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A Tale of Two Standard Setters: Striving for Convergence, amidst Crisis

Christopher Arnold  | 


Earlier this year, Barach College hosted a lively discussion with former Financial Accounting Standards Board (FASB) Chair Robert Herz and former International Accounting Standards Board (IASB) Chair Sir David Tweedie on “Accounting Standards for Global Capital Markets: Past, Present, and Future.” It covered convergence of International Financial Reporting Standards (IFRS) and US Financial Accounting Standards, the impact of the financial crisis, and their views on the future. Mr. Herz was appointed Chair of FASB, effective July 1, 2002 and served two terms until 2010, while Sir David was appointed the inaugural Chair of the IASB in 2001 and retained the role until June 2011.

The Great Hope of Convergence

Central to the terms of both Chairs was the issue of convergence and whether a single set of global financial reporting standards could be developed, for which there was “a lot of enthusiasm at the time.” It was evident a strong friendship had developed between the former Chairs, with Sir David describing Mr. Herz at one point as a “soul mate.” Early on in the tenures of both Chairs, steps were taken which led to each respective board accepting changes to their accounting standards based on the agreed best model. Over the first four years, the two boards worked to “converge” eight standards. In 2006, concerns over the time being taken with the process were raised, and the US Securities and Exchange Commission (SEC) advised that the boards need not adopt the respective standards word for word, as long as the principles were in alignment. One of the significant achievements was in 2007, with the amendment to eliminate the need for foreign private issuers to prepare US GAAP reconciliations to their financial statements prepared in accordance with IFRS in their SEC filings (Securities Act Release No. 8879[1]). Sir David indicated this was high point as around this time the US had intended to adopt IFRS by 2013.

Technical & Political Challenges

Sir David and Mr. Herz agreed that there were both technical and political difficulties in convergence. One of the biggest technical challenges was on stock options and the issuing in February 2004 of IFRS 2, Share Based Payment, which requires an entity to recognize share-based payment transactions (e.g., share options) in its financial statements. Similar to US GAAP, IFRS 2 requires a company to recognize an expense for employee stock option awards based upon the fair value of the stock option at the grant date. The proposals were controversial, with significant concerns raised in both Europe and the US.

The introduction of International Accounting Standard (IAS) 39, Financial Instruments: Recognition and Measurement was also identified as particularly challenging. IAS 39 outlines the requirements for the recognition and measurement of financial assets, financial liabilities, and some contracts to buy or sell non-financial items. It includes the recognition of financial instruments on the Statement of Financial Position and subsequent measurement at fair value with all gains and loss being recognized in the Statement of Profit or Loss. Sir David indicated that the European Commission was particularly opposed to the standard; however, the IASB published it in December 2003.

In 2002, the European Union agreed that from January 1, 2005, IFRS would apply for the consolidated accounts of EU-listed companies,[2] in a move that Sir David described as “in a way inevitable;” given the variety of financial reporting frameworks in Europe, it was seen as the only choice. Sir David noted that the European Commission was keen for IFRS to include reference to the 4th and 7th European Directives as its constituents were key users of IFRS. Interestingly, just a few months after the announcement, both Australia and New Zealand announced they would adopt IFRS and also wanted reference to their own regulations. The IASB ignored the pressure from either side, with Sir David acknowledging that certain groups seemed increasingly uneasy about the independent mandate of the IASB.

Global Financial Crisis

Sir David stated that had it not been for the global financial crisis they may have managed convergence. He mentioned that one month after the collapse of Lehman Brothers,[3] he attended a meeting at the Financial Stability Board and had “never smelt such fear in a room,” indicating that people feared the whole capital system was going down.

There was heightened attention on fair values and wide perception that accountants were causing the crisis. The IASB amended IAS 39 (effective from July 1, 2008) to enable, in rare circumstances, financial assets to be reclassified out of the “held-to-trading” and “available-for-sale” categories. The amendments were issued in a very short timeframe and without due process as an urgent response to the financial crisis. The effect was certain financial assets could be carried at amortized cost rather than fair value with an associated anticipated reduction in earnings and equity volatility.[4] Sir David acknowledged that following the amendment, the IASB was “crucified” and that it “could have been the end of the IASB.” There was also a fall-out with Europe and he noted there had always been a balancing act in getting the US to converge without losing the EU.

Sir David noted that there had been a significant change over time in the level of banks’ capital and how by the time of the global financial crisis banks’ equity was down to 2% as they had distributed everything. There were also a lot of questions over the value of financial instruments. This led to fundamental questions on what accounting standards were implemented for, with the banks believing it was for financial stability, whereas others argued they were for transparency to provide useful information for decision making by the market.

Non-Financial Information

It was acknowledged that there is an increasing appetite among regulators for non-financial information. Mr. Herz considers that, for example, the EU and South Africa are further ahead than the US, but both agreed it will have to be market driven: regulators will not enforce until the demand is there.

The Future

While Sir David was hopeful the US would adopt IFRS, both acknowledged that since 2009/2010 the relationship between the boards has not been as close and it may need another significant crisis to push them back into each other’s arms. Sir David cited the 3Cs as impediments to change—it costs money to change, nobody likes change, and the loss of control. Geopolitics will come into it, but currently the conditions don’t exist to force action. Mr. Herz observed that because of the accounting scandals, such as Enron[5] and WorldCom[6] and the introduction of Sarbanes Oxley,[7] financial reporting was in the spotlight like never before during the early years of their tenures as chairs.

Mr. Herz stated that the US has moved steadily away in the last few years, and even though the SEC still supports the idea of global standards, there is no systematic program to further convergence. It appears that the respective bodies are both comfortable with the good and bad of their standards and are contented in a two-GAAP world at this point in time. One possible trigger that may force a change would be if the US economy were to shrink in size.

Sir David recognized that you can’t have global standards without the US. He stated that 138 countries now use IFRS[8] with recent progress in Asia, India intending to adopt in 2017,[9] and 20% of the Japanese stock market now using the standards[10]. Mr. Herz remarked that IFRS has benefited the capital markets as before there was a “hodge-podge” of different accounting standards. Additionally, he believes that the work by the boards has helped lift financial reporting and audits around the world, to the benefit of investors.

What changes would they each like to see in the future? For Sir David, it is IAS 12, Income Taxes and for Mr. Herz an improvement to the FASB Conceptual Framework for Financial Reporting. It will be interesting to see if their vision of convergence will eventually be realized.

Christopher Arnold


Christopher Arnold is a Director at the International Federation of Accountants (IFAC). He leads activities on contributing to and promoting the development, adoption and implementation of high-quality international standards, including the Member Compliance Program, Intellectual Property and Translations. Christopher is also responsible for IFAC’s SME (small- and medium-sized entities), SMP (small- and medium-sized practices) and research initiatives, which include developing thought leadership, public policy and advocacy. He was previously an Audit Manager for Deloitte and qualified as a professional accountant in a mid-tier accountancy practice in London (now called PKF-Littlejohn LLP). Christopher started his career as a Small Business Policy Adviser at the Association of Chartered Certified Accountants (ACCA).