Principles or rules?

Although the convergence battle has been decided, with all parties agreeing to the need for an international set of accounting standards, the debate still rages on, as Christian Doherty discovers

You might have missed it but, in January, New York played host to a global symposium on accounting standards. Present were regulators from around the world, along with members of the accountancy and audit professions, investor groups and financial analysts. So far, so normal. But for Peter Wyman, partner in charge of regulatory affairs at PwC, it marked a significant sea change in the debate surrounding the adoption of a uniform set of international accounting standards.

'What I got from the symposium was the admission that IFRS will be adopted across the globe,' he says. 'The feeling in the hall was that the convergence debate was over and now it's all about adoption of IFRS. And that's a massive change.'

Wyman may well be right. In the battle to decide how best to achieve the Holy Grail of convergence - an internationally adopted set of identical standards - a new phase has been entered.

Up until now, the debate has centred over the two main approaches to accounting: rules and principles. The UK and Europe have championed its principles-based approach, arguing that this method allows for greater discretion and use of professional judgement. The US, rocked by scandals beginning with Enron, has strengthened its rules-based system. Now, however, it seems that the US' approach is falling out of favour, and regulators - principally the International Accounting Standards Board (IASB) - are looking into how best to adapt IFRS to make sure they are agreeable to all parties.

Certainly, Richard Martin, ACCA's head of financial reporting, believes the use of a principles-based approach when coming up with new international standards should be the way forward. 'As the standards develop, then we hope that they would be principles-based,' he says. 'Remember, this is a global push and it's true to say that principles are a more practical way of spreading this across the world.'

ACCA's view is shared by the six accountancy firms, which used the New York symposium to publish a white paper expressing their views on the future of standards. They argue that setting out a list of firm principles will go some way towards limiting the size and complexity of the rulebook. The white paper sets out explicitly the principles on which it believes all future standards should be based. It says any future standard should have as its basis the following attributes:

• a faithful presentation of economic reality
• be responsive to users' needs for clarity and transparency
• be consistent with a clear Conceptual Framework
• be based on an appropriately-defined scope that addresses a broad area of accounting
• be written in clear, concise and plain language, and
• allows for the use of reasonable judgement.

The view from the US

But what of the US? This debate is often framed in us v them terms, but it is not as simple as that. The landscape there has been shaped by scandal and the reaction to it. According to Sue Bielstein, the Financial Accounting Standards Board's (FASB) director of major projects, it is recognised that change is necessary to ensure that regulators don't apply unfair pressure on the preparers of accounts. 'We've developed a culture of second-guessing in the US and that isn't helpful,' she says. Although some argue that a rules-based approach reduces the amount of second-guessing by laying things out in detail, it is fair to say the cost of that is a much-extended rulebook. In Bielstein's view, excessive exceptions and clarifications mean 'you do end up with too many rules and we're trying to rectify that'. Bielstein points to the Emerging Issues Task Force (EITF) as proof that US regulators take the problem seriously.

There has been no shortage of critical voices, particularly in Europe. Paul Lee, investment director at Hermes Private Equity, sits on the Corporate Reporting Users Forum (CRUF). 'The problem in the US comes with enforcement,' he says. 'The rules-based standards in the US have driven everyone to adopt a rules-based approach, largely because the SEC [Securities and Exchange Commission] can wield its enormous powers in criticising and scrutinising accounts whenever it likes. The result is that people get very defensive and look to hard and fast rules to play by. Then you end up with much more of a box-ticking approach.'

It is fair to say that the SEC has seen its power grow exponentially since the wave of scandal starting with Enron in 2001. But has this compliance and value for investors? 'Last year, the SEC asked for around 1,800 restatement of accounts in the US,' says Wyman. 'And you could count on the fingers of one hand the number of those cases where the restatements caused the share price to move. So that should give an indication of the value to investors of a wholly rules-driven regime.'

What about the users?

Value to investors: it is easy to lose sight of what this debate is ultimately about. Surely the purpose of producing financial reports and statements is to provide investors with a clear picture of how the company is run and its prospects for future success? So, is the investment community being served by the current regime?

Lee is one of a growing band of investors who believe their voice - as users of the accounts - should be heard. 'Essentially, financial reporting is there to tell investors how the business works and how the owners manage it,' he says. 'And I can't speak for all investors around the world, but there is generally a feeling that we all want a principles-based approach.' Lee fears (and this is echoed by others in the debate) that the new IFRS regime may be too influenced by what the US wants - i.e. principles overlaid with unending exceptions, clarifications and rules.

Lee's hopes are now resting with the IASB. The IASB denies the US will enjoy a disproportionate amount of influence, and says that the principles-based approach already enshrined in IFRS is not as antithetical to US GAAP as many assume. As IASB board member, Steve Cooper, explains: 'The US is an important constituency and we need to be made aware of the views there. But there is a recognition that the principles-based approach is the correct way to go. The SEC is coming round to that view, as are the IASB and the FASB.'

And Cooper is keen to point out that the IASB is in the business of consultation, and that it takes into account all views on the subject. 'The IASB used to have less input from investors, and we certainly now encourage as much input as we can. We seek out that comment. But we listen to everyone with a view on the debate - auditors, national regulators, users of the accounts, and so on.'

Too many cooks?

All of which points to the steady adoption of IFRS across the world in the coming years. But the biggest danger in this process is that of trying to please all the people all the time - a laudable but impossible aim, argues Martin. He says the IASB will need to be strong when sticking to its principles. 'It's fair to say that any new standards - and the setters - will need to be strong enough to resist calls for all the special cases and exemptions,' he says. 'There needs to be a recognition that directors and auditors should be allowed to use judgement as best they can. Part of the reason why the rulebook has got bigger recently is because standard setters have had to provide explanations for its exemptions and decisions.'

For many, the signs emanating from the US are positive, although substantive progress will be slow. Wyman argues that the tide in the US is one of acceptance of the new order, but that patience will be needed. 'If the US is happy to adopt IFRS, then it will want a say in their substance,' he says. 'Now there is a danger that that will lead to more rules being added to IFRS, but I think it's fair to say that most of the clever thinking in the US accepts that principles should form the basis of the new standards. And now the mood is, "If the US is going to adopt IFRS in five years time, then what should they look like".' Essentially, it seems both the firms and the regulators would prefer the Americans to be inside the tent rather than outside. Watch this space.

Christian Doherty is a freelance journalist.