International financial reporting standards: Significance, acceptance, and new developments.

The international accounting standards board (IASB) has replaced the international accounting standards committee (IASC) as part of a comprehensive restructuring of the international accounting standard-setting organization. This paper traces this change and other recent developments in the

Introduction

The globalization of capital markets is driving the increasing convergence of accounting standards worldwide. While national standard setters have struggled with the issue of harmonizing local and international accounting standards since the formation of the International Accounting Standards Committee (IASC) in 1972, investors have proceeded without restraint into global markets. By the end of 1995, investors in the United States had invested over $1.2 trillion in non-US equities (5), while two-thirds of the investments in the United Kingdom were in foreign firms (6). Regulators finally seem to have realized that globalization of capital markets will not be abated by lack of uniformity in accounting standards -- that; indeed, "global convergence of our markets has [already] occurred" (5). They now seem to be ready to grab the reins, so that they will have a role in directing the progress of globalization and will continue to be able to protect the public.

Recently, the progress toward attaining a global financial reporting framework has accelerated, and many significant steps have been taken. The most important step is the formation of the International Accounting Standards Board (IASB), which replaces the IASC, as part of a comprehensive restructuring of the international accounting standard-setting organization. The restructuring program, begun in 2000, is the culmination of a series of movements toward the global convergence of accounting standards. At the end of 1999, the IASC completed the set of "core" International Accounting Standards (LASs) required in its agreement with the e International Organization of Securities Commissions (LOSCO), and they were accepted as the basis for cross-border filings of registration ion statements and listings on securities exchanges by JOSCO in May, 2000. At the same time, the US Securities and Exchange Commission (SEC) issued a Concepts Release, calling for comment on the acceptance of IASs in US filings and outlining the structural changes needed in the IASC in order for the US to fully support globalization of the international accounting framework. The restructuring program adopted by the IASC attempts to incorporate the SEC's suggestions, as evidenced in its new Constitution, issued in 2000. In January 2001, the restructuring was implemented, and the IASC was replaced by the International Accounting Standards Board (IASB) in March 2001. This paper discusses these recent events and assesses their impact on the global convergence of accounting standards.

The "Core" International Accounting Standards

In July 1995, IOSCO agreed to endorse IASs for use in cross-border listings on securities exchanges in all major countries when the IASC had satisfactorily completed a specified set of high-quality accounting standards (known as the "core" standards). The set of "core" standards was initially expected to be completed in early 1998, but the IASC did not complete the full set of "core" accounting standards required until early 1999.

The IASC's work on the "core" standards was geared toward global harmonization, and the project dramatically reduced the number of differences between IASs and US generally accepted accounting principles (GAAP) from the 255 items detailed by the Financial Accounting Standards Board (FASB) in 1994 (11). However, when the "core" standards were issued, the US still had significant differences with six of the IASs (and technical parts of a seventh), and it was feared that the SEC might block IOSCO's acceptance of the "core" standards. The contentious standards were: IAS 16, Property Plant & Equipment; IAS 18, Revenue Recognition (technical parts, which will probably require modification in US reporting for specialized industries); IAS 22, Business Combinations (including Goodwill); IAS 23, Borrowing Costs; IAS 36, Impairment of Assets; IAS 38, Research and Development Costs and Other Intangibles; and IAS 39, Financial Instruments: Recognition and Measurement. Instead of reifying a rift, however, the "core" stand ards have provided a forum for international and US standard setters to continue to promote convergence. During the development of the "core" standards, the FASB began its movement toward international convergence with the issuance of SFAS 128, Earnings per Share, which was designed to be similar to IAS 33. The harmonization effort has continued in the US since the issuance of the "core" standards. In fact, the FASB now declares on its website that its "obligation to its domestic constituents demands that it attempt to narrow the range of difference between the U.S. and other countries' standards."

During 1999, IOSCO's Technical Committee painstakingly reviewed the "core" standards submitted by the IASC. In February 2000, the Technical Committee published a report summarizing its assessment, noting outstanding issues that IOSCO members expect to be addressed for the present time through supplemental treatments, such as disclosure, reconciliation, interpretations, and limited use of waivers, while the IASC and member countries continue to work on these existing (and other emerging) issues. With this caveat, at its May 2000, meeting, IOSCO supported the resolution for its members to allow multinational issuers to use the "core" IASs for cross-border offerings and listings. IOSCO also declared its intention to continue to support the development of a global financial reporting framework.

The SEC's Concepts Release

Despite the FASB's efforts to harmonize standards, many feared that the SEC would try to block IOSCO's acceptance of the "core" standards because of differences from US standards, or that acceptance by the IOSCO of the "core" standards would not guarantee SEC acceptance (9). They noted that the SEC was prominent in IOSCO's rejection of IASs in 1994, prior to the IASC-IOSCO agreement, primarily because of its stringent accounting and reporting requirements. Indeed, the SEC clearly maintains the view first expressed in 1996 regarding the "core" standards, that "before it would accept those standards in the U.S., it would have to ascertain whether the IASC's standards result in the transparency, reliability and comparability that investors currently enjoy under U.S. GAAP" (14). It does not intend to downgrade the information provided to its constituents.

The SEC took a major step in defining its leading role in securing the globalization of financial reporting when it issued its Concept Release (Release No. 34-42430) in February 2000 (13). in this Release, the SEC states that it "is increasing its involvement in a number of forums to develop a globally accepted, high quality financial reporting framework" (p. 1). The Concept Release seeks comments from investors, lenders, creditors, and other constituents on the necessary elements of such a framework, as well as on ways to achieve the objective of convergence toward such a framework internationally. The Release specifically seeks input to determine under what conditions the United States should accept financial statements of foreign private issuers that are prepared using IASs--whether to maintain or reduce current reconciliation requirements, to replace them with other disclosures, or to accept IASs without additional US requirements. Responses from a wide spectrum of the constituency are posted at the SEC website www.sec.gov/rules/concept.

More importantly, the Concepts Release moves beyond the current issue of accepting international accounting standards to focus on the infrastructure required to support a global financial reporting framework in the long run. It states specifically that ensuring that high quality financial information is provided to capital markets does not depend solely on the accounting standards used. It notes that an effective financial reporting structure begins with a reporting company's management, which is responsible for implementing and properly applying the standards in a manner that is faithful to both their requirements and their intent For the standards to be able to be rigorously interpreted and applied, there must be a sufficient level of implementation guidance. Auditors then have the responsibility to test and opine on whether the financial statements are fairly presented in accordance with those accounting standards. If these fundamental responsibilities are not met, accounting standards, regardless of thei r quality, may not be properly applied, resulting in a lack of transparent, comparable, consistent financial information.

In the Concepts Release, the SEC emphasizes the importance of high-quality accounting standards being supported by an infrastructure that ensures that those standards are rigorously interpreted and applied and that identifies and resolves issues and problematic practices in a timely manner. The SEC specifies the primary elements required for this infrastructure, which include:

* effective, independent, and high-quality accounting and auditing standard setters;

* high-quality auditing standards and audit firms with effective quality controls worldwide;

* active regulatory oversight.

The SEC acknowledges that development of these elements will be uneven and that some will progress more quickly and expediently than others.

IASC Restructuring

The most important progress to date in developing the sort of infrastructure envisioned by the SEC is the restructuring of the standard-setting body. The IASC's Board approved a new structure in November 1999. The restructuring plan was laid out in a report, Recommendations on Shaping IASC for the Future, prepared by the IASC's Strategy Working Party, and it parallels in most respects the SEC's outline of the six characteristics of a high-quality standard setter in the Concepts Release, which include:

* An independent decision-making body;

* An active advisory function;

* A sound due process;

* An effective interpretive function;

* Independent oversight representing the public interest; and

* Adequate funding and staffing.

According to the Recommendations, the Trustees, which will be geographically representative of the constituency, will not only serve an active advisory function, but will be responsible for fundraising and overseeing staffing (12). The Board is intended to become the independent, decision-making body responsible for all technical matters, including the final approval of exposure drafts, standards, and interpretations prepared by the Standing Interpretations Committee (SIC). The Recommendations also include improvements to ensure a sound due process, so that it will become "a very open one which would extend the opportunities for the development of alternative views to be debated and concluded on by the Board" (p. 11). The due process includes voting, open meetings, comment periods, public hearings, field tests, and coordination with national due process.

In December 1999, the IASC appointed a seven-person nominating committee to select the nineteen Trustees. Arthur Levitt, Chairman of the SEC, was elected chairman of the nominating committee (10). The committee was required to maintain a specific geographical balance in selecting trustees, which is to be perpetuated among the trustees: six from North America, six from Europe, four from the Asia-Pacific region, and three others from any area, as long as geographic balance is maintained. After an exhaustive search over five months, the nominating committee announced the initial trustees on May 22, 2000. Paul Volcker, former chairman of the US Federal Reserve Board, was appointed as the initial chairman of the Trustees. The initial board of Trustees is shown in Exhibit 1.

Simultaneously with the effort to secure a new board of trustees, the IASC rewrote its Constitution. The new Constitution codifies the elements of the new structure (8), and it incorporates many changes suggested in the Recommendations. One important change was made to the IASC's stated objectives. While the old Constitution specified that the objective was to work for "improvement and harmonisation of regulations," the language in the new Constitution is much stronger and reiterates the current verbiage in the literature (e.g., the SEC Concepts Release). It states, as suggested in the Recommendations, that the IASC's objectives are:

* to develop in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements to help participants in the world's capital markets make sound economic decisions;

* to promote the use and rigorous application of those standards; and

* to bring about convergence of national accounting standards and International Accounting Standards to high quality solutions.

It is evident that the concept of uniformity or standardization has outweighed the notion of harmonizing local reporting. The Constitution reflects a commitment to convergence toward a global financial reporting framework. The IASC member bodies, representing over one hundred countries, unanimously approved the new Constitution, the restructuring plan, and the initial board of Trustees, at its Assembly in May 2000.

In the following months, the Trustees appointed members of the Board, according the provisions of the new Constitution. The Constitution specifies that the Board is to consist of twelve full-time and two part-time members, not selected for geographical representativeness, but for technical expertise and independence. The composition, designed to balance perspectives. and experience, calls for a minimum of five members with experience as practicing auditors, three as preparers of financial statements, three as users of financial statements, one academic, and the remaining two from any relevant background. Seven of the full-time members will have formal liaison responsibilities with their national standard-setting bodies. The initial Board members appointed by the Trustees are listed in Exhibit 2.

In March 2001, the IASC Foundation was formed as the independent parent entity to the new international standard-setting organization. The restructuring culminated in April 2001, when the International Accounting Standards Board (IASB) assumed the responsibilities of its predecessor body, the IASC. It was determined that the IASs issued by the IASC will be effective until superseded and that the international accounting standards will now be known as International Financial Reporting Standards (IFRS).

The Problem With Oversight

The restructuring plan clearly addresses five of the six characteristics identified by the SEC in its Concepts Release as necessary in a high quality standard setter. The notable shortfall is in oversight. A continuing problem is that the IASB lacks the resources and the legal authority for effective enforcement actions. In the Concepts Release, the SEC discusses the importance of effective oversight, not only in the development of high quality accounting and auditing standards, but also in reinforcing the application of accounting standards by registrants and their auditors in a rigorous and consistent manner and in ensuring a high quality audit function. In a recent speech, Commissioner Hunt of the SEC noted, "If we are going to set high standards to ensure transparency and comparability but then not enforce them, we have not accomplished our goal" (6).

Enforcement seems to be a significant area of concern for the SEC in considering the global financial reporting framework. Through its review and comment process, the SEC is currently able to review and comment on US firms' application of GAAP and related SEC disclosure requirements -- and the same significant interpretive and enforcement role would occur if international standards were used to prepare financial statements included in SEC filings. To perform that role, the SEC staff would need to develop expertise regarding international standards in order to provide proper oversight. Of course, in the present situation, SEC receives filings from over 1,100 foreign issuers from over 50 countries, many of which are submitted in their national GAAPs with a reconciliation. So today the SEC staff already have to have some level of expertise in over 50 GAAPs; achieving a high level of expertise in IFRSs would seem to be infinitely simpler.

Greater acceptance of international standards may further increase the instances in which an issuer's auditor is not based in the US. Lynn Turner, Chief Accountant for the SEC, observes that US regulators frequently experience enforcement problems with the foreign subsidiaries of US multinational companies. Audits may be lax by US standards, performed by foreign affiliates that are allied with, but not controlled by, the US audit firms (15). Moreover, most countries lack an authoritative body to enforce the application of even their own national standards in financial statements of companies that trade on their local securities exchanges. The SEC has the potential of using domestic compulsory mechanisms or enforcement tools such as memoranda of understanding and other arrangements with non-US regulators, but these approaches for obtaining information about an auditor's work can cause delays in investigations. In the end, they may still not permit obtaining access to working papers and testimony that are need ed to assess information the issuer has provided to its auditors and to investigate the adequacy of the work supporting the auditor's report. In the Concepts Release, the SEC notes that in considering changes in its current financial reporting requirements, it will consider the effects of possible changes on the ability of the SEC enforcement program to provide an effective deterrent against financial reporting violations by foreign issuers, their corporate officials, and their auditors.

Worldwide Acceptance Of The IFRSs

In the Concepts Release, the SEC noted that it is difficult to evaluate the effectiveness of certain of the international standards at this time because there is little direct use of them in developed capital markets, and where they are used, the newest or revised standards may not have been implemented yet. Nonetheless, a number of countries have already adopted IFRSs as an allowable reporting framework on their exchanges and for legal purposes; in some countries, it is the only permissible reporting format. Many countries are currently evaluating adoption of IFRSs in lieu of local standards. A comprehensive list of countries, their exchanges, and current acceptable accounting methods is available on the IASB's website www.iasb.org.uk.

The major securities exchanges and many of the prominent local standards-setters now champion the IASB and the convergence toward a global financial reporting framework. The European Federation of Accountants made an early suggestion in its "Discussion Paper on a Financial Reporting Strategy Within Europe" that European companies be permitted to use IFRSs even if there are differences from European Directives because the directives should not be an obstacle for opportunities in the global market (3). Subsequently, the European Union (EU) proposed a Regulation in February, 2001, that would require all firms listed on EU exchanges to prepare consolidated financial statements in accordance with IFRSs by 2005 (1).

In addition to the EU, the growing number of organizations that now support the IASB and a global financial reporting framework includes the International Federation of Stock Exchanges, the Basel Committee, the World Trade Organization, the European Federation of Accountants, the Arab Society of Certified Accountants (which encompasses 22 countries), the United Nations, the World Bank, and the Organization for Economic Co-operation and Development (11,14).

The most significant hold-outs to convergence prior to 1998 were the US, the UK, and Japan. While the US still has not accepted most IFRSs without reconciliation, the US has been heavily invested in the restructuring of the IASB, as described above. Indeed, five of the Trustees, including the new Chairman, and four of the Board members are from the US, and there are other US representatives on the SIC and the technical staff. The FASB is committed to working with the IASB to develop convergent standards, and advocates this position on its website. The primary impediment to full US acceptance of IFRSs at this point is the SEC's concern with oversight For the UK, the promotion of IFRSs by the EU will undoubtedly influence acceptance. Indeed, the UK was active in encouraging the EU to take its proactive stance. The UK has been nearly as heavily invested in the restructuring of the IASB as the US. Even Japan, which has tended to be obstructed by its own governmental regulation for a long time, has moved toward c onverging standards. This movement has been encouraged by Japan's participation in the US-Japan Business Dialogue Round Table (EJBDRT) in the last few years. Along with other recommendations geared to fostering mutual trade, the EJBDRT promotes the acceptance of IFRSs; the IASB was represented at the July 2001 meeting of EJBDRT (2). Additionally, Japan is one of the seven countries with a liaison representative on the IASB dedicated to promoting cooperation of efforts with the national standard setters. So these three countries -- the US, UK, and Japan--now seem to be promoting, rather than resisting, convergence.

Conclusion

In a speech on the Concepts Release, SEC Commissioner Isaac Hunt gave his vision of a global financial reporting framework: "... in an ideal world, international accounting standards would operate within a strong infrastructure that would work in tandem with the standards to achieve high quality. Each country accepting international accounting standards would have strong regulatory oversight to enforce consistent use of the standards. The audit function would be high quality with both national and international expertise. And the standard setter would have sufficient technical skill to issue consistent guidance and make adjustments where needed." (4)

His ideal comprehends almost all of the characteristics described in the SEC Concepts Release, toward which the IASB restructuring was geared. While the current status is far from the ideal model, especially in the realm of oversight, significant progress has been made.

Commissioner Hunt also raises the important question of "how close the world should be to this infrastructure before the U.S. adopts international accounting" (p. 5). There are important incentives to US investors, creditors, and other constituents for the acceptance of uniform international standards in US capital markets, and there are advantages to non-US companies as well. Non-US companies would save the substantial costs that they have been willing to incur to restate their accounts or reconcile their results to SEC and FASB requirements in order to gain access to US capital markets. More opportunities could be offered in US capital markets. Since investors in the United States have already invested heavily in non-US equities, those constituents would be better able to monitor their investments, consistent with the SEC's investor protection mandate. It would increase the efficiency of cross-border capital flows by promoting high quality, comparable information for capital market participants. The converg ence of capital markets has created an imperative for convergence toward a global financial reporting framework.

EXHIBIT 1

MEMBERS OF THE TRUSTEES OF THE IASC FOUNDATION, MAY 2000 (7)

Member              Outside responsibility    Representing

Roy Anderson        Deputy Chairman           Other (So. Africa)
                    and CEO, The Liberty
                    Life Group

John H. Biggs       Chairman, TIM-CREF        North America

Andrew Crockett     General Manager,          Other (Interational
                    Bank for International    Org. in Switzerland)
                    Settlements

Roberto Teixeira    Former Chairman,          Other (Brazil)
Da Costa            Brazilian Comisse
                    de Valores Mobiliaos

Guido A. Ferrarini  Professor of Law,         Europe
                    University of Genoa

L. Yves Fortier     Chairman, Ogilvy          North America
                    Renault, Barristers
                    and Solicitors
                    Former Ambassador of
                    Canada to the
                    United Nations

Toshikatsu          CFO, Mitsui & Co.,        Asia-Pacific
Fukuma              Ltd.

Cornelius           Former President,         Europe
Herkstroter         Royal Dutch
                    Petroleum

Hilmar Kopper       Chairman of the           Europe
                    Supervisory Board,
                    Deutsche Bank

Philip A.           Chairman,                 North America
Laskawy             Ernst & Young
                    International

Charles Yeh         Chairman, Hong Kong       Asia-Pacific
Kwong Lee           Exchange and
                    Clearing Ltd.

Sir Sydney          Chairman, UK Financial    Europe
Lipworth            Reporting Council

Didier Pineau-      Chairman, Association     Europe
Valencienne         Francaise des
                    Entreprises Prives

Jens Roder          Senior Partner,           Europe
                    PricewaterhouseCoopers

David S. Ruder      Professor of Law,         North America
                    Northwestern University
                    Former Chairman,
                    US SEC

Kenneth H.          Former Chairman,          Asia-Pacific
Spencer             Australian Accounting
                    Standards Board

William C.          Chairman and CEO,         North America
Steere, Jr.         Pfizer Inc.

Koji Tajika         Former Chairman,          Asia-Pacific
                    Deloitte Touche Tohmatsu

Paul A.             Former Chairman,          North America
Voicker             US Federal Reserve Board
EXHIBIT 2

MEMBERS OF THE INTERNATIONAL ACCOUNTING STANDARDS BOARD, APRIL 2001 (7)

Member                Board responsibility          Background

Mary E. Barth         Part-time                     Academic
Hans-Georg Bruns      Liaison with German           Preparer
                      standard-setter
Anthony T. Cope                                     User
Robert P. Gamett                                    User
Gilbert Gelard        Liaison with French           Auditor
                      standard-setter
Robert H. Herz        Part-time                     Auditor
Thomas E. Jones       Vice-Chairman of the IASB     Preparer
James J. Leisenring   Liaison with US               Other
                      standard-setter
Warren McGregor       Liaison with Australian/      Other
                      New Zealand standard-setters
Patricia O'Malley     Liaison with Canadian         Auditor
                      standard-setter
Harry K. Schmid                                     Preparer
Sir David Tweedie     Chairman of the IASB          Auditor
Geoffrey Whittington  Liaison with UK standard      User
                      setter
Tatsumi Yamada        Liaison with Japanese         Auditor
                      standard setter

References

(1.) European Commission Proposal on the Use of IASs in Europe. 2001 (February 17). www.iasb.org.uk/news.

(2.) EU-Japan Business Dialogue Round Table. 2001 (July 10). www.iasb.org.uk/news/other.

(3.) Gorbatova, L. 2000 (March). Russia and IASC Standards. IASC Insight, 17-19.

(4.) Hunt I. 2000 (February 17). International accounting st andards-the rules of the game. Speech given at the University of Texas School of Law 22nd Annual Conference on Securities Regulation and Business Law. www.sec.gov/news/soeech/spch348.htm

(5.) Hunt, I. 2000 (March 23). Financial reporting and global capital markets. Speech given at the Second European FASB-SEC Financial Reporting Conference in Frankfurt, Germany. www.sec.gov/news/speech/spch363.htm.

(6.) Hunt, I. 2001 (April 5). Remarks at the Third European FASB-SEC Financial Reporting Conference in Frankfurt, Germany. www.sec.gov/news/speech/spch489.htm.

(7.) IASB: Who We Are. 2001 (August). www.iasb.org.uk/aboutus.

(8.) IASC's Constitution. 2000 (May). www.iasb.org.uk.

(9.) Lipe, R. 1998. Some recent financial reporting issues at the Securities and Exchange Commission. Accounting Horizons, 12, 419-428.

(10.) Nominating committee. 2000 (February). FT Word Accounting Report, 3:1, 2.

(11.) Pacter, P. 1999 (July). International accounting standards: the world's standards by 2002. The CPA Journal, 15-21.

(12.) Recommendations for shaping IASC for the future. 1999 (September). www.iasc.org.uk.

(13.) SEC Concept; Release: International Accounting Standards. 2000 (February). Release Nos. 33-780, 34-42430; International Series No. 1215. Securities and Exchange Commission, Washington, DC. Available (August 2001) at www.sec.gov/rules/concept.

(14.) Sharpe, M. 1998 (March). Looking for harmony: building a global framework. Australian CPA, 68, 16-18.

(15.) Turner, L 2001 (June 7). The State of Financial Reporting Today: Au Unfinished Chapter II. Speech given at the Third Annual SEC Disclosure & Accounting Conference in New York. www.sec.gov/news/speech/spch506.htm.

(16.) Yoon, Y. 1998. Financial reporting in an international environment: a look at regulatory models and the case for a market approach. Multinational Business Review, 6, 29-36.