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Accounting: Critical stance

Peter Williams

Welcome to standard setting, global style. A place where it is accepted,
perhaps even assumed, you cannot please all of the people all of the time.
Certainly, in the case of accounting for borrowing costs – an accounting policy
not normally wreathed in controversy – it is hard to find anyone in the UK who
is anywhere near pleased. And the UK is not alone.

Just before Easter, the International Accounting Standards Board issued a
revised IAS23 Borrowing Costs. The IASB has confessed itself pleased with its
own work and says that financial reporting has been improved. One improvement –
and the main change from the previous version – is the removal of the option of
immediately recognising as an expense borrowing costs that relate to assets that
take a substantial period of time to get ready for use or sale. Instead, the
cost of such an asset will include all costs incurred in getting it ready for
use or sale. Another ‘improvement’ is the enhanced comparability between
companies because a previously existing accounting treatment has been removed.
And finally, the revision to IAS23 continues the IASB’s short-term convergence
project with the US Financial Accounting Standards Board to reduce differences
between IFRS and US generally accepted accounting principles (GAAP).

Under the old IAS23 the benchmark treatment was that all borrowing costs
should be expensed in the period in which they are incurred. The allowed
alternative treatment was that borrowing costs in relation to the acquisition,
construction and production of an asset could be treated as part of the cost.

The idea of capitalising interest cost directly attributable to long-term
assets met a reaction that went from scepticism, at best, to outright hostility,
at worst. When the IASB consulted on its proposal to capitalise interest, the
general sentiment was that the convergence proposed was “not full convergence,
merely a partial fix” resulting in a half-way house that would not result in
full alignment of the accounting standard. Others pointed out that under old
IAS23 companies wishing to capitalise applicable borrowing costs were already
able to do so.

It has been pointed out to the IASB that one of the guiding principles behind
the IASB/FASB convergence was the desire for going for the best of the existing
standards disregarding where they were originally made. In this instance there
is doubt whether SFAS34 Capitalization of Interest Cost is superior. And this is
not just an anti-American knee-jerk reaction. SFAS34 is an interesting standard.
It was issued more than 25 years ago and, at the time, became a standard only by
the narrowest of margins with three of the seven FASB members dissenting from
issuing the standard. A quarter of a century later and their dissension is still
fascinating. They considered interest to be a cost of a different order from the
costs of material, labour and other services. Cash – the resource obtained by
the payment of interest on debt – is unique in that it is fungible and obtained
from a variety of sources (earning, borrowing, issuing equity and sale of
economic resources). The FASB dissenters argued that the association of interest
on a debt with a particular category of non-cash resource (such as assets under
construction) is inherently arbitrary. They saw interest cost as the return to
lenders on capital provided by them for a certain period and therefore interest,
like dividends, is “more directly associable with the period during which the
capital giving rise to it is outstanding” rather than resources into which the
capital is converted. Under IAS23 the capitalised cost of the asset depends on
the financing structure of the company, ie, capitalisation of funding costs
could not occur in the event that company had no borrowings and used its cash
pile. This point is reinforced by the fact analysts reverse capitalised
borrowing costs when calculating coverage ratios.

It is hard to imagine that a UK-based accounting standard body would have
pressed ahead in the face of so much opposition. But in the new regime such
concerted criticism does not count. The IASB strongly dismisses the idea of
counting the opinions for and against before deciding whether to move ahead with
a particular accounting standard or not. Instead the board assures stakeholders
that it is the quality of the content of the response which is important. An
attitude which can turn consultation into a moveable feast. The IASB
acknowledges the weight of feeling against the move – including three of its own
14 members voting against – but stuck to its guns that costs that are directly
attributable to an asset should be accounted for as part of the cost. It also
said it was after reducing the differences, not full convergence with US GAAP.
Perhaps it needs to look again at its own conceptual framework, which says the
need for compatibility should not be confused with mere uniformity, and
compatibility should not be allowed to become an impediment to the introduction
of improved accounting standards. In the case of IAS23 that seems to be
precisely what has happened.

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