IFRS in practice – the broken “promise of comparability”?

by John Hughes

In connection with its ongoing deliberations about adopting IFRS, the SEC has issued a staff paper, An Analysis of IFRS in Practice, based on examining the most recent annual financial statements of 183 companies domiciled in 22 countries, some of them SEC registrants, others not (given the timing of the exercise, there aren’t any Canadian companies in the sample – 80% are from the European Union). The headline outcome is this: “The Staff found that company financial statements generally appeared to comply with IFRS requirements.” However, the report goes on to emphasize two recurring themes:

“First, across topical areas, the transparency and clarity of the financial statements in the sample could be enhanced. For example, some companies did not provide accounting policy disclosures in certain areas that appeared to be relevant to them…(and overall) certain disclosures presented challenges to understanding the nature of a company’s transactions and how those transactions were reflected in the financial statements. In some cases, the disclosures (or lack thereof) also raised questions as to whether the company’s accounting complied with IFRS…

“Second, diversity in the application of IFRS presented challenges to the comparability of financial statements across countries and industries…in some cases, diversity appeared to be driven by the standards themselves, either due to explicit options permitted by IFRS or the absence of IFRS guidance in certain areas. In other cases, diversity resulted from what appeared to be noncompliance with IFRS. The diversity arising from the standards themselves was, at times, mitigated by guidance from local standard setters or regulatory bodies (and) by a tendency by some companies to carry over their previous home country practices in their IFRS financial statements. While country guidance and carryover tendencies may promote comparability within a country, they may diminish comparability on a global level.”

Tom Selling in his Accounting Onion blog pounces on the report as follows: “The number of apparent departures from IFRS noted and the various ways that IFRS has been interpreted by the largest companies should explode the myth that worldwide adoption of IFRS will result in more comparable financial statements. The unavoidable conclusion is that even if a single set of global accounting standards were possible, the paper leaves no reason to believe that effective global enforcement would occur. A single set of standards without a single, consistent and rigorous enforcement mechanism will fail to deliver on the promise of comparability.”

Well, it’s hard to argue with that. The question though – and I know I’ve covered this territory before, so I apologize, but it’s just unavoidable – is why anyone would even claim that converting to IFRS comes with a “promise of comparability.” Certainly, the SEC report does set out some rank oddities, for example, in the area of share-based payments: “one company disclosed that it estimated the value of stock options once every three years and used that calculation as the basis to calculate share-based payments made during intervening years.” The report drily adds: “How these policies complied with IFRS was unclear.” But for the most part it documents the kind of oversights, corner-cutting and ambiguities that – if you’re realistic about it – just come with the territory for something as complex and multi-faceted as financial reporting. Selling knows of course that there’s not going to be any “single, consistent and rigorous enforcement mechanism” in our time – by setting that up as a criterion, he renders IFRS in the US an impossibility, forever.

But the truth is, investors can easily deal with a certain amount of incomparability, especially if it doesn’t affect key performance measures (which of course are frequently cash-driven – and although the SEC found a mishmash of issues relating to the cash flow statement, they don’t seem to suggest the core picture about the flow of cash is very often obscured). After all, investing may involve some measure of comparing and contrasting different possibilities, but it’s not as if material amounts of capital are going to be sent the wrong way based on quirks in calculating stock option expense. The more important question is whether a particular company’s financial communications make sense on their own terms, whether they adequately convey performance and financial condition and prospects and risks. Mature investors can deal with variations and untidiness around the edges (and as for immature investors, well, there’s not much you can do for them anyway).

To repeat again, I’m not really an advocate for the US adopting IFRS – I doubt it can effectively take such a leap in the face of so much opposition. Maybe a form of voluntary adoption would be more plausible, although of course it’s easy to set out arguments against that as well. But the case against IFRS shouldn’t turn on its failure to deliver some mythical ideal of uniformity. The questions for me – recognizing that like anything else, the payoffs will always be incremental rather than absolute, would be more along these lines: (1) in what ways does (or will) the existence of US GAAP hinder rather than help the optimum flow of capital and (2) would replacing it with IFRS improve that long-term assessment enough to justify the cost and effort of adoption? I don’t know the answers, but I also know they won’t be obtained by burying one’s head in a bunch of financial statements.

The opinions expressed are solely those of the author