IFRS: the next stage

written by Ian Dilks

2006 has seen a sea change in the UK business world as listed groups published their first full annual accounts under IFRS. Although some companies did extend their reporting deadlines temporarily, most achieved their IFRS conversion on schedule. Furthermore, there were few shocks for analysts or investors and no share price crashes – encouraging evidence that the UK business community rose to the challenge.

So how was it?

This is not to say that the road was easy. Finance Directors and their teams have worked extremely hard during an intense period of change. They have had to bear the cost, both human and financial, of the conversion process, and clearly recognise there is still a lot to be done.

The size of the challenge is nowhere more evident than in the increase in length of the financial statements themselves – on average they are more than 50% longer, and in some cases more than double the length of last year. In the vast majority of cases, resources to complete the task have not increased correspondingly.

Challenging issues

Whilst a lot of the additional information relates to the first year of transition, much of it will remain in the coming years because of the requirement to include new disclosures in complex areas. Upcoming standards, such as IFRS 7 on financial instruments, and the proposed segmental reporting standard, will provide fresh challenges going forwards.

Particular issues that companies have faced to date include the need to carry out annual impairment tests on goodwill and disclose significant detail on key assumptions and sensitivities. Valuations of financial instruments as required by IAS 39 and accounting for deferred tax have been as challenging as predicted, and valuing intangible assets, such as brands and licences, for example, has proved more complex than anticipated.

Pension deficits are more high profile than ever, both because IFRS brings them onto the balance sheet, and thanks to the increased powers of the new pensions regulator. It is essential to value your deficit and ensure that you disclose the key assumptions underpinning your valuation.

Many companies have seen a share-based payment expense appear in their Income Statements for the first time. In addition to the need to use sophisticated option valuation models to calculate the expense, the charge itself has led many to restructure their executive remuneration schemes to avoid it.

In terms of subsidiaries, thus far, most organisations have held back from converting their subsidiary and parent entity accounts to IFRS. The key factor here is the potentially negative impact on distributable reserves. This is driven by three main factors: the allocation of pension deficits arising from multi-employer schemes; higher provisions for deferred taxation; and dividends out of subsidiaries’ pre-acquisition profits being deducted from the cost of investment. Coupled with the more onerous disclosure requirements, notably for cash flow statements and related parties, remaining with UK GAAP for the time being has been the most popular route.

What next for those who have already converted?

The implementation of IFRS has required an extensive change and risk management process for many companies, but the hard work really begins now – in embedding IFRS processes into the organisation and in developing full IFRS understanding amongst employees.

Both our experience and independent survey evidence indicate that many companies understandably treated conversion as a short-term project in year 1, relying on tactical fixes, parallel systems and offline spreadsheets. Whilst these may have done the job first time round, they increase the risk of error and are more time-consuming to maintain.

Systems should be flexible enough to capture new information on a consistent and timely basis. This becomes even more critical for companies that have dual US listings and are subject to Sarbanes-Oxley rules.

IFRS reporting must be repeated in the next reporting cycle and every cycle after that. IFRS must therefore become part of ‘business as usual’.

And for new joiners converting soon…

Beyond the main market, others are planning their first move into IFRS reporting. IFRS will be a live requirement for AIM companies from 2007, and indeed they should already be preparing comparative figures on the new basis so was effective from 1 January of this year. As a matter of “best practice”, some large private companies are considering a move to IFRS to put themselves on a level playing field with their listed competitors, and become more marketable as a result.

It is important not to underestimate the scale of the conversion process; the time, effort, cost and expertise required to meet that first deadline. Effective and timely communication with investors and analysts will, as the larger listed groups found, be vital.

Any company looking to IPO will have to produce IFRS accounts, including comparatives for previous years. Furthermore, companies that are the subject of a trade sale or that are considering making acquisitions should be able to assess the impact of IFRS on the transaction. Not anticipating these requirements may mean an inability to respond quickly to a potential offer.

IFRS is here to stay

There is no doubt that the current IFRS reporting platform is far from perfect. Although the IASB has announced that no new international standards will become effective before 2009, improvements are ongoing, both to eliminate deficiencies in the current standards, and to facilitate global convergence and, crucially, remove the onerous requirement for a US GAAP reconciliation. Overall by 2009 there could be around five new or revised standards to implement, and possibly more given the current IASB agenda. Of course, early adoption is allowed.

In the UK, discussions continue over the future direction of corporate reporting – if, when, how, and for what type of company convergence with IFRS should happen. There are understandable concerns about the future direction and likely pace of change.

Whilst it is to be expected that first-time IFRS accounts retain an element of national identity, over time comparability should improve as precedents are set and interpretations established. That’s not to say that we need more rules – on the contrary, management and auditors must have the ability to make reasonable judgements, and regulators should refrain from heavy-handed enforcement.

Whatever happens in the future, IFRS is here to stay. Standards will evolve over time as circumstances change and experience grows, and companies must be able to respond efficiently and quickly to new developments.

Will it be worth it?

In the long term, a common financial reporting language will have many benefits, not least greater transparency, consistency and comparability between entities, across industries and amongst countries. This in turn should, as was always the intention, lead to more efficient markets and a lower cost of capital. Companies adopting IFRS will garner a competitive advantage as the quality, clarity and credibility of disclosure become a commercial as well as a compliance issue.

Conclusion

Finance teams should appreciate the scale of their achievements. IFRS conversion was a huge challenge, over a relatively short timescale dictated by international law. The fact that almost all companies achieved it on schedule and without mishap indicates the level of expertise and professionalism that exists within the UK finance community.

By 2007, more than 100 countries across the world will permit or require the use of IFRS for publicly traded companies. IFRS will become in effect the most widely used accounting convention in the world.

The challenge now is for investors and preparers to engage in the debate and positively influence future developments. The UK hosts the largest market using IFRS, particularly with the inclusion of AIM, and so has a key role to play.

Ian Dilks, a partner at PricewaterhouseCoopers, is responsible for IFRS conversion services in the UK.
Ian Dilks - 020 7212 4658