The City is preparing to crack down on unscrupulous companies that attempt to use the switch to international financial reporting standards as an opportunity to inflate earnings figures.
Fund managers are currently informing staff of what to look out for when examining new accounts prepared under IFRS, in order to root out those companies that provide misleading information during the transition to the new accounting regime.
Issues of aggressive earnings management arise from the significant amount of discretion and flexibility granted to preparers of accounts in some of the new standards, according to Iain Richards, head of governance at Morley Fund Management. The market is particularly vulnerable during this transitional phase, due to the extra concessions allowed and the lack of preparedness from the City.
But if investors are up to speed on these issues, the move to IFRS and the extra transparency it provides could reveal a lot more about a company than it intended investors to know.
‘A company’s approach to and clarity on transition is going to offer investors an opportunity to revisit and test their judgement of the board and management team,’ said Richards.
Another investor said: ‘The transition to IFRS could be quite revealing about how a company operates, so long as we keep ahead of the game.’
The issue is currently compounded by auditors’ inexperience in dealing with IFRS. ‘Clearly there is potential for companies to flatter their results,’ said Nigel Sleigh-Johnson, head of financial reporting at the ICAEW.
Market watchers are also gearing up to ensure that those companies looking to make short-term gains through IFRS do not slip through the net.
‘We are aware that the IFRS transition is quite an opportunity for a lot of choices to be made,’ said Sue Harding, European chief accountant at rating agency Standard & Poor’s. ‘These assumptions and estimations can be used to make a balance sheet look stronger, which then affects earnings.’
Harding said the agency was ‘doing a lot of training and having many discussions internally’ to prepare staff.
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