STEPHEN HASWELL
OVER-COMPLEXITY
IN ACCOUNTING
STANDARDS
AND THE EMERGING
DUOPOLY
OF US GAAP AND IFRS
F
ollowing the collapse of Enron Corporation in
late 2001, then others such as WorldCom, the
fabric of US statutory reporting was, for a time
at least, substantially discredited. The crisis has led
the US into a period of self-investigation and correction. The Sarbanes-Oxley Act was rushed into law in
2002, with far-reaching consequences for the regulation of securities issues, public auditing and the securities advising industry. Accounting reforms are coming along more slowly than that -albeit more rapidly
than usual - with regulatory agencies now mid-way
through a large program of changes.
During this time the International Accounting
Standards Board (IASB) has offered itself as the main
alternative for countries that wish to standardise their
accounting internationally, but no longer want US
GAAF’to be the means of standardisation. Already the
European Union (EU) has commenced a scheme
from 2005 to require all listed companies in member
countries to use the IASBs International Financial
Reporting Standards (IFRS) for consolidated statements. In addition, Australia, amid massive controversy, has been the first country with a history of accounting standard-making to announce that its companies will use IFRS for all statutory reporting purposes - single company as well as consolidated from the same date (Haswell and McKinnon 2003).
Recent surveys show that other countries are expected to follow (Ostling 2003).
The United States, however, may emerge from its
period of introspection to reassert its interests on the
revised world stage. How will a “reformed”US GAAF’
make its comeback? Would such a comeback be direct, or would it be in disguise, through US influence
on the IASB? In 2003 it was predicted that by 2005
“there will likely be only two accounting bodies with a
dominating influence on global reporting: FASB [US
Financial Accounting Standards Board] and the IASB”
(Barker 2003, p. 24). Supposing that such a truncation could be happening, one would wonder how the
rest of the world‘s accounting interests are expected
US accounting regulation has been
criticised for maintaining an overcomplex ccrules-based ” approach,
cited as the partial cause of
significant failures in covporate
governance. US regulators state that
they are now on a pathway to a more
“principles-based” approach, but the
International Accounting Standards
Board (LASB) claims superiority in
this approach already. The recent
efforts of the US Financial Accounting
Standards Board (FASB) and IASB
are examined to see if either claim is
clearly supportable. As these
authorities appear to be in the process
of creating a world accounting
standard-setting duopoly, unresolved
problems involving over-complexity
are likely to be transported to other
countries, including Australia.
AUSTRALIAN ACCOUNTING REVIEW VOL 16 NO. 2 2006
49
to squeeze themselves through such a formidable pair ing of recent accounting standards by both authoriof doorways.
ties, asks if there is clear evidence that either is comThe emerging duopoly of these two authorities is mitted to principles-based standard-making, and conevidenced both by the growing number of countries siders the apparent influences over these standardwhose own accounting regimes are influenced by US setters that may have been responsible for over-comGAAP or IFRS, and by the interaction of the FASB and pleXity problems.
IASB to mutually bolster their own power and influence. In Europe, for example, where
RULES, PRINCIPLES
before 2005 listed companies could
AND “PROGRESS” IN
choose broadly among GAAP to comTHE US
ply with EU protocols, US GAAP or
IFRS (or some permutation of these)
The popular depiction of a US “rules
based problem can be found in alwere chosen to the virtual exclusion
most innumerable journalistic, proof all other GAAF! In countries such
fessional and industry articles (for
as the UK and Japan there has been a
example, Heffes 2002, Mano and
considerable voluntary disclosure of
Mouritsen 2004, Ver Bokel 2004).
information in US GAAP or IFRS by
Common elements of this view can
large companies (Tarca 2004).
RENDERED
be
summarised as follows. During
The recent successes of the IASB
the
past three decades especially, US
and the problems aMicting US GAAP
AUDITORS
regulators
have stipulated a mass of
have meant a partial surrender of US
accounting
rules to coerce report
authorities. Historically, US regulapreparers so that they obey the actors had tried to influence or control
UNAB
counting requirements. The rules a p
the IASB without ceding any of their
proach tries to prevent manipulation
own authority; in effect they sought to
CHALLENGE THE by addressing every permutation of
have IFRS reinvented in the image of
circumstance that might lead to it.
US GAAP (Hopwood 1994, Flower
The
upshot, however, is a complex
1997, Zeff 1998). This no longer
VALDITYOF
and costly accounting bureaucracy,
seems to be the objective; now it
yet continued attempts at manipulaseems accepted that the two must be
tion, adversarial relations between
friendly, more equal rivals. In 2002
regulators and the corporate sector
the FASB and IASB announced a conand ever-increasing litigation. The
vergence project designed to minimass of expensive accounting reports
mise differences across a range of
produced
still failed to prevent comGAAP (FASB 2002). This may be
TIONS EVEN
panies such as Enron from grossly
seen as a symbiotic arrangement. For
manipulating their profits for years at
the US, convergence helps to restore
its legitimacy (see Fogarty 1992,
THEY DID a time. Indeed, technical compliance
with the rules rendered auditors unaBealing et al1996). The combined exble to challenge the validity of acpertise of these two great standardRE
counting
representations even when
makers can be seen at work, making
they
did
not represent underlying
repairs to problematic accounting areconomic
reality.
eas. For the IASB, convergence also
UNDE
In some quarters this view has p r e
helps to neutralise its rival. For other
pelled
anti-US sentiment to a new zecountries that seek harmonised
nith.
The
Sarbanes-Oxley Act, intendstandards, or do not have their own
ed
to
restore
confidence in US corpostandard-making, or are influenced to
rate governance, has had the reverse
use the standards of a powerful tradeffect for some, and is seen not only
ing partner, the net result will be less
as a descent into further rules-based
choice of GAAP overall. In this sense,
problems, but a descent that threatUS GAAP and IFRS are becoming an
accounting-standard duopoly. Supposing that stand- ens other countries - for example, “a backdoor atards are greatly improved by the emerging duopoly, all tempt to enmesh Europe in the morass of rules-based
will not be so bad for the rest of the world. Supposing legislation that the rest of the world sees as the root
the converse, however, then the consequences are cause of the US corporate governance and financial
very serious.
reporting problems” (Bruce 2003, p. 2). To what exNearly five years on from the accounting disasters tent is the infiltration threat of US “rules”grounded in
of 2001/2002, what can be said about the direction of reasoned argument?
progress of the FASB? Are the IASBs claims of supeAccounting rules are defined by Nelson (2003, p.
riority really justified? This paper considers the mak- 91) as “specific criteria, ‘bright line’ thresholds, exam-
TECHNICAL
WHEN
NOT
ECONOMIC
50
AUSTRALIAN ACCOUNTING REVIEW
ples, scope restrictions, exceptions, subsequent precedents, implementation guidance, etc.” This view of
rules is similarly depicted by Schipper (2003) and
Nobes (2005). Accounting principles are those which
lead to the satisfaction of definitions of financial reporting elements, such as asset, liability, profit, etc., in
the context of desirable financial reporting characteristics such as relevance, reliability and prudence
(Alexander 1999). Obviously these reporting element
definitions and the emphases on desired characteristics may vary according to each authority. Some locate
the definitions and characteristics in a single document, others do not. Requirements in the IASBs
Framework are different to the Australian Accounting
Standards Board’s (AASB’s) Statement of Accounting
ConceptsNo. 4 (the latter is now effectivelysuperseded by the Framework, except for its lingering argumentative value). US definitions and principles are
scattered throughout the standards and a conceptual
framework does not yet rank above or alongside
standards in the GAAF’ hierarchy.
To these observations one could add the following
statement about the relationship between principles
and rules. An accountingstandard’sapplicationshould
derive from its enunciated principled purpose, rather
than from a minutiae of rules, and the substance of
that purpose should prevail over its form, notwithstanding that some rules are necessary to help provide the form.
But what, if anything, is a “principles based” accounting regime? Schipper (2003) points out that a
mixture of principles and rules can be found in virtually all standards. Rules are necessary, according to
Nelson, to increase the accuracyof standards’requirements, although too many rules leads to “excessive
complexity and structuring of transactions” (Nelson
2003, p. 91). How many rules are too many? That the
US has too many is a belief echoed by academic writers and is usually a general sentiment rather than a
hard fact; or perhaps it is just self-evident.For example, Sunder (2002, p. 148) wrote: “After some 30 years
of writing, the accounting rules book has grown thick
with details to replace managerial and auditor judgment about fairness in financial statements. Instead of
writing a rule, which says ‘thou shalt not steal‘, the
FASB has wrapped itself up in the endless chase of
listing all the acts and circumstances that might constitute ‘stealing’. It is a losing game for rule writers.”
How many of the US standards have too many
rules? Few seem prepared to say for certain, although
almost everybody, including the staff of the Securities
and Exchange Commission (SEC), admits that there
is a problem (SEC 2003). There are studies that focus
on individual standards. For example, Nobes (2005)
identifies six FASB standards that have excessive
rules (leases, employee benefits, financial assets, government grants, subsidiaries, equity accounting).
Nobes argues that’some of the excessive or defective
rules exist because the standard “is based on a poor
principle or because it lacks principle” (2005, p. 16).
The list is not intended to be exhaustive and no such
list seems to exist. There certainly is no study that
ranks the world’s accounting regimes from most principled to least. The methodology required to test such
a nebulous ranking seems intimidating at best.
In the US, the SEC staff‘s study “On the Adoption
by the United States Financial Reporting System of a
Principles-Based Accounting System” (SEC 2003) is
the most comprehensiverecent attempt to distinguish
the extent of US rules-based standards. Ultimately it
falls short of that objective,but the study does provide
some useful criteria for being able to identifyproblematic rules-based standards.
SEC report on principles-basedaccounting
The study characterises rules-based standards in
terms of their shortcomings,which are, most signscantly,that they:
contain numerous bright-line tests, which ultimately can be misused by financial engineers as a
roadmap to comply with the letter, but not the
spirit, of the standards;
contain numerous exceptions to the principles
purportedly underlying the standards, resulting
in inconsistencies in accounting treatment of
transactions and events with similar economic
substance; and
further a need and demand for voluminously detailed implementationguidance on the application
of the standard, creating complexityin and uncertainty about the application of the standard (SEC
2003, p. 10).
In view of these shortcomings,the mandates of the
study were to investigate the extent to which principles-based accounting and financial reporting exists
in the US, and outline the means, and the time required, to change from a rules-based to a principlesbased system.
The study (p. 11) defines a principles-based accounting standard as one which “involves a concise
statement of substantive accounting principles where
the accounting objective has been incorporated as an
integral part of the standard and where few, if any, exceptions or internal inconsistencies are included in
the standard. Further, such a standard should provide
an appropriate amount of implementation guidance
given the nature of the class of transactions or events
and should be devoid of bright-liine tests. Finally, such
a standard should be consistentwith, and derive from,
a coherent conceptual framework of financial reporting.”The meaning of bright-line tests is clear enough;
these refer to rigid quantitative thresholds which slot
the accounting into one or another rule. An example
would be a test for 75%of the useful life of a leased asset, where life spans of 75%or above slot the accounting into a finance lease, or else into an operating lease
if below. But an “appropriate amount of guidance” is
not defined. Likewise, the degree of consistency with
a conceptualframework is a largely subjective matter.
However the study goes on to illustrate these criteria
AUSTRALIAN ACCOUNTING REVIEW
51
with examples of inappropriate levels of guidance and
of instances where a standard does not adhere to competent definitions of the elements of financial
statements.
The SEC study’s understanding of principles-based
standards is not necessarily the same as those of other
authorities. Because of this, the SEC study gave its
definition a unique label “objectivesbased standards”.
These may be distinguished from standards which are
principles-based but which give too little implementation guidance. “Principles-only standards typically require preparers and auditors to exercise judgment in
accounting for transactions and events without providing a sufficient structure to frame that judgment” (SEC
2003, p. 13). The SEC study’s desired standards are,
therefore, located on a spectrum between the extremes
of rules-based and principles-only standards.
The study gives examples along the spectrum of
standards. US standards that are “overly rules based”
include accounting for leases, for derivatives, for
stock-based compensation and for de-recognition of financial assets and liabilities (SEC 2003, pp. 21-22).
Nobes (2005) identified several rules-based standards
additional to this list. This indicates a certain amount
of subjectivity in the assessment of such lists, or else
the SEC study is more accommodating of rules than is
Nobes.
At the other extreme, the example given of principles-only accounting is the impairment of long-term
assets, where at one time there were insufficient
guidelines for determining the impairment (US GAAP
does not seem to lend itself to numerous examples of
principles-only standards). The principles-based
standard that comes closest to the SEC study’s ideal
of objectives-based standards is SFAS 141 Business
Combinations.This standard, released in June 2001, is
put forward as the hallmark of a more modern or progressive type of standard, which also includes SFAS
142 (intangible assets), SFAS 143 (asset retirement
obligations), SFAS 144 (impairment of long-lived assets) and SFAS 146 (exit or disposal activities) (SEC
2003, p. 23). The SEC study’s view is therefore that
standard-setters were already on the appropriate “objectives’’ or principles-based pathway, even before the
round of accounting disasters that began with Enron
at the end of 2001.
There are few concessions generally to the critics of
US GAAP. “In the staff‘sview, US GAAP, despite being
the historical product of a mixture of standard setting
approaches, constitutes the most complete and well
developed set of accounting standards in the world
(SEC 2003, p. 5). As to the extent to which principlesbased accounting and financial reporting exists, the
results are however, vague at best: “Many contend
that US GAAF’ provides an example of a rules-based
approach to standard setting. However, we do not fully
agree. While we agree that certain standards do suffer from the shortcomings of a rules-based approach,
many others are closer to the kind of principles-based
approach we prescribe herein” (p. 16).
52
AUSTRALIAN ACCOUNTING REVIEW
But no attempt is made by the SEC study to tabulate
the number of rules-based standards. In July 2004 the
FASB responded to the SEC study (FASB2004) in a
formal document that outlined broad agreement with
the SEC study’s findings. The FASB agreed with the
outlined ways to identify and move further toward objectives-oriented standards. These were summarised
by the FASB as follows:
1. The FASB should issue objectives oriented
standards.
2. The FASB should address deficiencies in the conceptual framework.
3. The FASB should be the only organisation setting
authoritative accounting guidance in the United
States.
4. The FASB should continue its convergence
efforts.
5. The FASB should work to redefine the GAAF’
hierarchy.
6. The FASB should increase access to authoritative
literature.
7. The FASB should perform a comprehensive review of its literature to identify standards that are
more rules-based and adopt a transition plan to
change those standards (FASB2004, p. 1).
There is no solid indication yet on the FASB website
of progress on point (7) above. The purpose of and extent of success in attaining the other objectives are examined during this paper.
Progress toward objectives-based standards
To determine if the standard-setter is really on a pathway to objectives-based standards, as claimed, it is
pertinent to examine recent FASB output. The SEC
study implies that the goal of objectives-based standard-making was well understood and accepted by the
FASB by 2001, as demonstrated by a string of successfully made pronouncements around that time, notably
SFAS 141 to 144 and 146. One would therefore expect
pronouncements issued after that string to continue
to demonstrate an appropriate degree of principlesbased attributes. Since SFAS 146 was published in
June 2002, a further 10 SFAS plus two interpretation
statements have been issued (to the time of writing,
January 2006). How well do these exhibit a sufficiently
principles-based approach?
Some of the SFAS statements amend earlier statements. In fact, these are the majority issued during
the past few years, namely SFAS 147,148,149 and 151
to 153. SFAS 148 and 149 are cited by the SEC study
but the later ones post-date the study. An amended
statement cannot be claimed as a principles-based improvement if its predecessor had a rules-based structure, unless the amendments substantially change
that structure. SFAS 148 amends an earlier statement
dealing with stock-based compensation (SFAS 123),
and SFAS 149 amends an earlier statement dealing
with derivatives and hedging (SFAS133). The amendments make some terminological, rule or disclosure
changes and clarifications, but leave the rules-based
structure of the earlier statements otherwise unchanged. Given that these two post-date the string of
objectives-based standards, the evidence is therefore
that in 2002 the FASB was still issuing statements of
mixed quality in the rules-principles spectrum, and
the SEC study seems to acknowledge this. To be fair,
it may have been the FASBs intention to overhaul
stock-based compensation and derivatives for principles-based repairs at a later time. All the same, we
should expect to see more appropriately principlesoriented standards issued from 2002 onwards.
SFAS 151, 152 and 153 are minor amendments of
earlier statements. These three were issued as part of
the IFRS convergence program; each contains just a
few pages that stipulate the changes. SFAS 151 contains some amendments to inventory recognition.
SFAS 152 concerns some amendments to real estate
time sharing, an obscure topic. Several of the amendment standards can be claimed as principles-based
improvements, but they are fairly minor improve
ments. SFAS 147 brings certain types of banking institution under the more principles-based SFAS 142.
SFAS 153 replaces a rules-based exception for recognition of non-monetaryassets.
The standards that are “new”or complete replacements rather than amendment standards are, in order,
SFAS 150, 132,123 (these last two are reissued without new numbering) and 154. SFAS 150 revises and
codifies recognition requirements for financial instruments which have the characteristicsof asset and liability. Industry commentators have labelled the new
standard exceptionally complex (Romanek 2004) ;
however, complaintsby users have led to an apparently indefinite deferral of its provisions for most affected
financial instruments (Sibelman 2005). There is no
mention of SFAS 150 in the SEC study. Perhaps it was
issued too late to be included (May 2003). SFAS 132,
reissued in December 2003, makes additional disclosure requirements about pensions. The commentaries in this statement make no mention of the rulesprinciples debates.
SFAS 123 Share-Based Payment was reissued in
December 2004. The original statement (issued in
1995) had alternative measurement methods and vcluminousguidance that led to “disjointed,rules-based
and form driven” accounting (SFAS 123, B7). The reissued standard has removed the option of footnote
only disclosure and it prescribes a single fair value
measure for recognising share options. In these r e
spects the standard has progressed toward principlesbased accounting. But there is still voluminous guidance. This statement, including implementation guidance, is 143 pages long in the downloadable PDF version. This total does not include an appendix describ
ing the basis for conclusions and other background
information,which may be necessary to help decipher
the standard. Although the fair-value estimation of
share options is by no means an easy topic, it is hard
to describe this implementation material as anythiig
other than voluminous and exceptionally complex.
SFAS 154, issued under the IFRS convergence program, is relatively brief and concerns accounting
changes and error corrections.
More controversialthan any of the FAS statements,
however, is one of the two recent FASB interpretations. The most serious counter-instance of progress
toward principles is surely the publication in early
2003 of FIN 46 (Interpretation No. 46 of Accounting
Research Bulletin ARB 51; the latter is a professionalbody pronouncement with de fact0 accounting standard status in the GAAP hierarchy). FIN 46 is a product
of the debates surrounding Enron and other companies that abused loopholes in the consolidation rules
for special purpose entities (SPEs) (Froud et a1 2004).
The objective of FIN 46 is to iden@ and require consolidation of “variable interests,” a new jargon term
meaning particular SPEs controlled by means other
than majority voting. The abuse itself stemmed from
interpretations by report preparers of requirements
that surrounded ARB 51. The latter is an old (1959)
standard, still current, which briefly outlies the basic
requirement of business combination and consolidation but gives scant detail. Far from being a principles
solution, FIN 46 is a sudden return to extreme rules,
with 90 pages of densely argued definitions, bright
lines and complicated tests for characteristicsand exceptions. FIN 46 was almost universally reviled by the
business and professional community for its excessive rules and complexity, which many find near incomprehensible. One industry commentator, referring to the circular logic of its characteristic tests,
called FIN 46 “a conundrum wrapped in a puzzle”
(Strauss 2003, p. 1). According to ratings agency
Standard and Poor’s, “the majority of securitization
professionals worldwide report that they are overwhelmingly frustrated, skeptical and confused by the
new set of rules” (quoted in Kothari 2003, p. 7).
Sometimes, industry leaders have a self-serving o b
jection to new rules, but on this occasion their comments seem justified. The FASB itself, meanwhile, is
experiencing difficultieswith compliance. FIN 46 had
to be substantially revised withii a year of its issue,
because certain provisions ”were not being interpreted as the Board intended” (FIN 46, p. 41). Although
SFAS 141 may have scored well on the rules-principles assessment, FIN 46, a pronouncement made
more recently and also related to business combmations, surely scores at the opposite extreme. FIN 46 is
mentioned in a footnote to the SEC study but is not
cited as an example of a rules-based pronouncement
This omission is questionable. Perhaps FIN 46 was
too embarrassing to cite, especially in view of its timing, issued well after the string of objectives-based
standards around 2001 that were supposed to have
ushered in a new era.
In summary, FASB products issued since SFAS 146
show mixed results.There is some evidence of streamlining, s i m p m g and removal of exceptions; these
represent improvements toward appropriately principles-based or “objectives”-basedaccounting. But the
AUSTRALIAN ACCOUNTING REVIEW
53
contrary evidence is perhaps stronger, with many
products demonstrating a rules-principles status quo
or a deterioration back toward rules. SFAS 148 and
149 have not changed their predecessor’s rules-based
structure and SFAS 123 is still extremely voluminous.
SFAS 150 and FIN 46, new products rather than reissues, have both been labelled as complex and difficult
to interpret; FIN 46 seems exceptionally disappointing and highlights the difficulties US authorities are
having in moving away from established approaches
when dealing with emergent accounting abuses. Later
it will be argued that in some respects the aftermath of
the accounting scandals may have blocked rather than
encouraged progress toward principles-based accounting. Is SFAS 141 or FIN 46 more representative
of the US direction of travel in the rules-principles
spectrum? Perhaps this question is difficult to answer
in a long-term context, but one can say that US authorities are still producing standards of greatly varying complexity and competence.
OVER-COMPLEX RULES IN IFRS
IASB chairman Sir David Tweedie was reported as
claiming that the Enron scandal would not have h a p
pened under the more principles-based IFRS (Tweedie
2002). The standards most highly touted as superior
were those most associated with the scandal, namely
the consolidation and related standards. Certainly it
can be argued that IAS 27 provides clearer guidance,
in which the principle of control obviates many of the
bright line and exception ambiguities of the ARB 51
constellation. (The designation “IAS”,for International
Accounting Standard, is still used for standards issued
before a constitutional revamp of the IASB in 2001.
IFRS is the term for standards issued since and also
the generic term.) Hypothetically, if US report preparers were to have worked under IAS 27, and complied
with its spirit, some of the 2001-02 episodes of accounting malfeasance may have been avoided. The
trouble with this argument is that only some of the
Enron accounting practices were inspired by grey areas in the accounting standards. Others were flagrantly illegal (Benston and Hartgraves 2002) and it is hard
to legislate against a culture of corporate criminality,
when from time to time this arises.
The IASB has marketed its products on the basis
that they are in a continual state of further improvement. When Australia announced its 2005 adoption, it
did so on the basis that many 2002 IFRS would be
changed before implementation day. Australian authorities clearly hoped, but did not know for certain,
that IFRS improvements would proceed in a direction
desirable to them (Haswell and McKinnon 2003).
Similarly, the 2002 Norwalk agreement saw US authorities and the IASB agree to be more closely involved in convergence of standards (Stock 2002).
Since 2001, as a result, IFRS have not stood still, but
are continually under refinement. Unlike the FASB
standards, most IFRS have received revisions during
the past five years. How is the IASB “superiority”
54
AUSTRALIAN ACCOUNTING REVIEW
claim holding up? It would require a large paper on its
own to examine all of the revised IFRS to assess their
extent of principles and rules, but a selection of the
important standards can usefully compare with the
FASB ones. The objective here is not to compare the
IFRS with corresponding SFAS point for point; such
an exercise would not be valid because the revision of
standards has not always occurred in a comparable
time frame. The objective instead is to examine IFRS
to see if they contain rules-based deficiencies to an
extent that might cast doubt on the “superiority”
claim. Are there IFRS problems similar to FIN 46?
There are. IAS39 was first issued in December 1998
and prescribes accounting for financial instruments.
Controversies and problems have caused numerous
amendments and reissues to IAS 39, in March and
October 2000, December 2003, March and December
2004 and April and June 2005. The standard is exceedingly complex by any measure. Raw length is usually
only a vague guide to complexity but is noteworthy in
this case. The standard and implementation guidance
(released in a separate file) run to 280 pages. This total does not include the basis for conclusions. FASB’s
SFAS 133 on financial instruments, though also considered excessively voluminous, has merely 117pages
including appendices other than the basis for conclusions. Because IAS 39 contains additional recognition
requirements and applies to a broader range of circumstances (Togher 2003), many commentators have
judged it even more difficult to interpret than SFAS
133;comments are common along the lines that “IAS
39 is by far the most complex accounting standard
that has ever been introduced (Beasley-Murray 2003,
p. 1). There is a certain amount of polemical content
in some of these statements. European commentators
are often aligned with interest groups who dislike the
profit volatility produced by financial instruments
measured at fair value under IAS 39 (Guerrera and
Parker 2003). These conflicts have partly inspired the
numerous amendments, some of which are attempts
at compromise or mollification of the Europeans. All
the same, the IASB has come under heavy criticism
from industry groups for the degree of resources required to obtain compliance (Damant 2003). Perhaps
the most telling admission comes from IASB chairmanTweedie himself, who needed to say in September
2004 ‘The IASB wants to find a better accounting solution for financial instruments that will produce
meaningful results without undue complexity and dependence on detailed rules, but experience shows
that an ideal solution will take several years to develop” (Tweedie 2004, p. 5).
In other words, the IASB has produced a voluminous rules-based standard of the type that had been
scorned as a defective US product.
There are other examples. IAS 36 Impairment of
Assets comes with an abstruse system for estimating
recoverable amount of assets based on the greater of
fair value less cost to sell and the present value of discounted future cashflows. There is an extremely
vague prescription for allocating goodwill to cash-generating units, indicating poorly developed principles.
Once again the amount of accounting resources necessary to try to determine these allocations will certainly be very challengingto report preparers. IFRS 2
Share Based Payment is of a similar level of complexity
to SFAS 123 and is surrounded by much the same
controversies, especially over the choice of technique
necessary to estimate the cost to the company of
share options distributed to executives; and the accompanying voluminous guidance (McLannahan and
Schneider 2 W ) .
Perhaps the most glaring complexity problem
though is not a new standard but one that has been
around since the 1980s: tax-effect accounting (IAS
12). This accounting technique has been heavily criticised by academicsfor its arcane, perhaps even meaningless calculations (Chambers 1968), but is widely
favoured by industry for its profit-smoothing abilities
(Gibson 1984, Gupta 1995). Tax-effect accounting did
not figure in the recent debates over the accounting
scandals because it was not directly implicated in that
round of corporate abuses. Tax-effect is, all the same,
a major source of unnecessary complexity (Ward
1996). This technique originated in the United States
(Schultz and Johnson 1998) and, whether by US influence or convergent evolution (pressure from corporations), found its way into IFRS. There does not seem
to have been much resistance to it from IASB
ideologues.
As Nobes (2005) said, if the standard is based on
defective principles, its rules will be defective too. An
example of such drafting defects is IAS 1 Presentation
of Financial Statements, reissued in 2003. Standardsetters generally have had trouble pinning down the
terms and inclusions for revenue and expense, but
IAS 1 does not seem to be a step forward. Partly this
is due to the muddled definitions of elements contained in the IASBs Framework, which have transferred to the financial statements standard.There are
five terms for the P&L elements: income, revenue, expense, gain and loss. “Income and expense” seems to
be a summary term that subsumes all five, but income, revenue and gain are not clearly distinguished,
nor are expense and loss. Revenues are vaguely described as attaching to ordinary activities, which are
not defined, and gains may be non-ordinary, but exceptions are allowed in any case. Expenses and losses
have the same problem. The “income”statement does
not produce an amount called income. Instead the
amount is profit or loss for period. Direct debits and
credits allowed by other accounting standards are not
included in the income statement but are spread to a
secondary statement. This latter has been a common
problem but IAS 1 makes no inroads into principled
definitions affecting direct debit and credit items or
the problem of reporting comprehensiveincome.
Country users of IFRS have found that problems
are compounded when refinements are made during
the adoption process. AASB 101, the new Australian
equivalent of IAS 1, is more uncertain in its classifications than any recent Australian predecessor. The
AASB has acceded to the element definitions, but
seems to have baulked at some aspects of the secondary statement. The AASB was forced to provide dual
names for it in a last-minute change to the standard (in
December 2004). Depending on presentation, the
statement is called “recognised income and expense”
or “statement of changes in equity“, presumably b e
cause the original name (the latter) made no sense in
that it did not necessarily detail equity changes at all,
if they are presented as notes to the statements (an allowable option).
In summary, classification ambiguities among
terms and the spreading of income amounts across
two statements makes the reporting of these amounts
a malleable and confusing product. IAS 1 is suffering
from a lack of clearly defined principles, namely the
definitionsof financial reporting elements.
While the above analyses of IFRS are not intended
to be exhaustive they show that many problems of
overcomplexity and poorly defined principles exist
within IFRS analogous to problematic SFAS. Recently
the European Financial Reporting Advisory Group
(EFRAG) wrote to the IASC Foundation (the governing body of the IASB) to complainof the IASBs recent
products: “The standards issued by the IASB have become increasingly complex, more voluminous and
more prescriptive as to details, and we shall therefore
urge the Trustees to work for simpler and more understandable standards that can be implemented in
practice in regions where the adoption of IFRSs is a
giant step” (EFRAG 2005, Appendix 1).
One would need to be very cautious before attempting to make a sweeping claim that IFRS were “superior” to US GAAP in the principles-rulesdebate. In fact,
both sets of GAAP continue to exhibit serious problems in their recent pronouncements.
ANYTHING UNIQUE ABOUT
US GAAP?
Although quality differences between US GAAP and
other Anglo GAAP such as IFRS seem exaggerated
for political purposes, there is one facet of the US environment that does seem remarkable. This is the extraordinary state of confusion that surrounds the
GAAP hierarchy itself. Authorities allow the simultaneous existence of numerous competing “accounting
standard”documents. It is not always clear how these
documents are to be ranked or interpreted. A recent
exposure draft proposes a new FASB standard to deal
with GAAP hierarchy. The exposure draft highlights
defects in the present hierarchy, including the level of
complexity (ED 28 April 2005, p. 4).
Example of GAAP hierarchy complex&
business combinations
ARB 51, a pronouncement of the American Institute of
Certified Public Accountants (AICPA), was published
in 1959. The statement,which followed two and a half
AUSTRALIAN ACCOUNTING REVIEW
55
years from the issue of ARB 48 Business Combinations,
is an early attempt to provide guidance on the circumstances requiring consolidated reports. ARB 51 is a
brief document and its theoretical principle or objective is not clear. Mention is made of a control basis but
para. 2 confuses this by stating that, while there are
exceptions, “as a rule ownership by one company, directly or indirectly, of over 50%of the outstanding voting shares of another company is a condition pointing
toward consolidation”. The statement also details the
mechanics of consolidation, the elimination of intercompany sales, etc. Later standard-setters adopted
ARB 51 as part of official GAAP. Rather than update
the statement itself periodically, ARB 51 was allowed
to remain in situ and its unexplored facets were presented in later additional documents, now spanning
more than 40 years. The exceptions to majority ownership are not explained in ARB 51. Some exceptions
are removed by SFAS 94, but the failure to deal with
exceptions in principle is partly what led to some of
the Enron and related abuses (Benston and Hartgraves
2002). Some, but not all, SPE requirements are treated
separately in SFAS 140; FIN 46 is an attempt to plug its
loopholes. There is also Regulation S X to the 1934
Securities Act, published by the SEC, which adds another layer of requirements to the consolidated reports. Standards dealing with “business combinations” developed separately from ARB 51. SFAS 141,
the present business combinations standard, depicts
when a business combination has occurred and how
the cost of the acquired entity is recognised. Despite
its intention to be an over-arching standard (ie, to
make consolidations conceptually a subset of business combination protocols) there is a crucial deficiency: SFAS 141 does not have its own definition of
control. In principle, a business combination occurs
when “an entity acquires net assets that constitute a
business or acquires equity interests of one or more
other entities and obtains control over that entity or
entities (SFAS 141, para. 9). For “control”, SFAS 141
refers back to ARB 51, meaning majority ownership
with exceptions, as interpreted by a large set of other
documents. In effect there is a confusing conceptual
overlap between ARB 51 and SFAS 141. This weakens
SFAS 141 greatly and enjoins it in a circular fashion
with the other constellation of standards that try to interpret which entities must be combined and their financial reports consolidated.
Moreover, these pronouncements link together in a
complicated way. New documents often do not M y
supersede old ones but instead refer back to them in
piecemeal fashion. They cross-reference each other in
a sophistic way and, to add nuance in specific situations, further refer to a maze of other documents Emerging Issues Task Force (EITF) statements, technical bulletins, AICPA industry guides, practice bulletins, etc. Most countries’ accounting regimes have
more than one type of standards document but in the
US the degree of cross-referencing, interweaving and
lack of definite conclusions within and among old and
56
AUSTRALIAN ACCOUNTING REVIEW
new documents could be fairly described as Byzantine.
In effect, the use of these documents is governed by a
ponderous common law system, one taken to its nth
degree of complexity. Which documents and interpretations take precedence over which other? The student of accounting who desires a fast answer to this
will be sorely disappointed. Although the FASB has
recently begun to publish its standards free of charge
on the Internet (disappointingly the IASB still does
not), for many standards, including business combinations, understanding GAAP is the province of specially trained accounting lawyers, each of whose opinion may differ, and who are likely to provide that opinion only for a fee. It seems hardly surprising that US
report preparers find themselves embroiled so often
in litigation or confrontation with government authorities. To an extent these interpretive problems can be
found in any country. But the author can not cite another country where the interpretation of accounting
standards has become more embroiled in a “common
law” manner of adversarial complexity. It is this multidocument complexity which partly explains the degree of muddle within the standards themselves.
When US GAAP documents are exported abroad, for
example when the contents are adopted as part of
IFRS, and then by other countries such as Australia,
this muddle is exported too.
Under the piecemeal approach of US standard-making, consolidated accounts and business combinations
became artificially separated, possibly not because of
any conscious or planned reasoning, but simply due to
the ad hoc developments of standards beginning, in
this case, in the 1950s. Almost certainly due to US influence, the IASB equivalents are similarly separated
(presently under IAS 27 and IFRS 3, which are roughly analogous in purpose, if not in detail, to ARB 51 and
SFAS 141). In turn, these have led to similar separate
Australian standards under its new regime. One could
argue that this is a backwards step.
Recently the FASB and IASB have issued exposure
drafts that propose to converge business combinations. Exposure drafts issued by the FASB on 30 June
2005 propose replacements for SFAS 141 and ARB 51.
The proposals still do not consider a principled, control-based definition of a business combination. The
IASB meanwhile has proposed in its exposure draft an
almost word-for-word duplication of SFAS 141 to replace IFRS 3. They seem to have baulked, however, at
being dragged into the ARB 51 scheme: principlesbased control is retained in proposed changes to IAS
27. So despite the attempted convergence, the basis
for establishing control in business combinations will
still be different for US GAAP and IFRS.
There is, of course, much else in the proposed
standard, which details for example how the cost of a
business combination will be measured. The latter aspects may be converged between US GAAP and IFRS.
Nonetheless, how this strange set of mix-and-match
standard-making will appeal to report users or country adopters of IFRS, if approved, is yet to be seen.
The proposed SFAS 141 seems to have its internal
logic still rooted in disjointed US GAAP protocols.
Although the latter should be of no relevance to IFRS,
the IASB has acquiesced to a standard whose chief
modus ofierandi is muddled by US GAAP protocols
and is less clear than the one presently existing. For
their part, US regulators have been unable to much
improve upon the basic problem: multiplicity of documents that require elaborate interpretation and have
inconsistent or unclear principles.
These difficulties faced by the present FASB are
consistent with problematic tendencies that have underlain US accounting bureaucracies for decades. In
1974 William A Paton wrote: The APB made considerable progress in the direction of entwining the CPA
in a network of prescribed, rigid 'principles' and proce
dures, and I'm fearful that the new FASB will endeavor
to finish the job of hogtieing us" (Paton 1974, p. 23).
NEW
OR
REPEATING ITSELF?
relations claims to the contrary, recent serious instances of standards still being made with -Doorlv
- described principles and/or excessive, overcomplex
rules. Are recent events responsible for these, or to
what extent are they reinventions of old problems?
There are numerous possible reasons why these bureaucraciesstill seem to be prone to over-blown standard-making. Mostly their internal workings are
opaque, which leads to a certain amount of guesswork
about motives and processes.
I
Political emergencies
Both FIN 46 and IAS 39 are reminiscent of the historical perspective noted by Watts and Zimmerman
(1979), who point out that major accounting changes
often arise opportunisticallyin the aftermath of political scandals. Indeed the whole edifice of the 1933-34
securitiesacts, upon which much of US corporate governance is still based, was a political brush-fire solution that followed the corporate collapses that came
with the 1929 stockmarket crash (Watts and
Zimmerman 1979, p. 297). FIN 46 seems to be a recent chapter in this tradition. One can observe a d e
gree of panic by the FASB. The accounting scandals
created an urgent need for remedial action, or certainly for something to be seen to be done. When confronted with a massive corporate complianceproblem,
the FASB seems to have reverted to its older groove
to produce a massively overcomplex and adversarial
solution. IAS 39 is surrounded by some of the same
characteristics. Financial instruments were heavily
implicated in the recent accounting scandals (Froud
et a1 2004) and the development of this standard can
be seen as an attempt to enhance the credibility of
IFRS. Once begun, the standard-setting process itself
seems to have taken on a life of its own. Standards
mooted by political emergency can quickly be taken
over by a standards bureaucracy and be turned into a
technical exercise of ever-increasing complexity.
Politics and compromise thereafter continue to muddy the original objectives, as evidenced by the IASBs
continual amendments to IAS 39.
Lobbying by report preparers
Bealing et a1 (1996, p. 334) state that regulators have a
long history of attemptingto legitimise their activities,
while in effect regulatory efforts are a series of compromises resultingfrom interactionswith constituents
and regulatees. According to Watts and Zimmerman
(1978) corporate lobbyists demand of regulators accounting standards that suit their purposes, but these
demands and purposes vary from one company to another. Regulators comply with lobbying when it is in
their interests to do so (Watts and Zimmerman 1979)
but are pulled in different directions by the lobbyists
(Fogarty 1992, p. 337). The result is accounting standards that lack coherence or rigorous principles and
have too many choices. All this is a likely partial explanation, for example, for IAS 1, which exhibits loose
terminology and exceptions that may have their gene
CONCLUSION: THE "JSPORT
O F OVER-COMPLEXITY
What are the dangers of the emerging USIASB duopoly?Whiie the US has the largest facilitiesand tradition for research into standard-making, it also has a
history of producing too many standards that are
rules-based and overcomplex. This partly derives
from the sheer complexityof US capital markets -for
example, their elaborate use of financial instruments.
There are also less benign explanations: the US accounting regulatory bureaucracy may have a vested
interest in mainlining complex systems to justify its
own continued existence at a high level of importance
and financial benefit (Willmott 1986, Fogarty 1992).
To this must be added the muddling effect of corporate lobbyists, who have conflicting demands on different accounting rules and whose insistences are
partly successful. This is set upon the backdrop of a
dual ideology which has free enterprise as its prime
directive but has bureaucratic control as a strong undercurrent, especially when faced by political emergencies. The net effect of all of this can be seen in certain rules-based standards but is most clearly o b
served in the controllingcomplexity of US GAAP protocol, with its multiplicity of documents, ponderous
framework of interpretation and common law manner
of adversarialcomplexity.
Although in individual standards there was evidence around 2001 of improvements toward principles-based accounting,there is perhaps greater recent
evidence of a stagnation or difficulty in moving away
from overcomplexity, as evidenced by rules-based
pronouncements like SFAS 150 and FIN 46. There is
also a lack of adequate repairs to the overcomplicated
GAAP protocols. Proposed further changes to business combinations standards only demonstrate the
AUSTRALIAN ACCOUNTING REVIEW
57
stagnation. Although exposure drafts for replacements to SFAS 141 and ARE3 51 may show evidence of
improvement in some of the standards’ details, they
will do little to improve the GAAP protocol problems
centred in the multiplicity of documents. Although the
latter might seem to be largely US problems, they can
also be transported abroad, because overcomplex
GAAP logic is embedded in the standards in the form
of unclear principles and overcomplex rules. Other
countries under pressure to harmonise may either
adopt the US standards directly, with the problems attached, or adopt them through US influence over
IFRS. The recent IASB exposure drafts on business
combinations demonstrate the transport of this complexity. The IASB proposes an equivalent of SFAS 141
even though its principles for the control basis of business combinations are less clear than those of the
IFRS incumbent. Perhaps this should be no surprise.
Although the FASB and IASB have been depicted as
adversaries for several decades, the IASB has often
adopted questionable US practices, for example, taxeffect accounting. This looks set to continue.
Notwithstanding US influences, the IASB’s claims
of superiority in principles-based accounting may not
hold up anyway. The IASB has manufactured its own
rules-based problems as evidenced, for example, by
IAS 39. In the long run can we really expect the IASB
to have a greatly different behavioural formula from
the FASB? The IASB is subject to similar bureaucratic
pressures and these can only increase as the IASB increases in size, power and prestige. corporate lobbyists, too, may simply switch their attentions to the u p
andcoming standards authority, thus increasing the
likelihood of confused principles. How really “independent” is the IASB? The direct influence on the
IASB of US accounting regulators is obviously very
large. These and lobbyists of the largest corporations
may seek to dominate the IASB agenda. Regulators of
other countries may struggle to be heard.
It is also true that any country could suffer similar
bureaucratic pressures and lobbying influences on
standard-making as do the FASB and IASB. Australia,
which had a history of its own standard-making, was
not without incidents that led observers to believe
that on some accounting topics standard-setters were
“captured” by the people they were supposed to be
regulating (Walker 1987). However, the concentration
of power in two main authorities, FASB and IASB, removes much of other countries’ abilities to remedy
these situations by their own political mechanisms.
Countries that seek to adopt IFRS for harmonisation purposes run the risk of being inundated with
standards that are political compromises fought out in
an arena far away and with no particular connection to
their own priorities. Australia is the obvious example,
having all but ceded its accounting standard-making
to the IASB. While the Australian Accounting
Standards Board (AASB) remains, its role seems now
little more than to make minor adjustments to the imported IFRS, which are re-labelled as Australian stand58
AUSTRALIAN ACCOUNTING REVIEW
ards. Some minor tinkering has been exhibited, for
example the AASBs refusal to allow the notion of
“temporary control” in the business combinations
standard AASB 3. But standards of unnecessary complexity and/or poorly devised principles have been
imported virtually intact, for example IAS 1 and IAS
39, which are re-labelled as AASB 101 and AASB 139;
and perhaps most significantly of all, the tax-effect accounting standard AASB 112.
Country users of IFRS will need to be especially vigilant that standard-making continues to improve rather than slide backwards. It is probably too soon to
forecast the shape of IFRS in its potential long-term
steady state, but some of the events of the past several
years are not very encouraging. The ultimate sanction
would be to opt out of IFRS adoption. This would be a
major setback for harmonisation but would be a necessary last resort.
Stephen Haswell CPA is a senior lecturer in Accounting
at Macquarie University. He thanks Neil Fargher, Ian
Langfield-Smith, Jill McKinnon, Mike Page and two
anonymous refereesfor their helpful comments.
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