UK listed companies have been grappling with the transition to IFRS for a long time.
However, an important milestone is imminent as, all across Europe, listed groups are considering the form and content of their first interim reports published under the new standards.
But they face a dilemma because there is more than one approach that can be taken in delivering their first IFRS interims, their contents and disclosures. For some companies, finalising their approach is now a matter of urgency. Although there is an international standard on interim reporting (IAS34: interim financial reporting), its use is not mandatory.
The Transparency Directive, which was approved by the European Union last December, will require compliance with IAS34 at least up until the half-year report. However, this does not need to be incorporated into UK law until 2007.
UK listed companies have a degree of choice about how 2005 interim results are presented. They may follow IAS34, which is perhaps what investors and analysts expect, but they don’t have to.
There may be advantages from not adopting IAS34. For example, the board might believe that the company’s accounting policies will change between issuing its interim report and its annual financial statements for 2005.
Or they might want to apply standards that have not yet been endorsed for use in the EU, but which they expect to be so by the year-end. Issuing an interim report under IAS34 and then changing accounting policies would require extensive disclosure. If the interim report is prepared according to a ‘basis of preparation’, and it is stated in the report that it has been prepared that way, the policies can be changed more easily.
But there is a potential pitfall for companies that want to highlight the change to IFRS in their interims. If a company’s interim report is described as ‘complying with IFRS’, it must comply with all the requirements of IAS34.
On the other hand, it might be considered confusing for a listed company not to mention that the results are based on a different accounting framework. Finding suitable wording will require considerable care.
Form and content
IAS34 permits a company to publish full primary statements (with a complete set of notes), condensed primary statements (with selected notes), or something in between. The decision about how much information to publish is a particularly important one for the boards of companies adopting IFRS for the first time.
This is not the time to be frugal with disclosures. It is vital that the transition to IFRS is explained clearly – there is already evidence that financial markets react adversely if the impact of the transition is not understood. This means that investors and analysts might (and probably will) expect more information to be included in the first IFRS interim report than in future periods.
Are companies ready to deliver all of this information? The Financial Services Authority is clearly concerned.
In October 2004, it announced that listed companies would have longer to publish their first interim reports under IFRS (120 days instead of the usual 90 days, provided the market is informed if a company wishes to do this), but this was followed in April 2005 by a reminder that any failure to submit interim results within the required timescale would be likely to result in the suspension of the company’s shares.
The UK Listing Rules require that an interim report is prepared in accordance with the accounting policies applied in a company’s most recent financial statements, except for any changes the company expects to make in its next financial statements.
Therefore, if a company expects to apply IFRS accounting policies in its next annual financial statements, the interim report should be prepared using the same policies. This raises an interesting question for listed groups that are to adopt EU standards. How should they approach standards that are not yet endorsed?
Strictly speaking, EU-listed companies are not required to prepare financial statements in accordance with IFRS. They are actually required to apply accounting standards adopted for use within the EU.
These are substantially the same thing, but as IAS39, which deals with financial instruments, highlighted last year, the EU does not necessarily endorse everything that emerges from the International Accounting Standards Board.
If the EU is considered unlikely to endorse a standard or interpretation that conflicts with EU-endorsed IFRS, the company is unlikely to be permitted to apply it in its annual financial statements and so cannot expect to do so. For example, this might be important for companies affected by IFRIC 3, ‘Emission rights’ – there is a possibility that this interpretation may not be endorsed in its current form.
Where a standard or interpretation is expected to be endorsed before the year end, it can be applied in the interims (although there should be disclosure of the possibility of a change in accounting policy before the year end). An important example is the recent amendment to IAS19, ‘Employee benefits’, which will permit companies to recognise actuarial gains and losses directly in equity. It seems likely that this amendment will be endorsed in the near future.
This potentially creates an interesting problem. What if a company wants to apply the amended version of IAS19 before it has been endorsed, but also wants to apply the carved out Euro-version of IAS39? The report would comply with neither IFRS, nor accounting standards adopted for use within the EU. This again highlights that boards must think carefully about how interim reports are described.
Recognition and measurement
One of the basic principles of interim reporting is that items should be recognised and measured in the same way as at a year end. Hence, adjustments are not made to ‘smooth’ the effects of seasonal revenues or uneven cost profiles; events in a later interim period are not anticipated in an earlier interim report.
This principle has some important implications. As more items are measured at fair value under IFRS, there will need to be more re-measurement if an interim balance sheet is to be prepared in a similar way to a year-end balance sheet. This may be straightforward in some cases – IAS34 recognises there will be a greater use of estimates at an interim date – but there may be practical problems, for example, where a company has a defined benefit pension plan.
Neither IAS34 nor IAS19 specifies how frequently the assets and liabilities of a defined benefit plan should be measured. However, in order to avoid an interim evaluation, IAS19 requires that the impact of any actuarial gains and losses since the last valuation is expected to be immaterial.
This may be the case where a company follows the ‘corridor approach’ and recognises only a small proportion of actuarial gains and losses. It will be more difficult to reach such a conclusion where these gains and losses are recognised in full. A company following this approach may need to obtain a valuation at each interim balance sheet date.
Judging by the few first-quarter reports issued to date, no consensus yet exists about how to describe a company’s approach to IFRS. Clearly ‘best practice’ will develop over time, but at the moment UK boards have some important decisions to make if they don’t want to fall foul of the regulator.
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