Listen to this article
The FT explains the rationale behind the new accounting standards and how they are viewed and used by accountants, investors, companies and analysts. For full coverage of IFRS, plus our online discussion and poll, click here.
What are International Financial Reporting Standards?
A set of rules that tell companies what they need to show in their accounts and how the numbers are to be calculated. Also known as international accounting standards, they come in a book that runs to over 2,000 pages and cover everything from cashflow and tax accounting to derivatives and pension fund deficits.
Why is there so much talk about IFRS?
The standards have been around since the 1970s, but they have risen to prominence this year because the European Union decided to make all listed companies report under IFRS from January 1 2005.
Why did the EU decide to introduce the standards?
The move – a step toward accounting “harmonization” – is one element of the broader drive to create a borderless market within the EU. It was also motivated by a desire to protect investors better by improving the quality of the information they receive about the companies they own. “Comparability” is another driver, as a single set of accounting standards should enable investors to compare companies in different markets directly.
Who is in charge of IFRS?
The standards are set by the International Accounting Standards Board, a group of 14 experts from around the world based in London. The IASB is independent and overseen by a group of trustees, but as the organisation’s influence grows it has had to make greater efforts to improve transparency and its communication with “stakeholders”. Some EU policy-makers, however, are not satisfied that the IASB is accountable to those affected by its work.
How are IFRS different from the accounting systems they are replacing?
The EU previously contained a patchwork of different national accounting standards, many of which had their roots in taxation, regulation or law, and required fewer disclosures and less rigorous measurement than IFRS. The character of the new standards has been shaped by the fact they are written for stock market investors and aim to provide information relevant to valuing companies. One of their most controversial features is a requirement for many assets and liabilities to be shown at “fair value” – a loose synonym for market value.
What are companies saying about the new standards?
Many are not enamoured with IFRS, because the new standards reflect a vision of accounting that conflicts with their own. Most companies prefer to focus on traditional notions of profit and loss, or even just cashflow, which they say give the best representation of their “underlying” performance. IFRS introduce many so-called “non-core” items, including fair value changes, which they say could be misleading.
Companies have also complained that IFRS accounts are becoming too complex to explain to investors. Their discontent has been intensified by the time and money involved in switching accounting standards. The cost of systems upgrades, training and external advice has been substantial.
But despite their reservations over IFRS, companies continue to support the principle of harmonising accounting standards. Multinationals spend a lot of money on compiling accounts under different standards in different countries and then converting them back to home country rules. A single set of standards, once bedded down, would eliminate those costs.
What is IAS 39 and why does it get so much attention?
IAS 39 is the standard on accounting for financial instruments, including derivatives. It has become most closely associated with fair value, and some of its provisions have raised the hackles of EU banks and regulators.
In the face of intense lobbying, the EU eventually “carved out” the two most unpopular rules from the version of IFRS enforced in the EU. The rules that worried regulators have since been rewritten and are set to be reinstated, but the IASB and European banks remain deadlocked over the source of the second carve out, which is linked to banks’ use of derivatives hedges.
Are the new standards seen as an improvement by analysts and investors?
Most analysts are wholehearted supporters of IFRS. The standards provide them with much more information, allowing them to use their expertise in wading through figures and identifying and explaining those most relevant to market valuations.
Fund managers are more hesitant in offering opinions on IFRS. Even though they are presented as the prime beneficiaries of IFRS, many have not previously thought in depth about accounting standards.
The issues raised by IFRS, however, have made them realise that they should know more about accounts, and start trying to influence accounting standards. A few investor representatives have said publicly that accounts are becoming too complex, but a clear articulation of what they want from financial reporting is yet to come.
Are market regulators interested in IFRS?
Very much so, given the potential effects of accounting standards on the credibility of financial reporting and investor confidence. The Committee of European Securities Regulators, a coordinating body for national watchdogs, has emphasized that IFRS must be applied consistently if the standards are to be seen as credible.
Consistency could come under threat in two areas. First, in the interpretation of standards, which are often based on principles and give accountants considerable scope for judgement in interpreting their meaning. The big four accountancy firms are working to ensure they come up with the same answers, but are facing pressure to do things differently in different markets.
The second area where consistency is at issue is enforcement. Regulators are watching to make sure that IFRS are applied correctly, but if enforcement actions against errors begin to vary then confusion is likely to emerge about the “right” answer.