Harmonization and Convergence of Financial Reporting and Auditing Standards

Position: It is in the best interests of investors and for global financial markets generally for the differing standards to be harmonized and complete convergence to be achieved at the earliest possible time.

Rationale: The costs investors incur to harmonize the various standards so that cross-border comparisons of companies may be made are large Such costs are ultimately impounded in the costs of capital that investors demand for cross-border investments The magnitude of the costs are sufficiently large in some cases as to serve as an effective barrier to cross-border movements of capital Investors, companies, and markets will benefit from the complete harmonization on a global basis of the differing national and supra-national standards Harmonization should converge to the best possible standard, that is, the method that best reflects the underlying economics of transactions, rather than to any particular national standard Only one method should be permitted for reporting similar transactions. The reporting method should not differ depending on country, industry, size of company, or any other consideration, and managers should not be permitted choices of reporting methods for similar transactions Auditing is the examination of a companys financial statements by outside experts. Auditors report to financial statement users on the accuracy and fairness of the statements High-quality audits are essential if the financial statements are to be regarded as reliable by investors and other users The quality of both audit standards and the resulting audits differs substantially worldwide It is essential that auditing standards be harmonized to the highest quality worldwide due to the critical importance of audits to the usefulness of financial statements

THE GROUP OF 100 AND INTERNATIONAL HARMONISATION

Purpose

The purpose of this paper is to:

a. set out the Group of 100s policy on the international harmonisation of accounting standards;

b. explain the development of that policy;

c. outline the reasons underlying the development of the policy;

d. describe the alternative approaches considered in the resolution of that policy; and

e. explain the harmonisation program funded by a levy on listing fees including the CLERP proposals regarding standard-setting arrangements. The Policy

The Group of 100s policy on international harmonisation is that compliance with Australian accounting standards should result in automatic compliance with international accounting standards being those issued by the International Accounting Standards Committee (IASC).

The Group of 100 considered that the development of a uniquely Australian set of standards, while superficially attractive, would eventually result in a loss of credibility of Australian financial reporting as had occurred in the 1980's. An outcome such as this would be to the disadvantage of Australian companies accessing international capital markets because they would be expected to provide information prepared on an internationally accepted basis.

This policy position of international harmonisation was seen as a step towards achieving the long-term objective of a global set of accounting standards which are applicable for domestic and international purposes. Such a set of standards will be:

generally accepted because of their quality and comprehensiveness; complete and in sufficient detail to facilitate operational implementation, consistency, comparability and transparency; and rigorously interpreted and applied.

An important dimension of this policy is that to properly participate in the development of international standards it is essential to the national interest for Australia to have a national standard-setter: which is broadly based with clear lines of accountability; which is strong and well resourced; which is a vigorous and respected contributor in international forums and standard-setting organisations; which has a strong commitment to the process of international harmonisation; and which is supported by a vigilant well resourced national regulator.

Thus an important element of the policy goal of harmonisation and the engagement of the international community is the enhancement, rather than the replacement, of the national standard-setter.

The Group of 100 policy has been influential in the development of policy of the Australian Accounting Standards Board (AASB) and the Public Sector Accounting Standards Board (PSASB) as reflected in their Policy Statement on International Harmonisation (May 1996). This support is best expressed in the Group of 100 Mission Statement issued in 1994 which committed it to: support the development of a comprehensive set of international standards which will ultimately supplant the need for national standards (except where individual national legal and cultural differences require otherwise) as a long-term goal; support for existing Australian standards to be tested against the relevant International standard and for exposure drafts to be developed in line with existing International exposure drafts or standards; actively encourage all members to state whether their accounts comply with International Standards and comment on differences; increase direct financial support to the IASC and make approaches to the ICAA and ASCPA to consider similar support; and

encourage the IASC to enhance the realisation of a truly internationally accepted code of accounting standards by inviting standard-setting bodies (such as the AASB, FASB etc) and business to be represented on the IASC.

In addition, the theme of the Group of 100's National Congresses held in November 1995 (Sydney) and March 1997 (Melbourne) was international harmonisation of financial reporting.

The policy goal of international harmonisation has broad and authoritative support. For example:

a. In 1996 the ASX surveyed listed entities to determine whether they supported a process of harmonisation of Australian standards with IASC standards or the immediate adoption of IASC standards. An overwhelming majority of respondents (87.5%) favoured harmonisation with rather than the immediate adoption of IASC standards. Listed entities also provided strong support for the imposition of a 3% levy on listing fees for 2 years to raise $1 million to fund a harmonisation program.

b. Alan Cameron, Chairman ASC (November 1997):

"The ASC also agrees with the proposal that in the immediate future, Australia should continue to harmonise its standards with IASC standards so that compliance with Australian standards will automatically result in compliance with IASC standards"

c. The Wallis Committee also recognised the importance of participating in these developments:

"Recommendation 12 : Australian Standards should be harmonised with international standards.

' The Australian Accounting Standards Board should, where practicable, seek to harmonise Australia's accounting standards with international standards."

d. In addition the harmonisation program is supported by the professional bodies, the Australian Society of CPAs and The Institute of Chartered Accountants in Australia.

Why this Approach?

The Group of 100 took the view that standards issued by the IASC represented the best prospect for achieving a globally accepted set of accounting standards in a reasonable time frame. It still holds that view.

This view is also reflected in CLERP Paper No.1 "Accounting Standards: Building international opportunities for Australian business" which states:

"The development of a high quality set of IASC standards, and their adoption by major capital markets, offers the best prospect for the establishment of globally accepted accounting standards" (p24) and

"It is in Australias best interests to harmonise Australian standards with IASC standards with a view to adopting them when they have been accepted for reporting purposes in major capital markets (emphasis added)" (p25)

An issue in this regard is what constitutes global acceptance and acceptance in the major international capital markets. Fundamental to the application of this policy is the endorsement of a comprehensive set of IASC standards by the International Organisation of Securities Commissions (IOSCO) for crossborder capital raisings and the resultant acceptance of those standards in international capital markets. In June 1998 the National Executive of the Group of 100 indicated that acceptance in international markets required IOSCO endorsement and adoption by the SEC for cross-border listings and capital raisings (see media release).

In the Australian context, the requirement that the Financial Reporting Council to report to the Minister on the desirability of adopting international standards is an ample recognition of the potential significance of international harmonisation to Australian practice. More recently the draft legislative provisions establishing the Financial Reporting Council (s 2 (2) (e)) state that its functions include:

"(e) monitoring the development of international accounting standards; and

(i) to further the harmonisation of Australian accounting standards with international standards; and

(ii) to promote a greater role for international standards in the Australian standard-setting process if doing so would be in the best interests of investors, business and Australia's capital markets."

In its submissions on the CLERP Paper No.1 on Accounting Standards (October 1997) and on the proposed legislation (May 1998) the Group of 100, while supporting the principle of harmonisation and the role of IASC standards, expressed concern about the dangers of "locking-in" to the timetable and agenda of an external body where Australia was not in control and its flexibility to adapt to changing/evolving circumstances was constrained.

Thus the Group of 100 position is one of strong support for the principle of international harmonisation where to do so does not conflict with Australian legislation. However, in implementing this policy the Group of 100 has indicated to the AASB that where a particular accounting requirement in IASC standards is unsuitable the AASB should first seek a reconsideration of it by the IASC but to ultimately harmonise with the IASC requirement when the IASC standard is accepted in international capital markets.

The Group of 100 views the process as comprising several dimensions and places increasing emphasis on the importance of convergence in the approach to issues by major standard-setters which will result in avoidance of unnecessary differences arising because of differences in the timing of their work programs. The activities of the G4+1 group of standard-setters and cooperation with the IASC in relation to work programs and common approaches to the resolution of issues is seen as an important part of this process. The process of international harmonisation encourages convergence of activities and accounting requirements which itself provides further impetus to a recognition of the benefits of international harmonisation. Alternative Approaches Considered

The Group of 100 considered a number of alternative methods of achieving its harmonisation objective. These included:

a. "rebadging" IASC standards, discussion papers, draft statements of principles and exposure drafts for issue as Australian standards.

This approach while superficially attractive would mean that financial reporting developments and responses to issues would depend on the work program and agenda of the IASC. It was also seen as limiting the ability to deal with institutional and legal requirements relating to Australian reporting including corporate governance and regulatory issues. While this approach was considered by some as a derogation of sovereignty others considered that such a process, managed appropriately, could accelerate international harmonisation.

The participation by business and other interested partners at the IASC level was seen as being more arduous than at a local level. Greater reliance on an integration of activities with those of the IASC would place substantial additional demands on business and other interested parties. In many cases Australian business would be less influential at the IASC level than at a national standard-setting level because of Australia's relative significance in the world economy. However, this is regarded by many as a reasonable price to pay to achieve a common business language.

The success of the IASC Improvements and Comparability Project has resulted in improvements in the quality of international standards and the replacement of a large number of alternatives with a benchmark and allowed alternative approach. The recent creation of a Standing Interpretations Committee (SIC) now means that there is an authoritative body to deal with diverse interpretations of IASC standards. However, some observers have noted, and expressed concern, that the IASC has recently introduced more options into its standards, for example, accounting for superannuation obligations.

b. Adopting US GAAP

Adoption of US GAAP was seen as an attractive option for those corporates whose securities are listed in the USA or in jurisdictions where US GAAP is accepted. However, this approach was not supported because there are many elements of US GAAP which are unlikely to be acceptable to Australian companies, for example, the ban on revaluations and the detail and breadth of the required disclosures. Further, given the European view that US GAAP was politically unacceptable, IASC standards were considered to be more acceptable in that environment. In the final analysis "political" factors were, and continue to be, such that US GAAP is unlikely to be universally accepted in the same sense that IASC standards were likely to be following the IOSCO endorsement. Thus, while the FASB may be prima facie the international standard setter the political dynamics dictate otherwise.

In this regard the IASCs experience in attempting to accelerate the development of a standard on the recognition and measurement of financial instruments by the issue of an exposure draft based on US GAAP indicates the difficulties and tensions associated with formally recognising US standards in this way.

Adoption of US requirements would also mean: a lack of responsiveness by a national standard-setter (the FASB) because its primary focus is on national issues rather than issues put forward by corporates from a different jurisdiction; the suitability of the FASB standards and other elements of US GAAP in an Australian environment and the problems of implementation, provision of guidance and interpretation in the local environment; dealing with significant differences from Australian practice including goodwill and intangibles, pensions, post-employment benefits, inventories, impairment of assets, the use of historic cost and the ban on revaluations.

c. Adopting a policy that compliance with national standards resulted in automatic compliance with IASs which are accepted in international capital markets.

The choice of this approach is discussed above. The benefits of international harmonisation

The Group of 100 considered that international harmonisation had the potential to provide the following benefits: reductions in the cost of capital through the resolution of uncertainty relating to the interpretation and implementation of national standards; administrative benefits arising from the ease of filing in multiple jurisdictions and the resultant simplicity in the development of common accounting systems in place of adjusting, reconciling and explaining different bases applied in different countries; enhanced comparability and transparency of financial reporting requirements and credibility of the reported information; facilitation of cross-border investment and fund raising and the removal of an impediment to a more efficient allocation of resources;

lower investment risk because it reduces an element of risk associated with understanding foreign financial reporting for investors and lenders. The Harmonisation Program

As mentioned above, this program is funded by listed entities through a 3% levy on ASX listing fees. The program provides for an accelerated work program by the AASB (and PSASB) over 2 years to achieve harmonisation such that compliance with Australian standards will result in automatic compliance with IASC standards but not vice-versa. This process has been characterised as involving some pain, for example, different rules on the revaluation of non-current assets and segment reporting and potentially some gains such as the adoption of merger accounting. Australia is the first country with a significant and active national standard-setter to undertake a program of this nature. While other national standard-setters may work closely with the IASC, for example, through the G4 + 1 group of standardsetters, none has implemented the approach adopted by Australia. Implications for Australia

The international harmonisation program has the following implications for Australia:

(a) The adoption of some IASC standards on issues where there is no equivalent Australian standard.

The program involves the introduction of standards where there are no equivalent Australian standards, for example, borrowing costs, accounting for superannuation liabilities, provisions and contingencies and intangible assets.

However, concerns have been expressed by the Group of 100 and others about some outcomes of the program for example, the failure in ED 84 "Acquisition of Assets" to propose harmonisation in respect of pooling of interests. The Group of 100 has indicated to the Board that the process of harmonisation will involve a balancing of some benefits (such as harmonisation with some requirements that are not presently permitted in Australia, for example, pooling of interests) and some costs (such as removal of some current practices).

(b) A challenging program of revision and harmonisation with new developments

An important feature of the program is the renovation and refurbishment of the fabric of Australian standards. Many standards which were developed several years ago are in need of care, maintenance and updating, for example, profit and loss statements, inventories, segment reporting, and

extractive industries. This has not occurred because of a lack of resources and new projects being given a higher priority.

The updating of old standards and the filling of gaps in the suite of standards will benefit the preparers and in particular, the users of financial reports.

The harmonisation program and the cooperation between standard-setters, for example, the G4+1, is also resulting in a convergence in the approach to issues which are being dealt with at approximately the same time. Projects on provisions and contingencies, impairment of assets, performance reporting and the recognition and measurement of financial instruments have been initiated during this period.

It is anticipated that an enhanced financial reporting framework resulting from the program will provide more relevant and reliable information for decision making which will result in improvements in the efficiency of capital markets and in corporate governance and accountability.

(c) Effect on domestic standards

Part of the price of globalisation is that the international standard-setter may not give Australian needs and circumstances the same emphasis as would a national standard-setter. As such, in the absence of a strong national standard-setter with a clear brief on the quality of financial reporting and active participation in the development of international standards, there may be some erosion of quality in relation to domestic standards. However, the compensations for this are the benefits to the economy and international competitiveness of a move to international harmonisation which is considered to be unavoidable in a period of globalisation of commerce, technological and financial innovation. IOSCO Endorsement

The Group of 100 recognises that IOSCO endorsement of IASC standards is crucial to achieving the benefits of harmonisation with IASC standards and that the views of the US Securities and Exchange

Commission (SEC) are first among equals in the IOSCO process. In this regard the SEC is unlikely to participate in an erosion in the quality of financial reporting in US capital markets merely to appease those constituents and other entities who perceive benefits from accepting IASC standards for crossborder listings in the USA. As such the US response is critical. In reporting to the US Congress in October 1997 the SEC stated that:

"At this point it is not clear what the Commission's final decision regarding core Standards will be. Nevertheless, the IASC's efforts to date already have contributed significantly to raising the level of accounting standards worldwide and reducing the number of differences between International Accounting Standards and accounting principles used in the United States. These and other efforts at the International level are encouraging development of accounting principles that have the needs of investors and capital markets as their primary focus."

Speaking at a conference in Brussels in March 1997, Mary Tokar, Senior Associate Chief Accountant of the SEC stated that:

" broader endorsement [of the IASC process and organisation] of the type the SEC has given to the FASB, is dependent on an oversight role and responsibility for the SEC a role that is unlikely to be duplicated at the international level."

Arthur Levitt Chairman of the SEC stated in May 1997 that:

"Commission acceptance of international standards is not a foregone conclusion. It bears repeating that while harmonisation is a desirable goal for the US our standards are already accepted in capital markets throughout the world, and their quality is unmatched. We can only accept a framework that will enhance, rather than diminish, the strength and stability of US capital markets".

It is likely to be some time before any endorsement by IOSCO translates into effective action because:

i. IOSCO does not have a normal procedure for endorsement;

ii. IOSCO members are not bound by its recommendations: and

iii. the impact of the SEC's due process and quality requirements on the endorsement process.

In addition, the IASC is now unlikely to have completed its core set of standards by the end of 1998.

While the Group of 100 acknowledges these difficulties it does not believe that their existence should detract from the pursuit of the goals and realising the benefits of international harmonisation. Current Concerns

A number of entities and participants in the process have recently expressed concerns about the approach to harmonisation and the timing of the process. In the main they support the principle of harmonisation but are concerned about; adopting approaches required by IASC standards which differ from the practices which are required or permitted in the USA and the UK, for example, the net cash investment method of accounting for leverage leases; the approach on particular issues, for example, accounting for intangible assets; the effect of adopting a new accounting requirement in respect of transactions and arrangements which were structured and undertaken under previous arrangements; the perceived damage to competitive advantage resulting from the adoption of standards which are more restrictive than those applying to competitors; the intensity of the international harmonisation program and the resultant lack of time to adequately review the proposed changes, their implications for current practice and to prepare submissions on exposure drafts etc; and the process by which IASC standards are to achieve acceptance in international capital markets.