20 June 2012

IASB Chairman Hans Hoogervorst: The imprecise world of accounting

Mr Hoogervorst started his speech by pointing out the reasons why accounting can be so controversial. One of them is the inescapable judgement and subjectivity of accounting methods. He mentioned as well the multitude of measurement techniques that both IFRSs and US GAAP prescribe, from historic cost, through value-in-use, to fair value and many shades in between. In all, IFRSs employ about 20 variants based on historic cost or current value. Because the differences between these techniques are often small, the significance of this apparently large number should not be over-dramatised.

It is also remarkable that standards can cause one and the same asset to have two different measurement outcomes, depending on the business model according to which it is held. For example, a debt security has to be measured at market value when it is held for trading purposes, but it is reported at historic cost if it is held to maturity. In this case, the business model approach certainly provides a plausible answer. Still, some may find it counterintuitive that a government bond that is held to maturity would be valued at a higher price than the same bond held in a trading portfolio, where it may be subject to a discount.

One of the biggest measurement dilemmas relates to intangible assets. Likewise, the money-making potential of pharmaceutical patents is often quite substantial. The fact is that it is simply very difficult to identify or measure intangible assets. High market-to-book ratios may provide indications of their existence and value. However, after the excesses of the dot.com bubble, there is understandable reluctance to record them on the balance sheet.

Although IFRSs do not permit the recognition of internally generated goodwill, standards do require companies to record the premium they pay in a business acquisition as goodwill. This goodwill is a mix of many things, including the internally generated goodwill of the acquired company and the synergy that is expected from the business combination. Most elements of goodwill are highly uncertain and subjective and they often turn out to be illusory.

According to Mr Hoogervorst, it is not only the balance sheet that is fraught with imprecision and uncertainty. There is a problem defining what income is and how to measure it. Three main components of income are reported: the traditional profit or loss or net income, other comprehensive income and total comprehensive income. Total comprehensive income is the easy part; it is simply the sum of net income and other comprehensive income (OCI). While the P&L is the traditional performance indicator on which many remuneration and dividend schemes are based, the meaning of OCI is unclear. In the future, OCI will most certainly be an important source of information about insurance contracts.

Mr Hoogervorst stressed that IFRSs as global standards have already contributed a great deal to transparency and international comparability. He illustrated his point by comparing private sector accounting with the "anarchy" of public sector accounting. Although IPSASs are base on IFRSs, they are used only haphazardly. Around the world, governments give very incomplete information about the huge, unfunded social security liabilities they have incurred. Many executives in the private sector would end up in jail if they reported like Ministers of Finance.

Mr Hoogervorst concluded his speech with the IASB future agenda. The IASB should concentrate on further improving the quality of IFRSs by the following three terms: principles, pragmatism and persistence. The IASB should use the coming years to strengthen the underlying principles of its work. The IASB should improve the significance of the quantitative outcome of IFRSs where possible. Where this is impossible however, the IASB should make this clear and put more emphasis on qualitative information.

Full speech

© IASB - International Accounting Standards Board