The time to scrap IFRS accounting has arrived, announces the title of a recent article by Richard Murphy
“This is not the moment to critique the multitudinous failings of IFRS accounting,” says Murphy. “It is instead the moment to note that they are the very opposite of the reasonably objective standards for reporting that any user of accounts might require, most especially at times like this.” The focus of his piece is on the IFRS 9 model of accounting for credit losses. Against the backdrop of the “bank accounting that helped deliver the 2008 crash because insufficient accounting warnings were given,” he goes on:
- Reform has happened. This is in what is called IFRS9. The trouble is the reform is also deeply flawed, largely by being too formulaic, and by (as is normal in IFRS accounting) ignoring the time dimension as to what is happening and instead accounting for all the consequences as if they happen in the present, when that is not the case….
- Suffice to say IFRS9 is also considered to be failing. That’s partly because it is resulting in the reporting of a great many losses and that means banks could fail the supposed stress tests that central bankers so recently said they passed. Of course, these losses may be real. Who knows? The accounting system will not let us know.
This leads to the following:
- So what do we need? The answer seems very clear. Historical cost accounting has a simple heuristic test for addressing this issue, which along with much else in that approach to accounting (which was abandoned in favour of IFRS) worked. The rule was that all assets should be valued at the lower of cost or net realizable value.
- The cost of a loan was the sum advanced.
- The net realizable value was the net sum now likely to be recovered from the advance, ignoring interest to be earned that should be allocated to future accounting periods.
- And, if there was doubt prudence required that a provision be made. Reinstatement thereafter was not permitted. That stopped game playing.
- …Accounting is about the application of clear logic to uncertain situations where clear guidance as to the required decision criteria (I.e. prudence in this scenario) can be given so that the likelihood of the opinion formed being capable of replication is high. That is as close to objective reporting as accounting can get.
- IFRS accounting is far removed from that. That is why it has to go.
Just as a practical matter, I found myself wondering within what time frame Murphy envisages that an entire accounting model might be junked and replaced and up to speed in a reliable and broadly-accepted fashion. It’s true that accounting preparers tend to neurotically overstate the difficulty involved in getting things done, but still… That aside, insofar as one can make sense of the position being argued, it seems to envision an extremely narrow path through competing pitfalls. Prudence is cited as a transcending virtue – however, it’s cited as a bad thing if IFRS 9 in its current form results in “the reporting of a great many losses.” The current model is criticized as being “too formulaic,” as if to propose that all assets be valued at the lower of cost or net realizable value wasn’t about as formulaic as anything could possibly get. The article refers to the “net sum now likely to be recovered from the advance,” as if this amount were readily available on the application of common sense, although it’s clear in the current environment that any assessment of what’s likely is far from objectively verifiable. And of course it skates over any number of conceptual questions, such as the blithe reference to ignoring the interest to be allocated to future accounting periods. And so on…
All of that said, the article does remind us (if a reminder were necessary) of the extreme challenges facing this aspect of IFRS. I previously noted ESMA’s reference to giving a “greater weight to long-term stable outlook as evidenced by past experience” in applying IFRS 9, calling that as much an existential question as an accounting one. Even more than usual, the way in which we report the past is now helplessly intertwined with the story we choose we tell about the future. Murphy asserts that “we know how to account properly,” as if it were in the blood of whomever constitutes the “we,” but we don’t know that, any more than we know how to get out of this thing in the best shape. If the pandemic has taught us anything, it should be that we know much less than we think we did, and that any strident assertions of superiority should be suspect. It’s a cheap shot to say as he does that IFRS financial statements are “intended to misinform,” but it’s only realistic to acknowledge that at best, they’re part of an uncertain conversation about where we are, and where we may be going…
The opinions expressed are solely those of the author