The international accounting world has been preoccupied in recent months by a heated dispute. A disagreement over the International Accounting Standards Board (IASB)'s drafting of the conceptual framework for the International Financial Reporting Standards (IFRS) has not only led to arguments within the profession, but has also provoked criticism from politicians and a threat from the EU to withdraw funding they give to the IASB.
IFRS represents an attempt to "unify the numerous methods of financial reporting across the world," says Steve Smith, an accountant working in the European division of a global retailer. "It's the benchmark for all financial reporting and for presentation of the main financial statements (statement of financial position, profit and loss, changes in equity and cash flows)."
First developed in the latter years of the twentieth century, IFRS were created to help ensure that corporate or governmental accounts would be understandable across national borders. The IFRS's framework and rules are set by the IASB.
The current controversy centres around the IASB's 2010 dropping of a reference to "prudence" in favour of "neutrality" as a core principle. This change might seem just a question of wording, but in fact goes to the heart of what IFRS are all about and how accountants bound by these principles will be required to conduct themselves.
Steve explained the difference between "prudence" and "neutrality" as follows: "Where an accountant is aware of a pending liability (for example, a customer appears to be going into liquidation), a "prudent" accountant would make provisions in the accounts for the potential bad debt and notify his/her superiors so steps could be made to recover the monies. A "neutral" accountant would wait until the matter had unfolded before taking any action."
Across the pond
The contrast between "prudent" and "neutral" approaches has a territorial dimension, with European accountants generally preferring the former and American ones the latter. "Across Europe," explains Steve, "under IFRS and UK GAAP (generally accepted accounting practices) prudence was always promoted as a method of protecting stakeholders and shareholders from liabilities before they materialise."
"However, there has been increasing suggestion within the industry that this method can be used to understate liabilities and overstate profits, creating a false financial position. American accountants under US GAAP are leaning more towards the neutral approach (only accounting when events are realised) and if you consider recent US economic disasters (the most well-known being Enron) you can see why!"
Recently the shift away from prudence and towards neutrality, widely seen as an attempt to conform IFRS more closely with US GAAP, has been criticised by accountancy industry bodies in the UK, France, Germany and Italy. Unlike American accountants, they see neutrality rather than prudence as most likely to produce flawed accounts and thus potentially destablise a business and even the economy as a whole.
MEPs, meanwhile, have not only strongly encouraged IASB to reinstate the reference to prudence, but have also threatened to withdraw IASB's EU funding if this isn't done, which currently represents about a third of its income.
The IASB is showing no signs of backing down on the point at the moment, however. Steve can see the merits of both sides' cases. "For me," he says "there is a fair argument for and against both principals and the best method to adopt should be dictated by the situation and information available." But he thinks both sides are absolutely right to take the matter seriously. "Accountants live by accounting standards," says Steve. "They're the basis of everything they do and they're naturally protective and passionate about their own methods."