Accounting - Standards go an FRS too far

For years accounting standard-setters around the world have believed that accounting practices are totally inadequate in the face of the widespread use of complex financial instruments. Changes in interest rates, credit risk, exchange rates and other market factors can hit hard a company’s financial performance and financial position. Yet, the effects of those changes are generally recognised in the financial statements only when the cash flows, and not when the events themselves, occur.

The result of this concern is a consultation paper Financial Instruments and Similar Items. The idea of the Joint Working Group (JWG) of International Accounting Standard Setters, which produced the paper, was to deliver a comprehensive standard on financial instruments. The paper covers recognition and de-recognition, measurements, presentation and disclosure.

If the paper becomes a standard, large chunks of FRS13 – the still new accounting standard on disclosure in derivatives and financial instruments – would be ripped up and a large chunk of FRS5 – reporting the substance of transaction the anti-off balance sheet standard – would go the same way. A lot of transactions undertaken by the mightiest and the humblest commercial and not-for profit organisations – factoring, securitisation, transfer of financial assets – would be accounted for in a different, some say a radically, different way.

Among these professional, full-time standard setters at least is the fundamental opinion that virtually all financial instruments – from your investment in your subsidiary through to your pension obligation – would be measured at the estimated market exit price and virtually all gains and losses would be recognised immediately in the p&l account. In other words, measures such as value in use, recoverable value and underlying economic value would be forbidden. Similarly hedge accounting would no longer exist, at least for reporting purposes.

A UK FRS, or more likely an IAS, would be unlikely to come into force until the end of the decade but don’t switch off, field testing on aspects of the paper – and hence the edging towards decisions – could start as early as next year.

From last month’s debate on these proposals organised by the Institute of Chartered Accountants in England & Wales, it is clear that FDs are deeply divided. Some argue that businesses are complex and subject to volatility, and therefore accounts should attempt to reflect, not deflect, that business and commercial reality. Managers should manage these financial positions on instruments, just as they should manage other assets. If they struggle to comply with many of the recommendations of the consultation paper then they aren’t managing their financial instruments properly.

This at least is the view of one former FD, Neil Chisholm, who sees fair value as the correct approach. Others see this move towards fair value as a proposal too far. David McGregor, group financial controller at AstraZeneca, described the proposals as looking through the wrong end of the telescope at theoretical ideas which are being pushed beyond the bounds of practicality. For instance, he says that the attack on hedge accounting is being made because it doesn’t fit in with the balance sheet approach and it relies on management intent.

He argues that the intent of the business often results in the best common sense answer. You understand the opposition of many FDs. The last decade has seen unprecedented levels of change in the philosophy and outpouring of accounting standards. The work of the JWG continues this trend. The practical outcome of some of this consultation paper is, to put it politely, counter-intuitive: for instance a fall in the market value of a company’s commercial debt can lead to a bookable gain.

These proposals have emerged at a time of great uncertainty in the world of standard setting: the new International Accounting Standards Board is still finding its feet, the reaction of US and European authorities to global standards is still unclear and as a result the substance of many of the accounting standards that companies will be complying with in a few years time is up in the air.