PracticeAuditNorthern Rock takes IFRS stoning

Northern Rock takes IFRS stoning

The furore surrounding financial instruments standard has moved into the heart of the City, as leading analysts predict Northern Rock's profits will be slashed by up to 10%. But the bank has hit back, claiming predictions are just a 'storm in a teacup'.

It seems that the arguments surrounding the most controversial of accounting standards, IAS39, just won’t stop. But now, the machinations taking place in the political arena have moved into the business world, with companies, investors and analysts all hotly debating exactly how the financial instruments standard will affect annual profits.

The first big example of a purely financial spat was sparked by the views of market watchers Credit Suisse First Boston. While a report from the investment bank said that the changes to accounting standards would boost the profits of banks such as HSBC and Alliance & Leicester, it said that the profits of Newcastle-based Northern Rock could be hit by as much as 10%. Accordingly it downgraded its advice on the bank from outperform to neutral and the share price of Northern Rock took an immediate hit of 20p.

In what looks like an attempt to head off some of the trouble caused by this report Northern Rock took the rather unusual step of issuing a pre-close statement just two months after its last trading update in which the specific issue of IFRS was tackled.

In this statement the bank said that the impact of IFRS on its accounts was still being determined, but rather than a 10% fall in profits it claimed its restated 2004 accounts would see a profit change of plus or minus 5%.

‘We expect the impact from the implementation of all IFRS – including IAS39 and other changes – will have no material impact when 2004’s results are restated next year,’ said chief executive Adam Applegarth. He went on to say that the issue was a ‘storm in a teacup’.

This may well be the first example of a split between market watchers and companies over the new accounting regime, but it won’t be the last. Accountancy Age has already reported that a Big Four firm has had to call in lawyers over the interpretation of IFRS, and differences of opinion seem to be becoming more commonplace.

The war of words between Northern Rock and CSFB highlights the difficulties the changeover is likely to bring in the near future. But it also signals that the controversy that IAS39 has caused – and continues to cause – may well mean big problems for analysts.

Last month ratings agency Fitch sent out a warning about the way derivatives are being accounted for. It said that the way companies are accounting for their derivatives transaction could bring problems in the future.

‘The complexity of current derivative accounting standards and the low level of transparency create a new set of challenges for investors and analysts,’ said the agency.

A study of 57 international companies found a significant lack of consensus over how these companies are applying the accounting rules for derivatives, which includes IAS39 and SFAS133 in the US.

‘This does not bode well for the pending implementation of IFRS for most large European companies,’ warned Fitch.

The potential for confusion over derivatives has been compounded by the European Commission’s decision to adopt a version of IAS39 different to that drawn up by the International Accounting Standards Board.

The carved-out version, which removes sections of the original standard to do with the hedging of core deposits and the fair value option, would not necessarily cause confusion by itself. But by allowing companies the option to use the full version of the standard, the market will be faced with companies using different standards in their accounts. The ability to truly compare results between competitors could be severely curtailed.

The situation with IAS39 arrives at a time when the market is struggling to come to terms with the biggest change in accounting for a generation. The introduction of IFRS means that market watchers have to cope with major changes in how a company’s performance is viewed.

With many companies well behind in their preparations for IFRS, informing the market on how the move will affect the result has come quite low down on the list of priorities. Similarly there is concern that analysts have yet to undertake the training needed to help them understand forthcoming changes.

While the markets may eventually settle down, over the next year or so, when companies are reporting under the new standards for the first time, there are likely to be some bumpy times ahead in the market.

IFRS battles blow by blow

Round 1
French banks raise opposition to several key proposals in financial instruments standard IAS39, claiming they are unworkable, and receive the backing of the European Commission. The IASB stands its ground and the EC adopts its own version of the standard.

Round 2
Accountancy Age learns that a Big Four firm has called upon lawyers to help in the interpretation of IFRS for a particular client. IASB chairman Sir David Tweedie tells the firm to ‘get some backbone’

Round 3
Credit Suisse First Boston says Northern Rock profits will be hit by up to 10% by the introduction of IFRS. Following a hit to the share price the bank issues a statement to the market that refutes these claims.

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