Is IFRS Hazardous to Your Investing Health?

This column by Gretchen Morgenson, highlighting forensic accounting work done by Accountability Research Corporation of Toronto, certainly makes a strong argument that IFRS isn’t the most robust set of standards in the world.

You should read the article, but one highlight stood out, in my view, regarding the bankruptcy of Sears Canada:

“Sears Canada’s numbers weren’t good. Both revenues and same-store sales had fallen, but it reported shareholders’ equity of 222 million Canadian dollars (about $171 million) and 1.24 billion Canadian dollars ($956 million) in total assets.

In the report, company management characterized Sears Canada as a going concern. In accounting parlance, that meant the business was expected to operate without the threat of liquidation for the next 12 months.

The auditor for Sears Canada did not challenge this view and assigned the company an unqualified — or “clean” — opinion on April 26. The report fairly represented Sears Canada’s financial position, the opinion said. And that opinion may well have been justified under Canadian rules.”

You can accuse the accounting standards of being poor quality based on that failure, but the way they are applied has a lot to do with the quality present in the end result. The auditor’s opinion is really what’s amazing to me. Would the same conclusion have been reached by Deloitte if they had to discuss critical audit matters?

Execution matters in everything - whether it’s application of international accounting standards or a trip to the moon. Investors have had more than enough of the “tastes great, less filling” Miller Lite-style arguments over the merits of IFRS versus U.S. GAAP. What they don’t have: objective evidence of how different their execution may be in practice. Until 2007, IFRS filers in the U.S. were required to present a reconciliation between IFRS-based figures and U.S. based figures for key financial information: earnings and equity. Then it was swept away by the SEC during the budding romance with convergence that began in the same year.

It’s too bad the reconciliation went extinct. It forced discipline on the presentation of both sets of figures: if one set was wildly different from the other, anyone in charge who cared even a little bit would want to isolate the differences and understand them before going public. It also made the accounting standard setters more accountable: the differences between the two systems were identifiable in practice and could provide grist for the improvement of the standards and their application. Eliminating the reconciliation destroyed that accountability. Given the current enchantment of standard setters with simplification of standards, there’s virtually no chance that the reconciliation will return. Without it, investors will continue having their endless debates over which standard system is somehow “better” than the other - depending on how you define “better”, and without hard evidence to support their views.  

 

 

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