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All for One, Or None for All?

The SEC is pushing international standard setters to follow FASB's lead, and with good reason.
Ian Springsteel, Others
April 1, 1998

The world wants international accounting standards, which promise to reduce accounting costs, improve comparability, and promote more efficient markets. And over the past 10 years, standard setters have come close to transforming this ideal into a reality. But members of the International Accounting Standards Committee (IASC) have several major hurdles to get past before they can present a proposal for the world to consider. The first hurdle is the standard setters themselves.

The friction began last November, when IASC members voted to reject their own staff's critical "financial instruments" proposal. Many European members considered the proposal too "American"--not surprising, since the proposals were lifted straight from U.S. accounting rules and proposals. These members also chafed at the detail with which reporting requirements were specified.

Meantime, the U.S. Securities and Exchange Commission (SEC), which holds the key vote to international approval of the IASC's work, has made it clear it will insist on standards that are as comprehensive and rigorous as the rules adopted by the Financial Accounting Standards Board (FASB). In view of the SEC's virtual veto power over any IASC proposal, by last January events were building toward a showdown. The standards, after all, will shape global capital markets as they enter the 21st century.

Diplomacy may yet prevail. "In February, board members reviewed a working document outlining a new approach, and an exposure draft will be ready to be approved at the April meeting," says Paul Pacter, international accounting fellow at the IASC who is charged with drafting the new document.

The resulting exposure draft would follow the principles of U.S. GAAP in most respects, absent the burdensome details and explanations typical of U.S. rules. For instance, the new version calls for recording the fair market value of all financial assets, excluding assets held to maturity and those impossible to value. As for liabilities--the bigissue--only derivative financial liabilities would be marked to market; all others would remain at historical amounts. The rule would also allow hedge accounting, adjusting both the hedge and the hedging instrument to fair value. The draft contains only slight differences from the U.S. rules: write-downs of financial instruments could be reversed in income if values go back up; IAS companies could recognize the unrealized changes in asset and liability values in earnings or in equity (as opposed to only equity in the United States); and the IASC proposal would allow nonderivatives to be used as hedging instruments.

THE LARGER HURDLE
Assuming the refashioned standard passes muster with the IASC's 16 voting members, a larger hurdle remains. Can the IASC persuade the SEC--a member of the International Organization of Securities Commissions (IOSCO)--to permit companies to sell bonds and list stocks across borders following the new rules? Moreover, will the SEC allow the international standards to be used in the United States without cumbersome reconciliations to U.S. rules? It's hard to tell. Pending final approval of new rules by the IASC, the SEC is reluctant to tip its hand.

"Acceptance of the IASC's standards by the commission is not a foregone conclusion," SEC commissioner Isaac Hunt Jr. warned in a speech last December at a conference of the American Institute of Certified Public Accountants. "The commission's decision as to whether or not to accept the IASC's standards should be made only after the core standards are completed, based on what is in those standards."

Leaders of the IASC, however, sound confident that their board will reach a solution in April. "I hope, and believe, that we will be successful in completing the work this year, and in presenting the core standards project to IOSCO," says Patricia McConnell, a senior managing director of Bear, Stearns & Co. and vice chairwoman of the IASC.

THIRTY-SEVEN DOWN, THREE TO GO
Even if it takes until 1999 to craft a set of standards to suit the SEC and international tastes, it is difficult to be critical of the IASC. A global organization of accounting and industry volunteers established in 1973, the group has worked at a feverish pace since 1995, when it agreed with IOSCO to develop a set of high-quality, comprehensive international standards for corporations to use in cross-border securities transactions.

Toward that end, the IASC has worked diligently to address 40 core standards outlined by the original agreement. As of February, all but 9 of the standards had been established, and 6 of those are pending approval as exposure drafts. The other 3--hedging, off-balance sheet items, and investments--are addressed in the financial instruments project.

Such rapid progress has prompted broader acceptance of IAS standards already. Lawmakers in France and Germany are considering whether to allow their domestic companies to use IASC guidelines as their only accounting rules in consolidated statements. Regulators in Asia are mulling similar decisions, according to Deloitte Touche Tohmatsu. And to facilitate cross-border activities, many global corporations are already keeping two sets of books, using both international standards and their domestic rules.v Yet the SEC does not want to allow international companies to list on U.S. markets using IAS standards rather than GAAP if those standards are weaker. In such a case, the SEC warns, access by these companies could undermine the stability and efficiency of U.S. markets. The agency also fears that if international companies can list using IASC standards, U.S. companies will lobby hard to follow suit, circumventing GAAP in order to look better.


It is well known that GAAP can cast an unflattering shadow on corporations relative to IAS guidelines. Last fall, Hoechst AG, the giant German pharmaceuticals company, was so affected when it listed its stock on the New York Stock Exchange. While IASC rules showed the company earning DM1.7 billion (US$1.2 billion) in 1995 and DM2.1 billion (US$1.4 billion) in 1996, U.S. GAAP shows Hoechst losing DM57 million (US$40 million) in 1995 and earning only DM1.1 billion (US$708 million) in 1996.

The difference lay principally in the treatment of goodwill. Plus, U.S. rules require in-process research-and-development costs to be written off at the time of acquisition. As a result, Hoechst took major hits related to the purchase of Marion Merrell Dow Inc. in 1995 and Plant Genetic Systems in 1996.

ALL FOR ONE, OR TWO
But two systems are better than dozens, argue finance executives tired of grappling with different rules in every sovereign jurisdiction. "If there were two standards here in the United States, one for domestic companies and one for foreign, that would be OK by me, because we would be able to make adjustments fairly easily and we'd know what we were looking at," says Jeffrey Davis, chief investment strategist for State Street Global Advisors, in Boston. "Companies that are concerned about differences in how they'd look compared with international corporations filing here, I think, are underestimating the ability of analysts to cut through the differences and adjust the results."

WHO'S AT RISK?
The securities industry, and especially the leadership of the exchanges, considers approval of the IASC's standards a crucial priority. "The financial markets are going to be global whether the SEC approves these standards or not," says James Cochrane, senior vice president of the research and international group at the New York Stock Exchange, and liaison to IOSCO.

"So if we don't [allow international companies to list with IASC standards], we'll find ourselves three or four years out and saying we missed the boat. Fewer companies will list here than they would otherwise, and the capital seeking those kinds of companies will flow overseas to other exchanges rather than be invested here in nondomestic issues."

Others challenge that view. "I find it hard to believe that the different, more stringent accounting standards in the United States are the biggest barrier to foreign companies listing here. Companies are still racing to list here, and that's not likely to stop if the SEC does not approve the IASC guidelines," says Patricia McQueen, a vice president at the Association for Investment Management and Research and technical adviser to the financial analyst delegation at the IASC.

Currently, she points out, companies wanting to raise public capital in the United States and list on an exchange here must either follow U.S. GAAP or reconcile their home country statements in amendments to their financial statements. "Certainly, people expect international standards to reduce costs for both investors and companies, but many are coming to the U.S. under the current rules despite those costs."

That's for sure. Today, more than 1,000 foreign corporations have filed for securities registration with the SEC, and the number of filers is increasing by 15 to 20 percent annually. About 350 issuers are now listed on the New York Stock Exchange, another 500 are listed on Nasdaq, and 22 are listed on the American Stock Exchange. The remainder are traded over the counter.

Most of these issuers are from three countries--Canada (more than a third) and the United Kingdom and Israel (both nearly 10 percent). But Japanese and German companies, for which the accounting differences are very pronounced, are also filing in the United States, drawn by the availability of capital. Smaller international firms are also entering the market, suggesting that the favorable cost of capital here outweighs theincreased accounting costs.

So, if the SEC withholds approval of the IASC's work, the jury is out on whether the U.S. securities industry and exchanges will suffer. Investors and companies, on the other hand, will certainly continue to be saddled with higher accounting costs and less-efficient markets. And should the SEC approve the international standards in principal at the IOSCO level, the agency could still require reconciliations on key items, like goodwill, when approving the rules for U.S. use.

Either way, it seems, foreign companies wanting to tap U.S. markets will have to face U.S. GAAP, or stay at home.

Ian Springsteel is an associate editor at CFO.

  MOVING FORWARD-SLOWLY
------------------------------------------------------------------------ --------------------- International acceptance of the International Accounting Standards Committee's (IASC) work for cross-border securities filings in the United States won't come soon. In fact, it won't happen this century, even if everything goes smoothly at the IASC this year. The optimistic timeline below lays out the ponderous process.




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