May 16, 2000
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Dear Mr. Katz:
This letter responds to the request for comment on the Securities and Exchange Commission (SEC) Concept Release, International Accounting Standards (File No.S7-04-00). The main part of the letter focuses on the more substantive issues covered by the Release. The attachment provides additional comments on the specific questions raised in the Release.
We welcome the SEC's commitment to achieving high-quality global accounting and financial reporting standards. The globalization of business and markets demands that regulators, standard setters and others develop one set of high-quality international accounting standards that will provide comparable, transparent, relevant and reliable financial information for making efficient capital allocation decisions. The Asian crisis highlighted the dangers posed by inadequate accounting and financial reporting standards in some countries and how they may add to market uncertainty and financial instability. As overseer of the largest, most active and liquid capital market in the world, the SEC must play an important role in achieving the goal of high-quality international standards, and we are encouraged by its willingness to do so.
Arthur Andersen's vision is the use of one set of high-quality global accounting and financial reporting standards, consistently applied by all companies around the world. This vision is significantly different, in some respects, from the concepts raised and discussed in the Release. Our comments on the Release reflect our desire to be directionally consistent with our vision.
We believe the International Accounting Standards Committee (IASC) is ideally positioned to become the international standard-setting body that could provide the high-quality global accounting and financial reporting standards that the global market demands with increasing urgency. The revised standard-setting structure that should be effective January 1, 2001, represents a positive step in improving the IASC's due process and providing it with the resources necessary to play that role. Additional factors that make the IASC a logical choice are:
For all these reasons, we believe the SEC is absolutely correct in seeking advice on whether, and when, it should accept IAS-only financial statements (i.e. without reconciliation to U.S. GAAP) filed by foreign registrants. We also believe that this determination must be based on the intrinsic quality of IAS and, more importantly, on whether the resulting package of information provides investors with relevant, reliable, and transparent information to make efficient capital allocation decisions. The issue is broader than just the quality of written accounting standards; the SEC recognizes this by focusing part of the Release on infrastructure considerations.
We strongly agree with the SEC that a comprehensive infrastructure must be in place in order for high-quality international accounting and financial reporting standards to be used, interpreted, and enforced consistently throughout the world. However, we disagree with certain aspects of the discussion about infrastructure in the Release including:
In our opinion, the main components of the infrastructure are:
Building such infrastructure will require the cooperation of many organizations, such as the IASC, the major national accounting standard-setting bodies, the IOSCO, the International Federation of Accountants (IFAC), the large international accounting firms, the World Bank, the IMF, and others. We are encouraged by the level of commitment already demonstrated by several of these organizations.
Until further steps have been taken to provide that an adequate global infrastructure is in place, the SEC should not eliminate its reconciliation requirement to U.S. GAAP for foreign registrants. Rather, we recommend the following actions at this time:
We believe that maintaining the U.S. GAAP reconciliation process for IAS financial statements used by foreign registrants in the short term is the most appropriate alternative. We also believe that the SEC should take an active role in encouraging the leaders of the large standard setters to cooperate within the next three years to agree upon the most significant accounting differences (recognition, measurement, and disclosure differences) between their respective GAAP, including IAS, and develop a methodology that would harmonize the accounting treatments on a global basis - modifying local standards and IAS accordingly. Harmonization in this manner would significantly reduce reconciliation requirements for foreign registrants in the U.S. and abroad, while promoting the acceptance of IAS as the set of global accounting and financial reporting standards.
We believe the above recommendations are aligned with one of our ultimate goals: the development and application of a single accounting and financial reporting language worldwide.
If you would like to discuss our comments, please do not hesitate to contact us. Please contact Jeannot Blanchet at 312-507-6523 or via electronic mail at firstname.lastname@example.org.
Very truly yours,
RESPONSES TO QUESTIONS RAISED IN THE RELEASE
Q.1 Do the core standards provide a sufficiently comprehensive accounting framework to provide a basis to address the fundamental accounting issues that are encountered in a broad range of industries and a variety of transactions without the need to look to other accounting regimes? Why or why not?
The IASC core standards provide a foundation upon which further International Accounting Standards can be developed, but they are not, nor were they intended to be, an exhaustive coverage of all needed guidance. We know of no other internationally-recognized accounting framework that is more comprehensive than IAS. We also believe there is no accounting framework (including U.S. GAAP) that truly provides comprehensive guidance on fundamental issues encountered in a broad range of industries. GAAP consists of much more than authoritative literature; it encompasses recognized industry practices that have developed over the years without ever being codified. It will take time, as well as a better developed infrastructure, for "international GAAP" to emerge and be consistently applied throughout the world. Meanwhile, we believe it is appropriate to refer to other sources of accounting guidance consistent with the IASC framework (including standards issued under other accounting regimes) to supplement the core standards.
Q.2 Should we require use of U.S. GAAP for specialized industry issues in the primary financial statements or permit use of home country standards with reconciliation to U.S. GAAP? Which approach would produce the most meaningful primary financial statements? Is the approach of having the host country specify treatment for topics not addressed by the core standards a workable approach? Is there a better approach?
If a specific (industry) topic is not covered in IAS, then preparers should defer to the guidance provided in IAS 1, paragraph 22, which addresses these situations and states:
In the absence of a specific International Accounting Standard and an Interpretation of the Standing Interpretations Committee, management uses its judgement in developing an accounting policy that provides the most useful information to users of the enterprise's financial statements. In making this judgement, management considers:
(a) the requirements and guidance in International Accounting Standards dealing with similar and related issues;
(b) the definitions, recognition and measurement criteria for assets, liabilities, income and expenses set out in the IASC Framework; and
(c) pronouncements of other standard setting bodies and accepted industry practices to the extent, but only to the extent, that these are consistent with (a) and (b) of this paragraph.
In practice, in the absence of IAS specific (industry) guidance, preparers tend to look to local accounting standards first if guidance exists and is consistent with the IASC Framework. If no local GAAP exists, reference is often made to U.S. GAAP because there is generally more application guidance available. In addition, certain foreign registrants prefer limiting as much as possible differences between their primary financial statements and their U.S. GAAP reconciliations in SEC filings.
We believe the approach described above is appropriate; it correctly emphasizes the need to look for analogies in IAS and to comply with the concepts included in the IASC Framework, while at the same time encouraging the use of other recognized bodies of standards to assist in the development of "international GAAP". We do not believe the approach of having the SEC or any host country regulator specify treatment for topics not addressed by the core standards is a workable or desirable approach. In many cases, global companies offer securities on several capital markets concurrently (e.g. in London, Tokyo, and New York). Which "host country" regulator should specify accounting treatment in these circumstances? A better answer is likely to emerge over time through a combination of (a) more guidance in IAS and more interpretations from the IASC Standing Interpretations Committee, (b) convergence of accounting practices by global companies using IAS in various industries, and (c) stronger worldwide infrastructure (regulators, auditors, educators, etc.) leading to more consistent interpretations and application of IAS and "international GAAP".
Q.3 Are there any additional topics that need to be addressed in order to provide a comprehensive set of standards?
The IASC standards represent a major improvement over, and are generally of a higher quality than, many sets of local accounting standards around the world. The core standards are fairly comprehensive in their scope; however, no body of standards, including U.S. GAAP, addresses adequately every type of transaction over the complete range of industries at the current time. No doubt the IASC will continue to issue standards on important topics not already covered under IAS or adequately addressed by other standard setters. For example, we believe that stock-based compensation, transactions between entities under common control, accounting by joint ventures, e-business reporting issues (revenue recognition and cost classification), valuation of intellectual rights, definition of financial performance, and industry specific guidance (e.g. high-technology, insurance, natural resources, etc.) among others should be addressed by the IASC over the next few years to enhance the current set of core standards.
Q.4 Are the IASC standards of sufficiently high quality to be used without reconciliation to U.S. GAAP in cross-border filings in the United States? Why or why not? Please provide us with your experience in using, auditing or analyzing the application of such standards. In addressing this issue, please analyze the quality of the standard(s) in terms of the criteria we established in the 1996 press release. If you considered additional criteria, please identify them.
As mentioned under question 3, the IASC standards are generally of higher quality than many sets of local accounting standards found around the world. The criteria established by the SEC in 1996 to assess the quality of IAS can be summarized as follows: comprehensiveness, full disclosure, transparency, comparability, and consistent application. Comprehensiveness is the only criterion that focuses exclusively on the written standards; the other four criteria apply both to the quality of the written standards and the quality of application of these standards by preparers of financial statements.
We have already provided our views on the comprehensiveness of IAS as an accounting framework under questions 1 and 3 above. With regard to the other criteria, our experience in auditing / reviewing the IAS financial statements of companies worldwide indicates that consistent interpretations and application of IAS are not yet a reality. In our opinion, this is primarily due to the lack of global infrastructure in interpreting, applying, and enforcing IAS; the process of creating `international GAAP' is still in the early stages. It is for this reason that, as stated in the main part of this letter, we do not believe it is appropriate at this time to remove the U.S. GAAP reconciliation requirement for foreign filers using IAS. We believe that users will wish to have the reconciliation at least in the short term while confidence in and knowledge of IAS increases.
In assessing the quality of accounting standards proposed by international, regional, or domestic standard setters, we use several criteria in addition to those included in the 1996 SEC press release, including:
We recommend the SEC use these additional criteria in assessing the overall quality of IAS.
Q.5 What are the important differences between U.S. GAAP and the IASC standards? We are particularly interested in investors' and analysts' experience with the IASC standards. Will any of these differences affect the usefulness of a foreign issuer's financial information reporting package? If so, which ones?
The 1999 edition of the FASB publication, The IASC-U.S. Comparison Project: A Report on the Similarities and Differences between IASC Standards and U.S. GAAP, provides an accurate and comprehensive list of differences between U.S. GAAP and IAS. The comments made by the external reviewers (analysts, preparers, and auditors) at the beginning of the chapters are particularly relevant to this question. It should be noted, however, that the report does not include differences arising from SEC accounting and disclosure requirements, which can sometimes be significant (particularly in regard to additional SEC disclosures).
Differences between U.S. GAAP and IAS can be classified into three groups: topics covered by U.S. GAAP and not IAS; topics covered by IAS and not U.S. GAAP; and topics covered by both, but with different guidance. They can be further subdivided among recognition, measurement, and disclosure issues. The FASB report contains examples for each of these categories and sub-categories.
Although the number of differences highlighted in the report is impressive, most of them do not lead to significant reconciling items between IAS and U.S. GAAP in practice. In addition, some of the potentially more important differences (e.g. capitalization of certain R&D costs under IAS) can easily be reconciled by users based on the disclosures required to be made under IAS. The more troublesome differences are those that have a pervasive effect on the financial statements, and for which not enough disclosure is provided for users to reconcile to U.S. GAAP. A perfect example of this situation is the classification of a business combination as either an uniting of interests (pooling of interests) or a purchase. It is not unusual for a business combination to meet the criteria for a pooling of interests under APB 16, while being classified as a purchase under IAS 22. Interestingly, the SEC decided a few years ago to allow foreign registrants not to reconcile to U.S. GAAP for this classification difference, presumably on the basis that the difference would not affect the usefulness of a foreign issuer's financial information reporting package.
Q.6 Would acceptance of some or all of the IASC standards without a requirement to reconcile to U.S. GAAP put U.S. companies required to apply U.S. GAAP at a competitive disadvantage to foreign companies with respect to recognition, measurement or disclosure requirements?
In our view, assessing "competitive advantage or disadvantage" is judgmental and not particularly productive in the context of accounting standard setting. One way U.S. companies could be at a competitive disadvantage versus foreign companies using IAS is if IAS would lack "neutrality", a notion embedded in both the FASB and the IASC conceptual frameworks. We subscribe to the FASB's approach to neutrality in standard setting, as described in paragraph 100 of Concepts Statement No.2:
Neutrality does not mean "without purpose", nor does it mean that accounting should be without influence on human behavior. Accounting information cannot avoid affecting behavior, nor should it. If it were otherwise, the information would be valueless-by definition, irrelevant-and the effort to produce it would be futile. It is, above all, the predetermination of a desired result, and the consequential selection of information to induce that result, that is the negation of neutrality in accounting. To be neutral, accounting information must report economic activity as faithfully as possible, without coloring the image it communicates for the purpose of influencing behavior in some particular direction.
We have no evidence to conclude that the IASC or the FASB has deviated from neutrality in setting accounting standards in the past. Therefore, we do not think the question should be posed in this context.
Another way of approaching the competitive advantage question is from a cost/benefit perspective. The acknowledged fact that U.S. GAAP contains more guidance and disclosure requirements (including SEC disclosure requirements) than IAS presumably raises the costs of compliance for domestic registrants. On the other hand, one theory argues the added transparency of the financial statements through increased disclosures leads to a lower cost of capital and therefore results in a competitive advantage for U.S. domestic registrants. However, we know of no definitive research quantitatively validating this assertion.
For reasons explained earlier in this letter, we believe it is not appropriate at this time to eliminate the reconciliation requirement for foreign registrants using IAS. However, the ultimate goal is to have one set of high-quality global accounting and financial reporting standards that would be used by all registrants (both foreign and domestic). This, in our view, is the only way to resolve the "level playing field" argument, and to achieve the objective of maximizing the efficiency of capital markets worldwide.
We also strongly believe that the SEC should not pick and choose which IAS should be accepted without reconciliation to U.S. GAAP, and which should not. This process would result in the SEC becoming de facto an international accounting standard setter; this role should be left in the hands of the private sector standard setting process, namely the IASC. The SEC should decide whether to endorse the IASC and its standard-setting process; once it has reached a decision to endorse the IASC process, it should not interfere with the process by determining how particular issues are to be resolved.
Q.7 Based on your experience, are there specific aspects of any IASC standards that you believe result in better or poorer financial reporting (recognition, measurement or disclosure) than financial reporting prepared using U.S. GAAP? If so, what are the specific aspects and reason(s) for your conclusion?
As discussed under question 5, differences certainly exist between IAS and U.S. GAAP. A fundamental difference is that IAS are much less prescriptive and detailed than U.S. GAAP. There are many reasons for this, including:
Considering the above, it is somewhat unfair to compare the two sets of standards, and to make subjective assessments of "better or poorer financial reporting". In our view, IAS require or allow more appropriate accounting treatments in certain areas such as the immediate recognition of vested past service costs for retirement benefits, the classification criteria for a business combination (purchase or uniting of interests), and the ability to measure long-term assets at fair value.
On the other hand, we believe that standards that permit alternative approaches ("free choices") inhibit the ability to analyze financial statements across companies, thereby diminishing comparability. For example, allowed alternatives exist under IAS for accounting for investments in joint ventures, correction of fundamental errors, and investment properties.
The quality of IAS has improved considerably with the completion of the core standards, and the body of established "international GAAP" is already of higher quality than many local GAAP around the world.
Q.8 Is the level of guidance provided in IASC standards sufficient to result in a rigorous and consistent application? Do the IASC standards provide sufficient guidance to ensure consistent, comparable and transparent reporting of similar transactions by different enterprises? Why or why not?
The IASC standards do not have the same degree of detailed guidance as U.S. GAAP, for reasons discussed under question 7. As a result, users are often required to refer to the underlying framework of the IASC to help interpret and apply the standards and, where no specific guidance exists, preparers must look to other sources of GAAP and rely on professional judgment. The increased use of judgment may result in inconsistent application in an international environment because of differences in experience, background, and knowledge of preparers.
As mentioned earlier, the lack of an adequate infrastructure to interpret, apply and enforce IAS contributes more to the potential inconsistent application of IAS than insufficient guidance in the IAS themselves. As more countries adopt or harmonize with IAS, coupled with more guidance from the IASC, the interpretation "base" will grow and consistency will emerge in the form of codified "international GAAP".
Q.9 Are there mechanisms or structures in place that will promote consistent interpretations of the IASC standards where those standards do not provide explicit implementation guidance? Please provide specific examples.
The Standing Interpretations Committee (SIC) of the IASC provides authoritative guidance and interpretation of IAS. The role of the SIC is similar to the U.S. Emerging Issues Task Force (EITF); however, the structure and operations are slightly different. The current SIC meets four times per year to help clarify and address topics that are unclear under existing guidance or which were not considered when the standards were written.
The staff of the IASC provides technical guidance on an ad hoc basis in response to constituents' requests.
The large professional accounting firms also have their own technical departments that provide central guidance to their respective professionals on IASC standards. (Refer to our response to question 15.)
Although these mechanisms are helpful, there clearly is a need for more global infrastructure that will foster consistent interpretation and application of IAS. Please refer to other parts of this letter for additional discussion of the needed infrastructure.
Q.10 In your experience with current IASC standards, what application and interpretation practice issues have you identified? Are these issues that have been addressed by new or revised standards issued in the core standards project?
As mentioned previously, the IASC Framework and core standards provide a good foundation upon which further International Accounting Standards can be developed, but they are not, nor were they intended to be, an exhaustive coverage of all needed guidance. Application and implementation issues occur in areas where current IAS guidance is not sufficiently robust. We believe that the IASC should enhance current guidance by addressing over the next few years implementation and application issues in the following areas :
Q.11 Is there significant variation in the way enterprises apply the current IASC standards? If so, in what areas does this occur?
As discussed under question 7, the existence of alternatives with certain IAS themselves lead to variation in application, although such variations are acceptable under IAS. This is the case, for example, for the measurement of long-term assets (amortized historical cost or fair value) under IAS 16 and the capitalization or expensing of borrowing costs under IAS 23. Nevertheless, many of these potentially important differences can be reconciled to U.S. GAAP by users based on the disclosures required under IAS.
The other, more significant, area where variation occurs is when there is no specific guidance under IAS and an enterprise resorts to other sources of GAAP, in accordance with the requirements of paragraph 22 of IAS 1, and relies on professional judgment. As mentioned earlier, enterprises tend to look first at their local GAAP to select an appropriate policy. Until such time as convergence of national accounting and financial reporting standards is significantly improved, variations in application will continue in these circumstances. We believe convergence can occur only through the establishment of a strong and comprehensive global infrastructure.
Q.12 After considering the issues discussed in (i) through (iv) below, what do you believe are the essential elements of an effective financial reporting infrastructure? Do you believe that an effective infrastructure exists to ensure consistent application of the IASC standards? If so, why? If not, what key elements of that infrastructure are missing? Who should be responsible for development of those elements? What is your estimate of how long it may take to develop each element?
As mentioned previously, we disagree with some of the elements of the needed infrastructure, and the over-emphasis on the role of auditing firms discussed in the Release. In our view, the essential elements of an effective global financial reporting infrastructure are:
The need for a global infrastructure is present whether or not the SEC eliminates the reconciliation requirement. However, its importance is heightened in the context of IAS becoming "international GAAP", because there is a need to develop the consistent application and interpretation of IAS worldwide. We do not believe the SEC, or any other national regulator, should unilaterally interpret IAS.
While an effective infrastructure capable of ensuring consistent application of the IASC standards exists in a number of major markets, the essential elements of the infrastructure are not in place on a comprehensive worldwide basis. However, a number of significant initiatives are underway to correct existing deficiencies. The most ambitious is the vision for "Improving Reporting and Auditing Practices Worldwide," which was endorsed by the International Forum on Accountancy Development1 (IFAD) in October 1999 and is being implemented under its auspices. The IFAD vision addresses each of the essential elements of an effective infrastructure by: supporting reform of the international standard-setting institutions (IASC and IFAC); endorsing strong external quality assurance and disciplinary processes for the profession; and proposing country action programs to raise national accounting and auditing standards and practices, corporate governance, regulation, ethics, and professional education and qualifications at least to the level of a series of recognized international benchmarks.
The large international accounting firms and the accounting profession, through its global, regional and national bodies, are committed to making this vision a reality by exercising leadership and investing resources in its implementation. Success, however, will only come with the active commitment and participation of all the parties that have an interest in improved accounting, auditing and financial disclosure. This includes governments, regulators, standard-setters, preparers, issuers, investors, lenders, international financial institutions and other international organizations, as well as the profession and large accounting firms.
Q.13 What has your experience been with the effectiveness of the SIC in reducing inconsistent interpretations and applications of IASC standards? Has the SIC been effective at identifying areas where interpretive guidance is necessary? Has the SIC provided useful interpretations in a timely fashion? Are there any additional steps the IASC should take in this respect? If so, what are they?
Since its inception in 1997, the SIC has been effective in providing interpretive guidance on existing IAS. It has dealt with relevant topics and has issued interpretations that have considerably tightened practice in certain areas, thereby reducing variations in application of IAS. However, some consider the current administrative structure and process of the SIC too cumbersome. When the IASC completes its restructuring, process improvements to the SIC should be a high priority. The recent increase in IASC standards will require more interpretations from the SIC and its process should be streamlined to reduce the time required to issue interpretations. One step to improve the process is meeting on a more frequent basis. Increased interaction with the SEC and other regulators, standard setters, practitioners, users and preparers to identify interpretation and application issues would also improve the process and output of the SIC.
Q.14 Do you believe that we should condition acceptance of the IASC standards on the ability of the IASC to restructure itself successfully based on the above characteristics? Why or why not?
The SEC's acceptance of IASC standards for registration purposes by foreign issuers (without reconciliation to U.S. GAAP) and domestic issuers should be subject to two conditions: the intrinsic quality of the IAS, and the underlying quality of the IASC's standard-setting structure and process. We believe that it is very unlikely that high-quality global accounting and financial reporting standards can be consistently developed without a high-quality standard-setting structure and process. Ultimately, the SEC should determine whether to endorse the IASC as a global standard setter (i.e. endorse the structure and process in the same way as it currently endorses the FASB as the U.S. accounting standard setter) rather than approving or rejecting individual IAS (thereby substituting itself as the standard setter).
Q.15 What are the specific practice guidelines and quality control standards accounting firms use to ensure full compliance with non-U.S. accounting standards? Will those practice guidelines and quality control standards ensure application of the IASC standards in a consistent fashion worldwide? Do they include (a) internal working paper inspection programs and (b) external peer reviews for audit work? If not, are there other ways we can ensure the rigorous implementation of IASC standards for cross-border filings in the United States? If so, what are they?
Arthur Andersen's internal inspection process (the Process) is a worldwide program. Offices are subjected to the Process on a rotational basis with an emphasis on risk inputs from leadership from around the world. The Process covers about one third of our practices annually. Compliance programs and checklists (tools) are developed to meet International Standards on Auditing (ISA), local professional and firm standards and are used on all office reviews. Also, the Process monitors Firm policies and standards applicable to the expert partner on all cross-border filings (Firm policies require that an IAS expert partner review be performed on all IAS cross-border financing filings around the world).
Our Firm is also subject to external peer review requirements in various countries around the world. Local country and area management coordinate these external peer reviews; however, the results are reported to leadership of our worldwide Process. Further, the peer review findings are considered by Firm leadership in ensuring that the results of these peer reviews are properly factored into our operating practices and policies.
Arthur Andersen has a global methodology, tools, policies and standards for the conduct of all attest engagements, including specific quality control policies and procedures for domestic and foreign SEC registrants, regardless of the GAAP used in the filing. A designated U.S. expert partner reviews all foreign SEC filings and IAS financial statements are subject to review procedures by designated IAS experts.
Arthur Andersen has created an internal department called the International Professional Standards Group (IPSG). The IPSG is composed of part-time and full-time resources that assist practitioners and clients worldwide in improving their interpretation and implementation of IAS. The IPSG serves as the Firm's central resource to respond to our professionals' questions, offers technical advice about IAS (through phone consultation and electronic researchable guidance tools), develops training material on IASC standards, and performs quality control review for IAS financial statements used in cross-border financing filings, not only in the U.S., but also on a global basis.
Q.16 Should acceptance of financial statements prepared using the IASC standards be conditioned on certification by the auditors that they are subject to quality control requirements comparable to those imposed on U.S. auditors by the AICPA SEC Practice Section, such as peer review and mandatory rotation of audit partners? Why or why not? If not, should there be disclosure that the audit firm is not subject to such standards?
We believe acceptance of financial statements prepared using the IASC standards should be conditioned on certification by the auditors that they are subject to quality control requirements (comparable but not necessarily identical to those imposed on U.S. auditors by the AICPA SEC Practice Section).
As noted in our response to question 15, our Firm subjects its entire global operation to the Process on a rotating basis. The scope and approach of the Process is consistent throughout the world. We believe our Process significantly enhances the overall quality and consistency of performance throughout our Firm. We further believe that if a firm does not meet the certification requirements noted above, there should be disclosure that the audit firm has not been subjected to these more rigorous international quality control requirements.
Q.17 Is there, at this time, enough expertise globally with IASC standards to support rigorous interpretation and application of those standards? What training have audit firms conducted with respect to the IASC standards on a worldwide basis? What training with respect to the IASC standards is required of, or available to, preparers of financial statements or auditors certifying financial statements using those standards?
The IASC standards have undergone such a dramatic transformation over the past few years that developing and maintaining expertise on a global level present unique challenges. Arthur Andersen, through its International Professional Standards Group (IPSG), attempts to address these challenges on a daily basis.
The IPSG develops training materials on IASC standards that are available to all Arthur Andersen professionals worldwide, provides technical consultation to engagement teams on IAS topics, and serves a quality control function by, among other tasks, reviewing IAS financial statements used in cross-border offerings around the world. The IPSG is also developing an integrated network of IAS partners in each office / region around the world that will assist local engagement teams with the day-to-day application of IAS in their local environments.
With respect to preparers, we believe that considerably more emphasis and efforts should be placed on developing and conducting training on IASC standards than has been the case to date. Preparers have primary responsibility for high-quality financial reporting, and they need to possess an appropriate level of knowledge and competency in IAS to discharge themselves of their responsibility.
Q.18 Is there significant variation in the interpretation and application of IASC standards permitted or required by different regulators? How can the risk of any conflicting practices and interpretations in the application of the IASC standards and the resulting need for preparers and users to adjust for those differences be mitigated without affecting the rigorous implementation of the standards?
We are aware of variations in the interpretation and application of IASC standards by different regulators around the world. For example, the SEC's restrictive interpretation of uniting of interests under IAS 22 is different from other regulators' interpretations. In other words, the SEC might not accept uniting of interests accounting in circumstances in which it would be accepted by certain non-U.S. regulators.
The level of involvement by regulators in reviewing IAS financial statements included in filings, and in challenging the enterprise's application of IAS is also different. At one end of the spectrum, regulators would simply not challenge any IAS financial statements with a clean audit opinion; at the other end (where we believe the SEC is), regulators will actively challenge and question specific accounting treatments and interpretations. We believe there is a lack of consistency in that respect and, because of the absence of an effective global regulatory infrastructure, there is no visible coordination taking place among regulators. This lack of coordination places enterprises using IAS, and their auditors, in an untenable position since IAS financial statements judged acceptable in one jurisdiction might later be challenged and rejected in another jurisdiction.
As mentioned earlier in this letter, the development of an effective global regulatory infrastructure is an essential component of achieving the acceptance of international accounting and financial reporting standards. The goal should be for a coordinated effort in getting regulators around the world to assist the IASC in identifying areas of variations in interpretation and application of IAS, so that the IASC, including the SIC, can focus its attention on resolving these issues. We strongly encourage the SEC to participate in the development of such an infrastructure.
Q.19 Would further recognition of the IASC standards impair or enhance our ability to take effective enforcement action against financial reporting violations and fraud involving foreign companies and their auditors? If so, how?
Further recognition of the IASC standards should enhance the SEC's ability to take effective enforcement action against financial reporting violations by increasing the number of financial statements filings by foreign issuers under the federal securities laws. This recognition in turn would establish a jurisdictional predicate for enforcing the antifraud provisions against such issuers. While the extraterritorial effect of the federal securities laws has not been definitively established, courts generally follow two approaches in deciding whether a particular securities transaction should be subject to American law. One approach focuses on the domestic conduct in question, and the other focuses on the domestic effects resulting from the transaction. Either approach is likely to be satisfied if the foreign issuer files financial statements directly with the Commission. Accordingly, recognition of the IASC standards should be viewed as a positive step from an enforcement standpoint.
Q.20 We request comment with respect to ways to assure access to foreign working papers and testimony of auditors who are located outside the United States. For example, should we amend Regulation S-X to require a representation by the auditor that, to the extent it relied on auditors, working papers, or information from outside the United States, the auditor will make the working papers and testimony available through an agent appointed for service of process? If not, should we require that the lack of access to auditors' workpapers be disclosed to investors? Is there another mechanism for enhancing our access to audit working papers and witnesses outside the United States?
Access to foreign working papers is a complex subject raising a number of issues unrelated to the main purpose of the Concept Release. Question 20 does not distinguish between access to working papers of a foreign firm whose report on audited financial statements is filed with the Commission, and access to working papers of a foreign firm which does not itself issue an audit report, but whose work is relied on by a domestic firm. In the first situation, an amendment to Regulation S-X of the type proposed by the Commission might be feasible, because the representation of access would be made by the same legal entity that owns and controls the work papers in question and whose employees are potential witnesses. However, the second situation is quite different. It is not practical to require domestic firms to commit to provide access to work papers and witnesses over which they have no legal control. A domestic firm would never be in a position to represent that it would provide such access because it would have no legal means of compelling the foreign firm to comply. Contractual provisions in the arrangement letter between the domestic and foreign firm are not a solution. Client privacy legislation in effect in many jurisdictions may severely restrict the ability of the foreign firm to agree to such provisions, and even when they are obtainable, remedies for their breach may be uncertain and difficult to obtain in a cross-border setting. For all these reasons, Arthur Andersen does not support the approaches proposed in Question 20.
Q.21 What has been your experience with the quality and usefulness of the information included in U.S. GAAP reconciliations? Please explain, from your viewpoint as a preparer, user, or auditor of non-U.S. GAAP financial statements, whether the reconciliation process has enhanced the usefulness or reliability of the financial information and how you have used the information provided by the reconciliation. Please identify any consequences, including quantification of any decrease or increase in costs or benefits, that could result from reducing or eliminating the reconciliation requirement.
Our experience with the quality and usefulness of the information included in U.S. GAAP reconciliations is varied. We offer the following observations on factors that influence the quality and usefulness of reconciliations.
Little doubt exists, however, that the reconciliation requirements have in many cases provided users with additional insights into the non-U.S. accounting framework used by foreign registrants, by clearly explaining the reconciling items.
No doubt exists that an Item 18 reconciliation for a first-time registrant normally is a costly exercise, as often the registrant does not have the expertise to perform the reconciliation and must rely on external advice to a large extent during the process. The additional costs of auditing the reconciliation are also significant. On the other hand, as discussed under question 6, we cannot quantify the benefits of the additional information provided in the U.S. GAAP reconciliation on a foreign registrant's cost of capital, although most presume such benefits exist. Ultimately, the use of one set of high-quality global accounting and financial reporting standards by all registrants (in all major capital markets around the world) should result in the optimal cost/benefit equation.
Q.22 Should any requirements for reconciliation differ based on the type of transaction (e.g., listing, debt or equity financing, rights offering, or acquisition) or the type of security (e.g., ordinary shares, convertible securities, investment grade or high yield debt)? Are there any other appropriate bases for distinction?
Reconciliation requirements already differ under current SEC rules (i.e. between an Item 17 and an Item 18 reconciliation), based either on the type of transaction (listing versus capital raising) or the type of security (ordinary shares versus investment grade debt). We do not recommend that the SEC further differentiate its reconciliation requirements as part of this Concept Release. In fact, we would suggest the SEC consider reviewing the basis for differing reconciliation requirements. We note, for example, that the distinction between an Item 17 and an Item 18 reconciliation in practice is often blurred, as the SEC staff sometimes (appropriately) insist on additional disclosures being made under an Item 17 reconciliation in excess of the literal requirements.
Q.23 If the current reconciliation requirements are reduced further, do you believe that reconciliation of a "bottom line" figure would still be relevant (e.g., presenting net income and total equity in accordance with U.S. GAAP)?
As mentioned in the first part of this letter, we do not recommend that the SEC eliminate part or all of the reconciliation requirements at this time. We believe the current requirements provide useful information to U.S. investors and should be maintained at least in the short term. The value of the reconciliation requirements is not only in the quantitative numbers for net income and total equity, but in the explanation of the nature and amount of each reconciling item, and the additional disclosures provided on these items that assist the users in understanding them.
Q.24 Should any continuing need for reconciliation be assessed periodically, based on an assessment of the quality of the IASC standards?
Yes. As mentioned earlier in this letter, the SEC should maintain the full reconciliation requirements until further steps have been taken to provide that a high-quality set of global accounting and financial reporting standards is in place and being consistently applied. This will happen only when a comprehensive global infrastructure is established to ensure a consistent interpretation and application of IAS by all enterprises seeking to raise cross-border capital. We suggest that the SEC reassess the need for reconciliation at the latest in three years.
Q.25 The IASC standards finalized as part of the core standards project include prospective adoption dates. Most standards are not required to be applied until fiscal years beginning on or after January 1, 1998, at the earliest. Should we retain existing reconciliation requirements with respect to the reporting of any fiscal year results that were not prepared in accordance with the revised standards or simply require retroactive application of all revised standards regardless of their effective dates? If not, why not?
Again, our preference is for retaining the existing reconciliation requirements until the SEC decides to endorse unconditionally the IASC as the global accounting standard setter, and accept IAS as high-quality accounting and financial reporting standards. Eliminating part of the reconciliation requirements or requiring retroactive application of all revised standards would equate to the SEC being the international standard setter, which in our opinion is inappropriate and counter-productive.
In addition, it would be unfair and potentially unrealistic to require retroactive application of IASC standards. The IASC examines the most appropriate transition for every standard it issues and many factors are considered before the transition requirements are determined. Some standards (such as IAS 36 and IAS 39) do not allow or require retroactive application because relevant reliable information may not always be obtainable or the additional costs associated with obtaining such information would simply be prohibitive. Also, the SIC has issued an interpretation (SIC 8) dealing specifically with the first-time application of IAS by an enterprise (the Interpretation does not recommend retroactive application prior to the effective date of a Standard).
Q.26 Does the existence of a reconciliation requirement change the way in which auditors approach financial statements of foreign private issuers? Also, will other procedures develop to ensure that auditors fully versed in U.S. auditing requirements, as well as the IASC standards, are provided an opportunity to review the financial reporting practices for consistency with those standards? If so, please describe these procedures. Alternatively, will the quality of the audit and the consistency of the application of the IASC standards depend on the skill and expertise of the local office of the affiliate of the accounting firm that conducts the audit?
Arthur Andersen has developed and implemented a global audit approach consistent with International Standards on Auditing (ISA). This approach prescribes procedures to follow for all attest engagements, which include specific policies for financial statements that are used in cross-border filings. These policies recognize that the existence of a reconciliation changes the way in which auditors approach financial statement audits in that (a) during the course of the audit the engagement team needs to be aware of and identify potential GAAP differences that should be addressed in the reconciliation and (b) the engagement team needs to review and test the reconciliation. Our Firm has adopted policies and practices to bring needed expertise to the engagements that involve reconciliations and issuance of financial statements prepared in the GAAP of a country other than the domicile of the issuing enterprise.
1 IFAD is an initiative of the International Federation of Accountants and the World Bank, which was launched for the purpose of promoting cooperation among a wide range of organizations in developing a common framework and strategy for improving the quality of accounting, auditing and financial disclosure worldwide.