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Thursday, Apr 18, 2002

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Enronitis and the antidote

Pratap Ravindran

Pratap Ravindran on the shake-up in global accounting standards in the wake of the Enron epidemic

THE outbreak of Enronitis in the West has lent urgency to the search for an antidote — accounting standards that are a) comprehensible to the common man, and b) accepted globally.

Let us get the comprehensibility bit out of the way at the outset — after all, accountants can't be expected to be enthusiastic about putting themselves out of business and nothing very substantial can, therefore, be expected to result from the recently announced initiative by the Financial Accounting Standards Board (FASB) to codify and simplify US accounting literature.

Quite simply, this initiative involves the FASB working with the Emerging Issues Task Force (EITF), the American Institute of CPAs (AICPA) and the Securities and Exchange Commission (SEC) to consolidate standards setting into a unified database which will improve retrievability and begin to address certain standards overload issues.

It will further involve an effort to reduce the complexity of accounting literature through the issuance of standards that are less detailed than the current ones and that have fewer exceptions and/or alternatives.

As for globally accepted accounting standards, most people will be hard put to understand why the International Accounting Standards Board (IASB), the London-based private body that evolves international standards, has, as of now, no clout at all in the world's biggest capital market, the US.

America, for quite some time now, has been saying that it will move to accept international accounting standards but the fact is that, to date, overseas companies which wish to list their shares on the New York Stock Exchange (NYSE) must still provide a reconciliation to the US Generally Accepted Accounting Principles (GAAP).

With Enronitis sweeping the US, leaving public confidence in accounting standards considerably weakened in its wake, the question now is whether the US will now look to the IASB for sustenance.

The IASB is inclined to believe that it will. Thus, in December 2001, the IASB Chairman, Sir David Tweedie, told a section of the financial press that Enron's incomplete disclosures and insolvency would, undoubtedly, make Americans, who currently have a rule-based approach to accounting standards setting, want to move closer to the IASB's principle-based approach to standards setting. (One cannot resist the temptation to succumb to levity here. Are Indian Accounting Standards plagiarism-based? And is their interpretation fee-based?)

The Enron meltdown may have persuaded Americans to pay more attention to the IASB — if Sir David had not chosen a highly sensitive subject as one of the IASB's top priorities: accounting for share-based pay. Sir David has drawn flak from all quarters — American business giants have written in, criticising his proposal that companies be required to treat stock options for employees as an expense.

And European firms are cribbing that they will be at a severe disadvantage if they are required to expense stock options when US companies are not.

Sir David leading with the wrong foot notwithstanding, the problem is that the US already has a whole raft of bodies involved in standard setting. They are:

  • The Financial Accounting Standards Board (FASB) which, since 1973, has been the designated private sector organisation for establishing accounting standards. As the primary standard setter in financial reporting, the FASB sets Level A GAAP standards that govern the preparation of financial reports.

  • The Accounting Standards Executive Committee (AcSEC), which is the senior technical committee authorised to speak on behalf of the American Institute of CPAs on accounting subjects. AcSEC sets Level B GAAP standards.

  • The Securities and Exchange Commission (SEC), which was set up under the Securities Exchange Act of 1934 with the mandate to restore investor confidence in the US securities markets. The SEC is responsible for setting standards for all public companies in the US.

  • The Emerging Issues Task Force (EITF) which is an independent group formed by the FASB in 1984, comprising persons who are able to tune into emerging issues before they become widespread.

    The upshot is that, although accounting rules appear fixed in the US, they are interpreted differently by these bodies.

    The face-off between the FASB and the International Accounting Standards Committee (IASC), structured in 1973 and restructured subsequently to undertake, among other things, the composition of the IASB, began in the autumn of 2000 in the office of the SEC Chief Accountant, Mr Lynn Turner. That was about the time that the SEC looked as if it just might do something about letting in IAS. The commission had asked for comment on the quality of IAS — and many of the letters that had come in were reflective of the sentiment that IAS rules weren't tight enough and would give companies that didn't follow US GAAP a lower bar to raise capital in the US markets.

    By way of illustration, one letter talked of Nokia, the Finnish mobile phone major, which claimed compliance with IAS. However, according to the letter written by Mr Kenneth Blair, citing a study by the accounting specialist, Mr David Cairns, published in the Financial Times, Nokia had claimed full compliance with IAS in its statement of its accounting policies, but had not disclosed geographical segment information or many of the required disclosures of retirement benefits.

    Mr Cairns, a former secretary-general of the IASC, had come down heavily on Nokia: "It's a serious breach. Nokia has operations in about 20 countries, and there's no geographical breakdown in the annual report..."

    How, then, did Nokia get away with not making available the segment information and other required disclosures? The answer is simple: There is no world equivalent of the SEC that can penalise companies that claim compliance with the IAS but are not.

    And then again, as Mr Olli-Pekka Kallasvuo, CFO and Executive Vice-President of Nokia, pointed out in sheer despair, "we don't know what to disclose" under IAS because of its vagueness on several key standards-related issues.

    The lack of an enforcement agency as also the vagueness of IAS have combined to ensure that although CFOs around the world concur on the need for a set of global accounting rules that will make it easier for their companies to raise capital, undertake acquisitions, and so on, in foreign markets, international standards remain, as of now, over the horizon. But, perhaps, not for long.

    The fact is that the FASB is not looking very good right now in the wake of the Enron fiasco and can no longer maintain, with any degree of credibility, that it is more rigorous and reliable than IAS. And then again, the SEC continues to have a strong commitment to allowing foreign companies to list their stock in the American markets.

    This commitment was first manifest in the move by the former SEC Chairman, Mr Arthur Levitt, prior to his demitting office, to get Mr Paul Volcker, former Chairman of the US Federal Reserve Board, to oversee the restructuring of IASC.

    To revert to levity, a universally accepted set of accounting standards would make life a whole lot easier for the Institute of Chartered Accountants of India (ICAI) in that its own on-going efforts to bring Indian standards in line with global ones will require "inspiration," as it were, from only one quarter.

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