The Impact of the Economic Crisis on the Financial

The Causes of the 2008 Financial Crisis 9 increasingly global nature of capital markets, the agency will work to promote higher quality fi nancial reporting worldwide and will consider, among other things, whether a single set of high-quality global accounting standards is achievable. 18

The New York State Society of Certifi ed Public Accountants (NYSSCPA) became probably the fi rst group of professional accountants to voice their concerns regarding IFRS adoption in their 2009 comments to the IASB Road Map. For instance, they specifi ed:

• The SEC’s plan for adoption lacked suffi cient detail as to “the methodology and criteria expected to be applied to the milestones in assessing the adequacy of IFRS in meeting the needs of preparers, users, and auditors.” • The proposal did not recognize any tilting in the cost-benefi t calculus that must surely have occurred as a result of the current economic environment:

companies, investors and other participants in the U.S. capital markets have to face the continued dearth of capital at an economically feasible price. It would be reasonable to conclude that the monetary and human capital costs of the transition to IFRS could be burdensome to entities with limited resources and prohibitive for smaller entities, even over a period of many years .

• For a variety of technical, legal, and practical reasons, IFRS will not enhance comparability of fi nancial statements across companies. As this is one of the purported benefi ts of IFRS adoption, if not the primary benefi t being touted, a positive net benefi t from adoption is somewhat illusory. Moreover, another benefi t of IFRS adoption put forth in the proposing release is the added fl exibility afforded to issuers to account for transactions and events by applying their judgment; the Society is concerned that opportunities for management judgment will result in less comparability. • Recent events indicate that the IASB is inappropriately infl uenced by various national regulators and others “who promote the interests of their specifi c constituencies, as opposed to the needs of the worldwide community.” 19

In this context, the NYSSCPA cites as an example the modifi cations to IFRS (IAS 39 and IFRS 7) that have allowed companies to “‘cherry pick’ [fi nancial] assets with signifi cant losses and reverse those losses out of net income.”

Fully acknowledging the extensive history of lobbying and political infl uence on US GAAP, it is still relevant to the IFRS adoption

10 Victoria Krivogorsky decision to recognize that by making that step the political pressure on accounting standard setting will intensify. Thus, the US capital market will be regulated by the standards that have been developed under the pressure, not just national but also international special interests. For example:

• IFRIC 2 3 : the long-established and well-reasoned basis for

“benchmark” alternative of expensing interest was abandoned. It is marked as merely the “allowed alternative” and capitalization of interests becomes a primary accounting treatment. The fact that no substantive basis was given for this change leaves little doubt that behind-the-scenes the

IFRS issuers that are the most addicted to interest capitalization spearheaded the change. • IFRIC 15: construction contract accounting treatment seems to be ingeniously crafted to provide the construction industry with the capability of managing its earnings. Looking back, the similar loopholes in US GAAP were closed decades ago.

So, probably under the pressure of political interests, the

IASB instead of converging to US GAAP decided to sustain theirs on regulation. • IAS 24 includes a requirement on special disclosure of the information about related party transactions. The

Chinese have never been big supporters of this requirement, and they continue to put pressure on the IASB to suppress it. It seems that they will be successful in changing it.

On a positive side, the IFRS 3R on business combinations is an example of the FASB’s victory during the convergence project with IASB. IFRS 3R was not fully converged with SFAS 141R in the area of measuring the noncontrolling interests, so the fi nal version of the international standard was ultimately changed to conform with the US standard fully. Overall, after more than 16 years of collaboration all the joint IASB/US FASB projects are complete or nearing their completion, but the convergence of IFRS and US GAAP has not been achieved, and the IFRS adoption in the US is not a part of a short-term plan.

It is both apparent and hopeless that politics has and will continue to play too signifi cant a part in both US GAAP and IFRS standard-setting process. Aside from the academic inquiry as to who is guilty of yielding to politics more in the past, the pertinent issue when considering IFRS adoption is whether it will infl ate or constraint the potential for politics to manipulate accounting standards used by American companies. With the expanded playing fi eld and numerous added participants to the game of standard setting, the answer is a self-evident “yes.”

The Causes of the 2008 Financial Crisis 11

Litigious Business Environment in the US

Among the general characteristics that make IFRS adoption even more problematic is the less prescriptive nature of IFRS. Under the assumption that a matter of principle maximizes the quality of fi nancial reporting, it becomes complicated to assess the degree to which an accounting rule has been infl uenced inappropriately. Thus, it raises the concern about how the standard-setters intent to appease special interests can be recognized. To this end, a set of accounting standards lacking clarity in rules will not be operational in a highly litigious business environment like the US. In the American environment of “high professional liability,” it is understandable and even justifi able that accountants and auditors demand a highly elaborate set of defi nite rules rather than “general principles” that “merely” declare neutrality and faithful representation, leaving the rest to preparer’s decision. There is no reservation that professional opinion is essential and even critical for a high-quality reporting process. At the same time, it is diffi cult to disagree that in real life, along with judgment, come different and contradictory opinions, selections of estimations, and other “leeways” that may assist other interests.

That is why FASB carries on creating detailed reporting rules, which focus on particular accounting issues and business situations, thus generating widespread gaps with IFRS. Those detailed rules are instrumental in protecting accountants and auditors from being blamed and sued together with the company’s preparers of fi nancial reports for investor or creditor problems that are even tangentially related to reporting. So, it looks like the war between the “principles-based” IFRS and the “rules-based” US GAAP (as it is not very reasonably perceived by many) is far from over yet.

Notes

1. www.forbes.com/2009/02/23/mark-to-market-opinions-columnists_recovery_ stimulus.html#3e5b481b738b 2. www.forbes.com/2010/02/13/wesbury-first-trust-intelligent-investingeconomy.html#3b96bdfa512b 3. FASB 157 is a standard from the US Federal Accounting Standards Board, that went into effect in 2007, reintroducing mark-to-market accounting. 4. www.forbes.com/2009/02/23/mark-to-market-opinions columnists_recovery_ stimulus.html#31ea8cf1738b 5. R. C. Posen, “Is It Fair to Blame Fair Value Accounting for the Financial Crisis?”

Harvard Business Review, November 2009 issue (https://hbr.org/2009/11/ is-it-fair-to-blame-fair-value-accounting-for-the-fi nancial-crisis). 6. It must be noted here, that accounting rules for impairment that are paired up with the historical costs approach represent an attempt to report a permanent reduction in the fair value of an asset below its book value (carrying amount).

Specifi cally, it compares an asset’s book value with its fair market value by including in the test the total profi t, cash fl ow, or other benefi t that’s expected to be generated by a specifi c asset.

7. www.fasb.org/jsp/FASB/Page/SectionPage&cid=1175801857762 8. https://fee.org/articles/did-deregulated-derivatives-cause-the-fi nancial-crisis/ 9. www.forbes.com/2010/02/13/wesbury-first-trust-intelligent-investingeconomy.html#3b96bdfa512b 10. www.forbes.com/2010/02/13/wesbury-first-trust-intelligent-investingeconomy.html#3b96bdfa512b 11. www.slate.com/articles/news_and_politics/the_big_idea/2008/10/the_end_ of_libertarianism.html 12. www.gpo.gov/fdsys/pkg/CHRG-110hhrg55764/html/CHRG-110hhrg55764. htm 13. October 13, 2008 Amendment to IAS 39 for reclassifi cations of fi nancial assets, effective date July 1, 2008. 16 April 2009 IAS 39 amended for Annual Improvements to IFRS 2009, original effective date January 1, 2010. 12 November 2009 IFRS 9 Financial Instruments issued, replacing the classifi cation and measurement of fi nancial assets provisions of IAS 39, original effective date January 1, 2013. 28 October 2010 IFRS 9 Financial Instruments reissued, incorporating new requirements on accounting for fi nancial liabilities and carrying over from

IAS 39 the requirements for derecognition of fi nancial assets and fi nancial liabilities, original effective date January 1, 2013. 24 July 2014 IFRS 9 Financial Instruments issued, replacing IAS 39 requirements for classification and measurement, impairment, hedge accounting and derecognition, effective for annual periods beginning on or after January 1, 2018 (www.iasplus.com/en/standards/ias/ias39). 14. Most fi nancial derivatives would not meet the fi rst test. Managing on a contractual yield basis usually means holding fi nancial assets to their contractual maturity date. 15. 28 October 2010 IFRS 9 Financial Instruments reissued, incorporating new requirements on accounting for fi nancial liabilities and carrying over from

IAS 39 the requirements for de-recognition of fi nancial assets and fi nancial liabilities Original effective date 1 January 2013. 24 July 2014 IFRS 9 Financial Instruments issued, replacing IAS 39 requirements for classification and measurement, impairment, hedge accounting and de-recognition Effective for annual periods beginning on or after 1 January 2018#( www.iasplus.com/en/standards/ias/ias39 ) 16. www.sec.gov/spotlight/globalaccountingstandards/ifrs-work-plan-finalreport.pdf 17. www.sec.gov/about/secstratplan1418.htm 18. www.sec.gov/about/secstratplan1418.htm 19. ww2.cfo.com/gaap-ifrs/2011/08/ny-cpas-ifrs-still-not-ready-for-the-u-s/