IFRS update December 2005 – Year one

It has been a hard year for finance teams applying international financial
reporting standards for the first time.
How have
companies coped
with the conversion process, and what standards have caused
most trouble?

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resource centre

‘It’s slightly early days, as only just over half the companies have made
half-year announcements,’ says Ian Dilks, lead IFRS conversion partner at

‘We can’t conclude anything at this stage, but we can take the temperature of
how things are going. The good news for people that have reported so far, which
is biased towards the bigger companies, is that they have coped. One company had
its shares suspended for failing to meet the filing deadline, but that’s the
only one so far.’

Companies have found it more difficult than they expected, Dilks says. Even
when figures reported under IFRS are similar to those previously reported under
UK GAAP, a lot of work can still go on behind the scenes in establishing them.

‘From the investors’ point of view, given that most announcements have been
on time, it’s easy to miss the amount of work that’s going on internally,’ Dilks
says. ‘It’s like a swan that appears serene on the surface, but there’s a
frantic effort going on beneath the water.’

Some aspects of IFRS are causing concern. ‘IFRS is moving very rapidly
towards a fair value system and that raises all sorts of questions about
reliability and stability,’ says Allister Wilson, partner in Ernst &
Young’s international financial reporting group.

‘A large proportion of balance sheet assets and liabilities will be measured
or determined on the basis of management models and management’s vision of the
future. You could get widely differing results, depending on the assumptions.
Yet we have no disclosure of what numbers are subject to judgement and what the
sensitivities are.’

Wilson is also concerned that IFRS has increased information overload due to
increased disclosure requirements, yet some disclosures miss the key issues.
‘There are pages of pensions disclosures, for example, but they don’t tell you
anything about the funding, which is the information that management uses in
making decisions about pensions,’ he says.

In terms of the sectors most affected by IFRS, Dilks notes: ‘The impact on
individual companies is more marked than the impact on sectors. There are some
obvious examples, however, such as the telecoms sector or new economy companies
that have a large proportion of stock-based compensation.’

Under IFRS, share options have to be expensed. ‘It causes complications for
companies,’ says Dilks, ‘but the issues have been well known for some time, so
are accepted by investors.’

The banking and financial sector has been deeply affected by the IAS32 and
IAS39 financial instruments standards, but all sectors involved in trading, such
as energy companies, have also felt the impact. International companies that use
hedging are equally affected.

‘Financial instruments ­ that’s half the work of IFRS conversion,’ says Ken
Wild, global IFRS leader at Deloitte. ‘We are handling it, but it was always
going to be a big one.’

Focusing on individual standards, IAS19 on pensions has also been
‘On the continent there are companies where quite large liabilities are coming
onto the balance sheet,’ Wilson says. ‘There is still a big question mark as to
whether that accounting model is right and the liabilities are appropriately
measured. The single biggest issue the IASB should be looking at is the pension

Wilson has concerns about the methodology in the standard, which involves
projecting the pension liability forward and making assumptions about future
salary increases, then offsetting that against pension assets at today’s values.
‘There is an argument that liabilities are being overstated,’ he says.

‘You are not making any assumptions about asset growth, so we are comparing
apples with pears. I have concerns that we are not measuring the net liability

Dilks points out another concern. ‘At an individual or small company level,
there are other standards that are causing a few problems.’ He cites accounting
for property leases under IAS17. ‘The requirement to split out the interest
between buildings and the land has had an impact on retailers and the
entertainment industry. That wasn’t foreseen 12 months ago, but they have got on
top of it.’

Wild also notes that lease accounting has been an issue for some companies.
Because the IFRS wording is similar to that in the UK standard, people didn’t
necessarily think there would be any great impact. But thinking afresh about
lease accounting in the light of IFRS has often triggered a new approach.

‘I wouldn’t say we were getting it wrong in the past, because everyone was
doing it one way,’ Wild says, adding that accepted practice has an impact with
principles-based accounting. ‘But when you stand back and look at it there is a
more obvious interpretation.’

Dilks says the combination of the standard on mergers and acquisitions
(IFRS3, business combinations) and IAS38 on intangible assets (see page 10) are
also causing some practical problems.

Previously, acquisition accounting required goodwill in an acquired business
to be written off over an arbitrary period. Now, that is no longer the case,
subject to an annual impairment test. However, acquired intangible assets do
need to be valued and written off over their useful lives ­ a period that is
often shorter than previously applied to goodwill.

‘That has affected companies that have done deals since IFRS became
applicable or are considering deals,’ Dilks says. ‘People are finding it quite
difficult. Individual companies generally haven’t had the in-house expertise to
assess the value of the intangible assets they are acquiring to a reporting

In addition, M&A teams have sometimes not properly thought through what
an acquisition will look like under IFRS. This is a problem because the
accelerated amortisation of the intangible assets typically produces a lower
earnings figure than would have been the case under UK GAAP.

‘Some people say that analysts add amortisation back anyway, so it doesn’t
really matter,’ Dilks says. ‘But still, there has been some consternation that
the numbers in the accounts before adding the amortisation charge back is a
lower number. Too late in the day, they have realised that earnings will not be
as strong as they would be under UK GAAP.’

One ongoing problem is caused by the fact that IFRSs and revisions to
standards need to be approved by the European Commission, a process that can
take 10 months.

Wild refers to the IASB’s Technical Correction 1, which addresses problems
with IAS21. ‘There is now an amended IAS, but Europe has to endorse it,’ he
says. ‘We now have a standard which was defective but which is fixed, but the
official standard is the original one. The EC has a very good process, and has
lots of public comment. That’s necessary, but how do we do it quickly? You can’t
take 10 months.’

Without a solution to the problem, companies applying IFRS may find they have
to apply outdated standards.

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