The move to a principles-based accounting system is likely to demand that corporate finance executives be good yarn-spinners, speakers at the annual CFO Rising conference said.
A system less like the rules-based U.S. generally accepted accounting principles (GAAP) and more like the judgment-focused international financial reporting standards (IFRS) would draw more heavily on the narrative skills of finance executives, according to David Sherman, a professor of accounting at Northeastern University. A good story, elaborated from solid principles, would be hard for an independent auditor to challenge under such a system, he suggested.
Speaking last week at a panel on the future of accounting regulation, Sherman noted, however, that under the more principles-based system envisioned under the Securities and Exchange Commission’s roadmap for global convergence of accounting rules, the footnotes to financial statements will necessarily expand to fill in the details formerly supplied under U.S. GAAP. “It means you get a lot more clarity,” he added, but also a lot more board involvement in approving those details.
But U.S. companies are a long way from having a solid foundation on which to base their stories. For example, unlike IFRS, U.S. GAAP has no single “conceptual framework” — a basis from which future accounting standards can be built. Currently, a company preparing financial statements under IFRS must consider the International Accounting Standards Board (IASB) framework when there’s no standard or interpretation that specifically applies to an action the company is taking.
There’s no similar requirement under U.S. GAAP. The Financial Accounting Standards Board’s concepts statements, which are used when there are no applicable standards or interpretations, wield the same authority as accounting textbooks, handbooks, and articles. Further, the concepts statements have “a lower authoritative status than practices that are widely recognized and prevalent either generally or in the industry,” according to a FASB document.
The absence of a conceptual framework means that U.S. issuers would be hamstrung in complying with a principles-based reporting system. “If you’re going to use a story line, you have to get very conceptual,” said another panelist, John Hepp, a Grant Thornton partner.
Hepp said he’s amazed at how many preparers that report in IFRS will propose using accounting methods that IASB already has explicitly rejected. Hepp stressed how important it is that accounting standard setters explain the basis for their conclusions when writing standards, because that allows auditors to explain to clients why certain methods are not acceptable.
Indeed, IASB has actually become more rigorous in terms of spelling out the reasons for its decisions. The members of the international board are “even amending [their explanations] now when they change their mind[s] about why they have made a particular decision,” Hepp said, “which we think is just excellent.”