Accounting: A low profile

The City has given a thumbs up to the way finance directors
have handled the transition from national accounting to international financial
reporting standards. Equity analysts’ main fears were that FDs would either not
communicate the IFRS effects in time, or that they would do so in a confusing
manner. Both preparers and users of accounts are still coming to grips with a
new financial reporting language. In particular, there was a deluge of changes
in the last six months of 2005, which meant that both sides were fighting hard
to keep up with the new numbers.

In the 2006 reporting season the City is focused on three areas which FDs
need to be aware of: financial instruments, pensions and the emergence of new
liabilities. Both financial instruments and pensions seem to have been with us
forever. The International Accounting Standards Board (IASB) is first in the
queue to condemn the present standard IAS 39 Financial Instruments: Recognition
and measurement, but is playing a game of chicken with the FD community by
demanding to know how it wants to proceed for accounting for swaps, derivatives
et al. The only provision from the IASB is that failing to account for them in
some way is not an option.

Accounting for pensions has been overtaken by a much wider debate on pensions
and barely a day goes by without some major corporate announcing it has either
closed its final salary scheme, switched to defined contribution, or has paid in
a huge amount to cut the deficit. Top of the league were Royal Bank of Scotland,
HSBC, HBOS and BT, all forking out more than £1bn each at some point in 2005.
But the funding crisis and the government-inspired reports of the Pensions
Commission has distracted attention away from the fact that reporting for
pensions is still a difficult, controversial and changing area. Analysts are
going to be reading the fine print of the pension disclosure with some care.

The final area that is emerging is renewed interest over liabilities (see
December 2005, page 18). As one analyst puts it: “there is a possibility for
some companies that new liabilities are showing up”. If this is true and
previously unrecognised, immaterial or undisclosed liabilities now enter the
accounts, FDs are going to need a good story to explain their appearance.

Having the story straight should not be impossible; most companies have not
seen any strong movement in their share price as a result of IFRS – the couple
that the City has marked had a raft of other problems.

One FD characterised his approach during the past year as keeping his head
down. The other approach adopted by sensible FDs is to hire good IFRS advisers,
as well as the auditor, to help with the interpretation and getting the story
straight. You can see this from the Big Four fee hike revealed last month. The
story that FDs have wanted to give the City is that, as far as IFRS goes, there
is no story. The key is to distinguish numbers changing purely due to technical
accounting issues, rather than changes due to movement in underlying business
performance. Killing the story is a classic PR tactic, but this year’s annual
reports are going to be scrutinised with more care than usual. Analysts are
looking to see if the new accounting sheds any light on underlying performance,
which changes their perception of the business. They will also be expecting to
be told how FDs are handling the accounting volatility caused by marking to
market. These are not insurmountable problems, but possible pitfalls for the
unwary and unprepared.

Just because IFRS implementation has gone well so far, it would be foolish to
assume that it is all plain sailing from now on. Last year was a run up a steep
learning curve for everyone. But analysts, according to a survey by KPMG, think
their knowledge and understanding of IFRS has increased significantly over the
past year – mostly, it has to be said, due to the efforts of the FD community.
With increased confidence about their knowledge, analysts will feel more able to
challenge FDs on the finer points. KPMG’s survey showed that the least
understood area of IFRS impact is mergers and acquisitions, with 54% saying that
their knowledge was poor (compared with 61% last year). FDs with significant M
&A activity to report take note.

The biggest danger is that 27% of analysts are still claiming that IFRS
introduction will precipitate market turmoil (last year the figure was 51%) and
77% believe that IFRS will impact on company share price, although they are
divided over whether the markets have factored that into their pricing yet (47%
think it has been factored in already). Nearly half of analysts (44%) say they
have, or would, in the future, mark down the shares of a company that shows
significant volatility after adopting IFRS, if the reasons for the volatility
are not clear. That this hasn’t happened in practice yet can be put down to FDs
doing a good job. Keeping your head down still seems the best tactic.