A former FASB chairman's take on international accounting standard setting.

It's mid-afternoon on a day in late January 1999. The closing conference with your auditors just began. As CFO, you are delighted with the year's record results, and your controller and manager of financial reporting have assured you the closing has been squeaky clean. Why, then, the grim look on the audit partner's face?

She begins the conversation by confirming that the company properly handled all of the latest FASB and AICPA pronouncements. "But we have a problem with IAS 36 and 38," she says.

CFO: "What the heck are IAS 36 and 38?"

Auditor: "Those are the International Accounting Standards Committee's new rules on employee benefits and financial instruments. IAS 36 won't let you defer certain actuarial losses as you've done under FASB Statement 87. And IAS 38 says the amounts you considered hedges under U.S. accounting rules have to be charged to income now. Unfortunately, by using these rules your adjusted net income will be about 20 percent less than you thought. Since you are making plans to list your company's stock in Tokyo and Paris early this year, you'll need another set of financials showing the lower amount."

CFO: "But we're a U.S. company, and our reports are correct under U.S. rules. I don't care about international accounting standards."

Auditor: "I'm sorry, but the SEC recently announced an international agreement that all cross-border securities filings must follow pronouncements issued by the IASC. The commission already has been allowing some foreign companies to use IASC standards when they sell securities in U.S. markets. Now U.S. companies will have to do the same overseas. In fact, this could become an even bigger issue in the future. There's been talk that there should be just one 'world GAAP.' If that happens, all U.S. companies will have to follow these standards as well."

CFO: "These things don't happen overnight. Why weren't we informed the IASC would be given the power to dictate rules for U.S. companies? And why didn't your firm or our company get involved to influence the IASC's conclusions?" ...

All of the above is purely hypothetical, of course. But it really could happen. That's why financial executives need to get involved now to influence the outcome of recent developments in internationalizing accounting standards.

WHERE IT ALL BEGAN

The IASC was established in 1973, the same year as the FASB. The IASC is affiliated with the International Federation of Accountants, an organization of professional accounting associations around the world. While a large number of countries belong to the IASC, its operating arm is the IASC board, which consists of 16 voting members representing 13 member countries, Swiss multinational companies, the International Association of Financial Executives Institutes (IAFEI) and the International Coordinating Committee of Financial Analysts' Associations. The IASC board is the group that promulgates international accounting standards. Members of the board are part-time representatives who generally are otherwise employed as accounting firm partners, financial executives, analysts and academics. Headquartered in London, the IASC also has a small full-time staff.

Each IASC board position has one vote. However, generally two individuals represent a country or organization. Currently, the two U.S. representatives are G. Michael Crooch of Arthur Andersen LLP, appointed by the AICPA, and John J. Perrell of American Express, appointed by the Institute of Management Accountants. The IAFEI representatives are David Potter of BAT Industries (from the United Kingdom) and Thomas E. Jones of Citicorp (from the United States). The FASB is not a member of the IASC, and the U.S. and other delegations' votes on IASC matters are not coordinated with the FASB. However, an FASB board member does observe the IASC meetings, and the FASB has the opportunity to provide input to the IASC through letters and discussions with staff and consultative group members.

The IASC began as a way of providing minimum accounting guidelines for developing countries and others that did not have their own standard-setting process. It issued standards that basically compiled what was acceptable in the parts of the world that had more developed accounting standards - in the United States, continental Europe, Japan and others. That is why many of the IASC's earlier standards were very basic and allowed for alternatives in several cases.

With the growing globalization of capital markets in the mid-1980s, the IASC began an "improvements project" designed to reduce the number of alternatives and to deal with more of the important overall issues that previously were not covered. That has been a slow, but reasonably successful, process that has continued into the early 1990s. Following the lead taken by the United States and other countries that share a "user perspective" for financial reporting, the IASC now has standards that cover many of the most pervasive accounting issues, and it has eliminated many alternatives. Even where alternatives remain, the IASC often identifies one approach as the "benchmark."

More recently, the IASC has developed an ambitious plan to attempt to move to the leadership position in establishing accounting standards for multinational companies wishing to raise capital in various world securities markets. Pursuant to an agreement with the International Organization of Securities Commissions, or IOSCO, the IASC plans to complete and refine a core set of accounting standards. According to a joint IASC/IOSCO press release on July 11, 1995, "Completion of comprehensive core standards that are acceptable to the Technical Committee [of IOSCO] will allow the Technical Committee to recommend endorsement of [IASC standards] for cross-border capital raising and listing purposes in all global markets." The SEC went beyond that IASC/IOSCO announcement to describe three key elements those standards must embody to be considered for U.S. markets. (See the box on page 20.)

There are differing views about the nature of the understanding between the IASC and IOSCO. In The New York Times on December 29, 1996, the IASC's secretary general was quoted as saying, "We have an agreement." He and other IASC representatives have been saying in speeches around the world that this is a "done deal" - the IASC need only complete the core set of standards and IOSCO will endorse them. However, while the SEC is a member of lOSCO, it must make its own decision regarding U.S. capital markets. And on December 10, 1996, in a major speech at an AICPA conference, SEC Chairman Arthur Levitt warned that "acceptance of IASC standards by the SEC is not a foregone conclusion." He added that "international standards must produce financial reporting with the same credibility and integrity produced by U.S. standards." But the SEC has not announced how it will determine "the same credibility and integrity."

THE IASC'S AGENDA

Initially, the IASC set a target of early 1999 for completing its core standards. But with the encouragement of many parties, including the SEC, the target date was moved up to March 1998. That deadline is now only months away. Although IASC leaders have consistently expressed optimism about timely completion, much remains to be done and at least some delay seems inevitable.

The core set of standards the IASC is developing includes several topics on which it is revising an existing standard and some first-time topics. The projects currently in process cover the following areas (in order of their expected completion): segment reporting, presentation of financial statements, intangible assets, research and development costs, business combinations (goodwill), impairment of assets, employee benefits, leases, financial instruments, interim reporting, discontinuing operations, and provisions and contingencies.

In some cases, the IASC is expected to move its existing standard closer to U.S. GAAP or to create a new standard similar to U.S. GAAP. In other cases, it is quite possible the opposite will occur because the IASC will follow the lead of the United Kingdom or other countries. While there is no way to predict how similar or different the IASC's final standards will be to ours, based on a recent FASB study we do know the present "gap" is quite wide. (The IASC's current work plan involves a significant overhaul of only approximately half a dozen standards. The majority of its existing standards will be unchanged or revised only slightly.)

In late 1996, the FASB published a comprehensive report, "The IASC-U.S. Comparison Project: A Report on the Similarities and Differences between IASC Standards and U.S. GAAP." The FASB spent literally thousands of hours comparing each IASC standard in detail to the U.S. counterparts and vice versa. This was done by the board's regular staff members, but a number of outside experts reviewed the drafts and contributed suggestions, including former IASC staff members.

The specific objectives of the study were to:

* Help the FASB and IASC raise the quality of their standards while narrowing the differences between them.

* Provide a tool for investors, financial analysts and other users of financial statements to use in comparing U.S. enterprises with enterprises that use IASC standards.

* Provide an information base that can be used in assessing the acceptability of IASC standards for securities listings in the U.S.

* Provide insights into the relative strengths of the IASC and FASB structures and processes for serving the ongoing information needs of U.S. capital markets.

The real benefit of this study is in its level of detail. For example, while it is not a wholly meaningful number out of context, 255 specific variations were identified between IASC standards and U.S. GAAP. (Of course, even where the standards are similar, differences can arise, and these may be even more troublesome to users because they are much more subtle.) The major differences are in areas where either the IASC or the United States has a standard but the other does not, where one body allows alternatives and the other does not, and where the two bodies simply reach different conclusions.

The problem, of course, is that there is no way to generalize about the impact of these differences because they depend on the circumstances of the reporting entity. So the FASB's study does not answer all the questions. In fact, it may actually raise more questions. But it should be a very useful tool for the SEC, users and others for carefully evaluating the implications of allowing filings based on IASC standards now or in the future.

It also should be noted the FASB has greatly stepped up its international activities in recent years. For example, Statement 128 on earnings per share was a joint project with the IASC, which issued a virtually identical standard. Likewise, Statement 131 on segment reporting was a joint project with the Canadian Accounting Standards Board. And the FASB is sharing research on and closely coordinating several other projects, such as business combinations and aspects of financial instruments, with the G4+1 group (standard setters from Australia, Canada, the United Kingdom, the United States and the IASC).

These efforts are very time-consuming, but they should result in much more comparable output among those standard setters over time.

THE DUE PROCESS

The study referred to above also included a fairly detailed analysis of the IASC's operating procedures and due process as compared with those followed by the FASB. There are key similarities, most notably that the IASC issues exposure drafts for comment before finalizing its standards. But there are important differences as well. And, with the possibility of IASC standards becoming binding on foreign companies that sell securities in the United States and U.S. multinational companies selling securities overseas - or ultimately even for domestic companies - the consequences of these procedural differences will become more evident over time.

Perhaps the most fundamental difference is that the FASB's deliberations are open to public observation and the IASC's are not. The IASC board members are all part-time members who are otherwise employed (not full-time, independent members as are FASB board members), so they have been sensitive about having their debates scrutinized by the press or general public. And because the IASC includes only limited reasoning in the published versions of its final standards (unlike the exhaustive basis for conclusions in FASB standards), outsiders have difficulty getting a good understanding of why the IASC reaches its conclusions.

Some of the other procedural or due process differences are:

* The IASC does not hold public hearings on or conduct field tests of its proposals.

* Materials for quarterly IASC board meetings generally are made available only days before each meeting, so there is little or no opportunity for consultation with other interested parties in each country.

* The IASC has a very small staff, so steering committees do much of the initial research and drafting of proposals, and the quality of the work varies considerably.

Not everyone will agree, of course, that the FASB's way of doing things is better. The FASB is continually challenged to change its operating procedures to one degree or another. The important point is that because of these and other differences, the business community and other interested parties will have difficulty keeping informed about and becoming involved in the IASC's decision-making. In short, financial executives and others who have become accustomed to actively participating in the FASB's process will find it much more difficult to participate in the IASC's process.

Limiting opportunities for involvement by interested outside parties is a plus for the IASC in the sense that it permits it to speed up its process. (Shortening comment periods is another way the IASC has chosen to try to meet the March 1998 deadline.) In fact, perhaps the only realistic way that an early 1998 or even 1999 timetable can be met is to limit openness and outsider participation. But for the entities that may ultimately have to follow the IASC standards, is that satisfactory?

A FEW EXAMPLES

The IASC's conceptual framework is modeled after and is substantially the same as the FASB's. Nevertheless, as noted above, the IASC has reached different conclusions in a number of accounting standards. For example, in the United States, all research and development expenditures must be expensed as incurred. The IASC requires that research costs be expensed and qualifying development costs be deferred and amortized. Another example: Under the IASC standard on business combinations, pooling of interests treatment is permitted only in rare circumstances. In the United States, many business combinations currently meet the pooling criteria, although the FASB has begun reconsidering this important topic.

Another difference might result from an IASC proposal on employee benefits that would limit the deferral of certain actuarial gains or losses. Finally, an IASC steering committee recently proposed guidelines for financial instruments that would move well beyond U.S. practice in certain areas. In particular, financial instruments would be marked to market through income in more cases, and hedge accounting would be more restrictive. Of course, these proposals are sure to be quite controversial, so the final outcome is unclear.

In addition to these differences, several more-specialized topics exist on which the IASC has not acted but U.S. accounting requirements are in place. For example, U.S. GAAP (but not IASC standards) exists for oil and gas development, insurance activities and rate-regulated enterprises. Neither the IASC nor the SEC has yet said what it expects from companies faced with these issues that want to be in compliance with "international standards."

These and other differences make it unlikely that whenever the IASC's core set of standards is completed it will be the same as U.S. GAAP. The question the SEC will face at that time is whether the information presented under different standards will be acceptable for the purposes of financial statements filed by foreign companies selling securities in the United States.

In making that evaluation, the SEC has to consider such questions as these: Given the SEC's requirement that IASC standards be of high quality, how will the quality of those standards be assessed, both initially and on an ongoing basis? Will the SEC consider permitting the use of IASC standards for all foreign issuers or for only a limited class of foreign issuers, for example, multinationals or the largest foreign issuers? How would the SEC respond if, as a result of accepting IASC standards for foreign registrants, pressure builds for IASC standards to be acceptable for domestic registrants? Would the SEC allow domestic registrants a choice of IASC or U.S. GAAP?

Whatever the SEC decides, it probably will not make a final decision without seeking public comment. That is, at least the following steps seem necessary.

* The IASC completes a core set of standards to its satisfaction.

* The SEC (and other IOSCO members) studies the core set of standards and decides whether they are acceptable for foreign registrant filings.

* The SEC issues a proposal for comment that indicates what position it plans to take on the IASC standards (perhaps including its views on whether domestic companies would be permitted or even required to follow IASC standards instead of U.S. GAAP).

* The SEC issues a final rule after considering comments on its proposal.

Assuming the IASC meets its March 1998 target (a highly unlikely assumption, in my opinion), the SEC will take at least a few months to determine its position and at least several more months to issue a proposal, seek comments and publish a final rule. Thus, under the most optimistic scenario, a final SEC decision is unlikely before about the beginning of 1999. In any event, the time to get involved is now, while the standards are still in process.

GET INVOLVED, NOW!

Some specific ways financial executives can get involved are:

* Educate yourself about the IASC's standards and its operating procedures (the FASB's publication referred to earlier is a good place to start).

* Provide written comments from your company or other organization on the IASC's proposals. Companies may write directly to the IASC or contribute their views to Financial Executives Institute's Committee on Corporate Reporting or other organizations or to their U.S. representatives on the IASC.

* Talk to analysts who follow your company about how they would feel about you or your international competitors adopting IASC standards.

* Monitor the SEC's evaluation of the IASC's core set of standards when it begins and make your views known to the SEC.

* Talk to your auditors about their position on the IASC standards and what actions they are taking.

Although the scene with which this article began may not play out as described, it seems inevitable that IASC standards and other international activities will have more and more influence over U.S. companies' reporting. While it is far from clear how all of this will be resolved, one message is clear: Financial executives need to be more aware of these international developments and get involved. Speak now or you may lose the opportunity to influence the outcome but will still have to face the consequences.

The SEC's Statement on International Accounting Standards

April 1, 1996 - The SEC is pleased the IASC has undertaken a plan to accelerate its developmental efforts to complete the requisite core set of standards by March 1998. The commission supports the IASC's objective to develop, as expeditiously as possible, accounting standards that could be used for preparing financial statements used in cross-border offerings. From the commission's perspective, there are three key elements to this program and the commission's acceptance of its results:

* The standards must include a core set of accounting pronouncements that constitutes a comprehensive, generally accepted basis of accounting.

* The standards must be of high quality - they must result in comparability and transparency, and they must provide for full disclosure.

* The standards must be rigorously interpreted and applied.

The commission is committed to working with its securities regulatory colleagues, through lOSCO, and with the IASC to provide the necessary input to achieve the goal of establishing a comprehensive set of international accounting standards. As soon as the IASC completes its project, accomplishing each of the noted key elements, it is the commission's intention to consider allowing the utilization of the resulting standards by foreign issuers offering securities in the United States.

How FEI Fits In

Financial Executives Institute's Committee on Corporate Reporting routinely discusses all IASC topics at its quarterly meetings and formally responds to all IASC exposure drafts.

John J. Perrell, vice president of financial standards of American Express and one of two U.S. representatives on the IASC board, is a member of FEI's CCR. Thomas E. Jones, executive vice president and CFO of Citicorp and one of two IAFEI representatives on the IASC board, is a member of FEI and a former chairman of CCR.

If you're interested in voicing your opinion about international accounting standard-setting matters to CCR, please send your comment letter or other observations to Susan Koski-Grafer, FEI's vice president of professional development and technical activities, via fax at 201-898-1207 or e-mail at [e-mail].

Mr. Dennis R. Beresford is Executive Professor of Accounting at the J.M. Tull School of Accounting at the University of Georgia. He retired as chairman of the Financial Accounting Standards Board at the end of June this year. You can reach him at 706-542-3502 or by e-mail at [e-mail].