19 May 2000
Jonathan G Katz Esq
Securities and Exchange Commission
450 Fifth Street, NW
Dear Mr Katz
SEC Concept Release on International Accounting Standards
I enclose the Institute's memorandum of comment in response to the SEC concept release on international accounting standards.
If there are any points that it would be helpful to discuss, please let me know.
Robert E Langford
Head of Financial Reporting
Direct Dial Tel. 0207 920 8552
19 May 2000
MEMORANDUM OF COMMENT
TO THE SECURITIES AND EXCHANGE COMMISSION ON THE CONCEPT RELEASE ON INTERNATIONAL ACCOUNTING STANDARDS
1. We have reviewed the SEC concept release on International Accounting Standards issued in February 2000 and our comments are set out in this memorandum. We deal first with our general observations. We then respond to the specific questions on which comments were invited.
2. The Institute of Chartered Accountants in England and Wales (ICAEW) comprises over 116,000 chartered accountants, of whom about half are practising members and half are business members. In preparing this response, we have consulted widely both amongst preparers and users of financial statements. We have also obtained input from accounting standard setters and regulators.
3. Our principal observations are that:
Criteria for Assessment of the IASC Standards
Are the Core Standards Sufficiently Comprehensive?
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?
4. Yes, we believe the IASC's core standards and Framework for the preparation and presentation of financial statements are sufficiently comprehensive as a basis for communications with investors. We accept that many of the new standards have yet to be applied in practice over a period of time and that there is a need for continuing development. However, our experience with UK GAAP, which is founded on similar principles, and the earlier adoption in the UK of some of the more recent standards, leads us to believe that the core standards are capable of being applied in a sufficiently comprehensive way.
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?
5. The IASC recognises that there are very limited circumstances where specialised industry accounting is needed and has made provision for this within the existing standards. Such exemptions in the existing IASC standards are limited to agriculture, extractive industries and insurance. The IASC has current projects to address each of these topics, which will result in industry-specific accounting treatment and increased disclosure. We agree with this approach and consider that, with these exceptions, the core standards now provide an adequate framework for all companies.
6. With the exception of these specific industry issues, which should be resolved shortly, we believe that the quality of application of IASC standards should now have reached a sufficiently high standard to be applied without reconciliation or any need to produce separate U.S. GAAP financial statements.
Q.3 Are there any additional topics that need to be addressed in order to provide a comprehensive set of standards?
7. No set of standards is complete, as changes in the business environment and evolution of new industries mean that new issues arise all the time. Such challenges exist in IASC standards and U.S. GAAP as in any other framework. However, we believe that, with the completion of the core program, IASC standards are sufficiently comprehensive for use as a basis for reporting to U.S. and other capital markets.
8. Further development work is still necessary on specific topics. For example, stock options and reporting financial performance: projects in which both the IASC and FASB are participating as an observer or member of the G4+1 working group.
Are the IASC Standards of Sufficiently High Quality? Why or Why Not?
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.
9. Yes. We believe that IASC standards are of a sufficiently high quality to be used without reconciliation to U.S. GAAP, or indeed to any other framework. We agree that there is scope for improvement and the new IASC board will need to undertake a full programme of review and further development of the standards so as to address emerging issues as they arise.
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?
10. There is a considerable body of literature that explains the differences. However, our experience of discussing such matters with analysts and investors in the UK is that they are able to compensate for the differences that exist between UK, US and IASC standards: analysts in the UK market have been able to work with financial information prepared under IASC and US GAAP for over 20 years.
11. We understand that analysts may have to spend a little more time in reviewing and using data prepared using different accounting principles. We also agree that it must be easier for them if the data provides directly comparable information. However, the absence of detailed information that enables users to produce comparable data for their own purposes is now extremely rare. It may be relevant to note that many investment houses have their own view of the performance and financial position of a company that does not necessarily reflect the accounting conclusions inherent in the use of UK, U.S. or IASC standards.
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?
12. We do not believe that there would be any competitive disadvantage for U.S. companies in permitting the use of IASC standards without reconciliation. Acceptance of financial statements based on IASC standards is likely to make the US capital market more attractive to overseas registrants and should thus open up further opportunities to US retail investors.
13. In our experience, capital markets are sufficiently perceptive to interpret the information without such a reconciliation. In any event, these differences have become less significant as convergence is achieved through revisions to both US and IASC standards.
14. We see no reason why U.S. companies should not be allowed to use IASC standards, particularly if they are competing in global markets with non-U.S. competitors. However, we suspect that they would wish to retain the use of home country standards, since these will be more familiar to their principal shareholders. In the same way, we would expect non-U.S. companies to prefer the use of IASC standards where these have been adopted as national standards in their home territories.
15. In our opinion, the costs of producing financial statements on two different bases outweigh the benefits.
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?
16. We believe that it is not possible to conclude that one set of standards is demonstrably better than the other. Both IASC standards and U.S. GAAP are clearly of high quality. However, both sets of standards also include areas that continue to need enhancement. For example, in relation to IASC standards, guidance is needed on accounting for equity compensation; under U.S. GAAP, more work may be needed to decide whether APB 25 or FAS 123 contains the appropriate accounting treatment or whether another solution should be found.
17. Almost all significant differences can be determined from group accounting policies and supporting data. This enables users to compensate when comparing entities that use different GAAPs. However, differences between the entities included or excluded from consolidation may have a substantial impact, particularly where special structures have been used. In the UK, companies are required by FRS 5 Reporting the substance of transactions to ensure that "special purpose" vehicles are not being used to manipulate balance sheets, cash flows or reported earnings. A similar requirement was introduced in IASC standards through the Standing Interpretations Committee's interpretation 12 (SIC 12). We understand that the U.S. is addressing this issue in its current project on the scope of the consolidation. Consequently, we believe that even these differences will be reduced to manageable levels within the near future.
18. The concept release notes a number of specific areas of IASC standards in which the SEC has expressed concerns. However, the IASC board reached its conclusions after due process and extensive debate and discussion with its constituents. The fact that these conclusions are different to those reached by FASB, or that the SEC would have preferred an alternative, does not mean that the resulting standards are not of sufficiently high quality. We believe that differences of opinion of this nature should not detract from full acceptance of IASC standards by individual regulators, whether in the U.S., Europe or elsewhere.
Can the IASC Standards be Rigorously Interpreted and Applied?
The Experience to Date
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?
19. We consider that IASC standards increasingly provide sufficient guidance for their rigorous and consistent application. We also believe they will be able to support the production of comparable and transparent reporting of similar transactions.
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.
20. Yes. The Standing Interpretations Committee (SIC) and the IAS 39 Interpretations Committee play a key role in this area. The SIC is increasingly working with equivalent bodies elsewhere, including the U.S. Emerging Issues Task Force.
21. Together with other professional bodies around the world, the ICAEW also promotes and sponsor various forums for identifying issues as they arise, thus ensuring that difficult and controversial issues are referred to the SIC for consideration.
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?
22. Business environments do not stand still. Thus there will always be areas where difficult application issues arise, whether financial statements are prepared under IASC standards or U.S. GAAP. Those that we believe are significant at present are being addressed by a number of joint projects in which both IASC and FASB are participating, including some of those on the current agenda of the G4+1 group.
Q.11 Is there significant variation in the way enterprises apply the current IASC standards? If so, in what areas does this occur?
23. The programme of revising and improving the core standards has already reduced the level of options in IASC standards significantly. As long as options continue to exist within IASC standards, it is inevitable that there will be some variation in application, although we believe that the level of options will continue to reduce over time. We would also point out that disclosure requirements covering benchmark or alternative treatments now exist for almost all of the options that remain within IASC standards. Options exist to some degree in all GAAPs, including US GAAP.
The Need for a Financial Reporting 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?
24. We agree that the underlying principles identified in the concept release in (i) through (iv) represent key elements of an effective overall financial reporting structure. However, we believe that there is clear need for global rather than national solutions to each of these issues. Only on this basis will capital markets be able to operate truly efficiently. The IASC and the SIC offer global solutions to the first two of these objectives.
25. A crucial element of an effective infracture is provided by directors and management, in particular from high standards of corporate governance. In relation to auditors, who play a key role in ensuring consistency in the way accounting standards are applied, the profession is increasingly operating on a global basis and should be given every encouragement and support to continue the developments already initiated by the International Federation of Accountants and the International Forum for Accountancy Development.
26. As regards regulators, we ask the SEC to combine its efforts with IOSCO and its counterparts in other territories. In this way, the SEC could take the initiative in proposing a partnership with other national enforcement agencies to solve individual application issues (generic issues should be addressed through the SIC), rather than adjudicating such issues by itself. We are seriously concerned that the latter course could undermine the credibility of IASC standards if, for example, different national enforcement agencies were to conclude differently on the application of a particular standard to a company that is listed in more than one jurisdiction.
The Interpretative Role of the Standard-Setter
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 interpretative 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?
27. The IASC's process for developing interpretations through the SIC is now well established and is making good progress. We believe that the links the SIC has now put in place with similar agencies show that it is credible world-wide and accepted as such.
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?
28. We do not believe such a condition should be imposed, as the development of core standards has been completed and the restructuring now seems certain to be achieved around the end of this year.
The Role of the Auditor in the Application of the Standards
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?
29. ICAEW member firms are required to have internal monitoring procedures, including working paper review programmes. The Institute has procedures for investigating complaints that lead to disciplinary action against member firms and individuals. Similar requirements and processes have been implemented by other professional accountancy bodies around the world.
30. In addition, in the UK, the Joint Monitoring Unit (a joint body involving the ICAEW and the Institute of Chartered Accountants of Scotland) conducts a program of independent inspection of the audit work of all firms that carry out engagements as Registered Auditors. Visits by these independent inspectors take place each year where the firm audits listed companies. Whilst at present the scope of the JMU is limited to UK statutory audit work, nothing prohibits its member firms from extending the scope of this review to financial statements based on IASC standards. When such financial statements are permitted or required of UK companies, these procedures will be extended automatically.
31. The UK Auditing Practices Board issues pronouncements that fall into three principal categories: Statements of auditing standards, Practice notes and Bulletins. Auditors are required to comply with auditing standards when performing company or other audits. Failure to comply with auditing standards makes auditors liable to regulatory action by the ICAEW. Practice notes assist auditors in applying auditing standards of general application to particular circumstances and industries. Bulletins provide auditors with timely guidance new or emerging issues. Practice notes and bulletins are persuasive rather than prescriptive but they do indicate good practice. Auditors must be prepared to justify any departure. We believe that these standards and the supporting procedures are sufficient to ensure that auditors complete their work to a high standard. Similar structures are in place around the world. The SEC should be aware of the work being carried out by the International Forum for Accountancy Development that is currently doing a comparison of such standards to those promoted by the International Federation of Accountants.
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?
32. Quality controls procedures need to be in place and must be effective. However, we are unconvinced that the US approach or any other process provides a perfect answer. We believe that the UK system is effective in this respect. This includes procedures for independent review and mandatory rotation of audit partners. Thus we do not believe that UK auditors should be required to certify that they are subject to quality control requirements that are identical to those imposed on U.S. audits.
33. The European Commission is developing a recommendation for minimum standards of conduct of quality assurance systems throughout Europe. We expect that our existing procedures will provide full compliance with this recommendation.
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?
34. In the UK, it is currently rare for financial statements to be prepared in accordance with IASC standards and consequently most firms do not need to be familiar with them. However, following an announcement from a recent meeting of European member state finance ministers in Lisbon, we expect that all listed companies will effectively be required to comply with IASC standards in their consolidated accounts within 5 years. A similar situation throughout Europe is likely to be confirmed in a European Commission strategy paper to be issued in June. The Institute has an extensive training programme for its members and this will increasingly address specific issues relating to IASC standards.
35. Recent years have seen a significant reduction in the differences between IASC and UK standards. The accounting treatment of items such as provisions, impairment, earnings per share and associated companies has increasingly become either identical to that under IASC standards or is founded on identical principles. Our experience is that it has been possible to design and provide training that enables these standards to be rigorously interpreted.
36. At present, the need for expertise in applying IASC standards to companies listed in the US is principally confined to the largest professional audit firms. These firms have developed mechanisms for ensuring that IASC standards are rigorously interpreted and consistently applied. The procedures employed include specific training on a UK, European or international basis, the provision of guidance, consultation with technical departments and with other members of the organisation.
The Role of the Regulator in the Interpretation and Enforcement of Accounting Standards
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?
37. Whilst endorsement of the core standards by IOSCO is a significant step forward, no regulator has yet addressed the extensive application of IASC standards in detail. In the UK, experience of application of standards that mirror their IASC counterparts, including recent standards such as provisions and impairment, shows that there is no difficulty in principle with rigorous implementation. However, it is of concern to us, even today, that the UK Financial Reporting Review Panel might reach a particular conclusion with regard to the application of a specific paragraph of FRS 12 (Provisions), yet a different conclusion might be reached by another enforcement agency in relation to the same words in IAS 37.
38. We believe that steps are needed to ensure the uniform application of IASC standards on a global basis and this process should be lead by IOSCO. In the absence of such a system, we believe that there is a significant risk that a dispute between two different agencies over an accounting interpretation could unsettle the market in an individual company's shares.
39. We urge the SEC and other enforcement agencies to seek a common solution to this problem. However, the SEC is well able to examine and enforce standards in regulatory filings for companies listed in the US. Thus we do not believe that the lack of a global enforcement system should prejudice the SEC's acceptance of IASC standards.
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?
40. We do not believe that recognition of the IASC standards will have any impact on the ability of the SEC to take action in appropriate circumstances.
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?
41. The complex issues raised by the subject of cross-border access to audit working papers are unrelated to a consideration of the acceptability of IASC Standards. In principle, we do not believe that it is practicable or acceptable for any regulator to seek to establish a right of access to workpapers and testimony from auditors outside its national jurisdiction. Even if auditors were prepared to agree to such provisions, client confidentiality obligations in many countries would preclude them from doing so. Any release by their client from such restrictions would be difficult to obtain and uncertain in effect in a cross-border context.
42. A national regulator will be able to obtain compliance with its requirements from a foreign registrant pursuant to the rules under which the securities are listed in its jurisdiction. This is therefore the appropriate direct channel through which it should request any further information it needs from the registrant. Any attempts by a regulator to extend this reach to the auditors and other advisors of a foreign registrant could result in reciprocal measures in other countries and have a counter-productive effect on the efficient operation of the international capital markets.
43. In any event, if there is a basis for the concern which appears to lie behind this question, it is as applicable to foreign registrants that presently file with the SEC using U.S GAAP as it would be to future registrants filing under IASC Standards. The answer to any such concern is not unilateral action but for all the parties to work together to develop an effective global financial reporting infrastructure as discussed under Question 12 above.
Possible Approaches to Recognition of the IASC Standards for Cross-Border Offerings and Listings
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.
44. We believe that reconciliations rarely add crucial information which is used by analysts for predictive purposes.
45. We suspect that individual investors seldom look at financial statements at this level of detail. By comparison, in the case of expert financial analysts and institutional investors, we believe that they are readily capable of compensating for such differences in their analysis of the individual companies.
46. An analysis of a sample of reconciliations indicates that, where such differences exist, the nature of the amounts would be reasonably well known and the magnitude of most of them could be readily estimated using the disclosures that are now provided in financial statements prepared under IASC standards.
47. In principle, such reconciliations would be more useful where there are many differences between amounts derived from the use of U.S. GAAP and IASC standards. However, the most fundamental problems arise from the use of different accounting methods for business combinations (acquisition accounting and pooling). In such cases, the extent of differences can become so pervasive that a reconciliation statement is of no value, despite the very considerable work often involved in its preparation.
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?
48. The same disclosure requirements should apply to the listing of all such instruments. If a GAAP reconciliation is deemed useful, it does not depend on the type of securities or debt instruments being registered.
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)?
49. The SEC should accept the revised arrangements for the operation of the new IASC board as being sufficient to ensure that future standards will be of sufficiently high quality. We also believe that the work involved in producing an earnings reconciliation is almost as extensive as producing such a statement for net assets. There is therefore little to be gained by leaving a requirement for a partial reconciliation, such as relating only to certain standards or just to earnings.
Q.24 Should any continuing need for reconciliation be assessed periodically, based on an assessment of the quality of the IASC standards?
50. No. We believe that the IASC standards are now of a sufficiently high quality to be used for conveying information to the capital markets. We cannot imagine there will be a subsequent drop in quality, particularly following the restructuring of the IASC. Having participated extensively in the design of the new board, we hope the SEC will now accept the IASC's future work in its entirety. We believe that a selective process would encourage other governmental agencies to adopt a similar approach and would undermine the objective of achieving one common set of global standards applied in a consistent way.
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?
51. No. All IASC standards have very clear transitional rules that have been carefully considered. In these circumstances, we believe that reconciliations are more likely to confuse than to add value.
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?
52. Our understanding is that UK auditors of foreign private issuers generally include partners and staff with U.S. qualifications or experience. Those firms affiliated to an SEC Practice Section Firm are already introducing (if they have not done so already) systems of SEC engagement reviewers. The firms in the UK can be expected to respond to emerging regulatory changes relating to IASC standards.
19 May 2000