Description
The enormous success of International Financial Reporting Standards (IFRS) in becoming
globally accepted accounting standards leads to challenges in the future. The purpose of this paper is
to outline challenges that arise from political influences and from the pressure to sustain a successful
path in the development of standards. It considers two strategies for future growth which the
International Accounting Standards Board (IASB) follows: the work on fundamental issues and
diversification to private entities.
Accounting Research Journal
Global accounting standards: reality and ambitions
Alfred Wagenhofer
Article information:
To cite this document:
Alfred Wagenhofer, (2009),"Global accounting standards: reality and ambitions", Accounting Research
J ournal, Vol. 22 Iss 1 pp. 68 - 80
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Alan Combs, Martin Samy, Anastasia Myachina, (2013),"Cultural impact on the harmonisation of
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Global accounting standards:
reality and ambitions
Alfred Wagenhofer
University of Graz, Graz, Austria
Abstract
Purpose – The enormous success of International Financial Reporting Standards (IFRS) in becoming
globally accepted accounting standards leads to challenges in the future. The purpose of this paper is
to outline challenges that arise from political in?uences and from the pressure to sustain a successful
path in the development of standards. It considers two strategies for future growth which the
International Accounting Standards Board (IASB) follows: the work on fundamental issues and
diversi?cation to private entities.
Design/methodology/approach – The development of IFRS is discussed and evaluated against
insights gained from accounting theory. In particular, results from information economics illustrate
potential dif?culties of the development of a new conceptual framework for international accounting
standards.
Findings – The main ?ndings are: the growth strategies adopted by the IASB are risky; the
conceptual framework does not suf?ciently take into account the diverse objectives of ?nancial
reporting; stewardship, prudence, and aggregation can be desirable characteristics of accounting
information; and standards that are developed for listed companies need not be well suited for private
entities.
Practical implications – The paper suggests that skepticism is warranted about the viability of a
consistent framework that applies globally, and that there are bene?ts to constrained competition
among different standards.
Originality/value – The paper reviews academic research that has implications for standard setting
and identi?es key issues in developing global accounting standards.
Keywords Financial reporting, International standards, Accounting theory, Globalization
Paper type General review
1. Introduction
The International Financial Reporting Standards (IFRS) issued by the International
Accounting Standards Board (IASB) have been extremely successful in terms of their
acceptance and application on a worldwide basis. This great success is unprecedented
in history and has been anticipated by few observers. However, the more successful
the IASB is, the more new challenges lie ahead. This paper outlines challenges that
arise from political in?uences and from the pressure to sustain the successful work on
the development of standards. The IASB is bound to further develop new standards in
order to grow and to justify the funding it receives.
In the paper, I particularly consider two strategies the IASB follows for future
growth, the work on fundamental issues, and the diversi?cation into standard-setting
for private entities. While both of these strategies ensure an enormous amount of work
and full use of the IASB’s capacity, they are not without risks of failure. This paper uses
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
This paper is based on a keynote address at the AFAANZ Conference 2008 in Sydney.
Helpful comments by Michael Bromwich, Graeme Dean, and Natalie Gallery (Associate
Editor) are gratefully acknowledged.
ARJ
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Accounting Research Journal
Vol. 22 No. 1, 2009
pp. 68-80
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309610910975333
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some general insights from information economics to discuss potential risks. The
discussion focuses on issues that have led to discussion in the development of a new
conceptual framework by the IASBand Financial Accounting Standards Board (FASB).
These issues include the objectives of ?nancial reporting, that is, decision usefulness and
stewardship; adopting the qualitative characteristic of neutrality and dropping
prudence; and the issue of aggregation or separation of items presented in the ?nancial
statements. Theory suggests that the value of accounting information is strongly
dependent on its use by different parties, their utilities and their information
endowment. So, using the same standards for public and private entities may not be
optimal. The paper also discusses some reasons why prudence may be bene?cial relative
to neutral accounting. Finally, the paper considers the level and the formof aggregation
of different items from an informational perspective and shows that the unweighted
aggregation usually done in accounting is rarely optimal. This observation can justify
why a mixed-attribute approach is used. The development of a single set of consistent
standards has not been successful so far if one looks at the history of accounting
regulation, and it is dif?cult to believe that the IASB can achieve a breakthrough,
particularly on a global level. Thus, the success of developing a consistent framework is
less than obvious.
Of course, standard setters need to trade-off the various bene?ts and costs of
standards across companies and, in the case of global standards, across jurisdictions.
Theory provides limited help in comparing welfare across different individuals and
groups. But, the question is whether standard setters are much better in drawing these
comparisons. The more powerful they become, the more are they subject to political
scrutiny. The development in the European Union is illustrative. An alternative would
be to allow for constrained competition among suf?ciently different standards and let
the market sort out an ef?cient solution.
The paper is not intended to give a comprehensive review of fundamental issues
that arise in developing a conceptual framework for ?nancial reporting. Its objective is
to draw out some key issues that are fundamentally important in this process. It also
does not provide a full survey of the information economics literature (for a
comprehensive survey, see for example Lambert (2001)) but uses some simple
examples to argue these points.
The next section outlines the success of IFRS, identi?es some challenges that arise
from this great success, and discusses the need for growth and the two main strategies
the IASB appears to follow. In Section 3, three fundamental issues that are discussed in
the recent joint IASB and FASB Exposure Draft on the conceptual framework are
examined from an information economics perspective, with conclusions presented in
Section 4.
2. Global accounting standards
2.1 IFRS – a success story
The IASB’s work has been a story of success measured in terms of acceptance of IFRS
across the world. Looking back, this success had not been predicted by most observers.
For some 20 years from its establishment in 1973, the (then named) International
Accounting Standards Committee’s (IASC) work was mainly related to accumulating
best practice in accounting, which included several different ways to account for certain
transactions and events. Consequently, the early international accounting standards
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(IASs) included many options and the regulatory content was weak; the result was not
dissimilar from the early efforts to harmonize accounting standards in the European
Union by the accounting directives. In 1995, the European Union chose to support the
work of the IASC rather than develop its own accounting standards. Further impetus to
global standard setting came from the International Organization of Securities
Commissions (IOSCO) that sought establishment of IASs to facilitate cross-listing of
?rms. The IASC worked on the core standards requested by IOSCO until 1999, and
IOSCO recommended them (with some supplemental treatments) in 2000. The major
breakthrough came in 2002, when the European Union decided to require listed
companies to prepare their consolidated statements under IFRS as of 2005 and to
provide an option for member states to allow or require IFRSs also for individual
statements and for unlisted companies. Many other countries, including Australia,
adopted IFRSs at the same time.
According to the IASB, currently over a hundred countries accept or require
IFRSs[1].While this is an impressive number of countries, a more detailed review
reveals that this number includes countries that allow IFRSs for a limited number of
companies, for example, companies in certain industries, and countries that adopted
IFRS in national versions. Nevertheless, froma general point of view, IFRSs do provide
a common language for companies’ ?nancial reporting across the world. “IFRS [is]
rapidly becoming the universal language. It is becoming the language of our
analysts”[2]. The great success is ascertained by the recent move of the USA towards
IFRSs, despite the fact that it has always been proud of its own accounting standards.
In 2007, the Securities and Exchange Commission eliminated the reconciliation
requirements for foreign listed ?rms that prepare their ?nancial statements under full
IFRSs; and in 2008, it proposed a roadmap for the use of IFRSs for all US listed
companies. Again, this is a development that would have been hardly anticipated by
most observers even two years earlier[3].
A major reason for this move towards IFRS in the USA was the convergence project
with the FASB that began in 2002 with the Norwalk Agreement under which many
differences between IFRSs and US GAAP were eliminated, and new standards were
developed jointly with the IASB. Despite their joint development, the resulting
standards are not always equal. For example, the new IFRS 3 on business
combinations includes an option for the measurement of minority interest that is not
included in SFAS 141R. This indicates different views on certain fundamental issues.
The IASB also seeks convergence with other national standards. Of major
importance is the convergence with Japanese GAAP, which is set to result in converged
standards by 2011. A conceptual question is how convergence can be achieved with
more than one standard setter if their national standards differ and one standard setter
has converged its standards with IFRSs already. Presumably, subsequent standard
setters must accept these standards to avoid differences with the ?rst standard setter.
Thus, the game is one of speed, that is, national standard setters may wish to in?uence
the IASB’s deliberations of a new standard early. For example, the European Financial
Reporting Advisory Group has formed a group called pro-active accounting activities
in Europe that publishes discussion papers with a European view (whatever this may
be) on certain issues. This development is likely to increase the competition among
national standard setters and groups of standard setters to provide input into
international standard setting.
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A somewhat more subtle way of in?uencing the standards is to provide resources to
the IASB, for example, technical personnel for the projects which develop the
standards. Aparticular example is the joint development of a conceptual framework by
the IASB and FASB, with the FASB devoting more resources to the project team than
the IASB. Even without an agenda for the standard, the background of the persons
who develop standards may be in?uential for the outcome of the deliberations.
2.2 Challenges ahead
The more successful the IASB becomes in terms of adoption of IFRSs in different
countries, the more challenges arise at the operational level. One dif?culty is that many
countries do not want to or cannot adopt the IFRSs right away but must make a formal
acceptance decision. The European Union endorsement process is illustrative. Besides
the European Commission, it involves three different committees, one technical, one
political, and one that overviews the process; further, it includes the participation of the
European Parliament and the Council. The involvement of many different institutions
increases the likelihood that a standard is not endorsed, which creates diverse
implementation of IFRSs around the world. The European Union, indeed, has carved
out a speci?c hedge accounting rule so that the European IFRSs are not compliant with
the full IFRSs. A study by ICAEW (2007, p. 78) lists eight banks that have used this
carve-out. The endorsement process is also a powerful tool to in?uence standards
development. For example, the European Union pushed the IASB to restrict the fair
value option in IAS 39 – in contrast to the equivalent SFAS 159 – and, more recently,
to amend IAS 39 with an option to classify certain ?nancial instruments out of the
category “at fair value through pro?t or loss.” This amendment was a response to the
?nancial crisis and was passed in a record few days; another record was set by an
endorsement process that was accomplished within three days, whereas usually it
would take a year or so. Had the IASB not acted quickly, the European Union would
have introduced accounting legislation itself, and this is still a possibility as some in
the European Union consider the changes not far-reaching enough.
Political pressure increases as the IASB’s activities become more important. Besides
endorsement and adoption decisions, countries may want to gain more in?uence in the
International Accounting Standards Committee Foundation (IASCF) andIASB. Areport
to the European Parliament argues that the decision to adopt IFRS in the European
Union has turned IASB into a quasi-regulator and this fact would require several
measures to change the governance structure of the IASCF(Committee onEconomic and
Monetary Affairs, 2007) – a clear “cost” of too much success. The IASCF reacted with a
review of the constitution that includes the plan to establish a monitoring group with
representatives of public authorities and international organizations. It is interesting to
see who eventually will end up being the “principal” of the IASB.
The degree of uniformity of ?nancial reporting under the same global standards
crucially depends on the institutional environment in which companies operate. It is
not suf?cient to implant the same accounting standards in various jurisdictions
to achieve actual quality and comparability of ?nancial reporting across the
world. Institutional differences across jurisdictions, such as in auditing, enforcement,
and litigation, matter (Ball et al., 2003; Daske et al., 2008). To see how institutions and
accounting standards interact, consider a standard that puts great weight on relevance
and assume that relevance requires management’s estimates for recognition and
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measurement of certain assets. If such a standard is implemented in an environment
with weak audit and enforcement it is unlikely that the standard will produce relevant
accounting numbers. In such a setting, a standard that puts more weight on reliability
and reduces the required amount of estimates in obtaining the numbers will result in
higher quality ?nancial reporting.
The IASB ignores such interactions and assumes that countries that adopt IFRSs
have or can ensure a high level of auditing and enforcement. Over the long-term, such
an assumption may be justi?ed because there are efforts underway to improve and
converge corporate governance, auditing, and enforcement globally. Corporate
governance has been the subject of OECD guidelines, and convergence is visible in
the implementation of rules that follow the US Sarbanes-Oxley Act. In the auditing
area, the acceptance of the International Standards on Auditing induces formal
convergence, the worldwide concentration of the big audit ?rms induces de facto
convergence, and the Public Company Accounting Oversight Body in the USA is a
model for audit oversight bodies in other jurisdictions. Enforcement and litigation are
more dif?cult to harmonize as they are fundamentally tied to the national legislature.
Court decisions that include an opinion about the application of IFRSs are even more
problematic to coordinate in a global environment.
2.3 Growth strategies
The IASB is a private standard setter that is currently heavily dependent on voluntary
contributions. In 2007, the annual budget was about GBP 17 million, of which only
some 15 percent were from the sale of its publications (less direct costs). Along with the
reorganization in 2001, the IASCF secured ?ve-year funding agreements with many
organizations. Since then, it has become more dif?cult to obtain a sustainable stream of
funding. The IASCF trustees are working on a plan for countries to agree to fund the
IASB based on their gross domestic product.
The permanent pressure to obtain funding induces the necessity to prove how well
the IASB works with these funds. Imagine if the IASB were to say, “We have
developed the best standards in the world, so we will not develop newstandards for the
next X years”; funding would cease immediately. Therefore, the IASB is forced to
produce new standards to justify its funding and, ultimately, its existence. Given the
current level of activity, it is not suf?cient to work on marginal improvements in
existing standards, and to merely react to current issues.
The principal market for the IASB is the world’s capital markets, which it serves by
providing a single set of high-quality global accounting standards. Growth in this
market can come from overproducing standards, for example, by focusing on speci?c
transactions and events or on speci?c industries; this strategy would seem to lead to
more rules-based standards, which the IASB does not want to produce. Growth is also
achievable by moving attention to fundamental projects. Indeed, aiming at more
principles-based standards creates a demand for more consistency in the standards
and, thus, for a uniform basis for developing standards. A review of the work program
of the IASB (most of it jointly with the FASB) shows that it includes a number of
fundamental projects, including the conceptual framework, equity and liabilities,
measurement, ?nancial statement presentation, leases, revenue recognition, and the
long-term project on ?nancial instruments.
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A driving force behind the project considering the fundamental concepts is that the
IASB and the FASB want to make ?nancial reporting standards more coherent and
consistent. Over time, several instances have arisen in which the application of
standards leads to ?nancial statement effects that do not well represent the economic
facts. An example is the mixed-attribute model that underlies the measurement
of ?nancial instruments, which can lead to an accounting mismatch of changes in value
of ?nancial assets and liabilities. Some mismatches can be avoided by hedge
accounting rules and the fair value option. Another example is accounting for emission
rights that led the IASB to withdraw an interpretation (IFRIC 3) because the
accounting effects were regarded as unpalatable by many. The move of the IASB
and the FASB towards an asset-liability approach and fair value measurement would
seem to provide a basis for consistent accounting standards because it would
effectively deal with (at least) the inconsistencies mentioned.
Normally, one would expect that academics applaud a move by standard setters to
more consistent accounting standards, as it would provide evidence that accounting
theory is important. However, the lessons from history clearly teach that there is no
such thing as a unifying theory of accounting that can be implemented in practice.
Over, at least, 100 years of accounting theory and practice there have been no
consistent accounting standards, despite of a wealth of accounting theories that have
been advanced. Common reasons for inconsistencies in accounting standards stem
from their development process. For example, standards are developed over a long
period of time, by different standard setters, different economic situations and different
priorities; and they are a result of political compromises and pressures. The IASB may
be in a position to avoid these obstacles but, as discussed in the next section, there are
other signi?cant reasons for inconsistent standards.
Another IASB growth strategy is diversi?cation into other market segments besides
capital markets. Although IFRSs are generally developed for application to listed
entities, they are currently used, or provide a basis for standards, for other entities as
well. Many jurisdictions allow or require IFRSs to be applied in the preparation of
?nancial reports for smaller andnon-listed companies, andfor individual companies, not
just consolidated ?nancial statements for corporate groups, as is the case in the EU; in
Australia, IFRSs apply broadly to all reporting entities. Interestingly, the IASB/FASB
(2008) discussion paper essentially rejects the usefulness of individual companies’
?nancial statements and allows them only as an appendix to the group’s consolidated
statements, thus foregoing a potential growth option for its standards.
The IASB does, however, enter a new market segment by developing standards for
private entities, formerly known as IFRS for small and medium-sized entities. In 2005,
the IASCF amended its constitution to take account of “the special needs of small and
medium-sized entities and emerging economies.” In 2007, it published an exposure
draft and the standard is expected to be published in 2009. Generally, the success of
diversi?cation strategies depends on how much adaptation the products, here the
standards, need before they can be rolled out into the new market segment. The IASB
believes that ?nancial reporting of private entities should not be different from that of
public companies (IASB/FASB, 2007), although the users and their composition
typically differ widely[4]. Consequently, it developed IFRS for private entities as an
abbreviated version of full IFRS, with limited modi?cations to simplify the standards
and, as it states, to address different users’ needs. However, the modi?cations do not
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touch the general recognition and measurement concepts of the IFRSs. It remains to be
seen if this is a valid working hypothesis when IFRS for private entities are applied in
practice, such as in South Africa, which has already adopted the Exposure Draft.
In the next section, I discuss some aspects of these growth strategies from a
theoretical, and particularly an information economics, point of view. The discussion
focuses on the conceptual framework that arguably requires more theory input than
other issues, and it contributes to better understanding the potential risks that are
inherent in the various efforts the IASB is undertaking.
3. Some insights from information economics
Information economics views accounting as an information system that provides
information to parties that are asymmetrically informed. It focuses on decisions by the
various parties, including preparers, users, auditors and regulators, and the strategic
interaction between those decisions. The main bene?t is to learn if intuitive, often
linear, thinking about means and ends really holds true. It emphasizes that the value
of information is strongly dependent on its use by different parties, their utilities and
their information endowment (Christensen and Demski, 2004). For example, more
information can have a negative value even if it is costless – this is because parties
anticipate that others will adjust their decisions to the information, and they react
accordingly, thereby changing the decision environment, which again affects the
informed parties’ decisions. Thinking in equilibrium terms is important to understand
the ?nal consequences of different accounting standards. Ex ante desirable accounting
standards may produce unfavorable effects ex post, and ex post favorable outcomes
may require ex ante second-best standards. The following themes are illustrative.
3.1 Decision usefulness versus stewardship
The joint IASB/FASB (2008) exposure draft (henceforth ED Framework) sets out the
objective of ?nancial reporting and the qualitative characteristics of ?nancial reporting
information. The overarching objective is to provide useful information to capital
providers, where usefulness encompasses assessing cash ?ow prospects and assessing
stewardship. The relationship between decision usefulness in the sense of providing
information to capital providers and stewardship has been a subject of controversial
discussion. Despite mentioning stewardship in the ED Framework, the IASB considers
stewardship as being part of the decision usefulness objective because stewardship
responsibility is generally related to resource allocation decisions. It suggests that the
same accounting system can serve both (sub-)objectives well.
Acknowledgingthat there are several meanings of stewardship, one of themis tode?ne
a performance measure for management that not only reports the performance over a past
period but also provides incentives for management to make decisions in the interests of
investors. This is an area for which agency theory provides a number of insights. One
important one is that decision usefulness and stewardship require different information
(see Gjesdal (1981) for a general analysis). To illustrate the logic behind this argument,
consider a simple LEN agency model with a risk neutral owner who contracts with a
risk-averse manager (with exponential utility)[5]. The manager exerts effort a to produce
stochastic outcome x(a, u) ¼ a þ u, where a is the activity of the manager and u is a
normallydistributednoise termthat captures all productive events beyondmanagement’s
control. The activity a is costly to the manager and unobservable. Outcome x is not
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observable in the short run, so the incentive compensation of the manager is based on a
noisy signal y of x. Assume that compensation is linear in y. The optimal linear contract
trades off incentives and risk by optimizing pay sensitivity.
Consider a choice between two accounting systems: system 1 provides a noisy
signal about outcome x, ~ y
1
¼ ~ x þ ~ 1
1
¼ ða þ
~
uÞ þ ~ 1
1
, whereas system 2 provides a
noisy signal about effort a, ~ y
2
¼ a þ ~ 1
2
. Assume that the noise terms ~ 1
1
and ~ 1
2
are not
correlated. Then, from a stewardship perspective, system 2 is preferable if the variance
of signal 1 is less than that of signal 2, i.e. Var½ ~ y
2
? ¼ Var½ ~ 1
2
? , Var½
~
u þ ~ 1
1
? ¼ Var½ ~ y
1
?.
This is likely to hold. Froma decision-usefulness perspective, signals are valuable if they
provide incremental information to the market price. The market price conditional on a
signal is:
Pð y
i
Þ ¼ E½~ xjy
i
? ¼ a
i
þ
Covð~ x; ~ y
i
Þ
Varð ~ y
i
Þ
· ð y
i
2a
i
Þ:
System 1 is clearly valuable because:
Covð~ y
1
; Pð~ y
1
ÞÞ ¼
Covð~ x; ~ y
1
Þ
Varð ~ y
1
Þ
· Covð ~ y
1
; ~ y
1
Þ . 0;
whereas system 2 is not valuable as Pð y
2
Þ ¼ E½~ xjy
2
? ¼ a
2
and Covð ~ y
2
; Pð ~ y
2
ÞÞ ¼
Covð ~ y
2
; a
2
Þ ¼ 0. The reason is that the market anticipates correctly on average the
incentives to the manager that are provided by the accounting system. Hence, providing
information about the activity is not useful for adjusting the market price, but it is useful
for stewardship purposes. Thus, value relevance is not necessarily a useful criterion to
measure the usefulness of information. In the simple example, it even reduces social
welfare, as system2 provides more ef?cient incentives, whichincreases the market price of
the ?rm, i.e.:
E½Pð y
2
Þ? ¼ E½E½~ xjy
2
?? ¼ a
2
. a
1
¼ E½E½~ xjy
1
?? ¼ E½Pð y
1
Þ?:
The example illustrates another point: in the EDFramework (BC1.26), the IASB suggests
that stewardship might imply that the performance measure should eliminate the effects
of events that are beyond management’s control, and this is not desired by the IASB.
Indeed, being able to separate out some noise in either of the two accounting systems
increases the stewardship value and, consequently, ?rmvalue inthe example because risk
stems fromthe noise inthe (linear) measures, and a risk reduction lowers the riskpremium
payable to the manager. However, suppose the noise includes information on the
productivity of the manager or the way the activity adds value to the ?rm. Then, it is
bene?cial to include it in the performance measure, as eliminating it would insure the
manager against the effects so that the incentives to adjust the activity are eliminated
as well.
An extreme example for the disadvantage of a very informative signal is the use of
market values for performance evaluation. Assuming a market with rational
expectations, market participants anticipate management’s incentives and activities
and price them correctly (on average). If this market price is used as the performance
measure, the manager maximizes his or her expected utility contingent on the market
price which he or she takes as given. That is, the manager does not control the bene?t,
but only the cost of the activities. Consequently, in equilibrium, incentives break down
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(Dutta and Zhang, 2002). The market anticipates this outcome and sets the market
price accordingly low. Again, relevant information for decision usefulness destroys
?rm value if it is used for performance measurement.
This discussion illustrates that decision usefulness and stewardship are clearly
distinct objectives. They cannot be simply dealt with by disclosures, but the objective
also affects recognition and measurement.
One might argue that ?nancial reporting standards are not aimed at providing
contracting information for parties that have the power to demand information they
need (Barth, 2008, p. 1168)[6]. Parties that can write individual contracts could then
design their own information system and accounting standards could ignore
stewardship. Even in that case, it might be in the best interest of parties to contract on a
single accounting system ( Feltham et al., 2006).
3.2 Neutral measurement
The ED Framework de?nes faithful representation as a fundamental qualitative
characteristic of ?nancial reporting information. Faithful representation includes
neutrality, which is the absence of bias, and it excludes prudence because it would
introduce bias inthe ?nancial information. Interestingly, accounting systems have always
been conservative, and the empirical literature that studies earnings attributes considers
(conditional) conservatism even as a desirable property of earnings numbers. The IASB
appears to view accounting as a technology that should just be designed so that it most
precisely measures the essence of economic transactions and events as if there were a
“correct” way of accounting. However, transactions do not occur exogenously; accounting
in?uences decisions made byeconomic players ( Demski, 2004). Byattemptingtoneutrally
measure transactions and events, accounting affects decisions in a certain way that may
be undesirable. Assuming that management has incentives to in?ate earnings, neutral
standards do not result in neutral ?nancial information after taking account of
management’s incentives (Chen et al., 2007). Moreover, several parties involved in the
accounting process, including auditors and enforcement institutions, have asymmetric
loss functions which induce biased veri?cation mechanisms.
Aside from induced bias, the information economics literature identi?es several
reasons why biased information can be strictly preferable to neutral, unbiased
information (Kwon et al., 2001). One set of reasons includes restrictions on management
contracts that can be ameliorated by adjusting the accounting system. For example,
contracts are generally incomplete in that they can be renegotiated, they include
limited liability, and they have a maximum length. Reporting unfavorable information
early or more precisely can ?t the contracting environment better and can ultimately
increase welfare.
Another issue is the information environment. Financial reporting is not the only
source of information about entities. The ED Framework acknowledges this fact, but
discusses no consequences for the qualitative characteristics. De?ning desirable
properties in a conceptual framework neglects complementary information[7]. Agency
theory suggests that biased accounting information can be bene?cial in such an
environment. Consider a multi-activities LEN agency model where two signals are
available for contracting. One signal is the market price that is determined in a rational
expectations equilibrium, the other is an accounting signal. The optimal accounting
system generates biased signals because they best complement the information
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contained in the market price. Intuitively, a neutral accounting system would mimic
the information in the market price and put too much incentive weight to those
activities that are included in the price (which are often the short-term results). A
biased accounting system generates signals that can be used to shift incentives to other
important activities at a lower cost (Feltham and Xie, 1994). Similarly, accounting
information has comparative advantages relative to other information sources. For
example, it is usually more reliable (veri?ability in the terms of the ED Framework).
Putting more weight on reliable information can be bene?cial if there are
complementary sources of information.
This discussion also highlights that the derivation of IFRS for private entities fromfull
IFRS may not adequately capture the differences in the information environment between
these two groups of entities. For listed companies, a wealthof additional information, such
as market prices, analysts’ forecasts, interim information and the like exists, which is not
available for private companies. It is dif?cult to imagine that such information would not
have an effect on the desirable characteristics of accounting standards for private
companies. Again, it appears as if the IASBconsiders accounting informationas “right” or
“wrong” rather than the result of a cost-bene?t trade-off in equilibrium.
3.3 Aggregation
Most ?nancial information is highly aggregated; users are generally interested in
“bottom line” measures, such as net income and net assets. Aggregation destroys some
of the information carried by individual items (except in the special case of a suf?cient
statistic). Let aside psychological effects, economic bene?ts of aggregations may arise
from the fact that the aggregate can be more precise than the individual items if they
are measured with error (Arya et al., 2004) or that the aggregation carries some
information not included in the individual items, such as their “similarity.”
Aggregation can also substitute for a lack of commitment not to use detailed
information “too” aggressively and, therefore, is useful if termination or renegotiation
of contracts cannot be excluded (Christensen et al., 2003).
Another theme is how items are best aggregated and what items should be
separately presented. In accounting, aggregation is performed by adding or
subtracting the carrying amounts of recognized items. This is rarely an optimal
weighting of signals. Weights depend, among others, on the relative relevance and
reliability of the signals, their bias, their covariances and their incremental information
content (see Banker and Datar (1989) for a single-action model). To illustrate, assume
again a LEN agency model with two outcomes that add to total outcome x:
~ x ¼ ~ x
1
þ ~ x
2
¼ ða
1
þ ~ 1
1
Þ þ ða
2
þ ~ 1
2
Þ;
where ~ 1
1
; ~ 1
2
are normally distributed and uncorrelated noise terms. Consider an
aggregated measure of the two outcomes x
1
and x
2
, mðxÞ ¼ m
1
· x
1
þ m
2
· x
2
, and let
management compensation be linear in m. The risk aversion of management is
captured by r, where higher r indicates higher risk aversion. Then, the optimal
aggregate results in a relative weight of:
m
1
m
2
¼
1 þ r · s
2
2
1 þ r · s
2
1
;
that is, the more noisy outcome (with higher variance s
2
i
) implies a lower weight[8].
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Given the importance of the various characteristics and interaction of the items that
are aggregated, it can be that a mixed-attribute approach is closer to an optimal
weighting than a consistent measurement approach. A mixed-attribute approach
introduces different weights based on type and precision of transactions and events.
For example, some transactions are not recognized, such as R&D, hence, receive zero
weight; impairment rules imply a greater weight on unfavorable than on favorable
events; and prudence in general puts less weight on less reliable indicators. Of course,
other themes are also important for different measurement concepts.
4. Conclusions
The IASB has been remarkably successful in developing accounting standards that
are accepted worldwide. This paper discusses some “costs” of this success, particularly
the increased scrutiny by powerful political players, such as the European Union, and
the pressure to remain successful and productive in the future. The paper identi?es two
growth strategies that are pursued by the IASB:
(1) the work on fundamental projects; and
(2) diversi?cation to private entities.
Both strategies are intriguing, and both carry risk of failure. Risks arise from the fact
that theory suggests there is no single optimal accounting system for different uses,
and history up to now shows that no single consistent accounting system prevails in
practice.
Theory sharpens our thinking about the potential economic effects of standards in
various environments that should be considered by standard setters. Examples of
insights from information economics illustrate that it is dif?cult to come up with robust
answers that would be of suf?cient guidance to standard setters to know how to set the
standards. Nevertheless, ignoring other effects can lead to undesirable standards.
Given that situation, it appears that a monopoly standard setter is not the best way
to regulate ?nancial reporting globally. Constrained competition may be better suited
because it would provide more and different solutions to companies (Benston et al.,
2006, Ch. 10). They could self-select the standards they apply based on their individual
costs and bene?ts, where the choice itself is revealing. Eventually, the market rather
than a global standard setter would sort out which standards are more useful than
others. Competition between standards would also generate data that can ex post be
used to empirically study the economic effects of the different standards. It should be
noted that the forming of a monopoly in accounting standard setting is not the “fault”
of the IASB; it has done, and is bound to do, its best to get as much acceptance
worldwide as it can. It is the task of jurisdictions and other institutions that adopt or
recommend IFRS.
In any case, these are fascinating times for accounting researchers, and they are
proof that accounting is important and has real economic effects, albeit one might wish
that the effects were less detrimental as they are in the recent ?nancial crisis.
Notes
1. See IASB Insight, Q3 2007; a detailed list of the use of IFRSs in countries is available at:
www.iasplus.com
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2. Greg Jonas (Managing Director von Moody’s Accounting Specialist Group) quoted in
Deloitte (2008, p. 10).
3. However, several major organizations, such as the FASB and NASBA, voiced concerns
about the proposal in their comment letters to the SEC.
4. Interestingly, the International Public Sector Accounting Standards Board Activities
develops standards for public sector entities, which are based on IFRS but adapted to the
special needs of these entities.
5. The example is taken from Wagenhofer and Ewert (2007, pp. 136-40).
6. The question is: if the IASB, for example, writes standards that are most useful to users who
do not have the power to write individual contracts, is the usefulness of the information
dependent on the availability of power?
7. Note also that empirical measures of earnings attributes usually cannot capture such
bene?ts and trade-offs adequately.
8. This result bears some resemblance to calculating conditional expectations, although their
expressions are different; in particular, risk aversion is important here.
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Dutta, S. and Zhang, X.-J. (2002), “Revenue recognition in a multiperiod agency setting”, Journal
of Accounting Research, Vol. 40, pp. 67-83.
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principal/agent relations”, The Accounting Review, Vol. 69, pp. 429-54.
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reporting – the reporting entity”, discussion paper, May.
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About the author
Alfred Wagenhofer is a Professor of Accounting at the University of Graz. He served as the
President of the EAA, Vice President-International of the AAA, and Vice President-Finance of
the IAAER. Alfred Wagenhofer can be contacted at: [email protected]
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This article has been cited by:
1. Christoph Kuhner, Christoph Pelger. 2015. On the Relationship of Stewardship and Valuation-An
Analytical Viewpoint. Abacus 51:10.1111/abac.2015.51.issue-3, 379-411. [CrossRef]
2. Ying Zhang, Jane Andrew. 2014. Financialisation and the Conceptual Framework. Critical Perspectives on
Accounting 25, 17-26. [CrossRef]
3. Christian Gross, Roland Königsgruber. 2012. What You Measure is What You Get: The Effects of
Accounting Standards Effects Studies. Accounting in Europe 9, 171-190. [CrossRef]
4. Keryn Chalmers, Jayne M. Godfrey, Barbara Lynch. 2012. Regulatory theory insights into the past, present
and future of general purpose water accounting standard setting. Accounting, Auditing & Accountability
Journal 25:6, 1001-1024. [Abstract] [Full Text] [PDF]
5. John Christensen. 2010. Conceptual frameworks of accounting from an information perspective.
Accounting and Business Research 40, 287-299. [CrossRef]
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doc_949844634.pdf
The enormous success of International Financial Reporting Standards (IFRS) in becoming
globally accepted accounting standards leads to challenges in the future. The purpose of this paper is
to outline challenges that arise from political influences and from the pressure to sustain a successful
path in the development of standards. It considers two strategies for future growth which the
International Accounting Standards Board (IASB) follows: the work on fundamental issues and
diversification to private entities.
Accounting Research Journal
Global accounting standards: reality and ambitions
Alfred Wagenhofer
Article information:
To cite this document:
Alfred Wagenhofer, (2009),"Global accounting standards: reality and ambitions", Accounting Research
J ournal, Vol. 22 Iss 1 pp. 68 - 80
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Alan Combs, Martin Samy, Anastasia Myachina, (2013),"Cultural impact on the harmonisation of
Russian Accounting Standards with the International Financial Reporting Standards: A practitioner's
perspective", J ournal of Accounting & Organizational Change, Vol. 9 Iss 1 pp. 26-49 http://
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Sharad Asthana, Steven Balsam, Sungsoo Kim, (2009),"The effect of Enron, Andersen, and Sarbanes-
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Global accounting standards:
reality and ambitions
Alfred Wagenhofer
University of Graz, Graz, Austria
Abstract
Purpose – The enormous success of International Financial Reporting Standards (IFRS) in becoming
globally accepted accounting standards leads to challenges in the future. The purpose of this paper is
to outline challenges that arise from political in?uences and from the pressure to sustain a successful
path in the development of standards. It considers two strategies for future growth which the
International Accounting Standards Board (IASB) follows: the work on fundamental issues and
diversi?cation to private entities.
Design/methodology/approach – The development of IFRS is discussed and evaluated against
insights gained from accounting theory. In particular, results from information economics illustrate
potential dif?culties of the development of a new conceptual framework for international accounting
standards.
Findings – The main ?ndings are: the growth strategies adopted by the IASB are risky; the
conceptual framework does not suf?ciently take into account the diverse objectives of ?nancial
reporting; stewardship, prudence, and aggregation can be desirable characteristics of accounting
information; and standards that are developed for listed companies need not be well suited for private
entities.
Practical implications – The paper suggests that skepticism is warranted about the viability of a
consistent framework that applies globally, and that there are bene?ts to constrained competition
among different standards.
Originality/value – The paper reviews academic research that has implications for standard setting
and identi?es key issues in developing global accounting standards.
Keywords Financial reporting, International standards, Accounting theory, Globalization
Paper type General review
1. Introduction
The International Financial Reporting Standards (IFRS) issued by the International
Accounting Standards Board (IASB) have been extremely successful in terms of their
acceptance and application on a worldwide basis. This great success is unprecedented
in history and has been anticipated by few observers. However, the more successful
the IASB is, the more new challenges lie ahead. This paper outlines challenges that
arise from political in?uences and from the pressure to sustain the successful work on
the development of standards. The IASB is bound to further develop new standards in
order to grow and to justify the funding it receives.
In the paper, I particularly consider two strategies the IASB follows for future
growth, the work on fundamental issues, and the diversi?cation into standard-setting
for private entities. While both of these strategies ensure an enormous amount of work
and full use of the IASB’s capacity, they are not without risks of failure. This paper uses
The current issue and full text archive of this journal is available at
www.emeraldinsight.com/1030-9616.htm
This paper is based on a keynote address at the AFAANZ Conference 2008 in Sydney.
Helpful comments by Michael Bromwich, Graeme Dean, and Natalie Gallery (Associate
Editor) are gratefully acknowledged.
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Accounting Research Journal
Vol. 22 No. 1, 2009
pp. 68-80
qEmerald Group Publishing Limited
1030-9616
DOI 10.1108/10309610910975333
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some general insights from information economics to discuss potential risks. The
discussion focuses on issues that have led to discussion in the development of a new
conceptual framework by the IASBand Financial Accounting Standards Board (FASB).
These issues include the objectives of ?nancial reporting, that is, decision usefulness and
stewardship; adopting the qualitative characteristic of neutrality and dropping
prudence; and the issue of aggregation or separation of items presented in the ?nancial
statements. Theory suggests that the value of accounting information is strongly
dependent on its use by different parties, their utilities and their information
endowment. So, using the same standards for public and private entities may not be
optimal. The paper also discusses some reasons why prudence may be bene?cial relative
to neutral accounting. Finally, the paper considers the level and the formof aggregation
of different items from an informational perspective and shows that the unweighted
aggregation usually done in accounting is rarely optimal. This observation can justify
why a mixed-attribute approach is used. The development of a single set of consistent
standards has not been successful so far if one looks at the history of accounting
regulation, and it is dif?cult to believe that the IASB can achieve a breakthrough,
particularly on a global level. Thus, the success of developing a consistent framework is
less than obvious.
Of course, standard setters need to trade-off the various bene?ts and costs of
standards across companies and, in the case of global standards, across jurisdictions.
Theory provides limited help in comparing welfare across different individuals and
groups. But, the question is whether standard setters are much better in drawing these
comparisons. The more powerful they become, the more are they subject to political
scrutiny. The development in the European Union is illustrative. An alternative would
be to allow for constrained competition among suf?ciently different standards and let
the market sort out an ef?cient solution.
The paper is not intended to give a comprehensive review of fundamental issues
that arise in developing a conceptual framework for ?nancial reporting. Its objective is
to draw out some key issues that are fundamentally important in this process. It also
does not provide a full survey of the information economics literature (for a
comprehensive survey, see for example Lambert (2001)) but uses some simple
examples to argue these points.
The next section outlines the success of IFRS, identi?es some challenges that arise
from this great success, and discusses the need for growth and the two main strategies
the IASB appears to follow. In Section 3, three fundamental issues that are discussed in
the recent joint IASB and FASB Exposure Draft on the conceptual framework are
examined from an information economics perspective, with conclusions presented in
Section 4.
2. Global accounting standards
2.1 IFRS – a success story
The IASB’s work has been a story of success measured in terms of acceptance of IFRS
across the world. Looking back, this success had not been predicted by most observers.
For some 20 years from its establishment in 1973, the (then named) International
Accounting Standards Committee’s (IASC) work was mainly related to accumulating
best practice in accounting, which included several different ways to account for certain
transactions and events. Consequently, the early international accounting standards
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(IASs) included many options and the regulatory content was weak; the result was not
dissimilar from the early efforts to harmonize accounting standards in the European
Union by the accounting directives. In 1995, the European Union chose to support the
work of the IASC rather than develop its own accounting standards. Further impetus to
global standard setting came from the International Organization of Securities
Commissions (IOSCO) that sought establishment of IASs to facilitate cross-listing of
?rms. The IASC worked on the core standards requested by IOSCO until 1999, and
IOSCO recommended them (with some supplemental treatments) in 2000. The major
breakthrough came in 2002, when the European Union decided to require listed
companies to prepare their consolidated statements under IFRS as of 2005 and to
provide an option for member states to allow or require IFRSs also for individual
statements and for unlisted companies. Many other countries, including Australia,
adopted IFRSs at the same time.
According to the IASB, currently over a hundred countries accept or require
IFRSs[1].While this is an impressive number of countries, a more detailed review
reveals that this number includes countries that allow IFRSs for a limited number of
companies, for example, companies in certain industries, and countries that adopted
IFRS in national versions. Nevertheless, froma general point of view, IFRSs do provide
a common language for companies’ ?nancial reporting across the world. “IFRS [is]
rapidly becoming the universal language. It is becoming the language of our
analysts”[2]. The great success is ascertained by the recent move of the USA towards
IFRSs, despite the fact that it has always been proud of its own accounting standards.
In 2007, the Securities and Exchange Commission eliminated the reconciliation
requirements for foreign listed ?rms that prepare their ?nancial statements under full
IFRSs; and in 2008, it proposed a roadmap for the use of IFRSs for all US listed
companies. Again, this is a development that would have been hardly anticipated by
most observers even two years earlier[3].
A major reason for this move towards IFRS in the USA was the convergence project
with the FASB that began in 2002 with the Norwalk Agreement under which many
differences between IFRSs and US GAAP were eliminated, and new standards were
developed jointly with the IASB. Despite their joint development, the resulting
standards are not always equal. For example, the new IFRS 3 on business
combinations includes an option for the measurement of minority interest that is not
included in SFAS 141R. This indicates different views on certain fundamental issues.
The IASB also seeks convergence with other national standards. Of major
importance is the convergence with Japanese GAAP, which is set to result in converged
standards by 2011. A conceptual question is how convergence can be achieved with
more than one standard setter if their national standards differ and one standard setter
has converged its standards with IFRSs already. Presumably, subsequent standard
setters must accept these standards to avoid differences with the ?rst standard setter.
Thus, the game is one of speed, that is, national standard setters may wish to in?uence
the IASB’s deliberations of a new standard early. For example, the European Financial
Reporting Advisory Group has formed a group called pro-active accounting activities
in Europe that publishes discussion papers with a European view (whatever this may
be) on certain issues. This development is likely to increase the competition among
national standard setters and groups of standard setters to provide input into
international standard setting.
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A somewhat more subtle way of in?uencing the standards is to provide resources to
the IASB, for example, technical personnel for the projects which develop the
standards. Aparticular example is the joint development of a conceptual framework by
the IASB and FASB, with the FASB devoting more resources to the project team than
the IASB. Even without an agenda for the standard, the background of the persons
who develop standards may be in?uential for the outcome of the deliberations.
2.2 Challenges ahead
The more successful the IASB becomes in terms of adoption of IFRSs in different
countries, the more challenges arise at the operational level. One dif?culty is that many
countries do not want to or cannot adopt the IFRSs right away but must make a formal
acceptance decision. The European Union endorsement process is illustrative. Besides
the European Commission, it involves three different committees, one technical, one
political, and one that overviews the process; further, it includes the participation of the
European Parliament and the Council. The involvement of many different institutions
increases the likelihood that a standard is not endorsed, which creates diverse
implementation of IFRSs around the world. The European Union, indeed, has carved
out a speci?c hedge accounting rule so that the European IFRSs are not compliant with
the full IFRSs. A study by ICAEW (2007, p. 78) lists eight banks that have used this
carve-out. The endorsement process is also a powerful tool to in?uence standards
development. For example, the European Union pushed the IASB to restrict the fair
value option in IAS 39 – in contrast to the equivalent SFAS 159 – and, more recently,
to amend IAS 39 with an option to classify certain ?nancial instruments out of the
category “at fair value through pro?t or loss.” This amendment was a response to the
?nancial crisis and was passed in a record few days; another record was set by an
endorsement process that was accomplished within three days, whereas usually it
would take a year or so. Had the IASB not acted quickly, the European Union would
have introduced accounting legislation itself, and this is still a possibility as some in
the European Union consider the changes not far-reaching enough.
Political pressure increases as the IASB’s activities become more important. Besides
endorsement and adoption decisions, countries may want to gain more in?uence in the
International Accounting Standards Committee Foundation (IASCF) andIASB. Areport
to the European Parliament argues that the decision to adopt IFRS in the European
Union has turned IASB into a quasi-regulator and this fact would require several
measures to change the governance structure of the IASCF(Committee onEconomic and
Monetary Affairs, 2007) – a clear “cost” of too much success. The IASCF reacted with a
review of the constitution that includes the plan to establish a monitoring group with
representatives of public authorities and international organizations. It is interesting to
see who eventually will end up being the “principal” of the IASB.
The degree of uniformity of ?nancial reporting under the same global standards
crucially depends on the institutional environment in which companies operate. It is
not suf?cient to implant the same accounting standards in various jurisdictions
to achieve actual quality and comparability of ?nancial reporting across the
world. Institutional differences across jurisdictions, such as in auditing, enforcement,
and litigation, matter (Ball et al., 2003; Daske et al., 2008). To see how institutions and
accounting standards interact, consider a standard that puts great weight on relevance
and assume that relevance requires management’s estimates for recognition and
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measurement of certain assets. If such a standard is implemented in an environment
with weak audit and enforcement it is unlikely that the standard will produce relevant
accounting numbers. In such a setting, a standard that puts more weight on reliability
and reduces the required amount of estimates in obtaining the numbers will result in
higher quality ?nancial reporting.
The IASB ignores such interactions and assumes that countries that adopt IFRSs
have or can ensure a high level of auditing and enforcement. Over the long-term, such
an assumption may be justi?ed because there are efforts underway to improve and
converge corporate governance, auditing, and enforcement globally. Corporate
governance has been the subject of OECD guidelines, and convergence is visible in
the implementation of rules that follow the US Sarbanes-Oxley Act. In the auditing
area, the acceptance of the International Standards on Auditing induces formal
convergence, the worldwide concentration of the big audit ?rms induces de facto
convergence, and the Public Company Accounting Oversight Body in the USA is a
model for audit oversight bodies in other jurisdictions. Enforcement and litigation are
more dif?cult to harmonize as they are fundamentally tied to the national legislature.
Court decisions that include an opinion about the application of IFRSs are even more
problematic to coordinate in a global environment.
2.3 Growth strategies
The IASB is a private standard setter that is currently heavily dependent on voluntary
contributions. In 2007, the annual budget was about GBP 17 million, of which only
some 15 percent were from the sale of its publications (less direct costs). Along with the
reorganization in 2001, the IASCF secured ?ve-year funding agreements with many
organizations. Since then, it has become more dif?cult to obtain a sustainable stream of
funding. The IASCF trustees are working on a plan for countries to agree to fund the
IASB based on their gross domestic product.
The permanent pressure to obtain funding induces the necessity to prove how well
the IASB works with these funds. Imagine if the IASB were to say, “We have
developed the best standards in the world, so we will not develop newstandards for the
next X years”; funding would cease immediately. Therefore, the IASB is forced to
produce new standards to justify its funding and, ultimately, its existence. Given the
current level of activity, it is not suf?cient to work on marginal improvements in
existing standards, and to merely react to current issues.
The principal market for the IASB is the world’s capital markets, which it serves by
providing a single set of high-quality global accounting standards. Growth in this
market can come from overproducing standards, for example, by focusing on speci?c
transactions and events or on speci?c industries; this strategy would seem to lead to
more rules-based standards, which the IASB does not want to produce. Growth is also
achievable by moving attention to fundamental projects. Indeed, aiming at more
principles-based standards creates a demand for more consistency in the standards
and, thus, for a uniform basis for developing standards. A review of the work program
of the IASB (most of it jointly with the FASB) shows that it includes a number of
fundamental projects, including the conceptual framework, equity and liabilities,
measurement, ?nancial statement presentation, leases, revenue recognition, and the
long-term project on ?nancial instruments.
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A driving force behind the project considering the fundamental concepts is that the
IASB and the FASB want to make ?nancial reporting standards more coherent and
consistent. Over time, several instances have arisen in which the application of
standards leads to ?nancial statement effects that do not well represent the economic
facts. An example is the mixed-attribute model that underlies the measurement
of ?nancial instruments, which can lead to an accounting mismatch of changes in value
of ?nancial assets and liabilities. Some mismatches can be avoided by hedge
accounting rules and the fair value option. Another example is accounting for emission
rights that led the IASB to withdraw an interpretation (IFRIC 3) because the
accounting effects were regarded as unpalatable by many. The move of the IASB
and the FASB towards an asset-liability approach and fair value measurement would
seem to provide a basis for consistent accounting standards because it would
effectively deal with (at least) the inconsistencies mentioned.
Normally, one would expect that academics applaud a move by standard setters to
more consistent accounting standards, as it would provide evidence that accounting
theory is important. However, the lessons from history clearly teach that there is no
such thing as a unifying theory of accounting that can be implemented in practice.
Over, at least, 100 years of accounting theory and practice there have been no
consistent accounting standards, despite of a wealth of accounting theories that have
been advanced. Common reasons for inconsistencies in accounting standards stem
from their development process. For example, standards are developed over a long
period of time, by different standard setters, different economic situations and different
priorities; and they are a result of political compromises and pressures. The IASB may
be in a position to avoid these obstacles but, as discussed in the next section, there are
other signi?cant reasons for inconsistent standards.
Another IASB growth strategy is diversi?cation into other market segments besides
capital markets. Although IFRSs are generally developed for application to listed
entities, they are currently used, or provide a basis for standards, for other entities as
well. Many jurisdictions allow or require IFRSs to be applied in the preparation of
?nancial reports for smaller andnon-listed companies, andfor individual companies, not
just consolidated ?nancial statements for corporate groups, as is the case in the EU; in
Australia, IFRSs apply broadly to all reporting entities. Interestingly, the IASB/FASB
(2008) discussion paper essentially rejects the usefulness of individual companies’
?nancial statements and allows them only as an appendix to the group’s consolidated
statements, thus foregoing a potential growth option for its standards.
The IASB does, however, enter a new market segment by developing standards for
private entities, formerly known as IFRS for small and medium-sized entities. In 2005,
the IASCF amended its constitution to take account of “the special needs of small and
medium-sized entities and emerging economies.” In 2007, it published an exposure
draft and the standard is expected to be published in 2009. Generally, the success of
diversi?cation strategies depends on how much adaptation the products, here the
standards, need before they can be rolled out into the new market segment. The IASB
believes that ?nancial reporting of private entities should not be different from that of
public companies (IASB/FASB, 2007), although the users and their composition
typically differ widely[4]. Consequently, it developed IFRS for private entities as an
abbreviated version of full IFRS, with limited modi?cations to simplify the standards
and, as it states, to address different users’ needs. However, the modi?cations do not
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touch the general recognition and measurement concepts of the IFRSs. It remains to be
seen if this is a valid working hypothesis when IFRS for private entities are applied in
practice, such as in South Africa, which has already adopted the Exposure Draft.
In the next section, I discuss some aspects of these growth strategies from a
theoretical, and particularly an information economics, point of view. The discussion
focuses on the conceptual framework that arguably requires more theory input than
other issues, and it contributes to better understanding the potential risks that are
inherent in the various efforts the IASB is undertaking.
3. Some insights from information economics
Information economics views accounting as an information system that provides
information to parties that are asymmetrically informed. It focuses on decisions by the
various parties, including preparers, users, auditors and regulators, and the strategic
interaction between those decisions. The main bene?t is to learn if intuitive, often
linear, thinking about means and ends really holds true. It emphasizes that the value
of information is strongly dependent on its use by different parties, their utilities and
their information endowment (Christensen and Demski, 2004). For example, more
information can have a negative value even if it is costless – this is because parties
anticipate that others will adjust their decisions to the information, and they react
accordingly, thereby changing the decision environment, which again affects the
informed parties’ decisions. Thinking in equilibrium terms is important to understand
the ?nal consequences of different accounting standards. Ex ante desirable accounting
standards may produce unfavorable effects ex post, and ex post favorable outcomes
may require ex ante second-best standards. The following themes are illustrative.
3.1 Decision usefulness versus stewardship
The joint IASB/FASB (2008) exposure draft (henceforth ED Framework) sets out the
objective of ?nancial reporting and the qualitative characteristics of ?nancial reporting
information. The overarching objective is to provide useful information to capital
providers, where usefulness encompasses assessing cash ?ow prospects and assessing
stewardship. The relationship between decision usefulness in the sense of providing
information to capital providers and stewardship has been a subject of controversial
discussion. Despite mentioning stewardship in the ED Framework, the IASB considers
stewardship as being part of the decision usefulness objective because stewardship
responsibility is generally related to resource allocation decisions. It suggests that the
same accounting system can serve both (sub-)objectives well.
Acknowledgingthat there are several meanings of stewardship, one of themis tode?ne
a performance measure for management that not only reports the performance over a past
period but also provides incentives for management to make decisions in the interests of
investors. This is an area for which agency theory provides a number of insights. One
important one is that decision usefulness and stewardship require different information
(see Gjesdal (1981) for a general analysis). To illustrate the logic behind this argument,
consider a simple LEN agency model with a risk neutral owner who contracts with a
risk-averse manager (with exponential utility)[5]. The manager exerts effort a to produce
stochastic outcome x(a, u) ¼ a þ u, where a is the activity of the manager and u is a
normallydistributednoise termthat captures all productive events beyondmanagement’s
control. The activity a is costly to the manager and unobservable. Outcome x is not
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observable in the short run, so the incentive compensation of the manager is based on a
noisy signal y of x. Assume that compensation is linear in y. The optimal linear contract
trades off incentives and risk by optimizing pay sensitivity.
Consider a choice between two accounting systems: system 1 provides a noisy
signal about outcome x, ~ y
1
¼ ~ x þ ~ 1
1
¼ ða þ
~
uÞ þ ~ 1
1
, whereas system 2 provides a
noisy signal about effort a, ~ y
2
¼ a þ ~ 1
2
. Assume that the noise terms ~ 1
1
and ~ 1
2
are not
correlated. Then, from a stewardship perspective, system 2 is preferable if the variance
of signal 1 is less than that of signal 2, i.e. Var½ ~ y
2
? ¼ Var½ ~ 1
2
? , Var½
~
u þ ~ 1
1
? ¼ Var½ ~ y
1
?.
This is likely to hold. Froma decision-usefulness perspective, signals are valuable if they
provide incremental information to the market price. The market price conditional on a
signal is:
Pð y
i
Þ ¼ E½~ xjy
i
? ¼ a
i
þ
Covð~ x; ~ y
i
Þ
Varð ~ y
i
Þ
· ð y
i
2a
i
Þ:
System 1 is clearly valuable because:
Covð~ y
1
; Pð~ y
1
ÞÞ ¼
Covð~ x; ~ y
1
Þ
Varð ~ y
1
Þ
· Covð ~ y
1
; ~ y
1
Þ . 0;
whereas system 2 is not valuable as Pð y
2
Þ ¼ E½~ xjy
2
? ¼ a
2
and Covð ~ y
2
; Pð ~ y
2
ÞÞ ¼
Covð ~ y
2
; a
2
Þ ¼ 0. The reason is that the market anticipates correctly on average the
incentives to the manager that are provided by the accounting system. Hence, providing
information about the activity is not useful for adjusting the market price, but it is useful
for stewardship purposes. Thus, value relevance is not necessarily a useful criterion to
measure the usefulness of information. In the simple example, it even reduces social
welfare, as system2 provides more ef?cient incentives, whichincreases the market price of
the ?rm, i.e.:
E½Pð y
2
Þ? ¼ E½E½~ xjy
2
?? ¼ a
2
. a
1
¼ E½E½~ xjy
1
?? ¼ E½Pð y
1
Þ?:
The example illustrates another point: in the EDFramework (BC1.26), the IASB suggests
that stewardship might imply that the performance measure should eliminate the effects
of events that are beyond management’s control, and this is not desired by the IASB.
Indeed, being able to separate out some noise in either of the two accounting systems
increases the stewardship value and, consequently, ?rmvalue inthe example because risk
stems fromthe noise inthe (linear) measures, and a risk reduction lowers the riskpremium
payable to the manager. However, suppose the noise includes information on the
productivity of the manager or the way the activity adds value to the ?rm. Then, it is
bene?cial to include it in the performance measure, as eliminating it would insure the
manager against the effects so that the incentives to adjust the activity are eliminated
as well.
An extreme example for the disadvantage of a very informative signal is the use of
market values for performance evaluation. Assuming a market with rational
expectations, market participants anticipate management’s incentives and activities
and price them correctly (on average). If this market price is used as the performance
measure, the manager maximizes his or her expected utility contingent on the market
price which he or she takes as given. That is, the manager does not control the bene?t,
but only the cost of the activities. Consequently, in equilibrium, incentives break down
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(Dutta and Zhang, 2002). The market anticipates this outcome and sets the market
price accordingly low. Again, relevant information for decision usefulness destroys
?rm value if it is used for performance measurement.
This discussion illustrates that decision usefulness and stewardship are clearly
distinct objectives. They cannot be simply dealt with by disclosures, but the objective
also affects recognition and measurement.
One might argue that ?nancial reporting standards are not aimed at providing
contracting information for parties that have the power to demand information they
need (Barth, 2008, p. 1168)[6]. Parties that can write individual contracts could then
design their own information system and accounting standards could ignore
stewardship. Even in that case, it might be in the best interest of parties to contract on a
single accounting system ( Feltham et al., 2006).
3.2 Neutral measurement
The ED Framework de?nes faithful representation as a fundamental qualitative
characteristic of ?nancial reporting information. Faithful representation includes
neutrality, which is the absence of bias, and it excludes prudence because it would
introduce bias inthe ?nancial information. Interestingly, accounting systems have always
been conservative, and the empirical literature that studies earnings attributes considers
(conditional) conservatism even as a desirable property of earnings numbers. The IASB
appears to view accounting as a technology that should just be designed so that it most
precisely measures the essence of economic transactions and events as if there were a
“correct” way of accounting. However, transactions do not occur exogenously; accounting
in?uences decisions made byeconomic players ( Demski, 2004). Byattemptingtoneutrally
measure transactions and events, accounting affects decisions in a certain way that may
be undesirable. Assuming that management has incentives to in?ate earnings, neutral
standards do not result in neutral ?nancial information after taking account of
management’s incentives (Chen et al., 2007). Moreover, several parties involved in the
accounting process, including auditors and enforcement institutions, have asymmetric
loss functions which induce biased veri?cation mechanisms.
Aside from induced bias, the information economics literature identi?es several
reasons why biased information can be strictly preferable to neutral, unbiased
information (Kwon et al., 2001). One set of reasons includes restrictions on management
contracts that can be ameliorated by adjusting the accounting system. For example,
contracts are generally incomplete in that they can be renegotiated, they include
limited liability, and they have a maximum length. Reporting unfavorable information
early or more precisely can ?t the contracting environment better and can ultimately
increase welfare.
Another issue is the information environment. Financial reporting is not the only
source of information about entities. The ED Framework acknowledges this fact, but
discusses no consequences for the qualitative characteristics. De?ning desirable
properties in a conceptual framework neglects complementary information[7]. Agency
theory suggests that biased accounting information can be bene?cial in such an
environment. Consider a multi-activities LEN agency model where two signals are
available for contracting. One signal is the market price that is determined in a rational
expectations equilibrium, the other is an accounting signal. The optimal accounting
system generates biased signals because they best complement the information
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contained in the market price. Intuitively, a neutral accounting system would mimic
the information in the market price and put too much incentive weight to those
activities that are included in the price (which are often the short-term results). A
biased accounting system generates signals that can be used to shift incentives to other
important activities at a lower cost (Feltham and Xie, 1994). Similarly, accounting
information has comparative advantages relative to other information sources. For
example, it is usually more reliable (veri?ability in the terms of the ED Framework).
Putting more weight on reliable information can be bene?cial if there are
complementary sources of information.
This discussion also highlights that the derivation of IFRS for private entities fromfull
IFRS may not adequately capture the differences in the information environment between
these two groups of entities. For listed companies, a wealthof additional information, such
as market prices, analysts’ forecasts, interim information and the like exists, which is not
available for private companies. It is dif?cult to imagine that such information would not
have an effect on the desirable characteristics of accounting standards for private
companies. Again, it appears as if the IASBconsiders accounting informationas “right” or
“wrong” rather than the result of a cost-bene?t trade-off in equilibrium.
3.3 Aggregation
Most ?nancial information is highly aggregated; users are generally interested in
“bottom line” measures, such as net income and net assets. Aggregation destroys some
of the information carried by individual items (except in the special case of a suf?cient
statistic). Let aside psychological effects, economic bene?ts of aggregations may arise
from the fact that the aggregate can be more precise than the individual items if they
are measured with error (Arya et al., 2004) or that the aggregation carries some
information not included in the individual items, such as their “similarity.”
Aggregation can also substitute for a lack of commitment not to use detailed
information “too” aggressively and, therefore, is useful if termination or renegotiation
of contracts cannot be excluded (Christensen et al., 2003).
Another theme is how items are best aggregated and what items should be
separately presented. In accounting, aggregation is performed by adding or
subtracting the carrying amounts of recognized items. This is rarely an optimal
weighting of signals. Weights depend, among others, on the relative relevance and
reliability of the signals, their bias, their covariances and their incremental information
content (see Banker and Datar (1989) for a single-action model). To illustrate, assume
again a LEN agency model with two outcomes that add to total outcome x:
~ x ¼ ~ x
1
þ ~ x
2
¼ ða
1
þ ~ 1
1
Þ þ ða
2
þ ~ 1
2
Þ;
where ~ 1
1
; ~ 1
2
are normally distributed and uncorrelated noise terms. Consider an
aggregated measure of the two outcomes x
1
and x
2
, mðxÞ ¼ m
1
· x
1
þ m
2
· x
2
, and let
management compensation be linear in m. The risk aversion of management is
captured by r, where higher r indicates higher risk aversion. Then, the optimal
aggregate results in a relative weight of:
m
1
m
2
¼
1 þ r · s
2
2
1 þ r · s
2
1
;
that is, the more noisy outcome (with higher variance s
2
i
) implies a lower weight[8].
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Given the importance of the various characteristics and interaction of the items that
are aggregated, it can be that a mixed-attribute approach is closer to an optimal
weighting than a consistent measurement approach. A mixed-attribute approach
introduces different weights based on type and precision of transactions and events.
For example, some transactions are not recognized, such as R&D, hence, receive zero
weight; impairment rules imply a greater weight on unfavorable than on favorable
events; and prudence in general puts less weight on less reliable indicators. Of course,
other themes are also important for different measurement concepts.
4. Conclusions
The IASB has been remarkably successful in developing accounting standards that
are accepted worldwide. This paper discusses some “costs” of this success, particularly
the increased scrutiny by powerful political players, such as the European Union, and
the pressure to remain successful and productive in the future. The paper identi?es two
growth strategies that are pursued by the IASB:
(1) the work on fundamental projects; and
(2) diversi?cation to private entities.
Both strategies are intriguing, and both carry risk of failure. Risks arise from the fact
that theory suggests there is no single optimal accounting system for different uses,
and history up to now shows that no single consistent accounting system prevails in
practice.
Theory sharpens our thinking about the potential economic effects of standards in
various environments that should be considered by standard setters. Examples of
insights from information economics illustrate that it is dif?cult to come up with robust
answers that would be of suf?cient guidance to standard setters to know how to set the
standards. Nevertheless, ignoring other effects can lead to undesirable standards.
Given that situation, it appears that a monopoly standard setter is not the best way
to regulate ?nancial reporting globally. Constrained competition may be better suited
because it would provide more and different solutions to companies (Benston et al.,
2006, Ch. 10). They could self-select the standards they apply based on their individual
costs and bene?ts, where the choice itself is revealing. Eventually, the market rather
than a global standard setter would sort out which standards are more useful than
others. Competition between standards would also generate data that can ex post be
used to empirically study the economic effects of the different standards. It should be
noted that the forming of a monopoly in accounting standard setting is not the “fault”
of the IASB; it has done, and is bound to do, its best to get as much acceptance
worldwide as it can. It is the task of jurisdictions and other institutions that adopt or
recommend IFRS.
In any case, these are fascinating times for accounting researchers, and they are
proof that accounting is important and has real economic effects, albeit one might wish
that the effects were less detrimental as they are in the recent ?nancial crisis.
Notes
1. See IASB Insight, Q3 2007; a detailed list of the use of IFRSs in countries is available at:
www.iasplus.com
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2. Greg Jonas (Managing Director von Moody’s Accounting Specialist Group) quoted in
Deloitte (2008, p. 10).
3. However, several major organizations, such as the FASB and NASBA, voiced concerns
about the proposal in their comment letters to the SEC.
4. Interestingly, the International Public Sector Accounting Standards Board Activities
develops standards for public sector entities, which are based on IFRS but adapted to the
special needs of these entities.
5. The example is taken from Wagenhofer and Ewert (2007, pp. 136-40).
6. The question is: if the IASB, for example, writes standards that are most useful to users who
do not have the power to write individual contracts, is the usefulness of the information
dependent on the availability of power?
7. Note also that empirical measures of earnings attributes usually cannot capture such
bene?ts and trade-offs adequately.
8. This result bears some resemblance to calculating conditional expectations, although their
expressions are different; in particular, risk aversion is important here.
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About the author
Alfred Wagenhofer is a Professor of Accounting at the University of Graz. He served as the
President of the EAA, Vice President-International of the AAA, and Vice President-Finance of
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