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The six biggest international audit firms have called for a complete overhaul of corporate financial reporting as the U.S. and Europe move toward convergence of international audit standards.

In a Nov. 8 report, the accounting firms propose to replace static quarterly financial statements with real-time, Internet-based reporting that encompasses a wider range of performance measures, including non-financial ones. The report was signed by the chiefs of PricewaterhouseCoopers International, Grant Thornton International, Deloitte, KPMG International, BDO International, and Ernst & Young. The report can be downloaded here.

"We all believe the current model is broken," Mike D. Rake, KPMG's chairman, told the Financial Times. "There are significant shortcomings to U.S. GAAP [Generally Accepted Accounting Principles] and issues of concern with International Financial Reporting Standards. We're not in a very happy situation."

Rake noted that quarterly reporting and the short-term focus on companies' ability to meet Wall Street earnings expectations helped foster accounting scandals. The firms have been working on their proposals for more than a year.

The large discrepancy between the "book" and "market" values of many listed companies is clear evidence that the content of traditional financial statements is of limited use, the report said. The audit firms recommend using non-financial measures that would provide more valuable indications of a company's future prospects, such as customer satisfaction, product or service defects, employee turnover, and patent awards.

The report said the following developments need to occur to ensure capital market stability, efficiency, and growth:

--Investor needs for information are well defined and met;
--The roles of the various stakeholders in these markets--financial statement preparers, regulators, investors, standards setters, and auditors--are aligned and supported by effective forums for continuous dialogue;
--The auditing profession is vibrant, sustainable, and provides sufficient choice for all stakeholders in these markets;
--A new business-reporting model is developed to deliver relevant and reliable information in a timely way;
--Large, collusive frauds are more and more rare; and
--Information is reported and audited pursuant to globally consistent standards.

ICGN Expresses Concerns Over Convergence

Meanwhile, the International Corporate Governance Network (ICGN) has expressed concerns about a draft proposal on harmonizing international and U.S. accounting standards. The ICGN argues that the draft doesn't pay sufficient attention to shareholder rights and the stewardship role of boards and investors.

"Convergence must be there to raise standards," ICGN Executive Director Anne Simpson told the Financial Times. "Convergence for its own sake is not of value."

The ICGN letter was in response to a request for comment by the International Accounting Standards Board (IASB) and its U.S. counterpart, the Financial Accounting Standards Board (FASB) on a discussion paper on harmonization objectives. The IASB and the FASB have been working on harmonizing the two accounting systems since October 2002 and have set 2008 as the goal for finalizing the process.

Unlike the current IASB auditing framework, the discussion paper endorses a model more similar to U.S. standards, dropping a key shareowner safeguard embedded in U.K.-style standards, the ICGN noted. Rather than focusing audits on past transactions, the discussion paper calls for audits to focus on "decision-usefulness" that can affect company cash flows, the letter said.

"We are concerned that this emphasis on the ability to forecast the future does not fully capture the requirements of stewardship, which is concerned with monitoring past transactions and events," Mark Anson, the CEO of Hermes Pensions Management who chairs the ICGN, wrote in the Nov. 2 letter. (A Hermes affiliate is a part owner of ISS.)

"In many jurisdictions, financial statements provide significant input into the decisions we make as shareholders, by providing an account of past transactions and events and the current financial position of the business," the ICGN letter noted. "In de-emphasizing things that are particularly [relevant to shareholders' risks and rights], the standards setters could achieve the perverse effect of actually increasing the cost of capital."

The ICGN includes more than 400 institutional and private investors, corporations, and advisers from 38 countries with capital under management in excess of $10 trillion, according to its Web site. The ICGN letter also was signed by Claude Lamoureux, CEO of the Ontario Teachers' Pension Plan.

A copy of the IASB discussion paper, which was published in July, can be downloaded here.

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