Final Observations of an Accidental Accountant
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 first of a three-part installment.
Introduction
I am delighted to be with you, for the final time, at this year’s IFRS Foundation annual conference. I had hoped this event would provide a final opportunity to meet personally with all the colleagues and friends from around the world who have made my time as Chair such a hugely rewarding and enjoyable experience. However, that was not to be. So here I am—delivering a farewell speech from my spare room, surrounded by piles of washing. Living the dream.
I came into this job as an Accidental Accountant. I am not an accountant by training and many were surprised when I became chair of the International Accounting Standards Board (IASB). The Great Financial Crisis of 2008 had impressed on me the vital interest of solid international economic standards.
Back to stagflation?
The belief in free trade and free markets has taken a severe hit. Criticism of globalisation, once primarily dominant in left-wing circles, has widened its intellectual appeal to the populist right. The excesses of deregulation in the financial sector before 2008 have undermined the belief in free markets more generally.
Balanced budgets are nowhere to be seen. That is not surprising in these testing times, but the size of deficits and debts are truly staggering. On average, budget deficits of the advanced economies are now in double digits. The worldwide total level of debt in the public and private sector is now at an unprecedented 335% of GDP and rising. We have mortgaged our global house more than three-and-a-half times. Monetary conventions have also been put aside. Investors have to pay for the privilege of buying debt from heavily indebted countries. Central banks buy up government bonds on a massive scale, quietly monetising public debti.
Policymakers could not stand, of course, stand aside as the Covid crisis threatened to paralyse the entire global economy.
However, as former IMF Managing Director Jacques de Larosière has remarked, the problem is that the massive stimulus hit an economic territory that had already been heavily mined by unconventional policiesii. He has described how, even in the decades before 2008, monetary policies in the industrialised world had become more and more accommodating. He -and many others- saw the resulting excesses in liquidity and debt as one of the main causes of the Great Financial Crisis of 2008.iii
Yet, fearing that the recession could turn into a depression, the world reacted to that crisis by doubling down on monetary accommodation. Determined to stave off a depression, central banks were determined to drive up inflation and pulled out all the stops after 2008.
In his memoirs Paul Volcker expressed considerable scepticism with these policies. He did not agree with the inflation target of 2%, or just below 2%, that almost all central banks have adopted. He drily commented that an annual inflation of 2% will halve the value of a currency in little more than a generation. He was also doubtful that the rate of inflation could be micromanaged. He warned that once you reach inflation of 2%, it can easily slip to 3% or more.iv Volcker’s warnings seem particularly apt today with inflation climbing above 3-4% in some parts of the industrialised world.
Meanwhile, the natural laws of economic gravity seem to have been suspended indefinitely. While we are still digesting the biggest economic contraction in decades, housing prices are going through the roof, stock markets set record after record, and bankruptcies are at historical lows. One could of course see these counter-intuitive developments as a triumph of economic interventionism. Yet there are also reasons to see them as expressions of excess.v While debt overhang and widespread zombification of the economy will likely depress economic activity in the future, a return of stagflation might very well be in the cards. Even if this does not happen, the unprecedented accumulation of debt represents a severe risk for financial stability.
Incessant stimulus also has a pernicious influence on economic behaviour. A generation of investors has grown up expecting authorities to step in whenever markets throw a tantrum. Excessively leveraged business models get bailed out time and again. And I think back to my time as Minister of Finance. My story about not having a money tree might no longer be so convincing when central banks are buying up 50% or more of debt issues. Even in the frugal Netherlands, budget discipline is now under severe pressure.
Policymakers are aware of all these risks, but they are understandably fearsome of what might happen once interest rates go up again. Yet the longer we go on like this, the more debt will accumulate and the more difficult it will become to raise interest rates and restore prudence. It is clear that the road back to normality will be extraordinarily painful and policymakers will need all the courage they can muster. But we cannot go on adding risk to a global economy that is already way too risky.
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
