One Size Does Not Fit All: The Case Against Global Accounting Standards

0:00Well, I'm back again, a second year to talk about accounting. Isn't this amazing? Accounting, a hot topic. You know, most of my colleagues became accountants because they couldn't stand the raw excitement of actuarial work. And I promise you that if CPAs had been running the country 234 years ago we'd still be working for the king. There's libertarian, there's conservative and then there's head in the mud. Two nights ago I was in Montgomery, it rains there too, and have you seen this ad? I saw it on Fox, it's a BDO, BDO Seedman, 8th or 9th biggest accounting firm in the country, talking about GAAP and IFRS, I was probably the only viewer who understood what they were talking about, but it was interesting to me that it was such a topic that they felt compelled to put it on TV.

1:15In the age of Obama, it's probably not surprising that we should have a push towards more central planning, something bigger, etc. Unfortunately, the Obama administration is picking up where the Bush administration left off. The global public accounting firms, the big four, I call them the four, you can think of another word that rhymes with four, have been pushing for a shift to international financial reporting standards for about a decade now.

2:02And they mask their advocacy and comparability across countries of financial reporting. And like the UN, it sounds like a really wonderful idea, unlike the UN, this is not just about talk. It's arguably more important than that and has, I think, some implications for the standards of living here in the United States that should concern all of us. First, why not international reporting standards? Wouldn't it increase market efficiency and presumably consumer surplus? Wouldn't the cost of capital go down? Wouldn't our standard of living go up? You know? Answers. 20. No, no, and no. Spontaneous order and accounting The Financial Accounting Standards Board is the arbiter of generally accepted accounting principles in the United States.

3:19It's a non-government agency. It's funded by the privately funded Financial Accounting Foundation. Frasbie in mid-2009 decided to take their 168 statements and codify them, put them all in one big document, and just an example of, here are just two of 168, there's 279 pages, 245. If you ever have trouble sleeping, if my writing doesn't do it, try this. What did I do, Peter, where did it go?

4:06There's a button on the bottom that says try that one. Ah, thank you. Mechanical devices baffling. Anyway, in addition to the 168 statements there, 46 FASB staff interpretations, 81 FASB have position memoranda, technical bulletins, topic pronouncements, and something called the EITF, the Emerging Issues Task Force which is composed of really, really smart people with way too much time on their hands. And ASB itself is, they have 67 employees there including the five members of the board itself and they're a really, really bright bunch of people. The Securities and Exchange Commission in this country has statutory authority under the 34th SEC Act to set accounting standards.

5:04From the beginning, the SEC has deferred to the private sector. The FASB's predecessor was the Accounting Principles Board. It went out in 1973. FASB has been there ever since. For some reason, among his many shortcomings, Chris Cox really got to be in his bonnet for IFRS. Cynics might speculate, well, maybe it had something to do with post-administration employment. Heaven forbid anybody would ever think of doing something like that. But anyway, in August of 2008, barely just under five months before he left office, his These people put out something called the Eifers Roadmap, and they did that of course while they slept soundly through the Madoff heist, having been warned by Harry Markopolos up in Boston since 1999, repeated written warnings from him about the fraud that Madoff was perpetrating.

6:10Mary Shapiro, arguably a better choice than Cox, despite the person who chose her, faced a dilemma to appoint the position of chief accountant at the SEC. This is the most powerful accounting position in the world and it's probably the most powerful position you've never heard of. But her choices essentially boiled down to, there were two finalists, Jim Croker, a former big four guy, and Jack Cezelski of Baltimore, who for 30 years has published the Accounting Analyst Observer, a high dollar newsletter for corporate clients about the intricacies of Gap. And the Big Four, of course, were singularly lined up behind Croker because they knew he would be their Cody and their water carrier. The civilized world was lined up behind Cezelski, including yours truly. And to paraphrase Lloyd Benson in 1988, you I know Jax Zazelsky. I've worked with Jax Zazelsky. Jax Zazelsky is a friend of mine, and Jim Croker is no Jax Zazelsky.

7:45Unfortunately, Shapiro chose Croker, which I guess proves Everett Dirksen's old admonition, She dithered for six months before she chose Croker. What do Obamacare and IFRS have in common? They're both what Hayek called made order, top-down order as opposed to grown order.

8:33In the road to serfdom, any international economic authority not subject to a superior political power, even if strictly confined to a particular field, was he thinking about could easily exercise the most tyrannical and irresponsible power imaginable, etc. We all know that centralization is bad stuff. History shows that centralization doesn't work, yet powers that be persist. We have examples all over the place, both historically and even currently. Yours is administered by the International Accounting Standards Board, which is based in London. IASB is to financial reporting, as the UN is to diplomacy, draw your own conclusions from that one.

9:23The IASB has a parent, the International Accounting Standards Committee Foundation, which is funded by listed and unlisted companies from around the world. The aim is to have it funded in rough proportion to each country's relative share of world GDP, which in 2009 is estimated to be $57.5 trillion, the five biggest contributors, holding about 52% U.S., Japan, China, Germany, and France in that order. The U.S. is at about 25% with over $14 trillion, even in a down GDP year as 2009 was. IASB has 15 board members, six from the UK, four from the United States, three from Asia, one each from Africa and South America, currently Brazil.

10:19These 15 board members, in turn, are appointed by a 22 member, and I'm doing this, not trying to get too far in the weeds, but just to show you just how opaque this process is. 22-member IASCF board, which in turn is overseen, I'm not making this up, by a monitoring board comprised of one member each from the European Commission, which is the Society of Securities Regulators over in Europe, the Japan Financial Services Agency, the US SEC, and then committees from IOSCO, which is, I've even forgotten what that stands for, the international, I mean it is so, there it is, the International Organization of Securities Commissions. So So we have this kind of a bureaucratic hierarchy, and having been tyrannized by a government agency, the Roanoke City Airport, two days ago, and I'm still grinding my teeth over that one, I can only imagine what this layering could do if it had authority here in the United States.

11:44As you can see, we have one vote on this monitoring board, one designated vote, one designated vote. As it happens, the member from the technical committee of IOSCO now is also from the United States. IASB Resources, it's a small, small agency, has a long tradition on any complex accounting question of, let's go ask FASB. IASB is trying to ramp up but it's going to take years, literally years, for IASB to have the reliable processes and routines in place that FASB has and I'm not especially a great admirer of FASB but it's kind of like favoring negligent homicide over murder one but it's is certainly better than something remote and totally unaccountable.

12:47PricewaterhouseCoopers publishes every year a kind of a dictionary of gap and eifers differences. That publication runs 220 pages right now. There are significant differences. They include stock options, which can be and was for the late 90s, early 2000s, a very hot topic. Evaluation of long-lived assets, you know, they get to mark these things to market up and down, more volatility, more risk in markets. But most important where the United States is concerned is inventory valuation. There is something called last in, first out. And in periods of inflation, when prices are rising, you want the cost of what you sold to be as high as possible in order to keep your taxes down.

13:39In the United States, that is legitimate. It is acceptable for generally accepted accounting principles. And right now, it has kept 59.1 billion in revenue from the federal budget, which we know they would spend it wisely. We were never so sure of anything in our entire lives. President Obama, of course, wants to repeal LIFO to get the $59 billion. In addition, there has long been a controversy between advocates of one set of financial standards and advocates of what are called big gap, little gap. Let's have a little version of financial reporting standards for smaller companies, particularly non-public companies, they shouldn't have to go through all the other hoops that everybody has to go through. And on the surface, you know, like IFRS, this sounds good. But ask a banker. You really want two sets of financial standards. Isn't one of these things tough enough? You can imagine, again, conversion costs, which mean lots of consulting fees for the big accounting firms and for not so big accounting firms. You can imagine the

14:59The additional training for accountants, the American Institute of CPAs for years pushed what's called the 150-hour rule. So CPAs now have to have 150 semester hours of credit, which equals about five years. Only a bunch of accountants could have been surprised when the barriers to entry went up and the number of entrants went down. and of course the AICPA was horrified when the number of people enrolled in accounting programs declined. If you do the cost benefit on that extra year of education, it's frankly not worth it. The opportunity cost is just horrific. But there are accounts. As I said, oh and where's the line between big and not big? That's another one. Nobody's quite determined and that one yet. But if accounting fees are high now, the one thing we can be sure of is that they will go higher if there are two sets. In shameless pandering to the small business crowd in mid-2009, the IASB issued a little Eifers brand. We have other issues.

16:17Some people say, well, if Eifers had been in place, we would have never had the meltdown in the United States, hogwash, didn't stop it from hitting Europe. We know what caused the belt down. It began with pressure over many years to relax mortgage lending standards as our own Tom Woods has amply documented and Stan Lebowitz did in a paper for the Independent Institute in 2008. There's the issue of culture and comparability. I have a quote here from Thomas Sowell, his wonderful book, Migration and Culture. Cultures differ in their relative significance. They attach to time, noise, safety, cleanliness, violence, thrift, intellect, sex, and art. These differences make for differences in social choices, economic efficiency, and political stability.

17:10Institutions vary across countries. Truth-telling and transparency are not universally embraced. Ask Toyota, IASB trumpets that 120 countries have adopted IFRS, but what they don't tell you is that 112 of them have only adopted IFRS partially. Scary stuff. And there's the issue, in my view, and one that has not received any press, of the potential impact on the United States standard of living. First requires less detailed financial reporting, lower levels of disclosure, and generally accepted accounting principles. Less transparency means less trust. You can sure make an argument for that.

17:57Does cost of capital rise? Does growth slow? Does unemployment go up? I think so. I think we end up with something that looks like a European economy, which I think President To summarize, IFRS upends spontaneous order. IASB lacks both the chops and the staff to make IFRS happen worldwide. Potential LIFO tax bonanza for the U.S. government. No one else on the face of the planet has LIFO. Little Gap is a siren song for higher costs. No impact on the 2008-2009 Collapse, Cultural Differences will always, always prevent IFRS from being fully embraced as a worldwide set of standards.

18:49All in all, this is a big grab for money by the four biggest accounting firms. They would sell their mothers if it would make them a buck. And I'm not a conspiracy guy at all, but I know hundreds of these people. I've been on committees with them. I have members of organizations with them. That's who and what they are. They are shameless. They are shameless. Shameless plug, speaking of shameless. You like that segue? May 24th, coming to a bookstore near you. Feel free to questions, phone calls. You have to call Dr. Warren, Hayek and Mises said that if we leave the choice of money up to the market, eventually, probably, gold will run out.

20:04If we left accounting choices up to the market, wouldn't the end result be a spontaneous order giving us a uniform, better system?

20:34Standards, and we relied on markets, would we end up with something that emerged bottom up, bottom up that would arguably work for everyone? Is that a fair restatement? I believe that, but when I say I believe, I am not saying I know. That's the first thing. The second thing is that I have long questioned, loudly and publicly, principally by pounding my spoon This is your local CPA too. In the main, particularly the smaller firms, are made up of fairly conservative people, and yet two out of the three functions they offer are government mandated, audits and tax returns.

21:22These are conservative, give me a break. I have long wondered why they are entitled to an annual mandated annuity flow of revenue. And I think your point is well taken. I believe that there should be no requirement to audit publicly held companies. I guarantee you investors like the people in this room and certainly including me would make prudent choices if companies did not choose to be audited. Boy would they get walloped. I think your point is well taken. Your point is well taken. That's a great question. Yes, sir. Is your paper on your website? It is not there yet. I have a late beta version with me. And I'd be glad to give you a copy.

22:13I've got about 20 copies with me. And I don't expect to get trampled in a stampede here, but I'll be glad to provide copies. You're welcome to send me an email. If you prefer the electronic version, I can send you a PDF. Anyone else? Yes, sir? If I want to invest in a country that has overseas investments, what would I want to make for its differences? Let me start by saying no sensible person wants to invest directly overseas. Unless that's how you make a living. Overseas investing, as Jack Templeton and others prove, is for specialists. It's for specialists.

23:01I don't know to the extent to which Brazil has adopted IFRS, but I would certainly be looking at I would be looking at options. I'd really be looking at the revaluation of long-lived assets because international financial reporting standards allow them to run those revaluations through the income statement. So you would want to see what portion of their profit came from this revaluation, but then you'd also want to try to look at how was this revalued, who did it, what are their credentials? You know, there are independent people, I'm one of them, but we do get paid by those companies. There is implied pressure there. It doesn't affect me, which is probably why I'm I'm still working at this age and have a mortgage.

23:50I value my freedom, integrity and reputation more than I value anything. Sometimes it terrifies my wife, but that's how things go. But I would first look at the revaluation issue. Other questions? If I could just follow up on Joe's question. In trying to imagine what kinds of practices, what kinds of disclosure standards would we have in practice in a world without mandated disclosure, a world without the SEC and so on, what can we learn from an historical record? In other words, when formalized and legally mandated procedures first emerged, were they codified practices that were fairly common at the time, were they implementing new practices? What were the disclosure standards prior to, in the 19th century?

24:43Prior to the 34 Act, there were none. In all honesty, I'm not an accounting historian. I really don't know the answer to that question. We know that the 34 Act came during the Depression when there had been a horrible meltdown in markets. Unemployment eventually reached 25 percent. But in all honesty, Peter, I don't know. I do know that they've gotten enormously, enormously more complex over the years. Part of that, in fairness, reflects the complexities of an advanced industrial economy. It's estimated that 75% of the net worth in the United States comes from intangible assets.

25:28And yet, if you look on Microsoft's balance sheet, Windows, Office, Internet Explorer, none of those are there. None of those are on their balance sheet. And that shows up in price to book ratios from a valuation standpoint. So we don't account for internally created intellectual property worth a darn. Not yet anyway. The only way you see these intangible assets show up on a balance sheet is when company A goes out to buy company B and they overpay for the quote tangible assets and then you start to get recognition of intangibles. But that's only been the case since July 2001. I would expect that we would have a greater push towards accounting for internally created intangible assets that has a lot of bear traps and a lot of opportunities to tempt people in the wrong way, which I'm sure is one reason that it hasn't happened yet.

26:28But it is a very contentious issue in a society economy like ours where so much of the wealth is in fact intangible, comes from intangible asset. Yes, sir? I have a question about the FDSB's recent action in 2009. It was basically... Caved? Yeah. Could you explain what the goal is? A group of pitchfork-wielding interest groups led by the American Banking Association came The same after the Financial Accounting Standards Board in March of 2009, a House committee had a hearing and Bob Hurst, the Chairman of the FASB, I think it was on March 12, 2009 in fact, I think a year ago today, was there and he was flogged awfully, awfully hard about mark to market for financial instruments and in financial instruments there are three classifications available for sale, The banking industry was reacting to what happened in May 2008 when Merrill Lynch sold $31 billion of mortgage-backed securities for $0.22 on the dollar.

28:00So 22 cents on the dollar became the public market benchmark for what mortgage backed securities were worth and the auditors who didn't want to be sued were leaned on their clients to say, you got to mark these things down. You have to mark these things down and of course, ultimately, the auditors have the power to say, you mark them down or we're not going to sign off on this. and so they dragged hers up there, flogged him pretty hard, threatened him with something called, something called, and if this doesn't scare you, nothing will, the Federal Accounting Standards Board to be appointed by the Senate, the House and the President, God help us all.

28:45Anyway, they did relax some of the standards, they did soften some of them. You can really get deep in the weeds on that stuff. Mark the myth or mark the model. Mark the model works too.