Change in Accounting: It Makes Sense Now

AUTHOR: Kevin Clarke   DATE: 01.05.05   ISSUE 1, 2005
As the spectre of international financial reporting standards is finally upon us and as various interest groups continue to publicly dispute the impact of their introduction, the truly political nature of accounting standard setting becomes more apparent.

The evolution of accounting policy rarely features in headline news articles or magazine cover stories but when there is the possibility of real financial consequences associated with such change, our collective attention becomes focused on ‘bean counting’.

"International financial reporting standards are an important first step towards true international comparability."

Accounting debates usually begin when different interest groups publicly call for regulators to abandon or delay the introduction of the proposed changes, claiming disadvantageous outcomes for their particular industry and dire consequences for all concerned. Failure to maintain the status quo is often followed by calls for more flexibility in the application of the new rules.

History would suggest that the machinations driven by the internationalisation of accounting standards are not totally unexpected, nor are they unprecedented. Similar events have accompanied any proposed or actual changes to the way firms prepare their financial statements. The greater the magnitude of the change or number of firms affected by the change, the louder the debate. The current scenario simply represents accounting politics on a global scale. This time we have been witnessing an‘economic consequences’ debate on an international rather than local scale.

"The current scenario simply represents accounting politics on a global scale."
Photo: Michael Frey (Kevin Clarke)

The Australian accounting profession was a founding member of the IASC thirty years ago and has been particularly proactive in its support of the harmonisation project. Since the late 1990’s, with the introduction of APS 3 ‘Compatibility of Australian Accounting Standards and International Accounting Standards’, Australian companies have used international standards as a set of minimum reporting requirements.

Since the introduction of the Government’s law reform program (CLERP) there has been a stated desire for an internationally common accounting language (see ‘Accounting Standards: Building International Opportunities for Australian Business’). Based on this, most companies had accepted the inevitable introduction of IFRS and have simply sort flexibility on specific issues.

Many of these issues, such as the treatment of intangibles, asset valuations and hedging are (and always will be!) problematic to financial reporting. This was the case prior to the IFRS adoption and will remain so. The focus of the introduction of these standards has not been about providing an immediate solution to all difficult issues in accounting but establishing an important first step towards truly international comparability.

Since the introduction of the Government’s law reform program there has been a stated desire for an internationally common accounting language.

As with any exposure to change, the adoption of international accounting standards is accompanied by uncertainty and therefore risk. Why expose Australian companies to such uncertainty? Well where there is risk there should also be return for many companies in an economy of our size. Regulators now believe a substantial number of local companies are being disadvantaged through variations in international reporting requirements given the relative size of our market. The return from harmonisation should be realised through an increase in international investor participation driven by a reduction in their transaction costs.

Australian firms currently bare such costs with regard both debt and equity. Therefore the rationale is a really just a reduction in the cost of capital for local firms. Accountants have discussed the unification of accounting practices for years but now it would appear its time has actually come because a critical mass of companies in Australia have reached a size relative to our economy where they will now benefit from international comparability.

"Returns from harmonisation should be realised through increased international investor participation driven by reduced transaction costs."

Given the global nature of investment those firms within markets of a size such as Australia’s it is inevitable that their accounting practices will conform to international expectations. Those within the accounting profession will remember submissions made by the G100 in the early 1990s with regard SAC 4 emphasising the need for international comparability and the difficulties they associated with a uniquely Australian reporting system. The change in accounting will lead to some redistribution of wealth, but from a holistic perspective the economy should be more competitive in an increasingly global business environment. The argument held back then and does more so now.

Why has Australia been one of the first countries to pursue and eventually embark on a harmonisation program? The IASC approach takes much from an Anglo-America accounting model rather than its European based alternatives, consequently its heritage has much in common with the pre-existing Australian framework. AASB suggests the major difficulties in the promulgation of international reporting are associated with factors such as different business and political environments, legal systems and cultures across individual countries.

Overall Australia has less major impediments in these areas when compared to other economies embarking on a similar path, so it would be natural to actively support the adoption of such a model. (It may also explain the resistance to adoption in some sections of the EU.)

"A critical mass of companies in Australia have reached a size relative to our economy where they will now benefit from international comparability."

Illustration: Gregory Baldwin

The new regime is more ‘principles based’ than many constituent groups would have wished but with the difficulties associated with the process of harmonisation the flexibility inherent in such an approach is probably the only workable solution. A principles based system may however demand a more interpretive approach from the users of accounting information.

Australian financial institutions have prepared with the recalibration of their performance evaluation metrics. As such local institutions are active in international markets the cost saving benefits of the unified standards should outweigh the short term costs associated with the adoption of the IAS. In any case, for over 30 years, accounting researchers have examined how the market and individuals react to changes in accounting numbers.

Major users of accounting have historically exhibited a consistent ability to anticipate information in accounting reports and adjust their expectations accordingly. Accounting is obviously not the only source of data, majority of price adjustments occur before the announcement of any change in reported earnings and are attributable to the continual release and aggregate impact of all relevant information of information (both of an accounting and non-accounting nature).

Smaller, local investors are subject to more risk as they lack sufficient resources to immediately analyse the impact of the changes to reporting practice. Australian markets have a relatively large proportion of small investors who (according to ASX research) get information from a variety of different providers. A primary source of information is through the media so perhaps as the increasing level of debate about the introduction of standards intensifies so does the understanding of their impact for the smaller, private investors. Having committed to the internationalisation of accounting maybe the dissemination of information and the changes in expectations that it may deliver is the really important outcome of such high profile accounting debates.