2.5 The development of the International Financial Reporting Standards (IFRS)

The International Accounting Standards Committee (IASC) was a private sector initiative founded in 1973, in response to the growing internationalization of capital markets after the Second World War.2 It was initially composed by professional accounting bodies and after 1977 when the International Federation of Accountants was founded, by some of its accounting members.3

The International Accounting Standards Committee was the first organization taking-up the responsibility of developing the International Accounting Standards and the challenge of promoting their use internationally.4 It was later in 2001, after a significant reorganization, replaced by the International Accounting Standards Board.5 This reorganization was necessary to overcome structural inefficiencies as a result of, for example, the fact that its representatives were serving on a volunteering part-time basis.6 Already in 1996, Bryan Carsberg thought that if the International Accounting Standards Committee was to become the leading international accounting standards-setter it was important to consider its future structure and organization.7 In September 1996, at an International Accounting Standards Committee meeting, the Strategy Working Party was set-up to advise about its future strategy, role and structure.8

Some of the fears of International Accounting Standards Committee’s board members and observers regarding the working party’s restructuring proposals were summarized by Michael Crooch.9 These were the fears that the US, just as Europe, would have too much power, that national standard setters would have too much influence, that small countries would have too much or too little influence, that the process would move too fast or too slowly, and that the Standards Development Committee would have too much or too little independence.10

Among others, the issues covered by the restructuring proposal were, the structure and composition of the International Accounting Standards Committee’s board (full-time and part-time members, geographic representation, professional background/ expertise and link to national standard-setters), its independence, votes, legitimacy, funding and timetable. The International Accounting Standards Committee’s members had the objective to turn it into the leading international standard- setter.

In the following years, the Strategy Working Party presented several draft proposals and it was only on the 6th of December of 1999 that the working party’s report entitled “Recommendations on Shaping IASC for the Future” was issued to the International Accounting Standards Committee’ Board.11 It was in May 2000 that unanimously the International Accounting Standards Committee’s restructuring was approved by its 143 professional accountancy member bodies.12 Its new constitution entered into force on the 21st of January of 2001, when the International Accounting Standards Committee ceased its functions.13

The International Accounting Standards were developed and issued between in 1973 and 2001 by the International Accounting Standards Committee. In 2001, the new International Accounting Standards Board (IASB) took over the International Accounting Standards Committee’s responsibility for setting international accounting standards. The International Accounting Standards Board is an independent and international private organization composed of a group of experts in the field of accounting and auditing which, as a standard setter in 2001, developed the International Financial Reporting Standards (IFRS).14 According to the IFRS’s Constitution, among the main qualifications for International Accounting Standards Board’s membership is having “professional competence and practical experience”15

The International Accounting Standards Board has the “technical authority”. “Technical authority” may be defined as “a form of applied knowledge that elicits compliance with its rules in its own right rather than owing to its connection with state power”.16 Below, it is explained how the International Accounting Standards Board as a transnational private organization, avoids public national or international authorities’ technical interference.17

The choice of a transnational private authority as the model of governance offered an alternative to the state regulation. In this model private organizations cooperate in the development of standards, in the case of International Accounting Standards Board, financial standards. The International Accounting Standards Board is a financial standard-setter based on expertise and not on politics which prevents higher public scrutiny, national public authorities’ veto, increased political and social interference and also challenges corporate opposition.18

The IFRS, developed by the International Accounting Standards Board, are often referred to as a principles-based instrument.1920When compared to rules-based standards, principles-based standards are meant to provide the user with a rather flexible, broad, less rigid set of financial reporting standards, and have a less specific industry guidance.21 In the Fourth and Seventh directives, the EU had already followed the preferred principles-based approach. At this moment company law was still developing, there was not sufficient political support for passing stricter legislation. Therefore, reaching agreement on the lowest common denominator was the only thing feasible at the time. The IFRS’ openness and flexibility are the conditions responsible for its large global acceptance and these characteristics are responsible for facilitating the application of these standards in countries with different legal systems and diverse cultures.22 The EU was not able to develop a set of European rules able to foster European financial integration.23 The European Commission saw the IFRS as a good alternative to its Company Law Directives, as these Directives had a focus on company law reform and not on the disclosure of useful information to investors. Until the end of the 1980s the European Commission did not consider the International Accounting Standards Committee’s standards24 and the idea of adopting the US-GAAP was out of the question because the EU did not want to give such influence and control of the European markets to the US25 (as we can see further explained below in section 6). Since 2005, all European listed companies are required to report consolidated financial statements prepared according to the IFRS.26 Until then, the use of the IFRS was not mandatory in any jurisdiction.27 Before 2005, European companies were mostly using national accounting standards.28 The IFRS are the most used financial reporting framework in the world, there are over 15,000 companies outside the US using these reporting standards (E. Needles, Jr., Belvert, and Powers, M., 2010- 2011).29

The International Organization of Securities Commission’s endorsement of the International Accounting Standards occurred after the announcement of the EU policy, and it seems that there was no reference to the International Organization of Securities Commission in the EU’s statements at the time.30 One may consider that once the EU decided to adopt the International Accounting Standards, the European International Organization of Securities Commission members could hardly not endorse the International Accounting Standards. The only question was whether the US would agree, and they did because they safeguarded the right to demand reconciliations to US-GAAP. However, on the contrary, some argue that one key reason for the EU’s endorsement of the International Accounting Standards was the formal backing of the International Accounting Standards by the International Organization of Securities Commission in 2000, which provided credibility to the standards.31 As explained above (see, above in section 3), the strong influence that the SEC had grown in the nineties and strong support of the International Organization of Securities Commission was determinant in 2000 when the International Organization of Securities Commission, backed by the SEC supported the EU with the endorsement of the International Accounting Standards.

The SEC reasoning for permitting the use of the IFRS by foreign companies listed on a US stock exchange starts with the collapse of major US companies as Enron and WorldCom in 2002. These events questioned the quality of the US financial accounting standards32 as the financial crisis showed that the US-GAAP would probably have some flaws. Therefore, it would be worthy to look at the quality of the IFRS. Besides, there was the interest of maintaining competitiveness in the global capital markets33 allied with the support for one set of global accounting standards by influential US accountants34 and American multinational firms.3536