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I have commented before on the movement to adopt International Financial Reporting Standards (IFRS) by the United States to replace US-GAAP (Generally Accepted Accounting Principles). Most recently I discussed the drive toharmonize the significant differences between US-GAAP and IFRS on revenue recognition and lease accounting. To those who are interested in but not intimately involved with the subject, I suspect the current situation is a bit confusing, since there are multiple groups involved in the discussions on how best to proceed, each with its own agenda. The full adoption issue remains in flux, but let me weigh in the matter.
I have long supported IFRS, largely because over the past three decades I have watched US-GAAP become increasingly unwieldy as the Financial Accounting Standards Board (FASB), the group that administers US-GAAP, has made it much more of a rules-based, rather than principles-based, accounting standard. Although the rules are well-intentioned, in several areas (such as revenue recognition) they have become increasingly complex and, to my mind, do not necessarily promote transparency. In an effort to be conservative, companies can understate their economic performance, which allows some investors (usually professionals) to gain an advantage because they can see through the distortions produced by the accounting rules. And it’s not that difficult for companies to slip up and require a restatement, as the recent example with JDA Software made clear.
Lately, though, I’ve been having second thoughts. Some of the arguments for the United States adopting IFRS are so overstated that I want to reject them on rational grounds. This offsets a suspicion that advocates for retaining US-GAAP are mainly attempting to retain their administrative power. In the end, though, I think that the SEC got it exactly right in advocating following a path of condorsement, which will converge US-GAAP and IFRS without formally adopting it for the near term while endorsing the ultimate adoption of IFRS at some time farther out. I agree that adopting IFRS is a worthy objective, but what’s the hurry?
The main argument for the U.S. adopting IFRS immediately is that in global financial markets it’s essential for all countries to use the same standard to ensure comparability of financial statements. This sounds reasonable, especially to those who aren’t accountants. Yet the reality is that today the overall differences between practices in the U.S. and IFRS are not especially great. For example, when global software company SAP shifted to IFRS from US-GAAP, only relatively small differences between the two approaches emerged in the years when it was reporting results in parallel. (SAP minimized differences by electing to largely follow US-GAAP revenue recognition methods.) In some industries (those affected by the differences in revenue recognition and the treatment of leases, for example) there can be meaningful differences. However, if the United States retains US-GAAP but the two systems converge on key differences, I expect that in most cases the gaps between what would be reported using either standard would be slight. Moreover, once the major areas of difference between US-GAAP and IFRS have converged, the argument that the two systems will not offer comparable results becomes specious. Indeed, IFRS is based far more on principles than US-GAAP is, and that approach creates the potential for a similar lack of strict comparability between two companies that use IFRS, even in the same industry.
I have another concern with the U.S. adopting IFRS: The eXtensible Business Reporting Language (XBRL) taxonomy in IFRS is less rich than the one developed for US-GAAP. As things stand, I believe adoption of IFRS by the U.S. would leave investors worse off in this respect. While the International Accounting Standards Board (IASB) talks a good game, I fear it will be many years before the IFRS taxonomy will become as rich in its descriptive capabilities as the US-GAAP version. The IASB views taxonomy-building as being tightly linked to standard-setting, and therefore requiring careful vetting and review. In my judgment, this is at odds with the nature of XBRL taxonomies, which are designed to be loosely coupled and dynamic. Inevitably, a more limited IASB taxonomy would lead to a considerable increase in the use of extensions and a corresponding reduction in financial statement comparability when using XBRL. This would diminish the value of XBRL in communicating financial results.
There is long-term value in the United States adopting IFRS, mainly because it will shift the accounting standard back to a principles-based approach from today’s rules-based regime. But I don’t see a great deal of value in rushing this migration if the main rationale is to achieve greater comparability, and even less if it means diminishing the value of the nascent use of XBRL for financial statement analysis and reporting.
Robert Kugel – SVP Research
I recently attended Vision 2012, IBM’s conference for users of its financial governance, risk management and performance optimization software. From my perspective, two points are particularly worth noting with respect to the finance portion of the program. First, IBM has assembled a financial performance management suite capable of supporting core finance processes as well as more innovative ones. It continues to build out the scope of this suite’s capabilities to enhance ease of use, deepen the capabilities of existing areas and broaden to coverage to complementary or immediately adjacent software categories such as its pending acquisition of sales performance management vendor Varicent Software (covered by my colleague Mark Smith). More specifically, automating management of the extended financial close – that is, all activities from closing the books through filing financial reports with regulatory bodies such as the Securities and Exchange Commission (SEC) in the U.S. or the FSC in the U.K. – is growing increasingly important as regulatory requirements for external financial reporting expand. Companies that have adopted software to manage the extended close are demonstrating the value of using it.
From the briefings I received and the event itself, I conclude that IBM has a clear roadmap for advancing its customers’ execution of the broad scope of their financial performance management functions. At the core is enabling consistent, fast, accurate and intelligent finance processes. Our benchmark research consistently shows a significant disparity between the best-performing organizations and the rest. Typically, two-thirds of corporations have below-average competence in their performance of ordinary finance procedures. For example, in the case of something as basic as the financial close, our research finds a wide disparity in how quickly companies with exactly the same characteristics are able to close their books. I believe that one important reason for slow closing is simply poor management – a lack of organizational agility, weak communication skills and an unwillingness to challenge the status quo mentality. However, another contributing factor is not having the proper tools (or not utilizing these tools to the fullest). Our assessment of IBM’s financial performance management suite last year put it in the upper echelon of these vendors for its ability to support and enhance the ability of finance organizations to perform planning, forecasting, reporting, performance management, closing, reporting and the extended close.
Beyond these important basics, IBM also offers important analytical tools and packaged solutions useful for Finance, which I covered in detail here. They have the ability to enhance productivity and increase effectiveness by providing individuals and organizations with a better understanding of how well they are performing and why, as well as offering guidance on the best course of future action. Analytics, especially predictive analytics, can continuously monitor the details of a business and alert managers only when something needs their attention, enabling them to focus their efforts efficiently on things that matter while knowing they’ll receive the information they need to make decisions about what to do next. Analytics also enables managers to perform simulations to assess the impacts of possible outcomes and calculate the impact of taking each of a variety of courses of action. Moreover, as companies address their data fragmentation issues, they are able to use these broader sets of data to have a clearer picture of their company’s performance beyond their workgroups or functional silos.
With respect to the extended close, one of the sessions at Vision 2012 was a case study of a large oil exploration and production company’s experience in adopting IBM Cognos Financial Statement Reporting (FSR) for managing the production of its financial disclosure documents, including tagging the statements using eXtensible Business Reporting Language (XBRL). The company was able to increase the efficiency of the process in almost every respect. The last-minute changes that once created turmoil are no longer a big issue. By managing the entire process in-house, the company got back the two weeks of lead time a third party would need and uses that time to prepare narratives and readily handle last-minute changes. Moreover, because the company does its own XBRL tagging, it has greater control over decisions on what tags to use. It has cut in half the number of taxonomy extensions (nonstandard tags) it uses. Today, a majority of companies use third-party providers to prepare their filings and tag their financial statements. I think this is a big mistake. Our recent financial close benchmark research indicates that about half of the companies using third-party providers plan to bring their XBRL tagging in-house over the next two years. If they integrate tagging with automating the preparation of their financial filing documents, most will find their extended close is more efficient, gives them more time to prepare the narratives, gives them more control over the tagging and cuts the cost of preparing these filings.
Our benchmark research shows that a majority of finance departments have the potential to improve the quality of and efficiency with which they execute core processes and support the strategic objectives of their company. Software can be a key enabler of efforts to improve finance department performance. I recommend that senior finance executives periodically review their operations to determine whether they are getting as much from their existing software as they can or their performance is hindered by not having the right tools.
Robert Kugel – SVP Research