IASB Chair Defends Fair Value Accounting; Says IFRS Global by 2011

Fair value accounting standards are not the cause of the current market crisis, declared IASB Chair David Tweedie in remarks to the Empire Club of Canada. While conceding the difficulty of valuing complex, illiquid securities and derivatives, he believes that showing the changes in values of these securities, even imperfectly, provides critical transparency and enables markets to adjust in a necessary albeit painful manner. More broadly, he noted that IFRS will essentially be the global accounting standards by 2011, with adoption by nearly 150 countries and the convergence project with FASB completed. He said that IFRS are principles-based standards whose implementation relies largely on the judgments of auditors and preparers.

With regard to the crisis and fair value accounting, the chair observed that financial reporting entered the picture by way of the requirement to value illiquid and complex securities reflecting bad lending practices and alert the market to the risks associated with their existence. When recoverability of a loan is doubtful, he noted, the loan has to be marked down to the present value of the cash flows expected from the loan, which value would be fair value. He pointed out that no entity is ever allowed to disclose assets valued at more than their recoverable amount in its financial statements. He discerns a growing consensus that fair value requirements for financial institutions will improve transparency and contribute to investor understanding of the risk profiles of these institutions.

Acknowledging that the existing IFRSs are not perfect, the chair said that the IASB is examining how to improve its standards in light of recent market developments. In endorsing a plan drafted under the auspices of the Financial Stability Forum and Central Banks, the IASB will improve the accounting and disclosure standards for off-balance sheet entities and enhance its guidance on fair value accounting, particularly on valuing financial instruments in periods of stress.

Indeed, there are IASB projects underway on financial instruments, fair value measurement, consolidations and derecognition. Chairman Tweedie pledged that, for the consolidations and derecognition projects, which directly address off-balance sheet issues, the IASB will move expeditiously. The IASB will also form an advisory group to help address the issue of valuing financial instruments in illiquid markets.

On the broader theme of global accounting standards, the chair sees clear momentum towards accepting IFRSs as a common financial reporting language throughout the world. This works on a number of levels. Multinational companies will benefit from reduced compliance costs associated with the removal of the need for the consolidation of different national accounts into a single statement to meet their home country’s requirements. Investors will be able to make comparisons of companies operating in different jurisdictions more easily. Whether an investor is looking at a financial statement in Toronto, Tokyo, or Tampa, he said, the accounting standard should be the same for the same economic transaction. Further, IFRS will allow regulators to develop more consistent approaches to supervision across the world.

The FASB-IASB convergence project is moving steadily along, he said, and there is reason to believe that IFRS will be used by US companies in the near future since the SEC is giving serious consideration to a proposal to allow such use.

Convergence is running on two tracks. First, the goal by 2008 is to reach a conclusion about whether existing major differences in a few focused areas should be eliminated through one or more short-term standard-setting projects and, if so, complete or substantially complete work in those areas. For the IASB, this would mean considering changes in six targeted areas, including joint ventures, segment reporting, impairment, and income tax. The FASB would also need to consider changes to six of its standards. At the same time, convergence would not need to exact replication of standards, but achieve agreement on major principles.

Second, the MoU established the target of 2008 to have made significant progress on a number of areas identified by both Boards where current accounting practices of US GAAP and IFRSs are considered outdated. The Boards have completed virtually identical business combinations standards already, eliminating an area that produced significant difference in financial results between IFRSs and US GAAP. They also decided not to tackle intangible assets as part of the MoU. This leaves nine other projects to complete with FASB. At the end of the process, the intention is to have identical standards, which should make US transition to IFRSs easier. He estimates completion of these MoU projects by 2008.

Finally, he pointed out the benefits of IFRS being principles-based. The idea is that the core principles are clearly stated, with sub-principles related to them in a tree-like structure. Principles should be tied to a sound conceptual framework, with any departure explained. It may be necessary to depart from the framework if emerging transactions indicate that the framework is out of date. Any exception to the framework, however, should provide a basis for elimination of the exception by later changes to the framework itself.

In his view, the use of principles should eliminate the need for anti-abuse provisions. It is harder to defeat a well-crafted principle than a specific rule which financial engineers can by-pass, he reasoned. A principle followed by an example can defeat the ``tell me where it says I can’t do this’’ mentality.

Since principle-based standards rely on judgments by auditors and others, he posited, disclosure of the choices made and the rationale for these choices is essential. If in doubt about how to deal with a particular issue, he instructed, preparers and auditors should relate back to the core principles.

The basis for conclusions should also include the question of whether there is only a single view to tackle the economics of the situation. Often there are competing views, with one deemed more relevant. If so, reasons for choosing that particular view should be explained in the basis for conclusions and reasons for rejecting the others clearly outlined.