Risk & Economy » Audit » On the alert to avoid the hurt

Europe’s capital market regulators and the accountancy profession are profoundly worried about the introduction of International Financial Reporting Standards in the European Union. The Committee of European Securities Regulators (CESR) betrayed its unease in an extraordinary letter to the body representing the European accountancy profession – the Federation des Experts Comptables Europeens (FEE) – in which it lectured European finance directors and auditors on the need to prepare for the implementation of IAS and IFRS.

CESR – which was created by the European Commission in 2001 and aims to improve co-ordination among European securities regulators – sees two unrelated issues which make it uneasy. First, the production of accounts for Europe-listed companies is undergoing a massive change in terms of the regulation of financial reporting, corporate governance and auditors.

Any one of these changes would have probably been enough for CESR to urge caution, but the three together increases the risks of a significant breakdown in European financial reporting.

The second issue that worries CESR is the integrity and efficiency of the capital markets in the light of the high-profile corporate reporting problems in Europe in the past year, including Parmalat, Adecco and Ahold.

In terms of money, the Parmalat scandal is as big as Enron, but it is taking place in Italy, whose economy is dwarfed by the US. The effect on Italy is massive and having repercussions all across the EU – look at the revised 8th Directive.

The problem for the EU is that although it likes to pretend its capital markets can match those of the US, there is no single Securities & Exchange Commission-like regulator that can stamp its foot. CESR is attempting to fill that gap by force of will, not force of law. Hence, its attack on the accountancy profession, the preparers and the auditors of financial statements.

John Tiner, FSA chief executive – in his capacity as chairman of CESR’s committee on financial services and company legislation – is warning the European accountancy profession that confidence in capital markets is “predicated on investors and the markets more generally receiving financial information about listed companies that is reliable, transparent and independently certified”.

CESR has some specific warnings to FDs of EU-listed companies as they prepare their accounts under IFRS. First, it expects companies to adopt a phased and transparent approach to the transition, including identifying the expected financial impact of the future IFRS. It is clear that CESR is expecting companies to communicate any material impact of changed standards to the market in good time. Key areas where companies may start to realise their figures will be hit include pension and deferred tax.

In effectively implementing IFRS, CESR says for most companies that the opening balance sheet as of 1 January 2004 is likely have the greatest impact on the first financial statements prepared under IFRS. And it therefore “expects both companies and their auditors to pay particular attention to the accuracy and fairness of the opening balance sheets at 1 January 2004”.

Securities regulators are also making threatening noises over the audits of financial years ending 31 December 2003. You could argue that much of the audit for this period is already done, but that does not appear to matter for CESR. In the light of the high-profile corporate reporting problems in Europe, it argues that the expectations of investors, regulators and others will focus on three issues: 1) the comfort drawn from the audit; 2) compliance with relevant auditing standards; and 3) the transparency of disclosures. While the first two issues fall primarily in the auditor’s lap, FDs are no doubt experiencing a tightening up of audit procedures as the pain from Parmalat et al is shared around.

CESR has warned auditors to pay attention in two key areas: first auditors who certify consolidated financial statements but who are not the statutory auditors of significant subsidiaries are being told to review the work conducted by the auditor of the subsidiary and, if needed, perform additional checks on the accounts of those subsidiaries. At the same time, auditors of groups of large complex structures are being told to exercise vigilance.

Such unflinching and detailed an intervention would have been hard to imagine a few years ago from a group which has no formal powers. The fact that it feels empowered to intervene in the financial reporting and auditing issues that are besieging Europe at the moment suggests it has strong reasons for fearing that we have not seen the last of the European corporate scandals. It seems that those responsible for Europe’s securities markets and accountancy regulation appear to think it is not a question of if there are further problems, but when.