Link: IAS special report
Last year, the member states of the European Union joined a growing list of countries, now numbering more than 90, that will either require or accept International Financial Reporting Standards (IFRS) for the purposes of financial reporting by 2005. Substantial time and investment will be spent on preparing for the 2005 deadline, but the potential of long-term sustained economic benefits certainly justifies this short-term disruption.
As with any major change, the move to IFRS by 2005 poses challenges.
To be IFRS compliant by the 2005 deadline in Europe, companies will need to prepare comparatives for 2004 as well. With the third quarter of 2003 nearly complete, the time to prepare is now.
Switching to international accounting standards will require companies to invest in new systems, and to explain the differences in financial reports due primarily to changes in accounting practices. This is a process that should be well under way, and should include company directors and management, auditors and IT specialists. Regulators and tax authorities should also consider the change to IFRS, particularly regarding the application of tax policy.
Indeed, IFRS will transform the basic infrastructure underpinning Europe’s capital markets and provide impetus to Europe’s effort to unite its many national markets. For companies, it should expand the pool of potential investors, bringing down cost of capital, and reduce the expenditure needed to consolidate the accounts of their subsidiaries.
At the same time, EU investors will be more readily able to understand the financial statements of companies outside their home jurisdiction.
The economic result should be a more efficient allocation of capital, leading to increased economic growth in Europe.
The impact of Europe’s decision extends beyond its borders. A source of frustration for many companies in Europe wanting access to US capital markets remains the requirement to reconcile their accounts to US generally accepted accounting principles (GAAP).
By signing up to international standards, Europe has provided momentum for, and should benefit from, the convergence process initiated last year.
Last September, the US Financial Accounting Standards Board (FASB) and the IASB agreed they would eliminate existing differences between US GAAP and IFRS through a short-term convergence project. The two boards are working closely together and changes to bring about convergence are being made in both US and international standards.
It is our joint hope that many of these differences will be eliminated by 2005 and nearly all by 2007. This would remove the need for the reconciliation requirement.
Securities regulators throughout Europe are already coordinating efforts to ensure standards are enforced in a consistent and rigorous manner.
This is essential to achieving a common financial market.
The Inland Revenue and other tax authorities should re-examine their increasing reliance on the accounts provided for investors in the capital markets. The direction that the IASB is taking is towards ‘tell it as it is’ accounting, meaning an increasing reliance on fair values, when those values can be determined reliably.
It is the IASB’s belief that these values provide the most transparent picture of a company’s financial health. However, governments and tax authorities may question whether it is good fiscal policy to tax gains and losses on market values that are real and reflective of the company’s health, but have not yet been realised.
The IASB is keen to make the transition to international standards as smooth as possible, and to minimise the disruption that the change may cause for affected parties. The IASB has recently issued its first entirely new standard, IFRS 1 (first time adoption of international financial reporting standards), which provides guidance on how companies should implement IFRS.
To give companies adequate time to implement new systems and establish comparative numbers, IASB will also complete the set of standards required for 2005 adoption by March 2004. This package of standards will include, by December, the improvements of 14 of the 34 standards that the IASB inherited from the IASC.
By next March, the IASB will have finished new standards on share-based payment, business combinations and the first phase of its insurance project.
Of course, work will continue on other projects as well, including pensions.
But to stabilise the platform for those adopting international standards from
2005 it will postpone the effective date of any standard issued after March 2004 until at least January 2006, while permitting earlier application by entities that wish to use them.
This is certainly a tight timetable. But much of the framework is already in place, and the IASB’s decisions are publicised. Therefore, the vital preparatory work can be done. In many ways, UK companies are in a better position than their European peers. The UK has a strong accountancy tradition and a set of accounting standards that are widely recognised as being of high quality.
The UK Accounting Standards Board (ASB) was actively involved with the IASB’s predecessor, and has continued to attach importance to alignment with international standards. As a result, UK and international standards are already similar in many ways.
In the coming months, attention will focus on the challenges facing Europe, as the EU prepares to adopt international standards in 2005. Some will complain about the costs of changing systems, some will question the value of being part of a new global infrastructure, and some will worry about loss of sovereignty.
But despite such concerns, the move makes sense. The UK is part of an increasingly integrated global economy, and its prosperity depends upon inward and outward capital flows to facilitate investment and promote economic growth. Adopting international standards will remove a hurdle in the way of developments that offer the prospect of benefits for the UK investor and for UK business as a whole.
- Sir David Tweedie, chairman of the International Accounting Standards Board.
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