audit standards. Importantly, too, acceleration of these major efforts over the past half dozen years reflects the influence of prodding by academicians, and investigations by congress such as the one which brings us together today. I believe the profession is evidencing a strong commitment to improve credibility and to develop more promptly responsive positions on accounting and auditing matters. It is my considered opinion that standard setting which governs disclosures and the preparation of financial data for the investing public, and which governs the conduct and responsibilities associated with independent examination of financial statements rests now where it should rest-in the private sector. I share the belief that the objectives we all seek can be achieved without new legislation.

Mr. WAGNER. Thank you, very much.

Senator METCALF. Thank you, very much.

I will ask a question, and then I will turn it over to you.

Senator PERCY. Fine.

Senator METCALF. I only have one major question. You said you believe that an audit engagement and a management advisory service engagement are incompatible if they are performed for the same client.

I think some of our witnesses have suggested that perhaps we go a little further and say that accountants should not be permitted to perform these management advisory services or personnel recruiting, whether it is for the same client or for some other client.

What would you say to that?

Mr. WAGNER. I do believe that there is great expertise developed within the accounting firms today related to management advisory services by virtue of the very fact that they are living with the kinds of problems which deal with these things on a daily basis.

I would hate to see this talent go down the drain. I also think it is possible for an MAS service and an audit function to be performed for the same client-without a conflict in fact. However, there is the appearance of a conflict, which is the reason why I have taken the position.

Senator METCALF. But if the audit is performed by a different firm than the management service, even though it is an accounting firm, you see no reason why not?

Mr. WAGNER. I see no reason why not.

Senator METCALF. Senator Percy.

Senator PERCY. We recognize the hour is late. I will just ask one or two questions. We certainly appreciate your being here and having been so closely affiliated with the management of your company through the years.

Don Perkins, I am not at all surprised, was not fully aware of the degree that you had gone in this area and how far ahead Jewel has been. The testimony has been very, very helpful, and I think will be an inspiration to a lot of questions.

You have given an excellent example of how an audit committee effectively functions to maintain the independence of the independent auditor on the corporation's internal control procedures. Does the audit committee sit down and go over with the independent auditors the scope each year?

Mr. WAGNER. Very carefully.

Senator PERCY. Very carefully, so the scope is a joint agreement be

Mr. WAGNER. They are given the specs, detailed scope, a week or two in advance of the meeting so they have an ample opportunity to very carefully examine it before sitting down with them at a meeting to review it.

Senator PERCY. We have had some examples, some suggestions as to how the ideas expressed during these hearings can be implemented. Cooper & Lybrand and Arthur Andersen suggest that as a condition precedent to accepting an audit engagement, a client must first have an independent audit committee.

What would be your reaction to that?

Mr. WAGNER. Obviously, as a representative of a company that has had a very active audit committee for many years, I would support such a requirement.

The New York Stock Exchange has, as you know, mandated that by June 30, 1978, to remain listed, companies must have an audit com mittee. This is another focus on the need for audit committees.

Senator PERCY. Do you think the New York Stock Exchange pro posal goes far enough in defining what is and what is not an indeper ent audit committee?

Mr. WAGNER. I think it could possibly have gone further.

Senator PERCY. Jewel goes further?

Mr. WAGNER. Yes. We do not have former officers who remain directors serve as committee members.

Senator PERCY [continuing]. Members of law firms that you retain banks, and so forth. I agree with you.

My other questions have already been asked. We duplicate each other. I want to express deep appreciation to you for being with us. Mr. Wagner. I also apologize for the delay.

Senator METCALF. Can you get down to make your speech?

Senator PERCY. I am going to try. I was supposed to give it at 1:15. I am not sure I am going to make that. I think we have had our witnesses wait so long, I just don't want to walk out on them.

TESTIMONY OF JOHN T. HACKETT, EXECUTIVE VICE PRESIDENT, DIRECTOR, CUMMINS ENGINE CO.

Senator PERCY. Mr. Hackett, I know the Chair agrees, you can submit your speech for the record and submit to questions or summarize it if you would like.

Mr. HACKETT. Whatever would be the pleasure of the Chair.

Senator PERCY. I can then go honor my commitment to the Kennedy Center? We have a bunch of corporate executives. I am vice chairman of the board. I am trying to raise money. I hate not to give my speech down there.

If that would be all right with you, I have gone over your testimony very carefully, I couldn't concur more with you on the simplifying financial statements. From the day I issued my first annual report at Bell & Howell in 1949, I addressed it to every employee in the company as well as every dealer. We sent one to every single retail dealer. every employee, every stockholder. It was really understandable, even to me, a nonaccountant.

I want to reiterate statements that I have made from time to time, that this subcommittee is very fortunate in having Senator Percy here. His knowledge of business activities and businesses practices has been invaluable to our inquiry at this time, and he has participated in these hearings and has helped our staff and his staff. I think that if we achieve the objectives that we seek, it will be due in large part to his contribution. We are so fortunate in the Congress to have a man who is so informed in this area.

Senator PERCY. Thank you, very much indeed. I appreciate your comments and I will use them against you. [Laughter.]

Senator METCALF. You are not ever going to hear them again. [Laughter.]

Senator PERCY. I want to reciprocate again. We have had really wonderful staff work and we are indebted to every member of our staff that has worked with us so favorably on this.

Senator METCALF. We are delighted to have as our last witness, with the dwindling audience and dwindling members of the committee, but nevertheless a very important witness, Mr. Hackett.

Mr. Hackett, go ahead.

Mr. HACKETT. Thank you, Mr. Chairman.

Mr. Chairman, I was invited to present my thoughts regarding the subcommittee staff study entitled "The Accounting Establishment." It is not my intention to address the technical accounting issues involved in the study recommendations. I believe that I can contribute best to the work of this subcommittee by addressing the issue of corporate accountability from the standpoint of a financial executive of a corporation.

I think in order to avoid any misunderstanding I would like to preface my remarks by stating that the observations and the suggestions that I have today are my own, have not been endorsed, nor have they been approved by any organization with which I am affiliated.

As a financial executive of an manufacturing corporation during the last 12 years, I have witnessed substantial changes in the complexity and problems of accounting and financial reporting.

In my opinion, the two major causes of misunderstanding and confusion surrounding corporate financial reports are inflation and the rapid growth in international trade and operations.

Both of these developments have created a need to reconsider many of the basic principles of accounting and financial reporting and in the process of adopting new rules and new techniques, I believe we have often created even greater complexity and confusion.

For example, I believe that the financial section of the annual reports of U.S. corporations are nearly incomprehensible to shareholders and the general public. With each successive year, the explanatory notes accompanying the consolidated financial statements become longer and they become more difficult to comprehend. Issues dealing with translation of foreign currencies, last-in-first-out inventory accounting, income taxes, intangible assets, foreign exchange gains and losses, retirement plans, leases, contingent liabilities, foreign operations, and replacement cost accounting are treated in greater detail each year in an effort to provide more information. Many of these issues have be

ports and 10K's has done little to increase shareholder knowledge and understanding.

It is not my impression that the increased complexity of accounting and financial statements are a result of laxity of impropriety on the part of auditors or accounting rulemaking bodies.

It does reflect the immense difficulty of attempting to maintain a body of accounting rules and reporting practices that provide relevant, accurate, and timely information to the public in an environment in which fundamental changes occur in the value of assets, liabilities, and income as a result of inflation, flexible rates of exchange, and attempts to recognize the financial impact of future events.

On the other hand, I know that there have been instances in which auditors and corporate management knowingly distorted or failed to report information in order to avoid criticism or protect management interests.

We should not view these abuses of responsibility as a new phenomenon however. We are more aware of such practices today than in the past because of improvements in auditing practice, management awareness and public criticism.

I acknowledge that public criticism, such as provided by this subcommittee, has played an important part in bringing about improvements in auditing and management practices.

However, the ultimate value of public criticism and resulting public policy will be measured by the improvements we achieve in the relevance, clarity and timeliness of financial reporting.

Public policy that only results in increased complexity will not help attain these objectives nor will public criticism that diverts attention away from issues of substance by focusing on issues which bear little importance in auditing or accounting practice.

I believe we have made progress toward improving the quality of financial reports in the past 12 years. However, I also believe we must progress at a faster pace because of the dynamics of the environment in which we operate.

At the same time, we must explain increasingly complex issues in a manner that permits the shareholder and general public to better understand.

This requires a combined effort by auditors, corporate management and regulatory bodies. It cannot be achieved by only placing restrictions on public accountants.

There are several recommendations embodied in the staff study which I support. For example, I believe that all independent auditors should be treated equally in disciplinary enforcement proceedings if, in fact, that is not the current practice of the SEC.

I also endorse the proposal that the large accounting firms be required to report basic operational and financial data annually.

If there is evidence that insufficient competition among accounting firms jeopardizes the quality of corporate reporting, I would agree with the recommendation that Congress consider policies to increase competition. However, to date, a substantial case for such action is lacking.

I find unnecessary the recommendation that accounting firms not be

auditing. I make no brief for the nonauditing services of public accounting firms, nor have I been a user of such services.

However, I am unconvinced that the existence of these activities either adds to or detracts from their auditing capabilities.

My only strong disagreement with the staff recommendations is the proposal that the Federal Government establish financial accounting standards for publicly owned corporations.

I believe that the public interest should be well represented within any accounting rulemaking agency or group. I agree that broader representation on the Financial Accounting Foundation and the Financial Accounting Standards Board is needed.

It would be desirable to include representatives from the public sector as well as a broader cross section of the private sector. The rapidly changing business environment requires that we provide wider participation in the determination of accounting and reporting standards and increased flexibility and response.

The proposal that the Federal Government assume that role runs contrary to the concept of broader participation and flexibility. It appears to me that the public interest would be better served by broadening the participation of the Financial Accounting Foundation and Financial Accounting Standards Board to assure that there is adequate representation and at the same time, utilize and improve upon an established organization.

It is my understanding that many of these changes have already been recommended by the Financial Accounting Foundation Board of Trustees.

Improvements in corporate accountability and financial reporting are also influenced by corporate management. Improving the quality and frequency of information to shareholders provides many opportunities.

Specific emphasis on the use of language in financial reports that can be understood by shareholders and the general public should be adopted by corporate management. At the same time, management should insist that auditors strive for greater clarity in their reports and Corporate management can also be more effective in financial reporting by utilizing the audit committee of the board of directors. I believe it is widely accepted that audit committee members be selected from members of the board of directors that are not officers of the corporation.

Regularly scheduled meetings of the audit committee with management and auditors can play an important part in assuring that the quality of accounting and financial reporting is manitained and improved.

Among corporations there is increasing use of the audit committee. to assure that the quality and accuracy of financial information and reporting is maintained. A limited number of corporations have adopted the practice of scheduling meetings of the audit committee with auditors and management prior to release of quarterly and annual financial statements.

Such meetings serve to assure that the quality and uniformity of financial statements is maintained. It also provides the outside members of the board of directors increased opportunity to understand and