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IFRS under fire at Parliamentary hearing

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17th Jan 2013
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International accounting standards came under sustained attack in a Parliamentary committee hearing into banking yesterday.

Accounting professors Stella Fearnley and Prem Sikka took centre stage during the committee hearings and laid into not just the complexity and ineffectuality of IFRS, but also the structures that lay behind them.

They were egged on at times by commission chairman Lord Lawson, who is leading the joint Lords-Commons committee examining professional standards within the banking industry and the lessons that can be learned from recent crises about the sector’s governance, regulation and transparency.

The former Chancellor was appointed to the role after participating in the 2011 Lords’ Economic Affairs committee enquiry last year, at which he took a close and sceptical interest in the role accounting standards played in the banking crisis.

“Some would say the purpose of the IASB [International Accounting Standards Board] to create a body that is not accountable to any government body,” the former chancellor commented at Wednesday’s hearing.

Professor Sikka answered: “Governments allow it to act that way.”

In his view international standards “foisted on people” should be scrutinised by parliamentary committees.

“The IASB is subsidised by Big Four accounting firms and major corporations, including banks… It has its own political agenda,” he added.

“It lacks independence from those organised interests and has failed to introduce any standard that requires banks to come clean about their special vehicles, offshore structures or even their transfer pricing practices.”

As an example, Sikka described how standards relating to related party disclosures were watered down. To make them more attractive to Chinese users, government-linked parties were not required to provide disclosures.

“Do international standards add/enhance transparency? No, because the main concern was to get China involved,” he said.

Sikka found it odd that regulators placed so much reliance on financial statements published by banks, yet did not play a role in setting those standards, which in his view and that of professor Fearnley did not provide a good vehicle for prudent banking or regulatory interventions.

But the critics did not get all their own way. Edinburgh university professor David Cairns, who has been a member of various standards-setting committees over the years disagreed with their analysis on several points, and in particular that the transition from UKGAAP to IFRS undermined the quality of banks’ financial reporting in the run-up to the 2007-8 crisis.

On financial instruments held for trading, the requirement to mark assets to market was the model for both approaches. “For disclosures that UK banks made on their transition from UK GAAP to IFRS, we did not see any significant changes. I know they got it wrong, but the suggestion there was a substantive change was not correct,” he said.

Fearnley broadened the nature of her attack. “I look on the IFRS/IAS39 model as having failed its first test. We had an explosion in banks’ behaviour… As the banks’ business models were moving really fast, the accounting was not really addressing it... As lending shoots up. As it was growing and as the portfolios were changing and behaviour was changing, the provisioning wasn’t really following it.

“What professor Cairns said doesn’t solve the problem. UK GAAP had true and fair and other safeguards within it to prevent what happened.”

Sikka also used the opportunity to argue for country-by-country reporting. The current segmental reporting accounting standard (IFRS 8) does not provide such information and leaves managers to decide the material segments, he noted. As a result, little is known about banks’ activities in tax havens.

“The IASB has maintained opposition to that,” he said. “That kind of info would enable us to see where banks are and which countries have responsibility for rescuing them, where profits are booked and so on. There are lots of things that could be done, but because the IASB funders do not agree on this, the IASB has not done much.”

Later in the afternoon IASB chairman Hans Hoogervorst appeared before the committee to defend how the standards performed in the financial crisis, and to acknowledge where they could be improved.

“IFRS showed very clearly that banks were excessively leveraged and that banking system was in a perilous state,” said Hoogervorst. “In terms of showing how vulnerable the balance sheets of banks were, IFRS did a good job. The main question is why didn’t anybody pay attention?”

What did not work so well under the standards was the incurred loss model used, which governs the level of provisioning, he continued.

“I think the incurred loss model as it still exists now could have been applied much more vigorously. For example it took banks up to 2011 to start recognising impairment of Greek debt, and then it was applied unevenly across Europe.”

The current phrasing of standards gave banks to too much leeway to banks to procrastinate in recognising their losses and face reality and facer elation, causing too low level of provisioning. The reporting regime also led to front-loading profit on financial instruments, with the losses kicking in during the crisis.

“That was bad timing,” deadpanned the IASB chief.

The IASB acknowledged that the incurred loss model for the impairment of assets needed improvement and was now working to finalise a new expected loss model that will require banks to take some provisioning for all assets.

These are just short highlights from the 2.5hr hearing. The full proceedings are available to view on Parliament TV, backed with written submissions available on the banking standards commission webpage.

Replies (4)

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collings
By Steven Collings
17th Jan 2013 23:24

True and fair

I can see where both arguments are coming from but I don't necessarily agree with Stella Fearnley and Professor Sikka on the grounds of practicalities but tend to err on the side of David Cairns.

Ms Fearnley says that "UK GAAP had true and fair and other safeguards within it to prevent what happened.”

One could argue that IFRS has the same principle in that it believes that financial statements should present fairly the state of affairs of an entity (albeit that IFRS doesn't necessarily cite the phraseology "true and fair") - and let's face it, UK GAAP's been more or less aligned to IFRS over the years so I'm not sure I am in agreement with this argument.

Professor Sikka says that Government allow the IASB to act in the way it does.  Do we [as accountants] really want a government body to influence the way we work in terms of standard-setting?  Perhaps many accountants' view would be "God forbid!"

Whilst all arguments warrant merit, the harsh reality is that neither GAAP/Co Act/princples/ethics/opinion will ever stop any bank, company, service organisation or any Tom, Dick or Harry wanting to manipulate financial statements if they really want to and where auditors might choose to turn a "blind eye".  I can't see how IFRS - in itself - can be wholly to blame as no GAAP is perfectly designed to prevent an economic downturn like we are currently experiencing. Yes, it has its flaws, but I think we have to be realistic.

Thanks (5)
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By Nigel Hughes
18th Jan 2013 11:57

Fair comment Steve - up to a point

I agree with you Steve that neither IFRS nor UK GAAP are that different from the true and fair perspective.If you look at RBS accounts over the period 2007/2011 the swings in values are all there in plain sight, and I don't believe that, following the introduction of FRS18 on accounting policies it would have been much different under UK GAAP.

The problem has been the downplaying of prudence (per FRS18) and the hugely complex disclosures in IFRS.

As accountants our job is to explain this often quite tricky stuff to the rest of humanity. IASB and ASB have confused disclosure with clarity - if you put it all out there it's the reader's problem if he doesn't understand it.

This is clearly wrong and doesn't do our profession any favours. The accounts of the banks should have explained the risks associated with having so much of the banks' capital tied up in risky investments, and they didn't.

Thanks (2)
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By Mcgowanjr
18th Jan 2013 23:07

True and fair view
It seems like a stretch to refer to the true and fair view as a safeguard. The premise is that companies/banks always strive for transparency. Accordingly, when necessary to clearly explain transactions they can use the true and fair view option to lay it all out for stakeholders. As Steve mentioned, when companies want to manipulate financial statements, rules will not hold them back.

This is why I thought the malignment and defamation of US GAAP around the time of Enron was misplaced. I teach international accounting in the US. To this day authors and commentators cite the complexity and detail of US GAAP as the cause of business corruption over here. Pleeeeeze can we dispense with this argument?!

When IAS 39 was first introduced in the 90s it had to be put on the shelf for fear of sinking hopes of IFRS adoption in Europe. It doesn't look like the current version of IAS 39 is working.

In any case ~ Cheers!

Thanks (1)
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By Nigel Hughes
20th Jan 2013 18:30

There are always opportunities for manipulation

Many thanks Mcgowanjr for this.

From this side of the pond the Enron thing was seen as abuse of the non consolidated controlled company rule - 97% owned SPVs with $21bn of debt attached but not consolidated - and the abuse of mark to market.

It was said that it couldn't have happened here, but of course it could. Those particular avenues of abuse were less likely here, but where there's a will there's a way and similar things had happened in the 1980s.

Surely the problem with fair value accounting is that as long as someone (however foolish) is prepared to pay such a price, that is the fair value. If a whole sector as crucial as the banks gets caught up in the nonsense, it's going to be extremely painful when the music stops.

I guess the real problem was not that such values were used and disclosed in the accounts, but the depth and interconnected nature of the exposure.

My beef with IAS is not so much this method of valuation or that, but the fact that the reader has to wade through so much of the guff that he loses the will to live before discovering what the results were, and there is still no greater certainty about the quality of the information.

Thanks (1)