Jonathan G Katz
Securities and Exchange Commission
450 Fifth Street, NW
UNITED STATES OF AMERICA
22 May 2000
Dear Mr Katz
SEC CONCEPT RELEASE ON INTERNATIONAL ACCOUNTING STANDARDS
FILE NO S7-04-00
The Institute has considered the Commission's Concept Release on International Accounting Standards and I am pleased to set out its comments below. In preparing this response, the Institute has focussed on answering those questions where it feels it has particular expertise.
(a) The need for global standards
The Institute agrees that, in the past, it has been difficult to encourage convergence of accounting standards due to the existence of differing views about the role of financial reporting. The Institute welcomes the contribution of the SEC, IOSCO and other regulators in addition to that of the IASC and other standard-setters in advancing the convergence of financial reporting to achieve comparable, consistent and transparent financial information. The Institute particularly welcomes the endorsement by IOSCO of the core standards announced on 17 May.
The Institute commends the IASC for the contribution of its members and staff towards raising the quality of financial reporting worldwide and notes that the IASC's work in recent years has been successful in introducing significant improvements to the quality of the IASs. The Institute has always supported the IASC in its efforts to develop an internationally recognised set of accounting standards and believes that this has now been substantially achieved. The Institute would also note that acceptance of IAS standards by the private sector will also open up their use by the public sector, particularly where governments look to the capital markets in the future to raise funds.
The Institute believes that, to ensure a high quality global accounting and financial reporting environment, it is essential that the implementation of any system of GAAP on an international basis is undertaken as a complete package. Some jurisdictions may require additional disclosure requirements over and above that set out in any system of GAAP to meet specific local requirements. However, it is vital to the introduction of an internationally accepted system of financial reporting that all standards in a system of GAAP are applied, as opposed to applying some of the standards and then adopting rules from other systems of GAAP to deal with specific financial reporting issues. Adopting a complete system of GAAP ensures that financial statements are relevant and reliable and therefore allow the users of those financial statements to make informed decisions.
The Institute does not necessarily agree with the view that, in order for users of financial statements to understand them, they need to be prepared on exactly the same basis. While it is important for investors to be able to compare the essential numbers in a set of financial statements, it is more important that they understand the differences in the bases of preparation and have easy access to their effects, so that they may be able to make informed decisions.
Although the IASC may take on the role of issuing standards, new or revised standards would be issued only after a considerable consultation period, involving many countries. This should therefore allow each country adequate opportunity to input its views during the development stage of new standards and the revision stages of existing ones.
(b) Principles v rules
In considering the adoption of a global system of GAAP, it is necessary to address the question of whether a system of rules or principles would be more appropriate. Rule-based systems tend to result in high legal compliance costs. Furthermore, the Institute is of the opinion that no system of rules will be comprehensive. Under principles-based systems, it is easier to handle individual transactions by analysing them against the background of established principles.
Where a rule-based system and principles-based system are mixed, this can result in inconsistent measurement and disclosure. This is why it is important to accept a system of GAAP as a complete package. The main problems therefore lie in ensuring that all countries have the same understanding; it is of course necessary for such a common understanding to be achieved under any system of GAAP.
(c) Accounting standards, enforcement and auditing
The Institute is of the opinion that the quality of the standards themselves and the enforcement of those standards are distinct and separate issues. It is not necessarily relevant to include questions regarding the enforcement of an IAS-based system and the monitoring of audit systems as part of the basic question of whether or not IAS would be a suitable system of GAAP. The issues raised in the Concept Release relating to enforcement and monitoring can be applied equally to any system of GAAP.
(d) Structure of the IASC
Having given careful consideration to the elements of a proposed structure, it is important to move forward on the assumption that the new system will deliver that which is expected of it, at least until evidence to the contrary emerges. It will therefore be important to monitor how the new IASC system progresses. It should also be recognised that, as with any financial reporting system, an IAS-based system will not be able to remain static. There will always be a requirement for new standards to deal with emerging accounting and financial reporting issues - for example, the recognition of revenue in relation to internet sales.
The Institute does not believe that the changes proposed to the present IASC structure should act as a deterrent from taking a view on the quality of the core standards developed to date. In addition, the Institute also believes that the new structure should be given the chance to work without being subject to the potential imposition of an initial probationary period.
ARE THE CORE STANDARDS SUFFICIENTLY COMPREHENSIVE?
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 Institute is of the opinion that the core standards, which were agreed with IOSCO (which includes the SEC) in 1995, are sufficiently comprehensive. However, it should be noted that the standards will need to be updated and new standards issued in the future to deal with emerging accounting and financial reporting issues. However, this comment would apply equally to any system of GAAP.
The Institute acknowledges that GAAP is made up of two elements, being the standards and generally accepted practices and that, in respect of IAS GAAP, the latter element is developing rapidly.
2. Should we require use of US GAAP for specialised industry issues in the primary financial statements or permit use of home country standards with reconciliation to US 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?
The Institute would refer to paragraph 22 of IAS 1 "Presentation of Financial Statements" which provides the following:-
"in the absence of a specific International Accounting Standard and an Interpretation of the Standing Interpretations Committee, ... 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."
It would therefore appear that local or industry practice would be acceptable, where the specific area is not dealt with by an International Accounting Standard or other guidance. However, it is accepted that, where there is a very specific industry relating mostly to one country, then the practices followed by that country should form the basis of worldwide best practice. This would for example be the case with the US motion picture industry.
3. Are there any additional topics that need to be addressed in order to provide a comprehensive set of standards?
As with any system of GAAP, there will always be areas that will require to be addressed as it will not be possible for any one system to predict issues that will arise in the future. The Institute is therefore of the opinion that the current core standards are sufficient but that, similar to every standard-setting body in the world, the IASC will require an ongoing work programme, similar to the one currently in existence.
Examples of areas that will need to be addressed include:-
However, the Institute would stress that the current absence of standards and guidance in the above areas should not detract from the perceived comprehensiveness of the present set of core standards. Very few (if any) countries have standards or other pronouncements on many (if any) of the above examples.
ARE THE IASC STANDARDS OF SUFFICIENTLY HIGH QUALITY? WHY OR WHY NOT?
4. Are the IASC standards of sufficiently high quality to be used without reconciliation to US GAAP in cross-border filings in the United States? Why or why not? Please provide us with your experience in using, auditing or analysing the application of such standards. In addressing this issue, please analyse 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 previously stated, it is the Institute's opinion that, if an IAS-based system is to be adopted, then it must be adopted as a package. The Institute also believes that the IASC standards are of a sufficiently high quality to be used without reconciliation to US GAAP in US cross-border filings. The IASC standards provide a basis for the provision of comparable, transparent, relevant and reliable information and cover all of the issues identified by IOSCO as being necessary to achieve a complete set of core standards. However, we would accept a reconciliation in the short term to address different adoption dates, interpretation or compliance issues. The need for such a reconciliation would eventually become unnecessary as experience grows and the remaining core standards take effect.
5. What are the important differences between US 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?
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 US GAAP? If so, what are the specific aspects and reason(s) for your conclusion?
The Institute would note some examples as being the pooling of interests method versus acquisition accounting and accounting for research and development. In both cases, we would regard IASs as being capable of providing better financial reporting information.
As stated above, it is important that, if an IAS-based system is to be accepted, then it is accepted as a complete package. A short reconciliation would cover any major differences in the basis of preparation of the financial statements. It is important to focus on the fact that the main requirement is for users of the financial statements to understand the basis on which the statements have been prepared. They do not require all financial statements to be prepared on exactly the same basis.
6. Would acceptance of some or all of the IASC standards without a requirement to reconcile to US GAAP put US companies required to apply US GAAP at a competitive disadvantage to foreign companies with respect to recognition, measurement or disclosure requirements?
The Institute does not consider the removal of a requirement to reconcile to US GAAP would make any real difference. US users of financial statements are accustomed to dealing with US GAAP and, to the extent that IASC standards differ from US GAAP and US users are unfamiliar with dealing with IASs, they may charge a risk premium for perceived information risk. This may create a higher cost of capital for those filing IAS-based financial statements. As the IASC standards become more widely used and users of financial statements become more familiar with these standards, this risk premium should decline. Any change in attitude would be as a result of the efficiency and sophistication of the capital markets.
CAN THE IASC STANDARDS BE RIGOROUSLY INTERPRETED AND APPLIED?
The experience to date
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?
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 SIC of course plays an important role in providing consistent interpretation of IASC standards. The Institute does not necessarily agree that a sufficient level of guidance will of itself result in the rigorous interpretation and application of standards. Whether or not IASC standards are applied on a rigorous and consistent basis will depend on the knowledge of the preparer of the financial statements and of the auditor and on the information they have available.
The Institute would also note that, just because one principle-based system did not work in a particular country, this does not mean another principle-based system will also fail. However, it is noted that the current guidance on IAS is not particularly comprehensive. This situation should improve as IASC standards become more widely used. The Institute is of the opinion that there are mechanisms in place to promote consistent application, for example internal guidance, procedures manuals and in-house training of auditing firms. It is likely that the SIC, IASC, IOSCO and the major auditing firms will have a role in developing guidance in the future.
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 noted in the response to question 3 above, there will always be emerging issues that will need to be addressed in what is a constantly evolving financial reporting environment. There will therefore always be topics that are not covered specifically by IAS or, for that matter, by other systems of GAAP. However, just because there is not a standard on a particular issue, this does not necessarily mean that there is no guidance on the topic. The Institute would again refer to paragraph 22 of IAS 1, which looks to other standard-setting bodies, local or industry practice as being a source of guidance where no formal guidance or standards exist in a particular area.
11. Is there significant variation in the way enterprises apply the current IASC standards? If so, in what areas does this occur?
The Institute is of the opinion that there is presently a greater degree of consistency in the way standards are applied throughout individual countries, where there will be an understanding of local GAAP, than there is across countries. One of the largest risks in introducing any system of GAAP is that local regulators will produce their own guidance. The Institute would therefore agree that there is currently a degree of variation in the way that enterprises apply the IASC standards. However, we would expect these variances to narrow as awareness and use of the standards develop.
The need for a financial reporting infrastructure
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 item?
It is essential to the development of an effective financial reporting infrastructure that any system of GAAP is adopted as a package. As with any financial reporting system, it is the quality of the financial reporting, rather than the underlying process, that is important. Ultimately, however, the Institute would consider this to be an enforcement issue and believes that this is an important area where co-operation between the EU securities market regulators can and will have a significant role to play in ensuring the consistent application of IAS' in the EU.
(i) The interpretative role of the standard-setter
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?
The number of issues to be dealt with by the SIC, which was established in 1997 and has made excellent progress to date under its present Constitution, will increase significantly with the growth in use of IASs. While there is a mechanism in place for addressing current issues, which does seem to be improving, the Institute would hope that the new structure of the IASC will result in the quicker issue of SIC Interpretations and will address a larger number of current issues.
(ii) The restructuring of the IASC
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 Institute does not believe that this condition should be imposed. As with the introduction of any new system of financial reporting, it is important to allow the system to develop while undertaking effective monitoring to ensure that the system is progressing to meet its stated aims and objectives.
(iii) The role of the auditor in the application of the standards
15. What are the specific practice guidelines and quality control standards accounting firms use to ensure full compliance with non-US 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 programmes 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?
Although this question is not directly relevant to the acceptance of IASs, the Institute believes that those member firms regulated by ICAS who are significantly engaged in the application of IASs have sufficient internal guidance and training processes available to them and in place to ensure the consistent application of the IASC standards. The Institute would also note that it would be important to have such rigorous controls and procedures in place regardless of the system of GAAP being applied.
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 US 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?
The Institute is of the opinion that respective arrangements already exist in many countries and that such arrangements would be required for any system of GAAP. Mandatory rotation of audit partners forms a fundamental part of the Institute's ethical guidance procedures. The Institute has also effected a strong system of review, with regular monitoring and compliance review visits to firms being made by the Joint Monitoring Unit and, as of January this year, the Institute's Activity Review team.
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?
Although IAS is not applied as the primary basis of financial reporting on a worldwide basis, it is important not to underestimate the current knowledge of IAS that exists around the world. Indeed, many countries already use IAS as national accounting standards.
As noted in our response to question 15, the Institute is of the opinion that those member firms regulated by ICAS who are significantly engaged in the application of IAS have sufficient internal guidance and training processes available to them and in place to ensure the consistent application of the IASC standards. The Institute itself also contributes to these efforts. For example, the Institute is currently involved in introducing an IAS-based system of accounting and financial reporting in Romania as part of that country's bid for accession to the European Union. There are also many similar projects underway around the world.
One key point to ensure here is that all translations of IASs should be approved by the IASC to ensure that the text is consistent in each language.
24. Should any continuing need for reconciliation be assessed periodically, based on an assessment of the quality of the IASC standards?
As stated earlier, the Institute believes that the IASC standards are of a sufficiently high quality to be used without reconciliation to US GAAP in US cross-border filings.
25. The IASC standards finalised 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 1 January 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?
The Institute is of the opinion that, if a company is an SEC registrant, then it will effectively adopt the new standards in advance of the mandatory adoption date either in the financial statements or via the reconciliation. Furthermore, the transitional provisions in the IASC standards appear to be adequate and should therefore be followed. Also, given the likely timescale involved in consulting on and agreeing implementation of IASC standards for cross-border listings, all of the core IAS will have come into effect. and this issue will therefore cease to be relevant.
We hope that our comments are of assistance to you in the further consideration of the approval of IASC standards as a basis for cross-border listings. If you wish to discuss any of these further, please do not hesitate to contact me.
LESLEY A HANLEY
Assistant Director, Accounting & Auditing