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Busting Some Myths About IFRS

Scott Taub | May 28, 2014

Guess what? Some commonly held beliefs about International Financial Reporting Standards are just plain wrong.

My six-year term as a member of the IFRS Interpretations Committee (IFRIC) ends this month, and I hope that I have helped to improve the international accounting standards during that time.  Either way, I have learned an awful lot about IFRS and the International Accounting Standards Board.

 In some cases, my experiences tell me that some things that are “generally accepted” are nonetheless untrue, while some of the conventional wisdom is grounded in reality. So, in the spirit of Discovery Channel's MythBusters, I'll discuss some commonly held misconceptions about IFRS and confirm some of the conjecture. I don't have access to explosives or super slow-motion cameras like they do on the show, so I'll have to rely on what I learned during the past six years to confirm or bust these myths.

Principles vs. Rules

Many believe without question that U.S. Generally Accepted Accounting Standards is rules-based while IFRS is principles-based. Let me bust that one right away. Both IFRS and U.S. GAAP are based on principles. Every piece of guidance in either set of standards is based on one or more principles.  To suggest that significant pieces of U.S. GAAP are just rules with no underlying principles is an insult to the Financial Accounting Standards Board and the other groups that have contributed to U.S. GAAP over the years.

Along the same lines, I often hear that one of the difficulties in converging U.S. GAAP and IFRS is that Americans want rules while those outside the United States are willing and able to work with principles. The questions that various constituents have asked of IFRIC belie that thought. They have asked repeatedly for us to address very narrow topics, individual transactions, and unique circumstances. They have asked us to provide additional guidance where none should have been needed and to write very specific guidance to root out bad practice.

In short, IFRS users request the same kind of detail and rules that U.S. GAAP users often request. Consider the myth about Americans wanting more rules than others busted as well.

Stopping there doesn't give a complete picture, though, because, while IASB and FASB constituents ask the same kinds of questions, responses have been quite different. U.S. standard setters have provided detailed guidance and rules frequently. While the intent of all those rules is to help ensure that the principles are followed, there are many examples where U.S. GAAP's rules allow reporting that is inconsistent with the principles and many other areas where U.S. GAAP is so complicated that the principles are hard to follow for many accountants.

What is true is that IASB has resisted providing the level of detail that exists in the United States. Indeed, one of the most difficult tasks for IFRIC is to provide useful guidance without resorting to rules or overcomplicating the standards. IFRS is noticeably less complex than U.S. GAAP in part because of the direction IASB has taken (and directed IFRIC to take) on this point.  So we'll consider this part of the principles vs. rules belief confirmed. Whether that makes IFRS better, worse, or simply different, is in the eye of the beholder.

Regulatory Matters

While many accountants in the United States are critical of the SEC, there is also a common belief that U.S. GAAP benefits from the SEC's enforcement of the standards through periodic reviews of filings and questioning of registrants. The conventional wisdom is that there is no effective similar function outside of the United States.

Perhaps this was the case a decade ago. But times have changed. During my years on IFRIC, I have been impressed with the work of several non-U.S. regulators, including the European Securities and Markets Authority. A representative of ESMA attends every IFRIC meeting, and those representatives have added important insights to our discussions. ESMA has appropriately taken a lead role in addressing many matters involving the application of IFRS, has brought important issues to the attention of IFRIC, and has shown that it is both committed to, and capable of, improving financial reporting through its work reviewing the application of IFRS by issuers.

So I'll consider this myth busted.  Strong regulation of accounting standards application may not exist everywhere, but it certainly is not limited to the SEC.

IASB Is Beholden to Europe

Some in the United States thought that one of the potential benefits of IFRS might be that IASB would be able to rise above political pressure from any national or regional government. When that proved not to be the case, Americans became wary of hitching themselves to IFRS. While FASB has certainly given in to political pressure from time to time, we seem to prefer our political interference come from Washington, not Brussels.

That IASB pays a lot of attention to the views of its European constituents isn't a surprise, as Europe has been the largest user of IFRS. This attention isn't necessarily a problem—after all, those that use the standards are in a good position to evaluate their strengths and weaknesses.

IASB has on a few occasions, however, given in to threats from the European Union, most notably in regards to treatment of financial instruments. Several exceptions were granted and projects were rushed in attempts to placate European political interests. In my experience, some IFRIC efforts were affected by a desire to placate these interests as well.

Many believe without question that U.S. Generally Accepted Accounting Standards is rules-based while IFRS is principles-based. Let me bust that one right away. Both IFRS and U.S. GAAP are based on principles. Every piece of guidance in either set of standards is based on one or more principles.

More commonly, however, IASB resists requests and pressures from the European Union, and the board has generally navigated the difficult political waters without compromising its integrity. Had IASB simply done Europe's bidding, financial instruments would be mostly carried at cost, losses on Greek bonds would have been recognized much later, and there would be no Americans on IASB or IFRIC.

So, IASB is certainly not at the beck and call of the European Union, but it isn't completely immune to pressure from the European Union, either. For the moment, then, the belief that IASB is beholden to Europe is partially confirmed.  

IFRS Still Lags Behind U.S. GAAP

Many in the United States continue to believe that IFRS is still inferior to U.S. GAAP. They note that IFRS doesn't cover certain important areas and believe that IFRS guidance is insufficient in other areas, as the principles are not backed by enough implementation guidance. Some also believe that IFRS permits too much diversity.

During the past six years, issues have come before IFRIC in just about every area of accounting. In that time, I can count five areas in which IFRIC had difficulty dealing with an issue because of a lack of guidance in IFRS, where U.S. GAAP has guidance, including: revenue recognition, common control transactions, rate regulation, extractive industries, and insurance. Of those, the most important by far is revenue recognition, and that will be resolved shortly by the issuance of the new joint standard. IASB has at least discussed and researched the other four, so these holes might be filled as well.

On the other hand, there are areas where IFRS has guidance, but U.S. GAAP is lacking. U.S. GAAP is largely silent on fixed asset capitalization and depreciation, while IFRS provides guidance on these. IFRS also covers general asset impairments, while U.S. GAAP has specific models for some assets and nothing for others. IFRS also covers service concessions, compensation arrangements, and government grants more completely than U.S. GAAP does.

With respect to options, it is true that IFRS allows optional re-measurement of long-term assets and investment property, while U.S. GAAP does not. It is also true that less-detailed guidance and rules is sure to lead to greater diversity in some areas. On the other hand, U.S. GAAP allows options on inventory valuation (LIFO, for example) that IFRS does not, and the detail in U.S. GAAP certainly has not ended diversity.

Furthermore, the fact that U.S. GAAP was developed over so many decades by different bodies has resulted in many areas in which seemingly similar things (asset impairments and long-term compensation arrangements, for example) are handled very differently based on characteristics that don't seem to warrant different accounting. IFRS, on the other hand, has much less of this.

On the whole, then, I think that while U.S. GAAP is better than IFRS in certain ways, IFRS is better in others. With the completion of the revenue recognition project, I can no longer say that IFRS is still behind U.S. GAAP when evaluated as a whole. For me, that myth is busted.

Looking Ahead

When I joined IFRIC, I thought that by end of my service, the United States would be far closer to adopting or converging with IFRS than we are. I'm sorry it hasn't turned out that way. Thinking about what I've learned about IFRS and the IASB, the biggest area of concern that I believe is justified relates to IASB's relationship with the European Union. I understand entirely why the United States is leery of that dynamic. Ironically, the most effective solution to that problem might well be for the United States to adopt IFRS, giving IASB another large constituent base.