The World Bank
Washington, D.C. 20433
JULES W. MUIS
Vice President & Controller
May 16, 2000
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Reference: File No. S7-04-00 (International Accounting Standards)
We welcome the opportunity to comment on the above referenced Securities and Exchange Commission's (SEC) Concept Release on International Accounting Standards. This comment letter represents the views of the International Bank for Reconstruction and Development (the Bank), as well as the International Development Association. The Bank appreciates the SEC's efforts not only to analyze the quality of International Accounting Standards (IASs), as promulgated by the International Accounting Standards Committee (IASC), but also to address the practical issues facing adoption of these standards for cross-border filings. We applaud these efforts and generally endorse the spirit and content of the Concept Release. Our response considers the issues raised from the perspective of both a user of IASC standards in our own financial reporting, and also as a catalyst for improved, consistent and reliable financial reporting in the developing world.
The Bank believes that transparency in financial reporting is a prerequisite for economies to flourish. For this reason, the Bank continues to have a great interest in the development of a worldwide set of accounting and reporting standards. Such standards should be more flexible than national standards to address the needs of a larger and more diverse community. The adoption of internationally accepted standards by the emerging economies of the world would, in many cases, represent a significant advance over their national standards, as currently written. But also, frequently, the Bank has become aware that although the existing national standards of many of these countries appear adequate, their application and the monitoring of their use is often substandard. The Bank believes that, for most of the world, the rigorous application and enforcement of existing standards, whether national or international, and the existence of enabling legislation to mandate their use is a larger issue than which standards to adopt. This point will be expanded upon in the "Application and monitoring in the international environment" section of this letter.
The need for global harmonization in setting standards
The harmonization of global accounting, auditing and regulatory issues is a monumental task, but one that has been necessitated by the globalization of capital markets. The Concept Release contains a thorough analysis of the very real and practical constraints faced by a national regulatory agency and potential standard setter, like the SEC, when considering full adoption and acceptance of IASC standards. The SEC clearly recognizes the need for internationally accepted reporting standards to avoid the confusion, inefficiency and loss of credibility which occurs when multiple sets of financial reports are issued for the same entity using differing standards. The SEC's adoption of International Disclosure Standards, developed by the International Organization of Securities Commission (IOSCO), was an excellent first step in the establishment of a sound international regulatory framework. The next logical step would be the acceptance of IASC standards, in accordance with the work program agreed to in 1995 by IOSCO and IASC. One of the challenges to improving global financial reporting is whether national regulatory and standard setting bodies can effectively develop standards through these international collective organizations, and minimize the development of national variations and required supplements.
The global investment realities of the major capital markets make it imperative that national regulatory and standard setting bodies work through international organizations, such as the IASC, rather than continue to develop country-specific practices. Simply stated, the time has come for global accounting standards and the IASC is uniquely placed to lead this effort. There are obviously differences between U.S. generally accepted accounting principles (GAAP) and IASC standards, but these gaps have been rapidly closing during the past few years. In the end, however, global standards should be more flexible - within reason - and allow a wider range of alternatives than national standards. This flexibility is their strength, and is what allows them to be more relevant to specific circumstances and a larger audience, especially in the developing world. Additional disclosures or reconciliation to national standards should be minimized to as few interpretations as possible, and only when the difference would be material to the financial information presented. The goal should be for the universal acceptance of one set of primary statements to enhance consistency and comparability.
Accounting standards evolve continually and should reflect the changing financial information needs of investors, decision-makers and other users of that information. No one country, nor international body, has developed the "perfect" set of accounting principles, either for national or international purposes. As an illustration, current U.S. accounting standards, as well as IAS, allow certain similar instruments to be held at cost and others at market value. The Bank believes standard setters, like the U.S. and IASC, need to work together to address such shared flaws in the current accounting framework because it affects the very relevance of GAAP information, as well as creates opportunities for inappropriate income management. The Bank fully supports the development of quality national standards for its member and client countries, especially when those standards serve as catalysts to the improvement of international standards. Ultimately, the improvement of international standards should be the goal, as national standards can carry some of the cultural and historical baggage unique to their environments. The international standard setting process can usually filter out such distortions.
The Bank's own financial reporting experience reporting with IASC standards
The Bank prepares its own financial statements in accordance with both U.S. GAAP and IASC standards. No insurmountable inconsistencies have emerged that have not be adequately resolved through increased disclosure. Generally, it has been our experience that IASC standards can accommodate U.S. GAAP more easily than the other way around. The assumption that less flexibility in accounting alternatives equates to better financial reporting is one that underlines the questions posed in the Concept Release. This may not be a valid assumption in all cases, as a rigid, one-size-fits-all approach may, at times, lead to misleading results. Similarly, voluminous and inconsistent disclosures can confuse users of financial information, rather than inform them. An important question is whether national regulators are willing to allow the market to assess the added value of rigid national accounting standards and disclosures over more flexible international standards.
The Bank's experience with the users of its own financial statements indicates that there is a lessening emphasis on the statutory information presented in the primary financial statements, and more emphasis being placed on information reporting on how the Bank is being managed. Users still want to see the primary financial statements prepared under U.S. and IAS GAAP, but increasingly they are more interested in other sources of information, such as Management's Discussion and Analysis (MD&A). Given the timing of disclosures and the wealth of other information used by analysts, the importance of including key information in the primary financial statements should not be under-emphasized. In addition, the users of the Bank's financial statements have expressed a preference for fair value statements; that is, statements that are reflective of all the market risks faced by the institution. Although note disclosures can be used to reconcile such statements to U.S. GAAP, it should concern the accounting profession that the information regulators require for "primary" financial statements are, perhaps, not considered primary by users.
Application and monitoring in the international environment
The Concept Release correctly emphasizes that an effective financial reporting structure requires the accurate and consistent application of accounting standards by the management of reporting entities. Such application requires a high level of expertise and knowledge of accounting and reporting standards, whether the standards are national or international. Similarly, a reliable financial reporting structure should also include an effective monitoring system, including the use of competent, independent auditors and oversight by a responsible regulatory body. Such a monitoring system also requires a high level of expertise and knowledge of auditing standards, as well as a government committed to ensuring that its regulatory representatives are competent and possess the appropriate authority to implement their mandate. The Concept Release cites examples where application of international accounting and auditing was substandard.
Establishing a sound regulatory framework and obtaining the professional knowledge that is a precondition to serious implementation of quality standards has been and will continue to be difficult at the international level. Without a regulatory demand for international standards, the importance which they are given is diminished. Without a supply of qualified professionals, a regulatory environment cannot be serviced. In our opinion, the weakness of international accounting and auditing systems can mainly be attributed to:
Many of the developing and emerging market countries have national accounting and auditing standards. In many cases, country authorities claim that their national accounting and auditing standards are based on the internationally recognized standards. In reality, the financial statements prepared by the business enterprises in those countries often do not comply fully or substantially with those national standards, nor with the international standards they were based upon. In addition to the standards themselves, compliance mechanisms are often very weak. The lack of efficient and effective enforcement mechanisms in most of the developing and emerging market countries allows widespread non-compliance with national or international accounting and auditing standards.
Often the accounting and auditing professions, including regulators and international firms, lack the intrinsic ability to ensure high quality financial reporting and auditing in developing and emerging markets. This inability results in a major expectation gap, one that became particularly manifest in the financial sector in the East Asian financial crisis. It is worth noting that neither international, nor often national, accounting and auditing standards were adequately followed prior to or during this crisis.
Progress may be slow in dealing simultaneously with improving accounting, auditing and regulatory practices, while addressing low skill levels and elements of society resistant to change. It seems clear that, in the long term, resources would best be used to adopt a single set of internationally-recognized, high quality standards useful across borders, rather than encourage individual national variations.
The Public Sector
The capabilities of the public sector in many countries is also below those in the developed world. The national Supreme Audit Institutions (SAI) in most of the developing and emerging market countries often lack the resources, skills and/or independence to be a credible agent for transparency and accountability. A SAI should be an indispensable link in a country's public sector governance system. If a SAI is functioning properly, transparency and accountability of both public, as well as corporate governance and financial management, is enhanced. A lack of seriousness in the public sector usually sets the same tone for the private sector. To achieve a viable international regulatory framework, SAIs need to be linked together through common accounting and auditing practices.
The Concept Release presents the reasons why the international capital markets, and entities who wish to access those markets, would be best served through the wide acceptance of a set of consistent, high-quality and reliable international accounting and reporting standards. Both the SEC and IOSCO recognize the IASC as the best organization to issue such standards. Concerns over the application and monitoring of international standards are well founded, and will need to be addressed as part of the long-term development of an international regulatory framework. It is important to remember that current compliance with existing national standards is substandard in many countries, so capacity building will continue to be necessary regardless of the standards that are adopted. The widespread use of international standards will only become a reality if they receive the acceptance of the regulators, exchanges and accounting professions of the major capital market countries, like the U.S. For emerging economies, the Bank considers the adoption of IASC standards to be highly desirable, due to their wide international acceptance and flexibility in incorporating a wide range of international best practices.
Going forward, the challenges facing the adoption of international accounting and auditing standards include their acceptance by parties within the major capital market countries, dramatic improvements in international systems of compliance, and strengthened international enforcement mechanisms. A step towards meeting these challenges would be the preparation of periodic disclosure statements of the operating philosophy, and compliance and governance mechanisms of all key links in the international regulatory architecture, including the main transparency agents. These include professional service firms/agencies, standard setters, and regulatory and oversight agencies, both in the public and private sectors.
The Bank welcomes the message and content of this Concept Release, because it supports our goal of increased transparency; a goal shared by IFAD and the SEC's own global leadership in this area. We would be pleased to discuss our comments with the SEC or its staff at any time.
Vice President and Controller
International Bank for Reconstruction and Development
International Development Association