We are told that, in this age of globalization, investors can compare companies in the same line of business anywhere in the world – from Harare to Honolulu.
Yet the way company A and company B express their accounts is likely to differ quite significantly from market to market. That can make comparing them a bit like comparing apples and oranges.
There was a time when few would argue that US Gaap was the world benchmark for accounting; few others could match the exacting standards required by the US authorities. But International Accounting Standards (IAS) emerged in the 1970s as a new supranational measure by which companies in the same industry sector could be compared with their peers; and when the International Accounting Standards Committee (IASC) made an agreement with the International Organization of Securities Commissions in the mid-1990s for global acceptance, it seemed everything could be sweetness and light in the very near future.
Well, not quite. While many companies in continental Europe have adopted IAS, resistance remains in both the UK and the US.
States the difference
The US Financial Accounting Standards Board’s (Fasb) recent study into the differences between US Gaap and IAS identifies a number of areas of disagreement. How an item on a statement is recognized – if at all – is one. The way an item is measured is another. Then there’s the question of using alternative ways to account for a similar transaction and the issue of the difference in the presentation of information. While there are many similarities it still adds up to a pretty long list of differences which ‘can be traced to the characteristics of the standard setters themselves,’ says Fasb.
The study goes on to argue that US standards have a relatively domestic focus and are ‘fairly detailed in response to the complexities of the US economic environment.’ By contrast, IAS responds to ‘a variety of national perspectives’ about what financial information is the most relevant and reliable for analysis of a particular topic area.
IAS still has to gain acceptance in the UK, too. The UK’s Accounting Standards Board (ASB) is particularly worried about the issue of off-balance-sheet finance. Its FRS5 standard has put a stop to a lot of different schemes but the IAS alternative – covering financial instruments – ‘does not account for all of this issue,’ says the ASB’s technical director, Allan Cook.
The ASB would also like to see an international standard in line with its own FRS7, which is very strict about what can provided for on the occasion of an acquisition. There are also differences between IAS and the ASB on the treatment of deferred tax and pensions.
Despite these misgivings, international standards are becoming increasingly popular among companies in continental Europe. For the converts, IAS raises standards to new levels of transparency and disclosure. And it seeks to improve on many continental European national standards which tend to understate profits and have traditionally been dominated by tax considerations. In continental Europe, items like depreciation and the valuation of stock or inventories can be determined in such a way as to minimize tax liabilities rather than to give a clear presentation of a company’s performance to investors.
But the long-term goal of getting an overarching international standard isn’t helped by recent evidence that indicates many companies which claim to fully comply with IAS actually fail to follow the rules. An independent survey by the IASC’s former secretary-general, David Cairns, looked at the accounts of 125 IAS companies. It found some of them specifying exceptions from full compliance or using the standards only for certain items. Some of Europe’s largest companies fell into the latter category, including household names like Roche, Nokia and Renault.
Cairns recommends that those which comply only partially with IAS should state clearly and unambiguously that this is the case; explain exactly what they have done and indicate how their financial statements fall short. He also recommends the IASC reconsider its policy toward full compliance, such as by requiring partial compliance to be clearly stated.
The problem is, unlike the national accounting standards bodies around the world, the IASC has no power to enforce its standards. It is an independent organization sponsored by the professional accounting bodies in more than 100 countries.
IASC project manager Paul Pacter says it accepts the survey findings but the organization does not have the resources or authority to force companies into line, although enforcement issues are currently being looked at in an organizational review. Nor can the IASC ‘second-guess’ the big accountancy firms by checking back to see whether or not the books they audit actually comply in all respects.
Flying high
German airline Lufthansa’s head of investor relations, Stephane Gemkow, says his company had a very practical reason for adopting IAS a year ago. ‘As the only publicly-listed airline in Germany our main analysts are located either in London or the US and they are all used to Anglo-Saxon accounting standards – US Gaap or IAS,’ he says. ‘None of them really understood what we were doing before we adopted IAS. They were really giving our shares a discount due to the lack of perceived transparency.’
Gemkow says there were two main aspects of the company’s transition from German Gaap to IAS. One was the accrual of provisions, which changed particularly in the area of pension provisions. The second was the treatment of aircraft leases. ‘Before we had substantial numbers of so-called financial leases off the balance sheet,’ he explains. ‘They are now on our balance sheet. This has also shed some more light on our assets.’
IAS has had a positive effect on analyst perceptions of Lufthansa – if only in terms of the number of calls asking for clarification. Such inquiries reduced sharply last year, but whether or not it has had any real effect on stock valuation is difficult to gauge. When IAS was first used, Lufthansa had very good annual results, so it was difficult to distinguish how much, if any, of the improved stock valuation could be attributed to the accounting change.
Swiss Life has also moved over from national standards to IAS. Head of investor relations, Beat Zimmermann, says his company will be adopting international accounting standards this year and will publish IAS-based accounts for the first time next spring.
‘As a large publicly-listed company it’s essential to have international accounting standards to compare ourselves across Europe,’ says Zimmermann. ‘The previous standards were not as strict as IAS. US Gaap is altogether different again, but our main competitors in Europe – like Zurich, Aegon and Axa – also use IAS so that is why we adopted it.’
All present and correct
One Swiss company singled out in Cairns’ report was the pharmaceutical group, Roche. His survey said Roche ‘does not disclose all the required information about its geographical business segments.’
But investor relations officer Marcel Brand is confident his company does fully comply. You only have to study its accounts, he claims. ‘IAS is the most widely accepted and complete set of accounting standards which focuses on the essentials and is not overly bureaucratic. In our view there is no reason to go for US Gaap. It would not add any value at all,’ he says. ‘For competitive reasons we don’t generally provide a geographic breakdown of individual pharma product sales. We may occasionally do it for key products, but only where it really makes sense to share that information.’
By contrast many UK companies, such as supermarket giant Tesco, remain staunchly opposed to the idea of going international on the accounting front. Investor relations manager Harjeet Drubra says the company sticks to UK standards because analysts can make meaningful comparisons with its UK peers.
‘The UK accounting standards are very rigorous and actually quite proscriptive. We have had no calls to consider using another standard, but if we were to consider such a move it would probably be demand-driven. I have to say the reconciliation between the two would be relatively straightforward – both for US Gaap and IAS standards – if we ever considered using them. Even contentious issues like goodwill have now been brought very much into line.’
ASB technical director Allan Cook says there are clear reasons why UK companies should stick to UK Gaap – quite apart from the fact that they are obliged to do so under the current domestic legislation. ‘The notion of compliance with international standards has been a little bit loose in some respects,’ he explains. ‘It’s pretty important that they should be tightened up on this, but in the course of doing so the kinds of tolerances that may have worked in the past may not work any longer. We have put a lot of effort into IASC and we take their standards and their debates extremely seriously. But we do not believe that the presence of an international standards setter removes the need for national standard-setting bodies.’
Transatlantic stories
And yet not all UK companies by any means want to stick solely to the national standard. For some, the composition of their shareholder base makes reconciling to the US standard pretty well essential. Marketing services group WPP, for example, which is listed on Nasdaq, has 40 per cent of its shareholders in the US. That makes US Gaap an important measure of the group’s performance.
Group finance director Paul Richardson says there are a number of differences in the two standards which he has to address in order to serve the needs of different investor audiences. For example, UK companies were traditionally allowed to charge goodwill on acquisitions to their reserves. This has now changed and a new standard requires it to be regarded either as a tangible asset on the balance sheet or to be amortized over the life of the acquisition – usually no more than 20 years.
‘By contrast the US standard permits either pooling of transactions in which no goodwill is created or it is regarded as a non-pooled share-for-share transaction. The vast majority of US acquisitions have amortization of goodwill over 40 years,’ Richardson explains. ‘Compensation is another difference. This is very technical in the sense that the American treatment of share options differs. On this issue the US and UK standards are actually in direct conflict with each other in certain respects.’
Richardson notes that these differences are overcome to a certain degree by companies being valued according to the Earnings Before Interest Tax Depreciation and Amortization (Ebitda) approach. This takes accounts before allowing for varying depreciation rates and before taking account of amortization.
By taking a line in the profit and loss account which is above amortization the impact of these variables can be excluded by analysts. So – at least for ‘sophisticated investors’ – Ebitda enables reasonably good like-for-like comparisons between different accounting standards. However, it does remain a difficulty when trying to strip out exceptional items.
Like many UK companies, WPP will not be adopting IAS as well as the other two standards. To do so would slow down the production of accounts. In any case, Richardson believes the US and UK standards are way ahead of the rest.
Common problem
Peter Knapton, managing director (securities) at L&G Investment Management, tends to agree. But he regards the problem of different accounting standards as relatively intractable. At the moment agreement cannot be reached over a common set of principles which, he says, is a state of affairs that undoubtedly needs sorting out.
‘Capital is increasingly international and companies need to appeal to international investors,’ he comments. ‘So it seems to me that international investors have a reasonably clear expectation that accounting should have common principles.’
He also agrees that Ebitda is a useful common measure, because it removes taxation from the equation. ‘The work that companies should be doing in making their accounts transparent to all investors across the world is effectively being done by the analysts in stockbroking firms,’ Knapton adds. ‘But if the companies were to provide the information themselves and it were to be audited, it would be open to all investors and not a relatively select group as at present.’
Robert Talbot, head of worldwide equities at Royal & Sun Alliance Investments, favors IAS. ‘Taking our parent company as an example, insurance company accounts are pretty much gobbledygook under US Gaap, so it doesn’t work to look at them in that way. We are pretty comfortable with UK accounting standards but on a broader note, as our investment policy becomes increasingly global, we have an interest in seeing some uniformity of accounting standards. The great debate at the moment is whether everything goes down the US Gaap route, or whether IAS should be the one people adopt. We would favor IAS. While the standard does have some way to go yet, it is probably going to be a preferable route in the future. There are a couple of areas where IAS is closer to what we are looking at than the US standard – namely in depreciation and accounting for pensions.’
So the question remains. Will different types of fruit ever be truly comparable? And if international standards were genuinely accepted across the globe, would this clarify matters or simply create some sort of fruit cocktail, which might be easy to digest but at the end of the day would remain of little nutritional value.
Perhaps it’s a case of too many cooks.
