Local financial reporting practices are already being transformed to international financial reporting standards (IFRS) at tens of thousands of listed companies in over 90 countries. And with investor confidence at stake, proficient IROs are deciding to engage the market well before the January 2005 compliance deadline.
The global convergence to IFRS – the new reporting standards devised by the International Accounting Standards Board (IASB) – will allow analysts to compare apples with apples, instead of oranges with bananas. But as the new standards are also likely to alter many companies’ balance sheets next year, many firms now understand it’s essential to get the message out early.
According to Peter Holgate, senior technical partner at PricewaterhouseCoopers (PwC), forward-thinking companies are giving top priority to the conversion project, and are already informing the market about the changes. ‘A company that wants to have good investor relations, and to protect its reputation and share price, will do some of what is being asked earlier than required,’ he explains. In other words, they will do it voluntarily.
New wave
Challenges are particularly fierce for the roughly 7,000 listed companies in Europe, especially the smaller caps. This is because the European Commission has decided to fully implement IFRS by January 2005, rather than require firms only to complete the first phase of the transition to the new rules by then, as is the case in the US. It is literally a race against time, where larger dual-listed companies already reporting in US Gaap (which closely resembles IFRS) are probably better prepared.
Because the new standards are based on principles and not rules, they can be implemented in a range of jurisdictions and business circumstances without supplementary guidelines. According to Philippe Danjou, chief accountant of the French Autorité des Marchés Financier and a member of the Committee of European Securities Regulators (CESR), the largest shift in thinking comes precisely because IFRS is principles-based. As a result, he says, companies, auditors and regulators will be required to make many judgments, leaving more room for subjectivity.
The switch to IFRS will require a major adjustment in the way companies view their financial reporting, notes Danjou, who also heads a committee investigating the impact of the transition. Firms in certain countries will have an easier time than in others, he adds. ‘The UK, Ireland and the Netherlands could be closer in terms of their way of thinking,’ he points out. ‘Latin countries such as France, Spain, Italy and Portugal will probably have to change a lot more.’
Growing pains
‘It’s a lot of work, but we’ll get there,’ says Gaele Chagnaud, IRO at France’s mailing and shipping equipment provider Neopost. ‘We’re trying to assess what the problems are and what the impacts will be. We don’t see huge changes for us or huge impacts on our P&L or balance sheet, but it’s too early to say – there will be pros and cons.’
However, it’s not just a problem of becoming acquainted with a new style. According to Daniel Lacalle, head of IR at Spanish utility company Enagas, the move to IFRS is not just complicated because of the new way in which assets and liabilities have to be accounted for, but also because many firms will have to restate their accounts to the investment community looking backwards.
‘Most or even all companies in the Ibex 35, once they have a clearer picture of what the new accounting standards are going to be, will reassess their accounts looking backwards,’ Lacalle explains. ‘In our case, this is from 2002 onwards, because that was when we went public. We all want to be proactive about this so that investors don’t have to second-guess or go to other sources for this kind of information.’
According to Richard Pike, head of corporate finance at UK glassmaker Pilkington, although the new accounting standards don’t change actual cash generation, there will be some concerns in people’s minds about how things are going to be affected. ‘By providing the market with an understanding of what the changes will be, you’re really breaking the back of the problem,’ he says. ‘We’ve had to invest a lot in both external and internal resources in time and effort for this.’
The great unknown
Danjou expects companies with complex international operations to have difficulties with some areas of IFRS that have taken longer to be determined – namely, those pertaining to share-based payments, which under the current proposals should be recognized as an expense in the company’s P&L account.
Richard Margrave, head of employee share ownership at UK share ownership advocacy group Proshare, says the IASB should consider exempting share-option plans from the current draft. Otherwise, he argues, many European companies, especially smaller ones that find it more difficult to account for these schemes, will think twice before using them.
‘It’s a clash of ideals,’ points out Margrave. ‘Share-based schemes have a very positive effect on productivity. [The IASB] is obviously trying to offer what it believes is a true and fair picture of the value of the company but it is a big issue for the people in Brussels because they want to encourage financial participation – and they perceive this standard to have a negative impact on that.’
According to Holgate, the first concern for companies with share-option schemes now should be to understand and determine the new requirements. But the next most important step, he says, is ‘getting the outside world to understand the charge to the income statement – [this step is] a crucial one that management should address early.’
The enlightened few
Issues such as expensing share schemes as well as other financial instruments have kicked up a stink between the European Commission and the IASB. And some observers feel this squabbling has served only to heighten the level of uncertainty, which in turn hasn’t encouraged companies to spend the necessary sums of money to start their conversion.
Although the new standards have come under much fire in Europe, some have come out in their defense. Jon Symonds, CFO of pharmaceutical giant AstraZeneca and chairman of The Hundred Group, a UK-based CFO association, did so in a recent Financial Times column. In it he argued that the wrangling over transition details is distracting companies from the process itself, and chastised institutional investors and auditors for failing to take up the cause.
Indeed, companies like AstraZeneca have heeded the advice of organizations like CESR and the UK’s Financial Services Authority (FSA), and have begun providing IFRS comparisons and explanations in their financials, prior to the 2005 deadline.
‘A broad note about the new standards is included in the financial review section of our [2003] annual report and accounts, published [in March],’ explains Mike Rance, vice president of corporate affairs at AstraZeneca. ‘Like most other companies in the UK, we have not as yet finalized our thinking about how we will position the new standards with the market, but we are working on it.’
While several surveys suggest many European companies are poorly prepared for the switch, it is also clear that an increasing number have begun to recognize the benefits of getting into the game early and providing the market with information on the possible negative and positive impacts.
‘Our 2004 mid-year results won’t be published under international accounting standards – they will still be published under the French standard,’ explains Chagnaud. ‘But they will inform the public that there will be some impact on the P&L from IFRS and what the main impact on shareholder equity will be.’
So even if companies cannot exactly quantify the entire impact of the new accounting requirements, they would be wise to explain – in narrative form at least – what the key differences are between their present accounting policies and those they will likely have to apply under the new rules.
Get cracking
By providing the market with detailed explanations – before the 2005 deadline – about the effects IFRS will have on results, companies are helping the market to familiarize itself with the new standards. More importantly, firms are also enabling the market to divorce any potential confusion arising out of IFRS usage from the overall interpretation of their results next year.
Whether or not the market will decide to reward those companies that are undertaking a clear and smooth transition to IFRS next year remains to be seen. But experts believe it is likely the market will penalize or downgrade those companies whose IFRS communication efforts appear late and/or poorly considered.
So no matter how different a company’s balance sheet might look next year, it goes without saying that investor relations officers and teams must be at the forefront of any efforts to engage the investment community before potential doubts arise.
‘The market doesn’t like uncertainties,’ says Chagnaud, ‘so the sooner you can be clear about the future, the better.’
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Additional reporting by Jana Sanchez
Be informed
There are many online resources for learning more about convergence. Here are just a few:
http://possom.blogs.com/ifrsuk/fasb_and_convergence/
Below the radar
Adrienne Baker discovers that the convergence of accounting standards is a ‘sleeper hit’ in the US
It’s three days since Laidlaw International’s listing on the NYSE, and Sarah Lewensohn, head of IR, has a rare moment to consider the implications of global accounting standards. Like most US-based IROs, the rapid pace of maintaining investor relations in challenging times combined with new disclosure requirements has pushed the harmonization of US and European accounting guidelines to the backburner for Lewensohn. ‘Everyone is so distracted by Sarbanes-Oxley we don’t have any extra resources to throw at these things,’ she explains.
Unlike the fiery debate it has ignited in Europe, the joint Financial Accounting Standards Board (FASB)/International Accounting Standards Board (IASB) convergence project is something of a ‘sleeper hit’ in the US. And it’s no wonder. With large US companies spending an average of $2.8 mn on external consulting fees and 35,000 hours of internal manpower to meet Sox requirements (according to a recent survey by Financial Executives International), senior management
is thinking compliance, not convergence.
‘KPMG estimates the transition to universal accounting standards will take [US] companies nine months – and they have not allotted the time, resources or dollars to carry this through,’ warns John Wood, accounting expert and head of the Altanta-based Playfair Group.
The danger of this Sox-centric mindset is that US companies will miss out on preparing investors and analysts for the impact convergence will have on US financial statements. This could cause confusion and volatility over the short term, according to Wood. ‘The first major area of obsession [in the convergence project] is financial instruments, and that concerns IROs directly,’ he says. ‘It’s time for IROs to put up an umbrella to avoid getting wet – because it’s going to rain.’
FASB’s proposal on changes to the calculation of EPS doesn’t overly concern Lewensohn because ‘the number that gets reported to investors won’t change’, just the method used to calculate basic earnings. More significant is the proposal to move to fair value accounting.
‘All of these adjustments [to fair value] will lead to greater non-cash expenses that will create a gap between net income and cash flow,’ notes Lewensohn. ‘Over time people will get it but if you’re an investor who looks at EPS and net income, you may see a much different picture than someone who focuses on cash flow.’
The move will wreak havoc on the share price initially, says Wood. ‘It changes the way you do things – which is all well and good if you have comparables but the phraseology asks you to produce an exact figure couched in guidance that is not fleshed out,’ he explains. ‘This will create short-term volatility.’
Over the long run, universal accounting standards will create a level of consistency and transparency in global markets that will make life easier for US-based IROs, especially those working for multinationals.
‘IR departments spend a lot of time explaining the difference between their financial statements prepared under Gaap and those of their competitors prepared under different guidelines,’ notes Jeff Johnson, project manager for FASB’s short-term international convergence project. ‘This will level the playing field and reduce the cost of capital because everyone will be using the same standards.’
But given that the first phase of the project is expected to be completed by January 2005, IR professionals need to educate themselves about how these changes will affect a company’s bottom line so they can explain it to investors, directors and senior management. Because, as Lewensohn notes, ‘[convergence] runs the risk of distorting the performance of the company if the person on the other end of the phone doesn’t understand the change.’
