate “huge” data-gathering efforts that could have been curbed if the boards had been able to agree on a single, less onerous standard, according to Filomia-Aktas. “The data gathering that you have do for financial instruments for IFRS is much greater than it will have to be for U.S. GAAP,” she says.
Still, the benefits of a full-scale move to IFRS always stood to be narrowly dispersed among big multinationals. “It’s only the large, global U.S. companies that favor using IFRS, because that’s going to save them duplicative costs. They already know IFRS because they have it through their subsidiaries,” says Carr. “That’s really the only constituent that favors this.”
At many smaller, domestically centered companies, on the other hand, the concept has always been synonymous with lost time, red tape and compliance costs. Every new convergence development has meant “having to learn something new once again—more standards and more rules to have to adhere to,” says Charles Best, CFO of BlackLine Systems, a finance controls and automation software provider. “I’m not sure what the consequences [of divergence] are, though I do believe many people in my position are not terribly distraught over this.”
David M. Katz is a deputy editor at CFO.