Let’s dump IFRS, before it kills someone!

by John Hughes

Al and Mark Rosen, long-time scourges of IFRS, have written a rather gloating article called Turning against IFRS, pouncing happily on the “expanding list of executives and companies that are addressing—through actions or words—the shortcomings of IFRS.” The article notes that 20% of the companies in the S&P/TSX 60 are now following U.S. accounting standards instead of IFRS, and goes on as follows: “It is hard to ignore that statistic if you are an investor, especially as it speaks to the perceived quality of IFRS among Canadian companies and executives .Will 20% be a tipping point in the cascade of Canadian companies moving to U.S.GAAP, and away from IFRS? Or could it be a high-water mark that recedes as changes are made to international accounting rules? We put our money firmly on the former, especially as junior and mid-cap Canadian companies get a good taste of the volatile results IFRS can create…Expensive as it would be in the short term, switching to U.S. GAAP might be the best route to take for all stakeholders.”

Well, first of all, absent a major rule change that’s nowhere on the current horizon, the “tipping point” can only tip so far, because Canadian reporting issuers only have the option of using US GAAP for domestic regulatory purposes if they’re registered with the SEC. I don’t know what portion of the reporting issuer population falls into that category, but I’m sure it’s less than 10% of them (admittedly more than that by market capitalization). It seems unlikely too many junior and mid-cap companies would go to the trouble of becoming US registrants just for the sake of escaping IFRS, but I guess we’ll see. But what’s most galling about the article is that the Rosens have spent the last several years setting out the reasons why managers would adore IFRS, as the perfect cover for their wretched, self-serving instincts. As I’ve set out (and tried to rebuff) on past occasions, they’ve variously called IFRS a “Ponzi scheme in progress,” claimed that it “allows you to ignore any rule, any time,” and laid out the following list of “some of the most common issues that will pose problems for investors”: “adjusting up and down the value of various assets at the time of adopting IFRS, with significant potential impact on future income; disguising executive greed by not quantifying and fair-valuing related-party transactions; building up hidden reserves for the purpose of manipulating future income; recording revenue years in advance of it actually being earned (if ever); hiding deteriorating cash flows through poor disclosure and netting together transactions; and adjusting the value of inventory up and down to meet short-term performance metrics.” Based on this shopping list of opportunity, and on the Rosens’ habitually dim view of ethical standards among Canadian managers, it’s hard to see why anyone would ever abandon IFRS for a (by this version anyway) more constraining set of standards.

The new article speculates in particular that Magna and Encana encountered something they “did not like” about IFRS, as if this (even if true) were prima facie evidence of its shortcomings – you know, in the same way that when someone complains about their taxes, it constitutes cast-iron proof they must be paying too much. But the only vague example of what this thing they didn’t like might be, as mentioned above, is IFRS’ potential for volatility. Expanding on this, they say “it is difficult to discount the sheer amount of volatility that IFRS can create in a company’s financial results.” This takes for granted, it seems, that this volatility is inherently a bad thing. But wait a second, didn’t the Rosens earlier slam IFRS for its supposed culpability in “building up hidden reserves for the purpose of manipulating future income” – in other words, for allowing management too much leeway in avoiding volatility? So does IFRS increase volatility or artificially reduce it? And in any event, is volatility a good or a bad thing? Is IFRS a collection of rules all of which can be ignored at will, any time, or is it such a stern taskmaster that companies have to go running to US GAAP to avoid it? The Rosens have no answers to any of this – if they did provide answers, they’d only contradict things they’ve said in the past, or other things they’ll no doubt write in the future.

Most distasteful about this display is that although the Rosens profess concern at the perceived absence of “the kind of picture that inspires confidence in the new accounting numbers among investors,” they never say anything remotely constructive or useful about what these investors should actually do. Is it to avoid investing in any Canadian companies except those using US GAAP (good news if so – it’s still fine to put money into Research in Motion)? Presumably they’d stop short of saying that, if only in the calculated way that a hyper-partisan politician stops short of actually calling his opponent an outright murderer. Which, now I mention it, is just about the only accusation they haven’t thrown at IFRS yet.

The opinions expressed are solely those of the author