IFRS, Transparency, and Economic Stability: A Critical Analysis

Introduction

In a speech on February 9, 2011, in Brussels, the then-new chairman of the International Accounting Standards Board (IASB), Hans Hoogervorst, discussed the role that financial reporting plays in society. His central points were that financial reporting is focused on investors first and that other stakeholders are secondary, that transparency is the primary objective of financial reporting regulations, and that economic stability flows from transparency. He disputes the notion that transparency and stability are mutually exclusive objectives, arguing instead that transparency actively contributes to economic stability. This means that financial statements produced under consistent, transparent methodologies are valuable contributors to overall economic stability.

Transparency in Financial Reporting

As Hoogervorst notes, one of the most important contributions that financial statements produced under International Financial Reporting Standards (IFRS) make is that they provide transparency. The statements are made public, and every company is subject to the same rules and methodologies that govern the compilation of those statements.

Transparency is an interesting issue with respect to reporting requirements. In a separate speech in China, Hoogervorst (2011) argued that it is necessary to "maintain the highest levels of transparency in financial reporting." Accounting systems such as IFRS are essential to this goal for several reasons. At the fundamental level, by insisting that statements are produced according to a consistent methodology, these standards allow investors and other stakeholders to understand how statements are rendered and compiled. Investors can analyze statements effectively because they are prepared on the same basis across companies within an industry and within a single company over time. Because IFRS requires that any changes to methodologies be disclosed in the notes to the financial statements, these changes are recorded and visible, providing transparency not only about the rules in use but also about any modifications to those rules.

There are criticisms, however, regarding the level of transparency that IFRS actually provides. Bruce (2011) argues that transparency in financial standards is taken for granted to the point where the issue receives little discussion at conferences dealing with financial reporting. Hoogervorst and others point to examples of accounting fraud as justification for IFRS and other transparency-enforcing systems, yet these systems did not prevent prominent frauds such as Enron. The frauds prevented by transparency are, of course, those that never occurred in the first place. As such, the effectiveness of the transparency afforded by financial reporting requirements is difficult to measure. A lack of fraud or opacity cannot be directly attributed to strict financial reporting requirements as opposed to simply a lack of attempt — and the lack of attempt itself may or may not derive from the controls those requirements provide. Therefore, the value of IFRS in improving transparency and preventing fraud remains open to interpretation.

As Hoogervorst notes, the purpose of financial reporting standards is to deliver to the investor or other stakeholder "as faithful a picture as possible of a company or organization," and he states that financial statements "should contain information that is as unbiased and reliable as possible." He acknowledges, however, that statements are produced primarily for investors. If statements were produced for other stakeholders, they might be prepared differently or contain different information. This criticism is echoed by Gray (1992), who pointed out that even transparent financial statements ignore the natural environment.

Conclusion

At its most fundamental, IFRS should be focused on transparency in reporting to the investor. This will guide the rules in a specific direction that may not fully meet the needs of other stakeholders. Financial reporting as a system has inherent limits: it cannot simultaneously stabilize the world economy, protect the environment, and help investors understand the financial condition of a company. Those guiding the development and improvement of IFRS need to take this reality into consideration at a policy level.