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The Financial Stability Forum’s recently published 100 Day Plan calls for urgent improvements in financial reporting for off-balance sheet vehicles and fair value accounting. Ken Wild and Veronica Poole review this and other significant developments in the international financial reporting arena.

International Financial Reporting Standards (IFRS) are now used for public reporting in over 100 countries, ranging from Australia to the United Kingdom. Other countries are expected to follow in the next few years including Chile (2009), Korea (2009), Brazil (2010) and Canada (2011). By 2011, a clear majority of the largest global companies could be using IFRS. Furthermore, with the International Accounting Standards Board (IASB) planning to issue a final IFRS for Small and Medium-sized Entities by the end of 2008, in the near future many companies without public accountability may be applying a consistent set of accounting standards based on IFRS.

Even across the Atlantic, IFRS is more of a topic than ever before. The Securities and Exchange Commission (SEC) last year approved a rule that eliminated the requirement for foreign private issuers using IFRS to reconcile to US GAAP. The SEC has announced it is now considering whether to permit US companies to use IFRS and a proposing release to this effect is anticipated in the next couple of months. We believe it is not really ‘whether’, it is a case of ‘when’.

Two years ago, the IASB acknowledged that those companies that adopted IFRS in 2005 had undergone a period of enormous change. To provide a period of stability, the Board therefore made a commitment not to require the adoption of new Standards or major amendments to existing Standards before 1 January 2009. Nevertheless, the intervening period has seen the issue of a number of Interpretations and minor amendments and, as we approach 2009, there are more significant changes on the horizon. In addition, the effect of the ‘sub-prime contagion’ and a belief by some that accounting standards have contributed to this global credit crisis mean that any period of stability seems well and truly over.

G7 response to turbulence in the financial markets

In October 2007 the G7 Finance Ministers and Central Bank Governors asked the Financial Stability Forum (FSF) to undertake an analysis of the causes and weaknesses that have produced the recent turmoil in global financial markets and to set out recommendations for increasing the resilience of markets and institutions going forward. The FSF has now published its report, which has been strongly endorsed by the G7. It has prioritised specific recommendations for implementation within 100 days, thereby placing significant pressure on the IASB.

The ‘100 Day Plan’ calls for urgent action to improve the accounting and disclosure standards for off-balance sheet vehicles and to enhance guidance on fair value accounting.

The FSF report states that the period of market turmoil and illiquidity highlighted the importance to market confidence of reliable valuations and useful disclosures of the risks associated with structured credit products and off-balance sheet entities.

The FSF has recommended that the IASB: -addresses the difficulties associated with valuing financial instruments when markets are no longer active; and -works with other standard setters towards international convergence of the standards on derecognition and consolidation on an accelerated basis.

The pressure is on. So, how is the IASB planning to respond to the demands being made under this ‘100 Day Plan’?

There is a sense that the IASB is being bombarded by often conflicting demands for prompt action without consideration for the Board’s operating practices and due process. Consolidation and derecognition issues have been on the Board’s agenda since mid 2003 with a view to developing control criteria for all types of entities within a single Standard.

While the IASB acknowledges that this agenda item has become increasingly important, with a particular need to review current accounting for securitisation transactions, the current timetable envisages the publication of a discussion paper in the second half of 2008. This hardly addresses the G7’s call for urgent action.

A quick fix?

There may be an immediate fix through additional disclosure. Over the past few months IASB staff have been analysing financial statements, meeting with representatives from investment banks and accountancy firms and assessing statements from regulators about what they perceive to be good practice and good disclosure relating to consolidation. It is likely that any revisions in this area will still require careful judgement to determine whether control exists but additional disclosure requirements will bridge the current information gap between deciding whether an entity is on- or off-balance sheet.

Where the control decision is difficult, management will be required to explain how they reached their decision and the effect of deciding whether to consolidate or not. This is likely to result in changes to IFRS 7 Financial Instrument Disclosures, a recent Standard which many companies have been grappling with for the first time over the last few months.

At the same time the IASB is working with a panel of valuation experts on issues of measuring financial instruments in illiquid markets. However, many at the IASB see the current credit crisis as a banking business model problem rather than an accounting standards problem and believe that possible alternatives proposed recently in the financial press (such as rolling averages or directors’ valuation) inhibited transparency and would not help capital markets. They would hide the true position rather than enhance understanding.

Investors’ perspective

This sentiment is one shared by the CFA Institute Centre for Financial Market Integrity, which represents the views of professional investors. In a recent press statement, Kurt Schacht, managing director of CFA, stated that the widespread use of fair value measurement would ultimately play an important role in improving market discipline and transparency, as well as assist in making more informed risk management decisions.

The CFA Institute Centre believes that current debate about the need to ‘rollback’ or revisit fair value is a misguided effort on behalf of preparers that would ultimately result in less transparency and market integrity. In its view, maintaining the current mixed attribute model for reporting financial assets and liabilities has enabled more complacent risk management and has contributed to the lack of market discipline identified by regulators.

The CFA Institute Centre strongly supported the IASB’s recent discussion paper, published in March, on Reducing Complexity in Reporting Financial Instruments. This paper is the first step in responding to the widely held view that the existing requirements for the reporting of financial instruments are difficult to understand, interpret and apply. It concludes that the long-term solution is a single measurement principle for all financial instruments within the scope of a standard and that ‘fair value seems to be the only measurement attribute that provides relevant information for all types of financial instruments’.

IFRS and US GAAP/b>

Consolidation, Derecognition and Fair Value Measurement are all projects on the roadmap for the convergence of IFRS and US GAAP, as set out in the 2006 Memorandum of Understanding between the IASB and the Financial Accounting Standards Board (FASB).

The Memorandum of Understanding set a number of goals for 2008, either as short-term convergence or joint improvement projects. These are major challenges but one should not underestimate progress already made. Significant milestones include the publication in November 2006 of IFRS 8 Segment Reporting, with the objective of reducing the differences between IFRS and FASB Statement No.131 Disclosures about Segments of an Enterprise and Related Information. The Standard proved controversial within Europe but was finally endorsed by the European Parliament in November 2007.

The start of the year saw the completion of the second phase of the Business Combinations project with the publication of the revised IFRS 3 Business Combinations and IAS 27 Consolidated and Separate Financial Statements. This was a joint project undertaken with the FASB.

There are some significant changes to IFRS in this area, including:

-a greater emphasis on the use of fair value; -a focus on changes in control as a significant economic event; and -a focus on what is given to the vendor as consideration, rather than what is spent to achieve the acquisition, leading to greater volatility in profit or loss.

However, it is the US Standard, FASB Statement No. 141 Business Combinations, which has undergone a considerably more extensive revision.

The two Boards are currently assessing their progress to date and developing a work plan for completion of a number of projects that are part of the convergence agenda. Their key objective is to ‘outline the improvements to existing IFRS that are needed to facilitate mandatory adoption of IFRS in all major capital markets’.

For those capital markets that have not yet adopted IFRS, the target date for mandatory adoption is no later than 2013 with the assumption that a ‘quiet period’ of at least a year before that date will be provided. That leaves a period of three years to tackle a number of projects ranging from:

-those which address ‘fundamental deficiencies’ in IFRS (revenue recognition, fair value measurement, consolidation and derecognition); to -areas in need of ‘significant improvement’ (financial statement presentation, post-employment benefits, leasing and financial instruments); to -short-term convergence projects on earnings per share, joint ventures and taxes.

Bearing in mind that it took 18 months to take the Business Combinations project from Exposure Drafts to final Standard, the IASB certainly has its work cut out. In Europe the process of endorsement of IFRS presents a further challenge, although the recently amended IAS regulation calls on the Commission, the Council, and the European Parliament to act speedily to ensure that IFRS and interpretations are adopted in a timely manner.

Conclusion

The movement towards IFRS as a single set of globally accepted accounting and financial reporting standards will entail challenges. The convergence of accounting standards may be relatively easy compared to coordinating the variety of cultural differences and perspectives involved in interpreting and applying IFRS. For multinational companies ensuring that IFRS is applied in a globally consistent manner instead of as an amalgam of local versions may involve significant efforts around the creation of policies, the modifications of systems, and the training of personnel. Only if a common financial reporting language is achieved in practice will investors and other interested parties be able to examine and compare companies in a transparent and equal way.

Ken Wild is Global Leader for International Accounting Standards with Deloitte in the UK. Veronica Poole is Centre of Excellence Leader, Deloitte UK.