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”.