Why A Single, Global Financial Reporting Standard Won’t WorkPublished: August 09, 2006 in Knowledge@Emory
H.L. Mencken once noted that for every complex problem there is a solution that is simple, neat – and wrong.
In an increasingly global economy, the existence of competing accounting standards is seen as an expensive nuisance for many companies. Many accounting standards leaders want to try to reconcile those country-based rules into a single, global financial reporting standard. But George Benston, a professor of economics at Emory University and a professor of finance and accounting at Emory’s Goizueta Business School, concludes in a recent book that the single-standard idea may fit into that category of Mencken’s category of attractive – but ultimately bad – solutions.
In his latest book, Worldwide Financial Reporting: The Development and Future of Accounting Standards (Oxford University Press 2006), Benston and co-authors Michael Bromwich, professor at the London School of Economics; Robert Litan, senior fellow at the Brookings Institution in Washington, D.C.; and Alfred Wagenhofer, of the University of Graz, Austria, have concluded that as much trouble as the differences between the U.S.’s Generally Accepted Accounting Principles (GAAP) and other accounting standards are, a single standard would be worse.
Although most accounting is the same the world over, Benston says, reconciling the details that differ between the standards would turn out to be very costly and “not a feasible or desirable outcome.”
“The main problem is that each country has its own history, its own set of mores and laws, and its own ways of interpreting things,” Benston explains. Even individual terms that seem to be the same when translated can mean quite different things in different cultures. “It’s not feasible to have a single standard that’s truly a single standard.”
Beyond the problems of translation, Benston and his colleagues see a potential for political difficulties as well. Unlike traditional accounting, which evolved over hundreds of years in response to the needs of investors and companies, the current impetus for a single, global standard is being directed by quasi-governmental authorities, particularly the Financial Accounting Standards Board (FASB) in the U.S. and International Accounting Standards Board (IASB) in Europe.
Since the standard would be determined by a rule-making body with a large staff and budget, the FASB, Benston argues that the number or rules tend to multiply over time. When standards boards “are empowered to make any rules they want, they make rules,” Benston says. Since FASB was created in the 1970s, the number of rules has multiplied. “They are under the impression that they can make a rule for everything,” he says.
And quantity may not be synonymous with quality. Benston argues that standards boards are inevitably susceptible to lobbying by companies interested in crafting particular rules in ways that would benefit them. One case in point: the multi-year debate in the U.S. over whether stock options should be listed as an expense. While the logical traditional accounting answer is yes, options should be considered as an employment cost—as are salaries and bonuses— Benston says, the political answer was quite different. In the course of the debate, for example, Sen. Joseph Lieberman (D-Conn.) actually introduced legislation that would prohibit the FASB from ruling on the issue “because the people who pay his bills wanted it,” Benston alleges. “It’s the great American tradition.”
Historically, Benston charges, most government-legislated rules have tended to increase costs without making investors any safer. Almost all corporations with publicly traded stock actually supplied financial information before the Securities Exchange Act of 1934 mandated it, he says. In fact, Congress at the time had little evidence that bad accounting had anything to do with the stock market scandals of the late Twenties or the 1929 crash. The Sarbanes-Oxley Act, which created a variety of new reporting requirements for public companies in 2002, has followed a similar path in reacting to corporate scandals by creating new financial reporting requirements. And Sarbanes-Oxley’s upshot, he argues, has been the same: more rules, but not necessarily more safety than investors had before.
In fact, Sarbanes-Oxley’s biggest impact has been on the accounting profession, he maintains, which has profited enormously in its new role advising companies on how to meet these new reporting requirements. “Sarbanes-Oxley is the accountants’ full employment act. It’s a wonderful bill from that point of view,” he says.
Reconciling the different standards regimes might also be difficult for other reasons as well, Benston says. The United Kingdom and other European countries tend toward a principles-based approach in their laws, which have evolved over hundreds of years. The United States has increasingly adopted a rules-based approach, in which FASB-promulgated rules attempt to cover most situations. Such rules-based accounts are designed to protect accountants and their clients from investor lawsuits. But Benston argues that they also make financial statements less reliable, and hence less useful to investors, since under a rules-based approach the goal becomes meeting the letter of the law rather than the spirit.
Another problem with a global accounting regime, in Benston’s view, is that over time standards setters are likely to become distant from the practicalities of maintaining financial statements. Although companies are likely to make their views known through lobbyists, accountants themselves may find that their influence may wane over time. FASB’s experts, for instance, have been increasingly removed from the actual practice of accounting. The result, says Benston, has led them to make rules that have been neither practical to implement nor ultimately helpful to investors.
One such issue, in his view: the FASB’s move toward fair-value accounting. Traditional accounting has based the value of assets on the cost of actual arms length market transactions. Fair-value accounting, however, asks companies to estimate the value of the assets now, whether or not there is a transaction. To date, these fair valuations have been limited to financial assets. However, as Benston explaines in Worldwide Financial Reporting, it is not difficult for companies to extend such inherently subjective valuations to other assets.
“In our book, we agree that valuing assets and liabilities at the current economic values would be a great idea, if we knew how to do it. Net income then would reflect change in the values of all assets and liabilities as well as sales and related expenses. But, as anyone who has sold a house knows, you don’t know how much it really is worth until an offer is made and accepted and the buyer’s check clears the bank,” Benston says. “Fair-value accounting,” he warns, gives opportunistic or dishonest managers too much latitude in deciding how much assets are worth and, as a result, how much net income to report.”
Benston and his co-authors criticize the FASB’s and IASB’s movement towards fair-value accounting for not learning much from history. That is one reason that their book includes chapters that outline the development as well as the current state of accounting standards in the United States, the United Kingdom, Germany, the European Union, and Japan. The United Kingdom adopted standards in response to some scandals. Germany has a very conservative accounting system right now in part because in the past it had undertaken its own disastrous experiments with fair value accounting. The SEC also took a conservative approach, wherein it would not accept asset revaluations and delegated standard setting to American Institute of Certified Public Accountant (AICPA) committees whose members were full-time practicing public accountants. Until the FASB was established in 1973 and during its early years, fair-value accounting not based on actual market transactions was rejected.
“In any event,” Benston explains, “there is no obvious single truth. There are great benefits from allowing companies to choose among alternative sets of standards. One argument, though, against maintaining multiple systems is that the ‘worst’ system – the easiest to comply with – would eventually become the most popular.” Actually, Benston says, such “a race to the bottom” isn’t likely. Companies that can’t assure investors about their honesty and that do not publish useful (which is to say, trustworthy) accounting numbers either will have a harder time attracting investors and lenders or will suffer costs as financial statement users discount numbers they cannot trust. Over time, he says, the companies with the cleanest financial statements are likely to have the lowest capital costs.
Consequently, Benston and his colleagues maintain that there is value in having more than one standard. “Being trained in economics, we thought that the way markets work best is through competition. Let alternative standards compete, and the one that would seem to be the most useful would be the one most likely to come out first,” he says. Furthermore, different companies might find that one standard or another presents their financial performance more effectively to investors. Both from historical experience and knowledge about how investors make decisions, we concluded that a single world-wide accounting standard is neither useful nor feasible.”