Purchase pooling, mandatory expensing of stock options and consolidating variable interest entities. These are three of the recent high-stakes battles we have had with the U.S.-based Financial Accounting Standards Board (FASB). Two were successfully resolved, while the third, on mandatory expensing, is ongoing.
But what if we were constantly fighting a two-front war? The broad mandate and increasing reach of European accounting standards setters could mean trouble for VCs at home and abroad.
Created in 2000, the International Accounting Standards Board (IASB) has the stated goal of developing “a single set of high-quality, understandable and enforceable global accounting standards.” The European Union (EU) has agreed that rules of the IASB are binding for all European companies starting in 2005, but the European Commission will retain the power to overturn an international standard. This is not unlike the situation in the United States, in which the FASB writes the GAAP rules and the SEC approves them and enforces them. In addition to determining how businesses operate is Europe, the IASB is significant because of its ongoing project with FASB to achieve convergence or harmonization between IAS and GAAP standards.
Clearly, a set of global accounting standards could be beneficial as our industry increasingly looks for opportunities abroad and could, in the long-term, aid in capital formation for countries whose capital markets are not as efficient as our own. But we share the concerns of those in Europe, here in the States, and in other industrialized countries that the IASB’s initial projects cast suspicion upon whether high-quality, consensus-based accounting standards are achievable.
The IASB has not shied away from controversy. Thus, it is under tremendous pressure from many businesses for its proposals and from politicians in the EU for its process in producing those proposals.
Among its first projects were the mandatory expensing of stock options and fair-value accounting for derivatives. As we have discussed previously in this column (see June VCJ), the IASB’s proposal on expensing stock options, ED 2, fails to address the significant problems with valuation, among other problems. IAS 32 and IAS 39 are draft standards that would require that all investment assets of financial institutions, such as banks and insurance companies, to be measured at fair or market value rather than historic cost, which the industries fear would lead to artificial volatility in quarterly earnings reports.
In Brussels on July 15, EU finance ministers stepped up political pressure on the IASB, demanding that European viewpoints – especially when it comes to calculating the value of derivatives in company audits – carry greater influence in decision-making. The EU finance ministers endorsed all IASB standards except the two involving derivatives.
On July 9, commenting on the flaws in the IASB’s processes with particular regard to the handling of IAS 32 and 39, Mr. Bolkenstein, a Member of the European Commission wrote: “There is growing unease concerning the standard setting process itself. The perception seems to be that there is a lack of willingness on the part of the IASB to move away from theoretical concepts to accept solutions that are based upon solid, practical experience. I am convinced that in the future the IAS-endorsement process will become more and more difficult unless ways and means are found to ensure that the standard setting procedures become more open and thorough allowing all parties concerned to fully participate in the process at all stages.”
French President Jacques Chirac also had harsh words for the IASB’s process, writing the following: “Several other standards could also have negative effects on companies and the European economy [referring to the expensing of stock options]. More in general, I believe it urgent and necessary, given my experience, to quickly start thinking thoroughly about the institutional framework which is put in place to adopt accounting standards which would be of application for our companies.”
Although these comments were made in reference to the IASB’s work on derivatives, we believe the same criticisms can be leveled against its proposal on stock options. Thus, while we will continue to oppose mandatory expensing, we recognize that it is essential for our industry’s long-term success to constructively engage all the parties to develop a well-functioning, collaborative process at the IASB that actually results in a set of consensus-built, high-quality, understandable accounting rules.
Mark Heesen is President of the National Venture Capital Association.