Accounting - United affront

Critics of the International Accounting Standards Board – and, in particular, of its charismatic and influential chairman Sir David Tweedie – feel the board has betrayed users, preparers and financial regulators with the premises it has set for its radical programme of accounting standards.

The rows which are presumably going on behind the scenes broke through to the public arena when Sir Andrew Large, deputy governor of the Bank of England, gave a speech in 2004 to a banking conference on financial instruments. What he said amounted to a blunt warning for those who run the IASB. On IAS 39, he said: “The only way forward is to take a few steps back before work starts on re-engineering the standard. I believe many of those interested in the debate would be supportive of this.” In plain English, that amounts to ‘scrap the standard, it stinks’.

Tweedie’s response was not to think about revising the standards he has made so far but to promise even more trouble. Tweedie forecast there would “blood in the streets” by the time he and his colleagues had finished revisiting and reforming the “sacred cow” standards relating to leasing, insurance, performance and pensions.

The question is, whose blood? If the IASB is being criticised in public by the likes of Large, you can bet it is being criticised in private. And the man enduring most of the earache is Paul Volcker, the chairman of the trustees of the International Accounting Standards Committee Foundation. In effect, Volcker is Tweedie’s boss. The criticism Volcker has heard is likely to be along the lines that the IASB has been allowed to veer off into some private view of what financial reporting should look like and has not considered what is reasonable or practical. As one IASB critic put it: “Tweedie and co have been allowed to conduct an academic experiment. The only problem is this hasn’t been done in an ivory tower, but live on European Union companies.” There is still sustained disquiet over the move to fair values, especially where fair value means having to construct a model to find a value in the absence of an easily traceable market price.

And what has Volcker’s response been to this mounting criticism of the IASB? In the past few months, he has given a couple of speeches where he seems willing to debate the nature and authority of the standards that the IASB is producing. Volcker realises that achieving international convergence – which he sees as a simple objective with great benefits and is, in his words, “conceptually defensible” – is a difficult job.

The Foundation and the IASB are not dealing simply with technical or professional issues. It is now a huge intellectual challenge developing accounting standards relevant to the modern world. For Volcker, the old rule book of historic value doesn’t seem “quite right” for a world with layers of volatile finance with every kind of derivative dominating trading, with the complexities of insurance and pensions, and issues such as leasing that mimics ownership. On the other hand, he also raises doubts that marking to market really captures the underlying reality. The answer may be that we live with a mixed and complex, and abstractly illogical, accounting system. As a result, Volcker says it is impossible to satisfy everyone and retain any hope of accounting consistency.

He points to examples on both sides of the Atlantic to illustrate the influence of interest groups: in the US, business is lobbying Congress to prevent, by law, expensing of employee stock options as proposed by FASB. FASB says it will introduce the standard in June 2005, and opponents are confident – especially after a Bush victory – that Congress will kill it. And in Europe, the banks led a successful attack on IAS 39 winning carve-out concessions.

For Volcker, these illustrate the need for professional independence in the decision-making process of the IASB. Volcker warns that if legislators fail to respect the due processes that the IASC Foundation and the IASB have put in place, they will be undermining convergence in accounting standards. However, Volcker acknowledges that while accounting standards are a matter for experts, they cannot emerge full-blown from an ivory tower.

By chance the constitution of the IASC Foundation and the IASB are under review and comments are due by the end of February. The Foundation is likely to come under pressure to gain greater control over the IASB and its work in order to make its output more palatable. That will be decision time, and Volcker won’t be able to back his deeply unhappy constituents and a robust Tweedie.