“Right GAAP” and the move to IFRS

by Kurt Schulzke on September 3, 2010

Whenever “risk-management” professionals characterize their prognostications as near-certain, I get nervous.  Memories of the Berlin Wall, Black-Scholes, Long-Term Capital Management, Salomon Brothers and AIG dance before my eyes.  Today’s exhibit A: Bruce Pounder’s September 2, 2010 CFO.com article, “Why the SEC Won’t Flip the IFRS Switch.”

Pounder’s “most significant” point — that “for the SEC to order a switch from future U.S. GAAP to future IFRS despite substantial differences … the SEC would have to conclude that the FASB and its standard-setting predecessors completely failed to get U.S. GAAP ‘right'” — embodies a whopping non sequitur.*  Why? Among other things, there is no “right” GAAP any more than there is “a” right spelling of “grey”.

Where Pounder wants to find “right” GAAP answers, reality offers fact-, culture- and jurisdiction-dependent opinions mixed with probability distributions.  The historical record is devoid of a single “right” reported net income number, no matter the GAAP.   When a company reports net income of $X what readers should see is more along the lines of, “With a probability of 95%, our net income was somewhere within the continuum $X plus or minus $100 million.”  And even this net income assertion is of dubious value because it utilizes a variable unit of measure — whether we’re talking U.S., Hong Kong, or Australian $ doesn’t really matter.  None of these currencies offers a constant value.

Hence, the SEC could justifiably say, “We will move to IFRS because while U.S. GAAP narrows P&L uncertainty somewhat in relation to IFRS, the costs of maintaining and regulating an accounting system that duplicates IFRS are higher than the benefits of the associated reduction in uncertainty.”

Will the SEC quickly move to IFRS?  Probably not.  Would it be a good idea?  That depends on the objectives of accounting standards, a matter of considerable controversy.  Arguably, the world of finance is a better place with competing accounting standards-setters.  On some level, they keep each other honest.  Over the long haul, Nassim Taleb offers good counsel: Find out which way the risk management professionals are headed and then run (don’t walk) in the opposite direction.

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* Worth at least a footnote is that the FASB have failed completely in that huge gaps remain in U.S. GAAP after decades of standard-setting. For example, U.S. GAAP still contains no general standard on revenue recognition.