Somehow I ended up on the mailing list of Risk.Net, which hails itself as “The world’s leading monthly magazine dedicated to the risk management and derivatives industries.”  In this week’s top story, headlined “Abuse of revised IFRS standards “inevitable” – IASB’s Leisenring“, Jim is quoted as expressing concern about using management intent to determine how financial assets are measured:

The new International Financial Reporting Standard (IFRS) 9 for financial instruments accounting will “inevitably lead to abuses and accounting arbitrage”, according to Jim Leisenring, a member of the International Accounting Standards Board (IASB).

The first part of the new directive, approved at the end of 2009 and to be expanded to encompass hedging and impairment issues in 2010, would allow the valuation of financial products at amortised cost, rather than fair value, in management of businesses whose “objective… is to hold [it] to collect the contractual cash flows”, regardless of whether they sold it before term.

“IFRS9 doesn’t have a prohibition on how many sales you can make before they stop you valuing products under this option,” Leisenring told Life & Pensions. “How many sales can you have and still say you intend to collect the cash? Can I sell every day?”

The article goes on to discuss Jim’s view of whether abuse of the standard’s objectives would be transparent:

Leisenring acknowledged the argument of defenders of the directive – due to come in force in January 2013 – that abuses would be “obvious” because of a clause forcing companies to acknowledge discrepancies between previous accumulated profit and sale price as a loss, although he said he was “not particularly convinced”.

Maybe Russell Lundholm could find a way to convince Jim one way or the other on the ability of ex-post reporting to mitigate abuses of reporting discretion ex ante.  Lundholm proposed this type of solution in his 2001 Accounting Horizons piece:

[From the Abstract]:  I propose that the financial reporting model be amended to report on the ex post accuracy of a firm’s prior estimates. Doing so will identify firms who have abused their reporting discretion in the past and provide valuable information about the expected credibility of the firm’s disclosures in the present. Firms will also have a greater incentive to make accurate estimates and accruals if they know that opportunistic estimates will be explicitly revealed in the future.

This seems like a good opportunity for laboratory research, and in a few years we might have enough archival data to know how investors respond to firms that repeatedly sell assets they had  “intended” to hold.

Read the full article to see Jim’s views on the “look-through” provision, embedded derivatives and transaction structuring, and hopefully Jim will elaborate on his views at next week’s Round Table discussion.