Whose Trojan Horse? The Dynamics of Resistance against IFRS

The following post comes to us from Martin Gelter, Associate Professor of Law at Fordham University. The post is drafted based on a paper co-authored by Professor Gelter and Zehra G. Kavame of Fordham Law School.

The US is the last major economy that has not yet adopted International Financial Reporting Standards (IFRS) while, from Europe to Canada, from Australia to China, around 120 countries are already requiring or permitting IFRS; this figure will likely rise to 150 countries in the near future. The introduction of IFRS has been debated in the United States for several years. The Securities and Exchange Commission (SEC) first issued a paper that includes a plan for possible implementation, and several SEC Staff Reports followed up until the July 2012 Final Staff Report with regard to the work plan. However, whether domestic issuers should be permitted to use IFRS is still very controversial.

The European Commission’s decision in 2000 to mandate the use of IFRS starting from 2005 and the unprecedented worldwide acceptance of IFRS since then prompted a debate about the relations between the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB). An important argument in the US debate is the idea that IFRS, which are promulgated by the London-based IASB, are dominated by Europeans. In the United States, IFRS are therefore often seen as a “Trojan horse” proposed by Europeans (and others) to replace American accounting culture, which is still based on GAAP (Generally Accepted Accounting Principles) promulgated by FASB (Financial Accounting Standards Board). To slightly exaggerate the argument, IFRS is seen as an effort of the European accounting tradition to colonize the US with an allegedly inferior set of accounting standards. In this article, we suggest that this perception is a myth. In fact, IFRS have rather been an element of Anglo-American accounting culture, developed with the support of FASB, that Continental European countries have been encouraged, and ultimately forced, to accept by way of the EU with encouragement from the US. In other words, IFRS have been the Trojan horse of the US that had and still has to overcome a significant level of resistance in Europe.

Our article is to counter the majoritarian view by shedding light on the purpose and origins of IFRS, and to draw possible lessons from the “internationalization” of accounting standards applicable to publicly traded European firms. While these firms are required by EU law to use IFRS in their consolidated accounts, we show that IFRS developed out of an accounting tradition similar to the US with its Anglo-Saxon financial reporting approach. Both US GAAP and IFRS share a common basis, the assumption that the purpose of public accounting is to provide a useful basis for decision-making by participants in capital markets.

This was not the case in Continental Europe before the 1990s, where other purposes such as taxation and creditor protection played key roles. The objections to IFRS in Continental Europe were far more severe than the ones brought in the United States today. European accounting since the 1970s has been characterized by the EC Accounting Directives, which set forth a supranational framework for national accounting laws and standards; however, these directives had many gaps and created intended and unintended options that were effectively used by the Member States to maintain their previous accounting systems, which were often very different from that of the US or the UK. By and large, they reflected a very different orientation in the purpose of accounting based on Member State traditions. Thus, IFRS faced considerable resistance when they were initially introduced in Continental Europe, and some issues have still not been fully resolved. In a number of key EU countries the use of IFRS is still limited to consolidated accounts, and primarily to those of publicly traded firms. Traditional domestic accounting standards tend to remain in parallel use for the financial statements of other entities, as well as for the entity-level accounting even of publicly traded firms. Convergence in accounting has therefore remained superficial.

Paradoxically, most of the arguments in the US against IFRS today relate to how they are supposedly an accounting system emerging from a foreign legal system that would provide a bad fit for the US economy and its legal and corporate governance environment. As our article demonstrates, these arguments are false. Culturally, economically, and legally, the US capital market is much closer to the biotope from which IFRS developed than Continental Europe is. Since other countries had to make much greater strides, we argue that the purported hurdles in the US should be considered comparatively unimportant and rather easy to overcome. Moreover, given the historical support of IFRS from the US and capital market actors in the Anglosphere in general, the SEC’s present reticence to endorse IFRS is almost surprising. Now that the US has helped to foist an accounting tradition it shares on everyone else, it is surprising that the country itself would not go all the way and embrace IFRS. We discuss whether a changeover would lead to substantive changes in accounting, and what implications the inevitable institutional changes would have, looking at various possible policy strategies for the future.

The full paper is available for download here.

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