May 23, 2000
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street NW
Washington D.C. 20549-0609
RE: File No. S7-04-00, Concepts Release: "International Accounting Standards"
I am writing in response to the Commission's request for comments on the Concepts release International Accounting Standards, dated February 16, 2000. As this letter will become a part of the public record, I have included information about my professional qualification as an addendum to the letter. The views expressed in this letter are my own and cannot be attributed to my employers or any organization to which I belong. My purpose in writing is to provide you with a view from my role as a knowledgeable professional who has been involved in the analysis, preparation, research and use of financial statements.
I have chosen to address those issues that I believe are of most importance and not to answer the twenty-six individual questions you specify. My answer to most of the questions is implicit in the substance of the comments reflected in this letter.
- Investors in the United States [US], especially those who are less sophisticated, will be better served by acceptance of International Accounting Standards [IAS] for non-US corporations than the system we have today.
- Accounting principles are not an exact science but result from a compromise of views by well-intended professionals. As such, no set of principles, including US Generally Accepted Accounting Principles [US-GAAP], can ensure consistency and comparability of treatment for all transactions. Even with the significant investment in the development of US-GAAP we have, management has significant discretion in selecting accounting measures and playing the "Numbers Game" that Chairman Levitt has correctly decried. This suggests that any judgments about the relative quality of accounting standards should be treated with caution unless there is empirical evidence to support the view.
- Based on my research and practical experiences, I believe strongly that the evidence suggests that IAS are of sufficient quality to provide appropriate measurements and disclosures for the transactions and events that most companies encounter. I have come to this conclusion from my experience, helping Daimler-Benz with its initial reconciliation to US-GAAP and its listing in the U.S., working with several companies moving to IAS, conducting academic research in the area and performing global equity research. In fact, in some cases, benefiting from the past experiences from other national standards, IAS is of a higher quality than the equivalent US-GAAP standard. Furthermore, where alternatives exist in IAS, there is clear evidence that in some of these areas (for example revaluations of fixed assets) the alternative treatment (revaluations to current values) is relevant to investors.1 It is even plausible that U.S.-GAAP will shift to this alternative approach if the current emphasis on fair value accounting is adopted. In addition, the apparent lack of comparability when these alternative practices are used is overstated as disclosures allow for pro-forma adjustment to the benchmark treatment (such as historical cost in the revaluations case).
- Using US-GAAP financial statements as a benchmark for comparison with IAS, for non-US registrants, is potentially misleading. As non-US registrants are not required to prepare full financial statements in accordance with US-GAAP, most of the detailed financial statement components for non-US registrants are not comparable to financial statements of US companies. The reconciliations of earnings and stockholders' equity in Form 20-F are often very difficult for even sophisticated users to decipher. My experience with many analysts and investors indicates that these reconciliations are not used directly in analyzing, or projecting, the earnings and cash flows of registrants.
- Academic research of the measurement differences reflected in US-GAAP reconciliations (from non-US national GAAP, not IAS) in Form 20-Fs, finds that most differences are not associated with stock returns. Furthermore, for the differences that are priced (primarily, revaluations and goodwill adjustments) the evidence suggests that the information is already available in many of the local jurisdictions so that the 20-F reconciliations are not required to reveal the information.2 This does not mean that registration and the provision of Form 20-F is not relevant. But my view is that most of the benefit to US investors arises from the regulatory oversight rather than from the remeasurements that occur.
- Given the multitude of national standards currently provided by non-US registrants, a shift to IAS for non-US registrants will allow for more, not less, meaningful comparisons.
- I suggest it is beholden on those critics of IAS to demonstrate with explicit examples how and where investors will be harmed by "low quality" information if the Commission accepts IAS for non-US registrants. Research evidence exists that IAS, applied in conformity with the standards will not result in materially lower quality financial statements.3
- I am unaware of any study that demonstrates that more prescription in accounting standards leads to higher quality financial information. To the contrary, we have found that sometimes this just makes it easier for companies to argue that they do not need to abide by the intent because their transactions do not fit within the boundaries the prescription establishes. To cite three specific examples. IAS 17 on Leases is considered to be lacking in rigor, while the myriad of standards on leasing in the US epitomizes an attempt at eliminating off-balance sheet financing with detailed prescription. The FASB has published a separate compilation of GAAP on leases that runs to over 400 pages. Yet, as most financial market participants know, there is an active industry in avoiding these rules. Further, despite this prolific literature, in a study of the Global Airline sector we found it was the US carriers who had the highest portion of their fleet (and the related debt) not reported on the balance sheet, resulting in distortions of operating and net income as well.4 As a second example, when Honda Motors applied US-GAAP, when listing in the U.S., it was forced to defer recognizing almost 90 percent of its obligation as a result of having to apply SFAS 87, a standard written when a political compromise of deferral was needed. IAS 19 would not have allowed this to occur. The final example is for NTT the Japanese telephone company. When it first listed in the US and applied US GAAP it was forced to defer expenses, and create assets, under SFAS 71 that did not exist under Japanese GAAP. Most sophisticated investors who understood the competitive landscape and the nature of SFAS 71 would have realized that these assets would never be realized and it was no surprise when NTT had to write off these assets several years later. A case where US-GAAP created a fiction that only the very sophisticated investor could have unraveled. Of course there are examples that would favor US-GAAP over IAS, but the key point is that there is no empirical evidence to date that I am aware of that IAS will in fact lead to lower quality information.
- Those of us actively engaged in the capital markets know that U.S. companies are already aggressively competing with non-US companies for capital. One example of the shift in investor sentiment can be gauged from the trend of many large investment banks adding to their global research efforts. For the first time in 1999, Institutional Investor published a Global Equity Research poll using sectoral research, reflecting the importance of a sectoral rather than a geographical investment focus. The analysis and valuation comparisons are not restricted to US companies and non-US registrants, so analysts and investors struggle with a myriad of different reporting systems. As investors already grapple with non-US GAAP, a shift to IAS will encourage a move to greater quality and comparability for many non-US companies who move from their national standards to IAS, and US companies will compete more fairly.
- Any set of GAAP is incomplete otherwise we would no longer need standard setters. So adoption of IAS should not be delayed because IAS is not complete, it never will be. Nevertheless, there are clearly cases in which U.S. GAAP is more comprehensive than IAS. This is largely because the SEC and the FASB have created a hierarchy of standards from a variety of standard setting bodies. It seems plausible to argue that a similar hierarchy should be applicable to non-US registrants reporting under IAS. There are also cases where the SEC needs to facilitate the application and interpretation of US-GAAP with its own Staff Accounting Bulletins. It is clear that the SEC cannot do this for a wide array of national standards but there is no reason it should not do this for non-US registrants applying IAS. Again by establishing IAS as an acceptable alternative, investors (and enforcement agents) will have more comparability for non-US registrants than currently exists, so the overall quality of the financial statements of companies in which US investors are already actively trading, should improve..
- It is appropriate for the Commission to be concerned about the structure of the accounting standard setting process. But no set of GAAP can be judged on the enforcement process surrounding it. The SEC hopefully still retains jurisdiction over all registrants, so it can enforce compliance with IAS as it does with US-GAAP and US registrants. Hence, I see no need to base acceptance of IAS for non-US registrants on the enforcement process in every national constituency.
- I see no need for reconciliations from IAS to US-GAAP as these are too opaque to be useful. Rather, the SEC should adopt a hierarchy of acceptable standards for non-US registrants. This will allow for additional guidance in areas where standards are deemed to be incomplete. It will also mean that users have a full set of high quality financial statements to use.
The Commission should be commended for the incredible efforts that many of the SEC staff have put into the development and enhancement of the quality of IAS. As a result of your efforts and the efforts of the FASB and many other conscientious and well intentioned professionals, you can be assured that IAS are now of sufficient quality to provide a core set of standards for non-US issuers that will meet the needs of US investors.
I appreciate the opportunity to comment on the Concepts Release, and will be happy to discuss these issues further if it is of any help in your deliberations.
Trevor S. Harris
Jerome A. Chazen Professor of International Business, Columbia Business School
cc Sir Bryan Carsberg
Trevor S. Harris
Jerome A. Chazen Professor of International Business
Morgan Stanley Dean Witter Faculty Research Scholar
Columbia Business School
Columbia University, New York
Tel: (212) 854-3495 Fax: (201) 750-1485
Professor Harris earned his doctorate from the University of Washington in 1983 and has been at Columbia University since then. He became the Chair of the Accounting Department in 1999.
Professor Harris is a Chartered Accountant (SA) and was a local manager with Arthur Andersen before moving into academia. Since 1997, he has served as a consultant to Morgan Stanley Dean Witter on global accounting and valuation issues where he has headed up the Apples-to-Apples Global Equity Research project, and served as their accounting analyst. In June 2000, he is joining Morgan Stanley Dean Witter as a Managing Director in Equity Research. He has served as one of the United Nation's representatives on the Consultative Group of the International Accounting Standards Committee since 1990 and is a member of the International Capital Markets Advisory Committee at the New York Stock Exchange (NYSE). He assisted Daimler-Benz with their move to US-GAAP and their listing on the NYSE and has worked with several companies in evaluating their accounting relative to International Accounting Standards and US-GAAP. He has provided consulting services on international accounting, controllership and valuation issues to many large international corporations as well as Salomon Brothers and their clients, Standard & Poors and TIAA/CREF's investment group. He also served as the accounting and economics expert on a team hired to evaluate the pricing and rate-making structure of the US postal service.
Professor Harris has published widely in the academic accounting literature. His research has focused on the value-relevance of accounting information with an additional focus on international issues. Recent publications include: "Dividend Taxation in Firm Valuation: New Evidence" with D. Kemsley in Journal of Accounting Research (Autumn 1999); International Accounting Standards versus U.S.-GAAP: Empirical Evidence Based on Case Studies (Southwestern Publishing Company, 1995); "The Value Relevance of German Accounting Measures: An Empirical Analysis" with M. Lang and H.P. Möller in Journal of Accounting Research (Autumn 1994); and "A Comparison of the Value-Relevance of U.S. Versus Non-U.S.-GAAP Accounting Using Form 20-F Reconciliations" with E. Amir and E. Venuti Journal of Accounting Research (Supplement 1993);. Professor Harris has made presentations at over 100 conferences, institutes and universities around the world.
1 Easton, P.D., P.H. Eddey and T.S. Harris. "An Investigation of Revaluations of Tangible Long-Lived Assets." Journal of Accounting Research. (Supplement 1993) pp. 1-38.
2 Amir, E., T.S. Harris and E. Venuti. "A Comparison of the Value-Relevance of U.S. versus Non-U.S. GAAP Accounting Measures Using Form-20F Reconciliations." Journal of Accounting Research. (Supplement 1993) pp. 230-264. Rees, L. and P. Elgers. " The Market's Valuation of Non-Reported Accounting Measures: Retrospective Reconciliations of non-U.S. and U.S. GAAP." Journal of Accounting Research (Spring 1997) pp.115-127.
3 Harris, T.S. "International Accounting Standards versus US-GAAP: Evidence Based on Case Studies." Southwestern Publishing 1995.
4 Apples to Apples Global Airlines: Flight to Quality. Morgan Stanley Dean Witter, October 13 1998.