COLUMNISTS What has fair value accounting got to do with how much shareholders get in dividends? An increasing amount, it would seem.
Company law has long imposed rules limiting the size of pay-outs to shareholders to ensure that there is a pool of cash left to pay creditors.
But changes in accounting standards risk unintentionally restricting pay-outs and have helped prompt growing suggestions in Europe that we should overhaul the entire basis of the capital maintenance regime, simplifying the requirements – and potentially freeing capital for distribution to shareholders.
At the bottom of all this is the fact that the rules regarding what can and cannot be paid out are based on published accounts and depend on net profits.
Some countries, including the UK, have gold-plated this to distinguish between realised profits – roughly cash, or clear legal entitlement to it – or unrealised, which cannot be included in the pay-out pool.
When this was all first drawn up decades ago, it matched the accounting focus, which was more on a company’s profits and therefore the income statement. More recently, accounting standards have shifted towards the balance sheet and valuing assets at their “fair”, or market, value and recording the changes in worth through either income, or equity.
The use of fair value has only increased with the introduction of IFRS. In addition, more items such as pensions have appeared on the balance sheet.
To make the balance sheet balance, the addition of the pension fund has to be matched elsewhere and in this case, it is through equity, providing a direct hit to distributable reserves.
So what is to be done? Everyone agrees creditors must have protection. But a number of accounting groups think shifting to tests based on a company’s solvency, rather than its accounting profits, would be a better reflection of corporate reality.
A paper from the Fédération des Experts Comptables Européens, a grouping of European accounting bodies, puts this view, suggesting use of a “snapshot” balance sheet or “net asset” type test and also a forward-looking exercise based on sufficiently certain projections over at least a year.
But why aren’t companies leading the calls for change? For starters, it is hideously technical, which deters all but the most dedicated.
The ICAEW, the UK’s leading professional accountancy body, recently spent a lot of time and 129 pages to come up with revised guidance on the topic.
And companies have long managed to get around any problems caused by the rules with what lawyers like to call “legal technology”.
In this case, there is a tried and tested route involving a new holding company, a share-swap for existing shares and some other steps to give the company more headroom to distribute dividends.
It works, but it is clunky. It also causes headaches for analysts who might think a company is close to the wire in what it can pay out, only to find that there is plenty to go round.
The European Union commissioned KPMG to do a feasibility study into the issue, which concluded – 442 pages later – that the system is not a real barrier to companies. This suggests the door is closed, but officials have hinted that should someone be able to show reason for making the change, the topic could be reopened.
In many respects, a change can be justified from the simple standpoint of being simpler and clearer – this issue is a money-spinner for those dedicated few who truly understand the details.
Linking it to the debate about the merits of fair value accounting might seem somewhat left-field, but the anti-fair value crowd are growing ever more strident, and anything that suggests the concept is causing problems, rightly or wrongly, will be grist to their mill.
