Toward a common language.

• Author: Carley, Alvin H.
• Position: International accounting standards

International accounting standards have come a long way, but they haven't quite arrived, says this observer. Find out why in an inside look at the standard setters and their quest for universality.

You're an American executive contemplating an acquisition and are very interested in the potential acquiree. A company in the United Kingdom is also interested and has proposed a substantial price that will result in consolidation goodwill of $450 million. The U.K. company has the option, under U.K. generally accepted accounting principles, of charging the goodwill directly to equity accounts, thereby not impairing future net income.

But your company will have to capitalize the goodwill on the balance sheet and amortize it by charging expenses over a period not to exceed 40 years. That will depress your future earnings, including, incidentally, the earnings amount used to determine executive compensation. It will also impact certain ratios mentioned in the covenants and commitments section of loan agreements of your company. By the way, the U.K. company can restore the depleted equity section of its balance sheet by assigning a value to the brand names of the company to be acquired and by crediting the equity section, a practice forbidden under U.S. GAAP.

Or say you're an executive of a U.S. mining company with significant operations in the Philippines. Your company and a Philippine mining company have debts denominated in U.S. dollars and Japanese yen, and both companies use the borrowed funds to increase productive capacity. The peso suddenly drops in value by 25 percent. The resulting transaction loss must be charged against your earnings in the year of the devaluation. But the Philippine company, under Philippine GAAP, can capitalize all or a significant portion of the transaction loss to fixed assets and write it off against future earnings. The two companies are competitive, and that includes their ability to obtain capital through debt or equity offerings.

There are many other accounting differences like these that could result in significantly different net income and net worth in companies' financial statements. Consider also the effect this has on international business: Does the consolidation goodwill issue give the British an advantage over U.S. companies in the mergers and acquisitions arena? Or will the Philippine company be perceived as more valuable than a competitor because of higher net income in the year of the devaluation; will its cost of capital be favorably affected? Think also about the international financial markets - of the time and cost involved in restating to another GAAP to register securities outside your own country.

The differences in GAAP worldwide are a serious matter and should be resolved by attaining a much higher level of commonality of GAAP and overall financial reporting practices. Some organizations are making a serious effort to achieve that objective. The International Accounting Standards Committee is contributing...