Our principles are being eroded

The much-touted idea that international financial reporting standards are principles-based rather than rules-based took another bashing as Big Four firm Ernst & Young published its new 2,750-page guide, International GAAP 2007.

Sir David Tweedie, chairman of the International Accounting Standards Board, is fond of quipping that the Europeans have no rules and the Americans have no principles. Allister Wilson, head of the UK financial reporting group at Ernst & Young, says that the description of the new international standards as principles-based is “poetic licence”. “It is principles-based compared with US GAAP,” he says. “But some of the standards have no principles at all.” Chief among such principles-devoid standards is IAS 39, which Wilson describes as “a rules-based standard that is a précis of the [comparable] American standard.”

The principles base for IFRS is due to be bolstered by the IASB’s decision to create a conceptual framework for accounting standards. But after all the work that has gone into creating new standards over the past four years such a move might sound like getting the cart and the horse in the wrong order.

Wilson insists that the conceptual framework is “long overdue” and that the IASB “should be focusing a lot more effort into the conceptual framework project.” They’re not doing so, he says, because the IASB is “obsessed with convergence”, the programme by which the IASB and the American FASB are drafting new standards that will be adopted by both to bring their accounting in line. This raises the question whether the litigation-obsessed Americans will be happy to accept principles-based standards unless they are heavily rules-laden.

The E&Y Guide points to IFRS 5, which covers discontinued operations. The Guide says the international standard is “virtually identical” to the American SFAS 144, and yet it “cannot be seen as being a superior solution” to its predecessor, IAS 35.

The Financial Services Authority’s recent Financial Risk Outlook regarded the future development of IFRS as containing a “major risk” because of the convergence programme. “There is a view that a converged set of accounting standards that is acceptable to the SEC will need to be more like US GAAP,” the Outlook said.

The FSA also noted that the principles-based standards were “increasingly underpinned with more detailed rules” and expressed the worry that companies and their auditors might “default to a narrow, more rules- and precedents-based interpretation, which may not necessarily reflect their best judgement about the underlying economic reality of the business”.

Tweedie told the Financial Times, “When you write a risk assessment you have to put these things in.” But Ernst & Young’s Wilson is in no doubt: The outlook, he says, is “more standards, more complexity”.