By 2005 all 7,000 companies listed on EU stock exchanges should have changed their financial reporting practices, bringing them into line with international accounting standards (IAS), and ironing out confusing differences between national standard-setters for the benefit of international investors.
The move is being driven by European Commission proposals announced in February for unified accounting standards. EC internal market commissioner Frits Bolkestein hailed the move as ‘the beginning of a new era of transparency and the end of the Tower of Babel in financial reporting in Europe.’
He went on to explain the EC’s logic behind the proposal: ‘The use of one global accounting language will greatly benefit European companies. It will help them to compete on equal terms for global capital. Investors and other stakeholders will, at last, be in a position to compare company performance against a common standard.’
Only 275 of Europe’s listed companies now use IAS when preparing their accounts. The rest face having to quickly change to the new standard or risk being ignored by analysts and investment professionals who may be unwilling to devote time to companies whose accounts are not reconciled to IAS.
Despite the slow take-up, Europe’s finance directors broadly welcome the switch to IAS. A research exercise carried out by PricewaterhouseCoopers in November 2000 found that 80 percent of CFOs from 16 countries support the move. ‘If this proposal becomes EU law, it will introduce the biggest changes to financial reporting in Europe in 30 years,’ the report concludes.
‘Europe’s CFOs know that IAS is a strategic business issue, not just a debate about different accounting frameworks,’ said Mary Keegan, then PwC’s head of global corporate reporting. ‘Whether companies are working toward issuing IAS accounts in 2005 or sooner, they recognize the advantages of starting the process and educating the market now. CFOs are keen to ensure that analysts and investors react positively to a different presentation.’
Ahead of the game
Some major European firms are already well ahead of the game. Finnish telecoms giant Nokia regards this as a positive development. ‘We have been using IAS since 1987,’ says a spokesperson. ‘In addition, we have given a short US Gaap statement since 1994.’ It’s a similar story over at Unilever, the Anglo-Dutch group. ‘We believe that having one set of global accounting standards suitable for all financial reporting purposes would reduce unnecessary complexity and enhance the transparency of financial reporting,’ comments spokesman Trevor Gorin. ‘The proposal by the EU to mandate the use of IAS by 2005 is therefore welcome. Indeed, Unilever would encourage the authorities in the UK to allow companies to adopt IAS earlier where a company’s directors believe this to be appropriate,’ he adds.
Fiat, Italy’s dominant blue chip, has been compliant for some time, according to IR chief Giovanni Maggiora. ‘The standards which underlie our accounting principles are very much compatible with IAS. To all intents and purposes we consider our accounts already IAS compliant – from an Italian point of view,’ continues Maggiora, ‘The level of detailed disclosure currently required under Italian law is greater than IAS, so IAS is probably already the de facto standard for major Italian companies.’
BP is another leading company that has thrown its weight behind the EC’s shift to IAS. ‘BP supports the move to IAS as a component of global harmonization of accounting standards, and recognizes the importance of consistent application of any new standards,’ comments a company spokesman.
Differences remain
Nevertheless, there remain considerable differences between IAS and national accounting standards across Europe. According to Peter Holgate, senior technical partner at PwC, some continental European accounting standards are more tax-orientated and less conditioned toward the international capital markets than the Anglo-American standards on which IAS is based.
In the UK, the Institute of Chartered Accountants in England & Wales has produced a guide on the subject entitled The Convergence Handbook, which runs to over 100 pages. It contains a lengthy laundry list of changes that company accountants will need to get prepared for.
‘UK companies would no longer be able to present the current form of cash flow statement, adopt indefinite useful lives for goodwill and intangible assets, use a timing differences approach to deferred tax or classify long-leasehold properties as investment properties…’ the Handbook says. Multiply the UK/IAS convergence difficulties by 15 to reflect the differences of all EU member states and the scale of the task facing the EC in implementing the standards across the continent falls into sharp focus. The Federation des Experts Comptables Europeans (FEE), a pan-European accounting body, says that the move to the single currency only serves to mask the lack of accounting compatibility among member states. ‘The fact that a large number of eurozone companies report in euros creates a false sense of transparency that may lead to the impression that companies use one accounting language in addition to a common currency. But that is far from being the case,’ the group claims.
The FEE adds that because the EU proposal to adopt IAS by 2005 has not yet become law, there remains the question of whether another standard may yet be adopted. The only other obvious candidate is US Gaap, primarily because of the desire of many EU firms to access the US capital pool.
However, the European Commission ‘hopes and expects’ that the US Securities and Exchange Commission (SEC) will recognize IAS, allowing IAS-compliant EU companies to list in the US without reconciling their financial reports to US Gaap, as it requires at present.
While IAS will affect all listed companies, non-listed firms may be obliged to report according to the new standards in due course, particularly if they plan to raise capital in the international markets. However, as Peter Chidgey, an audit partner at accountants BDO Stoy Hayward, explains, smaller unlisted businesses may bear less compliance burden due to changes to company law that are currently proposed across Europe.
Out of time?
Companies can be forgiven for imagining that this upheaval will only succeed in throwing their balance sheets into turmoil. And until IAS is developed into a set of unanimously agreed practices, uncertainty over the precise form of IAS will remain.
The International Accounting Standards Board is hard at work developing the standards but there are fears there will not be enough time for them to be fully prepared in time for 2005. Indeed, there are fears that undue haste could result in poor quality accounting standards being promulgated.
The message for European companies has to be watch this space. There seems little doubt that IAS is going to provide something of an accounting fest for the profession, which will have plenty of work to do digesting the new rules and applying them to company financial statements. Investor relations department staff, meanwhile, should be concerned that their companies are up-to-speed on IAS: as usual, it is they who will take the flak from investors if companies are seen to be dragging their feet.
IASB objectives
-To develop, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements and other financial reporting to help participants in the world’s capital markets and other users make economic decisions;
-To promote the use and rigorous application of those standards; and
-To bring about convergence of national accounting standards and IAS to high quality solutions.
Source: The constitution of the International Accounting Standards Board
Fair value & financial instruments
One of the more controversial aspects of adopting IAS surrounds the use of fair value accounting and in particular applying it to financial instruments.
The Fédération des Experts Comptables Européens (FEE), the Europe-wide accounting profession body, has pointed out that fair value accounting is at loggerheads with many national accounting practices where historic cost is the norm. This particularly applies to the treatment of financial instruments.
IAS 39, which covers fair value accounting for financial instruments, has come in for a lot of criticism from the FEE, which has called for it to be revised. However given the time span of some instruments used to hedge financial exposures, there may not be time to redraw the standard and incorporate it into companies’ reports ahead of the EC’s 2005 deadline.
Web references
www.euro.fee.be – The European Federation of Accountants www.europa.eu.int.comm/internal_market – The European Commission www.iasc.org.uk – The International Accounting Standards Committee www.icaew.co.uk – Institute of Chartered Accountants in England & Wales
Realized gains
Under current UK accounting practice the profit and loss account is widely used to gauge company performance. However, it only reflects realized gains – when gains or losses have actually been crystallized. This ignores amounts that have not actually been realized and so misreports financial performance.
Proposals in financial reporting exposure draft 22 (Fredd22), currently being considered by the UK Accounting Standards Board, seek to address this fault. The result may be a new hybrid P&L, which deals with realized and unrealized gains more holistically, providing a fairer view of a company’s financial management.
Whether Fredd22 is adopted in the UK may depend on whether its proposals are incorporated into IAS. If it is included, then it would mean that a large number of European companies would have to move to the new British model. If it isn’t, then UK companies moving to Fredd22 may find themselves taking a backward step when adopting IAS in 2005.
The case of Fredd22 is doubly significant because as well as addressing the issue of realized gains, it also illustrates how the adoption of IAS could potentially clash with national accounting standards, possibly to the detriment of both.
Accounting authority
Q&A with Sir David Tweedie, chairman of the standard-setting International Accounting Standards Board
Q Is IAS certain to be the standard adopted by the European Commission?
AThere is uncertainty. Everybody here at the IASB would say it is a gamble but it is one that industrialists, central banks and the big firms around the world have put forward and put $17 mn (£12 mn) into supporting. The big accounting firms have put in $1 mn each. The central banks have contributed – the Bank of England, the Fed – and they are all expecting, hoping it will work.
Q Is there enough time to meet the 2005 deadline?
A We have to officially put our agenda to our advisory committee, composed of 49 people from 29 countries, and we can’t say until then. But we are going to take all the standards and rush through all the mistakes and ambiguities and change them. That is underway right now and that will be ready by 2003.
Q Will the SEC accept IAS?
A The SEC was a major force in setting the IASB up. If they weren’t genuine a lot of people would be pretty angry.
If we produce tough international standards they’ll go along with it. If we produce compromises and start bending rules here and there, the Americans won’t touch them.
Q Is there a disproportionate UK influence at the IASB?
A We have the chairmanship. We’re based in London. There are many other Brits on the staff. But the EU is moving toward Anglo-American accounting and it probably felt that would inevitably involve a lot UK people because we had to get staff here that were used to it. It would have been very difficult to appoint an American chairman. Relatively few continental Europeans are versed in Anglo-American accounting – a Brit was an obvious choice.
