THE GREAT DEBATE
Volcker referees the fight over global accounting standards.
By Tom Leander

Olli-Pekka Kallasvuo, CFO and executive vice-president of Nokia, seems a prince of transparency as he sits in Nokia House, a steel and glass corporate temple in Helsinki, Finland. The 47-year-old talks with confidence of Nokia's information disclosure practices under international accounting standards (IAS), a body of accounting rules now under consideration by the US Securities and Exchange Commission (SEC). Critics say the rules aren't stringent enough and would give powerhouses like Nokia a lower bar than US generally accepted accounting principles (GAAP) to raise capital in America - and therefore an unfair competitive advantage.

For Asian CFOs, the stakes are high. Many large Asian companies have converted their local GAAP reporting to IAS in anticipation of the code's eventual acceptance worldwide. An IAS approval by the SEC would ease access to the US, which comprises some 40 percent of the world's equity and could potentially deliver such benefits as lowering the cost of capital for high quality Asian companies hobbled by high risk premiums.

Despite US skepticism of IAS, many CFOs in Asia swear by it, saying the levels of transparency it demands are equal to that of US GAAP. "Besides a few fundamental differences, such as GAAP's allowance of pooling of interests [in M&A accounting], IAS and GAAP are close," says Thierry Moulonguet, CFO of Nissan and a former controller at Renault, the French auto maker which bought Nissan last year. Moulonguet oversaw lengthy, difficult reconciliation to IAS at Nissan as a result of the acquisition, a process which he believes improved relations with Nissan's foreign institutional investors into the troubled firm, because it greatly improved transparency.

In Europe, Kallasvuo is also a staunch defender. Seventy percent of Nokia is owned outside of Finland; it has more than 1 million US shareholders; and it has long disclosed discounted cashflow figures and economic value added. The company listed on the Big Board in 1993, then decided that its global ownership merited a conversion to IAS.

"Realizing that our shareholders would always be largely outside of Finland," says Kallasvuo, "we decided to primarily report in IAS."

Across the Atlantic, Lynn Turner, the SEC's chief accountant, sits in the agency's drab and workaday Washington, DC headquarters mulling the SEC's initiative to open the door for IAS. The decision, expected by the first half of 2001, isn't one he's taking lightly. Allowing IAS without its current requirement of lengthy reconciliations to US GAAP would greatly expand foreign companies' access to the US market. And Turner is wary because of companies like Nokia.

With reason. The SEC asked for comment on the quality of IAS last February, and one letter, which complained of companies claiming to disclose fully in IAS in reports to investors but actually omitting crucial details, cited Nokia. "Nokia claims full compliance with IAS in a statement of its accounting policies, but does not disclose geographical segment information or many of the required disclosures of retirement benefits," contends the letter's author, Kenneth Blair, citing a study published in the Financial Times of London last year by accounting specialist David Cairns.

Cairns, an author as well as a former secretary general of the International Accounting Standards Committee (IASC) in London, is no less harsh. "It's a serious breach," he says. But since there's no global SEC to stop companies from claiming, but failing, to meet IAS, they can do so without suffering any penalty.

In Helsinki, Kallasvuo, who has never seen the letter, reacts with shock. "This can't be true," he says, but then concedes that he doesn't know. He falls back with: "We are among the most transparent companies in the world." His chief accountant, controller Maija Torrko, admits that Nokia fell short of full geographical segment disclosure in 1998, but was in full compliance in 1999, when the IASC released new guidelines. Cairns disagrees, saying it still didn't reveal enough. About the pension disclosure, Torrko echoes Kallasvuo's confusion on the requirements. Nokia has adopted a wait-and-see attitude, because "we don't know what to disclose."

Nokia discloses some geographical segment information in its 20-S reconciliation filing to the SEC. The commission had no comment about Nokia's apparent noncompliance to IAS.

New World Disorder?

The discrepancy may not, in fact, be that unusual. Nor, for that matter, are US companies beyond reproach when it comes to adhering to US GAAP. But the relative vagueness of IAS on such matters, coupled with its lack of enforcement, helps explain the SEC's skepticism about the standards. That, in turn, is holding back progress on a universal set of accounting rules, which CFOs around the world agree would make it easier to raise capital and complete acquisitions in foreign markets. But they are likely to be disappointed until the SEC is satisfied that investors will be treated no less well under IAS than under US GAAP. "Noncompliance is a serious problem with a lot of companies that say they fully disclose under IAS," says Turner.

Yet even Turner admits that in the fight over the quality of international accounting standards versus the sanctity of US GAAP, CFOs can get lost in the ledger lines. And since the SEC has a strong interest in allowing foreign companies to list, SEC chairman Arthur Levitt and Turner responded last year to one of many frequent pleas to consider IAS by putting out the request for comment letters. Then, last summer, the SEC quietly stepped up its influence with the restructuring of the IASC.

In a clear sign of the SEC's interest in IAS, Levitt asked Paul Volcker, former chairman of the US Federal Reserve Board and most recently chairman of the committee to repatriate money from Holocaust victims in Swiss banks, to oversee the IASC's restructuring.

"I was talking with Arthur Levitt," recalls Volcker, "and I said, ÔIsn't it arrogant that we believe that everyone should report in GAAP?'" Levitt was bemused, but asked Volcker to chair the committee. "I'm not an accountant," the plain-spoken former Fed chairman admits. "I have a semi-consumer's view of these things."

And he will apply that view as he selects and nominates the new board of the IASC, which will be responsible for modifying the current body of standards and aligning them to US GAAP and other accounting standards in use around the world. He's also going to have to raise enough money to get the new, more powerful IASC rolling in perpetuity, much of it from companies themselves. Success, then, will ultimately depend on Volcker's ability to get companies to agree that they need a global standard that's better than GAAP. "There are basic questions about accounting models that nobody feels comfortable with at this point," he says.

No one national body of standard setters, including the Financial Accounting Standards Board (FASB), Volcker says, can bear the burden of absorbing these changes and adopting a set of rules suitable to the markets undergoing them. The obvious solution is to turn to the IASC, which has been in existence since 1973, as a kind of FASB to the world. The SEC and FASB don't seem particularly bent on expanding their turf. In fact, the two bodies have long favored certain methods promoted by the IASC. One such is purchase accounting for acquisitions, used instead of the pooling-of-interests method still allowed in the US. The SEC has had a hard time scrapping pooling in the face of protests by powerful US companies. Clearly, the decision would be better placed in the hands of an extranational rule-making body. The question is, is the IASC up to the job?

Turner says the stakes are huge. "The changes to international accounting standards," he says, "will have enormous impact on businesses."

Multiple GAAPs

No one has to convince Mark Malcolm, head of global accounting for Ford Motor, which has operations in 83 countries including Tahiti and Iceland, and has to reconcile all operations to US GAAP. In July, Malcolm flew to Seoul with his team to perform the due diligence on Daewoo Motor, a member of the debt-laden Daewoo chaebol, which Ford had announced the intention to acquire.

The deal ultimately collapsed because of accounting, according to an investment banker who advised Ford on the deal. "Daewoo wasn't collecting the kind of information that a normal accounting system would require," says the source. Once Ford looked closely at Daewoo, it was confronted with information in no single GAAP. Only a straightforward reconciliation would have been required if Korean GAAP were all that Malcolm and his team encountered. Korean GAAP, for example, handles research and development costs much in the way IAS does, by requiring capitalization, whereas US GAAP requires R&D costs to be expensed. But Malcolm's group was confronted with a Babel of GAAPs recording information from Daewoo subsidiaries in markets ranging from Uzbekistan to Poland.

It took about 90 days to pick through the information and come to the conclusion that shut down the deal. "Ford found debts in India, Poland and Uzbekistan that it couldn't accept," says the investment banker, "plus commitments that Daewoo had made to the governments of those countries that it didn't think it could live up to." Ford wanted Daewoo badly enough to bid 7.7 trillion won (US$7 billion) at the outset, compared with rival bids of 5 to 6 trillion won from a consortium of Hyundai Motor and DaimlerChrysler, and 4 trillion won from General Motors. By the time Malcolm had completed his due diligence, Daewoo had revised the asking price down to US$3 billion. But Ford walked anyway. Daewoo has since filed for bankruptcy.

"Ninety days is a long time to get line of sight," says Malcolm, who declined to comment on the Daewoo deal directly. "But no matter how difficult the process, the fiduciary responsibility to shareholders rests with us," he says, meaning him and the due-diligence team. "We have to get at the truth no matter how long it takes." He adds: "Sometimes turning down a deal is the most important decision we have to make."

But of course the longer it takes to arrive at such a decision, the greater the opportunity cost (see box "The Price of Opacity").

Thierry Moulonguet confronted a similar situation when he became CFO of Nissan in July 1999. Renault invested 643 billion yen (US$6 billion) for a 37 percent stake in Nissan that year. The transaction was heralded as a first: an acquisition by a European auto giant of a troubled Japanese motor-vehicle company. This deal, too, rode on accounting, but Renault isn't listed in the US and it reports in IAS, so it examined Nissan's books through the prism of those standards.

"It was a test case for IAS in some respects," says Paul Pacter, director at Deloitte Touche Tohmatsu in Hong Kong, a former adviser to FASB and the IASC. The test question was whether IAS would promote the same quality of transparency as the US GAAP methods used by companies like Ford. Moulonguet's answer is unequivocal. "The two standards are very close together," he says. "I don't think the principle-based nature of IAS detracts from its quality at all."

Moulonguet discovered underfunded pension liabilities that went unreported under Japanese accounting, which does not require that the liabilities be written off against equity. The write-offs for the underfunded liabilities amounted to about US$3 billion and increased Nissan's losses for the fiscal year ended March 31, 2000, to about US$6 billion, roughly equaling Renault's initial investment.

A viable standard?

While IAS seems to have worked for Renault and Nissan, the case is considered an exception in some quarters. "The question is, is IAS a standard at all?" muses Jean-Franois Phelizon, president and CEO of Saint-Gobain, the North American subsidiary of French building-materials conglomerate Compagnie de Saint-Gobain, based in Paris, where he was CFO until September. Saint-Gobain is planning to list on the New York Stock Exchange next year, he says, and he had to make a choice. For practical reasons, "we had to leave IAS last year." In order to list in the US, companies have to provide a reconciliation to US GAAP for at least two previous years, so supporting the IAS, no matter what its merits, became untenable.

For Phelizon, who has been a vocal supporter of IAS in the past, the switch was dictated by expediency. The European Commission has said that it will endorse IAS in full by 2005, but "in the meantime," says Phelizon, "we will report in US GAAP and French GAAP." Phelizon regrets this, because he views the two standards as the same in many respects, despite major differences in several areas. Yet the only way he sees IAS surviving is if it becomes so similar to US GAAP that it essentially becomes "the US GAAP for the world."

Despite Phelizon's pessimism, surveys suggest that IAS has gained the confidence of the European financial community. If so, Europe's CFOs are being badly served by the regulators and national bodies responsible for the promotion of IAS. "Because the European governments are not able to present a common position, the process is being driven by FASB and the SEC," says Jeremy Jennings, the head of the EU Office of Public Affairs for Arthur Andersen in Brussels. European community members squabble over the thorny issues of local accounting versus methods applied by IAS. But behind the scenes, there's a suspicion that the SEC is indulging in regulatory imperialism by its hands-on direction of the restructuring of the IASC, and that the restructured committee will be packed by Anglo-Saxon interests.

Volcker denies this, but concedes that: "If you just pick people that have experience in this area, you're going to be overloaded with Anglo-Saxons."

It depends, of course, on what kind of experience you're talking about. SEC officials refer to the American securities market as the jewel of the world, and point to the higher levels of transparency in US accounting practices as the reason. Lynn Turner describes the decision of whether to allow unreconciled IAS into the US markets as a "no-brainer" until "they start writing better standards."

But are there material differences of quality? Most respondents to the SEC call for comment say that IAS standards are of sufficient quality to be allowed entry into the United States. But a hard core of skeptics - including FASB and Turner - have grouped themselves into a powerful minority. They cite two issues: the fact that IAS is vaguer than US GAAP and leaves too much to interpretation, and the lack of a consistent and powerful method of enforcement for IAS.

Related Party Time

Consider the case of Lernout & Hauspie Speech Products (L&H), a Belgian maker of voice-recognition and translation software that has a listing on Nasdaq and reports in US GAAP. Sources at the SEC say they regard the L&H case as a good example of situations in which US GAAP - bolstered by zealous SEC gatekeeping - alerts regulators to a potential problem, which IAS as it stands would allow to slip through the cracks.

The backdrop: L&H recognized revenue when it sold rights to its software products to a number of companies in Korea and Singapore. The transactions represented an astronomical leap in revenues for those markets. In Singapore alone, sales to 15 companies accounted for US$57 million, or 17 percent of L&H's worldwide revenue. The reason that the SEC became suspicious was that the financing of those units was done by FLV Fund, a Belgian venture-capital fund, with direct ties to Jo Lernout and Pol Hauspie, L&H's founders, and other company officials.

"The principal issue is how and when revenue should be recognized," says a US accounting expert. "Question was," says this source, "to what degree had they set up these entities to buy the rights? And the further issue was whether they had actually completed the work that they were supposedly selling." In other words, were these legitimate arm's-length sales, and was L&H selling products before they had been fully tested and recording the sales as finished products?

L&H CFO Carl Dammekens did not return phone calls.

Dennis Beresford, executive professor of accounting at the University of Georgia in the US, suggests that the L&H case illustrates that the fundamental difference between IAS and US GAAP has more to do with how the standards are applied than with the standards themselves (see box "Learning from Lernout,"). "In the US, if you lined up 25 accountants and gave them the same set of circumstances to be analyzed by US GAAP, you'd get 24 of them agreeing on the interpretation," says Beresford, a former chairman of FASB and a member of the IASC in the early 1980s. "It's not necessarily the way things work at IAS board meetings."

What Becomes a Legend?

In response, several accounting bodies have made an effort to raise the bar for self-enforcement by the auditing community. But they have made little progress.

Consider Legend, a program started by the Big Five in Thailand, Korea and Indonesia after critics charged that the major accounting firms had loosened their standards and contributed to the economic meltdown of the Asian crisis. If a company's disclosure didn't meet the levels required under US GAAP or IAS, then its report was made to bear a legend saying that the audit had been done using local accounting standards only. Local government officials and regulators complained that the program would meddle with companies' efforts to attract capital and damage an economic rebound. The Big Five backed down and discontinued the program. Both KPMG and PricewaterhouseCoopers, for example, sign Nokia's annual reports. Why didn't they make an issue of the lack of full disclosure under IAS to Kallasvuo?

Says accounting specialist Cairns: "Nokia has operations in about 20 countries, and there's no geographical breakdown in the annual report." That leaves Nokia short of the IAS standard.

Back in Helsinki, Kallasvuo has one recurring wish: that the various constituencies fighting over the eventual adoption of a single global standard of reporting come to an agreement quickly. As far as he's concerned, it doesn't matter whether US GAAP or IAS prevails, so long as "there's a single, consistent way to disclose information."

But Cairns disagrees: "The investor isn't getting all the information, and [giving it] is the price of a listing on a major stock exchange."

Tom Leander is managing editor of CFO Asia