Standards deviations: U.S. financial accounting heads for change

August 27, 2008

Earning your stripes as a certified public accountant is no picnic. So far this year, less than half of the people who've taken the Financial Accounting and Reporting section of the CPA exam passed it on their first attempt. In fact, the first-time pass rate on all sections of the test is under 50 percent.

Worse, this grim rite of passage is about to get even more complicated for those focusing on financial accounting. That's because the United States Securities and Exchange Commission is moving toward adoption of International Financial Reporting Standards (IFRS).

When it does, there will be a scramble to train people who are in or headed for financial accounting careers. Plus, there will be a host of issues that arise for the profession: Schools and firms will be stretched to prepare auditors for the switch. Accounting firms may face new legal liability. And, investors will have a new breed of financial statements to study.

There's work ahead for all involved.

World-class catch up

IFRS are the international equivalent to Generally Accepted Accounting Principles (GAAP), which are the standards and rules auditors follow when preparing financial statements in the United States.

Since 2005, companies in the European Union have been adhering to IFRS, a circumstance that some feel puts U.S. markets at a disadvantage. "Banks are interested in IFRS because U.S. regulations place a significant cost on firms," says Philip Reckers, professor of accountancy at the W. P. Carey School of Business. According to him, some see the cost as being more onerous than the cost of IFRS compliance.

Kevin Dueck, a senior manager for Deloitte & Touche LLP, says some maintain that GAAP compliance makes U.S. markets more expensive places to raise capital and less competitive than foreign markets. That was particularly true for foreign firms, as they had to reconcile statements to U.S. GAAP prior to this past January, when the SEC dropped the GAAP-reconciliation requirement. "The fact that the SEC said it's OK to file under IFRS is tantamount to saying those standards are acceptable," Dueck notes.

IFRS may soon be acceptable for U.S. securities issuers, too. The SEC today (August 27) voted to publish for public comment a proposed roadmap that could lead to the use of IFRS by U.S. issuers beginning in 2014. The proposed multi-year plan sets out several milestones that, if achieved, could lead to the use of IFRS by U.S. issuers in their filings with the commission.

Earlier this week, SEC Chairman Christopher Cox entered into an arrangement with Australian officials opening the door for U.S. and Australian firms to participate in each other's financial markets while following their native nation's reporting regulations.

Cox said this arrangement reduces "the barriers that U.S. and Australian investors now face in investing in each other's markets." A goal of the arrangement, he says, is "to ensure that the significant protections afforded to investors under each nation's regulatory system are maintained and enhanced."

With market globalization as a driver, the push to bring U.S. accounting in line with international standards is definitely on.

Manny Fernandez, national managing partner for university relations from the tax and auditing firm of KPMG, says 2011 is the year by which "we'll need more robust IFRS education." Reckers says that is the year academics expect IFRS questions to first appear on the CPA exam.

Hitting the books

Firms already are rushing to educate their auditors in IFRS conventions. Dueck is one of thousands of Deloitte accountants who is being trained to become a go-to guy on the international ways.

KPMG is doing "just-in-time training," according to KPMG's Manny Fernandez. "If you train 20,000 people when only 2,000 will use the activity this current year, that other 18,000 will need a refresher course," he says. "We have a definite and well-calculated strategy in place to make sure we have the right amount of people trained for the right number of engagements."

Fernandez was one of the powers behind a survey jointly produced by his firm and the American Accounting Association (AAA) that went to hundreds of universities. Few are rolling out the needed changes in curriculum this year, he reports.

According to Reckers, a vice president of AAA, about 20 percent of universities that responded to the survey have IFRS integrated into curriculum for the Fall 2008 semester. Materials were not available during the curriculum-development months of summer, he says, and it's too late to get them fully incorporated into this semester's classes, which already are crammed with content.

Rules of engagement

One thing most accountants have probably learned is this: U.S. GAAP largely is considered a rules-based set of standards, while IFRS is considered more principles-based and, therefore, subject to more interpretation. Of course, there are rules in IFRS, too.

Universities teach fledgling accountants such rules but, according to the recent KPMG/AAA survey, professors like to split teaching evenly between dictates and the conceptual framework surrounding them. Reckers says that's because "no rule can comprehensively cover every permutation of actual events. There always will be some gray areas where you have to interpret the rules, so you need to understand their intent and meaning."

That, he continues, requires that accountants know "business, the economics behind transactions and the accountant's responsibility to society to report things that reflect economic reality." Without this knowledge, they may present data in ways that could be misunderstood or misleading.

"Arguably, if we're going to IFRS, this is even more important," he adds. "If there's going to be less specificity in the rules, you need to understand intent -- what you're trying to accomplish and why."

Will professors focus more on principles and the conceptual framework for the rules rather than on the rules themselves? They'd like to, but Reckers wonders if they'll have time to teach anything but regulations and the how-to mechanics of accounting. As mentioned earlier, accountancy curriculum already is jam packed.

Reckers also wants academics to graduate students who know more canon than context. "Bosses and managers can do the interpretive work. Firms want entry-level people who know enough rules to be effective when sent out on a job."

KPMG's Fernandez says that his firm "relies on universities to teach technical aspects of accounting," and "prepare students for the CPA exam." The firm itself, he says, trains new grads on internal methodology.

Despite calling on universities to teach "technical" accounting, Fernandez maintains that now schools will need to "focus first on the conceptual framework, which is more heavily relied upon in IFRS." Professors can round out this knowledge by comparing IFRS specifics to those of U.S. GAAP, he states

According to Reckers, classroom comparisons of the two standards has an upside. "They allow us to talk about how things could be interpreted in multiple ways," he says.

Blame game

Most agree that principles will be of increasing importance in training the next generation of accountants. As Dueck notes, "There is more judgment needed in applying IFRS."

But, Reckers maintains, judgment brings risk. "Litigation is going to be a big issue," he says. "If you have detailed rules, you can go into court and say, 'These are the rules. We made sure the company conformed to them.' Rules give you some defense."

That's not as true with principles. For one thing, he notes, they can be interpreted differently, and the interpretation that seemed like a good idea during audit season might not look as good in front of a jury. Worse, the interpretation could appear to be complicity with a dishonest corporate manager. That's "where auditors can really get nailed," he adds.

What's more, accounting firms already face huge legal liability. According to Reckers, legal costs eat up around 15 percent of gross revenues for large accounting firms, and whopper lawsuits can bring a firm to its knees. In fact, that has already happened, which is one reason why the "Big Five" are now the "Big Four."

 "Some feel IFRS brings too much legal exposure," Reckers says. "This speaks to the sustainability of the profession."

New standards, new skills

In light of legal issues, Dueck thinks the shift to "fewer rules and more principles" will prompt accountants to hone skills in "documenting judgments and procedures clearly and concisely." He's not sure the change actually will bring more documentation but, he says, "The entry-level person will need to be a critical thinker and a good writer."

And, what about the tug-of-war between auditors and corporate management over disclosures and unqualified financial statements? "A lot of people think IFRS will give managers more power in negotiating with auditors" over rules interpretation and adverse opinions in statements, Reckers notes.

Dueck doesn't see that hazard. "It's at the auditor's discretion which type of opinion to issue or whether to issue an opinion at all," he says. But, he adds: "What you will see is more footnote disclosures in financial statements." That means investors will work harder to understand the financial health of companies they're researching.

Investors better get ready, and so should corporate managers. The switch to IFRS is already "a done deal," according to Reckers and others.

Fernandez agrees. Convergence between the two standards -- U.S. GAAP and IFRS -- already is under way. But, considering the accounting regulations and revisions that have hit firms over the past 6 years, he thinks auditors are up to the challenge. "We've managed changes like this before," he says. "We'll manage through this one, as well."

Bottom Line:

  • The U.S. Securities and Exchange Commission is moving to replace existing rules-based accounting standards with principles-based, international ones in filing requirements.
  • This move, say some, will make U.S. markets more competitive globally.
  • The switch impacts students now entering accountancy programs, as well as practitioners already working in the field.
  • Among changes to come: Auditors will require dramatic retraining; accounting firms face different legal liability issues; and investors will likely see more footnote disclosures in corporate financial statements.