PwC IFRS blog

Can we achieve consistency in IFRS application?

It would be great to have consistent application of a global set of accounting standards. A common reporting language helps users understand financial statements, whatever the industry or jurisdiction. But with a principles-based framework, we will still inevitably see some degree of diversity.

How does inconsistency or diversity arise?

There are several obstacles to achieving worldwide consistency. IFRS sometimes allows an accounting policy choice. Differences also arise in interpreting IFRS and in exercising judgement where an estimate is required. Although distinct, these are quite often confused by commentators. Disclosure can help here − for example, by explaining the extent of any significant estimation uncertainty and the accounting policy choice. But the value of a common reporting language would be lost if disclosure became a justification for inconsistency.

National or regional endorsement mechanisms (for example, the EU carve-out of part of IAS 39) can impose differences. Interestingly, a 2011 study by the SEC identified one of the most common causes of inconsistency as the tendency at a national level to roll interpretations from a country's prior GAAP into IFRS.

How can consistency be achieved?

Achieving consistency has to be a collaborative exercise of preparers, users, auditors, regulators and the IASB itself.

Preparers − Peer pressure helps to support consistency. Many preparers belong to industry or national groupings that discuss accounting issues to arrive at a common answer. Preparers might give additional disclosure or present non-GAAP measures in the front half of the annual report where they are uncomfortable with the IFRS answer. There is much debate about non-GAAP measures, but I believe that, provided they are reconciled back to IFRS to anchor the consistency with other companies, they can provide valuable information on how management sees the business.

Users − Users should communicate with preparers where there have concerns about inconsistency in the application of IFRS.

Auditors − Auditors have an important role in enforcing consistency of interpretation, but they cannot enforce a single answer for an estimate; their role is to judge whether the estimate is reasonable in the overall context of the accounts. There will be a range of tolerance for this.

Regulators – Regulators have the greatest armoury for enforcement: most can apply sanctions to preparers that they believe have not interpreted IFRS appropriately. Regulation, though, is typically applied nationally, and national regulators arrive at different answers. Some regulators meet on a regional basis to discuss interpretations; but in the absence of a global forum, there is potentially a role for the IFRS Interpretations Committee in resolving differences. Where regulators create inconsistency by an endorsement process, the problem is different – the inconsistency is more visible, clearly not IFRS issued by the IASB. Endorsement processes are inevitable where countries are reluctant to give up sovereignty over standard setting. We can regret they exist but we have to live with them. It is crucial to keep the number of differences as low as possible, and all stakeholders have a role in working to achieve this.

IASB – High-quality standards are essential. The IASB's consultation in the standard-setting process is vital in identifying and resolving difficult areas. The IFRS Foundation Trustees say that the IASB can do more to promote consistency, by identifying issues through post-implementation reviews and consulting with regulators and national standard setters. I also welcome the Trustees review conclusions on the operations of the IFRS Interpretations Committee, which propose a broader range of ‘tools’ for IFRIC to be more responsive.

Estimation uncertainty

We can’t expect every preparer to arrive at exactly the same assumptions and judgements when faced with uncertainty, but estimates present real concern for users. Of course, this problem relates to all GAAP frameworks, not just IFRS. To the extent there is a solution, I believe it lies with improving disclosure around significant uncertainties. IFRS already requires disclosure but allows the preparer to judge the degree of detail. Practice has not always been consistent. Therefore the challenge for all stakeholders is to work on developing more consistent good practice.

In a principles-based system, consistency will always remain an area of debate. Let me know what you think.

When will the leases project take off, and where will it land?

The scenario is all too common: you get on a plane anticipating that you will take off on time, only to discover that you’re sitting on the runway, delayed indefinitely. Could this be the fate of the frequently quoted aeroplane that Sir David Tweedie fought so hard to get onto the balance sheet as part of the proposed new leasing standard? I hope not.

The IASB and FASB have made significant progress on several key redeliberation issues; I broadly support the boards' revised position on lease term, variable lease payments and definition of a lease. These should significantly improve the operationality and reduce the complexity and costs of applying the new standard without significantly reducing the benefits. However, the boards have been debating at length without yet reaching a consensus on two key remaining issues: subsequent expense recognition for lessees, and a cohesive model for lessor accounting. It is important for the boards to agree a way forward if the whole project is not to be delayed indefinitely.

Constituents have been vocal that the impact of the proposed front-loading of expense is positively unhelpful to those trying to forecast, especially if cash flows are actually back-loaded.  But the boards could not agree on how to resolve this. It would take an entire blog to explain the approaches favoured by the IASB and FASB (see Straightaway 80 – FASB/IASB leasing redeliberations]. But, at a simplistic level, both approaches at the extremes would result in the same expense recognition − that is, front-end loading of expenses for some leases and straight-line expense recognition for others. The key difference is that the IASB’s preferred approach would graduate between these extremes, whereas the FASB would use a ‘bright-line’ to make a cut between either straight-line or front-loaded expense profiles.

It is easy to understand why the IASB’s preferred approach could be attractive in theory, but it might be overly complex. So the FASB’s preferred approach would appear to better meet the request for a workable standard. Although a bright-line would still be retained, it is based on a risk-and-rewards concept that is generally well understood and known to be operational. It is also worth remembering that under both approaches, all leases will be on-balance-sheet. The boards have instructed the staff to gather feedback on whether preparers can operationally achieve the IASB’s preferred approach, but determining the operationality is just one piece in the puzzle. It is equally important to address the cost/benefit question. Does the graduated scale and conceptual underpinning of the IASB’s preferred approach give the user more relevant and faithful information compared to the use of a bright-line based on current IAS 17 indicators? If so, does this increased benefit outweigh the additional cost and complexity associated with the IASB’s preferred approach?

Consider also the implications of the above matters for lessor accounting. Should the IASB’s approach for lessees be chosen, it would undoubtedly raise questions about whether lessors could approach their investment property leases differently from other leases (as currently proposed). So the debate on lessee income statement recognition has implications for lessors as well as lessees. I would prefer the boards look at lessor and lessee accounting at the same time but do not believe the proposed hybrid approach is a sufficiently significant improvement to current guidance to justify the substantial cost of change. I would therefore recommend lessors to continue applying the existing lease guidance (perhaps with some amendments to matters such as lease term, variable lease payments and definition of a lease) until the boards are able to develop a lessor approach that is consistent with both lessee accounting and accounting for leases/licences of intangible assets.

Key to the success or failure of the leases project is the participation of users and preparers in the consultation process that will allow the boards to determine the cost and benefits of the proposed approaches. Armed with that information, the boards must remain focused on meeting the primary objective of the project − namely, the need to get all leases on-balance-sheet while proposing a workable standard. If they are able to do this and reach consensus, there is still a chance that the project’s delay will only be temporary and that eventually the aeroplane will take off, and land on a lessee’s balance sheet.

Belated, but welcome – final reports on IFRS governance

The IFRS Foundation has finally released – a little later than planned – its strategy review alongside the Monitoring Board’s review of the Foundation’s governance. It seems the delay was due to the Monitoring Board’s difficulties arriving at a consensus on its report.

The reports do not propose any radical change to IFRS governance. The current three-tier structure (the IASB being responsible for the technical quality of the standards, and the two oversight bodies ensuring independent standard setting and accountability) will continue. I think that’s sensible − it seems to be working. Some of the detail, though, points to changes of emphasis, which I think could be interesting.

Firstly it is worth stating that both reviews have involved extensive consultation, and it is clear that commentators have been listened to carefully. The process should allay the concerns of those who have been critical of IASB governance in the past – or least those whose concern is about the transparency of the governance rather than a disagreement with the technical content of the standards. This may help resolve one of the barriers to IFRS adoption cited in this summer’s US roundtables on IFRS adoption.

The review by the IFRS Foundation Trustees is very similar to the draft published in October. I was glad to see that the commitment to do more to promote consistency of IFRS interpretation across borders was widely supported; this is perhaps the biggest challenge for the IFRS community as it expands. The enhanced role of the Due Process Oversight Committee is also important for building confidence in the standard-setting process among the sceptics.

The Monitoring Board on the other hand has made a number of changes, backing off from what could have been seen as a dramatic extension of its role. Proposals that the Monitoring Board should be able to put topics directly onto the IASB agenda and should take a much greater role in appointing IASB members  have been dropped. There are caveats though: if the Monitoring Board suggests an urgent topic that the IASB rejects, the IASB will have to give the reason why. Similarly, the Monitoring Board will be closely involved in the appointment process for a new Chair. But these proposals are really just a reflection of what is already happening today.

Membership of the Monitoring Board looks like the area that probably had the most intense discussion. It will be expanded to include some emerging markets representatives, and two of the seats will be rotating – this in itself is uncontroversial, although the report admits the details of how to achieve it are not yet worked out. Membership will be restricted to capital markets authorities rather than expanded to include prudential and other regulators – a pragmatic decision, as it would be difficult to know where to stop.  More significantly, members in future will have to come from countries where IFRS is required for domestic use. One can see the tensions here – if a country   permits IFRS but few companies actually use it - is this sufficient “domestic use”? The elephant in the room is of course the US position –can one conclude that allowing use by foreign companies filing with the SEC amounts to ‘domestic’ use? On this, no doubt, there will be more!

Finally, the most disappointing part of the reviews is the lack of a concrete proposal on the future funding of the IASB. Both boards agree there should a transparent system whereby the jurisdictions using IFRS commit funds. The Monitoring Board says the Trustees are primarily responsible; the Trustees comment that they do not have the authority to mandate financing.  At the same time, the Trustees have indicated an aspiration to have a significantly expanded budget.  This is perhaps the biggest collective challenge for the two oversight bodies to resolve.

As ever let me know what you think about any of this.