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Accounting across borders.

International comparability of financial statements is the most important accounting issue facing businesses today. Setting broad standards that preserve country-specific rules and harmonize country-to-country differences would go a long way toward meeting this challenge.

With the globalization of business and capital markets, there is an ever increasing need for international comparability of financial statements. Comparable financial statements would bring benefits to U.S. and foreign companies in three main areas of business and finance:

* First, in conducting competitive surveillance. Because of growing foreign competition, CFOs of U.S. companies are users of both their own and other companies' financial statements. It is difficult, if not impossible, to understand the strengths and weaknesses of one's company vis-a-vis its foreign competitors without the solid grasp of relative profitability, liquidity, and financial "staying power" that comparable financial statements can provide.

* Second, in managing relationships with customers, suppliers, and others. To cope with today's rapid pace of change in technology and volatility in world markets, companies need to manage for maximum flexibility. More than ever before, this demands a careful assessment of the financial wherewithal of foreign customers. It also means constantly staying on top of alternative sources of overseas supply and potential foreign business partners for international alliances and joint ventures.

* Third, in raising capital abroad or investing in foreign securities. Companies have more options today in terms of both investing and financing. This relatively recent development has come about as a result of increased capital mobility and an easing of restrictions on foreign investors by local securities regulators. Examples of the latter include the SEC's Rule 144A, which eases restrictions on private placements by foreign companies, and its multijurisdictional agreement, which eases restrictions on some Canadian companies.

Growing numbers of companies are taking advantage of these new options to gain a higher rate of return or lower cost of capital, to diversify their investment portfolios or shareholder bases, or to raise capital abroad because it gives them valuable local publicity for brand names and markets. Whatever the reason, the result is that growing numbers of corporate treasurers - both U.S. and foreign - need to understand other countries' financial statements to facilitate raising capital or managing investments.

In all three of these areas, the lack of comparable financial statements is a problem - probably an even bigger problem than most companies realize. Financial statements are similar in appearance, a similarity that masks very fundamental - and very important - differences in accounting principles.

For example, Telefonica, Spain's largest industrial company and a veteran filer of 20-Fs ever since they floated the world's first multi-country simultaneous offering in the mid-1980s, reported 1990 net income under U.S. GAAP of 176 billion pesetas, more than double the 76 billion pesetas it reported under Spanish GAAP. The difference was due mainly to an add-back of the incremental depreciation on assets carried at historical cost for U.S. GAAP, but written up to more recent market values under Spanish GAAP. The effect of this difference in basis on shareholders' equity, however, went in the opposite direction, resulting in an equity of about 15 percent less under U.S. GAAP as the book value of the assets was marked back to cost.

In another example, in 1989, the year in which U.S.-based SmithKline Beckman merged with U.K.-based Beecham, SKB's post-merger earnings, properly prepared in accordance with the U.K.'s Companies Act, were 130 million [pounds]. This was quite a bit more than the 87 million [pounds] that appeared in their U.S. annual report as a result of reconciliation procedures accepted by the SEC.

The difference resulted primarily from the income statement effects of different asset bases arising from treatment the merger as a pooling for U.K. purposes and as a purchase for U.S. purposes. Even more troubling, the differences resulted in shareholders' equity of 3.5 billion [pounds] in the U.S., but a negative 300 million [pounds] in the U.K. After the release of these figures, SmithKline's stock in the U.S. was trading at 17 percent below the shares listed on the London exchange. The disparity was not surprising, given the startling differences in reported results under the two different sets of accounting rules.


What can be done to make the results more comparable? There are several possibilities:

* The standard-setting bodies of the world can take the initiative in reaching agreements as to common accounting treatments. Through a network of bilateral and multilateral cooperation, the FASB and its counterparts around the world could hammer out a series of agreements similar to the reciprocity agreements the SEC is working out with other securities regulators. The SEC is already in the trial stage of its reciprocity agreement with Canada. If the results are positive, it will consider expanding the agreement to the U.K.

* The securities regulators of the world could agree to acknowledge the authority of some transnational organization in international standard setting. The organization most likely to succeed is the International Accounting Standards Committee. Formed in 1973, IASC's early standards were very liberal because they were intended to accommodate the accounting principles of virtually every country. By being so liberal, IASC's standards gained acceptance, but they offered little hope of international comparability.

The emergence of the international Organization of Securities Commissions has forced IASC to take a different stance. IOSCO was formed in 1975 to promote the free flow of capital across borders. To remove the barriers set up by differences in accounting standards, IOSCO told IASC that it would enforce IASC's standards if IASC would reduce the number of acceptable treatments in its existing standards and fill in the gaps for any standards that are missing. To achieve this objective, on January 1, 1989, IASC issued E32, a sweeping set of guidelines designed to eliminate alternatives. It has also set out to beef up its financial resources and staffing to address the many issues that remain.

If successful, this effort could mean some unexpected, maybe even unpopular changes for U.S. companies. This fall, IASC plans to issue an exposure draft, to become effective immediately, that would eliminate LIFO as a method of inventory valuation. And, as this issue of Financial Executive goes to press, IASC is preparing to issue an exposure draft on poolings of interest, with the hope of introducing a new standard in mid-1993.

* Some future altenatives can be developed, evolving from a combination or fine-tuning of one or both of the above possibilities. One suggestion might be for the FASB to work with IASC, as well as other such bodies as Britain's Accounting Standards Committee, the Japanese Business Accounting Deliberation Council, and the European Commission. Such cooperation could include researching, identifying, and developing new standards that address emerging issues common to multinationals. By becoming more involved in setting international standards, the FASB could enhance its role in shaping new standards that protect U.S. companies from potentially unfair accounting and reporting requirements.

Let me suggest some of the criteria a truly viable solution must include:

First, it must provide for broad, rather than narrow, standards. International standards shouldn't try to close every loophole that could possibly jeopardize comparability. The loophole-closing approach leads straight into the temptation to issue standards that are costly to comply with, are difficult to understand, and emphasize form over substance. Broad standards are far preferable.

I say this because I believe preparers will make responsible judgments even in the absence of detailed guidance. And because I know there are areas in which the SEC has already demonstrated that it can be tolerant of differences (e.g., inventory accounting and how it is applied), and history shows the public has suffered no harmful effects as a result.

The switch to broad, rather than detailed, standards would be a fundamental change for U.S. companies, but one that could bring us closer to our goal of useful, comparable financial statements. Specifically, it would help level the playing field when it comes to the cost of preparing financial statements (for U.S. companies, the cost would be less than it is under U.S. GAAP), and users would benefit as well because the resulting financial statements would be likely to have fewer standard-specific disclosures and therefore be less complex to read.

Second, the solution must provide for harmonization without constraining local standard-setters such as the FASB and FEE (a European accounting standard-setter) from dealing with emerging conditions or trends in their respective regions or from improving accounting for issues already covered under existing GAAP. The approach being pursued by IASC leaves unanswered some important questions about the role of national standard-setters such as the FASB. Because the FASB is unique as a private-sector standard-setter, its role in IASC's process is difficult to define. Additionally, the IASC process has implications for purely domestic standard-setting. One longer-term possibility is that local standard-setters could confine their efforts to issues where there is a consensus that greater guidance is needed and issues that are not dealt with by IASC. The latter would include country-specific kinds of issues such as accounting for OPEB, since benefits such as retiree health care are provided by the government, rather than employers, in most other countries.

Third, the solution must find a way to prioritize the harmonization of the wide range of country-to-country differences that exist today. At the SEC's request, Price Waterhouse participated in a survey of six major accounting principles in eight countries. We researched the depth of diversity and the extent of differences in cost of compliance in the area of consolidations. Other accounting firms have conducted similar research in the areas of accounting for income taxes, pensions, leasing, business combinations, and foreign currency translation. While the scope of the principles covered by this research is obviously not all-inclusive, our analysis of the findings shows there is currently considerable diversity between the U.S. and other countries around the world in accounting for pensions, leases, and business combinations. The results of the survey should be available within the next several months.

Clearly, there will be many opinions as to priorities. And, just as clearly, the issue of setting priorities is a knotty one. In today's volatile global marketplace, one wonders if comparability of accounting principles alone will be enough to protect investors and managers from the kinds of unpleasant surprises we read about in the business press. Without an early warning system that addresses this concern, I doubt that comparable financial statements alone will ever fully meet user needs.


Companies in all industries are faced with risks and uncertainties, the level and complexity of which are greater today than ever before. The advent of more intense foreign competition, with today's rapid pace of technology and volatile economic and political conditions, have all added new complexities to the judgments management must make in order to prepare financial statements in a global business environment. Without an understanding of these underlying judgments, users of financial statements cannot realistically assess the extent to which an enterprise is in danger of failing or of suffering severe financial setbacks in the near term.

Suppose, for example, the management of a local savings and loan invests in fixed-rate mortgages because it believes interest rates will stay stable or decline, certainly a high-risk strategy, especially in today's uncertain economy. Yet, the S&L's financial statements would be perfectly acceptable today without any disclosure of the risks an uncertainties associated with its interest-rate assumptions. If you were using the financials as a basis for your personal investing decisions, wouldn't you want to know the facts about the bank's assumptions, so you could make your own informed judgment about the risks involved? Or if a bank decides not to diversify its lending and investing activities, it may face more risk than other banks. If you were using the bank's financials as a basis for your company's investing decisions, wouldn't you want to know the facts about its decision not to diversify?

Let's take a completely different issue. Suppose you are evaluating an aggressive competitor, trying to assess its competitive strengths and weaknesses. And suppose the competitor is highly dependent on a supplier of a critical component not available from other suppliers. Wouldn't you want that information to be readily apparent from the company's financial statements? Wouldn't you want to know even if the current level of purchases was not "material" in a monetary sense?

Finally, say you are evaluating a potential foreign acquisition that has had to make a particularly tough estimate - the allowance for doubtful accounts, inventory obsolescence, or the resolution of a lawsuit, for example. Your targeted company has made its best estimate, but it could still be wrong, possibly by a material amount. Wouldn't you want to know about this situation? And doesn't the goal of truly comparable financial statements demand the disclosure of such risks and uncertainties?

Obviously, some of these points would be disclosed if the company were a U.S. company, especially one subject to the disclosure requirements of the SEC. But I believe the only effective way to make this kind of information available for multinational companies is to get disclosure requirements out of securities law and into international accounting standards.

I recognize the difficulties inherent in developing an accounting standard on disclosure of management's judgments in these areas. Perhaps the thorniest issue is how to segregate the significant matters that warrant reporting from the host of lesser generic risks and uncertainties that do not. This difficulty notwithstanding, I believe an accounting standard that prescribes uniform disclosure of such matters is fast becoming an absolute necessity - just as important, if not more important, than the elimination of alternatives or filling in of gaps in IASC's standards.

The important task of developing this standard is one that could fall to either IASC or the local standard-setters such as the FASB. The AICPA's task force on risks and uncertainties is reviewing a report on these issues, and the AICPA plans to issue an exposure draft late this year or early next year addressing the task force's report. A final statement that would take effect December 31, 1993, is possible by early 1993.

Very briefly, the AICPA task force port recommends two key disclosures: a discussion of significant, change-sensitive estimates used by management to measure assets and liabilities at the reporting date, and information about current vulnerability to risk due to concentrations, for example, of assets, customers, or suppliers.

These are not terribly onerous reporting requirements, but at the same time the risks inherent in any company's financial statements would be difficult to understand without an appreciation of them.

There is little doubt in my mind that we are about to enter a new era of accounting. The growing need for international comparability and the complexity of today's global business world will force accounting standard-setters to come to grips with some important new issues. Within the next decade, I am hopeful we will have in place both international standards and improved disclosures that will help users better assess financial statements issued anywhere in the world and better prepare them for possible adverse effects in the near-term future.
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Title Annotation:international comparability of financial statements
Author:O'Malley, Shaun F.
Publication:Financial Executive
Date:Mar 1, 1992
Previous Article:The debate over consolidating statements.
Next Article:Benefits that bend.

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