Practical means of promoting common international standards. (includes a related article on current efforts to promote international accounting and auditing standards by the International Organization of Securities Commissions)by Solomon, Morton B.
The goal has always been considered long-term because differences in accounting and auditing principles reflect national laws, customs, and cultures. The practical question is, what can be done now to make progress in this difficult task? The International Organization of Securities Commissions (IOSCO) recognized this at its 1987 Annual Conference with a recommendation to "examine practical means of promoting the use of common standards in accounting and auditing practices."
The Internationalization of the Securities Markets
At one time, capital markets were mostly national. For example, U.K. companies raised capital in the U.K. market, and U.K. investors evaluated one U.K. company against another in choosing their investment. Today, capital markets have become more complex and less tied to geographic boundaries. Companies can decide whether to raise capital onshore, offshore, or both, while investors search the world for the best risk adjusted rate of return. An Australian investor may consider securities in Japanese, French, or other non-Australian companies.
Varying exchange rates, less expensive materials and labor costs, additional markets, and a host of other reasons lead many companies to expand or establish businesses overseas. To finance these operations, capital is borrowed or raised through equity issues. Over 500 companies currently have equity securities actively traded in more than one country. About 84 U.S., 73 Japanese, 49 Australian, 48 U.K. and 40 Canadian companies are actively traded on foreign exchanges. Raising capital through debt markets is also expanding greatly. The dollar value of bonds issued on the London-based Euromarket increased from $38 billion in 1980 to $195 billion in 1987.
It became apparent in October 1987, that trading in the world's capital markets has become integrally linked. The behavior of exchanges in Tokyo, Sydney, Toronto, New York, London, Frankfurt, Zurich, and Singapore demonstrated this. Moreover, some believe that when clearing and settlement practices allow efficient trading among markets, the volume of international equity trading will increase significantly.
The surge in international securities trading has undoubtedly increased the population of investors who use financial reports of transborder issuers. It has also made the decisions of these investors more important to the world economy. Nevertheless, accounting and auditing requirements for financial statements are still determined on a country-by-country basis. Because national accounting standards differ, the financial statements prepared in different countries are much less comparable than they ought to be. The significance of information, especially quantitative data, depends primarily on the ability of the user to relate it to some benchmark. Limits on the availability of comparable information, therefore, can diminish the effectiveness of investing decisions that involve evaluating alternative opportunities.
Users of financial statements are also affected by differences among national auditing standards. Because these standards govern the evidence required to support an opinion, sharp differences among them may cause a financial statement user to place more reliance on a given set of statements that is warranted. International auditing standards are, therefore, like international accounting standards, very important to the comparability of financial statements throughout the world.
Responses by Regulatory Bodies
The acceleration of international capital flows and the potential benefits have given some regulatory bodies and stock exchanges the choie of facilitating the flow of international capital or having their markets less favored. Accounting and auditing standards can play a major role in these choices. For example, registrations by foreign issuers could be facilitated by using common accounting and auditing standards or by making reporting requirements for foreign issuers less stringent than those for domestic issuers.
Because of the national differences in accounting standards and the alternatives available in current standards established by the International Accounting Standards Committee (IASC), some countries have unilaterally adopted requirements for foreign issuers. Unfortunately, however, as each country develops its own approach, incentives for common approaches may diminish.
In the U.S., the SEC requires foreign issuers to file special forms to meet the requirements of the securities laws. The SEC permits some foreign issuers to file financial statements conforming to GAAP in the issuer's country of domicile provided the issuer reconciles net income and stockholders' equity to amounts conforming with U.S. GAAP.
In Japan, the Tokyo Stock Exchange simplified and reduced the number of documents foreign issuers are required to file. The Japanese Securities and Exchange laws and regulations were amended to ease the financial reporting requirements for foreign companies. For example, certain deadlines have been extended, and financial statements audited by an independent accountant in the country of origin do not have to be also examined by a Japanese accountant.
In addition to actions by individual countries, multilateral approaches to facilitate registration for foreign issuers have been considered. The U.S. took initial steps in 1985 when the SEC requested public comment on concepts aimed at facilitating multinational offerings. Under one concept, the U.S., Canada, and the U.K. would agree that a prospectus accepted in the issuer's home country, that meets certain standards, would be reciprocally accepted for offerings in each of the three countries. Another concept was the development of a common prospectus acceptable for filing in any or all of the participating countries. The SEC has not established agreements for either concept, and is currently concentrating on the reciprocal concept, including a recent proposal for cross-border offerings by Canadian issuers.
The choice between the reciprocal and common prospectus approaches is fundamental and was addressed in 1987 IOSCO conference workshops. Although a common multinational approach is desirable because it would ensure that all countries have the same level of disclosures, many believe that establishing worldwide agreement on the information to be included in a prospectus is not readily achievable. Proponents of this position advocate the reciprocal approach because it is more achievable in the near future. With either approach the need for common accounting and auditing standards remains.
A regional approach was taken by the European Economic Community. In 1980, the European Council adopted Directive 80/390 regarding the requirements of preparation, review, and distribution of a prospectus for stock exchange listings. In 1987, the Council amended the Directive requiring Member States, under specified circumstances, to materially recognize prospectuses and to limit the supplemental information required when applying for admission on stock exchanges in two or more Member States.
Turning to auditing requirements, the European Commission is currently collaborating with the Federation of European Accounting Experts (FEE) in developing a new and separate Directive to harmonize definitions of the independence of auditors. The 8th Company Law Directive contains a description of minimum training and qualification requirements for statutory auditors, but provides no detailed measures on independence.
Status of International Accounting and Auditing
The IASC formulates and publishes accounting standards. In 16 years it has approved 29 International Accounting Standards (IASs). A recent ED, "The Framework for the Preparation and Presentation of Financial Statements," proposes basic concepts -- the objectives and qualitative characteristics of financial reports and the definition, recognition, and measurement of the elements of financial statements.
The International Auditing Practices Committee (IAPC) established by the International Federal of Accountants (IFAC) develops and issues guidelines on generally accepted auditing practices and on the form and content of the auditor's report. It has approved 26 International Auditing Guidelines (IAGs) in 12 years.
Neither the IASC nor IAFC has the ability to mandate the adoption of its standards and override local regulations within each country. Therefore, both organizations must depend on the efforts of their members -- private-sector, professional accounting bodies -- to promote acceptance of and compliance with the standards issued.
IAGs are generally followed by most IFAC members. A recent survey by member bodies indicated that:
* IAGs have been adopted in substance;
* National standards/local requirements conform in substance to the IAGs; or
* IAGs are used as a primary reference or form a basis for national standards.
The high rate of indicated compliance may be a result of the IAGs being written in a general tone -- suggestive in nature, rather than requiring specific auditing procedures. The survey revealed, however, less acceptance and compliance with Ethics guidelines, which deal more with independence and competence rather than procedural guidelines.
The international accounting firms are another source of uniformity in auditing. Those firms and their affiliates, which perform the majority of audits of international issuers, are believed to have a high level of compliance with IFAC guidelines and to have developed detailed auditing procedures using these guidelines.
Although the existing IAGs are generally followed by most IFAC members, there is a question whether they are sufficiently detailed and complete to use in auditing financial statements included in multinational prospectuses. In response, the IAPC and IOSCO recently formed a joint working party to explore the need to modify and expand IFAC auditing guidelines.
Nineteen eighty-seven was a turning point in the IASC's history. Previously, it often permitted alternative accounting treatments to achieve consensus among its members. In March 1987, it decided to shift emphasis from developing additional standards to reducing the number of options in existing standards. One IASC goal is to form a benchmark for use in multinational securities offerings. The IASC recognized that to achieve this goal, it must work more closely with regulatory authorities, national standards-setting bodies, multinational companies, and accounting firms to achieve the harmonization that users and preparers wish. IOSCO has indicated to the IASC that its accounting standards might eventually be accepted for use in prospectuses of multinational offerings, provided fewer accounting alternatives exist.
Much of the work to eliminate these accounting options is being done by a steering committee. This committee's project proposes the removal of free choices of accounting treatment presently permitted and to eliminate all but one treatment when the different treatments represent a free choice for like transactions and events. However, where alternatives are to be retained to obtain acceptance and to avoid local prohibitions of practices, additional disclosure (such as reconciliation to a preferred treatment) will be prescribed. The steering committee also proposes to amend individual IASs, thus eliminating alternatives for prepares applying the IASs.
The steering committee has identified the following criteria in deciding which alternatives should be required or preferred.
* Current worldwide practices and trends in national accounting standards, laws, and GAAP;
* Comformity with the proposed IASC Framework for the Preparation and Presentation of Financial Statements;
* The views of regulators and their representative organizations, such as IOSCO; and
* Consistency within an IAS and with other IASs. As an important step, in January 1989, the IASC issued an exposure draft of a standard, Comparability of Financial Statements. The proposed standard would eliminate 23 treatments presently allowed and amend 13 existing standards. The ED also specifies 14 preferred or benchmark treatments for whcih free-choice alternatives are allowed but which require reconciliation to the benchmark when that treatment is not the choice. The original comment period for the ED ended in September.
The Prerequisites for Improved IASC Accounting
The comparability project holds the promise of providing standards that can be used for reconciliations in multinational prospectuses or to prepare financial statements for multinational prospectuses. But the promise is no cause for euphoria; there is much to be done. There are prerequisites to acceptable standards that will be difficult to achieve, and still other issues that should be considered for IASC standards to satisfy those who support their use for multinational prospectuses. The four essential prerequisites follow:
1. the standards must be sufficiently detailed. The more general a statement of requirements, the more it opens the way to alternatives in similar circumstances; the absence of specified alternatives, therefore, may not eliminate them. Unless the standards provide sufficient detailed guidance, they will not generate comparable financial statements, but could lull users into believing presentations are comparable when, in reality, they are not.
If the standards are too general, prepares will interpret them in accordance with their customary practices, which may differ from country to country. For instance, the concept of "liability" differs. Provisions are made for all "liabilities" or losses in some countries, but not in others. Severance pay obligations, pension agreements, and estimated losses on purchase commitments or other forward contracts are not recognized in the statements of some European and South American countries, even though other countries do so. Some allow the creation of so-called "secret reserves" through liberal estimates of liabilities and of the financial effects of uncertain future events. Again, specificity is needed. This does not, of course, mean that judgment can be eliminated or that specificity should be doctrinaire and stifling; but it does require greater detail in guidance.
2. The standards must be sufficiently complete. IASC standards have concentrated on essentials. The committee relied on individual countries for guidance on topics not covered by IASC standards, such as earnings per share and discontinued operations, and accounting for specialized industries, e.g., insurance. If multinational companies must rely on individual country guidance for subjects not covered by IASC standards, comparability will not be achieved.
The IASC should establish an agenda of subjects treated in the authoritative accounting literature of different countries and/or incorporated into law, and act on that agenda. The task calls for great prudence, and restraint to assure that the agenda is practical and will not result in excessively detailed standards.
3. The accounting standards must contain sufficient disclosure requirements. IASC standards focus on accounting measurements. They contain relatively little on the nature and extent of needed disclosures. Disclosures, usually in the form of notes, provide information on material matters that may affect the use, understanding, and interpretation of the statements. The IASC should reexamine the extent of accounting disclosures within its standards.
4. The standards must be perceived as developed with sufficient mindfulness of the needs of users. All elements of the standards- setting effort should demonstrate concern for these needs. The IASC should ensure that the improved standards are developed with sufficient midnfulness of these needs and convey this fact in the resulting documents.
Other Issues About Multinational Prospectus
Utilizing IASC and IAPC Standards
The four previously mentioned prerequisites would have to be reasonably satisfied for multinational prospectuses utilizing IASC standards to have a chance of success; but a number of other issues will influence acceptance of IASC and IAPC standards.
1. Securities regulators may be reluctant to endorse the use of IASC accounting standards for multinational prospectuses because of the effect on domestic issuers. If a foreign company prepares its financial statements in accordance with requirements of its country of domicile and then reconciles in some manner to the IASC standards, domestic issuers' financial statements will not be comparable to those of multinational issuers; this difference may be perceived as giving foreign companies preferential treatment. Some regulators have considered that domestic issuers might reconcile their financial statements to IASC standards, but are concerned about the additional record-keeping burden on issuers who securities are traded only domestically. Conversely, when foreign companies are required to reconcile to requirements of the country in which the securities are to be offered, domestic and foreign issuers are on a "level playing field." This issue exemplifies the balance needed between facilitating the flow of the international capital markets and maintaining consistency within the domestic markets.
2. If the improved IASC standards are considered to be less stringent than a given country's domestic standards, that country's securities regulators may be reluctant to adopt the improved IASC standards for multinational prospectuses because that would be unfair to domestic investors. Regulators have a responsibility for domestic investor protection. Ideally, IASC standards that are different from domestic standards would not be perceived as less stringent than those standards. Multinational prospectuses, which include financial statements based on IASC standards that are sufficiently detailed and complete and require adequate disclosure, would enable all users to make informed decisions about those issuers. The reconciliation concept is a practical approach to satisfying both local country requirements and allowing multinational issuers access to the global markets.
3. International auditing guidelines do not contain sufficient detailed guidance on independence, and may need to be modified and expanded in other areas. IFAC's ethics guideline says, "When in public practice, an accountant should both be and appear to be free of any interest which might be regarded, whatever its actual effect, as being incompatible with integrity and objectivity." This guidance requires each country to form its own detailed requirements. Unlike accounting standards, auditing standards of one country cannot be "reconciled" to those of another country. The IAPC should consider clarification of independence for multinational issuers. In addition, the IAPC should utilize the work of the joint IOSCO and IAPC working party to determine whether the IAGs are sufficiently detailed.
4. The opinions in auditors' reports vary from country to country. The auditors' reports of the U.S., U.K. and the Netherlands serve as examples. Unqualified auditors' reports issued in the U.S. state that the statements are "presented fairly in conformity with generally accepted accounting principles." An unqualified auditor's report in the U.K. states the financial statements "present a true and fair view and comply with the law." A Dutch auditor's report states the financial statements "comply with the law and company statutes." Yet, all three reports are in substantial compliance with international guidelines. The IAPC should eliminate the existing alternatives permitted by the IAGs and develop a common set of requirements for audit opinions for multinational issuers. The guidelines for auditors' reports would address issues such as references to comparability and consistency between reporting periods.
5. Improved IASC standards endorsed by IOSCO and accepted by a given country may appear to undermine that country's accounting standards- setting body. Undermining domestic standards-setting bodies in this way would not serve the goal of quality in financial accounting and reporting. International standards-setters should seek to cooperate with national standards-setters. It is important that the IASC continue its efforts to have national standards-setting bodies find new international accounting standards acceptable. Existing national bodies have personnel and estbalished research capabilities that could be used in IASC's work. Furthermore, because IASC accounting standards will be used worldwide, the needs of varying economic and social environments must be considered. Working more closely with national standards- setters would enhance the acceptability of IASC standards to the national communities. On the other hand, national bodies should contribute to the IASC's effort by establishing additional liaison groups and regularly submitting information on their activities and plans.
6. If IASC standards are to serve as the basis for a comparable multinational prospectus, financial statement presentation issues other than those covered by accounting standards would have to be commonly treated. For example, multinational issuers should provide financial statements covering the same dates and periods in their prospectuses. Issues such as how recent the date of the statements should be at the time of registration, the possible need for statements of acquired businesses, and any special instructions for interim statements should also be addressed. Devising recommendations for such requirements should be undertaken by a private sector body such as the IASC. The requirements would form a framework for consistency and would be beneficial when prospectuses are filed simultaneously in more than one country.
7. The legal implications of financial statements that are reconciled to the IASC standards remain to be fully explored. In many major capital markets, financial statements are prepared for statutory reporting purposes with the authoritative literature embedded in national laws. The financial reports are sometimes as integral component of taxation systems and profit-sharing and labor agreements. Research is needed to determine whether financial statements reconciled to IASC standards or filed under them create legal problems in these or other situations.
8. IOSCO's participation in setting international accounting standards may be perceived as standards-setting in the public sector. IOSCO has not set out to establish accounting or auditing standards; that position is appropriate and should be continued. Moreover, by participating in the IASC's development of standards, IOSCO would be acknowledging that the IASC is the proper forum for that task. Nevertheless, if the roles of the IASC and IOSCO are not distinguished, IASC's stature could be diminished.
It is now fair to ask whether resources are available to get the job done with reasonable dispatch. Is the standards-setting operation adequately staffed and funded? How can the national bodies help to achieve these goals? Does the IASC have the necessary research capability? Is the structure designed for efficient communication with the widely dispersed and numerous interested parties? Assuming the resources are put in place to get the job done, implementation issues should not be put off until suitable standards have been completed. The need for transition procedures should be addressed in advance of completion of the standards.
When asking these questions, it is fair to ask as well whether professional accounting organizations and accounting firms are providing enough support to the IASC work. Collectively, professional accounting bodies have a claim to represent global users. Moreover, international accounting firms, because of their international network, should not be biased by national obligations and requirements. It is not unreasonable to hold that additional support from the accounting profession would be constructive.
It is also well to look further into the future on the adequacy of the resources devoted to standards-setting. The IASC should expand its structure to provide a forum to identify emerging issues and to facilitate timely updating of its standards.
The need for common accounting and auditing standards is apparent from the internationalization of the securities markets and the impediments to international liquidity posed by the absence of a multinational prospectus. The current level of activity is a response to the global market's demand for transnational capital. It makes no sense to inhibit international economic activity. The absence of a multinational prospectus has that effect.
The primary question has been now to achieve common accounting standards. IASC's project to eliminate accounting options in its standards is one step in the process. There are other related tasks: comparability will not be achieved without providing in the standards a sufficient level of detail, coverage of accounting topics sufficiently broad to achieve the necessary level of completeness, and more guidance on the extent of appropriate disclosures.
The article has identified other issues that could affect the succes of a multinational prospectus using IASC and IAPC standards. More should be known about the legal implications of statements that would be reconciled to IASC standards and how to arrive at appropriate financial statement presentation requirements for matters other than those prescribed by accounting standards. The IAPC needs to develop a common requirement for audit opinions and more guidance on auditors' independence.
There is much work to be done and additional resources may be needed before the goal of a multinational prospectus is achieved. Achievement is unlikely without the participation of all interested parties; without serious thought, constructive commentary, and an uninhibited exchange of ideas and opinions; or without a willingness to devote sufficient attention to the standards-setting process and to commit the resources to get the job done. In recent years, IOSCO has made a major contribution towards a multinational prospectus and has acted in a spirit that is an example for others. We look forward to ultimately achieving the goal.
(*1) The authors acknowledge the significant held of Karen W. Honaker, CPA, in preparation of this article. Ms. Honaker is a senior manager with KPMG Peat Marwick, and a statistical audit specialist and national instructor with that firm.
Donald J. Moulin, CPA, is a partner in KPMG Peat Marwick and serves as his firm's liaison partner to the SEC. He is partner-in-charge of Professional Practice in his firm's Washington office. Mr. Moulin is a member of the AICPA, several state CPA societies, and chairman of the AICPA SEC Regulations Committee.
Morton B. Solomon, MBA, CPA, is a partner in KPMG Peat Marwick and is partner-in-charge of Professional Auditing Standards and International in the firm's Department of Professional Practice. He is a member of the AICPA, the Auditing Standards Board and co-chairman of the National Conference of Accountants and Lawyers. Mr. Solomon is the author of numerous articles published in professional journals.
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