IFRS update October 2005 - Subsidiaries
British Airways - flying high?
The impact of IFRS across business is already causing consternation for
companies with
diverse subsidiaries, with some seeing a reduction in their net assets and a
squeeze on distributable reserves. This issue now is: are these just teething
problems or the shape of things to come?
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This year’s tranche of standards, bought in to create a stable IFRS platform,
will have a wide-ranging impact on accounting for subsidiaries. The European
Commission’s accounting regulatory committee has already begun an investigation
into the effect IFRS is having on companies’ distributable reserves and
shareholder dividends.
The fear is that standards which bring liabilities onto the books for the
first time, could substantially reduce assets and distributable reserves to such
an extent that companies are legally prevented from paying dividends to
shareholders.
The first casualty has been British Airways. This year it is unable to pay
shareholders a dividend, despite an increase in operating profit, because its
£1.4bn pension deficit came onto the books and effectively wiped out its
distributable reserves. Food and drink manufacturer Cadbury Schweppes has also
been hit.
Chris Jackson, director of structuring services at PwC, believes that most
groups are likely to see adoption of IFRS at subsidiary level reduce
distributable reserves. So while UK company law allows firms to choose IFRS for
consolidated accounts or just for parent companies, more may stay with UK GAAP
for subsidiaries.
The standards creating most noise are IAS27, which outlines the treatment of
dividend earnings on subsidiaries post and pre-acquisition, and IAS12 on
deferred tax.
IAS27 is acknowledged as a ‘tremendous book keeping problem’ even by insiders
at the International Accounting Standards Board. It clearly states that
companies must separate the profits a subsidiary made before it was acquired and
those after.
Firms are expected to point out whether dividends are a return on capital or
a return on earnings. This could have an impact on company assets. Unfortunately
it is retrograde and applies from when a subsidiary was bought. ‘The workload is
monumental,’ says Caroline Beer, senior IFRS manager at the ICAEW. ‘It means
companies have to drill down into every company they bought and go through all
the transactions.’
The institute is currently lobbying the IASB to introduce more guidance and a
clear cut-off point of two years from when the subsidiary was acquired. The
standard is expected to return to the IASB’s interpretative committee shortly
and it does privately acknowledge that there are ‘shortcuts’.
It also concedes that with little practice, companies don’t yet know the
difference between what are ‘permissive shortcuts’ and the IASB may move to
resolve the situation.
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The standard on deferred tax, IAS12, is unpopular in the UK and ends the
practice of discounting deferred tax liabilities. It is forcing companies to
recognise higher levels of deferred tax.
Firms have to re-evaluate their assets and future tax liabilities, even when
in practice it will make little difference until the asset is sold. ‘This is
producing huge anomalies,’ warns Ken Wild, global head of IFRS at Deloitte. ‘The
standard setters really need to have a rethink about his one.’
The IASB is working on a convergence project with the US, although this may
do little to help the UK. Many of the problems with IAS27 and IAS12 appear to be
peculiarly British.
Beer says there is an increasing concern that the standards board is being
‘dominated and driven by the US’ and that the drive for global convergence has
resulted in other national standard setters ‘not being given an equal voice’.
The institute is in talks with the DTI to reclassify the definition of dis
tributable assets. Currently companies can only pay dividends if they have
positive assets on their balance sheets. Beer wants this linked to a
solvency-based system as in other countries, which should prevent cash rich
companies looking paper poor.