International Financial Reporting Standards apply to company accounts of public companies whose financial periods begin on or after 1 January 2005. In December 2004, Morgan Stanley’s Equity Research division published a guide to IFRS highlighting the most important areas for investors to consider when getting to grips with the new standards.
Morgan Stanley’s 10 Things You Need To Know About IFRS are:
1. Companies will be late and investors aren’t ready. Morgan Stanley advises investors to keep a list of companies that have not disclosed much about their IFRS preparation. It is particularly worried that too many companies are leaving it to the last minute to compile their numbers.
2. Share price volatility may cause chaos as investors and analysts will struggle to make sense of the numbers. As hedge funds become more interested in IFRS, expect further volatility.
3. Reported earnings are going to be more volatile than ever. This is because of the new value measures under IFRS for financial instruments, stock options and the like. It is also because there are now fewer tools to manage earnings, such as using provisions to smooth earnings.
4. Behavioural change will accompany accounting changes. Morgan Stanley thinks companies’ approaches to stock options, pensions, hedging and off-balance sheet financing are the areas most likely to change.
5. Smaller companies are more risky investments under IFRS because of the amount of additional disclosure they have to make. This means mid- and small-cap firms have more potential to unsettle investors with delays and surprises.
6. Companies reporting under German, French, Spanish or Italian GAAP are most at risk of surprising investors under IFRS because of the volume of new information these companies will have to disclose.
7. The new standards will not have an immediate effect on distributable reserves, so dividends will not be an issue at first. But companies with a ‘delicate’ distributable reserves position should move swiftly to IFRS and spend time looking closely at their future dividend policy.
8. Different companies that use a variety of definitions in their accounts for the same items will cause added confusion under IFRS. “We think pro-forma disclosures will prevail in the next couple of years,” says Morgan Stanley.
9. Data providers for investors will only provide local GAAP and IFRS data in parallel for a short time. Investors must learn to live with a wide dispersion of results.
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10. In Morgan Stanley’s view, it will take at least three years for consistent application of IFRS by companies and for investors to get fully fluent with the language of the new standards.