The pros and cons of reporting under international financial reporting
standards and the potentially adverse effect on accounts have long been
discussed. Yet these discussions have, so far, not provided a catch-all solution
for those wondering whether to report parent and
subsidiary accounts in
IFRS as well as consolidated figures.
Link: Access IFRS –
PwC’s IFRS resource centre
Now, with the year-end reporting season in full swing, many businesses will
be watching with interest the tactics taken by their counterparts. Will an
organisation convert its parent company and subsidiary accounts to IFRS, or go
with UK GAAP and leave international standards for the consolidated accounts?
Unfortunately, there is no simple template that makes it easy for businesses
to decide what to do. Indeed, IFRS experts have witnessed a wide variation in
reporting tactics. A number of businesses have corrected all their accounts into
IFRS, according to ICAEW head of financial reporting Nigel Sleigh-Johnson. ‘But
the majority have held back - adopting an attitude of wait and see,’ he says.
The issues that have led businesses to hold back on going fully into IFRS are
complex, revolving mainly around concerns over potentially adverse tax and
distributable profit effects of moving from UK GAAP.
IAS27, which covers the treatment of dividend earnings on subsidiaries,
requires that the cost method dividends from pre-acquisition profits are
used to reduce the cost of investment, rather than recognised as income. This is
fundamentally different from UK GAAP and leads to a number of implications.
First, companies will need to identify pre-acquisition dividends, adjusting
the cost of investment and retained profits accordingly. This restatement could
hit retained earnings and cut back on distributions to stakeholders.
The International Accounting Standards Board has indicated that there are no
major changes to IAS27 expected in the near future, although it is working with
the US standards setters to reach standards convergence.
‘IAS27 is a big issue in the UK,’ claims Sleigh-Johnson. ‘It’s about looking
back at the cost of acquisitions in the past. There is a lot of work in
restructuring the value of subsidiaries look at dividends pre-acquisition.
Distribution is a big factor, in terms of the impact upon distributable profits
Sleigh-Johnson indicates that many senior finance professionals are awaiting
joint guidance on the thorny topic from the ICAEW and ICAS, which is to be
‘We expected to see everyone go onto IFRS but many hit problems, tax-related,
company law and over the distribution issue,’ agrees Ken Wild, global head of
IFRS at Deloitte. He argues that concerns over distribution have led most
businesses with subsidiaries to produce UK GAAP accounts instead of going over
completely to IFRS.
Yet the effect of using international standards is different for each business
and while those with subsidiaries are unlikely to have switched all sets of
accounts across to the new rules, some companies may still have moved some of
their accounts (see below).
Companies that have taken the plunge into IFRS have found that the deferred
tax position is worse than that under previous rules. IAS12 requires companies
to make full provision for deferred tax, as opposed to UK GAAP, which contains
exemptions around revaluation gains and, most importantly, with regards to the
retained earnings of investments in subsidiaries, associates and joint ventures.
But what other issues have to be taken into account for a business to decide
whether to switch fully across or not? Experts see the usual problem of IT
systems raising its ugly head again. As with any change within the accounting
function, systems usually require recalibrating to make sure they are capturing
the correct data.
So operating to produce both UK GAAP and IFRS figures is as much a concern
for heads of IT as it is for finance directors. In addition, producing two sets
of accounts, as well as being complex and time-consuming work for the accounts
department, will inevitably result in increased ongoing cost.
Experts believe there will have to be some rejigging of IT systems, although
advisers have been trying to make the transition as smooth as possible.
A more general problem with IFRS has been the level of interpretation open to
businesses. This has left the IASB with the task of getting IFRS off the ground
and implemented, while at the same time altering the more controversial
standards such as IAS39 on financial instruments, and handling teething problems
for those that are being used by UK plc.
IAS27 is no different, but there is a glimmer of hope over reducing the
compliance burden of the standard. Just two months ago, the IASB issued a
statement considering holding back on the standard until problems could be
ironed out. It decided to offer organisations a lifeline.
‘In some cases, it is difficult to determine the initial cost of an
investment in a subsidiary in the separate financial statements of a parent, in
accordance with IAS27 when an entity adopts IFRS for the first time. This
difficulty has been highlighted by the use of merger relief accounting in the
UK,’ according to the statement.
Because this type of accounting sees the shares provided in consideration at
the nominal value, this is ‘not in accordance’ with IAS27.
But where IAS27 requires the initial cost to be adjusted for any dividends
paid out of pre-acquisition reserves, pre-acquisition earnings also need to be
restated to determine what distributions are a recovery of the initial
investment - the bone of contention for finance directors who view this work as
long and complex. The IASB has though thrown out a lifeline.
It will add a ‘short-term project’ to its agenda to address the difficulties
in determining the cost of a subsidiary.
A reason to go fully ahead with reporting in IFRS hangs on the IASB’s plan to
converge with US standards setters, which could prove a boon for businesses
looking to operate in the biggest capital market in the world.
Plans to replace IAS27 with a single IFRS on consolidation ‘should be driven
by the principle of reporting a parent and its subsidiaries as if it were a
single economic entity’, says the IASB. An exposure draft should be released
towards the end of 2006.
Chris Jackson, director of structuring services at PricewaterhouseCoopers,
says a reason to stay with UK GAAP was its flexibility over the distributable
reserves issue and, for those looking to make a decision on one or the other, he
summarised the three other main points to consider.
First, there is the issue of deferred tax. Second, the more onerous and
extensive disclosure requirements and finally, distributable reserves. These are
the key factors to weigh up.
Reclassifying the definition of distributable assets, linking its measurement
to a solvency-based system that prevents a company’s financial position looking
worse than it is, as in other countries, could be the key, he says.
‘There have been calls to move to the solvency-based structure, but that’s a
few years off yet,’ Jackson admits. ‘Until then it will remain a complex
Some of the UK’s largest listed companies have taken different paths when
reporting the performance of the parent company.
AstraZeneca, BP and GlaxoSmithKline have reported the parent company under UK
GAAP, while Northern Rock, Royal Bank of Scotland and BG Group have chosen IFRS.
And, as if to complicate matters, AstraZeneca also produced figures under US
GAAP on behalf of its shareholders across the Atlantic. For example, deferred
taxation under US GAAP is calculated differently to IFRS on the elimination of
intra-group profit on inventories and share-based payment transactions.
And accounting for the acquisition of Zeneca hit the company’s net income
under US GAAP by $1bn (£532m), while adjusted IFRS deferred tax took the
business by half a billion dollars out of its equity.
Perhaps due to a lack of subsidiaries for the business to worry about,
Northern Rock has chosen to report fully under IFRS. Balance sheet and profit
and loss reconciliation from UK GAAP to IFRS are provided in its 2005 annual
report, without a separate breakdown for the parent company as the disclosures
are ‘not significantly different form the group disclosures,’ the report states.
Under IAS12, BG Group recognises its deferred tax liabilities in respect of
unremitted earnings of overseas associates and jointly controlled entities of
£16m, and in respect of non-current assets held at fair value following a
business combination of £34m.
In addition, £4m in deferred tax was recognised, while increased tax charges
for 2003 and 2004 amounted to £32m in total. The calculations must have kept
BG’s accounts team through some sleepless nights, due to the group’s structure,
which is mostly conducted through jointly controlled operations.
BG also provides comparison figures under US GAAP.
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