Fulkerson, Cheryl Linthicum; Cane, ThomasMultinational Business Review v4n2 PP: 30-35 Fall 1996
ABSTRACT:
The SEC requires that non-US private issuers disclosesubstantially the same information as disclosed by US domestic issuers. Insubstance, foreign issuers must recast financial statements in accordancewith US' accounting rules. The reconciliation from non-US to US accountingstandards has been a major impediment to foreign companies listing theirstock on US exchanges. Recently, the SEC has taken steps to reduce issuers'financial reporting burden. Recent amendments to US Securities and ExchangeCommission's accounting and disclosure requirements for foreign firms,together with implications for foreign, as well as domestic issuers, aresummarized.
TEXT:
The SEC requires that non-U.S. private issuers disclose substantially thesame information as disclosed by U.S. domestic issuers. In substance,foreign issuers must recast financial statements in accordance with UnitedStates' accounting rules. The reconciliation from non-U.S. to U.S.accounting standards has been a major impediment to foreign companieslisting their stock on U.S. exchanges. Recently, the SEC has taken steps toreduce issuers' financial reporting burden. This paper summarizes recentamendments to U.S. Securities and Exchange Commission's accounting anddisclosure requirements for foreign firms, together with implications forforeign, as well as domestic issuers.
INTRODUCTION
The last decade is marked by increasing crossborder investment. The UnitedStates' capital markets lead the world in attracting foreign securitieslistings. In the United States alone, 343 foreign issuers entered theUnited States market in the period from 1991 to 1994, increasing the totalnumber of foreign issuers to 667, representing 43 countries. In the periodfrom 1992 to 1994, 537 foreign offerings totalling $131 billion wereregistered with the United States Securities and Exchange Commission (SEC)(Carnall [1995]). This paper summarizes recent amendments to United States'accounting and disclosure requirements for foreign firms listing securitiesin the United States, together with their implications for foreign, as wellas domestic issuers.
The U.S. Securities and Exchange Commission
The United States SEC (SEC, or Commission) is charged with controllingaccess to, and regulation of, domestic and foreign companies listing onU.S. securities markets. Specifically, the SEC mandates financial reportingand disclosure rules. Many foreign firms find the SEC's disclosure andreporting rules too rigorous, demanding and costly with which to comply(Berton [1995]). Furthermore, quantifying results using U.S. accountingrules can degrade earnings. As an example, the first German firm to file onthe New York Stock Exchange, Daimler-Benz was forced to disclose hiddenreserves of $2.82 billion as an extraordinary gain, only to show a netoperating loss as a result of applying other U.S. accounting rules. Forfiscal year 1994, DaimlerBenz reported a $100 million profit under Germanaccounting rules, and a $1 billion loss after applying U.S. generallyaccepted accounting principles (GAAP) (Aeppel [1993], Berton [1995]).Considering costs to file, and the potential for deflated earnings, manynonU.S. firms eligible to list on major U.S. exchanges choose not to do so.Likewise, U.S. investors may miss opportunities to invest in the foreignfirms who choose not to list.
SEC RULES PRIOR TO 1994
To protect U.S. market investors, the SEC requires that non-U.S. privateissuers (defined as issuers incorporated under foreign law) disclosesubstantially the same information as disclosed by U.S. domestic issuers(SEC [1984]).
In substance, foreign issuers must recast financial statements inaccordance with United States' accounting rules. This requirement issignificant, given that U.S. GAAP is known as the most detailed in theworld (Choi and Mueller [1992], p.121). Furthermore, the disclosuresrequired by the SEC are numerous, and U.S. rules require more timelyreports, as compared with many home jurisdictions.
The cost of registration, legal counsel, marketing, and otherlisting-related expenses are high. The SEC's Form 20-F, used by mostforeign companies to satisfy the SEC's annual financial reportingrequirement, carries an average completion time of 2100 hours (SEC[1991],p. 1).
In the past, the SEC has been hesitant to relax requirements for foreignfirms. This resistance persists, despite lobbying efforts by major U.S.stock exchanges, potential foreign listers, and organizations such as theInternational Organization of Securities Commissions (IOSCO) (Berton[1995]). The SEC cites investor protection as its motivation for strictlisting requirements.
As early as 1982, the SEC adopted a foreign integrated disclosure systemfor registration and reporting. The SEC sought to balance investorprotection with keeping U.S. markets open and competitive. Even though theintegrated disclosure system streamlined filings, the SEC held fast to itspolicy of requiring like financial information from foreign private anddomestic issuers.
Today, foreign issuers, like U.S. domestic issuers, face a myriad of SECforms. Specifically, forms filed vary from the 10-K (which is also filed byU.S. firms) for Canadian issuers, to form 20-F for issuers domiciledoutside of Canada. Issuers using form 20-F must follow one of two sets ofalternative instructions:
1) Item 17 outlines the minimum requirements acceptable for annual reports;
2) Item 18 instructions require full disclosure of all financialinformation required of U.S. firms, including such information as segmentalprofits. Item 17 filers are exempt from segmental reporting. For all suchissuers, SEC rules concerning measurement are generally the same forCanadian and non-Canadian foreign issuers. If a foreign issuer utilizes abasis of accounting other than U.S. GAAP, the issuer must reconcile allmaterial differences to U.S. GAAP. At minimum, the following items must berestated to U.S. GAAP, where material differences exist: net income andcomponents of net income, earnings per share, and balance sheet data foryears covered by the accompanying income statements. Such a reconciliationis not necessary when a firm presents annual financial statements inconformity with U.S. GAAP, even where segment disclosures are not present.Most Item 17 filers, including most Japanese firms, file under this option.
RECENT LOBBYING EFFORTS
SEC rules for foreign firms reflect the Commission's goal to ensurecomparability of information across domiciles (SEC [1984] CH IV).Nevertheless, firms have lobbied hard to reduce their financial reportingburden (e.g., Japanese firms) (SEC [1987] CHIV), while researchers Frostand Kinney find what appears to be substantial noncompliance with the SEC'ssegment and reconciliation disclosure rules (Frost and Kinney [1993) p.3).In light of such pressures, the SEC has taken steps to reduce the financialreporting burden on foreign private issuers.
AMENDMENTS TO RULES FOR FOREIGN ISSUERS
During 1994, the SEC issued four releases which streamlined and simplifiedthe registration process for foreign issuers. The releases target schedulesand statements (including the Statement of Cash Flows), reporting currencyand hyperinflationary environments, business combinations, as well asmodifications for reporting by domestic issuers with foreign subsidiaries.
Perhaps more important than the reduction in requirements, these amendmentsmark the Commission's first acceptance of an International AccountingStandard.
Cash Flow Statement
Foreign issuers now have three choices in preparing a statement of cashflows. First, foreign firms may prepare a statement of cash flows under theaccounting principles used in the primary financial statements, andreconcile the information to U.S. GAAP. Second, the firm may prepare a U.S.GAAP statement of cash flows. Third, and most recently, a foreign issuermay prepare a cash flow statement in accordance with InternationalAccounting Standards (IAS) No. 7, without supplemental reconciliation toUnited States' GAAP. To qualify for the third option, the originalstatement of cash flows must be prepared in accordance with IAS 7. Theforeign issuer may not prepare the statement in accordance withhome-country GAAP and later reconcile to IAS 7. In other words, onlyreconciliations from foreign GAAP to U.S. GAAP are permitted (SEC [1994b]).
Schedules Eliminated
Eight schedules, formerly required in the filings of foreign issuers, havebeen eliminated. These schedules formerly detailed:
1) MarketableSecurities and Other Investments;
2) Accounts Receivable from Related Parties, underwriters, promoters andemployees other than related parties;
3) Indebtedness of and to Related Parties Not Current;
4) Property, Plant and Equipment;
5) Accumulated Depreciation, Depletion and Amortization of Property, Plantand Equipment;
6) Guarantees of Securities of Other Issuers;
7) Short-Term Borrowings (not applicable for investment companies); and
8) Supplementary Income Statement Information.
The same eight schedules are eliminated for domestic issuers, as well. Theelimination of these schedules is effective for filings made after December20, 1994 (SEC [1994a]).
Accounting in Hyperinflationary Economies
The second SEC release of 1994 addresses the reporting currencies andoperations by foreign issuers in countries with hyperinflationaryeconomies. The release relaxed Rule 3-20 of Regulation S-X to allowmanagement complete flexibility in selection of a reporting currency.Nevertheless, the Commission held fast to the existing requirement that thecurrency of the primary economic environment of the issuer is used tomeasure transactions.
With respect to reporting currency, management may use any currency itdeems appropriate, so long as the following are disclosed:
1) the currency that is used to prepare the financial statements isdisplayed prominently on the face of the statements;
2) the currency that will be used to pay off dividends, if different fromthe reporting currency; and
3) a description of material exchange restrictions or controls on thereporting currency, the currency of the issuers' domicile, and/or thecurrency in which the issuer will pay dividends (SEC [1994a]).
The amended rule does not apply to financial statements of acquirees orinvestees. However, the financial statements of these entities may beprepared either in the same currency as the issuer, or in the currencynormally used to prepare the entity's statements. A domestic issuer mayprepare financial statements of an acquiree or investee in U.S. dollars.
Measurement Currency
While the SEC does not specifically refer to SFAS 52, its amended rule isdesigned to be conceptually consistent with the U.S. accounting standard.The SEC specifies that the results of all operations, including the parentcompany, not operating in a hyperinflationary environment, are measured inthe functional currency of the primary economic environment. These itemsare translated to the reporting currency based on financial statementplacement. Assets and liabilities are translated at the period end exchangerate and the income statement is translated at the weighted averageexchange rate. The effects of translation (gains/losses) are reported as aseparate component of stockholders' equity.
Changes in Reporting Currency
If an issuer elects to change its reporting currency, financial informationfor previous periods should be shown in the new reporting currency. Incomestatement items are recast into the new reporting currency using theweighted average exchange rate for the initial reporting period, and thebalance sheet is translated using the original reporting period's year-endexchange rate. The rule, as adopted, states that only financial statementsformat the earliest period presented in the filing be comprehensivelyrecast (SEC [1994a]).
Hyperinflationary Economies
Foreign registrants no longer must reconcile for the effects ofhyperinflation accounting if their original financial statements complywith IAS 21 using the historical cost/constant currency method. Inaddition, issuers which prepare financial statements in a reportingcurrency that comprehensively includes the effects of inflation are notrequired to eliminate the effects of price level changes in theirreconciliation to U.S. GAAP. In the past issuers from countries such asMexico, Chile, Israel, and Argentina have prepared statements in pesos orshekels, which are adjusted for inflation. Under the revised rules, thesestatements would be accepted, with reconciliation, where IAS 21 is applied(SEC [1994a]).
Business Combinations
Under previous SEC rules, one of the most significant (both in terms oftime to reconcile and dollar amount) of all reconciling items was derivedwhen recasting financial statements based on alternative consolidationmethods. While these differences are not completely eliminated, the SEC hasmodified reconciliations for accounting for business combinations, as wellthe amortization of goodwill and negative goodwill (SEC [1994a]).
Method of Accounting for Combinations
Under U.S. GAAP, two basic accounting methods may be applied to businesscombinations, each with criteria dictating the case in which the method isapplicable. The purchase method is used when a business combination istreated as an acquisition; the pooling method is used (less often) when thecombination is deemed a uniting of interests. IAS 22 outlines twoconceptually, although not quantitatively, similar approaches.
The SEC now allows firms preparing financial statements in accordance withIAS 22 to maintain the character of the acquisition. In other words, thereis no need to reapply the criteria for and reclassify a transaction whichmay be considered a uniting of interests under IAS 22, as a purchase underU.S. GAAP. Rather, issuers are now required only to quantify thedifferences between an IAS 22 uniting of interests and a U.S. pooling, andthe differences between IAS acquisition and U.S. measurement of a purchase(SEC [1994a]).
Goodwill
Under IAS 22, goodwill and negative goodwill are generally amortized over aperiod not to exceed 5 years, unless a longer period, not to exceed 20years, is justified. Under U.S. GAAP, goodwill is amortized over a periodnot to exceed 40 years. Form 20-F has been amended to allow firms to usethe IAS 22 term, without quantified reconciliation in the 20-F. Obviously,the shorter amortization term will produce more conservative income (in thecase of positive goodwill) compared with income generated applying U.S.GAAP.
The amendments do not allow an issuer to reconcile to IAS 22. That is, aforeign issuer which charges goodwill against equity (as in the U.K.) couldnot reinstate the goodwill, later amortizing in accordance with IAS 22. Anyreconciliation must comply with U.S. GAAP (SEC [1994a]).
Domestic Issuers
The fourth SEC release addresses domestic (U.S. based) issuers withinternational investments, as well as foreign issuers. The amendmentsrecognize that U.S. issuers with investments in foreign businesses facesimilar difficulties in obtaining certain financial information as foreignissuers. In particular, U.S. companies are not required to provide areconciliation to U.S. GAAP for foreign investees with significance levelsof less than or equal to 30 % . Further, when such a reconciliation isrequired, it may be prepared in accordance with Item 27 of Form 20-F. Inaddition, the age of the financial statements of the foreign business maybe the same as those of the foreign business (six months after year end forannual reports; ten months for interim statements) (SEC[1994a]).
In the context of these amendments, the SEC's definition of a foreignbusiness is key. The SEC does not consider a foreign subsidiary of a U.S.firm a foreign business. Furthermore, a foreign business with majorityownership by U.S. citizens or residents is not considered a foreignbusiness. The definition of a foreign business is, in practice, designed toaccommodate those situations in which the issuer would not have access toU.S. GAAP information, or be subject to U.S. reporting requirements.
RESPONSE TO CLOSING THE "GAAP"
Forty-one comment letters were received by the SEC when the Commissioncalled for response to the aforementioned amendments, pending finalapproval (SEC [1994b,c,d]). The commentaries represented industry (29),public accounting (6), professional accounting organizations (1) andfinancial analysts and related organizations (4). In addition, the New YorkStock Exchange commented on the proposed amendments. It is not surprisingthat most registrants joined the NYSE in favoring the proposed changes.Taken as a whole, public accountants basically favored the action. Commentsby financial analysts were critical of the proposed amendments, voicinggeneral concern that the amendments mark the first stage of a progressiverelaxation of U.S. disclosure requirements (SEC-[1994b]).
Now that the amendments are in force, the discussion continues in thefinancial press. James L. Cochrane, former SEC Commissioner and currently asenior vice president and economist for the New York Stock Exchangepromotes the opening of U.S. securities markets to non-U.S. firms (Berton[1995]).
Meanwhile, some stock market analysts fear lack of comparable disclosureamong U.S. and foreign stocks, which would ultimately prevent U.S.analysts/investors from making meaningful company-to-company comparisonsbetween U.S. and non-U.S. listing firms. While accountants are aware of thedifferences between U.S. and non-U.S. financial results, U.S. accountingrulemakers seem to be even more interested in preserving U.S. accountingrules. Analysts, as well as many in the profession, believe U.S. accountingrules should be the "rule rather than the exception" (Berton [1995]).
Still another group is tormented by possible further relaxing of filingstandards for non-U.S. issuers - U.S. domestic issuers. The head of theSEC's corporate finance division is described as "adamant that U.S.accounting standards still won't be dropped for domestic companies" (Berton[1995]). Such comment suggests that non-U.S. firms are afforded moreconsiderations than their U.S. counterparts.
In the end, the SEC is unlikely to grant foreign firms significantconsiderations not afforded U.S. firms. For years the Commission has beencharged with "leveling the field" between U.S. and non-U.S. firms. Perhapsit is time to reseed the field, beginning with a simplification of rulesfor domestic issuers. Ultimately, such simplification would provide relieffor foreign issuers and spur additional cross-border investment.
Reference:
REFERENCES
Aeppel, T. 1993. Daimler Says Mercedes Has Operating Loss. The Wall StreetJournal. (28 July): A10.
Berton, L. 1995. All Accountants Soon May Speak the Same Language. The WallStreet Journal. (29 August): A15.
Carnal, Wayne E. 1995. International Reporting Issues in the Division ofCorporate Finance. AICPA 22nd Annual Conferences on SEC Developments.Washington, DC.
Choi and Mueller. 1992. International Accounting: Second Edition. EnglewoodCliffs, New Jersey: Prentice-Hall.
Reference:
Frost, Carol A. and William R. Kinney, Jr. 1993. Regulation S-X andComparability of Disclosure for Foreign Registrants in the U.S. Unpublishedworking paper. Washington University. St. Louis.
United States Securities and Exchange Commission. 1984. Memorandum of theOffice of International Corporate Finance. Division of Finance, Securitiesand Exchange Commission on the Application of the Securities and ExchangeAct of 1934 to Foreign Private Issuers. Washington, D.C., SEC, January.
United States Securities and Exchange Commission. 1987.Internationalization of the Securities Markets: Report of the Staff of the
U.S. Securities and Exchange Commission to the Senate Committee on Banking,Housing and Urban Affairs and the House Committee on Energy and Commerce.Washington, D.C.: SEC, July 17.
Reference:
United States Securities and Exchange Commission. 1991.
Form 20-F. SEC 1852(7-91). Washington, D.C.: SEC, July.
United States Securities and Exchange Commission. 1994a. FinancialStatements of Significant Foreign Equity Investees and Acquired Businessesof Domestic Issuers and Financial Schedules. Division of CorporationFinance. Washington, D.C.: SEC, April 19.
Reference:
United States Securities and Exchange Commission. 1994b. Summary ofComments: Financial Statements of Significant Foreign Equity Investees andAcquired Businesses of Domestic Issuers and Financial Schedules. Divisionof Corporate Finance. Washington, D.C.: SEC, December 13.
United States Securities and Exchange Commission. 1994c. Summary ofComments: Reconciliation of the Accounting by Foreign Private Issuers for
Business Combinations. Division of Corporate Finance. Washington, D.C.:SEC, December 13.
United States Securities and Exchange Commission. 1994d. Summary ofComments: Selection of Reporting Currency for Financial Statements ofForeign Private Issuers and Reconciliation to U.S. GAAP for Foreign PrivateIssuers with Operations in a Hyperinflationary Economy. Division ofCorporate Finance. Washington, D.C.: SEC, December 13.
THIS IS THE FULL-TEXT. Copyright University of Detroit Mercy 1996
COMPANY NAMES:
SEC
GEOGRAPHIC NAMES: US
DESCRIPTORS: SEC registration; International finance; Accounting standards;
Financial reporting; Disclosure; Studies; SEC regulations; Foreign investment
CLASSIFICATION CODES: 9130 (CN=Experimental/Theoretical); 3400
(CN=Investment analysis); 4120 (CN=Accounting policies & procedures); 9190 (CN=United States); 4310 (CN=Regulation); 1300 (CN=International trade & foreign investment)
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