Europe's Bean Counters Are Sneering
As the U.S. accounting industry ponders the bitter lessons of the Enron (ENE ) debacle, finance professionals around the world are also studying the events in Houston, and drawing their own conclusions. One effect may be a setback for the cause of U.S. accounting as a global standard. But more important, it seems that executives worldwide are acquiring a new respect for the need for diligence to make sure an Enron does not erupt in Germany, or Japan, or wherever.
The Enron disaster has certainly strengthened the hand of those who favor International Accounting Standards, or IAS, as the standard over U.S. practice. U.S. regulatory officials have adamantly rejected IAS and every other foreign accounting system, insisting that none is as rigorous as U.S. Generally Accepted Accounting Principles, or GAAP. Yet supporters of IAS, which will become mandatory for all publicly traded European Union companies by 2005, maintain that their standards would have exposed the hanky-panky at Enron long before the company went bankrupt.
While U.S. GAAP follows a cookbook approach--providing auditors with a comprehensive checklist of rules to follow--IAS is based on general principles, compelling auditors to enforce the spirit of the law and not just the letter. Under IAS, the Enron auditors would have looked not just at the numbers but also would have quizzed management about why it had shunted assets and liabilities off its balance sheet, for example. And whatever management told them, the auditors would be required to make their own assumptions about what was actually going on.
"IAS lays down broad standards obliging auditors to take into account the intentions of company managers as well as to apply basic accountancy rules," explains Nigel Sleigh-Johnson, an executive at the Institute of Chartered Accountants in England & Wales. Enron says its off-balance-sheet transactions weren't intended to mislead investors, but that was the effect in the end. "We'd likely have spotted what was going on," says Sleigh-Johnson.
Even before Enron, IAS was winning the competition with U.S. GAAP. A growing number of developed countries and jurisdictions outside the EU--including Singapore, Hong Kong, and Australia--have chosen IAS. That's partly because its principles-based system places higher demands on auditors and so might be better-suited to markets that are less stringently regulated than the U.S. The drawback, of course, is that auditors' judgments can vary widely, and if they miss something, the regulatory agencies might not be there to catch it. Still, as a senior executive at the Hong Kong office of one of the Big Five accounting firms puts it: "This embarrassing case shows the advantages of a principles-based system. It will help make IAS the preferred accounting standard outside North America."
Many countries, including most of the developing world, haven't seen fit to adopt either system, so the overriding challenge is to persuade them to clean up their act, and, in the process, their companies' books. "I'm worried some places will use Enron as an excuse to drag their feet," says the Hong Kong accountant. "They might try to argue that it shows the U.S. isn't much better than they are."
The fact is that both IAS and U.S. GAAP are sound when scrupulously applied. They certainly protect shareholders against dishonest executives far better than the systems that hold sway in much of the world. Just look at what happened in South Korea in mid-1999. Daewoo Group, the country's second-biggest conglomerate, went belly-up with $70 billion in debt, hammering thousands of investors and almost bringing the banking system to its knees. "If only we had put in place American accounting standards, Daewoo would have fallen much earlier, and its impact on the economy would have been much smaller," says Lee Dong Gull, an economist at the Korea Institute of Finance. "The irregularities at Enron look like a mere smidgen compared with Daewoo's."
Even in the EU, the local accounting systems that are now heading for the scrap heap in favor of IAS often failed to spot trouble. Take the case of Lernout & Hauspie Speech Products, the Belgian maker of speech-recognition technology that from 1998 to 2000 used phony transactions to inflate revenues. The company recorded $275 million in fictitious sales to companies in Singapore and South Korea--a fact that came to light only because L&H was listed in the U.S. and was subject to tougher U.S. GAAP regulations. "If they'd been reporting [only] under traditional Belgian standards, they wouldn't have been caught as easily," says David Cairns, a former secretary general of the International Accounting Standards Committee in London. Europeans say IAS also would have uncovered the scam.
The debate over which accounting system is better is certain to continue. But at the end of the day, both sides must recognize that even the most demanding regulations can be circumvented. After all, there will never be an accounting system that guarantees integrity as well as transparency.
By David Fairlamb in Frankfurt, with Carol Matlack in Paris and Moon Ihlwan in Seoul