Global Accounting
Many blame a simple accounting rule known as “mark-to-market” as a contributing factor to the financial crisis. As banks and corporations are facing huge losses and potential bankruptcy, understanding the role of accounting and it associated system of global rules is helpful for understanding how companies divulge their finances. One would think accounting would be a simple profession. In theory all one needs to do is record every financial transaction as a debit in one account and as a credit in another. The sums of all the credits should equal the sum of all the debits. This basic system of double bookkeeping has been used for thousands of years, since the times of ancient Rome. The role of accounting standards is to provide a set of rules defining how institutions report their profits and losses.
Oversight for accounting is done through auditors. Auditors are responsible for interpreting the accounting standards and deciding whether institutions have accurately presented their financial information. Internal auditors (usually employees of the institution) examine financial information for use by management. External auditors (always an independent outside firm) examine an institution’s financial statements to ensure that they are truthful and fair. The big four auditing companies worldwide include Deloitte Touche Tohmahtsu, Ernst and Young, KPMG, and PriceWaterhouse Coopers. These firms work with local, partner institutions in many countries worldwide.
Recently, the field of accounting has adopted dramatic measures that integrated accounting standards worldwide. In 2007, the United States joined approximately 100 countries in its acceptance of the London-based, International Accounting Standards Board’s (IASB) International Financial Reporting Standards (IFRS) standards. Until then, the U.S. only used the Generally Accepted Accounting Principles (GAAP) standards. The new standards will be phased in for all companies in the next five to ten years; albeit some major corporations will be able to start using the new accounting system as early as 2009. The IASB expects that within five years, 150 countries will have signed onto the IFRS.
The main difference between the two systems of accounting is that the IFRS is principle-based and the GAAP is rule-based. Auditors will need to understand the purpose of each transaction, to check whether the accounting fits the related IFRS principles. For example, when examining a company’s lease of a piece of machinery, auditors will need to determine if the company intends on owning the machinery (thus counting it as an asset) or if the company intends to return the machinery (expense). This disclosure of the purpose of machinery or more importantly technology may conflict with a company’s trade secrets and its desire to keep its potential future products secret.1
There are many positives associated with having one worldwide accounting standard, including “a decreased cost of capital, greater mobility of capital, greater efficiency in the allocation of resources, improved and more comparable financial reporting, and a decrease in the opportunities for earnings management.”2 Multinational companies now only have to keep one set of accounts, which makes it easier for investors to compare companies.
There are also many challenges associated with adopting the new standard. Different interpretations may arise from auditors from different countries and by different auditing bodies. How are these different interpretations resolved?3 Others worry about increased lawsuits due to different interpretations. In the developing world, challenges include changing legal, regulatory, and economic structures to comply with IFRS accounting rules, as well as challenges associated with the “culture” of Western-oriented accounting principles.
For example, the United Arab Emirate’s (UAE) banks, companies listed on the UAE’s new stock exchange, and the Dubai International Foreign Exchange must abide by IFRS standards in order to attract for capital. To prepare to comply to IFRS standards, the UAE has overhauled its legislation, courts, regulatory environments, and regulators. The Big Four accounting firms all set-up offices in the UAE, which helped drive the country’s adoption of the standards. The UAE has had problems implementing the standards due to a local culture of secrecy, in which companies are not used to reporting their financial earnings. Money laundering is also quite common in the UAE, thus making it difficult to supply the needed financial information for accounting purposes.4
One of the controversial tools used by accountants is the Mark-to-market methodology, in which a financial instrument is valued based on the current market price, rather than historical or future prices (for example a bond that is set to mature in six months, but is valued at its current price). This particular type of accounting can have major consequences in certain fields, such as futures trading, in which accounts can be “marked daily” and the trader will make or lose money accordingly. Fraud can occur when the value is not objectively determined. During the recent U.S. hearings on the $700 billion financial bailout, lawmakers considered suspending mark-to-market rules for financial corporations who were having difficulty assigning a value for the mortgage-backed securities. Potential losses associated with these securities would be extremely high as companies would have to admit that their investments were worth very little.
The current financial crisis further highlights to problems associated with accounting. As noted in a David Bogoslaw in Business Week “The core of the problem is the failure of many companies to provide a complete and accurate depiction of their financial standing…”5 Many companies have not assigned the proper value to their assets, thus projects a false image of their health. The IFRS and GAAP rules determine how a company projects its financial health; hence they play an extremely important role for investors and regulators. Moving forward, regulators and auditors will need to work together to ensure that companies and institutions provide an accurate picture of their financial health. (globalization101.org)
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