Final Observations of an Accidental Accountant: Part 2
On the 3rd of June, Hans Hoogervorst, Chair of the IASB delivered his farewell speech at the IFRS Foundation Virtual Conference 2021 titled: “Final Observations of an Accidental Accountant”. He reflected on his 10-year tenure; how IFRS Standards have evolved during that time; and on the importance of independent standard-setting. He also reflected on developments in the economy during his time as Chair. Here is an excerpt from that speech. This is the second of a three-part installment.
Strengthening IFRS Standards
I propose we now leave the extremities of macro-economic policies and turn to the relatively uneventful world of accounting. Financial accounting has a much more modest ambition than macro-economics. We bean-counters do not seek to move or influence markets. We merely aim to describe economic reality as faithfully and neutrally as possible.
This modest ambition is difficult enough to achieve as it is. In an early speech, I sketched some of the many vulnerabilities of accounting. We employ a mixture of current and historical measurement techniques, causing all sorts of accounting mismatches. Historical cost accounting, despite its reputation for reliability, is full of subjective estimates, such as the measurement of value in use or the useful life of an asset. Intangible assets, which are increasingly important as value drivers for companies, largely escape the financial statements. We cannot explain precisely what Other Comprehensive Income is. While accrual accounting is vastly superior to cash accounting, it can also be vulnerable to earnings management, which is at the root of many accounting scandals.
In the past decade, the IASB has worked hard to reduce some of these vulnerabilities and I am truly proud of the progress that we have been able to achieve. IFRS 9 has improved accounting for loan losses, making it more responsive to changes in the economy. IFRS 15 has made revenue recognition more robust and more comparable globally. The quality of the balance sheet has greatly improved with IFRS 16 recognising all lease liabilities.
If anyone still needs convincing as to how essential proper global accounting standards are, just look at insurance accounting. Currently, there is widespread diversity in income recognition, with some national standards counting even investment deposits as revenue. In many countries, insurance liabilities are still measured using historical interest rates which are no longer relevant in the current low interest rate environment. After 2023, when IFRS 17 will be effective, income recognition will be internationally comparable and much more reliable. The insurance liability will everywhere be measured at current interest rates, reflecting economic reality much more closely.
The updated Conceptual Framework has created much clearer principles for measurement, that make it easier for the Board to determine which measurement basis to prescribe in what circumstances.
Many avenues to earnings management had already been closed before my time. Revenue recognition and the insurance Standard have further reduced opportunities to do so. The abolishment of the available-for-sale category for equity instruments in IFRS 9 has also made it less easy to realise profits and losses when they come in handy. Precisely for that reason there is a lot of nostalgia for available-for-sale. I do not wish to rule from my grave, but I certainly hope it will never be brought back. If you don’t like the volatility of equity instruments, don’t invest in stocks.
After we filled most of the gaps in recognition and measurement, we have been able to focus our energy more and more on improving the presentation of financial information. Our Primary Financial Statements project will provide a much better structure to the income statement and will enhance transparency and discipline around non-GAAP measures. Our proposals will greatly enhance the relevance of the income statement and have been received enthusiastically by investors. A better structure of the income statement is also immensely important as more and more financial information is consumed through electronic means.
Consolidation of the use of IFRS Standards
I am also proud of how IFRS Standards have become firmly established as the leading accounting standard for the global economy. When I started out in 2011, IFRS Standards were still relatively new and there was a lot of nervous excitement about their future. On the one hand, the goal of a single set of global accounting standards was still alive and mentioned in all communiques of the FSB and the G20. On the other hand, there was also a lot of uncertainty about whether the United States would finally adopt. Many feared that if the US failed to do so, the world of IFRS Standards might fall apart.
In the course of 2011 and 2012 the dream of a single-set of global accounting standards gradually faded as the US Securities and Exchange Commission (SEC) became increasingly hesitant about IFRS-adoption. Following the Great Financial Crisis companies were under a lot of pressure everywhere and the SEC felt it could not push through a reform that would generate considerable cost in the short run. The Japanese Minister of Finance also became more cautious after the terrible tsunami of 2011.
Yet the much-feared dissolution of the world of IFRS Standards did not happen. One by one, the IFRS family was joined by individual jurisdictions in Asia and Africa, ultimately reaching a total of more than 140. In Japan, the number of individual companies adopting IFRS Standards grew steadily and before long, more than 50% of the Japanese stock-market will be denominated in IFRS Standards. China has stayed very close, incorporating all the new Standards and many Chinese companies are able to state full compliance with IFRS Standards. Importantly, the European Union, which made the dream of IFRS Standards a reality in 2005, was thus far able to resist the temptation of adding carve-ins to our Standards.
Those who follow the endorsement of IFRS 17 closely, know there is a distinct possibility that Europe will end up making a carve-out of the annual cohorts requirement of this standard for some insurance companies. This would give insurers the possibility to mix old profits (even on contracts that have already expired) with new profits that could be lower due to low interest rates. The resulting income statements could show artificially high profits and even mask losses.
All in all, the use of IFRS Standards has consolidated in large parts of the world and it is no longer subject to fierce debates. The culture war between proponents of fair value accounting and the fans of historical cost accounting -still very much alive in 2011- has also lost much of its fire. The IASB steered a well-reasoned pragmatic course in which current measurement steadily gained ground while the pitfalls of fair value accounting were not ignored.
The excitement around IFRS Standards that greeted me 10 years ago has largely dissipated. But in this case, the fact that we have become a bit boring is a positive thing. It means that IFRS Standards have firmly established itself as the leading global accounting language. The dream of a single set of global standards has not yet been achieved. But the degree of consolidation that has been achieved is nothing short of astonishing, especially in this time of scepticism about globalisation.
I would like to think that jurisdictions have converged on IFRS Standards because of the quality of our standards. But equally important is the contribution of IFRS Standards to the ease of doing business. Many Japanese companies voluntarily embraced IFRS Standards, simply because it makes managing a multinational organisation so much easier.
And finally, I think that the governance of the IFRS Foundation has greatly strengthened our credibility. The relative independence of the Board, shielding it from excessive wheeling and dealings, has hopefully contributed to its trustworthiness. Indeed, the enthusiastic response of stakeholders to the proposed role of the IFRS Foundation in sustainability reporting was to a great extent fed by the trust in our governance and due process.
To view our related Courses – IFRS Training material on the standards discussed above, follow the links before:
> COVID-19 & IFRS | COVID Impact on Financial Statements | IFRS Training
> IFRS 9 Financial Instruments Updated 2020 2021 | IFRS Training
> IFRS 15 Revenue From Contracts with Customers Updated 2020 2021 IFRS Training
> IFRS 16 Leases Updated | 2020 | 2021 | IFRS Training
> IFRS 17 Insurance Contracts Updated | 2020 | 2021 | IFRS Training
> IFRS Masterclass Updated | 2020 | 2021 | IFRS Training
> IFRS Fundamental Concepts Updated 2020 2021 IFRS Training
Source: ifrs.org