IFRS: a global IFRS: a global threat to threat to

cooperatives?cooperatives?Rob BryerRob Bryer

A Different Business Model?

Our members have worked hard all over the world to inform accounting standard setters about the co-operative model. But we have often found in the past that standard setting organisations reached simplifying assumptions that would treat the co-operative business model as synonymous with the investor-owned business model (International Cooperative Alliance, 2008).

• Combines the needs of the owners with the needs of the users

• Profit making but not profit oriented. • One member one vote.• In investor owned companies, the more money

you invest, the higher your returns.• But in co-operatives, the “return” is often

focused on your patronage or use of the co-operative.

• Many co-operatives remunerate their members by paying a patronage dividend, which represents an adjustment, aimed to compensate the members for what they paid in excess or received less in their transactions with the co-operative.

Welcome to the world of ‘Mad-professor accounting’!

“At least some of the board’s critics – including finance directors, investors and accounting firms – have got more cranky in 2006. They harbour different gripes, but there are recurring themes: the board is promulgating mad-professor standards; it is in the pocket of the US Financial Accounting Standards Board; and that while willing to listen to critics, it never changes its mind” (Financial Times, 21st December 2006).

Globally uniform rules?

“The … Enron collapse revealed, as perhaps never before, the central role of financial reporting in a capitalist system. Where doubts and lack of confidence exist money will not be invested.

Sir David Tweedie, Chairman, International Accounting Standards Board

The role of the IASB is to ensure that the worldwide accounting method for dealing with any particular transaction is the same whether the event takes place in Stuttgart, Seoul, Seattle or Sydney.

Our mission is to produce one set of high quality, global standards. Our aim is to converge on the best possible answer”.

Accounting is the language of business?

In theory, all business entities should account for identical transactions the same way no matter where they occur.

Spread of DEB and cost-based accrual accounting in the 18th and 19th centuries = shared the same accounting model.

With economic development, accounting regulations and laws increased.

Different histories, traditions, and practices. Caused different rules and institutions. Many differences remain today.

We are on the road to global accounting!

Since 2005, all EU listed groups use IFRS. Australia, NZ, Russia and China, agreed to

implement IFRS. Japan & China aligned their rules near to IFRS. 2006: FASB/IASB agree on ‘convergence’. 2007: companies listed in the US that use IFRS

need not reconcile to US GAAP. 100+ countries now require or allow IFRS. US will switch to IFRSs from 2011-14! December 2009: Japanese option of IFRSs for

listed companies.

IFRSs around the world

Darker areas indicate countries that require or permit IFRSs.

Lighter areas are countries seeking convergence IASB or pursuing adoption of IFRSs.

In August 2008, the SEC announced that the US planned to adopt IFRS from 2014.

“… the triumph of IFRS as the single global accounting language” (Financial Times, 28th August 2008).

The issue of global financial reporting

Why is the world adopting IFRSs? Why is the world adopting IFRSs? Will the IASB succeed:Will the IASB succeed: In writing agreed rules? In writing agreed rules? Enforcing them?Enforcing them? For For allall for-profit entities? for-profit entities? AllAll entities will account for same transactions entities will account for same transactions

the same way? the same way? What are the implications for co-operatives? What are the implications for co-operatives?

Long Booms and Downturns

Average % change

1890-1913 1950-1973 1973-1996

GDP 4.0 4.0 2.9

GDP/hour 2.2 2.6 1.2

GDP/capita 2.1 2.5 1.8

Real wage (mfgr)

1.6 2.2 0

Gross capital stock

5.4 3.2 -

Gross capital stock/hour

3.4 1.7 -

Source: Brenner (2006), Table 1

The decline in world profitability

0

5

10

15

20

25

30

35

40

1949-59 1960-69 1970-79 1980-90 1991-2000

Net p

rofit

rate

s

US mfgr

US private

Japan mfgr

Japan private

German mfgr

German private

Source: Brenner (2006, table 15.1, p.282).

Who are global investors?

• 2000: Top 1% > $500,000 capital = 37 million adults.• Anglo-Saxon countries have 46.9% of the world’s

richest 1% (Davies, 2006, Table10b), and own most of the world’s shares.

Percentage Membership of Wealthiest 1%

North America, 39.1

Latin & Caribbean, 2.1Europe, 26.2

Asia: China, 0

Asia: India, 0

Asia: High income, 31

Asia: other, 0.6

Africa, 0.2

Oceania, 0.8

Source: Davies, et al (2006, Table 10a).

The drive to IFRSs

1. Global capital market allows investors to hold globally diversified portfolios to improve their returns.

Requires comparability of accounting. Overcomes ‘home bias’.

2. Persistent overcapacity in manufacturing, particularly in Germany & Japan.

Underlies continuing low global profitability. IFRSs will allow the global capital market to

discipline entity management?

Source: Solnik, 1988, pp.47.

Does it work?

Sharpe Ratio = (Portfolio Return - Risk-Free Return) / Standard Deviation

EAFE = Europe, Australia and Far East

The distribution of world GNP(Each county's size is relative to its share of the world's GNP in 1991.)

Source: http://www.developmenteducation.ie.

Global distribution of wealth in 2000 (%)

North America, 34.3

Latin & Caribbean, 4.4Europe, 29.5

Asia: China, 2.8

Asia: India, 0.9

Asia: High income, 22.9

Asia: other, 3.1

Africa, 1.1

Oceania, 1.2

Source: Davies, et al (2006).

Two accounting languages of business?

1.1. ‘‘Conservative’ + secretive:Conservative’ + secretive: Germany, Japan, France, Italy‘, etc. Deliberately understate and/or ‘smooth’ profits

and capital. For insiders: ‘stakeholders’ (creditors, employees,

suppliers, government, customers, investors) or family owners/managers.

2.2. ‘‘Fair’ + transparent: Fair’ + transparent: UK, US, Canada, Australia, NZ, etc. ‘True and fair view’ (UK) or ‘present fairly in

accordance with GAAP’ (US). For outsiders: well-diversified, equity investors.

Shareholders’ equity in German and US GAAP

1992 1993 1994

DM millions

DM millions

DM millions

According to German GAAP 19,719 18,145 20,251

According to US GAAP 27,604 26,281 29,435

German GAAP/US GAAP 0.7144 0.6904 0.6880

“… support[s] the conservatism and smoothing hypotheses generally linked to German GAAP in the literature” (Radebaugh, Gebhardt and Gray, 1995, p.186).

A global conceptual framework?

To judge accounting the ‘best’ requires an agreed theory.

Only the US, UK, Canada, Australia, and New Zealand and the IASB have a conceptual framework based on ‘decision-relevance’:

“… the role of financial accounting and reporting in the economy [is] ... to serve the public interest ... to provide even-handed financial and other information that, together with information from other sources, facilitates efficient functioning of capital ... markets” (FASB, 1978, Preface).

Is there an ‘Anglo-Saxon’ model?

Capital markets

USA UK

True & fair view‘Present fairly in

accordance with GAAP’

Efficient capital markets Stewardship

Agency problemLegal problem

Auditors hired by management Auditors hired by shareholders

Stewardship (accountability) theory

Personnel controls

Action controls Results

controls

Aim Dedicated, uncontrolled behaviour

Control of observed behaviour

Control of unobserved behaviour

Methods

Qualifications

Tests

Judgement

Ideology

Supervision

Law

Contracts

Physical constraint

(e.g., buildings)

Targets

Accounts

Punishments &

rewards

Principals use a mixture of all three

Judgements

Punishments & rewards

Accounts (results)

Explanations

Principal Agent

Auditor

Checks

Produces

MotivatesHands down

Requires

Hires

Reports

Hires

Sets financial targets

To audit the auditor, shareholders need a theory of accounting.

To hold the agent accountable shareholders need objective accounts.

Stewardship or decision-relevance?

“Shareholder accounts provide information in the investment chain for direct accountability purposes and this transparency brings self-discipline on boards of directors and managers alike.

This accounting goal … should actually be good for … a range of decision-making purposes, though the defining purpose is a proprietorial stewardship purpose, for holders not just share traders” (Bush, 2005, p.12).

Caparo v Dickman (1990) 1 All ER 568:

“[Accounts] provide shareholders with reliable intelligence for the purpose of enabling them to scrutinise the conduct of the company’s affairs and to exercise their collective powers to reward or control or remove those to whom that conduct has been confided”.

 

“Efficient markets and efficient companies are not the same thing” (Bush, 2005, p.14).

Are US accounts the best?

“Because of a constitutional quirk, the US federal reporting model does not address in enforceable law the fundamental capitalist proposition ‘do the accounts show how efficiently a company is run on its capital resources?’ …Instead the federal model poses a legally very different, and actually far more ambiguous question, ‘are the accounts consistent in showing what a company might be worth when a share is exchanged?’” (Bush, 2005, p.2).

The IASB shares the FASB’s aim: “… to help participants in the various capital markets of the world and other users of the information to make economic decisions” (Preface to IFRSs, para.6).

The distinction between debt and equity

Depends on the nature of governance in society. the aim of financial reporting. Regarded as highly significant (Botosan, 2005,

pp.169-171): Shareholders: Dividends and interest = information about returns. Information about financial risk. Lenders: Specify maximum ratios. Regulators use it to manage capital adequacy. Different tax treatment.

The FASB’s Framework Defined liabilities: “… probable future sacrifices of economic benefits

arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events” (FASB, 1985, para 35).

Created a huge area of ambiguity (Botosan, 2005, p.160).

US companies exploited it: Issued ‘corporate bonds’ in the early 1980s. Would repay only if the share price fell (or did not

increase). Accounted as ‘quasi-equity’ (‘mezzanine’). Claimed repayment was only a ‘remote possibility’!

Proprietary theory

Starts from the viewpoint of the owner: Equity = Assets – Liabilities.

Equity is ownership capital: Remunerated only from net profits. Repaid from net assets (accumulated profits). Asset = recoverable cost of a controlled use-

values. Debt is capital: Carrying an enforceable obligation. Remunerated from gross assets. Repaid from the gross assets.

The circuit of capital after interest

M′ - i

P C

C' M

Dividends

EquityDebt

Interest

The traditional distinction

“… between equity and liabilities is clear. The issue of equity creates an ownership interest in a company, remunerated by dividends, which are accounted for as a distribution of retained profit, not a charge made in arriving at the result for a particular period. Liabilities, such as loan finance, on the other hand, are remunerated by interest, which is charged in the income statement as an expense” (International GAAP, 2007, p.1227).

The proprietors

Entity Creditors

Profits or losses

Interest

Loans

Equity

Entity theory

The entity

Ordinary shares

Preference shares

Bonds

DerivativesPerpetual debt

Redeemable shares

‘Claims’ on the entity

Capital goods

Flow of services (Psychic income)

Capital value (PV) Income value

(cash)

The farmer

The banker

The balance sheet

The income statement

C-M-C′

M-M′

Assets = ‘liabilities’?

Starts with assets:

Assets = Equity + Liabilities

Assets = Claims on Assets = ‘Equities’

“For a fictitious person, … as for instance a corporation or a partnership, the liabilities are always exactly equal to the assets; for the balancing item called capital is as truly an obligation from the fictitious person to the real stockholders, as any of the other liabilities” (Fisher, 1906, p.92).

The boards’ entity concept

BC1.12 Under the entity perspective (also known as the entity theory) the reporting entity is deemed to have substance of its own, separate from that of its owners. … Claims of different capital providers have different priorities and different rights with respect to the reporting entity, but they all represent claims on the economic resources of the reporting entity. Therefore, financial reporting from the perspective of the entity involves reporting on the economic resources of that entity and the claims on those resources held by its capital providers.

William A Paton

Puttable instruments?

The right to sell back to the issuer. IAS32: all ‘puttable’ instruments are

liabilities! Proprietary theory: Right to ‘put’ is irrelevant. The relevant question: does the instrument

gives the holder the right to:a) a share of net assets, or b) total assets?

International GAAP

“This analysis has what some regard as a rather startling effect on the financial statements of entities such as open-ended mutual funds, unit trusts, partnerships and some co-operative entities. Such entities often provide their unit holders or members with a right to redeem their interests in the issuer at any time for cash. Any entity whose holders have this right could have net assets of nil, or even negative net assets, under IAS 32 since what would, in normal usage, be regarded as the ‘equity’ of (say) a unit trust or a professional partnership (i.e. its assets less external borrowings) is classified as a financial liability under IAS” (2007, p.1346).

Issued financial instrumentClassification under

existing IAS 32Classification under

amended IAS 32

Share puttable throughout its life at fair value, that is also the most subordinate, does not contain any other obligation, with discretionary dividends based on profits of the issuer

Liability Equity

Share puttable at fair value, that is not the most subordinate

Liability Liability

Share puttable at fair value only on liquidation, that is also the most subordinate, but contains a fixed non-discretionary dividend

LiabilityCompound (part equity, part

liability)

Share puttable at fair value only on liquidation, that is also the most subordinate, but contains a fixed discretionary dividend and does not contain any other obligation

Liability Equity

Any of the instruments described above issued by a subsidiary held by non-controlling parties, in the consolidated financial statements

Liability Liability

2008 amendment to IAS32

Could create “unexpected results”:

“For example, an entity might have one million redeemable units in issue that, but for the redemption right, would be equity under IAS32.

Under the [changes] … these units are equity if there is no more subordinated instrument in issue, but debt if the entity issues just one share that is either subordinated to the units or non-puttable” (International GAAP, 2008, p.1349).

The FASB/IASB is listening?

According to the March 2009 IASB update, the Board tentatively decided that an ownership instrument that is redeemable at the option of the issuer should be classified as equity. Cooperative shares which fulfil the requirements of IAS 32 and IFRIC 2 are redeemable at the option of the issuer and should be considered as permanent instruments and treated as equity.These dispositions certainly accommodate many co-operatives, but not all of them, as some co-operatives have an obligation to redeem their member shares when the member leaves the co-operative (International Co-operative Alliance, 2009).

A ‘new approach’?

This is why we welcome the new approach on puttable or mandatorily redeemable instruments with characteristics of equity. According to the March 2009 and May 2009 IASB updates, the Board tentatively decided that an ownership instrument that is puttable or mandatorily redeemable only upon the holder’s retirement or death (the term retirement being used broadly to include events such as termination, resignation or ceasing to be a member in a co-operative) should be accounted for as equity. This approach could offer great relief to those co-operatives which have an obligation to redeem their members’ shares ….

Problem solved?

We also appreciate … three characteristics (subordination, settlement requirement and claims to percentages of remaining assets) will be used to develop principles for distinguishing liabilities from equity.

These principles and the way they will be used must nevertheless be developed as it is not clear today whether they would result in an equity classification of our member’s shares.

For instruments that the issuer settles with assets: 1. Classify as equity if asset-settlement occurs

because of the following reasons:    a) on distribution of all of its assets (such as

bankruptcy)b) the issuer chooses to pay a dividend or repurchase sharesc) redemption allows existing instrument holders to maintain control of the entity d) the holder ceases to participate in the activities of the entity

2. All other asset-settled instruments are classified as liabilities.

IASB is working on an exposure draft!

IFRS for SMEs?

Changes in accounting standards over the past few years have created big challenges for cooperatives. Even though we understand the advantages of creating a unique set of international financial reporting standards for SMEs, it appears to us that some of these standards are not relevant or useful for SMEs and particularly for cooperatives. …SMEs would require a knowledge and understanding of the full IFRS, which would be difficult for small and medium-size entities which financial and human resources are far less developed than those of listed companies. …We are concerned that the cost and burden of preparing financial statements compliant with IFRS for SMEs would be too high … .

Conclusions

1. IFRS is driven by the global capital market dominated by the USA.

2. ‘Decision-relevance’ is pathological ideology.3. Neoclassical economics or the labour theory of

value.4. Capitalists AND cooperatives need socially

objective accounts.5. Companies AND cooperatives are NOT

‘economic entities’ that ‘has substance of its own’.

Companies are accountable to the collective capitalist.

Cooperatives should be accountable to the collective worker.