Paul Tsongas once said, “We are a continuum. Just as we reach back to our ancestors for our fundamental values, so we, as guardians of that legacy, must reach ahead to our children and their children. And we do so with a sense of sacredness in that reaching.” Yet some people embrace the notion that legacies can be cobbled together quickly, leaving those left in their wake to deal with the change. Christopher Cox is offering the US shareholder the opportunity to enhance his legacy, for whatever it might be worth, and eliminate the continuum that has kept the American markets in check. All you need do is nothing.
I am speaking of course about the attempt by the SEC chairman to throw out the principles of accounting that have kept our companies under the kind of scrutiny that has given their shareholders the confidence to invest. And although this confidence is a legacy in and of itself, it is the rules that govern those companies that have made it possible.
The general acceptable accounting principles or GAAP has been the focus of the SEC and the White House for a number of years. This administration has held the belief that the tight controls that allow the free market to operate should be removed, making those markets even freer and in the process opening the door for American companies to operate under the same lax rules that govern the rest of world’s companies. What is a free market they ask if there are regulations in place that are costly and burdensome and focused, so the argument goes, against the ability of these businesses and their effort to compete?
So much for “beholden to the investor”. The way GAAP works, for those that may not be aware, is quite simple. These are broad based rules based on the understanding that no two companies are identical.
Some of the hallmark underpinnings of this accounting is consistency (you recognize this as the regular quarterly reports that are issued by a company), relevance (simply giving information is not what this principle concerns itself with but instead, when a company communicates with shareholders, they want something they can understand and is actually important enough to allow that investor good investment decisions), comparability (it is not enough to know something about a company operating within an industry but what that information tells investors about how the company does compared to its peers) and lastly, the information must be reliable (can the information provided to investors on the financial statement be counted on for accuracy, portraying an accurate picture of not only what just happened but what might in the future). The Financial Accounting Standards Board (FASB) through the SEC governs GAAP.
So why change it? According to the SEC, the rules keep our companies from competing on an even playing field. That playing field, while already level, perhaps even skewed towards American companies because of GAAP, does not permit investors to do good comparisons with companies based overseas. And with good reason.
The SEC would like to change the rules to allow these well-trusted standards to be changed – at first for 110 multinational companies – to those based on International Standards (IFRS). PriceWaterhouseCoopers publishes a comparison of the two systems, lamenting that one day, perhaps soon only the IFRS will be the only accounting system.
Under IFRS regulations, financial statements are not specifically formatted. Balance sheets may contain the minimum items, income statements may choice function or nature in their presentation and SoRIE (the statement of recognized income and expense) can be presented as a primary statement but not to portray the potential change in shareholder equity.
Numerous accounting principles are similar when the two methods are held side-by-side, so why change it for some differences in valuations and expensing? Oil, insurance and pharmaceutical companies would benefit while other companies will show unrealistically inflated earnings because of it.
When I wrote in May of 2007 that the proposed change was actually an attack on Sarbanes-Oxley, it was because American companies – and all companies for that matter make mistakes. “SarbOx, to its credit, has forced over 464 restatements of earnings in the past three years. This is quite the shift from the previous ten years, which saw a combined average of 45 restatements a year.” Pushing for this change has been spearheaded not by the SEC chairman but the Treasury Secretary Henry Paulson.
Since SarbOx, auditors have been increasingly cautious but not due to this landmark piece of legislation but be cause companies face the implied threat of litigation should those statements be less than factual. In effect, the regulation that SarbOx has created for many accounting firms have been overseen by the threat of shareholder action should they sign-off on phantom write-offs.
According to CFO.com, the reasons behind many of the restatements are almost always known to the companies and hidden from the audit process. Improper revenue-recognition is cited as a primary culprit in the restatement process followed by improper inventory valuations and inadequate allowances for bad debt. Arthur Levitt, the former SEC chairman is no stranger to this type of restatement calling it accounting hocus-pocus.
Contrary to what these regulators might think, changes in SarbOx will not increase competitiveness in the US marketplace. The real reason for foreign companies to list overseas dates back to a pre-SarbOx Congressional action concerning litigation against companies who misrepresent themselves to our capital markets.
Adopting one accounting standard would make globalization a much friendlier place for American based companies doing business overseas. But the changes are not in the best interest of the shareholders of these companies. Demoting our system will not increase the use of the American exchanges when public offerings are made. But for those companies that do, the perception of these principles being in place lends much more credence to their financial statements.
And although you have the opportunity to offer your opinions to the SEC on this change and writing now to change something so wrong will benefit the continuum of good principles, the walls are already crumbling. Chances are, if you invested in a foreign company that files its financial statements in the US, they used IFRS rules.