Political intervention: defensive position

The intervention of politicians in financial reporting issues is nothing new.
Those with long memories will recall inflation accounting and deferred taxes in
the UK or accounting for derivatives, stock options and oil and gas exploration
costs in the USA. Those with shorter memories may recall President Chirac’s
claim that the requirements of IAS 39 would have
‘nefarious consequences for financial stability’.

Political intervention is not surprising. Accounting requirements affect the
relative interests of different stakeholders and, therefore, have political
consequences. Politicians and bureaucrats tend to support influential groups
that claim they will be the losers ­ hence their willingness to seek the easing
of the rules on fair value accounting.

It is an easy target because it appears to be something new imposed by the
adoption of IFRS. However, the losses that banks and others want to hide arise
in the context of historical cost rather than fair value. The banks should have
recognised these losses under their national GAAPs as well as IFRS.

The term ‘fair value accounting’ implies that all assets and liabilities must
be measured at fair value at each balance sheet date and the resulting gains and
losses included in profit and loss. IFRS require this form of fair value
accounting for derivatives and other held-for-trading financial assets. Rightly
or wrongly, the IASB believes that this is the only meaningful way to account
for these items.

For virtually everything else, IFRS follows the same historical cost model
that has been in existence for decades. As all accountants know, the carrying
amounts of assets under this model should not exceed the amount that can be
obtained from their use, sale or other means of recovery. Some might call this
prudence.

Those calling for the easing of fair value accounting want to hide losses
that should be recognised under both historical cost and fair value accounting.
They want to assign the blame for bad or ill-informed decision-making on the
accounting. As Lynn Turner, former chief accountant at the SEC, argued, they
will tell lies to investors if they pretend that loan assets are worth more than
the borrower will repay.

Such accounting may be acceptable to politicians. But, as a profession, we
should tell them we will not be associated with it.

David Cairns is a visiting professor at the
London School of
Economics