Archives For IFRS

Accounting standards

aksaroya —  18 March 2013 — Leave a comment

By Jane Fuller, former financial editor of the Financial Times and co-director of the Centre for the Study of Financial Innovation think tank

the city

UK politicians spent considerable time in January holding hearings on tax, audit and accounting under the auspices of the Parliamentary Commission on Banking Standards.

Having advocated electrifying the ring-fence between retail and investment banking, the PCBS has galloped onto a wide range of other subjects. Now this joint body of both houses of parliament has got to accounting standards.

Comments have been gathered via a questionnaire, published on 4 December with a 21 December deadline. Genuine users of accounts had to scramble to meet even the informal extension to early January – here I will declare an interest as I chair the financial reporting and analysis committee of the CFO Society of the UK.

It was very important that we did respond. The questions betrayed some preconceptions: ‘What was the role of accounting standards and reliance on fair value principles in the banking crisis’? ‘Fair value principles’ seem an odd way to describe an accounting model for financial instruments that is a hybrid between fair or current market value and amortised cost.

Another underlying assumption seemed to be that marking to market, or to model, would not give a ‘true and fair’ view of the value of a trading instrument. Leaving aside the point that fundamental valuation techniques rely on models, neither cost nor stale prices would be relevant for derivatives and many asset-backed securities.

The running on this issue has been made by corporate governance experts from respected UK instutions, all ‘long-term’ shareholders. They have produced a Concerns with IFRS in the EU paper that champions prudence over neutrality in the accounting, and suggests the EU should resist International Financial Reporitng Standards (IFRS), which they view as tainted by US influence.

Users of accounts who disagree must make themselves heard.

There is no contradicition between neutrality and a true and fair view – both tell it how it is in a cyclical and volatile world. Yes, judgements must be made, but why aim for something a bit worse than your best estimate?

Prudence should be located in management’s business decisions and in the judgement applied by boards, investors and regulators. But all should start with data that is as unbiased as possible. Auditors should indeed curb optimisim but pessimism is no panacea.

If the real problem is banks’ ability to absorb losses, then building up equity capital – as is happening – is the best solution. In the run up to the cirism bank balance sheets showed assets ballooning and equity suppressed. Failures of corporate governance, prudential supervision and investor oversight were far more importanct than any accounting weakness.

IFRS is not perfect. It develops in response to abuse and poor practice. IFRS 9 addresses concerns on fair value measurement and will switch the loan-loss model to expected losses, so why delay endorsement in the EU?

What is the alterantive to IFRS? A return to UK GAAP? Surely it would now have a standard for financial instruments that chimed with US GAAP. International standards are not only what the G20 wants, but users of accounts want. As for an EU version of IFRS, variation so far has been for the dubious reason of placating preparers.

Accounting standards are an odd scapegoat for the financial  crisis. Accounts provide evidence that can be used with other information – from stress test results to environmental risks – to form a picture of a company and its prospects. It is what is done with the information that matters, and long-term investors are in the best position to take a dispassionate, or a prudent view.

This article first appeared in Accounting and Business, UK edition, February 2013

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Fairytales vs fundamentals

aksaroya —  8 February 2013 — 1 Comment

By Jane Fuller, former editor of the Financial Times and co-director of the Centre for the Study of Financial Innovation think tank

Out on the cutting edge of the technology sector, the grand corporate ambitions and the eye-popping financial performance are not always built on a foundation of solid accounting stone.

 circuit board

 

The eyebrow-raising allegations of accounting improprieties levelled at Autonomy by its acquirer, Hewlett-Packard, had me reaching for my ‘spot the dog’ checklist. This refers not so much to signs of financial distress – it’s too late by then – as to the big gap between valuation and reality which sets a company up for a fall.

The trouble starts with good news. Too much of it puts management under pressure. Autonomy, the software founder whose co-founder was chief executive at the time of HP’s $11bn purchase, was a poster child for innovative technology and rapid growth. In early 2003, when the market bottomed after the dotcom bubble, its shares were trading at around £1.20. In late 2011 HP paid £25.50 per share in cash. Between 2006 and 2008, Autonomy’s sales (measured in dollars) had doubled to about $500m and its operating profit margin soared from 27% to 41%. More of the same was clearly expected: its p/e ration at the end of 2008 was about 50.

Fast forward to Autonomy’s 2010 annual report – the last before the takeover. The first thing to note is that it was still a relatively small company with sales of $870m. The second is its astonishingly high operating margin of 45%. Revenue growth had, however, slowed to 18% – and to 16% in the first half of 2011.

As with other software companies, some revenues come from customer support contracts entailing payments in advance. This raises the questions of whether certain sales have been recognised early and also flatters the cash position. The issue of ‘deferred revenue’ is set out in the annual report, audited by Deloitte, via both explanations and line items.

Critics have made much of the accounting for sales through intermediary companies, or resellers. The accounting policy section has a note on the evidence needed to recognise such a sale. It is clear that judgement is involved and collection may be complicated. As for profits, the word ‘adjusted’ should always attract questions. Autonomy is not unusual in excluding amortisation and restructuring costs. However, by the time it has counted out interest on convertible loan notes, the gap  between IFRS pretax profits and its adjusted ones of $379m is nearly $100m. This is racy, but agin the company’s approach is clear.

The most puzzling thing is the issue of the those loan notes in March 2010, raising about $760m. The main aim was a war-chest for acquisitions. But the company had net cash and appeared profitable enough to support net debt of several hundred million dollars. So why raise it at all?

Also, Autonomy’s main source of growth was supposed to be organic. As it happens it had made significant purchases every other year since 2005, leading to nearly $1.4bn of goodwill on its balance sheet. Once again the reality did not match the spin, but this was not difficult to detect.

The same can be said of Autonomy’s corporate governance. Apparently, it was classic  chief executive and FD balanced by five non-executives. But one of the latter was co-founder Richard Gaunt (not claimed as an independent) and another had been around since 1998 and should not have been regarded as independent. That left three relative newcomers to challenge the incumbents if necessary.

Maybe the investigations prompted by HPs $8.8bn write down of the acquisition price will turn up something. It did, however, pay a premium of over 70% to a price already inflated by unrealistic expectations of sales growth, apparently naive acceptance of ‘adjusted’ profit margins, and oblivious to cashflow and balance sheet issues. The technology sector is littered with such dogs and it is not difficult to spot them.  

This post first appeared in Accounting and Business UK, January 2013.

The big picture fades

aksaroya —  28 January 2013 — Leave a comment

By Romano Dzinkowski, economist and business journalist

2012 brought CFOs in the US so much to get to grips with on financial standards and mandatory auditor rotation that precious little headspace was left for strategic direction of business.

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2012 was a tough year for US corporate accountants. With heads down, eyes focused on managing risk, and more often than not buried in compliance and tax issues, there was little room for strategic growth for the finance C-suite. While most CFOs would claim their role is to be a true business partner and a critical forward-looking thinker on the C-level team, last year was full of distractions.

First, the US Financial Accounting Standards Board (FASB) issued up to 15 new exposure drafts (13 at the time of this writing) and seven freshly linked new standards. CFOs were also anxiously awaiting the final revisions to several big memorandum of understanding projects with the FASB and International Accounting Standards Board (IASB) – on financial instruments, impairment, hedge accounting, accounting for macro hedging, leases, and, last but not least, revenue recognition. Many finance folks were busy figuring out exactly what the proposals would mean for them.

Also on the standards agenda, the FASB and newly formed Private Company Council (PCC) proposed a new, simplified framework for modifying US GAAP for private companies. There was much debate on whether what many are calling a two-GAAP system would ultimately be good for corporate America as a whole. That argument continues.

Also in 2012, the coming of International Financial Reporting Standards (IFRS) was again a source of confusion for public company CFOs who would have liked some direction one way or another. An announcement regarding adoption (or not) was expected at the end of 2011, and again in 2012…but none was forthcoming. This has angered many US finance chiefs who would like a heads-up for their planning cycle and have already started going down the IFRS adoption path.

Against the backdrop of a fairly heavy accounting standards agenda came the threat of mandatory auditor rotation in the US, which many CFOs say would make their life much more complicated, not to mention expensive. The Public Company Accounting Oversight Board is now deliberating on what, if anything, it is going to do about changing the rules on mandatory auditor rotation in 2013. Currently, most votes are in the nay camp.

At the same time, COSO – the Committee of Sponsoring Organisations of the Treadway Commission – released a significant update to its original risk management framework, which many SOX 404 filers have adopted. The new model has been criticised for being prohibitively large for all but the bigger public companies with the resources to adopt it. COSO is revising the document; the hope is that the new framework will be ready for CFOs to start implementing in 2013.

So what does it all foreshadow for the role of the CFO this year and beyond? More of the same, says a recent ACCA/IMA study released in October 2012. CFOs, predicts the study, will continue to be challenged by the tug of war between their role as senior strategist and business partner and the ever-increasing demands of greater compliance,control and regulatory complexity.

This post first appeared in Accounting and Business International, January 2013.

Truly international standards

aksaroya —  23 January 2013 — 2 Comments

By Barry Cooper, ACCA President

The growth of Islamic finance brings a need for harmonising its standards with those of IFRS.

Barry Cooper-0513Towards the end of last year, I was delighted to take part in ACCA’s International Assembly. We heard from some outstanding speakers and looked at a number of key issues, including the progress being made on globalisation of standards and the increasing role played by emerging economies in the standard setting process.

These discussions chimed with a report, Global alignment, produced by ACCA and KPMG which called for consistency and harmonisation in the way in which Islamic financial institutions report, and for the International Accounting Standards Board (IASB) and the Islamic finance industry to work together to develop guidance and standards, and to educate the investor community on key issues.

It also suggested the IASB consider issuing guidance on the application of International Financial Reporting Standards (IFRS) when accounting for certain Islamic financial products; that it review the needs of the report users with leading Islamic finance standard setters and regulators; and that Islamic financial institutions should form an expert advisory group to help develop standards.

There have already been signs of progress. IASB chairman Hans Hoogervorst told the International Assembly that the IASB was considering establishing an Islamic finance advisory committee. This is an excellent start but, given the growing importance of Islamic finance, everyone involved in the sector needs to work to ensure that the sector operates to consistent and harmonised standards.

This post first appeared in Accounting and Business International, January 2013

Impaired vision

aksaroya —  7 January 2013 — Leave a comment

By Jane Fuller, former financial editor of the Financial Times and co-director of the Centre for the Study of Financial Innovation thinktank

The IASB and FASB differ over how best to switch from an incurred loss model for loans to an expected loss one. While the IASB has the ‘least bad’ option, it will be a case of seeing which works best.

Goodbye convergence, hello competition. Now that the US has backed away from adopting International Financial Reporting Standards (IFRS), the latest transatlantic duel is over how to switch from an incurred loss model for loans to an expected loss one.

As the chair of a committee responding to the plan from the International Accounting Standards Board (IASB), we felt a definite steer towards its ‘deterioration approach’. So it was hard to give the ‘lifetime loss approach’ proposed by its US peer, the Financial Accounting Standards Board (FASB) a fair hearing.

This is a pity because the FASB version appears simpler. Its ‘current expected credit loss model’ offers a single measurement objective of assessing expected losses (EL) over the life of the loan. So on day one there is no impediment to recognising any losses, whereas the IASB model entails booking ‘a portion’ effectively a 12-month horizon.

As the loan progresses, expectations are reassessed and adjustments made to the loan loss allowance. A bank that expands its lending by making more loans and/or extending its maturity will have bigger upfront losses.

Objections to this include that a day one loss is a nonsense. What management in its right mind – and let’s assume what chastened bankers are now closer to that – would lend at an immediate loss? Is it right that growing bank has to book bigger upfront losses?Is there a perverse incentive to keep loans to a short maturity?

The IASB suggest there is no reason to make a growing lender look less profitable than one in a steady state. The obvious counter is that the growing bank is more risky – and that should be reflected in the accounting.

It should be remembered that the IASB made itself vulnerable to US divergence by proposing a confusing ‘three-bucket’ approach to impairment. The deterioration model still has a trigger that switches loans from one bucket, where only a portion of EL are provided for, to another that allows the full lifetime losses. But the trigger sounds rather fussy – ‘a sufficient deterioration in credit quality’.

Forecasting full life-time losses at the outset of a loan is also fuzzy, so you have to pick which of the approaches offers better information about credit quality and is less easily gamed.

The principle should be that the accounting reflects economic reality, indeed that’s what the incurred loss model did. Banks are cyclical. They make a profit on a loan until it goes sour: the cliff edge is there. This can be anticipated with the help of experience – the EL idea – and postponed through forbearance, but it is not a smooth business.

Since the incurred loss model was used as an excuse for foot-dragging on loss recognition, the move to EL has broad support. But it should not provide an opportunity for a return to ‘general provisions’ that can later be fed back in to flatter profits.

The FASB promises that investors will receive plenty of information about changes in credit quality through the lenders’ regular reassessment of loss expectations. But this still means the analysis of profits will be done through the prism of movements in and out of the provision pool, at a remove from the actual performance of the loans.

There is a suspicion, denied by the FASB, that prudential regulators have applied pressure for more upfront provisioning. Accounting should remain neutral in this. It is bank boards, prompted by much tighter prudential requirements, that need to ensure enough profits are retained to absorb expected – and unexpected – losses.

So the IASB’s hybrid looks the least bad option. We are back in a world of competing standards, so let’s see which works best.

This post first appeared in Accounting and Business UK December 2012