Accounting: Report card

How was it for you? The question which finance directors must have been dying
to ask each other for the past few months. And behind closed doors there have
doubtless been frank exchanges of experiences. How listed company FDs and their
staff have coped with the transition from UK GAAP to IFRS has garnered much
attention. Indeed, moving to IFRS has been a major challenge for Europe’s top
companies.

Few can doubt that the switch has been accomplished without major mishap.
Companies have complied with the requirements, but the cost – in terms of late
nights for the FD and finance team, and extra fees for the audit firms – is
beyond calculation.

Some of the challenges are less to do with how companies have coped with the
switch and more to do with IFRS themselves. FDs believe that IFRS accounts are
too long and too complicated. As a result of this, the Financial Reporting
Review Panel (FRRP) has found that there is a tendency to use boiler plate
descriptions for disclosure of accounting policies whether or not the issues
described actually apply to the company. Companies can be forgiven for heaving
the kitchen sink into their first reports and accounts. Perhaps this year we can
expect to see more judicious editing. As the FRRP puts it: “More focused and
thoughtful treatment would reduce length and increase understanding of the
complexities, which are inevitable in sophisticated commercial operations.”

Now that implementation has happened, the key question is how it can be
improved. Charlie McCreevy, the European Commissioner for internal market and
services, isn’t convinced FDs and their advisers have got it 100% right.
Speaking in late 2006 at a conference, Financial Reporting in the EU: Striking
the right regulatory balance, organised by the European Accounting Federation,
McCreevy claimed that the consensus is that the investment was worth it and that
the benefits outweigh the initial costs. He went on to give FDs a stark warning:
“We still need to maintain our focus so that further improvements can be made.
In particular, more consistency and coherence still need to be developed… if
there are big differences of approach across the EU, then this will not
contribute to financial stability and transparency.”

MCreevy’s judgement was not a million miles away from the conclusions by
Ernst & Young. It looked at the accounts of the 8,000 listed companies in
the European Union that had implemented IFRS and concluded there was still a
long way to go to achieve consistency and comparability in all aspects of
financial reporting.

E&Y highlights three key problems. First, company accounts still maintain
a distinctive national flavour. IFRS’s biggest impact is on recognition,
measurement and disclosure, not on presentation. Naturally, companies have gone
for as little change as possible, so cross-border sectorial comparison is still
difficult.

Second, IFRS is a work in progress and, without industry-related guidance,
extensive judgement has had to be applied. While many would see the exercise of
judgement by FDs as good, this has to be seen in the context of some accounting
standards permitting alternative accounting treatments.

Finally, IFRS is more complex than national standards. This threatens to turn
financial reports into a technical compliance exercise rather than a mechanism
for communication performance and a company’s financial position.

Within the UK, the FRRP believes that disclosures relating to subjective or
complex judgement made by management were sometimes bland and uninformative.
Some companies have continued with disclosure required under UK GAAP, but not
under IFRS. The FRRP found that the words did not always match the actions.
Companies had retained UK GAAP terminology, but when companies where questioned
it was found that the description, rather than the underlying numbers, was
“inappropriate” and international GAAP had actually been applied.

The biggest pressure FDs are under is to personalise reporting. Descriptions
of accounting policies are more useful when they identify issues relevant to a
company’s individual circumstances. The FRRP picks the example of revenue
recognition, where policies under IAS 18 need to describe the methods applied to
determine the stage of completion of transactions involving services rendered.
Methods vary and so policies should include specific relevant details.

If FDs are feeling that regulators and politicians are ungrateful nitpickers,
then they will be pleased to know that the FRRP formally recognises all the hard
work in making the introduction of IFRS such a success. But there is still more
work to do.

In terms of reporting, the risk is that key information will be lost in the
sheer volume of disclosure and that the usefulness of accounts will diminish
under IFRS. This is a task for standard setters and regulators. For FDs and
their advisers, IFRS second time around has to be about sharpening up the
thinking in order to drive best practice.