Qualityworld

• Knowledge portal
• FAQs
• Information
• Qualityworld
  • Current issue
  • Editorial comment
  • Free Qualityworld
  • Past articles
  • Advertisers
  • Subscribe to Qualityworld
  • Advertise in Qualityworld
• Journal of Quality
• Jobs
• Press
• Links

The other transition deadline

As Europe gets set to adopt new international financial reporting standards in January 2005, Helen Yates finds out how they will change corporate reporting forever and checks whether public companies are suitably prepared

The increasing lack of public confidence in the financial markets since accounting scandals like Enron, Worldcom, and more recently Parmalat and Adecco, has resulted in a renewed call for greater transparency among listed companies. As a result, those geeky men sitting with their ledger books in some tucked away back office have been given a makeover.

In September 2003 the Financial Services Authority (FSA) issued a statement to all UK listed companies (those trading on stock exchanges) urging them to prepare for the adoption of new accounting standards due to begin on 1 January 2005. And it is not just the UK. Up to 8,000 companies across the EU will have to comply with the new international financial reporting standards (IFRS) - formerly known as international accounting standards (IAS) - on that date. Most experts agree that the new standards will lead to a revolution in the way companies report their financial information.

Patchwork accounting

The UK government has estimated that the move to IFRS will cost UK business between £576m and £1.4bn in one-off costs. But it is not just the costs that have many companies worried. The technical aspects of the proposals promise to be highly complex and sometimes controversial, and will involve a lot more than just altering financial statements. So why do it?

Marc Gardiner, managing director of IASeminars, a training organisation which specialises in preparing companies for the transition to IFRS, explains some of the history behind accounting standards: 'Accounting grew up in every single country independently of the country next door, just like the British tax laws. The French didn't stop and ask the Germans about their accounting, everyone just went off and did what was right for their economy. The result was a complete patchwork of national accounting systems.'

These international differences were not much of a problem until the 1980s when the growth of the global capital markets became a force. Cross border trading and investment activities continue to grow at an exponential rate, but this resulted in confusion for cross-border investors when they wanted to buy shares in foreign companies. 'How does an American shareholder know he can trust British profits? How can he make his calculation about profit and equity etc?' asks Gardiner. 'He or she will have to rely on the numbers coming from a completely unfamiliar jurisdiction.' This increasing desire to better understand and compare corporate information from all over the world gained renewed zest following Enron and other high profile accounting scandals.

Transparent global economy

It is hoped that adoption of IFRS will lead to more transparency as well as comparability of company results. This will provide investors and stakeholders with more relevant and reliable information, and thus help to boost investor confidence in the international capital markets. The new standards will, among other things, require banks and insurance companies to measure more of their exposures using fair value techniques and make various contentious, but long-established, accounting practices a thing of the past.

Gardiner however, believes the impetus behind the EU's decision to adopt the new common international standards was more an attempt to improve the European market, than just this virtuous motivation of world transparency: 'The EU was required to tackle the accounting problem, not because it believed in some rosy global idea that "we should all harmonise because it's the right thing to do". It was actually trying to improve the European single capital market and you can't do that when you've got 25 countries with 25 different measurements of profit.'

The deadline looms

Whatever the true motivations, 1 January 2005 creeps ever closer, and in order to provide comparable prior-year data for when the deadline does hit, companies should already be implementing IFRS, even though not all the standards have been agreed on yet. In its statement, the FSA acknowledges this may make things difficult but threatens de-listing for those companies which do not comply: 'Failure by issuers to submit preliminary or interim results within the required timescale is likely to result in the suspension of the issuer's securities.'

While the EU and FSA have confirmed the plans and issued a deadline, it is not up to these bodies or other regulators to implement IFRS, it is the responsibility of the individual company. Every quoted company in the EU will have a legal obligation to prepare a set of 2005 accounts which gives a true and fair view based on the IFRS. 'It is the companies' responsibility to prepare accounts which are correct and it is the auditor's responsibility to give an opinion on those accounts,' explains Gardiner. 'For a listed company to have a public disagreement with its auditor over the quality of the numbers would be almost as suicidal for its share price as having it de-listed.' For public companies therefore, it is in their best interests that they implement IFRS correctly.

Being prepared for IFRS promises to be a complicated task - not just a simple pushbutton exercise. Mark Vaessen, head of IAS advisory services at KPMG, recently warned that: 'IAS will change the complexion and quality of financial information in ways not seen before, and so it is vital that companies understand the extent of the impacts and ensure stakeholders understand it too.' A changeover to IAS raises important issues for regulators, governments, companies and other parties, but it is companies especially that will suffer if they are unprepared.

Dragging their feet

Chief financial officers of public companies should have IFRS at the top of their boardroom agendas. Yet despite this urgency, a study by PricewaterhouseCooper and Economist Intelligence Unit, conducted last year, found that just 22 per cent of businesses surveyed thought IFRS adoption was a key business priority. Almost half of those required to adopt the new standards in 2005 had yet to start implementation. 'There are a number of surveys that point out that the companies themselves and their auditors, are not ready,' explains Gardiner. 'They're going to have to hurry up.' He thinks one of the reasons companies are unprepared is that many of them have underestimated the complexity, timing, and the difficulties of completely changing the basis of their company's accounting. Another reason is that many of the standards are still being revised and have yet to be finalised.

While 2005 may still seem like a long way off, an added problem is the need to provide comparison data for 2004. This essentially means that in order to accurately gauge a companies performance over time, the data collected with the new standards in 2005 will need to be compared to data collected in the same way for 2004. This means companies will need to provide two sets of reporting data for 2004 - one using the old national accounting standards, and one using the new IFRS. This is even more onerous for private companies wanting to launch an initial public offering in 2005, who will have to provide three years of comparable IFRS accounts.

'Whenever you issue numbers to the public it is a legal requirement that you have to give them comparatives, or prior year figures, so they can say "well sales are better than last year, but profit is worse than last year etc,"' clarifies Gardiner. 'At the same time that they publish 2005 IFRS figures they are going to have to publish 2004 IFRS figures. So for 2004 there are going to be two different figures floating around - the last set of UK accounting figures and the first set of IAS accounting figures, which will come out later.'

Many companies are concerned that the dual accounts for 2004 might reflect different information. 'The last set of accounts under the former accounting principles might suggest "2004 was a great year" but next year's accounts - which will show 2004 IAS comparatives - might show that the 2004 profit was a loss,' explains Gardiner. While this would be down to the technical differences in financial reporting practices, Gardiner theorises that it might have an effect on the uninformed investor: 'I wonder if when you start pumping out numbers - which look vastly different from the last set of numbers - what affect that will have on shareholder confidence. This is a jittery time in the marketplace, not least when it comes to accounting issues.'

Investors, shareholders and analysts will have to be properly informed about the changes and how they will impact upon financial statements, or the result could be investor confusion and stock price volatility. To avoid markets reacting negatively, educating stakeholders to understand the differences that IAS will make is crucial.

The Committee of European Securities Regulators (CESR) proposes a two-fold approach. They recommend that companies fully explain the key differences to their stakeholders, and that at 2004 year end, give quantified information on the impact of the new standards on their 2004 financial statements, rather than waiting until the end of 2005 to release the comparison data.

Not everyone agrees with this approach. There is disagreement between two major UK accounting institutes as to how much information should be given out to stakeholders. The Institute of Chartered Accountants of Scotland believes companies should wait until the standards are finalised before giving out information, while the Institute of Chartered Accountants in England and Wales believes a smooth transition is more likely if investors and analysts get clear explanations of companies' preparations well in advance of the deadline.

The scary standards

With potential stock market volatility to worry about, many companies are particularly scared about two of the IAS standards - namely IAS 39 and IAS 32 - which cover the reporting and measurement of financial instruments. These are often seen as overcomplicated, and will affect areas such as long-term liabilities, forward exchange contracts, derivatives, interest rate swaps, hedge accounting, classification of preference shares, presentation of convertible loans, and investments. For those unfamiliar with the financial jargon, this essentially means that many companies will have to disclose certain financial instruments for the first time, which they do not want to disclose because the disclosure can have a significant impact (both negative and positive) on how company profits look.

'Derivatives, or financial instruments, or hedging is when you enter into a complicated contract where you may have to pay a great deal of money if events go the wrong way - it is a kind of insurance contract,' explains Gardiner. 'IAS 32 and 39 are very contentious and political (there is a lot of political resistance in Europe, particularly by the French) because they force you to acknowledge all of these things on your balance sheet at current market value. In the UK we've been disclosing them for a while in the notes, so it's not going to have such an impact on the UK market, but it may have a huge affect on other European markets.'

While many companies may be worried about this new transparency, there are likely to be some very nervous European companies that are preparing themselves for the weaknesses IAS is about to expose. These companies may see their share price fall where problems have been hidden or have gone unnoticed by the markets. It will be especially difficult for companies in the emerging market economies to deal with all the new regulation, believes Gardiner: 'It is a hell of a thing to ask a recently emerged, former communist country, to suddenly become IAS compliant'. But there is not a lot of choice in the matter.

It is not impossible that a last minute amendment to IAS 32 and 39 could be rushed through, and a lot of lobbying is currently taking place to do just that. Whether those for whom derivatives' accounting is a contentious area will succeed is currently irrelevant because there is no time to delay, to sit back and wait to see what happens. The reality is that IFRS is coming and that listed companies need to be prepared, not in 12 months, but now. They should not postpone addressing IAS and all its implications, or informing their stakeholders of the potential impact. Nor should they underestimate the time and effort that is required to convert from national standards.

IASeminars

IASeminars has been training financial executives in international accounting for ten years. For more information go to www.iaseminars.com.