Enron crash played into the hands of those who say that the USA should shift to IFRS due to become mandatory by 2005 for all EU companies whose shares are traded at exchanges.
While American accountants have been deriving the bitter lessons from the Enron affair, analysts throughout the world have been studying the case from their own positions and making their own conclusions. There is a possibility that U.S. principles of accounting and auditing will loose their benchmark status. However, it is far more important that companies’ managers around the world have been developing the understanding that measures must be taken to prevent a relapse in Germany, Japan, and elsewhere.
The Enron crash played into the hands of those who say that the USA should shift to the International Accounting Standards (IFRS). Regulatory authorities in the United States have so far emphatically dismissed the IFRS and other foreign accounting systems, saying that none of them is as tough as the Generally Accepted Accounting Principles (GAAP). IFRS supporters are certain, though, that their system would have exposed machinations inside Enron long before the company’s bankruptcy was announced. (The IFRS will become mandatory for all EU companies whose shares are traded at exchanges, by 2005).
The GAAP is a sort of code of laws for the auditor to strictly follow. It describes in the most detailed of ways all rules the auditor should stick to, whereas the IFRS is based on some general principles that oblige auditors to observe both the letter and spirit of the law. Auditors following the IFRS would have studied not just Enron statistics, but certainly ask the company’s management, why the company’s assets and liabilities had removed from the balance. And irrespective of the answer received the auditors would have formulated their own opinion.
The IFRS obliges the auditor to use not only basic accounting rules, but to take into consideration the intentions of the company’s management, says Nigel Sleigh-Johnson, one of the leaders of the Institute of Chartered Accountants in England and Wales. Enron claims that its off-balance transactions were not aimed at misleading the investors, but the end result was precisely the opposite.
We would have most probably found out what really happened, Sleigh-Johnson said.
The IFRS emerged the winner in competition with the GAAP long before the Enron affair. It has been preferred by an ever number of developing countries and territories outside the EU, including Singapore, Hong Kong, and Australia. Partially this is so because that system poses far more requirements the auditor must meet, and for that reason it fits in better with those markets where the degree of regulation is far lower than that in the United States. True, a potentially wide range of auditors’ conclusions is its considerable disadvantage. Should auditors overlook something, the regulatory authorities may fail to correct the error. However, the chief of the Hong Kong office of one of the firms in the Big 5 group has said that the Enron affair proved the advantages of the IFRS and it will help the system become the main accounting system outside North America.
Many countries, including most developing countries, see no reason why they should adapt themselves to any of the systems. In the first place they would be persuaded to establish order in general and then to put in order the accounting of their companies.
I am worried that some may use the Enron bankruptcy as a justification of their own imbecility, says the Hong Kong auditor. They may also use it as evidence that the United States is not at all better.
In reality both the IFRS and GAAP are effective on the condition of diligent approach. Both protect shareholders from corrupt managers to a far better extent than the systems used in most countries of the world.
Suffice it to recall the events of the middle of 1999 in South Korea, when its second biggest corporation, Daewoo Group, collapsed under the burden of a 70 billion dollar debt, harming thousands of investors and nearly ruining the banking system.
If only we had introduced the American accounting standards, Daewoo would have crashed far earlier and the impact on the economy would have been far weaker, says Lee Don Gull, an economist at the Korea Institute of Finance. Next to Daewoo the Enron case is a sheer trifle.
Even in the EU countries the local accounting systems, to be shortly replaced by the IFRS, have in many cases been unable to expose problems. Take the Lernout&Hauspie Speech Products, the Belgian manufacturer of voice identification systems. In 1998-2000 the company forged its profit statistics. Alleged sales in Singapore and South Korea totaled a record-high of 275 million dollars. That abuse surfaced only because the L&H was registered in the United States and was subject to the tougher GAAP.
If the company had had to report only under Belgian standards, they would not have been caught that easily, says David Cairns, a former general secretary of the International Accounting Standards Committee in London.
The Europeans say that the IFRS, too, would have exposed the affair. Debates on whose accounting system is better cannot but go on. But in the end everybody should understand that even the toughest rules can be sidestepped. Let us be realistic: it is impossible to create a system of accounting that will guarantee honesty and transparency.
This article was reprinted from the «Profil – Business Week» (January 28, 2002).