What's the FASB doing about international accounting standards?

What's the FASB doing about international accounting standards?

What does the FASB think about financial reporting standards that span the globe? The Board's chairman says their development is "clearly impossible" for the near term, but that doesn't mean you shouldn't be preparing. With the globalization of financial markets, international accounting standards have been propelled into the spotlight. But the global market is a myth, according to Jack Ruffle, vice chairman of J. P. Morgan & Co. and president of the Financial Accounting Foundation. "What we have," he said in a speech last year at the University of Chicago's Graduate School of Business, "is the global linkage of local markets, both electronically and via financial instruments like swaps, which can tailor financial flows and currency denominations to just about any specifications."

Economist Milton Friedman reinforces the point. He agrees that markets for goods and services have become more fragmented, and therefore less global, over the past century. Friedman's analysis, as he wrote in The Wall Street Journal last year, indicates that international trade as a percentage of national income has declined steadily in the United States, except during the two world wars and the inflation-scarred decade of the 1970s. And he expects the decline to continue because protectionist policies are more restrictive than they were in the nineteenth and early twentieth centuries.

Globalization is prominent in financial markets because of the high mobility of capital and the speed of telecommunications. But domestic financial markets, the terminals of the global network, are buffered from the full impact of foreign market forces by national monetary policies. Domestic markets for goods and services are even more buffered from foreign market forces by national trade policies and the immobility of resources.

Demand for international accounting standards is coming from participants in the global financial network. They have common interests, and it is readily conceivable that, despite their different national backgrounds, they could agree on accounting standards. It is not so readily conceivable, however, that such standards would be acceptable in the more fragmented and insulated national markets.

Accounting standards were developed in response to the needs of domestic markets. They are still evolving in response to those needs and, if Milton Friedman is right, national markets will continue to be insulated from one another despite the efficiency of the global financial network.

International or domestic priority?

The dilemma for those who regulate securities markets and those who set accounting standards is how to adopt standards that facilitate cross-border capital movements without lessening the quantity and quality of information available to investors and without putting domestic companies at a competitive disadvantage with foreign companies.

To illustrate the dilemma, let's consider some of the differences between the Generally Accepted Accounting Principles (GAAP) in the United States and the standards set by the International Accounting Standards Committee (IASC). * U.S. GAAP covers more topics--The IASC has issued 29 standards. But, in more than 50 years of formal standard-setting, the Committee on Accounting Procedure, the Accounting Principles Board, and the FASB have issued many more standards--and these standards have been supplemented by issuances of the Securities and Exchange Commission, the AICPA's Accounting Standards Executive Committee, and the FASB's Emerging Issues Task Force. * GAAP in the U.S. covers topics in greater depth--IASC standards are typically statements of broad principle. U.S. standards are more specific about principle, more detailed about measurement methods, and more extensive about disclosure requirements that augment recognition and measurement requirements. * GAAP in the U.S. has incorporated a large body of common practice not covered by formal pronouncements of standard-setting bodies--There is no similar body of common international practice. To get full comparability between U.S. GAAP and IASC requirements, all these differences would have to be eliminated. To get worldwide comparability, a high multiple of those differences would have to be brought into sync, overcoming in the process many economic, political, and cultural hurdles. Not the least of these hurdles is the sheer volume of standards in the U.S., representing the cumulative response to a variety of domestic pressures--competitive, regulatory, litigious. Those pressures continue. Thus, quite apart from the problem of reaching international agreement on methods of accounting, it would be difficult in the accounting environment in the U.S. to reduce the level of detail, and, no doubt, equally difficult to gain international acceptance of a level of detail comparable to that of U.S. standards.

Given all the hurdles, it is clearly impossible to achieve universally accepted international standards in the foreseeable future. Therefore, we need to turn our attention to other ways of coping with incomparable standards.

One way is for national securities regulators to accept financial statements prepared in accordance with a foreign registrant's domestic GAAP. Canada, for example, might accept registrations using U.S. GAAP financial statements, unreconciled to Canadian GAAP, and the U.S. might reciprocate.

This solution could work on a small scale if national accounting standards were reasonably similar, as they are between Canada and the U.S. But it puts the entire burden of wrestling with incomparabalities on the users of financial statements, a caveat emptor approach not likely to be acceptable in the United States. U.S. GAAP is part of the investor protection shield required by U.S. securities law. It would be difficult to waive for a foreign company what is mandated for a U.S. company. Further, since U.S. GAAP is more stringent than are standards for most other countries, in terms of the kinds and amount of information they require of companies, U.S. corporations would feel they are on the down side of a tilted playing field.

Another way to deal with incomparable standards is the one presently used by the U.S. and some other countries: require foreign registrants to conform to domestic GAAP, either directly or by reconciliation. This approach achieves comparability of financial reporting for all registrants in a given national capital market, which benefits investors in that market and levels the playing field for both domestic and foreign registrants. But this approach does not achieve comparability for investors who want to invest in several national capital markets, each with its own accounting standards. Moreover, from a U.S. perspective, some claim that to require foreign companies to reconcile to U.S. GAAP inhibits their ability to raise capital in U.S. markets because too much information is disclosed and the cost of compliance is too high.

A third way is to develop a separate body of international standards that would link national standards, much as telecommunications technology links national financial markets. This is an alternative currently being explored by the IASC and the International Organization of Securities Commissions (IOSCO). At the urging of IOSCO, the IASC eliminated free-choice alternatives from its existing standards, to the extent feasible. The IASC's Exposure Draft E32, on comparability of financial statements, is a result of that effort.

The objective of this approach is to have national securities regulators accept IASC standards for securities registration in their countries. Companies in Country A, for example, could then register securities in Country B by providing financial statements using IASC standards or, perhaps more likely, by providing statements that reflect domestic standards with a reconciliation to IASC required or preferred standards.

This approach might encourage cross-border capital raising and achieve some degree of comparability of financial statements for the benefit of investors in cross-border issuing companies, but it would not achieve comparability between foreign registrants and domestic registrants. Given the lesser scope and greater generality of IASC standards, compared to U.S. GAAP, U.S. companies would still be at a disadvantage. And financial statements would continue to differ because companies would deal in different ways with the many issues that the IASC standards do not cover, including the large body of common-practice GAAP not articulated in any pronouncements.

SEC Chief Accountant Ed Coulson said recently that the Commission is not likely to adopt this networking approach even if E32 is adopted as proposed. He believes that it will first be necessary for the IASC to consider the issues of lesser scope and greater generality.

A fourth way to improve comparability is for national securities regulators to require all companies under their jurisdictions to reconcile to IASC standards regardless of whether the companies participate in cross-border financing. The problem with this approach is that, while it would achieve worldwide comparability, it would have the same shortcomings as does the networking approach.

If, as it seems, none of these approaches solves the comparability problem, what is the solution?

For the near term, I believe the emphasis should be on fleshing out the IASC standards--adopting an approach based on E32 as the first step--to minimize differences between these and national standards. For the long term, I believe the goal should be the internationalization of accounting standards by developing IASC standards into a body of standards that national standard-setters can adopt without compromising their domestic responsibilities.

Starting with concepts

We at the FASB feel there is little chance of achieving wide agreement on accounting standards if different countries approach standard-setting from different conceptual bases or, perhaps worse, from no explicit conceptual basis at all.

This conviction has deep-seated roots in standard-setting history in the United States. We have learned that without a shared frame of reference each member of a standard-setting body comes to the table with a different, and often unexpressed, view of accounting. These different concepts make it difficult to agree even on the identity of a problem, let alone a solution.

The American Accounting Association was a pioneer in the development of accounting concepts in the U.S. Its "Tentative Statement of Accounting Principles," issued in 1936, and the subsequent elaboration of that statement by Paton and Littleton have had enormous influence on U.S. practice. Both the Committee on Accounting Procedure, through its Accounting Research Bulletins, and the Accounting Principles Board, most prominently through its Statement Number 4 on basic concepts and principles, tried to establish a conceptual foundation for their standard-setting activities. The Trueblood Committee pushed the conceptual evolution forward with its landmark report in 1973 on the "Objectives of Financial Statements." The FASB picked it up from there by undertaking a series of projects to construct what it called the "Conceptual Framework of Accounting."

Let me illustrate the difficulty of achieving consensus even on concepts: of those responding to the FASB's first discussion memorandum on the conceptual framework of accounting, only 37 percent agreed that the basic objective of financial statements is to provide information useful for making economic decisions. (Another 22 percent recommended that adoption of the statement be rejected out of hand, while 10 percent insisted the matter needed further study.)

Of course, the FASB did adopt that objective in Concepts Statement Number 1. Today, I venture to say, it has solid, though still not unanimous, support in the United States. That concept and other fundamentals, such as definitions of assets and liabilities, a concept of capital maintenance, and a hierarchy of qualitative characteristics of accounting information, have given a distinct orientation to FASB standards.

Agreement on concepts has not by any means assured agreement on standards, but it has helped Board members reach agreement on the questions--a considerable contribution. In addressing a 1985 forum on harmonization of accounting standards sponsored by the Organization of Economic Cooperation and Development, Don Kirk, then chairman of the FASB, put it this way: "Although concepts statements do not establish GAAP, they provide parameters within which to resolve standard-setting issues. The Board has used the concepts statements as a basis for addressing many significant and long-standing issues of financial accounting and reporting. Respondents to Board proposals also use those same concepts statements in analyzing the Board's position. The framework serves as a common language and a common starting point for solving problems--not as a black box for quick automatic answers."

The six concepts statements that the FASB has issued continue to serve as the common language and starting point for debate within the FASB and among its constituents. Use of the framework has revealed some weaknesses, but it has also shown that the framework is basically a solid structure that can be helpful, even though it may eventually need expansion and modification.

There is no reason to expect that the FASB's conceptual framework would be accepted by other countries, though it has influenced efforts to develop frameworks in some of them. The FASB supports a conference of standard-setters from around the world to discuss accounting concepts. The point of such a conference would be not to debate the merits of particular views but to identify differences and to assess the potential benefits of a conceptual approach. The IASC framework could serve as the basis for a dialogue about concepts to further the internationalization process. We do not suggest that efforts to agree on specific accounting standards should wait for agreement on concepts. Concepts and standards should be considered simultaneously.

One plea to reconsider

The perplexity of the international accounting scene is evidenced in a proposal I received from the chairman of a large multinational U.S. corporation. He wrote to urge the FASB to reconsider U.S. accounting for goodwill acquired in a business combination, alleging that the amortization requirement had been a major cause of the dramatic increase in acquisitions of U.S. companies by foreign investors. He argued for immediate write-off to equity and supported his case with a thoughtful conceptual analysis, based on the FASB's conceptual framework, and an equally thoughtful pragmatic assessment of the unfair advantage he perceived foreign companies had over U.S. companies in pursuing acquisitions.

We are accustomed to getting that kind of proposal--a seemingly easy accounting fix to solve a difficult economic problem. Surely other, more powerful factors affect purchase price differentials between foreign and domestic acquirers. Exchange rates and tax treatment of goodwill are obvious candidates. Still, it is not easy to explain or justify such widely divergent accounting practices for seemingly similar economic circumstances. Financial statements can only lose credibility over time if divergencies of that kind are allowed to continue.

But can you imagine a quick international resolution of that "simple" issue? In the United Kingdom, for example, some companies immediately write off purchased goodwill to equity, while other companies capitalize nonpurchased intangibles, such as brand names, and do not amortize them. And in the United States, how many savings and loans, or their acquirers, would support immediate write-off of goodwill? Or if the FASB accepted the IASC proposed standard--mandatory capitalization of goodwill with five-year amortization preferred and 20 years the absolute limit--how many companies would see that as worse than either the U.S. or the U.K. practice?

If we add in all the other countries involved in an effort to achieve a worldwide standard, you begin to see the dimensions of the problem. The fact that the conceptual basis for goodwill has never been settled helps explain why divergent practices have developed and emphasizes the need to start the internationalization process with agreement at the conceptual level.

To end the story, the FASB declined the proposal to reconsider goodwill, largely because other projects had higher priority. But that is not the end of the controversy. We will follow developments in connection with the IASC proposal and then see if action on our part is appropriate.

Doing more

In a report dealing with oversight of the FASB and its operating procedures, in March 1989 a special advisory group to the trustees of the Financial Accounting Foundation recommended that the FASB be encouraged to be more active in the international arena. It said: "The trustees should encourage the FASB to increase its influence in international standard-setting activities by becoming more actively involved in the process. At the same time, the FASB should continue to consider the conclusions drawn by standard-setters in other countries, as well as the IASC, in arriving at its conclusions on related issues."

The trustees accepted that recommendation, giving the first formal endorsement to FASB involvement in international activities. The FASB charter and mission statement are silent on international involvement. What the FASB has done so far internationally has been incidental to carrying out its national mission, but we are entering a new era with a potential mission of unknown extent. Clear support by the trustees is essential because these are uncharted waters. We need help in picking a direction.

Like "harmonization," "active involvement" is an objective that, on its face, is hard not to support. Obviously, the FASB does support it. But, like harmonization, active involvement can have a wide range of connotations, some contradictory. Does the recommendation of the special advisory group mean that the FASB should sell American (attempt to "increase its influence in international standard-setting activities") or buy foreign ("consider the conclusions drawn by standard-setters in other countries")? Does it mean that the FASB should deliberate the issues in IASC exposure drafts and respond to the IASC? Should full due process be applicable to such FASB responses?

The FASB involvement could meet a broad spectrum of objectives. The essence of the question is what priority the FASB should assign to international, as opposed to domestic, considerations. For example, the IASC Exposure Draft E32 would, for the first time, establish standards that conflict significantly with U.S. standards. How should the FASB react? Should we accept five-year amortization of goodwill? Should we eliminate the LIFO alternative for inventory accounting? Should we do away with completed-contract accounting? Should we require that translation adjustments on long-term monetary items be taken to income? We will be seeking advice from our advisory council and from all our constituents as we proceed.

Harmony at last

With technological advances, our small world is getting even smaller. We all have to give a little extra effort if we want to break down nationalistic barriers and make this smaller world a more productive one. Accounting's role in this effort is to contribute to more efficient world capital markets by improving financial reporting.

United States history demonstrates that accounting practice can improve steadily if the will to do so is combined with time and talent. The FASB describes accounting development in the U.S. as "evolutionary." Some would say that accounting change has certainly been gradual enough to earn that label and that a process similar to Darwin's natural selection has been working to assure that the best practices ultimately prevail. Others would dispute that, no doubt, thinking that the accounting selection process shows more evidence of Gresham's law than Darwin's.

I won't take sides in that argument, but I do firmly believe that accounting improvement in the U.S. has come about not merely as a matter of nature taking its course. Improvement has resulted from sustained, committed, cooperative effort. Every step of accounting evolution has been helped along by a good firm push. Improving international accounting standards will require the same kind of commitment, the same kind of effort, the same kind of push. The FASB is committed to contributing what it can.

PHOTO : Pacific Outdoor, Laurence Dreiband, 1984, charcoal, oil stick, and oil

PHOTO : Pears #4 (Version 2), Martha Alf, 1976, graphite and oil

PHOTO : Double Knot, Charles O. Perry, 1979, bronze

Dennis R. Beresford Chairman Financial Accounting Standards Board