Criteria for an Independent Accounting Standard Setter

Donna Street is the Mahrt Chair in Accounting at the University of Dayton.

In 2008, the Council of Institutional Investors (Council) adopted a policy regarding the independence of international accounting and auditing standard setters. The Council’s policy supports the goal of convergence to a single set of high quality accounting standards designed to produce comparable, reliable, timely, transparent and understandable financial information that will meet the needs of investors and other consumers of financial reports. Importantly, the policy also opposes replacing U.S. accounting standards and standard setters with international accounting standards and standard setters unless and until seven criteria have been achieved.

In a recent white paper commissioned by the Council of Institutional Investors, Criteria for an Independent Accounting Standard Setter How Does the IASB Rate? I explore evidence and views regarding each of the seven criteria. The paper is designed to assist Council members and other interested parties in evaluating whether the International Accounting Standards Board (IASB) and its International Financial Reporting Standards (IFRS) satisfy any or all of the criteria. This evaluation is particularly timely.

The U.S. Securities and Exchange Commission (SEC) has announced plans to decide in 2011 whether to require or permit U.S. companies to adopt IFRS for their financial reports. This paper was completed prior to the SEC’s release on May 26, 2011 of a staff report (available here) exploring a possible method of incorporating IFRS in the United States.

In regard to each of the Council’s criteria, the evidence and views explored indicate the following:

  • Criterion #1: In the aggregate, information that results from application of [IFRS] is, at a minimum, of the same quality as the information resulting from U.S. accounting . . . standards. Research regarding the comparability of IFRS and U.S. Generally Accepted Accounting Principles (GAAP) is inconclusive regarding whether applying IFRS provides, at a minimum, the same quality of information as GAAP. However, a majority of U.S. and European financial executives surveyed believe the quality of IFRS is high or very high. Most also believe that the IASB and the U.S. Financial Accounting Standards Board (FASB) have made progress developing joint standards to address improvements needed prior to adoption of IFRS in all major capital markets. But concerns remain regarding fundamental deficiencies in some key areas of IFRS.
  • Criterion #2: [A]pplication . . . and enforcement . . . of [IFRS] are at least as rigorous and consistent as the application and enforcement of U.S. accounting . . . standards.While there is no direct evidence indicating how the application and enforcement of IFRS in the United States would compare with the application and enforcement of GAAP, research reveals a relationship between a country’s institutional setting, including corporate governance and audit quality, and characteristics of a country’s financial reporting.
  • Criterion #3: The [IASB] has sufficient resources — including a secure stable source of funding that is not dependent on voluntary contributions of those subject to the standards.Historically, most of the IASB’s funding has been from voluntary contributions, raising questions about the IASB’s independence. Furthermore, the IASB ran a deficit for several years, including 2010, and is deferring certain expenditures. On a more positive note, the IFRS Foundation, the parent entity of the IASB, is focused on moving as soon as possible to a funding source that relies on public sponsorship or other intermediated mechanisms. As of 2011, the United States is the only country where the IFRS Foundation will seek direct corporate contributions. The IFRS Foundation’s 2011 budget, released in April, projects a break-even year and indicates that direct contributions from U.S. companies (8 percent) and international accounting firms (26 percent) represent 34 percent of total projected revenues.
  • Criterion #4: The [IASB] has a full-time standard-setting board and staff that are free of bias and possess the technical expertise necessary to fulfill their important roles.Recent changes to the IASB’s governing documents have elevated the importance of geographic representation as a criterion for serving on the board (previously, technical expertise was the primary criterion). The changes also permit up to three part-time members of the board. Limited resources may further stretch the IASB’s staff and inhibit the board’s ability to develop high quality accounting standards.
  • Criterion #5: The [IASB] has demonstrated a clear recognition that investors are the key customer of audited financial reports and, therefore, the primary role of audited financial reports should be to satisfy in a timely manner investors’ information needs. This includes having significant, prominent and adequately balanced representation from qualified investors on the standard setter’s staff, standard-setting board, oversight board, and outside monitoring or advisory groups. The IFRS Foundation and the IASB have taken several steps to increase their focus on investors. Those steps include changes to the IASB’s governing documents to designate investors as a major target audience, increasing investor representation in the standard-setting process and enhancing investor outreach. Incoming IASB Chair Hans Hoogervorst said recently, “[t]he interest of the investor will always remain the main focus of accounting standard setting.” In addition, research suggests investors and other users need to be more proactive and enhance their participation in IASB due process. Notwithstanding the progress that has made to increase investor representation in the standard-setting process, only five of the present 20 seats on the IFRS Foundation, eight of 47 seats on the IFRS Advisory Council (IFRS Council) and three of the 15 seats on the IASB are held by individuals from the investor community.
  • Criterion #6: The [IASB] has a thorough public due process that includes solicitation of investor input on proposals and careful consideration of investor views before issuing proposals or final standards.IASB due process, like that of other standard setters over the years, has been challenged, particularly during the recent credit crisis and the ongoing convergence process. Some have criticized the adequacy of the IASB’s due process in connection with the board’s plans to complete several major projects in 2011. Moreover, evidence is mixed about whether recent amendments to the IASB’s governing documents are sufficient to improve due process. Nevertheless, in 2007, an independent think tank recognized the IASB as possessing the best developed external stakeholder engagement capabilities among 30 of the world’s most powerful global organizations.
  • Criterion #7: The [IASB] has a structure and process that adequately protects the standard setter’s technical decisions and judgments (including the timing of the implementation of standards) from being overridden by government officials or bodies.All organizations involved in standard setting face ongoing questions regarding their authority and responsibility. The IASB is no exception. To date, its technical decisions and judgments have been subject to significant pressures from governmental officials and bodies, particularly those representing the European Union (EU).

The full paper is available for download here.

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