Translation from original text in French


Accounting standards at the heart of corporate scandals
 


• LE MONDE | 06.08.02 | 10h27
 
Investors feel lost. Enron, WorldCom, Tyco, Dynegy, ABB, Merck, Adelphia, Xerox..., almost every day, leading corporations come under accusation of cooking their books, and global equity markets continue collapsing. After having been considered for a long time as minor issues, these scandals have reached such a level that they put question marks on the very infrastructure of the financial system. "When you see an accident on a road, you think the driver is responsible. When you see several accidents at the same place, you begin to have doubts about the state of the road. That's where we are now", as Joseph Stiglitz, the 2001 Nobel Prize winner, recently said during a conference in France (Le Monde, July 9).

At least, these scandals had the merit of putting into daylight an important issue which until now had been left to specialists: accounting standards. "These standards are the common language which Capitalism needs to work properly, as investors must compare data from different businesses to pick the ones they'll invest in", summarizes Nicolas Véron, former CFO of Multimania, who recently co-authored a discussion paper on this topic for En Temps Réel, a think tank, together with Saint-Gobain CFO and executive VP Philippe Crouzet.

Not only do companies use different accounting standards--there's a genuine influence struggle between Europe and the US on this. These tables of the Capitalist Law are written by private organisations, which elected governments control only weakly and belatedly.

Two systems, for that matter, dominate the financial planet. One, in the US, emanates from the Financial Accounting Standards Board (FASB), the body which sets the so-called GAAP accounting standards implemented by US corporations. The other, international in essence, is based on the International Accounting Standards Committee (IASC), whose International Accounting Standards Board (IASB) produces the so-called IAS or IFRS accounting standards.

On March 12th this year, the European Parliament nearly unanimously approved an EC rule which makes IAS compulsory as soon as 2005, for all companies publicly listed in Europe. The problem for these companies is that these systems will probably cohabit during several years, and stem from different approaches. "IAS standards are principles-based and leave some leeway to the corporations and auditors. In contrast, US GAAP are based on highly detailed rules. The Americans usually explained that their standards were more reliable, but now it becomes clear that they can be more easily circumvented because the absence of guiding principles leaves loopholes", says Gilbert Gélard, a former auditor and CFO who now is a member of IASB.

Will there be one single set of standards in the future? Officially, everybody desires so. But in truth, each of the parties want to impose its own rules. "Europe would like the IAS to be acknowledged by the SEC in order to spare its companies the need to produce several sets of accounts. The Americans have hesitated some time, but now they start to look in the same direction. Enron, WorldCom and the like are an opportunity for us", comments Patrick Rochet, general manager of Association française des entreprises privées (AFEP), a business advocacy group. Through IAS accounting standards, therefore, Europe could be scoring some points. "It may actually be the only area in the world of Finance where Europe is on a level with the US", Mr Véron notes.

In spite of some opposition, one must admit that both standards-setting bodies are dominated by Anglo-Saxon finance types. "The relationship between IASB and FASB is currently a mix of imitation and rivalry", say Philippe Crouzet and Nicolas Véron. Bob Herz, a former US member of IASB, resigned on July 1st from that position and became the chairman of FASB. IASC is a private-sector entity based in London. Its chairman is one Paul Volcker, former chairman of the US Federal Reserve . Among the 19 IASC Foundation Trustees, there is one Frenchman, Didier Pineau-Valencienne, former CEO of Schneider and chairman of AFEP, who declined to answer our questions. Moreover, the fourteen members of IASB are chosen for their professional background in auditing, corporate finance, investment banking or standard-setting. Officially, their nationality is not taken into account, but ten out of 14 come from the English-speaking world; a German, a Swiss, a Japanese and France's Gilbert Gélard fill the remaining seats. "But I don't represent France, Gélard explains. I'm paid by the IASB, and when decisions are taken I vote following my own opinion. I'm even more independent as I am nearing retirement age."

According to Rochet, "these guys represent only themselves: maybe it's good, but sometimes it's also risky". In any case, it's unusual. On this economically essential issue, Europe accepted to transfer its own powers to a private body, created relatively recently, chaired by an American and not generally accepted by businesses. "But you shouldn't fool yourself. Even in France, where the standard-setting National Accounting Council directly reports to the minister of Finance, this has not been a matter for legislative acts. The truth is that accounting standards are technically complex and require rapid adaptation to a changing economic environment. Parliament will probably never directly write them, because it would be inefficient", Véron says. "Europe has tried with accounting directives in 1978 and 1982, but it failed in harmonizing corporate accounting. The issue is much too complex to be handled by politicians", thinks Gélard.

Nevertheless, Europe keeps a key card: to become enforceable for European listed businesses, IASB's accounting rules must be ratified by the EU. They can be rejected if deemed incompatible with "the European public interest". Real menace, or paper tiger? Nobody really knows, for now. Since the endorsement of IAS by the European Parliament, the Commission has not had to take such a decision yet. But if an IAS rule were rejected by the EU, it would theoretically stay valid in other countries who use IAS, e.g. in Asia. Such an imbroglio could only foster US GAAP.

Frédéric Lemaître

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Three sensitive issue that make finance people nervous
 

There is an in-built dilemma in setting accounting standards. "Accounts must reflect the economic situation of a company, and at the same time be as reliable as possible, says Nicolas Véron, co-author of a study on accounting standards. But these two requirements sometimes collide with each other. To mirror the company's situation, assumptions are needed, and these assumptions may be somewhat arbitrary."

Stock-options are a key example.

If stock options are considered at the time they are granted, there must be an assumption for determining their cost. "There was a debate in 1994 in the US. After intense corporate lobbying, especially by high-tech firms, the standard-setting authorities have chosen reliability instead of reality. Therefore, stock-options are not included at all in income statements. But we know this isn't reality, because stock options actually have a cost", says Véron.

The debate is revived now, but the SEC's head of accounting recently declared that a change in stock options accounting was not a priority. However, several US corporations, including Coca-Cola, the Washington Post, Amazon.com and USA Interactive, have announced in July that they would expense stock options. At USA Interactive, the dilution of earnings per share would have been 18.3 % in 2001.

Meanwhile, the IASB, which sets international accounting standards enforced in dozens of countries now including the European Union, may force companies to expense their stock options. "We want them to be booked as costs. These costs must reflect the value of options when granted. There can be a consideration of the time delay until the options are exercized", says Gilbert Gélard, a member of IASB. This project has not yet been officially released, and there will be a public debate followed by a formal vote of the Board, but all IASB members favour stock option expensing.

The valuation of banking and financial assets is another matter for debate.

Accounting financial assets traditionally involves historical considerations including, for loans, the initial amount and successive capital reimbursements. But the IASB wants to adopt the so-called fair value method, which considers only the value of the asset at the date of closing of accounts. "Intellectually, it's a nice idea, but in practice it leads to unjustified and excessive variations of corporate profits", says Patrick Rochet, general manager of AFEP, a business group. "We have public debates on this issue", Mr Gélard replies. According to him, "this will make corporate profits more volatile, but it is only sound that the market can know whether a business has earned or lost money. Historical costs do not reflect reality".

Amortization of acquisition goodwill.

This issue is apparent in the 2001 accounts of many corporations. Generally, the price paid by a company to acquire another business is higher than the latter's book value. The buyer and the seller include future profits and synergies into the transaction price. This gap between purchase value and book value is named the "goodwill". It must be booked in the company's assets (Le Monde, June 4th). But how should it be depreciated? Until the 1970's, there was no goodwill amortization in the US companies' accounts. Afterwards, it had to be amortized on a long time period, up to 40 years. That's also how French businesses treat it. But in July 2001, the US accounting standard-setter decided to take another step: no more systematic amortization, but write-offs calculated every year on a case-by-case basis. Therefore, following the collapse of tech stocks, some large companies that had conducted mergers or acquisitions, such as AOL Time Warner, Vivendi Universal or France Télécom, had to announce losses of several billion euro.

Frédéric Lemaître

 

Translation by the author
 

 © Le Monde 2002