July 19, 2002

Mr. Jonathan G. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington D.C. 20549-0609

Subject: File No. S7-16-02

Dear Mr. Katz:

Eaton Corporation appreciates the opportunity to respond to the Securities and Exchange Commission's Proposed Rule, "Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies" ("Proposed Rule".)

The collapse of several major corporations in connection with recently identified accounting irregularities has shaken investor confidence in the financial markets and has prompted a review of the adequacy of financial reporting. The events of the last several months have resulted in numerous proposed regulations from various agencies in an attempt to restore confidence in the financial markets, regulate the accounting profession, restore the integrity of financial reporting and hold those accountable who perpetrate these accounting irregularities. Overall, we support the Commission's views on the need for improvement in the area of transparency of financial disclosures, which includes the discussion of a company's significant accounting estimates.

Financial Reporting Release No. FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies ("FR-60") issued in December 2001 provided requirements for additional disclosures about significant estimates. We believe our Company and many other companies made a genuine attempt in responding to FR-60 in their 2001 Annual Report to Shareholders by providing a section in MD&A discussing critical accounting policies. In most cases, our discussion represented an elaboration on the accounting policies already discussed in the footnotes, which we believed was the intent of the Commission's request. We subsequently learned the disclosures provided by most companies generally did not meet the Commission's expectations, which we attribute primarily to the issuance of FR-60 late in 2001, which did not give companies much time to clarify and comprehend fully the SEC intentions.

We understand the Commission has issued the Proposed Rule to clarify and further define elements included in FR-60. As stated earlier, we agree with the underlying concept of the proposal to increase transparency of financial disclosures, however we have several significant concerns, which are discussed below.

In light of these observations about FR-60 and the further clarification to be forthcoming from the SEC on this proposal, we have great concerns about the added burden and the questionable usefulness of the additional Proposed Rule we are now being asked to comment on. The Proposed Rule is very broad in scope and potential content and very costly to implement. Our view is that the costs seem to outweigh the benefits to users of financial statements. The amount of detailed disclosures required by this proposal is overwhelming and, when coupled with the requirement to breakdown the disclosure by business segment, will add significantly to the current level of information overload.

We are not aware of persuasive information or studies suggesting users of financial statements are requesting improved disclosure of critical accounting estimates. Most companies inform users of the financial statements that one of their limitations is that they include the use of estimates and judgements, and that actual results could differ from these estimates. Most users recognize this limitation of audited financial statements and are willing to rely on the management of the company to make their best judgement as to the outcome of future events that could effect the financial statements.

It appears that if this proposal had been in effect, it may not have prevented the recent collapse of WorldCom, Enron or other major companies. These collapses resulted almost completely from the misapplication of and disregard for existing generally accepted accounting principles (GAAP) related to capital expenditures, SPEs, revenue recognition and leases, not significant swings in accounting estimates. We suggest that stricter enforcement of existing GAAP would be a better solution to preventing the types of accounting fraud that struck WorldCom, Enron and other companies, instead of the new information required by this proposal.

Definition of Critical Accounting Policies

The proposal should more clearly define a critical accounting policy since as written it could sweep in many kinds of normal accounting estimates. This will lead to many accounting practice and interpretation problems and information overload. The proposal defines a critical accounting estimate as one involving assumptions that are made about highly uncertain matters where other estimates that could have reasonably used would have had a material impact on the financial statements. On the surface the definition seems relatively straightforward, however when the requirements are applied in practice, questions arise and confusion results as to what constitutes a critical accounting estimate. The use of the above criteria could potentially include accounting estimates such as pension and other postretirement liabilities, which we believe was not the intention of the SEC, as expansive disclosure requirements currently exist in this area. The definition also does not provide guidance on the application of materiality to the effect of accounting estimates on financial statements and to disclosure of these estimates by business segment.

Segment Disclosures

We believe that the disclosure of critical accounting estimates by business segment should not be required. This proposal will increase MD&A to a level of detail that will become unmanageable and obscure management's discussion of important business risks that could effect a company. We are also concerned that there will be a significant amount of explanatory disclosures around the critical estimates related to each segment to ensure that the disclosures are not materially misleading, which will further add to information overload.

Sensitivity Analysis / Qualitative Measures

We have significant concerns with the proposal to include sensitivity/other quantitative analysis in the disclosures concerning critical accounting estimates. We feel more qualitative disclosures about critical accounting estimates would be more beneficial to the users of financial statements. Often, estimates are based on several major assumptions and changes in several of those assumptions could not be adequately captured in a sensitivity analysis. We believe that management's discussion of the required assumptions and why those assumptions were selected would be more informative compared to a range of possible outcomes that would portray the potential impact on earnings. The qualitative analysis would enable the user to better understand the development of the estimate and provide an understanding of the possible impact of changes in market conditions/variables.

We are also concerned with sensitivity analysis on critical accounting estimates from the perspective of managing the business. We believe this would be putting companies at a competitive disadvantage if sensitive estimates such as environmental liabilities, litigation, insurance receivables or tax reserves were required to be disclosed in the form of sensitivity analysis. The disclosure of ranges of possible outcomes could compromise a company's ability to negotiate and settle litigation, tax audits, insurance claims or environmental matters.

As described earlier, the development of estimates requires management's assumptions and best judgement of circumstances or events which will occur in the future. Management uses the knowledge of their business to determine the appropriate assumptions to utilize when developing the estimate. Sensitivity analysis would provide users a forum to second-guess management if an assumption was determined inaccurate. We believe if this information is provided to investors it would detract from the current and future prospects of the business. The qualitative approach to disclosure would provide investors with an understanding of why management changes assumptions from time to time and eliminate some second-guessing of the estimates contained in the financial statements.

Disclosure Overload

The business environment has significantly increased in complexity in recent years and has resulted in more required information in SEC filings. Investors have become overwhelmed with the amount of data available in companies' filings. The Commission continually seeks to provide accounting guidance that balances investors need for useful information with eliminating superfluous disclosure. We are in support of additional disclosure which provides investors with a view of the Company "through the eyes of management", however we believe this proposal in its current state will only add to the disclosure overload, especially when coupled with the requirement to breakdown the disclosures by business segment. The proposed disclosure requirements would essentially expand MD&A by several pages for each significant issue with the required quantitative analysis. We believe users of financial information would be better served if the SEC returned to its original objective in FR-60, which was to highlight a company's significant accounting estimates. We encourage the Commission to provide limited guidance in the area of providing information on significant accounting estimates versus a detailed "one-size fits all" approach.

We continue to believe disclosure overload is a significant issue facing the Commission and financial community (both preparers and users), especially in light of the expanded disclosure requirements of this proposal. We contend that disclosure overload is a significant obstacle to realizing the Commission's objective of accelerated filing deadlines.

Outside Auditor Involvement

We question the benefit of the requirement for the independent auditor to examine the proposed disclosures related to critical accounting estimates. The auditors have presumably audited these estimates in connection with the audit of the financial statements and additional scrutiny seems unnecessary. Most likely this would result in an increase in the cost of the audit without a significant benefit.

Accelerated Filings

In addition to this proposal, the SEC is sponsoring a proposal to accelerate annual and quarterly filing requirements. If these Proposed Rules move forward, we request the Commission consider the effect on the proposal related to accelerated filings, as these two proposals appear to be working towards incompatible objectives. The critical accounting estimate proposal would inevitably require more time, effort and disclosure, while the proposal on accelerated filings seeks quicker, more accurate filings. We believe the Commission must address the issue of disclosure overload before considering the proposal to shorten deadlines. Another element of the proposal to be considered in conjunction with accelerated deadlines is the requirement for auditors to opine on MD&A. The addition of this requirement to the proposed rule would impose difficulties in meeting the accelerated filing requirements.

We appreciate the Commission's consideration of these important matters and welcome the opportunity to discuss any and all issues with the Commission at its convenience. Answers to selected questions contained in the proposal are included below. If you have questions regarding this letter, please feel free to call me at (216) 523-4175.

Sincerely,

/s/ Billie K. Rawot

Billie K. Rawot
Vice President & Controller
Eaton Corporation

Answers to selected questions

We solicit comment with regard to broadening the scope of our proposals to achieve a more expansive objective.

• Should we require in MD&A a discussion of the impact that alternative accounting policies acceptable under GAAP would have had on a company's financial statements even when a company did not choose to apply the alternatives?

  We strongly object to including discussions of the impact of alternative accounting policies. The method of accounting is in accordance with generally accepted accounting principles, therefore a requirement to disclose policies not adopted would only confuse the reader and result in disclosure overload. The readers have enough information to decipher without having to concern themselves with accounting methods the Company did not adopt. In addition, Companies would constantly be forced to defend their selection of accounting principles to investors even though the policy selected is in accordance with GAAP and acceptable to the auditors.

• What costs would companies incur if they had to prepare disclosure about the effects of alternative accounting policies that could have been chosen but were not?

  There would be incremental time and effort required by the company's internal accounting department to 1) understand the alternative requirements, 2) gather the information, 3) prepare the calculations and 4) reconcile the alternative accounting policy to the chosen policy. Companies would spend substantial time in meetings to discuss the alternative policies with the company's management, auditor, and audit committee. It is impossible to determine how much extra effort this would be since the accounting policies can vary tremendously in complexity. The ability to comply with the Proposed Rule would require additional headcount to assist in gathering and analyzing information while meeting the proposed accelerated timetables. The benefits derived from this exercise would in no way exceed the costs of implementing the proposed requirements.

We seek comment on the proposed definition of critical accounting estimates.

• Is the definition appropriately tailored?

  The Proposed Rule defines a critical accounting estimate as one meeting two criteria - assumptions are made about highly uncertain matters and other estimates a company could have reasonably used would have a material impact on the financial statements. On the surface the definition seems relatively straightforward, however when the requirements are applied in practice questions arise and confusion results as to what constitutes a critical accounting estimate. The use of the above criteria could potentially include accounting estimates such as pension and other postretirement liabilities, which we believe was not the intention of the SEC, as expansive disclosure requirements currently exist in this area. The definition also does not provide guidance on the application of a material impact on the financial statements as discussed below.

• Is the definition appropriately designed to identify the accounting estimates involving a high potential to result in a material impact on the company's financial presentation?

  It is our belief that the definition will result in accounting estimates disclosed that were never intended by the SEC to be critical accounting estimates if the current definition of materiality (SAB 99) is applied. If the SEC continues to apply SAB 99 for guidance on materiality, several issues are raised. Clear guidance is not provided on the appropriate measure of materiality - financial condition versus results of operations. The potential exists for the company to have estimates which materially impact one quarter's earnings but not the next. We do not believe the SEC intended for a company's significant accounting estimates to change on continuous basis.

• Should we consider setting a minimum percentage impact on results of operations in the second criterion of the definition, or would that be unnecessary because the proposed definition would not capture changes that have an insignificant impact?

  We oppose using results of operations as the basis for determining materiality. Operating results for many firms are subject to wide swings both up and down. Minimum percentage criteria could result in accounting estimates being considered material one year and not the next, even though the accounting estimate didn't change. Materiality in the context of this Proposed Rule needs to focus on financial condition and long-term financial health.

• Should we establish a maximum number of accounting estimates that may be discussed as critical accounting estimates (e.g., seven)? If so, what should the maximum number be and what criteria should be applied to set the number so as to strike the appropriate balance between information truly useful to investors and overly extensive disclosure of marginal use? If a maximum were set, should the number of segments a company has be considered?

  We believe the SEC should not set a maximum number of critical accounting estimates or suggest that most companies will even have 3-5 critical accounting estimates. Management's Discussion and Analysis represents the opportunity to discuss the business "through the eyes of management". We believe the SEC would be better served by providing guidelines with respect to critical accounting estimates rather than a "checklist" of items to be disclosed. We believe more meaningful discussion will be provided if companies are allowed the flexibility in presenting the data versus superficially trying to comply with "bright-line" requirements of the Proposed Rule.

We request comment on the proposed identification and analysis of changes.

• Are there some types of critical accounting estimates or some circumstances where the proposed disclosure relating to sensitivity would not be meaningful or otherwise helpful to investors? If so, which estimates or what circumstances?

  We are concerned with the requirement to provide sensitivity analysis of the assumptions "that a company reasonably could have used" in accounting for and disclosing significant accounting estimates (i.e. potential liabilities). We believe the disclosure of highly sensitive possible outcomes of litigation, insurance receivables and tax audits would not be in the best interest of the company or its shareholders. The disclosure of these items could result in competitive harm to a company as they are forced to disclose ranges of possible exposure which could compromise its negotiating position in many circumstances. Our belief is the risk associated with the disclosure of such information is greater than the benefit derived by investors in knowing the range of possible outcomes. We also believe undue scrutiny of management will result from disclosure of possible outcomes, when those outcome deviate from management's estimates. Management will be continually questioned and second-guessed for estimates which creates a no-win situation as management attempts to defend its position in hindsight rather than focusing on the future of business.

  We believe robust qualitative disclosure could provide much more meaningful information than the proposed quantitative disclosures. Significant accounting estimates typically are contingent upon more than one material assumption, and a sensitivity analysis based upon the change in one of those assumptions may not be as useful as qualitative data related to an estimate such as the assumptions selected, the reasons for selecting assumptions, etc. The disclosure should provide an appropriate balance of quantitative and qualitative information that can be easily understood and interpreted.  

We solicit comment with respect to independent auditor examinations of the proposed MD&A disclosure regarding critical accounting estimates.

• Should we require that the critical accounting estimates disclosure in the MD&A undergo an auditor examination comparable to that enumerated in AT §701?

  We are not in favor of such a requirement. The estimates discussed in MD&A would presumably be audited in connection with the audit of the financial statements and additional examination would be redundant. However, the Proposed Rule as drafted requires sensitivity analysis disclosures for significant accounting estimates of the Company. This would require the auditor to examine sensitivity analysis information and understand the assumptions utilized in addition to the work performed in auditing the accounting estimates. An examination by the auditor of critical accounting policies in MD&A would likely result in an increase in the cost and the length of time to complete the audit without a significant benefit.

We solicit comment on the disclosure presentation aspects of the proposals.

• Should the proposed disclosure be presented in a separate section of MD&A or should we require that it be integrated into the other discussions of financial condition, changes in financial condition, results of operations and liquidity and capital resources when the proposed disclosure is closely related to an aspect discussed in those separate sections of MD&A?
  

  In our attempt to comply with FR-60 we included our discussion of critical accounting policies as a separate section of MD&A in the 2001 Annual Report to Shareholders. However, we believe that companies should be afforded the flexibility to present the information based upon management's views or integrated within the discussion in MD&A in the appropriate section. Management of companies may choose to portray critical accounting estimates in a separate section of MD&A, but companies should be given the flexibility to determine if that is appropriate.

We solicit comment with respect to the potential benefits of the proposed MD&A disclosure.

• Would the proposed disclosure serve as a deterrent for improper accounting practices?

  While we believe transparency of financial reporting will provide more useful and meaningful information to investors, we do not feel these additional disclosures will prevent improper accounting practices. Several of the more recent cases of accounting irregularities would not have been avoided by the Proposed Rule as they involved fraudulent behavior or a misapplication of GAAP.