Accounting standards a product of political action

By Djohan Pinnarwan

JAKARTA (JP): There was once a time, not so many years ago, when accounting could be thought of as an essentially nonpolitical subject. If it was not as far removed from politics as was mathematics or astronomy, it was at least no more political than psychology or surveying or computer technology or statistics.

Even in areas of accounting such as taxation, which might be thought to be most relevant to questions of public policy, practitioners were generally content to confine themselves to technical issues without getting involved as accountants in the discussion of tax policy.

Today, accounting can no longer be thought of as nonpolitical. The numbers that accountants report have, or at least are widely thought to have, a significant impact on economic behavior. Accounting rules therefore affect human behavior.

Hence, the process by which they are made is said to be political. Charles Homgren writes that "the setting of accounting standards is as much a product of political action as of flawless logic or empirical findings.

"Why? Because the setting of standards is a social decision. Standards place restrictions on behavior; therefore, they must be accepted by the affected parties.

"Acceptance may be forced or voluntary or some of both. In democratic society, getting acceptance is an exceedingly complicated process that requires skillful marketing in a political arena."

Few, if any, accounting standards are without some economic impact. Numerous politically sensitive accounting reports could be cited, but none has received as much attention as the recently issued accounting standards by the Committee on Financial Accounting Standards of Indonesia, Institute of Accountants, that are Pernyataan Standar Akuntansi Keuangan (PSAK) or Statement of Financial Accounting Standards No.38 on "Accounting for Restructuring of Entities Under Common Control" and Interpretasi Standar Akuntansi Keuangan (ISAK) or Interpretation of PSAK No.4 on "The Allowed Alternative Treatment for Exchange Differences".

The first requires all restructuring transactions of entities under common control be accounted for at net book value. Previously, those transactions have been treated at whatever amount, usually at market value, in order to boost the bottom line of assets reported. Since its effective date, Oct. 1, 1997, all restructuring of entities under common control shall be accounted at its net book value using the pooling of interest method.

The second has been waited for by almost every enterprise. It tries to interpret the allowed alternative treatment for exchange differences which are prescribed by paragraph 32 PSAK 10 on "Foreign Currency Transactions".

Normally, the exchange differences (both realized or unrealized) should be directly recognized as income or as expenses in the income statement in the period which they arise.

Under the allowed alternative treatment, the exchange differences may be included in the carrying amount of the related assets if certain criteria and tests are met.

The criteria are (1) the exchange differences result from a severe devaluation or depreciation which it is impossible to hedge, resulting in liability which can not be settled as a consequence of the acquisition of an asset that is to be settled in a foreign currency, and (2) the adjusted carrying amount does not exceed the lower amount of the replacement cost and the amount recoverable from the sale or use of the asset.

ISAK 4 defines what "severe devaluation or depreciation" and "impossible to hedge" mean. If the depreciation of rupiah against some foreign currencies reaches 133 percent of average rupiah depreciation in the last three calendar years, the Committee concludes that a severe devaluation or depreciation has happened. While the criteria of "impossible to hedge" is met if (1) hedging premium reaches 133 percent of average hedging premium in the last three years, or (2) hedging facility is not available.

The Committee ignores the phrase "resulting in liability which can not be settled". The writer is not sure whether the ignorance of that phrase is intentional or unintentional. But one thing is sure, if the phrase "resulting in liability which can not be settled" is not ignored in the ISAK 4, under no circumstances will the exchange differences be capitalized to the related assets because until now, there is no exchange control in Indonesia.

Therefore the liability arising from the acquisition of the assets denominated in foreign currency can be settled. In other words, if we strictly apply the requirement of paragraph 32 PSAK 10 on "Foreign Currency Transaction", the issuance of ISAK 4 is useless, but is a kind of compromise so the enterprise could defer part, but not all, of the exchange loss incurred in this year.

Since most enterprises in Indonesia have huge amounts of liability denominated in other foreign currency, it is believed that most enterprises will report large amounts of exchange loss if the requirement of PSAK 10 still applicable.

The issuance of ISAK 4 is actually an overruling of PSAK 10 in its interpretation. It does not make sense at all. How can the requirement at lower level overrule the requirement at higher level which is very clear?

The fact that the enterprises suffer a huge amount of exchange loss is still there and can not be erased just by changing the accounting treatment.

In my opinion, whichever of the methods is chosen, the amount of foreign currency still has to be disclosed in the notes of the financial statements so everybody will know the facts. Are the users of financial statements fool enough to be deceived so their decisions will change like the changing of the accounting method?

The above example will serve to illustrate some of the points of contact between accounting and politics. Many more could be cited. Some believe that "because the Committee has the power to influence economic behavior, it has an obligation to support national goals (that is to rescue most enterprises from reporting huge amounts of foreign exchange loss)".

Simply because information has an effect on human behavior does not mean that it should not seek to be neutral between different desired modes of behavior. Neutrality in accounting implies representational accuracy. Neutrality does not imply that no one gets hurt.

As the American Accounting Association committee on the social consequences of accounting information says: "Every policy choice represents a trade-off among differing individual preferences, and possibly among alternative consequences, regardless of whether the policy-makers see it that way or not. In this sense, accounting policy choices can never be neutral. There is someone who is granted his preference, and someone who is not."

David Solomons writes that "information cannot be neutral -- it cannot therefore be reliable -- if it is selected or presented for the purpose of producing some chosen effect on human behavior.

"It is this quality of neutrality which makes a map reliable; and the essential nature of accounting is cartographic. Accounting is financial mapmaking. The better the map, the more completely it represents the complex phenomena that are being mapped.

"We do not judge a map by the behavioral effects it produces, but we judge the map by how well it represents the facts. People can then react to it as they will. As the geographic features that cartographers map, different financial facts need to be represented in different ways, and different facts are needed for different purposes."

In every standard-setting process, the profession is always confronted by a choice between appearing to be indifferent to national objectives or endangering the integrity of their measurement techniques.

But if in the long-run the well-being of our discipline is what matters, the right choice should be made. It is our job -- as accountants -- to make the best maps we can. If we are going to make a decision, principles should govern our decisions. Otherwise, we would lose our credibility and then our capacity to serve society, and in the long run, we all lose.

Moreover, the issuance of ISAK 4 is contrary to the initial reason to adopting the International Accounting Standard as a benchmark standard so our accounting practices will be of a world-class standard. Instead of moving to harmonize, it moves to disharmonize.

The allowed alternative treatment for exchange differences under ISAK 4 is not what it is meant by International Accounting Standard 21 on "The Effects of Changes in Foreign Exchange Rates". For the enterprise which is required to reconcile the accounting principles in Indonesia to some other benchmark accounting standards, the choice to capitalize certainly makes them bear additional cost to reconcile ISAK 4 to the benchmark standards.

One lesson from the current volatility of rupiah exchange rates against other foreign currency, is that from now on, the government is no longer "subsidizing" the interest rate for those who borrow foreign currency, loans of which usually carry a lower interest rate than loans denominated in rupiah. It is time for enterprise to manage its risks arising from the volatility of exchange rates.

The writer is professional member of staff at Kantor Akuntan Publik Drs. Hadi Sutanto & Rekan (Price Waterhouse). The views expressed in this article are strictly personal and do not reflect the views of the firm for which the writer works.