FDs deliver their judgment on IFRS

It’s not looking good for the International Accounting Standards Board and
its supporters. Financial Director’s readers have given them a firm thumbs down.

A snapshot survey of opinion among the readership reveals a high degree of
disgruntlement. Asked to judge the value of IFRS accounts as compared to their
UK GAAP predecessors, 65% of respondents said they were worse or much worse.
Just 13% thought they were better.

This is unfortunate, given the evident effort involved in IFRS adoption. The
technical accounting decisions involved and the pressure on finance manpower,
were cited as particularly significant challenges in the process. In addition,
almost three-quarters (74%) of respondents said they had “a few difficulties” to
resolve with their auditors as a result of the IFRS switch, while 14% bemoaned
significant difficulties.

“The general view is that it [IFRS adoption] hasn’t really made any
difference,” says Ken Lever, FD of Tomkins and chairman of The Hundred Group’s
financial reporting committee. “It’s a bit like shopping: a lot of pushing and
shoving and not a lot to show for it at the end.” For Tomkins, the adoption of
IFRS has had relatively little impact on its published accounts. “A lot of time
and effort went into it, a lot of head scratching, a lot of discussions with
auditors, who didn’t necessarily know the answers because they were learning as
they went along,” says Lever. “And the end product was not much more helpful
than what you had before. Most companies have worked exceptionally hard for the
December reporting year end, to get the numbers out, and in the end they didn’t
see much effect.”

That hard work has been reflected in the expanded size of IFRS reports and
accounts. According to the survey, the majority of respondents said their IFRS
accounts (including notes) were longer (or likely to be longer) than their UK
GAAP predecessors. Around 40% estimated the IFRS accounts would be up to 20%
longer, and another 30% said they would be up to 50% longer.

This is a finding backed up in recent research performed by
PricewaterhouseCoopers. “We4 have reviewed the first 60 [IFRS] accounts to have
come out, and the average length of increase of accounts is about one-third,”
says Ian Dilks, IFRS conversions leader at PwC. About 60% of companies’ accounts
had increased by around 50%. “For some companies, the size more than doubled,”
Dilks notes. “That means a lot of extra work and finance resources have been
grappling with new policies, quite apart from the extra disclosures required.”

This may explain the strength of negative feeling about IFRS currently being
expressed. “What’s in people’s minds at the moment are the problems,” says
Dilks. “People have just been through a period that’s been fairly torrid. But
it’s early days to be looking at any benefits. There’s been a lot of extra
disclosure, the benefits of which are probably more obvious to investors than
the companies producing the information.”

Nevertheless, some companies may have benefited from adopting IFRS. Lever
suggests that, the financial services sector aside, pensions accounting has been
the biggest issue for most companies moving to IFRS. “Some companies have
benefited, because they could push their pension fund deficit into the past, as
it were,” he says. “Going forward, they are not having to charge that deficit
through the income statement, but that could be misleading because they still
have to provide the cashflow funding for the pension fund deficit going forward.
Their earnings per share have benefited, because the charge going through the
income statement in 2005 is less than previous years because it’s taken care of
in the opening IFRS balance sheet. It got slipped through reserves. So some
companies, from an EPS perspective, have benefited.”

Nevertheless, if most companies are sceptical about any advantages of IFRS
accounts, what of investors and analysts? As far as Tomkins is concerned, the
move to IFRS doesn’t seem to have excited analysts. “There haven’t been many
questions from investors or analysts,” Lever notes. “They either look at it
[IFRS accounting] and understand it, or they decide it’s not that significant.”

However, most of those who participated in our snapshot survey appear less
charitable. Just 5% thought investors/analysts had a good understanding of IFRS
numbers. Meanwhile, 93% thought their understanding was either only reasonable
or poor.

Communicating with investors

This perhaps explains why one of the next priorities for companies, once
their first year-end IFRS accounts are published, will be further communication
with investors and analysts. Other key priorities include reviewing other
companies’ disclosures and explanatory notes to identify best practice,
reviewing sector trends for comparability of accounting treatment and embedding
IFRS in accounting systems.

Reviewing other companies’ accounts is to be expected at this early stage of
IFRS reporting. Dilks refers to the fact that the size of some companies’ IFRS
accounts hasn’t increased, while others have increased by up to 147%. “Clearly
there has been a different response to the challenge of disclosures,” Dilks
says. “It will probably take a year or two to settle down. There is some work to
be done to review the differing approaches companies have taken. I think a
consensus will start to emerge as to what is appropriate. Inevitably there has
been a tendency for some companies in year-one to say ‘we will do it in a boiler
plate way’.” However, in subsequent years, Dilks believes these companies will
review whether they are getting the right message across in terms of the
performance of the business and the quality of reporting could improve.

Embedding IFRS into systems will take some extra effort too. “A lot of the
data [for IFRS] doesn’t come out of the core systems,” Dilks says. “Many
companies are now using twin-track systems, because they have only switched over
their group accounts [to IFRS]. It means they are having to do more work. The
pressure it puts on finance is considerable. It’s got to be addressed. Companies
have to do something about it, both to take out cost and reduce risk in terms of
reporting under the new accounting.”

Relatively few companies have moved their subsidiary accounts onto IFRS
accounting as yet. Reasons given for not doing so in the survey responses
included tax repercussions, adverse reserves impact and concerns over the extra
work involved. One respondent said: “It is irrelevant to the way the business is
run, and at4 times counter-intuitive.” However, 20% of respondents had switched
their subsidiaries over, with the desire for consistency across the group being
the dominant driving force.

At VT Group, operating divisions are still using UK GAAP. “VT Group adjusts
centrally for IFRS,” says Neal Misell, FD of VT Communications, a division of
the VT Group. “We [VT Communications] are producing our accounts based on UK
GAAP and then having to provide a lot of additional information on those
accounts to allow them to be adjusted for IFRS. We expect to move to IFRS at
some stage.”

An easier life

This might make life easier, particularly in terms of explaining the
financials to non-financial managers. “We have done several budget presentations
to directors,” Misell says. “We say that this is our profit under UK GAAP and
then these are our other figures. It sounds a bit suspicious, having two sets of
figures. So that’s been the biggest challenge to me – dealing with non-financial
managers and explaining why I have two sets of figures, or why the figures this
year are not comparable to those for last year.”

There is some evidence of strategies being adjusted as a result of IFRS
adoption, most commonly in terms of hedging, but sometimes also in connection
with remuneration and share-based payments. A small percentage of respondents
said their acquisitions and pensions strategies had been changed as a direct
result of the reporting implications under IFRS.

On balance, the majority of respondents do not want to see UK accounting
fully converged with IFRS, though, if it happens, the majority would prefer a
gradual approach. There is some acknowledgement that this would bring advantages
in terms of UK accounting being streamlined with the rest of Europe and there
being greater comparability between unlisted and listed UK companies. However,
the two key disadvantages of full conversion are seen as the complications of
fair value accounting and greater volatility in accounts.

Fair value is an issue that The Hundred Group’s Lever sees as being key.
Adopting IFRS may have involved a lot of work, but he foresees more strategic
issues needing to be addressed. “These issues include convergence with US GAAP,”
Lever explains. “Does that mean we will have increasingly rules-based standards,
rather than standards based on principles? The second major challenge going
forward is the issue of the basis of measurement and the extent to which there
will be greater use of fair values.” Lever doesn’t have a problem with using
fair value for, say, derivatives where a clear marketplace exists, but he warns:
“When it comes to asset impairment tests or share-based payments, trying to use
fair value calculations is more difficult. It’s a question of reliability.”

Specific sectors may also face additional challenges ahead. Mark Laidlaw, CFO
of Aegon UK, part of one the world’s largest insurance groups, notes that
insurance company accounts have only incorporated phase one of the IASB’s
insurance accounting project. In simple terms, phase one covered straightforward
single premium insurance contracts. Contracts with guarantees, with-profits and
annuities are being dealt with in phase two. “In effect, a lot of our balance
sheet assets had to be reclassified under IFRS, but a lot of our liabilities
didn’t,” Laidlaw says. “It was a big piece of work to change over, but not as bi
g as phase two will be, which comes in in 2008. Only 15% of our business was
classified as investment business, and so affected by phase one. That means 85%
of our business is sitting there waiting to be dealt with.”

Nevertheless, Aegon did take a very thorough approach to its IFRS adoption.
“We are a large international company,” says Laidlaw. “We had a project team in
The Hague who were the main people doing the work. Then we had country units
working on their own IFRS projects. The project [switching to IFRS] ran for more
than a year. It went very well, though it took up a lot of resources. We decided
we would represent the whole of our 2004 results under IFRS, which we did in
April 2005 – quarter by quarter, line of business by line of business.”

Time and resources

Like many companies, adjusting to IFRS disclosures was tough. “The biggest
challenge for us was the disclosures,” Laidlaw confirms. “There’s much more
disclosure in the year end reports and accounts, and it took a lot of time to
get the data.”

The extra time has been frustrating for FDs and their personnel. “It took a
lot of time spent answering questions and getting information that we wouldn’t
normally have to supply,” says VT Communications’ Misell of the IFRS reporting
experience. “That means time away from the real thrust of what we are trying to
do. We want our reporting to be quite routine and falling out of our system, so
that we can concentrate on running the business. Having to get the extra
information for IFRS accounts is not a great use of everybody’s time. It’s
important that we report correctly and clearly. We have a duty to shareholders
and I have no problem with that. But the shareholders should be as interested in
us getting out and winning new work to make sure we increase shareholder value.”