Part 3: Setting standards internationally

3.1
In this Part, I comment on setting financial reporting standards by the two main international boards that set such standards: the International Accounting Standards Board, and the International Public Sector Accounting Standards Board. These comments show that there is a set of international financial reporting standards for use by public sector entities around the world.

Standard setting activities of the International Accounting Standards Board

3.2
The International Accounting Standards Board is an independent international standard-setting board established in 2001. Members of the Board are appointed and overseen by trustees who are accountable to capital market authorities and are expected to act in the public interest. The Board's objective is to provide the world's international capital markets with a common language for financial reporting.

3.3
Until 2001, there was an International Accounting Standards Committee that had created international accounting standards and international interpretations of those standards for application by profit-oriented entities. Those standards and interpretations were largely a product of international consensus. As a result, the requirements of the standards and interpretations often contained options for recognising, measuring, or presenting transactions.

3.4
The International Accounting Standards Board decided to adopt the standards and interpretations of the International Accounting Standards Committee as a basis for the standards that it would put in place. In my view, that decision was made for expediency rather than because the International Accounting Standards Board members necessarily agreed with the full content of the standards and interpretations they adopted from the International Accounting Standards Committee. I am aware, for instance, of several occasions when the International Accounting Standards Board chairman has made less than favourable public comments about several International Accounting Standards Committee standards adopted by the International Accounting Standards Board.

3.5
Nevertheless, the decision to adopt the International Accounting Standards Committee's standards and interpretations meant the International Accounting Standards Board had a suite of 31 standards and 11 interpretations soon after it was established.

3.6
Soon after the International Accounting Standards Board was established, the European Union passed a regulation to adopt IFRS for listed entities from 2005. The European decision was followed by decisions in Australia and New Zealand in 2002 to adopt IFRS as the basis for financial reporting standards for all entities (see Part 2).

3.7
The pace of adoption of IFRS for listed entities by other countries has been phenomenal. There are now more than 100 countries that either require or permit the use of IFRS for listed entities (although very few of these countries adopted IFRS, or used IFRS as a base, for public benefit entities).

3.8
The early decision by the European Union to adopt IFRS from 2005 for listed entities put some pressure on the International Accounting Standards Board to have in place a reasonably stable set of standards by 2005 to ease the adoption of IFRS. In the lead up to 2005, the International Accounting Standards Board added five standards and one interpretation to the suite of standards and interpretations adopted from the International Accounting Standards Committee. Standard setting work continued after getting these standards and interpretations in place. However, the International Accounting Standards Board decided that any further standards or interpretations would not apply until 2006 or beyond.

3.9
In the first full year of the International Accounting Standards Board's operation, there was a joint meeting with the United States Financial Accounting Standards Board. I understand the meeting took place because the International Accounting Standards Board wanted IFRS to have international credibility. International Accounting Standards Board members were aware that the United States was a very influential country in international capital markets.

3.10
At a joint meeting of the International Accounting Standards Board and Financial Accounting Standards Board, both Boards acknowledged they were committed to creating high-quality compatible accounting standards for cross-border financial reporting. The Boards would use their best efforts to:

• make their existing financial reporting standards fully compatible as soon as practicable; and
• co-ordinate their respective future work programmes to ensure that, once achieved, compatibility would be maintained.

3.11
Six to seven years later, the convergence of United States financial accounting standards and IFRS is still a priority for the International Accounting Standards Board. That Board and the Financial Accounting Standards Board continue to work on converging their standards. There needs to be enough convergence to enable non-United States companies registered in the United States to use IFRS-based financial information without the need to reconcile that information to information based on United States financial accounting standards. Further to that, I understand the United States Securities and Exchange Commission is giving thought to whether and when it might permit United States companies to adopt IFRS for financial reporting purposes.

3.12
The International Accounting Standards Board has produced many standards, interpretations, changes to standards and interpretations, and discussion papers. I know that there have been more than 50 such pronouncements issued by the International Accounting Standards Board in the past 4½ years. That volume of material is difficult enough for large multinational companies, their stakeholders, and other interested parties to engage with, let alone others.

3.13
As is to be expected, the International Accounting Standards Board's standards and interpretations are focused largely on companies operating in the world's capital markets, including standards and interpretations for:

• the types of transactions those companies carry out; and
• the information used by people interested in those companies (for example, investors, analysts, and regulators).

3.14
Some of the significant areas of standard setting work carried out by the International Accounting Standards Board in recent years include:

• new standards on disclosing financial instruments information, and reporting disaggregated financial information;
• revised standards on accounting for business combinations when one entity acquires another entity, on capitalising borrowing costs when constructing assets, and on recognising and measuring financial instruments;
• a possible new standard (later this year) on recognising and measuring liabilities; and
• discussion papers about presenting financial statements, and measuring assets and liabilities at fair value.

3.15
Also, for the past few years, the International Accounting Standards Board (in conjunction with the Financial Accounting Standards Board) has been putting a lot of effort into creating a new conceptual framework for profit-oriented entities. Because this is a large project, it has been split into eight distinct phases. Each phase is expected to result in a discussion paper and a draft proposal before any proposal is finalised.

3.16
At the end of March 2009, two discussion papers and one draft proposal had been issued for comment but no proposals had been finalised and issued.

3.17
The proposals for the framework seem to be built on the following main purpose for financial reporting – that of providing financial information about an entity that can be used by capital providers (current and potential equity investors, lenders, and other creditors) to make economic decisions. There is also a strong emphasis on assessing cashflow prospects, including the ability to generate cashflows and reinvest in operations.

3.18
The seventh phase in the International Accounting Standards Board's project to create a conceptual framework will consider how the framework could be applied to not-for-profit entities. Given the positioning of this phase within the context of the overall project, I have doubts about what the phase will achieve. I also have doubts about whether the phase will be carried out at all, given that not-for-profit entities are currently outside the International Accounting Standards Board's overall objective (see paragraph 3.2).

3.19
In my view, the direction being taken by the conceptual framework project does not bode well for New Zealand public benefit entities. I believe that as long as IFRS remain the basis for financial reporting standards for public benefit entities, the International Accounting Standards Board's conceptual framework will be the basis for any new New Zealand equivalent framework. This conceptual framework will have a narrow focus that will make it difficult to adapt in a meaningful way for most New Zealand public sector entities. I elaborate on this concern in Part 4.

3.20
In summary:

• the International Accounting Standards Board is acknowledged as an international standard setter for entities operating in the capital markets;
• already more than 100 countries have adopted IFRS (however, in nearly all of these countries, IFRS are being adopted by listed entities only); and
• increasingly, the International Accounting Standards Board is narrowing its focus in a way that will make adaptation for public benefit entities more difficult.

Standard setting activities of the International Public Sector Accounting Standards Board

3.21
The International Accounting Standards Board is not the only international board setting financial reporting standards. The International Public Sector Accounting Standards Board (also known as the IPSASB) is a part-time international standard setting board within the International Federation of Accountants (the global organisation for the accountancy profession).¹ One of my staff represented New Zealand on the International Public Sector Accounting Standards Board from 2004 to 2008. The objective of the International Public Sector Accounting Standards Board is to serve the public interest by creating high-quality financial reporting standards for use by public sector entities around the world.

3.22
The main focus of the International Public Sector Accounting Standards Board up to 2002 was establishing a core set of financial reporting standards for the public sector. The core set of standards was largely based on IFRS. Importantly, however, IFRS were modified in ways that made the standards more easily applied in the public sector.

3.23
In my view, putting in place the core set of standards helped to establish the credibility of the International Public Sector Accounting Standards Board as an international standard setter.

3.24
From 2002, the International Public Sector Accounting Standards Board began to work on some of the more difficult areas of public sector financial reporting that differentiate the public sector from the private sector. Public sector standards have since been established in several areas including:

• reporting historical results against budgeted information;
• accounting for impairment of assets that are not designed to generate a commercial return; and
• accounting for revenue that is not derived through a normal commercial transaction.

3.25
Writing standards about difficult public sector issues has taken considerably more time than the core set because of the work needed to properly address the public sector perspective.

3.26
More recently, in 2007, the International Public Sector Accounting Standards Board reconsidered its strategic direction. Four strategic themes emerged. These themes were:

• creating a public sector conceptual framework;
• working on public sector-specific projects;
• converging International Public Sector Accounting Standards (IPSAS) with IFRS; and
• promoting and communicating IPSAS.

3.27
The International Public Sector Accounting Standards Board gives equal weight to each of these strategic themes. That equal weighting is a change from the International Public Sector Accounting Standards Board's focus, until 2002, on converging IPSAS with IFRS.

3.28
A significant focus of the International Public Sector Accounting Standards Board's work since 2007 has been creating a conceptual framework for reporting by public sector entities. The International Public Sector Accounting Standards Board decided that this work would not be part of its convergence with the work of the International Accounting Standards Board. That is, the International Public Sector Accounting Standards Board's conceptual framework project is separate from, and not designed to adapt, the conceptual framework of the International Accounting Standards Board (as discussed in paragraphs 3.15–3.19).

3.29
The International Public Sector Accounting Standards Board's conceptual framework is focused on the public sector and will need to recognise the real differences between the public and private sectors. The framework will also need to make explicit the concepts, definitions, and principles that will underpin public sector reporting in future. The Board's approach to the conceptual framework could have significant implications for the convergence of IPSAS with IFRS.

3.30
Work has also continued on core public sector areas such as social policy obligations (for example, the obligations of governments in relation to pensions) and long-term fiscal sustainability. In 2008, the International Public Sector Accounting Standards Board approved a project on long-term fiscal sustainability reporting.

3.31
There is an implicit recognition by the International Public Sector Accounting Standards Board in taking on a project about long-term fiscal sustainability reporting that traditional historical financial statements (such as income statement, statement of cashflows, and balance sheet) have their limitations in providing useful information. I agree that traditional financial statements do not work particularly well for some of the difficult public sector accounting and accountability issues.

3.32
New Zealand already has various forms of long-term fiscal sustainability reporting. For instance, the Crown has a report on its long-term fiscal position for at least 40 years ahead. In the local government sector, long-term council community plans include forecasts for at least 10 years.

3.33
Long-term fiscal sustainability reporting is gathering momentum around the world as the affordability of government programmes comes more sharply into focus. Increasingly, this is the sort of information that people need to see in order to hold governments and public sector entities to account, in addition to the information in the traditional financial statements.

3.34
Although a lot of the International Public Sector Accounting Standards Board's attention is focused on difficult public sector accounting issues, convergence with IFRS remains an important part of the Board's work plan. The convergence of IPSAS with IFRS is not yet complete. Work is under way on a range of topics, such as financial instruments, intangible assets, and entity combinations. For these topics, IFRS continue to be used as the starting point for IPSAS.

3.35
The Board's approach to convergence is straightforward in that, where appropriate, IFRS are adapted to suit public sector circumstances and transactions. The International Public Sector Accounting Standards Board has established what it calls "rules of the road". The rules (better described as guidelines, as they are not applied rigidly) help the International Public Sector Accounting Standards Board to decide when it is appropriate to change IFRS to produce high-quality IPSAS for application by the public sector.

3.36
The International Public Sector Accounting Standards Board's approach includes a set of criteria applied on a case-by-case basis. These criteria for amending IFRS include things such as "where objectives of public sector financial reporting will not be met", and "where the cost of applying the IFRS (without change) would exceed the benefit".

3.37
It is interesting to contrast the International Public Sector Accounting Standards Board's approach to IFRS convergence with the approach being taken in New Zealand. As noted in Part 2, the approach in New Zealand, particularly since the establishment of the stable platform of NZ IFRS in late 2004, has been to make minimal change to IFRS. In my view, the International Public Sector Accounting Standards Board's approach is a more neutral approach and generally results in more changes being made to IFRS.

3.38
During the next few years, the International Public Sector Accounting Standards Board will create further standards and guidance to deal with issues not addressed in the current financial reporting standards. During that period, I expect there will be an increasing trend around the world for countries to adopt (or adapt) the International Public Sector Accounting Standards Board's standards for use by governments and other public sector entities.

Concluding comments

3.39
In my view, those responsible for setting public sector financial reporting standards in New Zealand need to make better use of the work of the International Public Sector Accounting Standards Board. That work should help shape New Zealand's public sector financial reporting standards.

3.40
The relevance of the International Public Sector Accounting Standards Board to New Zealand is only likely to increase as it deals with issues not adequately dealt with in IFRS (given that the focus of the International Accounting Standards Board is on large profit-oriented entities accessing capital markets).

1: The International Public Sector Accounting Standards Board is not currently subject to independent oversight. It is possible that the Public Interest Oversight Board within the International Federation of Accountants could provide independent oversight sometime in the future.