Other Countries’ Methods Also Under Scrutiny

Accounting is a global issue. Around the world, highly developed countries such as Germany and Japan and developing ones such as Mexico and China use accounting methods different from those of the U.S.

And most non-U.S. methods are less revealing to investors of just what lies behind the figures that companies report on income statements and balance sheets.

But that situation is about to change as global investment and accounting authorities work toward uniform international standards.

Meanwhile, world accounting is a Tower of Babel. Mexican companies, for example, still use inflation accounting--they write up the value of company assets to keep up with inflation, but then record a gain from that written-up, illusory value.

Many companies in South Korea and Japan do not report profits and losses on a consolidated basis, but instead hide losses among subsidiary companies while reporting profits for the parent company.

“That kind of accounting caused a lot of troubles for the International Monetary Fund when it was asked to aid loss-making companies and banks in Korea,” says economist Glenn Yago of the Milken Institute, a Santa Monica-based economic research organization.

Many countries still do not require that companies account for pension obligations or keep pension funds separate from other corporate capital. That’s of great significance to the world economy right now. The pension issue has left an enormous problem in Japan--more about that later--and is causing most countries to reform their financial systems.

Thus, accounting, which may sound dull and distant to most people, has enormous importance in the world. In fact, misunderstandings about asset values and reported profits contributed to the Asian crisis.

But the Asian crisis also has provoked demands for change. The bankers, insurance companies, corporate treasurers and pension and mutual fund investors whose investments make up the global capital market want uniform, “transparent” international accounting standards.

Action is being taken. The U.S. Securities and Exchange Commission is now reviewing a proposed set of global accounting standards drawn up by the International Accounting Standards Committee, or IASC, a 34-nation body that has been working since 1995 to prepare more uniform rules.

The SEC’s purpose is not to impose U.S. standards on the world. In some cases, such as accounting for merger transactions, foreign standards are more rigorous. And U.S. rules are now changing to reflect that rigor, as Thomas S. Mulligan reports today in this special report.

The goal is to arrive at a common set of standards that assures investors and bankers that promises of returns on investment or payments of loans are based on reality. Obtaining such standards will take years of evolution and consultation. But in the short term, the SEC may soon request comments from the U.S. investment community and other public bodies on acceptance of international standards.

“The SEC’s prime purpose is to protect U.S. investors, but in the age of the Internet, U.S. investors will purchase stocks of foreign companies directly, without benefit of U.S. disclosure rules,” notes Stephan Richter, head of Transatlantic Futures, a Washington-based research organization.

U.S. investors already can choose among 1,100 foreign companies that now trade their securities on the New York Stock Exchange or Nasdaq. But all of those companies have reconciled their accounts with U.S. standards and SEC disclosure rules. They have done so to gain access to the U.S. capital market, the most abundant in the world.

But reconciling accounts is costly. And companies that do not adjust their accounts to U.S. standards often are charged higher interest by global bankers and receive relatively lower prices on their securities.

“More uniform international standards are needed to reduce costs of capital for world business,” says Patricia McConnell, a vice chair of the IASC and a senior managing director of Bear Stearns, the investment firm.

Large issues are involved. Lack of uniform standards is hindering development of global capital markets, says the Milken Institute’s Yago, who issues an annual ranking of countries’ access to international capital.

Surprisingly, Japan ranks low on access to the world’s capital, below such poorer countries as South Korea and Spain. One reason is Japan’s accounting systems, which have distorted the financial reality of Japan’s companies for decades.

In pension accounts, for example, Japanese companies have made unrealistic assumptions about investment gains, with the result that corporate pension plans now are severely underfunded. One Japanese research institute puts the pension shortfall at more than $500 billion--a debt that companies must pay in the years ahead.

From disaster sometimes comes progress. It is the specter of such pension shortfalls and other financial troubles that is forcing Japan now to fundamentally change its accounting systems. U.S. firms such as PriceWaterhouseCoopers and Deloitte & Touche are active in helping Japan put things right.

But Japan is not alone in suffering consequences of inadequate accounting. In Europe, too, companies typically did not keep pension money separate but used it to fund operations year in and year out. As a result, great liabilities now loom, and European companies are setting up pension accounts on the U.S. model.

That U.S. model was created in 1974 by the Employee Retirement Income Security Act, or ERISA. Congress passed ERISA because it feared that without separate pension accounts, companies could go bankrupt and leave employees facing hardship and demanding government support.

It has turned out to be a great law, bolstering the huge pension funds that help fuel today’s prosperous U.S. economy.

There’s a lesson there. ERISA, like the Securities and Exchange Commission itself, is one more example of how proper regulation and solid accounting principles serve a purpose in our complex society. We should not forget that as the world moves to emulate those very accounting and regulatory systems.

*

James Flanigan can be reached at jim.flanigan@latimes.com.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Depends on how you count

Three examples below compare reported company results under accounting systems in Mexico, South Korea and Germany with what they would be under U.S. accounting rules.

Accounting for Inflation

Cimientos Mexicanos (Cemex) restates the value of plants and equipment to reflect inflation, adding billions of pesos to its reported income. U.S. accounting rules don’t allow that.

Cemex’s reported 1997 pretax income: 6.14 billion pesos

What it would have been under U.S. rules: 2.61 billion pesos

*

Counting Subsidiaries

South Korea’s Samsung Electronics reports net income of just the parent company. Under U.S. rules, it would be forced to consolidate all its subsidiaries in its accounts.

Cemex’s reported 1997 pretax income: 164 billion won

What it would have been under U.S. rules: 110 billion won

*

Reporting Cash Flown

Daimler-Benz (now DaimlerChrysler) reported income plus depreciation, or cash flow, under German accounting rules, which allows reserves to be kept aside to smooth out reported profits in bad years. U.S. rules don’t allow this and would yield a higher reported profit figure.

Cemex’s reported 1997 pretax income: 4.5 billion marks

What it would have been under U.S. rules: 5.5 billion marks

Source: Glenn Yago, Milken Institute, Times staff calculations.