Closing the Information GAAP

What's the definition of an accountant? Someone who solves a problem you didn't know you had
in a way you don't understand.
What's an auditor? Someone who arrives after the battle and bayonets the wounded.
And drum roll, please: What are Generally Accepted Accounting Principles? The difference
between accounting theory and practice.
No joke, accountants are the Rodney Dangerfields of business. But perhaps they deserve some
respect after all. Accountants in the U.S. are signing up for a fundamental rethinking of how they
do their jobs. As a result, it should finally be possible for global investing and trade to operate on
a common understanding, or accounting, of businesses.
The Securities and Exchange Commission recently announced that the U.S. will abandon
Generally Accepted Accounting Principles -- for almost 75 years, the bible for U.S. accountants
-- joining more than 100 countries around the world instead in using the London-based
International Financial Reporting Standards. Pointing to the "remarkably quickening pace of
acceptance of a true lingua franca for accounting," SEC Chairman Chris Cox set out a timetable
for all U.S. companies to drop GAAP by 2016, with the largest companies switching as early as
next year.
There are specific differences between the two systems; for example, the international system
only allows the first-in, first-out inventory accounting system. The most important difference is
that the international standard is based on principles, whereas GAAP is based on rules. GAAP
suffers from the complexity of trying to set rules for all situations, a complexity that often masks
economic reality.
GAAP rules fill a nine-inch, three-volume set of pronouncements plus interpretive information.
In contrast, IFRS is a slim two-inch book. GAAP was crafted in part by the pressures of the U.S.

legal system. Companies have been glad for GAAP rules as defenses for claims of accounting
irregularities. But these rules often only pretend to provide clarity. There are hundreds of pages
of GAAP covering how to account for derivatives, but this didn't stop opaque pricing
mismatches, which helped create the credit crunch. GAAP rules allowed trillions of dollars in
securitized financial assets and liabilities to stay off the books of U.S. financial firms, while the
international standard, by focusing on the true underlying economics, kept these on the books for
firms based elsewhere.
It's surprising that there is no common language for measuring the performance of companies.
Until recently, all major countries had their own accounting rules, but IFRS has become the
approach of choice. Inconsistent approaches to accounting make it hard to compare an energy
company based in Texas with one based in Amsterdam, a bank in New York with one in London,
or a biotech firm in Boston with one in Singapore. A single set of accounting rules would mean
more effective global disclosure and transparency. It would reduce costs for multinationals that
must now prepare multiple books. It would also make U.S. exchanges more competitive for
listings by eliminating accounting differences.
A measure of the importance of a single standard is the dislocation that getting there will cause.
It will mean rewriting business school texts and retraining of corporate finance departments. The
forensic accountants who sniff out problems will have to develop instincts using a new set of
measures. The transition will also be tough on investors. Under the SEC proposal, larger
companies in the same industry would switch to the international standard before smaller
companies do. Investors for the transition period would have to compare similar companies using
different accounting.
The big U.S.-based accounting firms generally support the abandonment of GAAP. Skeptics
could call this switch in systems the equivalent of the accountant full-employment act for many
years, but the profession itself also recognizes that GAAP often fails to reflect underlying
economics.
A PriceWaterhouseCoopers briefing document for executives on the accounting change notes
that changes will also be necessary in the law. "If an accounting and reporting framework that

relies on professional judgment rather than detailed rules is to flourish in the U.S., the legal and
regulatory environment will need to evolve in ways that remain to be seen." These include that
"regulators will need to respect well-reasoned professional judgments."
A system based on principles could create new defenses for company boards and accountants
who try to do the right thing, if they fully disclose why they thought that a particular accounting
treatment made sense. The law will have to adjust to accept more ambiguity in accounting, as a
necessary condition for reporting with maximum accuracy.
As technology has shown in other areas of life, agreed-upon standards and accepted operating
systems drive usage and efficiency. Common measures add value to information. If even the
belt-and-suspenders accounting profession is willing to take on the risks of switching its basic
system for assessing businesses, we're truly in an era when anything that adds to understanding
belongs in the asset column, while anything that undermines transparency is a liability.