Global Accounting Standards? Not So Fast

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It's odd that something promoted as beneficial to investors should be called into question for potentially lowering the quality of reporting standards and in turn, preventing investors from analyzing what a company's assets are really worth.

The key difference between U.S. Generally Accepted Accounting Principles (GAAP) and IFRS is that U.S. standards are based on explicit rules while the international standards' reliance on principles gives companies more room to use their judgment in deciding how to recognize revenue and other key metrics. Adoption of IFRS would also probably trigger a big tax hike for U.S. companies, which would no longer be able to use the last-in-first-out (LIFO) inventory accounting method, which doesn't exist under the international standards. The LIFO method assumes that goods purchased most recently are sold first and that the remaining items have been purchased at earlier periods, yielding a lower gross profit during high-inflation periods than the first-in-first-out accounting method.

Don't Sue Me

The debate over switching to accounting standards based on something less explicit than rules comes down to questions about whether the less explicit standard will provide adequate protection against lawsuits, says James Leisenring, director of technical activities in research at the FASB. "You can't understand the debate about gratuitous vs. obligatory guidance [within IFRS] until you understand the litigation system in the U.S.," where companies are more concerned about getting sued than in other parts of the world, he says. "What it's really about is safe harbors. What [IFRS skeptics] really want to know is 'If I do it in a particular way, am I home free or not?'"

The explicit rules under GAAP may appear to offer safety, but the downside is there are so many of them that the odds of missing one or two are greater, he says. From Leisenring's perspective, the big accounting firms that are drawn to IFRS believe they'll get sued less since it will be harder to point to their mistakes. White agrees that some companies like the freedom allowed under IFRS to interpret standards to suit their convenience, which undercuts auditors' ability to prohibit certain accounting choices.

The most strident critics of migration to IFRS argue that the primary goal of the SEC and U.S. Treasury Dept. is attracting capital to U.S. markets, rather than ensuring that the highest quality accounting standards prevail. While attracting more capital to the U.S. "is a valid business objective, it's not clear we can do that by going to international financial reporting standards," says Ashwinpaul Sondhi, president of A.C. Sondhi Associates in Maplewood, N.J., who has served on CFA Institute committees.