The Long and Winding Road to Financial
Posted by Robert Eccles (Oxford
University), and Kazbi Soonawalla (Oxford University), on Wednesday,
July 20, 2022
Robert G. Eccles is
Visiting Professor of Management Practice, and Kazbi
a Senior Research Fellow in Accounting at Oxford University Said
Business School. This post is based on the first part of a
three-part series on financial reporting by Professor Eccles and
It is currently an exciting
time in the world of setting standards for sustainability reporting. It is
also a complex and confusing one. Last year saw the IFRS Foundation establish
the International Sustainability Standards Board (ISSB). The ISSB has
consolidated the Value Reporting Foundation (VRF) and the Climate Disclosure
Standards Board (CDSB). The VRF was formed in a merger of the Sustainability
Accounting Standards Board (SASB) and the International Integration Reporting
Council (IIRC). The ISSB has also made the framework of the Task Force on
Climate-related Financial Disclosures (TCFD) a key part of its work. At the same
time, the European Financial Reporting Advisory Group (EFRAG) is working to
establish the reporting standards for the European Union’s Corporate
Sustainability Reporting Directive (CSRD). The Global Reporting Initiative (GRI)
had been supporting this work and more recently announced a collaboration with
the ISSB. Many wonder whether the confusion of many NGOs working on standards
for sustainability reporting is simply being replaced by a world of confusion
from different government-backed organizations doing the same thing. It is in
this context we think it is useful to put the last two years into the historical
perspective of 150 years of setting standards for financial reporting. There is
a rich and fascinating literature on the history of the accounting profession
and establishment of accounting standards with Professor
Stephen A. Zeff being one of the most distinguished scholars in this field.
We have benefited enormously from his work.
Double entry bookkeeping, the place where the road started, is often credited to
Lucas Pacioli’s 1494 publication “Summa de Arithmetica Geometria Proportioni
et Proportionalità.” However, the Italian and other double entry methods
date back to at least 1211.
Over 600 years later The Institute of Chartered Accountants in England and Wales
(ICAEW) was formed in 1880 and was probably the first professional accountancy
body in the world. In the U.S., the American Institute of Certified Public
Accountants (AICPA) and its predecessors were created in 1887 with the formation
of the American Association of Public Accountants. Legislation on reporting
requirements followed and, in the UK, The Companies Act 1900 required all
registered companies to appoint auditors (no professional qualification needed)
to report on their balance sheets and these had to be presented to shareholders
every year. By the 1920s more than 90% of listed industrial firms in the U.S.
prepared audited financial reporting, although there were few formal reporting
obligations. This changed with the formation of the Securities and Exchange
Commission (SEC) in 1934 following on from the stock market crash of 1929. The
Securities Act of 1933 and the Securities Exchange Act of 1934 required firms to
be audited and laid the foundation for financial reporting in the U.S.
The formalization of standard setting followed on from the creation of the SEC,
and the AICPA was an early player in the standard setting world. In 1939 it
appointed the Committee on Accounting Procedure (CAPs) to issue standards. The
CAP’s formation was one of the first attempts to rationalize and legitimize
standard setting. However, in reality it continued to be heavily influenced by
its parent body the AICPA, and the accounting profession was under regular
threat that the SEC could take away its rule-making authority. The main outcomes
of this period were the improvement in uniformity of accounting practices and
the clear establishment of the private sector as the source of accounting
standard setting and policy making.
Despite issuing 51 Accounting Research Bulletins, there were concerns that the
absence of a guiding framework and the lack of independence from the AICPA meant
that the CAP could not effectively do its job. These concerns led to the
creation of the Accounting Principles Board (APB) by the AICPA in 1959. The APB
was regarded as being relatively independent of the AICPA and was created with
the specific purpose of issuing authoritative guidance about accounting theory
and its practical applications. The APB did early good work in standard setting,
but concerns about independence from the AICPA persisted. In the 1970s
responsibility for standard setting was transferred to the newly formed
Financial Accounting Standards Board (FASB). By delegated authority from the SEC
the FASB was made responsible for establishing U.S. Generally Accepted
Accounting Principles (U.S. GAAP), thereby laying the foundation for the
separation of practice and standard setting.
On the global stage, early progress in standard setting took place with the formation of
the International Accounting Standards Committee (IASC) in 1973, through an
agreement made by accountancy bodies from Australia, Canada, France, Germany,
Japan, Mexico, the Netherlands, the UK and Ireland, and the U.S. The IASC
promulgated a substantial body of International Accounting Standards (IAS),
Interpretations, a Framework, and other guidance that was adopted directly by
many companies and used by national accounting standard-setters in developing
their own accounting standards. It meant that even though few countries fully
adopted or required IAS, these standards played a significant role as guidance
or consultative documents for national standard setters. In turn, with some
variation, national standard setters influenced and impacted the work of the
IASC. This was particularly the case with a group known as the G4+1 which
consisted of members of national standard-setting bodies from Australia, Canada,
New Zealand, the UK, and the U.S. (the plus one).
After 25 years of work the IASC concluded in 1997 that to continue to perform
its role effectively it needed to facilitate convergence between national
accounting standards and high-quality global accounting standards. Towards that
end a new constitution was adopted in 2000 and the standards-setting body was
renamed the International Accounting Standards Board (IASB). It was made
responsible for setting International Financial Reporting Standards (IFRS). At
the time of the formation of the IASB few countries had adopted IAS as issued by
the IASC. Two key events changed that quite dramatically. In 2000, the
International Organization of Securities Commissions (IOSCO) endorsed IFRS (and
any extant IAS) for cross-border security offerings in global capital markets.
In 2002 the European Union (EU) made the decision to require IFRS for all
companies listed on European stock exchanges. In a single stroke, all EU-listed
companies were required to adopt IFRS from 2005 and were given a couple of years
to get their houses in order. This gave the IASB a ready and significant
jurisdiction, and national standard setters’ work became more about IFRS
interpretation and writing standards for non-listed companies.
One of the early objectives of the IASB was to create some sort of synergy with
U.S. GAAP and work towards a single set of high-quality global standards. To
this end the convergence project, the “Norwalk
Agreement,” between the FASB and IASB in 2002 was heralded as a much-needed
step towards harmonization.
More generally, the response to the project wasn’t unanimously positive, and
critics harbored concerns about U.S. GAAP/IFRS dominance. These were compounded
with disquiet about inevitable implementation issues around a potential “one
size fits all” approach. There was apprehension that there was considerable
variation in the starting level of preparedness amongst IFRS adopters. For
instance, one country could be adopting IFRS from a situation where their
national standards were closely aligned to IFRS, these would typically be
countries with greater Anglo Saxon or common law influence. In contrast, another
country’s national standards could be ideologically and practically quite
different from IFRS and U.S. GAAP. There were trepidations that “harmonization,”
term which denotes a coming togetherness and flexibility would instead be
stealthily replaced with “standardization,” a term which on occasion signifies a
rigid and autocratic approach to standard setting.
One of the objectives of the Norwalk Agreement was to reach common agreement on
a conceptual framework whose purpose is to set out the fundamental concepts for
financial reporting such as guidance in selecting transactions, the events and
circumstances to be accounted for, how they should be recognized and measured,
and how they should be summarized and reported. FASB’s The
Conceptual Framework was initially issued in the 1978 and The IASC’s Framework
for the Preparation and Presentation of Financial Statements was issued in
1989 and grandfathered through by the IASB in 2002. The conceptual framework was
added to the convergence project agenda in 2004. It was anticipated that this
step would be relatively straightforward. That did not prove to be the case.
The project was divided into a number of phases. In 2010 on the completion of
Phase A, the IASB published The
Conceptual Framework for Financial Reporting and the FASB issued its
updated counterpart. At this stage the boards gave up on getting a common
conceptual framework. Today both boards have their own conceptual framework
related agendas for their ongoing development.
Post the signing of the “Norwalk Agreement,” a number of other countries either
decided to adopt IFRS in full or move their national standards towards IFRS/U.S.
GAAP. Australia transitioned to IFRS in 2005 and Canada in 2011. Accounting
standards for New Zealand companies are based on IFRS and are referred to as NZ-IFRS.
In 2007, the Accounting Standards Board of Japan and the IASB entered into an
agreement to converge Japanese Accounting Standards with IFRS. Since 2010 large,
listed firms in Japan have been permitted to use IFRS to prepare their
consolidated financial statements, in lieu of Japanese GAAP.
In a significant and high-profile move, in 2007 the SEC removed the
reconciliation requirement for foreign registrants that use IFRS. In its 2012 “Final
Report” the SEC staff made no recommendation on potential incorporation of
IFRS into U.S. financial reporting.
In 2013 bilateral efforts started winding down. In its place was established the
Accounting Standards Advisory Forum (ASAF), an advisory body comprising 12
standard setters from across the globe. The FASB was selected as one of the
members to work on global accounting issues and represent U.S. interests in the
IASB’s standard setting process.
There was some inevitable political blaming for the winding down of convergence
efforts, and in June 2014, the former SEC Chairman Christopher Cox, speaking at
the SEC and Financial Reporting Institute Conference, blamed the IASB for the
“divergence” of U.S. GAAP and IFRS. In response, IASB Chair Hans Hoogervorst
defended the project in a letter,
arguing that “Convergence was a limited-scope project,” and like any program had
its successes (such as the converged standard on revenue recognition) and its
challenges (such as the highly contested reporting of financial instruments). In
that context, the creation of the ASAF could be viewed as convergence evolving
into something more dynamic and reflective of global dynamics.
The point of this brief review of the long and winding road to develop financial
reporting standards is obvious. It is also important to note that while the EU
will mandate the standards developed by EFRAG through the CSRD, the ISSB will
depend upon governments requiring their use. The tension with the EU is obvious.
Will there eventually need to be some form of the “Norwalk Agreement?” However
this happens, work should be done to get as close as possible to a global set of
standards for sustainability reporting. But it is important to be realistic
about the effort, difficulties, and time it will take to accomplish this goal.
Which will never be achieved in the purist sense. Just as is the case for
financial reporting standards.
Harvard Law School Forum
on Corporate Governance
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