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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Moving Toward the Globalization of Accounting Standards


Robert K. Herdman

Chief Accountant,
U.S. Securities & Exchange Commission

Schmalenbach Institute for Business Administration Conference
Cologne, Germany
April 18, 2002

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Herdman and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.

Thank you very much Dr. Börsig for that kind introduction. I am very glad to have the opportunity to speak at this conference, as it gives me the chance to stress the importance of the relationship between the United States and Germany and other members of the European Union on financial reporting issues.

Over the last several years, we have seen an increase in the number of German companies listing in the United States. The shares of some of Germany's most prestigious companies now trade on U.S. markets. For example, Deutsche Bank, Siemens, Allianz, Daimler-Chrysler, BASF, and Deutsche Telekom. This development benefits all those involved. It provides German companies with access to a deep and liquid source of capital - including a "currency" in the form of listed stock available for acquisitions in the U.S. It provides U.S. investors with increased opportunities for the allocation of their investments. And it increases the integration of the global economy. It is a positive development that I hope continues into the future.

Today, I would like to spend some time with you discussing International Accounting Standards, (or their new name, International Financial Reporting Standards), the infrastructure that supports their use, and my current thinking on potential action the Commission could take in response to the Concept Release published in 2000. As I am sure you are aware, that release was the vehicle used by the SEC to seek input as to what would be its future position with respect to the use of International Accounting Standards in financial statements filed with the Commission by registered companies and those seeking an initial registration.

But before I go on, I must remind you of the standard disclaimer that my remarks today are my own, and do not necessarily represent the views of the Commission, the Commissioners, or other members of the Commission's staff.

Developments in the International Capital Markets

More than ever, recent events have clearly demonstrated that the countries and capital markets of the world are increasingly interdependent. A shock in one area may affect the others. Investors have shown increasing interest in cross-border investment opportunities, and indeed, technology is making borders disappear.

As a result, we have seen dynamic changes in both domestic and foreign markets. Consider the following: US holdings of foreign securities stand at approximately $2.5 trillion, up 7 fold from 1990 and foreign holdings of US securities are approximately $4 trillion, an increase of almost 340% over the same period. Capital flows to opportunity everywhere, and information - particularly financial information - is the critical currency for investors seeking returns and for companies seeking capital to grow.

As financial information is primarily driven by accounting standards, the staff has had a keen interest in IAS and the developments related to those standards. As we worked in the area of IAS, we heard from issuers and others about the requirements to access the US markets. One of the things we heard was that having two sets of financial statements - one set that has been prepared in accordance with IAS and the other which has been prepared in accordance with U.S. GAAP - was difficult for users to understand. Companies would report the results of their operations under the two sets of standards and, in some instances, those results would be markedly different. As a result of reporting under two standards, the company would have the challenge of explaining that both sets of financial statements were "correct", even though the amounts reported showed different results, sometimes significant in amount.

It is easy to appreciate the concern raised and why many would like to avoid this situation. As part of a reconsideration of the requirements for foreign private issuers, and as I mentioned earlier, the Commission issued a Concept Release in February 2000 seeking public comment on many aspects of IAS and the potential for the SEC to reduce or eliminate its requirement to either file financial statements prepared in accordance with U.S. GAAP, or reconcile net income and shareholders' equity to the amounts that would be obtained under U.S. GAAP.

Within the Concept Release, we solicited comment on the status of the financial reporting infrastructure that supports the use of International Accounting Standards. In that release we stated that the elements of an effective global financial reporting infrastructure include:

  • effective, independent and high quality accounting and auditing standard setters;
  • high quality auditing standards;
  • audit firms with effective quality controls worldwide;
  • profession-wide quality assurance; and
  • active regulatory oversight.

We learned from comments in response to the Concept Release that there is a wide variety of views on the present quality of International Accounting Standards and the financial reporting infrastructure necessary to support their consistent application and interpretation. Those differing views translated to conclusions that one would generally expect: some said drop the requirement to reconcile to U.S. GAAP; others said keep it until further progress is made.

While we recognize that some of the elements of the infrastructure may be at different stages of development and that decisions and progress on these infrastructure issues may be independent of the quality of International Accounting Standards, we believe these issues must be considered in the development of any proposals to modify the current reconciliation requirement. With that said, it may not be necessary that all elements be in place at the same time and everywhere in the world. For example, in the U.S. auditing standards can be viewed as largely already supporting the infrastructure, as audits of U.S. registrants are required to be completed in accordance with U.S. auditing standards. Consideration of other elements of the infrastructure is important because our decisions should be based not only on the quality of the standards themselves, but also on the way the standards actually are interpreted and applied in practice. In other words, our decisions must be based on whether investors receive transparent and neutral information - not on the changes made to each element of the infrastructure that provides such information to investors.

So, what actions are needed to develop an effective financial reporting infrastructure, such that the set of IAS in use, which if we presume is deemed high quality, can facilitate the consistent interpretation and application of the standards? Before that question can be answered, we have to examine what has happened and what is currently in progress.

Developments in International Financial Reporting

In the last 12 to 24 months, there has been a tremendous change in the financial reporting infrastructure within the European Union, as evidenced by the many interesting and important developments that have occurred. Let me mention a few.

On the regulatory side,

  • the European Commission (EC) issued a draft regulation that will require the use of IAS by 2005, or 2007, for 7,000 companies. That draft regulation was endorsed by the European Parliament less than 2 months ago;
  • the European Financial Reporting Advisory Group, or EFRAG, was established to coordinate the development of input to the IASB; and
  • securities regulators in Europe have come together to agree on a more unified structure via the Committee of European Securities Regulators, otherwise known as CESR.

For the standard-setters,

  • in April 2001, the IASC, the predecessor to the IASB, was reorganized into a full-time, independent standard-setter; and
  • the IASB agreed on its initial agenda, which included an "improvements" project, a project on the first-time application of IAS and a project on the Preface of the standards that dealt with the so-call black/gray lettering issue.

And lastly from the accounting profession, the International Federation of Accountants or IFAC has drafted documents for an international oversight mechanism.

European Commission's Directive

As you are aware, the European Commission proposed a draft regulation that would require all listed EU companies to apply IAS for their 2005 financial statements. While the final regulation has not yet been approved, significant progress appears to have been made. First, the regulation's "general orientation" was agreed to by ECOFIN, the European Council of Finance Ministers, at their meeting in December 2001. While the ECOFIN meeting did result in the option to allow for a delay for some companies until 2007, the regulation was substantially unchanged. Second, on March 12, 2002 the European Parliament voted to endorse the proposal with only minor modification.

As a result, it is widely reported that the regulation will be considered by ECOFIN in early May and that ECOFIN will give final approval to the draft regulation. This means that by 2005, approximately 7,000 publicly listed EU companies would be required to prepare financial statements in accordance with IAS. That is a monumental leap from the roughly 350 listed companies in Europe that currently use IAS.

The EC's proposal will significantly change the landscape of financial reporting in Europe and has served as a catalyst in bringing increased attention to the work of the IASB. Because of the ramifications of having most European issuers using a single set of accounting standards by a specific date, the 2005 deadline provides an inviting target date for the SEC staff to bear in mind as we consider potential changes to the disclosure requirements for foreign issuers. If by 2005 there has been sufficient progress in the development of the financial reporting infrastructure and short-term convergence of accounting standards, then I believe the SEC should consider the question of whether foreign private issuers from EU member countries should be required to continue to reconcile from IAS to U.S. GAAP.

With that said, I think there are important aspects of those conditions that must be included in the SEC's consideration, including:

  • the development of the elements of the financial reporting infrastructure for EU issuers that facilitates the consistent interpretation and application of International Accounting Standards; and
  • the differences in principles between U.S. GAAP and IAS that remain after the completion of any short-term convergence project between the IASB and the Financial Accounting Standards Board or FASB.

In order to explore the aspect of the differences between U.S. GAAP and IAS in more detail, let me talk about convergence.

Convergence - What Does It Mean?

In recent years, the staff of the SEC has called for convergence to a single set of high-quality international accounting standards. The IASB and FASB have endorsed this concept. While convergence can have a variety of different meanings, it has generally assumed that, ultimately, all standard setters should agree on a single, high-quality answer. In the long-term, this definition of convergence is a laudable one to which all should aspire so that a single set of high-quality accounting standards could be used by all preparers. And, more important to the SEC, whose duty is to take the steps necessary to protect investors, a single set of high-quality accounting standards applied even-handedly greatly reduces uncertainty about comparability of published accounts, thereby greatly enhancing the transparency of information to the market place.

In the short-term, German companies and other companies that are subject to the European Commission's draft regulation will have to go through a transition process to begin reporting under IAS. I know that this will be a time-consuming and costly effort. So it is understandable that those companies will want to be able to send their financial statements prepared in accordance with IAS to their U.S. shareholders without reconciliation to U.S. GAAP.

To help make that possible, there is a critical need to focus on convergence, not as a long-term goal, but rather a short-term one. In order to do so, the FASB and the IASB have to work together more closely than they have to date. I recognize there is a joint project on business combinations and the staff is encouraged by that development. However, there is an immeasurable need for the FASB and the IASB to converge the principles in their standards in the short-term, and so, much more needs to be done.

The SEC has encouraged both the IASB and the FASB to re-examine their agendas in order to speed up their convergence efforts. The desire to eliminate reconciliation items is greater than ever. What is different, however, is that there is a full-time IAS mechanism to accomplish this objective. Working together, I would encourage the FASB and IASB to develop reasonable and pragmatic short-term solutions to eliminating as many accounting principle differences as possible.

Let us focus on a few key points about how this can be accomplished.

First, short-term convergence is a two-way street, not a one-way street. There may be times when the U.S. experience points to the best way to go, times when an IAS answer may be better, and times when both need to work together and with other standard setters to create a new approach. For example, capitalized interest was a topic of some discussion by the IASB in the Improvements Project. I could see this area of accounting as one on which the FASB and the IASB should be able to achieve convergence. A conclusion to expense all interest costs by both the FASB and the IASB - it is currently an allowable alternative under IAS, but not permitted in the U.S. - would permit both sets of standards to be in agreement in principle. I recognize the project has been dropped from the IASB's improvements project; however, I would encourage the IASB and the FASB to consider this and other similar opportunities, in connection with projects on convergence.

Second, we are putting forward the idea of short-term convergence on high-level principles. For example, the IASB's project on business combinations could attain convergence with the U.S., should the standard contain three or four high-level principles that are the same as SFAS 141 and 142, including:

  • the elimination of the alternative for the uniting of interests method;
  • use of a "purchase" method that requires assigning a fair value to all assets and liabilities acquired, including identified intangibles; and
  • the elimination of amortization of goodwill and intangibles with indefinite lives, subject to a rigorous approach to impairment.

Now, a word of caution. I am not advocating that the IASB simply conform to U.S. GAAP, as this example would cause some to believe, although in this case I understand the IASB is favorably disposed to adopting the principles on business combinations outlined previously. The point, though, is that convergence should be attained at the point of the high-level principles. Lower-level principles and application guidance, for example, the date on which one values equity shares issued in a business combination, are not necessarily required to be identical, provided there is adequate qualitative disclosure of the how the high-level principles have been applied in the financial statements.

Lastly, and this may be the most difficult area for the SEC to consider with respect to the issue of accounting standards, the staff would like to see agreement on as many principles as possible, but recognize that agreement on all principles may not be achieved in the short-term. As such, we will have to carefully consider the significance and pervasiveness of areas where differences continue, as well as whether forms of disclosure other than a reconciliation would sufficiently inform investors. In addition, some of these differences may relate to areas where the IASB has reached a comprehensive and principled decision different from the FASB's. Does this mean that the SEC would judge an IAS standard as something other than high quality if agreement on principles was not attained? Not necessarily, because as long as there are multiple standards setters, I don't think we will ever get agreement on the single "highest" quality answer in all cases at any one point in time. With adequate qualitative disclosure, however, I believe it may be possible to provide U.S. investors with high quality information when the principle within IAS differs from the principle within U.S. GAAP.

Let me turn to the important elements of the infrastructure that must be in place regarding the application and interpretation of IAS, an issue that in may respects is as important as the content of the standards themselves.

The European Financial Reporting Infrastructure

Clearly, audit firms with effective quality controls and active regulatory oversight are the two most important elements that are needed to attain the consistent interpretation and application of IAS. Those elements also present the greatest challenges.

In the United States, it is typical that the largest national audit firms maintain an internal quality control mechanism that includes a centralized system where the interpretation and application of U.S. GAAP is controlled by a group of technical experts that specialize in specific topical areas, such as business combinations, leasing or financial instruments. In the U.S., achieving consensus on application and interpretation is generally an efficient and timely process. This is mainly attributed to three factors. Perhaps the most obvious: U.S. GAAP is the product of a standard setter from one country. Second, the application of U.S. GAAP is made predominately by professionals within one country. Lastly, most accounting professionals are trained in U.S. GAAP during their college education. In addition, the role of the Emerging Issues Task Force or EITF in the consistent application and interpretation of U.S. GAAP cannot be overemphasized.

In contrast, the application of IAS by European professionals has the potential to be much more challenging. Not only is there the mere fact that the standards will be applied by professionals in at least 15 different countries, as most of you know, IAS is a set of high-level standards based on very general principles, which in many cases lacks sufficient application guidance. I am not advocating that the IASB abandon its principle-based approach. Application guidance can be principle based as well. This is in contrast to the rules-based standards that have been issued by the FASB in recent years, for example SFAS No. 133 and 140. However, having high-level, principle-based standards could create an issue on how to address the potential differing interpretations that can arise when the standards are applied in practice - not only by professionals from different countries, but also professionals from different audit firms, and in an environment of extensive and immediate change from practices these professionals have followed during their entire careers.

All of us will want to avoid the emergence of multiple interpretations of IAS for identical transactions not only within the EU, but also between the SEC staff and practitioners in the EU. A significant amount of work would seem to be necessary to create a mechanism within the EU to ensure the consistent interpretation and application of IAS by European issuers. In that vein, I am very much aware of this issue and encouraged that issues are expected to be brought to the International Financial Reporting Interpretations Committee or IFRIC for consideration. While I believe IFRIC will be an important element of the infrastructure, the audit firms and European regulators must also play a key role in creating an environment where consistent interpretation and application can flourish.

Now let me turn my focus inward and talk about some of the developments in the infrastructure in the United States and some issues brought to light by events surrounding Enron.

Recent Developments

If you will permit me to say so, our financial reporting system in the U.S. has long been considered the best in the world and is one of the underpinnings of our capital markets, which are the deepest and most liquid in the world. However, certain aspects of the system can and should be improved so changes to accounting standards can be implemented more quickly, be more responsive to market changes, and provide more transparent information to investors.

The events surrounding Enron's sudden bankruptcy have emphasized our need to address three overarching reforms. The first of those reforms relates to disclosures made by public companies. Those disclosures must be truly informative and timely. Second, corporate governance of American companies needs to be, and must be, improved. Lastly, oversight of accountants and the accounting profession must be strengthened, and accounting principles that underlie financial disclosures must be made more relevant and comprehensible.

Accounting Reforms

The need to improve our accounting system is perhaps the most urgent need of the three reforms. The reform in this area could be separated into two sections: the regulation of accountants that perform audits of public companies and the manner in which accounting standards are set within the U.S. Let me first focus on the oversight of the accountants who practice before the Commission.

The Public Accountability Board

The oversight system that has been used in the U.S. since 1971 - many refer to this system as a "peer-review" system - has been questioned as to its effectiveness in ensuring high-quality audits. As a result, the Commission expects to soon make a proposal for a different system. The proposed system would include the concept of a Public Accountability Board or PAB. The PAB would direct periodic reviews of accounting firms' quality controls for their accounting and auditing practices and also would discipline auditors for incompetent and unethical conduct.

There are several important aspects of the PAB that I want to mention. First, our proposal would call for the PAB to work as a complement to the enforcement efforts of the Commission and focus on ethical and competence requirements rather than federal prohibitions and requirements. We have seen success of such a two-tier system of regulation, specifically within the securities industry. The proposed system is aptly designed to handle behavior that is unethical or incompetent.

Second, the PAB would be an organization that is dominated by members that are unaffiliated with the accounting profession. Because there is a public benefit to having some expertise of the accounting profession, the PAB should have a minority of representation from that industry.

Lastly, the source of funding of the PAB is one that must be secure and independent. Our proposal would include a system where involuntary fees would be imposed upon those who benefit from the financial statements audits, whose quality would be overseen by the PAB. Those subject to the involuntary fees would include, but not be limited to, the accounting firms that perform such audits.

I hope that those responsible for regulatory oversight of the accounting profession within Germany and elsewhere in the EU will take note of our initiatives in this area. Standardization within the EU will facilitate the development of an infrastructure that supports the application of IAS.

Now let me say a few words about setting accounting standards.

Accounting Standard-Setting

The SEC relies on an independent, private sector standards-setting process that is thorough, open, and deliberate. While the Commission has the statutory authority to set accounting principles, for over 60 years it has looked to the private sector for leadership in establishing and improving accounting standards. The quality of our accounting standards and our capital markets can be attributed in large part to the private sector standards-setting process, as overseen by the SEC.

If you will let me digress a moment, I'd like to address a mischaracterization about IAS and U.S. GAAP that has been reported by some in the media. That is that Enron's accounting for special purpose entities (or SPEs) could not have happened under a principles-based set of standards, and specifically couldn't have happened under International Accounting Standards. Based on the Commission's policies regarding investigations that are in process, I am not at liberty to discuss specific Enron matters that have not already been publicly disclosed. I can tell you, however, that while IAS and U.S. GAAP have different principles underpinning their standards, the contention it "couldn't have happened" is one that simply should not be asserted. To do so misinforms the public and I would encourage everyone to note the comments of Sir David Tweedie, Chairman of the IASB, who I believe has made quite clear that he shares my opinion on this matter.

But even before Enron's collapse, we called upon the FASB to work with us to address concerns about timeliness, transparency, and complexity. Specifically, we asked the FASB to address criticisms that:

  • the current standard-setting process is too cumbersome and slow;
  • much of the recent FASB guidance is rule based and focuses on a check-the-box mentality that inhibits transparency; and
  • much of the recent FASB guidance is too complex.

Going forward, we plan to make some changes to the historical way in which we have delegated our authority to oversee the standard-setting process. Let me briefly summarize the four initiatives we plan to undertake. We plan to:

  • broaden funding sources and make the funding involuntary;
  • meaningfully participate in selecting of the members of FASB and setting the FASB's agenda;
  • exercise our authority to review standards actually adopted; and
  • ensure that the FASB promulgates principle-based standards, which adapt faster to changing business environment and emphasize overall accuracy and completeness.

We believe that FASB's standards, at least going forward, should evolve to become general and principle-based, instead of encyclopedic and rule-based, standards. While principle-based standards can also be subject to abuse, and some level of standardization is necessary for comparability and verifiability, we believe that principle-based standards in general are better suited to the sort of rapidly changing financial landscape in which companies operate. In addition, this approach to standard setting allows the standards to be issued more quickly, which is increasingly important. Lastly, the evolution of the FASB's standards should facilitate the short-term convergence of U.S. GAAP and IAS, which I have mentioned is a critical point of consideration for the SEC. As the IASB continues to grow in importance, we must consider, as well, the specifics of our interrelationship with it.


In conclusion, let me summarize and amplify. The prospect that 7,000 listed companies in the European Union member states will be satisfying their listing requirements by disseminating financial statements prepared under IAS is one that we at the SEC must give serious consideration to viz a vis our filing requirements. The following matters will influence whether the SEC will arrive at the result you all, I am sure, hope for - that we would accept those filings in the U.S.

  1. The standards themselves, through the IASB's existing projects on improvements, etc., as well as what I hope can be achieved through cooperative efforts between the IASB and the FASB, achieve sufficient short-term convergence.
  2. Infrastructure is sufficiently developed so that the standards are interpreted and applied in the manner intended with sufficient consistency across countries and firms. IFRIC alone is not enough, I believe, to accomplish that goal.
  3. Training of thousands of accountants and auditors who have not previously worked with IAS, keeping in mind the standards will be moving targets.
  4. Continued progress is made in the areas of regulatory oversight of the auditing profession and in CESR's determination of appropriate regulation of filing and other processes.

What I have not addressed at all today is the need for companies to begin the projects necessary to convert from their current accounting models to models based on IAS. These conversions require significant effort by companies and their auditors and while 2005 seemed a long way off when the European Commission first established it two years ago, it will be here soon.

I wish us all Godspeed in the journey ahead.




Modified: 04/29/2002