I previously suggested in this blog that the Financial Accounting Standards Board (FASB), International Accounting Standards Board (IASB), and other standard-setters throughout the world should establish a single, global registry of financial reporting standards. The fundamental premise of my suggestion is that having a global registry would accelerate the elimination of differences in financial reporting standards among countries while maximizing the benefits that we would derive from more-similar standards, without expecting anyone to give up quality, sovereignty, or anything else they're reluctant to give up. This post is the first of many that will describe why a "single sandbox" approach makes more sense than expecting the whole world to agree on a single set of standards or a single standard-setter.
As I described in my previous post, this single sandbox in which I'm suggesting the world's standard-setters play would have three key characteristics:
- A common conceptual framework
- A common codification system
- A common set of core standards
A major benefit of the single-sandbox approach is that it would significantly enhance the comparability of financial statements prepared in accordance with registered financial reporting standards without imposing a one-size-fits-all solution on reporting entities.
Aren't there aspects of financial reporting that are more important than comparability? Sure there are, but comparability is still pretty darn important. And if you don't believe that comparability is a good thing, all I can do is encourage you to review some fundamental economic principles about the efficient allocation of capital and the effect of comparability thereon.
Some folks have a hard time understanding how financial statements could be sufficiently comparable if reporting entities aren't forced to use the exact same set of standards. Keep in mind that comparability derives from the understandability of the information presented in the financial statements and the transparency of differences among the standards used to prepare the statements at least as much as it derives from the similarity of the standards used. So if user of financial statements can perform meaningful comparative evaluations across different reporting entities, then we have comparability, even with different underlying standards. And in this sense, the three characteristics of the single sandbox can clearly be expected to enhance comparability over our present situation. In short, the single-sandbox approach would be a big step in a positive direction, and well within the bounds of feasibility.
In my next post, I'll talk about how the single-sandbox approach would drive non-value-adding costs out of the financial reporting supply chain.
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Financial capital maintenance in units of constant purchasing power is only ignored in US GAAP
Mr Pounder,
You state:
"I am sympathetic to the argument that ignoring constant-purchasing-power accounting is a fundamental flaw in existing standards,"
First of all: I never in my original comments made any reference to Constant Purchasing Power Accounting. I stated Constant ITEM Purchasing Power Accounting and provided you with a link that you chose not to follow. But, since you mis-read my comment, let´s deal with your statements regarding CPPA.
Constant Purchasing Power Accounting, i.e. inflation accounting, is ONLY ignored in US GAAP, not in "existing standards" as you so mistakenly state. I think you did it on purpose (which I totally disapprove of), because, I know you know, at least, about IAS 29: you may not have realized the implications of the IASB Framework, Par 104 (a) which states in IFRS not in US GAAP: "Financial capital maintenance can be measured in either nominal monetary units OR IN UNITS OF CONSTANT PURCHASING POWER." (my capitals). Nothing is stated about "ONLY during hyperinflation." That is done in IAS 29. IAS 29 Financial Reporting in Hyperinflationary Economies sets out the rules for CPPA to be applied ONLY under hyperinflation. I repeat: I never stated anything about CPPA in my original comments. I know you know at least about CPPA in IAS 29.
You also stated:
"but I consider that flaw to be relatively insignificant compared to the many other inherent flaws in current U.S. GAAP and IFRS."
Once you understand the proven fact that "the erosion of business profits and invested capital caused by inflation" as your FASB member, Mr Mosso, stated in 1979 in FAS 33 is not "caused by inflation" as you and almost all accountants and economists believe, but by accountants´ choice of implementing the stable measuring unit assumption as part of traditional Historical Cost Accounting during LOW inflation, and that the hunderds of billions of Dollars in real value unknowingly, unnecessarily and unintentionally destroyed by accountants world wide each and every year can automatically be maintained by accountants when they implement financial capital maintenance in units of constant purchasing power during low inflation and deflation as authorized in IFRS twenty one years ago in all entities that at least break even - whether they own any revaluable fixed assets or not, you will agree with me that the hundreds of billions of Dollars destroyed by accountants world wide annually is not an insignificant problem as you state.
Accountants all agree and admit to “the erosion of companies´ profits and invested capital caused by inflation” as stated by your Mr. Mosso in FAS 33 in 1979. However, it is not inflation, but their free choice of the stable measuring unit assumption, i.e. traditional Historical Cost Accounting during low inflation, doing the destroying. Inflation is always and everywhere a monetary phenomenon as stated by your late Nobel Laureate, Milton Friedman. Inflation can only destroy the real value of money and other monetary items – nothing else. It is impossible for inflation to destroy the real value of any non-monetary item ever.
I am not the only person understanding that and stating that.
This is what two Turkish academics state:
“Purchasing power of non monetary items does not change in spite of variation in national currency value.”
Prof Dr. Ümit GUCENME, Dr. Aylin Poroy ARSOY, Changes in financial reporting in Turkey, Historical Development of Inflation Accounting 1960 - 2005, Page 9.
All items in shareholders´ equity are non-monetary items. Mr. Pounder, you and all accountants would confirm that. It is thus impossible for inflation per se to erode or destroy the real value of companies´ profits and invested capital as was stated by your Mr. Mosso in FAS 33 in 1979 and believed by you and most accountants.
Luckily for me, I did not write the IFRS Framework, Par 104 (a) twenty one years ago: the IASB authorized it in 1989. The only and perfect remedy to automatically maintain hunderds of billions of Dollars in real value currently destroyed in entities´ equity annually by accountants that you and almost all other accountants and economists mistakenly think is caused by inflation, was approved by the IASB: I did not come up with the Framework, Par 104 (a) twenty one years ago.
Kindest regards
Nicolaas Smith
http://blogs.fin24.com/realvalueaccounting
It is not inflation doing the destroying, but accountants with their stable measuring unit assumption.
Mr Pounder,
Thank you for your response.
I wish to point out that I never stated anything about Constant Purchasing Power Accounting. I clearly stated Constant ITEM Purchasing Power Accounting and provided you with a link to find out about CIPPA which is not the same as CPPA. Financial capital maintenance in units of constant purchasing power as authorized in IFRS in the Framework, Par 104 (a) twenty one years ago means measurement in units of constant purchasing power can be used to maintain the existing real value of all constant real value non-monetary items, e.g. shareholders´ equity, constant forever during LOW inflation and deflation (something you did not know about) in all entities that at least break even - whether they own any revaluable fixed assets or not.
Remember the banking crisis? Banks having to "slowly recapitalize through profits" as Paul Krugman stated. Well, that is not required under financial capital maintenance in units of constant purchasing power during LOW inflation as authorized in IFRS in the Framework, Par 104 (a) twenty one years ago (but, NOT provided for under fundamentally flawed US GAAP). When banks´ accountants do not automatically unknowingly and unnecessarily destroy that part of banks´ existing equity never maintained constant with sufficient revaluable fixed assets under the HCA model with their stable measuring unit assumption during low inflation, but, instead, automatically maintain that EXISTING (yes, you know, the capital did exist when it was originally provided) constant real value constant forever in entities that at least break even - whether they own any revaluable fixed assets or not - then Paul Krugman´s "slowly recapitalize through profits" would not be required simply to maintain the existing constant real value of existing constant real value equity constant forever - ceteris paribus - in all entities that at least break even.
You concur with the Boards that the concept of capital maintenance and the appropriate measurement thereof are not priorities because you are secure in your knowledge that it is generally accepted that the erosion of business profits and invested capital is caused by inflation and that accountants have no control over the level of inflation: according to you and almost all other accountants and economists, accountants can do nothing to stop this erosion or destruction. You are dead wrong. It is impossible for inflation per se to erode or destroy the real value of any non-monetary item ever. Accountants do the destroying with their stable measuring unit assumption – not inflation. Whenever you come to realize the fact that accountants unknowingly, unnecessarily and unintentionally continuously destroy hundreds of billions of Dollars in real value in this manner PER ANNUM world wide and that financial capital maintenance in units of constant purchasing power during LOW inflation as authorized in IFRS would stop this forever in all entities that at least break even, maybe then you will change your mind.
Thank you again for your responses to my comments.
Kindest regards,
Nicolaas Smith
http://blogs.fin24.com/realvalueaccounting
Thank You
Mr. Smith,
Thank you for commenting on my blog post. I concur that a single conceptual framework would not necessarily be better than the conceptual frameworks that underlie U.S. GAAP and IFRS today. But it is important to remember that the FASB and IASB are not working to develop a single conceptual framework merely for its own sake; each Board is committed to ensuring that the future converged conceptual framework will in fact be superior to each Board's existing conceptual framework.
As you have seen, the concept of capital maintenance and the appropriate measurement thereof are not priorities for the Boards to address in their joint conceptual framework project. Personally, I concur with the Boards that these concepts are not among the highest-priority issues to be addressed in the short term. I am sympathetic to the argument that ignoring constant-purchasing-power accounting is a fundamental flaw in existing standards, but I consider that flaw to be relatively insignificant compared to the many other inherent flaws in current U.S. GAAP and IFRS.
Best regards,
Bruce Pounder
A future converged Conceptual Framework would not necessarily be better.
Mr Pounder,
I agree with you that a common Conceptual Framework is essential. However, convergence of the FASB and IASB frameworks as the two Boards have been working on for the last 6 years does not necessarily mean the future converged Conceptual Framework will be better than the two individual ones. It may even be worse.
When a person reads the data available about their joint Conceptual Framework project to date, one notices that discussion of two of the most basic concepts, namely the concepts of capital and capital maintenance concepts (which determine the basic accounting model), do not form part of any of the eight phases of the joint project. When I enquired about this a month or two ago, Kevin McBeth, the FASB project manager for the Measurement Phase of the joint project stated:
“I cannot speak for the Boards with respect to your query. I can only say that early on in the measurement phase the staff suggested that capital and capital maintenance be discussed in the measurement phase, as it was in the original FASB Conceptual Framework. However, to date the Boards have not taken a decision on where, or even whether, those topics will be included in the converged framework.” (My bold lettering and underlining.)
I then put the same question to the US Financial Accounting Standards Board.
Ron Lott, the FASB director who is responsible for the joint FASB-IASB Conceptual Framework project responded by email:
“We are of course familiar with paragraphs 102 – 110 of the IASB Framework as well as paragraphs 45-48 of FASB Concepts Statement 5. Although not labeled as such, capital maintenance ideas have been raised at various points in the discussions of measurement concepts and will continue to be discussed until the board makes decisions about measurement concepts.
We do not know yet whether there will be a section in the yet-to-be-completed measurement concepts chapter labeled capital maintenance, but the concepts will almost certainly be discussed.”
Kevin McBeth stated the following by email:
“I believe that you may have misunderstood the discussions the FASB and IASB have had about measurement. Those discussions have used examples of various items, some of which you refer to as variable real value non-monetary items. That may have led you to believe that some of your concerns are being ignored. However, the scope of the measurement phase of the Conceptual Framework project does not exclude the items you refer to as constant real value non-monetary items. The Boards are concerned about the effects of selecting measurements on all elements of the financial statements.
Much remains to be done on this project. Although future discussions probably will not use the terminology and classification scheme that you are espousing, there is reason to expect that they will address the items of concern to you.”
As can be seen from the above "we do not know yet whether there will be a section in the yet-to-be-completed measurement concepts chapter labeled capital maintenance."
Imagine even contemplating leaving capital maintenance out of a common Conceptual Framework!
It has to be noted with alarm that after discussing measurement for the last 6 years on the joint Conceptual Framework project, units of constant purchasing power are not regarded as a candidate for primary measurement basis although the FASB has stated that capital maintenance will continue to be discussed in the future.
The current IASB Framework permits financial capital maintenance in units of constant purchasing power during low inflation and deflation while this is not allowed under US GAAP. A future converged Conceptual Framework that does not authorize financial capital maintenance in units of constant purchasing power will be fundamentally flawed as US GAAP are currently fundamentally flawed as a result of the absence of the only correct accounting model under inflation and deflation.
Nicolaas Smith
http://blogs.fin24.com/realvalueaccounting/
Thank You
Professor Albrecht:
Thank you for taking the time to comment on my blog post. I am puzzled, however, by your comments. They seem to attribute opinions and beliefs to me that I have not expressed nor do I hold. Because you have acknowledged coming in late to my blog, I encourage you to go back and read my prior posts (there aren't that many of them) in chronological order.
I concur that the world's capital markets are still rather local in scope despite being linked globally. I also concur that many cultural, legal, tax, social, and economic differences exist throughout the world. For those and other reasons, I believe that a one-size-fits-all approach to financial reporting is not realistically attainable and therefore it would be inadvisable to try to force it. I have tried to make that clear in this and prior blog posts.
I don't recall ever saying that the world needs a single set of accounting standards. Obviously, the world can and does function without such a set of standards.
What I have advocated in this blog is an approach that respects the right of any jurisdiction to be different for any reason or for no reason at all, as long as they accept the consequences of being different. At the same time, one of many benefits resulting from the approach I advocate would be the natural elimination of present differences in accounting standards that add cost and/or risk without adding commensurate value. Some differences, though, might still persist, and I'm "OK" with that.
I find it interesting that you chose to use an old propagandist's trick in the last paragraph of your comments, attributing arguments that you presumably support to "the smartest accounting professors in the U.S." I assure you that I am quite familiar with the many arguments both for and against convergence that have been expressed by many people. For years, I have addressed the strengths and weaknesses of common arguments for and against convergence in my speaking and writing. I'll close by saying that I'd be happy to point out the particular strengths and weaknesses of any argument for or against convergence that you care to specify.
Best regards,
Bruce Pounder
in response
Am late to getting to your IFRS series. I think you ignore the basic argument of the non-IFRS side within the U.S. The smartest and brightest accounting theorists see the world as a linked set of local capital markets. As such, the markets work much better with locally optimized information. There are so mabny cultural, legal, tax,social and economic differences that one-size fits all accounting is not only sub-optimal from a macro sense, it is way way way way way way way way sub-optimal. In the U.S. we prefer restrictive or "bright-line" rules, and the more restrictive the better. It is obviously different in other parts of the world that don't pay as much homage as the U.S. does to prioritizing investor information needs.
Anytime I hear someone talking about the need for global accounting standards, I think to myself, that person doesn't get it.
Have you read any of the arguments for why the smartest accounting professors in the U.S. do not want accounting convergence?
David Albrecht
Concordia College
The Summa
http://profalbrecht.wordpress.com