Assignment 1: Global View After 7 weeks in the program, you have developed a kee
ID: 2424033 • Letter: A
Question
Assignment 1: Global View After 7 weeks in the program, you have developed a keen sense of how business should be operating. You are also engaging in conversations with your peers in the business about how you can make the business better and stronger. Now is the time to put that brain power to work. Write an analysis about how economics, government, and law affect value creation in the global context for your business.
Requirements
1. In a 5-page research paper, address the following: Analyze how economics, government, accounting standards, GAAP and IFRS, and law would impact your business if your business would expand globally.
2. Include four academic references.
3. Minimum of 5 pages in length utilizing APA formatting and citation style (excluding title and reference pages).
Explanation / Answer
1.
An old joke, attributed to The Economist and Ronald Reagan, among others, is that economists are people who are good with numbers but didn’t have enough personality to become accountants. Like mothers-in-law, accountants over the years have been an easy butt of jokes; they are commonly and over-simplistically characterized as introverted, Cream-of-Wheat-bland, bean-counting drones. But that stereotype is utterly belied by a current hot-button issue: should the U.S. adopt a uniform set of global accounting standards, particularly the widely used International Financial Reporting Standards (IFRS)? When it comes to IFRS, accountants have notably strong feelings, pro and con, and they have few inhibitions about expressing those feelings; indeed, some of them sound more like trash-talking pro-football players than like the green-eyeshade-wearing nerds they are caricatured as being.
Consider these two contrasting in-your-face broadsides from accountants about the issue:
"Anyone who believes all countries can embrace international accounting standards and use those standards in the same way is dumber than a sack of rocks," said a CPA blogger on The New York Times Web site.
"U.S. GAAP [generally accepted accounting principles] must go," a staff member of the American Institute of Certified Public Accountants (AICPA) declared in Forbes.com. "U.S. GAAP has become so cumbersome that it’s in danger of collapsing under its own weight. The complexity is leading to lot of gaming of financial reporting. You know there’s something wrong when all the standards of IFRS fit into one book about two inches thick, but all the U.S. GAAP standards require four books about nine inches thick. U.S. GAAP desperately needs to be replaced by more streamlined international accounting standards."
Adoption likely
Whew! In light of the tumult and shouting coming from accountants, of all people, this question hangs in the air: is the U.S. in fact going to switch from GAAP to IFRS? Pricewater-houseCoopers, for one, thinks it’s highly likely. In a recent report, the big accounting firm noted, "Within a few years the SEC [Securities and Exchange Commission] is likely to designate a date for mandatory adoption of IFRS by all U.S. public companies." We agree, but we think the adoption date may be later rather than sooner -- sometime after 2016.
As we see it, there are four compelling motivations for the U.S. to adopt IFRS:
* The globalization of business, finance, and the capital markets has made it increasingly impractical to tolerate different accounting standards for nations around the world. That goes a long way toward helping explain why IFRS has been adopted by more than 100 countries. Canada, India, Korea, and Japan plan to join them in 2011. The U.S. is the largest nation that has yet to commit to IFRS -- or as the International Herald Tribune put it, "The U.S. has chosen to remain the most conspicuous wallflower at the IFRS dance."
It seems to us that if financial statements and accounting standards exist mainly for the benefit of investors, then investors -- whose vision is increasingly global in scope -- deserve a uniform international language of financial disclosure, created under a single set of international accounting standards. That way, investors can make apples-to-apples financial comparisons and thus become more informed.
To serve a big market
To be sure, the investors who would be served by uniform international accounting standards represent a big market. U.S. investors are buying more foreign stocks in more foreign markets, more foreign companies are trading their shares in the U.S., and foreign investors are buying more U.S. stocks. The SEC estimates that U.S. investors hold more than $4 trillion in international stocks and foreign investors own roughly the same amount in U.S. stocks. To put that combined $8 trillion figure into perspective, it nearly equals 60% of the U.S. gross domestic product.
* As the AICPA staff member who was quoted in Forbes.com pointed out, the current U.S. accounting standards are unwieldy, impairing their effectiveness to some degree. As a result U.S. companies must deal with a tangled forest of loopholes and a growing incidence of mistakes in applying the standards. And in a small number of instances, companies like WorldCom, Enron, Qwest Communications, and HealthSouth have exploited the complexities of U.S. GAAP to commit fraud. Robert H. Herz, chairman of the Financial Accounting Standards Board, which oversees U.S. GAAP, favors making a fresh start: "I believe it’s better to create something new than to patch up something old and outdated."
* Adopting IFRS should create cost efficiencies for U.S. companies in the long run. For U.S. multinational companies that trade their shares on foreign exchanges, the cost of implementing at least two sets of accounting standards, as required by securities laws, is rising. To flinty-eyed chief executives who are embracing the religion of cost-reduction with evangelical zeal in this recession, the extra costs seem increasingly hard to justify. Accordingly, a number of multinational companies such as ExxonMobil and United Technologies have already begun preparing to convert to IFRS.
$32 million per company
Although we think that IFRS may save money for U.S. companies over time, it won’t in the short term. Margaret Smyth, the controller at United Technologies, estimates that IFRS will cost her company at least several million dollars in the next few years. "We see that IFRS is inevitable, and we want to get out in front of it," she explained. The largest U.S. companies that may be eligible to use IFRS first would have to spend about $32 million apiece over time to make the changeover, the SEC calculates.
We hasten to note that even though enthusiasm for IFRS seems to be gradually growing in the U.S., it isn’t shared by many accountants at small companies. Small companies have been the most vigorous and vocal opponents of international accounting standards. And since small companies -- typically defined as firms with fewer than 500 employees -- account for all net employment growth, generate more than 50% of the nonfarm private gross domestic product, and generate a disproportionate share of innovation in this country, their resistance to IFRS isn’t to be taken lightly. Small companies maintain that the differences in U.S. and international accounting standards have neither helped nor hurt their businesses much, even if they do business overseas, so why change? Nevertheless, we think that even small companies doing business only in the U.S. may find that they would benefit from the accounting simplification and cost savings that IFRS can deliver, although the cost/benefit payoff may take longer for them to achieve than it would be for their larger corporate counterparts.
* Uniform international accounting standards may make the U.S. capital markets more competitive and promote the more efficient flow of capital around the world.
Our analysis shows that IFRS has the potential to decrease the cost of allocating capital internationally. As it stands now, companies wishing to raise capital in more than one country are confronted with two problems: 1) duplicative compliance costs and inefficiencies in preparing multiple sets of financial statements to comply with differing national regulations and 2) some hesitancy by sources of capital around the world to back business ideas presented in an accounting lingua franca that they aren’t entirely familiar or comfortable with.
The bandwagon grows
For all these reasons, a growing ensemble of supporters is getting on the IFRS bandwagon: the CFA Institute, the AICPA, New York Mayor Michael Bloomberg, former Federal Reserve Board Chairman Paul Volcker, management consultants McKinsey & Company, and the Big Four accounting firms Deloitte Touche Tohmatsu, Ernst & Young, KMPG, and PricewaterhouseCoopers. (We feel compelled to note that the Big Four have been accused of hyping IFRS out of unmitigated self-interest because it presents a new-business bonanza for them down the road; they would have the opportunity to guide U.S. corporate clients through the new standards -- the type of windfall that information-technology consultants reaped from the Year 2000 computer problem. There may be some truth to that, but we think it’s also true that the Big Four believe IFRS represents a better way, lowering certain costs of doing business for most public companies and providing more uniform financial information to investors.)
In our judgment, although IFRS won’t be perfect and almost certainly will produce its share of unintended consequences, it’s a more-than-adequate framework on which to build an integrated, uniform set of accounting standards -- standards that can incorporate some of the best of U.S. GAAP and serve the best interests of global investors.
The International Accounting Standards Board (IASB), based in London, and the U.S.-based Financial Accounting Standards Board (FASB) have been working in tandem since 2002 on rule changes needed to recast IFRS into a body of standards that most, if not all, nations in the world can embrace. For its part, the SEC gave a hefty boost to IFRS in 2007, when it decided that foreign companies whose American Depositary Receipt shares are traded here would no longer be required to reconcile IFRS with U.S. GAAP. Some observers in the accounting field considered the SEC’s elimination of the IFRS-U.S. GAAP reconciliation requirement a gesture designed to encourage U.S. companies to warm up to IFRS. McKinsey & Company lauded the SEC’s decision, saying it sent "a powerful signal" around the world that the U.S. is "willing to respect and honor approaches outside its shores."
Some obstacles loom
Be that as it may, what could inhibit the ultimate willingness of the U.S. and other nations to respect and honor -- and actually accept -- IFRS as the undisputed accounting standards worldwide? We think there are four main impediments:
One, achieving a uniform set of international accounting standards, or what’s called in accounting-speak "convergence," will mean synthesizing differing cultural, legal, regulatory, and economic priorities among nations -- no small challenge.
For instance, Charles Niemeier, a board member of the Public Company Accounting Oversight Board (PCAOB), who is perhaps the most prominent critic of international accounting standards in the U.S., has cited a French study that shows that IFRS isn’t being applied consistently from country to country in the European Union. The study concluded that each country was practicing "nostalgic accounting," i.e., each was applying a customized version of IFRS that resembled its own original accounting standards. BusinessWeek estimates that 29 countries using IFRS are mixing their own accounting flavors into the IFRS recipe. That of course defeats the whole purpose of a global standard and could make IFRS unpalatable to the U.S. and others.
The IASB and the FASB have set 2011 as the deadline for making IFRS truly uniform. As we see it, IFRS may be in some jeopardy if the two accounting bodies can’t produce a hybrid standard that most countries can live with by then.
Who’s in charge?
Two, countries may fail to agree on a common regulator -- as of now, the IASB is ordained to fill that role -- to enforce IFRS worldwide.
Clearly, a single international regulator would be best able to enforce IFRS rules, as the SEC now does with U.S. GAAP. One proposal, advanced by former SEC Chairman Christopher Cox and Charlie McCreevy, a member of the European Commission, is to establish a global monitoring authority that would help choose the IASB trustees responsible for regulating IFRS, that would serve as a watchdog of the IFRS, and that would help ensure the IASB is properly funded so as to secure its independence. As articulated in one communiqué, the SEC has been adamant that the IASB must be "independent from special pleaders, from the political process, from favored industries or industry players, and from national or regional biases" for it to be a credible regulator.
Some accounting experts say that the model for funding the FASB can be applied to fund the IASB as well. In 2002, as part of the Sarbanes-Oxley law, Congress made provisions for the FASB to essentially impose a tax on all public companies, as paid by the PCAOB that oversees the accounting profession. We see no good reason why a similar model couldn’t work internationally, with a tax imposed directly or indirectly on all public companies to fund the IASB, so that it would be beholden to no political or corporate special interests.
As an alternative, Paul Miller, a professor of accounting at the University of Colorado, has recommended that the stock exchanges around the world subsidize the IASB, by charging a fee to investors using the exchanges. His rationale: "I would far rather see money going to an international board from users of financial standards than those who prepare them."
Lest we move too fast
Three, the SEC may drag its feet in authorizing IFRS.
The SEC under Christopher Cox established a tentative timetable or "roadmap," whereby in 2011 it would decide whether to authorize all public companies to adopt IFRS by December 15, 2016. Under this timetable, the 20 largest public companies by market capitalization in their industries would begin using IFRS first, in 2010. In November the SEC issued for public comment its roadmap for implementing IFRS in the U.S. and asked for responses by February 19.
But that was then. This is now: Mary Schapiro, the Obama administration’s newly appointed SEC chairman, has made no bones about her underwhelming sense of urgency in moving IFRS along. At her confirmation hearing in January, she said she would "proceed with great caution" in adopting IFRS and indicated she planned to delay some of the SEC timetable. "I will not be bound by the existing roadmap that’s out for public comment," she declared. Even so, she has endorsed the desirability of common international accounting standards, so we think it’s probably a matter of only when such standards are deemed acceptable to the SEC, not if they are acceptable. In our estimation, the odds are that IFRS won’t be used widely by U.S. companies until after 2016.
Four, significant differences between certain IFRS and U.S. GAAP rules may fail to be resolved by the IASB, the FASB, and national governments.
Saying no to LIFO
For instance, IFRS doesn’t accept the last-in, first-out method of inventory accounting, known as LIFO. If U.S. companies must switch from the LIFO method to the FIFO (first-in, first-out) method that’s sanctioned by IFRS, they face paying significantly higher taxes, in our analysis. To make the IFRS more appealing to U.S. companies, Congress may need to pass legislation that minimizes or eliminates the adverse tax impact of FIFO.
Also, IFRS, in relation to U.S. GAAP, tends to boost the earnings of Europe-based firms, which could hamper the ability of investors to make valid comparisons of the financial results of companies in the U.S. and Europe.
For instance, a study by Risk Metrics, an analytical firm, revealed an "earnings gap" in the 30 largest foreign companies whose shares are traded as ADRs in the U.S. In 2006, the last year that major foreign companies like Bayer, BP, Royal Dutch Shell, and Unilever were required to report their earnings under U.S. GAAP, they reported better earnings under IFRS than under GAAP; the IFRS earnings were 14% higher. The biggest discrepancies involved accounting for pensions and acquisitions. Also, more than 70% of the companies reported a lower return on equity under U.S. GAAP, due to lower values accorded to earnings and higher values given to book value.
Legacy differences likely
According to Risk Metrics, these differences between IFRS and U.S. GAAP "have material impact on key performance metrics. . . [and suggest] that investors face significant challenges in making apples-to-apples comparisons without mandatory disclosure of the differences. Our analysis also suggests that the convergence between IFRS and U.S. GAAP likely will not eliminate the impact of legacy differences for years to come."
We think all four of these impediments, although daunting, can be overcome, and we would hope that the FASB, IASB, and SEC develop a new, coordinated timetable for introducing IFRS in the U.S. if future circumstances warrant it. As every high-school sophomore faced with writing an English composition knows, things tend to get accomplished more readily under a deadline, and U.S. companies need time to integrate IFRS into their operations. USA Today predicted that corporate America would require two to three years to gear up for IFRS -- to upgrade communications and software systems and train thousands of financial and accounting professionals in IFRS. Beyond that, regulators, CPAs, and investors need to familiarize themselves with IFRS, business schools need to begin teaching IFRS, and ultimately IFRS needs to be included in the Uniform CPA Examination in the U.S.
In all, we think IFRS is as good a potential set of international accounting standards as any. We think governments, corporate executives, accountants, auditors, and investors are likely to get the chance to voice their opinions to the IASB and the FASB about what constitutes good international accounting standards. And after the IASB and the FASB issue a set of standards that reasonable people agree adequately accommodates those diverse viewpoints without compromising prudent accounting principles, then it’s incumbent on everyone affected to accept those new standards. We hope that will be the case.
Advantages trump disadvantages
Although the IFRS may err on the side of less specificity on certain accounting matters, the advantages of a uniform, more concise, straightforward set of international accounting standards offer ample compensations, in our view. In sum, uniform international accounting standards can provide a common accounting language that makes possible valid comparisons of corporate financial results for investment analysis; can make the process of allocating capital globally more efficient; can simplify accounting rules and diminish the risk of accounting errors; and can reduce the costs resulting from the need for multinational companies and auditors to produce multiple versions of financial reports for investors.
We think James Largay, a Lehigh University professor, cut to the heart of the brouhaha among accountants over international standards in a letter to The Wall Street Journal. U.S. generally accepted accounting principles, Professor Largay wrote, have been "accreting guidance, exceptions, and amendments for at least 75 years. That it often looks like a book of arcane rules is not coincidental -- preparers, auditors, litigators, and to some extent users demanded it. IFRS is young, relatively untested, and only recently emerged as a comprehensive system of accounting standards. It will accumulate its own barnacles over the years. But I say go for it! The global economy needs a common set of sound accounting standards."
In a sense, IFRS is neither the problem nor the solution; any accounting standards are only what people make of them. We think all the heated arguments over the advantages and disadvantages of IFRS among those wild and crazy professionals known as accountants are somewhat misplaced. To us, the answers to these key questions are the most germane to the issue:
To be or not to be?
Is IFRS less specific and more "principle-based" than "rules-based" U.S. GAAP, as some claim?
Yes, as we see it.
Does that in turn mean that IFRS can’t be a clear, fair, and workable standard for companies and investors worldwide?
No, in our opinion.
Most important of all, does the evolution of the globalization of business, finance, and capital cry out for a common international accounting standard?
An emphatic yes, on our part.
To us, here’s the bottom line: any accounting standards have their flaws, but those flaws are less critical than the ability and integrity of the people who are responsible for upholding and using the standards. That tells us that IFRS -- provided it’s followed, used, and enforced competently and in good faith -- can be effective. It is only when standards are intentionally or unintentionally misused by people lacking in competence or ethics that they become ineffective and even dangerous. We are confident that any potential problems involved in adopting IFRS would prove surmountable in no small part because we believe the accountants who would apply IFRS have largely proven to be highly competent, ethical, and worthy of trust.
So we say: accountants of the world, unite; you have nothing to lose but your green eyeshades.