When our Managing Partner, William S. Kanaga, testified at the hearings of the Subcommittee on Reports, Accounting and Management on May 25th, he was asked by you to submit additional written material on two of our firm's recommendations.

If you

Two copies of that material are enclosed herewith. had specific questions which are not covered in this additional material, we would, of course, be pleased to attempt to provide further information.

ADDITIONAL INFORMATION ON ARTHUR YOUNG & COMPANY RECOMMENDATION #5

In our response to "The Accounting Establishment", "Professional Responsibilities in a Time of Change", we recommend:

1"Congress should urge government agencies to

furnish independent public accountants with infor-
mation useful in audits.

Many government agencies do not furnish inde-
pendent auditors useful information. Examples in-
clude failure to respond to audit inquiries
concerning clients' receivables, refusal by the
Internal Revenue Service to disclose the status of
tax examinations, and refusal by the enforcement
division of the SEC to disclose whether their in-
vestigations have disclosed information that may
materially affect financial statements being ex-
amined. Congress should encourage all government
agencies to respond to auditors' inquiries and to
undertake a positive duty to inform the auditors
of a public corporation of any matter that comes to
their attention which in the view of the agency
could have a material affect on the company's finan-
cial statements."

2Confirmation of accounts receivable by correspondence with the customer is a generally accepted auditing procedure.

For many years independent auditors have encountered difficulty obtaining replies to their confirmation requests from government disbursement offices. As the AICPA audit guide "Audits of Government Contractors" points out,

3.The independent auditor may attempt direct confirmation of the amount; however, the likelihood of receiving a reply is not as great as for commercial trade receivables because government disbursement offices seldom reply to these requests. Consequently, the independent auditor will often employ alternative audit procedures."

As accounting systems have evolved, even commercial customers have found it increasingly difficult to confirm total account balances. They have, however, been willing and able to confirm individual billings or vouchers. Perhaps government offices could do the same.

The SEC has at times been unwilling to make available to independent auditors material in its investigatory files even when the auditors made specific requests for the information. Attached is

1. Pages 101 - 102.

2.

3.

Statements on auditing standards, Section 331.

AICPA Industry Audit Guide, Audits of Government Contractors, Pg.48.

Arthur Young & Company
Recommendation #5

Page 2

Judge Pollack's memorandum on this issue in the Republic National Life Insurance Company case. In this case the SEC did not respond to inquiries from a Big 8 firm, Peat, Marwick, Mitchell & Company, and from a smaller firm, Westheimer, Fine, Berger & Company. While Judge Pollack concluded that he did not have jurisdiction over the SEC's exercise of discretion, he added, "To say that this court lacks subject matter jurisdiction over the counterclaim, however, is hardly to say that this court condones as a matter of policy the course of action pursued by the SEC in this case. Unless the SEC's pronouncements of cooperation with public accountants in the interest of providing full and understandable disclosure to the investing public are to be taken as mere exercises in public relations, the SEC must genuinely indicate that cooperation is indeed a two-way street. Surely the SEC would not choose to have accountants judge it by the precept 'do as I do, not as I say". Our firm has had similar experiences as indicated by our report, attached, on our examination of the January 1974 financial statements of First Mortgage Investors.

Since the SEC is the government agency directly concerned with the full and fair presentation of financial information, its reluctance to cooperate is most surprising. Other agencies have had similar records.

Agencies with investigative functions are most likely to have an unexpected impact on companies. The Federal Trade Commission and the Internal Revenue Service are examples. The existence and status of investigations by them may be required disclosure in financial statements. Accordingly, agencies should be responsive to auditors' inquiries on status of investigations. In addition, since the auditor would not normally expect such investigations, the agency should accept the duty of notifying the auditors that such an investigation has commenced.

Progress is possible. For example, until recently, the Controller of the Currency would not make available to independent auditors reports by bank examiners of national banks. The possibilities for progress are well illustrated by the fact that these reports are now made available.

concerns.

We do not suggest that an immediate congressional order to government agencies is appropriate. Certainly the agencies have legitimate The disbursing officers may be reluctant to confirm a billed amount when there are asserted or potential claims. Judge Pollack discusses the legitimate concerns of the SEC's enforcement division. The FTC or IRS may be reluctant to disclose the status of their investigations. The Controller of the Currency undoubtedly feared the spreading of information that could lead to bank failures. Nonetheless, we believe government agencies can be more responsive to the needs of investors for information concerning asserted and unasserted claims by government agencies. A clear expression by the Subcommittee of its desires for additional cooperation would cause the agencies to work with the AICPA to design procedures which would provide information needed for financial statements while protecting agencies' legitimate

ADDITIONAL INFORMATION ON ARTHUR YOUNG & COMPANY RECOMMENDATION #6

One of several recommendations in our firm's response to the staff study entitled "The Accounting Establishment" was that:

"Government and the AICPA should mount a massive effort to end unsatisfactory practices in the financial statements of governments.

Emphasis should be placed on recording of all assets and liabilities, on improved disclosure as to commitments and other important matters, and on condensation and clarification of the voluminous material now being prepared. Participation by government representatives should be encouraged, but those who wish merely to prepetuate the status quo should be excluded.

We are pleased to expand upon this recommendation, as you requested, as we believe that fundamental improvements in governmental financial reporting concepts and practices are required and that a massive, coordinated effort is essential to achieve this objective.

The government reporting deficiencies cited are clearly of major significance. Even so, they are illustrative rather than all-inclusive. Indeed, they are symtomatic of a far more fundamental and pervasive problem: Accounting systems and reporting practices of governments have failed to keep pace with the dramatic changes in recent years in the nature and scope of their activities, and their burgeoning financial resource requirements and levels of indebtedness. Until recently, there has been little apparent demand for financial statements of governments prepared in accordance with generally accepted accounting principles. Accordingly, many government officials have considered their voluminous, highly detailed, legal compliance oriented annual reports to be sufficient for both internal and external reporting purposes.

All too often it seems that accounting, reporting and other accountability requirements are viewed as controls to be imposed on others by governments, particularly at the federal and state levels, but not on themselves.

This is not to say that governments do not issue financial reports. Most do. But all too often they are based on federal, state or local legal requirements, internal reporting needs and local tradition rather than on generally accepted accounting principles; are unaudited, or are not audited in accordance with generally accepted auditing standards; and are so voluminous and complex as to defy understanding by anyone except a governmental accounting expert intimately familiar with the governmental unit. Further, they frequently exclude the assets, liabilities and operations of related authorities and other governmental or quasi-governmental organizations, some of which appear

Arthur Young & Company
Recommendation #6

Page 2

to have been created solely to avoid legal debt limits, debt issue referendum requirements and/or disclosure of total government operations, assets or liabilities. And all too often the underlying accounting records and internal controls are so deficient as to raise serious question as to the accuracy of the data reported.

Numerous factors and events over the past 40 50 years have contributed to this situation. For example:

Partially because of constitutional questions as to
federal authority over the states--and local govern-
ments are creatures of the states--governments are
exempted from the financial reporting, auditing and
other requirements of the Securities Acts of the
1930's. Thus, and because the Comptroller General
prescribes Federal Government accounting standards,
private sector standards setting bodies have focused
almost exclusively on private sector financial ac-
counting, reporting and auditing standards.

Accounting and reporting standards for state and
local governments have been authoritatively promul-
gated since 1934 by the National Committee on Govern-
mental (Municipal) Accounting, succeeded in 1974 by
the National Council on Governmental Accounting
These standards were recognized by the American
Institute of Certified Public Accountants in 1974, as
generally accepted accounting principles.
tunately,

no regulatory or audit mechanism exists by when these
standards can be enforced.

Many states prescribe municipal accounti
and
financial reports that differ significany from those
required by generally accepted accounting puples.
Therefore, despite the existence of the gen CAI ac-
cepted accounting principles described above, any state
and local governments fail to adhere to ther and most
federal and state auditors focus on legal V6 tance
rather than on conformity of government
ments with generally accepted accounting priemies.

state

For these and other reasons, governmental ac001 ng and reporting practices have evolved slowly, and remain essential unchanged from those common in the 1930's.

The inadequacy of contemporary governmental aceting and reporting practices has increasingly been recognized by st s of the public and private sectors during the past several yo and some positive steps have been undertaken. For example.