There are few promised outcomes that produce more skepticism than the prospect of two international bodies finding common turf for regulation. And when one looks at the realities facing the U.S.'s Financial Accounting Standards Board (FASB) and Europe's International Accounting Standards Board (IASB), one can readily see why.
On Jan. 1, 2005–a mere 10 months and counting away–the IASB is scheduled to become the European Union's accounting standard-setting body, with the adoption of the board's International Financial Reporting Standards (IFRS) as the principles governing all companies accessing EU capital markets. Unfortunately, the convergence between the U.S. Generally Accepted Accounting Principles (GAAP) and these European standards seems essentially out of reach for the moment. While meaningful steps in this direction have been made, there remain two thorny issues–accounting treatment of derivatives and stock option expensing–that threaten not only convergence between the two continents on either side of the Atlantic, but also the ascendance of the IASB to the head of the regulatory pack in Europe.
Should companies care? Given the relative deluge of new reporting regulations in the past two years, convergence is a good thing, most accounting experts claim–something that, indeed, companies should hope can be accomplished. "The stakes are very high," says Ian Wright, global corporate reporting leader at PricewaterhouseCoopers (PwC) in London. "What's at stake is the vision of a single European capital market."
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Most U.S. and European executives agree that achieving a single set of standards for European capital markets would prove beneficial for those anxious to raise money there. It is also something they would like to see because it would save a considerable amount of time and money now expended on compliance with essentially three major sets of standards–in the U.S., the U.K. and the Continent–not to mention the Babel that exists globally. "The larger companies in Europe have got listings in New York as well," says Richard Martin, head of financial reporting for the London-based Association of Chartered Certified Accountants (ACCA). "At present, they've also got to do U.K. standards or whatever in addition. Reconciliation to U.S. GAAP is no big deal in that it does not take up a lot of space on a financial statement, but it does take quite a lot of work. The whole idea was to try to converge and eliminate this."
So how serious are the roadblocks? The most substantial obstacle at the moment appears to be reconciling U.S. and European treatment of derivatives. The IASB is facing stiff challenges to its authority from EU officials who are being leaned on by European banks, most notably those in France, that are less than thrilled with the prospect of marking derivatives to market value. This should hardly come as a shock, given the Sturm und Drang from banks and corporations on this side of the Atlantic at the 2001 adoption of FAS 133, the U.S. standard that requires marking derivatives to market. "Suddenly, everybody's academic interest in international standards"–which have never been mandatory before–"has been riveted," explains Kevin Stevenson, IASB's director of technical activity.
In fact, Fritz Bolkestein, internal market commissioner of the EU, actually went as far as to threaten that the EU would suspend requiring adherence to certain IAS standards (specifically, derivative-reporting IAS 32 and 39) when the standards as a whole are made mandatory in 2005. And this is after an IASB compromise in 2003 that basically lessened the reporting involved by allowing companies to apply the mark-to-market provision as a whole to separate hedge components. While this concession left a small divergence between U.S. and European standards, it was one that U.S. regulators seemed prepared to live with.
A Failure To Adopt
Now, Europe's drama over derivatives is prompting noises from the U.S. Securities and Exchange Commission that if IAS 32 and 39 are not endorsed, then the SEC might renege on earlier commitments to accept IFRS financial statements from companies listing in both Europe and the U.S. next year. SEC officials have said that compromising on best practices in accounting would not be acceptable. As ACCA's chief executive Allen Blewitt puts it, failure to adopt the standards already in use in the U.S. and U.K. "only gives the impression that your banking sector is not healthy and you don't want to disclose it."
On the U.S. front, the issue is stock option expensing. Here, the great debate over whether companies should expense employee stock options has been gradually heating up since the FASB, after capitulating to congressional pressure in 1994 to oppose expensing, said last year it had plans to promulgate a standard that would now require it. The IASB has already taken the lead in February by adopting a standard requiring "share-based" compensation to be expensed. The FASB is now set to issue an exposure document with the same requirement. But presidential election-year politics have had a way of derailing initiatives before, and 2004 may prove to be no exception. Add to that the fact that some of the best-funded opposition to convergence is coming out of California, with its cache of electoral votes and wacky politics, where much of Silicon Valley is still dead set against mandatory expensing of stock options, despite the defection of Microsoft.
All this is not to say that no progress has been made toward convergence. In fact, before the recent flare-up over these two issues, a betting person might have given relatively good odds on it. The two accounting standards boards have been in the process of ironing out several "short-term" convergence items–items that basically only needed to be tweaked to attain uniformity. In mid-December, the FASB proposed a set of rules designed to eliminate "the many differences … that, while not necessarily important issues for either [the FASB or IASB] individually, are collectively major irritants to those using, preparing, auditing or regulating cross-border financial transactions." One of the new rules, slated for adoption in mid-April, would bring GAAP into agreement with IFRS by requiring companies to restate earnings retroactively when they voluntarily change an accounting principle, disclosing both the nature and justification for the change.
The new regulations would also require that companies use this method when changing their accounting as a result of pronouncements by regulators, including the FASB. Since most companies are currently in the practice of issuing a "cumulative effect" statement, this rule is expected to greatly increase the already record number of earnings restatements for accountants to prepare and investors to muddle through.
In February, another convergence standard was expected to be floated that would move the U.S. treatment of long-term financial liabilities closer to the accounting called for under IAS rules. Currently, the IASB requires debt scheduled to be settled within 12 months to be classified as current, regardless of whether the company intends to refinance. The IAS exception: if a refinancing deal has already been inked as of the balance sheet closing date.
Moving In Increments
But the success or failure of convergence, and with it the globalization of European and U.S. capital markets, may not be an all or nothing proposition. PwC's Wright argues that Europe and the U.S. may still agree to disagree on some principles without having to retain the present need for international companies to have to file or reconcile to more than one standard. "The question is going to be how many things get left on the wayside," he says. "If there are 10 standards and we manage to agree on nine of them, we may still come out of this. At the moment, my fingers remain firmly crossed."
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