From Times Online, UKSeptember 05, 2004
International benefits
Moving towards a global accounting standard should cut costs and boost economic activity, reports Damian Wild
With barely four months to go until Europe's largest companies begin issuing accounts prepared using international financial reporting standards, the first signs that the financial world is putting the final touches to probably its most fundamental change in a generation are emerging. In August Lloyds TSB admitted it could be forced to delay the release of its full-year results due to the proposed introduction of a new accounting standard on life assurance.
It may have been talking about a (for now) UK standard, but it showed just how important previously arcane accounting rules are becoming for companies, auditors and the investor community at large.
When it comes to IFRS, there is more than mere accountancy at stake. International Accounting Standards Board chairman Sir David Tweedie believes IFRS will transform Europe's capital markets. For companies, it should expand the pool of potential investors, bringing down cost of capital and reducing the expenditure needed to consolidate subsidiaries' accounts. Investors will be better able to understand the financial statements of companies outside their home jurisdiction. The economic result, meanwhile, should be a more efficient allocation of capital, leading to increased economic growth in Europe.
Bob Herz, chairman of the US accountancy body Financial Accounting Standards Board (FASB), puts it more simply. "It's about lowering the cost of capital, lowering the cost of preparation and lowering the cost of using information," he says. For Herz to be taking such a keen interest in the European IFRS 2005 project speaks volumes. He knows that if it works for Europe it will be a much easier sell back home. Countries as far apart as Australia and Estonia, China and South Africa are already making use of the global reporting rules. Demonstrate it works in Europe and IFRS would become the de facto reporting system for companies across the world. However there are still considerable hurdles to be overcome before we get there.
An Accountancy Age survey carried out earlier this year of 3,000 accountants revealed that more than half had had no training to get ready for 2005. In August another poll by software house Geac highlighted the extent to which companies will be relying on the auditors to ensure they comply. More than two-fifths of respondents said they would be placing the onus on their auditors. It's true to say that the larger listed companies in Europe, such as GlaxoSmithKline (see box, right) are better prepared than the smaller ones.
However size is not everything. The continent's biggest banks are still arguing over IAS 39, and the future of the derivatives standard is by no means settled. The matter now rests in the hands of Brussels eurocrats and politicians. Meanwhile many smaller companies, including accountants and business adviser Numerica (see box, opposite), are well advanced in their preparations.
More telling is the fact that particular industries — and countries, for that matter — have their collective heads in the sand. According to research by investment bank Morgan Stanley into more than 150 annual reports, it is companies in the energy, utilities and transportation sectors that are lagging. By geography it's German, Spanish, Portuguese, Benelux and UK companies that are most guilty of dragging their heels."We are puzzled by the lack of adequate disclosures by UK companies, perhaps due to a perception that the impact will not be significant for them," the bank said in June. It warned investors to prepare for "transition accidents" next year.
Perhaps the best example of a transition accident and, indeed, of the impact an accounting standard can have on the country at large — is FRS17. The controversial — and soon-to-be introduced — UK pension accounting rule takes a snapshot of a company's pension scheme on a particular day, rather than looking at a longer-term view of the scheme. It has already resulted in the appearance of huge deficits for those adopting the standard early (in that they use current values at a time the stock market was depressed instead of higher historic values) and highlighted more than ever how a change in accounting practice can really affect the man in the street. The standard bites next year, and for companies adopting international standards, IAS 19, its equivalent, will have a similar effect.
Ian Dilks, partner responsible for PricewaterhouseCoopers' IFRS conversion services in the UK, warns that companies will need to explain themselves to the markets to avoid nasty shocks. "The challenge for companies is to avoid 'surprise' changes when reporting under IFRS for the first time, to reduce the potential risk of adverse market reactions," Dilks says."Market communication does not begin with the publication of 2005 annual financial statements — companies should have already opened the dialogue with the investment community to help it understand the likely impact of IFRS."
For example, many of the UK's top companies will see a reduction in profits under share-based payment accounting standard IFRS2. The charge is predicted to wipe an average 5.42% a year, or £68m, from the profits of the top 25 FTSE-100 companies by 2007. Drinks producer Diageo would be the worst-hit if the standard was applied now, taking a 43% charge on its latest year profits of £76m, while BSkyB and Standard Chartered would also suffer. Andrew Ratcliffe, chairman of the Institute of Chartered Accountants' audit and assurance faculty, warns of other likely problems. "There will be a big change in the format of the accounts; different accounting policies need to be formulated, and there are more extensive disclosure requirements," he says.
"To achieve all this entails a significant project for companies that will affect their entire reporting process and may result in changes in their accounting systems. Being ready only at five minutes to midnight will not be good enough."To avoid this, Ian Wright, a senior partner of PwC's global corporate reporting group, says companies should concentrate on the "emotional" issues that really impact on the business. The revenue recognition standard will affect everyone, for example, whereas other rules will only affect particular business combinations or financial instruments."Companies have to work out which ones have the potential to undermine their credibility," he says. "What's critical is different for different businesses."
But the IFRS project does not begin and end in 2005. "My taste date is mid-2006," says Wright, pointing to when most affected companies will have issued IFRS-compliant accounts. After that comes international standards for smaller companies, a project already underway at the International Accounting Standards Board (IASB), which has also begun the long process of updating many of the existing international standards. The reputation of international standards has also improved dramatically.
The Johannesburg stock exchange has been requiring South African firms to use the rules since the late 1990s. "South Africa was criticised for adopting them, now people are saying, 'well done'," says Irene Christopher, head of policy development for the Association of Chartered Certified Accountants, South Africa branch. "There's been a big shift in the mindset."Tweedie believes that's because IFRS amounts to "tell it as it is" accounting, placing more reliance on fair values. "It is the IASB's belief that these values provide the most transparent picture of a company's financial health," he says. And telling it like it is also what companies have to do if they are to survive the IFRS transition unscathed.
Damian Wild is editor of Accountancy Age
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