What do you mean by "profitable"?

Why Latin American companies and societies have much to gain from adopting a new set of international accounting standards

By Daniel Drosdoff

How much should you know about someone before you lend him money?

It seems like a simple question. But in the world of international finance, where bankers in London must decide whether to entrust their capital to companies in Lima, it is surprisingly complex. For one thing, countries tend to have different ideas about how much financial information companies must disclose to shareholders or investors.

These differences in accounting standards can be a problem, especially for developing countries that need to attract foreign capital. Historically, investors have been more willing to put their money in countries where accounting rules require companies to release detailed, accurate and timely financial information. Such rules reduce the likelihood that investors will be misled about a company’s prospects; in other words, they lower the risk associated with that investment. Conversely, investors are often reluctant to place their money in countries where accounting standards make it difficult to get a clear picture of a company’s finances.

For years, accountants, corporations and government regulators have debated the merits of different accounting standards. The debate has often been dominated by the United States, which uses so-called Generally Accepted Accounting Principles (GAAP), and the 28-year-old International Accounting Standards Committee (IASC), which promoted a rival set of rules used by most other industrialized countries.

Now, the IDB has joined a worldwide drive to adopt a uniform international auditing and accounting standard that should facilitate investment in Latin American companies, while reducing global financial volatility and the cost of capital.

Last April, organizers in Washington, D.C., established the International Accounting Standards Board (IASB) as a successor to the IASC. The new entity will have a professional staff and will include the participation of the United States, clearing the way for the eventual adoption of a harmonized set of high-quality accounting principles that could be applied around the world. The U.S. Securities and Exchange Commission is expected to take a major step toward integrating the two major world accounting systems by eventually accepting stock exchange listings prepared according to the international standard. For now, companies that want to list securities on U.S. stock exchanges must still prepare financial statements according to GAAP rules.

The IASB was launched on the same day as an IDB conference in Washington that was designed to promote implementation of the new international standard. IDB finance experts believe that by adopting the worldwide accounting standard, most countries will improve their financial accounting and disclosure systems, raise investor confidence and reduce uncertainty and the cost of capital.

At the conference, IDB President Enrique V. Iglesias called the new international standard a "global good" and says there are powerful macroeconomic factors that make it sensible to adopt them. "The quality of financial information impacts on the costs of capital," he said. "Capital will move where risk is lower."

Representatives of governments, regulatory bodies and the private sector at the IDB meeting examined the advantages and potential costs of adopting the international standards. Tom Jones, vice chairman of the ISAB, said the new organization will stress the independence of the accounting profession, partnerships with existing standard-setters around the world, and assistance to emerging economies as it accelerates implementation of the international standard. Momentum toward a unified standard is "moving faster than expected, " he said, and firms should plan to implement them "in three or four years." The European Union has proposed a 2005 deadline.

Changes in bookkeeping are just a part of the process. "We need to look beyond the balance sheet," said Tsuguoki Fujinuma, chairman of the International Forum on Accountancy Development, a global accounting organization that promotes the new standard. In addition to new accounting principles, he said, implementing the new standard will require legal and regulatory reform, information disclosure, training of accountants and regulators, oversight and enforcement.

That won’t be easy for many countries in Latin America and the Caribbean, where changes often have a high cost. Not only must firms finance new procedures, but governments must also modify regulatory structures and laws to accommodate the modifications (See accompanying interview with Antonio Vives, deputy manager, IDB Sustainable Development Department).

IDB capital markets expert Kenroy Dowers said improved financial disclosure could help to discourage excessive risk taking, avert financial crises, enhance corporate governance, allocate capital more efficiently, and increase cross-border financial activity.

While industrial countries are leading the effort to implement a world accounting standard, some advanced nations have loopholes in their accounting systems, such as the failure to require full disclosure for all stock offerings. Prof. Nelson Carvalho of the University of São Paulo, who has served on several national and international accounting and auditing committees and organizations, warned participants at the conferences that these loopholes must be closed. If wealthy countries do not rigorously apply the full international standard, Carvalho said, "you can’t expect emerging economies to do it."

Brazil has made important progress in adapting to the international standard, according to Carvalho, but changes will be required in the country’s accounting culture and the commercial code before full implementation. Accountants will have to deal with new rules that "they never had to deal with before" and overcome a bias in which "tax rules are more important than information reporting," Carvalho said.

Nevertheless, he added, Brazil "shares the vision" of achieving an international accounting standard, and he said Brazilians "are eager to see it implemented everywhere in the world."

Date posted: June 2001

The IDB's Antonio Vives explains the link between accounting standards and development...