Internal Market DG
Mr. Jonathan G. Katz, Secretary
Securities and Exchange
450 Fifth Street, N.W.
Washington D.C. 20549-0609
United States of America
SEC Concept Release: International Accounting Standards - FILE N° S7-04-00
I have pleasure in submitting the response of the European Commission to the Securities and Exchange Commission's invitation to comment on its Concept Release "International Accounting Standards". Our comments first deal with general issues of principle, and thereafter with the specific questions to which the Securities and Exchange Commission has sought answers.
1. General issues of principle
On 23-24 March, in Lisbon the European Council of EU Heads of State and Government underlined the key importance of a single financial market in contributing to the Union's objectives of growth. The Lisbon Council conclusions called for the realisation of deep and liquid European capital markets and included a specific reference to the need to enhance the comparability of companies' financial statements and to develop more intensive co-operation by EU financial market regulators.
The European Commission's approach to financial reporting is to ensure that securities can be traded on EU and international financial markets on the basis of a single set of financial reporting standards. As a matter of urgency, the Commission is at present discussing with Member States and interested parties about the possibility of requiring listed EU companies to prepare their consolidated financial statements in accordance with International Accounting Standards. In developing this policy, the Commission has examined the consequences that such a requirement would have for the regulation of financial reporting in the EU. The Commission recognises that the adoption of IAS will improve the functioning of the securities markets only when they are properly and rigorously enforced. Clearly, supervisors of the European capital markets have a crucial role to play in ensuring that companies comply with financial reporting requirements. There is already considerable co-operation between the securities markets regulators (The Forum of European Securities Commissions, FESCO) and that cooperation will be further developed through the implementation of a common EU approach to enforcement thereby establishing a level playing field of rigorous enforcement and preventing regulatory arbitrage.
The European Commission is, therefore, firmly committed to promoting the development and application of high quality accounting standards that provide comparable, transparent, relevant and reliable financial information for making efficient capital allocation decisions. We believe this is a necessary step in order to ensure transparency, provide safeguards for investors and contribute to the overall stability of markets. The International Accounting Standards Committee (IASC) is the organisation best positioned to be the standard setting body that could provide the high quality international accounting that the global markets urgently demand.
As stated in the Concept Release, we consider that "the globalisation of the securities markets has challenged securities regulators around the world to adapt to meet the needs of market participants while maintaining the current high levels of investor protection and market integrity". This underlines the challenge for securities regulators to adapt. Not only does this mean further co-operation between EU securities markets regulators, but also closer co-operation between the SEC and the European Commission.
We note that the Concept Release is entitled "International Accounting Standards" and that it seeks input to determine under what conditions the SEC "should accept financial statements of foreign private issuers that are prepared using the standards promulgated by the International Accounting Standards Committee". We note further that the Release discusses a number of other matters related to the financial reporting environment, such as auditing standards, audit quality assurance, regulation and enforcement.
These are indeed crucial issues that need to be addressed within the entire infrastructure of global financial reporting. In Europe, regulators, auditors, preparers and users of financial reporting are very aware of the pressing need to address all those surrounding issues that are of vital importance to the efficient operation of the global capital markets. Many of these issues (such as auditor independence and quality assurance, auditing standards, regulation and enforcement) are currently being addressed as a matter of priority. Nevertheless, the Commission does not see them as issues that are specifically relevant to the inherent quality of IAS, and therefore to the acceptance or non-acceptance of IAS as a financial reporting framework for use by foreign private issuers in the US capital markets. This is because all these elements are pertinent, irrespective of the body of accounting standards applied by the reporting entity. For a European company seeking to raise equity capital in the US capital markets, the issues of quality assurance, regulation, enforcement etc. in the entity's domestic market are equally applicable, regardless of whether it reports under US GAAP or IAS.
The Commission shares many of the concerns that are expressed in the Concept Release. We acknowledge that a comprehensive infrastructure is essential for high quality, international accounting standards to be interpreted, applied and enforced consistently throughout the world. We believe that International Accounting Standards should be transparent, fully understood, properly audited and effectively enforced to have a positive effect on the efficient functioning of the world securities markets and deliver the necessary protection to investors.
Today, more dynamic securities markets and increasing consolidation, driven by new technologies and globalisation, increasingly exert pressure to achieve convergence of accounting standards. Even though there are numerous differences in practical reporting requirements, US GAAP and IAS are both investor-oriented financial reporting systems that provide generally equivalent levels of investor protection. We believe it necessary to consider the general quality of IASC standards, rather than differences or a selection of differences with national GAAP. We find particularly enlightening FASB's view (expressed in its Comparison Project on the Similarities and Differences between IAS and US GAAP):
"It would be misleading to make sweeping generalizations or blanket assertions about the relative quality of IASC standards based solely on the similarities and differences between two sets of accounting standards. The mere existence of differences between accounting standards is not a sufficient measure of the quality or merit of any particular accounting standard relative to the other. The true test of an accounting standard is whether it satisfies the demand for information in the environment in which it is intended to be used."
There are cultural differences between the way IAS and US GAAP are expressed. IASC standards are couched in terms of principles not rules, and preparers and auditors exercise proper judgement in their application to particular circumstances, as opposed to merely following detailed rules. In the Commission's view, the reality is that IAS are as much investor-oriented as US GAAP. IAS, in reflecting the economic substance of transactions in most industries, are of equivalent quality to US GAAP.
We believe that the IAS are a conceptually robust set of standards that provide a sufficiently comprehensive accounting framework to address the fundamental accounting issues that affect most industries. Consequently, we believe that it should be possible for EU companies that apply International Accounting Standards to access the US capital market without undue restrictions.
2. Answers to the specific questions
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?
Yes. In the Commission's view, IAS are high quality, investor-oriented suitable for reflecting the economic substance of transactions in most industries. The IASC's core standards work programme was agreed with IOSCO (including the SEC) in 1995. The IASC Board accepted this agreement in good faith, and since then has worked extraordinarily hard to fulfil its part of the agreement, which it has now done. IOSCO has participated fully in the IASC's due process through its observer status on the Board, the SIC and Steering Committees, and through the comment letter process.
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?
In asking this question, the Concept Release seems to have overlooked paragraph 22 of IAS 1, which reads as follows:
In the absence of a specific International Accounting Standard and an interpretation of the Standing Interpretations Committee, management uses its judgement in developing an accounting policy that provides the most useful information to users of the enterprise's financial statements. In making this judgement, 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.
We believe that this paragraph provides preparers and auditors with the appropriate approach and sufficient guidance on the procedure that should be followed in the circumstances described in the question. In fact, it is not necessarily permissible under all circumstances for a company reporting under IAS to adopt either US or home country standards, since to do so might be inconsistent with sub-paragraphs (a) and (b) of paragraph 22 of IAS 1. We note also that the IASC is currently engaged in major projects focused on developing accounting standards in the areas of insurance contracts, agriculture and the extractive industries.
Q.3 Are there any additional topics that need to be addressed in order to provide a comprehensive set of standards?
As indicated in our answers to Questions 1 and 2 above, we consider that the core set of IAS is already sufficiently extensive and robust to constitute a comprehensive set of standards for the purposes of recognition by the international capital markets, including the US. However, at the same time, we recognise that accounting standard-setting is an evolutionary process. Because of the rapid development of the business environment and the increasing complexity of business transactions, no body of GAAP can be regarded as "comprehensive". There are clearly a number of topics that need to be addressed by all standard setters, including FASB. These include the following:
Clearly, therefore, the same challenges face all the major standard setters, and the IASC and FASB are no different to any other. However, having now completed its core programme, we have no hesitation in concluding that IAS are sufficiently developed for endorsement by the US and other international capital markets.
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.
Yes. We find the Concept Release's discussion of whether IAS are of high quality to be slightly troublesome. This discussion is based heavily on certain specific differences between IAS and US GAAP about which the Concept Release has expressed concern. It then goes on to compare IAS directly with US GAAP in terms of the "level of transparency and comparability that generally is provided to US investors under US GAAP" - the possible implication being that US GAAP has got it right and is the benchmark to which IAS should aspire.
However, what troubles us is that many of the specific concerns raised by the SEC staff about IAS as listed in the Release appear to relate to areas in which US accounting standards are seemingly inconsistent with the concepts from which they are supposed to be derived. For example:
Consequently, in our view the concerns listed in the Concept Release do not add up to fatal flaws in IAS, and certainly do not alter our view that the core set of IAS is already sufficiently extensive and robust to constitute a comprehensive set of standards, particularly when weighed against the immense advantages of a common international approach.
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?
IAS or any system of GAAP must be taken as a package. One cannot pick-and-mix from different systems, because one would end up with incoherent GAAP. Any investor or analyst has to assume that a set of GAAP has been developed by a group of people applying a common philosophy, ethos and underlying principles in order to produce a coherent body of GAAP - as is the case with the core IAS.
We understand that what is important to users is that they must be able to compare the essential numbers across time periods and between companies. However, not all numbers are essential, and what is most important is being able to understand what underlies the numbers - irrespective of what set of GAAP has been applied in the preparation of the accounts.
Another crucial question for analysts is whether or not the capital markets can operate efficiently and effectively in an IAS environment. The view is that they can and do. Clearly, users (including US investment funds) are already using IAS as the basis for informed investment decisions, and are doing so without having a US GAAP reconciliation.
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?
The Commission has no reason to believe that the acceptance of IAS puts entities applying US GAAP at a competitive disadvantage. In fact, we note that in some instances (for example, scope of consolidation and impairment of fixed assets) IAS are more demanding than US GAAP.
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?
Please refer to our answers given to Questions 4 and 5. We do not consider it appropriate for one set of GAAP to cherry pick from another. Both IAS and US GAAP have been established after rigorous debate and due process. They should both, therefore, be accepted as separate packages. However, for the avoidance of doubt, we do not see the specific differences between IAS and US GAAP about which the Concept Release has expressed concern as being indications that IAS result in poorer financial reporting than reporting under US GAAP.
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?
On this issue of whether IAS can be interpreted and applied rigorously, the Concept Release goes full circle back to the preconditions it lays down about the infrastructure of accounting and auditing standard setting and enforcement. This is highlighted when it says that compliance with both black and grey letter sections of IAS should be regarded as necessary. We are not sure that we share that view.
We are somewhat surprised also that the Concept Release has pointed to inconsistent application and misapplication of IAS 22. One would assume from this that the SEC has never found fault with any US company's application of APB 16, or that restatements following the misapplication of specific US GAAP do not occur.
It seems to us that the Concept Release's view of accounting standards is that "more equals better", and that there is a direct relationship between the volume of standards and the reliability, consistency and comparability of financial reports. The truth is that there is no such direct relationship. One only has to look at a typical reconciliation to US GAAP in a 20-F: it is unlikely to contain more than a handful of material reconciling items, and even these are likely to be unessential and/or clearly transparent in the accounts.
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.
Yes. The Standing Interpretations Committee of the IASC plays a key role, as does the IAS 39 Implementation Guidance Committee. There is extensive guidance to be found also in the various accounting textbooks and other literature that deal with IAS. We also see this as an important area where the co-operation both between the SEC and the European Commission and between the EU securities markets regulators can and will have a significant role to play in ensuring the consistent interpretation and application of IAS in the EU.
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?
Please see our answer to Question 3. We see little difference between the issues facing IAS and those facing US GAAP.
Q.11 Is there significant variation in the way enterprises apply the current IASC standards? If so, in what areas does this occur?
Yes, but this applies equally to other sets of GAAP, including US GAAP. Ultimately, we see this as an enforcement issue, and once again we see this as an important area where the co-operation both between the SEC and the European Commission and between the EU securities markets regulators can and will have a significant role to play in ensuring the consistent application of IAS in the EU.
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?
As already noted, the Release is based on the assumption that an accounting and auditing standards environment along US lines is essential for the effective functioning of financial markets and investors. This assumption would be less objectionable if there were incontrovertible evidence to support it. However, we are not aware, for example, that the London financial markets operate less effectively than the New York market or that, if they do operate less effectively, this can be attributed to inherently superior US accounting and auditing standards.
Nevertheless, as we have already stated in section 1 of this letter, in Europe, regulators, auditors, preparers and users of financial reporting are very aware of the pressing need to address all those surrounding issues that are of vital importance to the efficient operation of the global capital markets. Many of these issues such as auditor independence and quality assurance, auditing standards, regulation and enforcement are currently being addressed at EU level as a matter of priority. This includes the need for EU securities markets regulators to be actively involved in enforcement issues on the basis of a co-ordinated approach.
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 interpretive 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?
Yes, we believe that the SIC has been effective at identifying areas where interpretative guidance is necessary and that it has provided useful interpretations in a reasonably timely fashion. Nevertheless, we believe that the SIC does need to gain a higher profile within the IASC structure and could issue interpretations more expeditiously. However, we are confident that the new IASC structure will be able to deliver both these things.
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?
The new IASC structure is designed to deliver the characteristics that the Concept Release has identified for an effective high quality standard-setter. We believe that a high quality structure and due process fully adapted to the needs of the international environment is a necessary condition for the existence of a global accounting standards setting body. We also believe that the new structure should be endorsed in good faith and given a chance to work - particularly in the light of the fact that the SEC Chairman is the Chairman also of the IASC's Nominating Committee. In the light of this, it would seem somewhat harsh to impose a form of probationary period on IAS.
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?
In section 1 of this letter, we state our view as to the relevance to the acceptance of IAS in the US capital markets. On the basis of the work of the EU Committee on Auditing, the European Commission will establish this year requirements for external Quality Assurance of statutory audit in the EU. This means that every EU statutory auditor will be covered by a robust quality assurance system that ensures enforcement of auditing standards and ethical (including independence) rules. Two methodologies peer review and monitoring, will be possible on the basis that the requirements will ensure an equivalent enforcement of audit quality in practice. The quality assurance requirements include: on the spot quality reviews, public oversight over the quality assurance system, public reporting of the results and systematic links with disciplinary procedures. The requirements provide for quality assurance systems in the EU that are at least of equivalent quality compared to the present US-SEC peer review system.
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?
We do not see this question as being of specific relevance to the acceptance of IAS in the US capital markets. The same considerations apply equally to the application of US GAAP or any other set of GAAP. In any event, though, issues such as audit firm quality assurance and auditor independence (including mandatory partner rotation) are being addressed as a priority by the EU Committee on Auditing.
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?
Yes. In fact, the IAS expertise available outside the US is arguably greater than is the case with US GAAP expertise. In particular, the SEC should not underestimate the considerable IAS expertise available within Europe. The European Commission has itself sponsored many projects throughout Europe and further afield which have focused on the adoption of IAS at the national level and the provision of IAS training to locally qualified accountants. Other organisations such as the World Bank have financed similar projects, including a project that is currently underway in China.
In addition, the major accounting firms have substantial IAS training programmes that are delivered in many parts of the world, both to their own audit staff and to clients.
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?
We do not see this question as being of specific relevance to the acceptance of IAS in the US capital markets. The same considerations apply equally to the application of US GAAP, particularly in the case of non-SEC registrant companies.
Nevertheless, there is recognition in Europe that the absence of an integrated enforcement mechanism severely limits the credibility of financial reporting and that at this moment enforcement of accounting standards throughout the EU can be improved. It is therefore accepted that EU securities regulators need to improve their supervisory action on financial reporting through a system of co-ordinated enforcement, and steps are under way to ensure that this becomes a reality.
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?
We cannot see how the recognition of IAS would have any impact on whatever ability to take action the SEC already has. We see little difference legally between a foreign issuer filing IAS accounts with and without a US GAAP reconciliation. In fact, it is possible that, through the co-operation amongst regulators that will necessarily result from the adoption of global accounting standards, enforcement effectiveness will be enhanced.
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?
We see the acceptance of IAS in the US capital markets and regulatory access to the working papers of non-US auditors as being separate issues. In any event, it seems that issues such as these will remain subject to the provisions of the legislation in the foreign countries concerned.
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.
As already noted, a typical reconciliation to US GAAP is unlikely to contain more than a handful of material reconciling items, and even these are likely to be unessential and/or clearly transparent in the accounts. In our view, reconciliations rarely contain information that is either crucial or new. In any event, it is clear that analysts and investors (including US investment funds) are already using IAS as the basis for informed investment decisions, and are doing so without having a US GAAP reconciliation.
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?
Whilst we do not believe that a case exists for any such reconciliation requirement, we nevertheless think that if some form of reconciliation is to remain then the same such requirements should apply only to ordinary shares and other securities convertible into ordinary shares.
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)?
No. Although we do not support the retention of any reconciliation requirement, in the event that some form of reduced reconciliation is required we do not see that the reconciliation of a bottom line number would be relevant. This is because such number would not represent anything, as it would not conform to any recognised GAAP.
Q.24 Should any continuing need for reconciliation be assessed periodically, based on an assessment of the quality of the IASC standards?
If any such assessment is to take place we believe that it should be based on experience of how IAS are being applied in practice, and not on an assessment of the "quality" of the standards. Moreover, any such assessment should be carried out on an on-going basis.
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?
In our view, the transitional provisions of IAS are adequate. However, we would have no objection to the SEC retaining a reconciliation requirement in respect of those core standards that are yet to be adopted. However, this would be academic as it would merely cause companies to adopt any such standards early.
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?
We do not see that this question is relevant to the reconciliation requirement. This is purely a matter of risk management within individual audit firms and we believe that the quality of the audit and the consistency of the application of IAS should not depend on the skill and expertise of the local audit office.
John F. MOGG