International Financial Reporting Standards

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International Financial Reporting Standards

  1. 1. International Financial Reporting Standards The quest for a global language KPMG LLP (UK)
  2. 2. The quest for a global language 1 Contents Foreword Richard Bennison 2 Overview Robert Bruce 4 Philip Broadley 8 Peter Elwin 12 John Hegarty 16 Robert Herz 20 Archie Hunter 24 Kenneth Lee 26 Ken Lever 28 Cees Maas 32 Baroness Noakes 36 Richard Reid 38 Sir David Tweedie 42 © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  3. 3. 2 The quest for a global language Foreword Richard Bennison Head of Audit KPMG LLP (UK) The introduction of International Financial Reporting Standards (IFRS) in over a hundred countries across the world has without doubt marked one of the biggest revolutions in financial reporting in living memory. For such a fundamental shift, progress has been perhaps surprisingly smooth. There have been no major disconnects and the financial world appears to have adapted successfully to its new reporting language; indeed we have seen no major volatility in the capital markets as a result of IFRS. However, there is still much to do and much to consider, as the views expressed in this report reflect. Whilst IFRS has brought greater comparability and consistency in company accounts across borders, this is only in relative terms. Reporting in each country still bears the hallmarks of its previous national GAAP . Beyond this, a frequent observation is that IFRS has brought a considerable amount of complexity to financial accounts. Some of this complexity is inevitable as the transactions that the business world undertakes have themselves become more complex. Much of the change has been the far greater degree and complexity of disclosures that companies are now required to make. As a result, many annual reports have become almost unmanageably large and this vast amount of information in many cases needs a highly trained user to understand it. We have to question whether this is best serving the needs of shareholders and the analyst community, who after all should be the ultimate beneficiaries of any improvements to financial reporting. The financial reporting community globally – standard-setters, regulators, accounting firms, preparers, users - needs to find a way of stripping back this complexity, and of ensuring that sound accounting principles are allowed to drive reporting, without the need for dense disclosure notes or a narrow rules-driven approach. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  4. 4. The quest for a global language 3 Much will depend on the development of the convergence programme between IFRS and US GAAP US standards are much . more rules-driven – so will we see a continued drift in IFRS towards the current US approach? I sincerely hope not. Recent signs have been very encouraging. The SEC has made positive announcements about the possibility of dropping the reconciliation requirement between the two sets of standards. And it has even suggested that it may consider allowing US companies to choose which standards they report under. This movement towards concerted international cooperation and joint working is extremely timely. We are entering a crucial next phase for IFRS, in the movement towards a truly global financial reporting language. It is an opportunity to produce shorter standards based on principles. But this will need preparers and auditors to exercise judgement and integrity. I am confident about what can be achieved - provided a focus is retained on serving the needs of the users of financial accounts. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  5. 5. 4 The quest for a global language Overview Robert Bruce Leading commentator on accounting and financial reporting issues. The aftermath of the first year of implementation of International Financial Reporting Standards has confirmed that what has happened is a ‘once-in-a-generation’ transformation of the business landscape. Company reports are at once more complex but more comparable. The number of countries embracing the use of IFRS has produced a global tipping point in favour of the system. The accounting walls are coming down all around the world. The old provision that companies from elsewhere round the world wishing to list on US stock exchanges had to reconcile their figures to the US GAAP system looks to be on the way out. The once impregnable system of US GAAP no longer looks quite so secure. Even the US regulator, the Securities and Exchange Commission, is talking of the possibility of US companies using IFRS, if they so wish, in the foreseeable future. This report focuses on the experiences and thoughts of those involved in this historic transformation. The views expressed in this report come from the main players in the changes which have happened. The views have come from CFOs, from regulators, from standard-setters, from analysts and auditors. They reveal the depth of change experienced. They reveal the opening up of global markets as a result of having, at last, a truly global accounting language. They reveal how companies have coped with the challenges of what, at least at first, appears to be a much more complex financial reporting process than before. They show quite how worried people within the business are about those complexities. But it also documents the way in which narrative reporting is developing as a means of showing strategic corporate change and making performance measurement clear. They also emphasise the scale of feeling between those who would like to see a more principles-based process and those who see a rules-based system as inevitable. The process of moving to IFRS has not simply been a series of technical accounting changes. It has been a cultural transformation as much as an accounting one. The views expressed in this report show just how fundamental the changes in corporate and accounting attitudes have been. And it is clear that, once the dust has settled, businesses all around the world will find that though the detail has become more complex their strategic objectives can be more simply achieved. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  6. 6. The quest for a global language 5 The scale of the transformation The transformation of the business landscape has been the greatest change of them all. ‘IFRS has been a revolution’, said Robert Herz, chairman of the US standard-setter, the Financial Accounting Standards Board. ‘In many places capital market reporting didn’t exist before. The figures were produced for a tax-based system, for example. The changes have been exactly what the capital markets needed’. ‘Analysts and investors now have the ability to look at figures across the board and get the same answers’, said Sir David Tweedie, the chairman of the International Accounting Standards Board which brought the revolution about. ‘IFRS is implemented in over a hundred countries. In five years’ time it will be 150 countries. The accounting risk is beginning to disappear’. ‘An investor should be looking at the world as investable’, said Ken Lee, head of accounting and valuation research for Europe with Citi Investment Research. ‘At the moment that’s not the case. IFRS has made a significant contribution to start that process’. ‘In essence it’s done what it said on the tin’, said Peter Elwin, head of accounting and valuation research with JP Morgan Cazenove. ‘There is greater comparability and more disclosure, and that is particularly true on the continent of Europe and across Asia’. And it has shone a light into places where lights had tended not to have been shone before. Some of these simply emphasise quite how fundamental a change IFRS has brought about. ‘The biggest change we have seen with the implementation of IFRS has been the introduction of accounting for financial instruments which in most countries was not previously done at all’, said Tweedie. ‘Things which could destroy earnings had previously been invisible’. Cees Maas, honorary vice-chairman at the Netherlands-based financial services giant, ING Group, summed it up from a banking perspective. ‘Our reporting has changed fundamentally’. ‘Without doubt there is a greater use worldwide of IFRS for financial reporting by public interest entities’, said John Hegarty of the World Bank. ‘Increasingly the default position globally is that IFRS should become the benchmark for countries’ financial reporting frameworks’. But such a huge change has also, inevitably, brought greater uncertainties, at least for the time being. ‘The old certainties have changed’, said Archie Hunter, chairman of the audit committee at the Royal Bank of Scotland. ‘The concept of “substance over form” used to be embedded but we haven’t got anything to replace it’, he said. And these initial changes have brought despair to some. ‘Financial statements have exploded in length and become unintelligible’, said Baroness Noakes, chairman of the audit committee at Hanson plc. The perils of complexity It is clear that the perception of greater complexity is also changing the way people view financial reporting. ‘Financial reporting is getting much more complex’, said Ken Lee. And as a result: ‘It is very difficult to get a definitive grasp of what is happening’. And it is clear that this complexity has initially created problems within the corporate world. ‘It has added complexity to reporting, increased the use of fair values and it is less connected to the operation of the business’, said Ken Lever, finance director at engineering group, Tomkins plc, and chairman of the financial reporting committee of the influential 100 Group of UK finance directors. This, for him, is the biggest change. ‘Financial reporting is not that helpful internally to the management of the business. Most people in the old days felt happy that the data used to manage the business was the same as that used to produce the external financial reporting. Now there is a clear disconnect between the information used to run the business and the information we report externally’. ‘There is a lot more information in the accounts and in some businesses you need to pull the accounts apart more’, commented Richard Reid, chairman of KPMG’s consumer and industrial markets practice in the UK. ‘It hasn’t’, said Elwin, ‘become easier to understand the underlying business’. And there is a lack, at present, of the old intuition. ‘Understanding requires familiarity’, said Hunter, ‘and both users and preparers have not yet got that familiarity. Previously we could look at the figures and say: “Hold on, there’s something wrong here”’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  7. 7. 6 The quest for a global language The future lies in narrative reporting People may disagree about the underlying reasons. But the growing belief that narrative reporting is the way forward to increase understanding of a company’s performance and strategy continues apace. Some argue that it is due to the complexity which IFRS is perceived to create. ‘Complexity is leading to a greater use of narrative reporting’, said Philip Broadley, group finance director at financial services giant Prudential and chairman of the 100 Group of UK finance directors. Herz would disagree. ‘It’s not the complexity of IFRS’, he said. ‘Businesses are complex and numbers on their own are never going to tell the full story. Narrative reporting is a vital complement to the figures’. And the standard-setters are trying to encourage its use. ‘We want people to use non-financial narrative reporting’, said Tweedie. ‘It’s essential. The accounts don’t show what is going to happen next’. Analysts agree. ‘I would prefer a company to explain, for example, if IFRS has produced a counter- intuitive result’, said Elwin. ‘You will always want managements to give their view of the world outside accounting constraints’. Baroness Noakes is another who sees it as inevitable. ‘The drive towards non-financial information was happening anyway’, she said. ‘Accounts don’t give you enough answers about performance or clues about future performance’. Lever agreed. ‘Financial standards and financial reporting weren’t ever really intended to give investors a view of how the company will go forward over time. Accounting was never ever set up to do that’, he said. ‘It was set up for a stewardship purpose’. Principles or rules Another argument has come to the fore as IFRS became the chosen financial reporting system for much of the rest of the world except the US. This was the debate over whether principles-based or rules-based standards should prevail. IFRS is clearly designed as a principles-based system. For Sir David Tweedie it is a no-brainer. ‘It is quite clear that outside of the US there is an abhorrence of US standards’, he said. For him it was clear that accounting was reaching a crucial time. ‘It is a tipping point’, he said. ‘I hope the principles- based approach will gain the upper hand. Certainly that’s what we are intending to try’, he said. ‘If we lose it now then we will be rules-based’. The problem lies in the US. ‘The US can be unnecessarily prescriptive’, said Lever. ‘But that is the nature of the country. It seems they have their whole lives driven by rules’. But there were doubts. Cees Maas said he was very much in favour of principles-based standards. ‘But I see a tendency that rules- based standards will gain the upper hand’, he said. And part of this was the effect of the added regulatory responsibility that everyone in business was being asked to take. ‘Rules­ based standards are very bad’, he said, ‘but they are the consequence of being held accountable’. ‘In the end I suspect that it will move to a compromise with rules-based systems in the ascendant’, said Baroness Noakes. ‘But I say that with great reluctance. In the end there is not enough genuine desire for a principles-based view outside the UK’. For Tweedie one of the key issues was the attitude of the large audit firms. ‘We are going to the firms asking them to use much more judgement and don’t ask for exceptions’, he said. ‘Firms should look at the principles and look at their answers’. In the end his ruling principle was a simple one. ‘You can work these out for yourselves’. The fight over fair values Fair values is another issue which raised people’s blood pressure. For Philip Broadley it should be a short debate. ‘Their role is to report the value of assets and liabilities where there are deep and liquid markets’, he said. ‘The end’. To do more was to muddle the whole process. ‘Annual reports are for stewardship and they are not valuation statements’, he said. Peter Elwin agreed. ‘The market does not want a full fair value model’, he said. ‘Investors and analysts do not want the balance sheet to simply give you the market cap. That’s completely bonkers’. ‘I think fair value is nice in theory but hugely complicated in practice’, said Baroness Noakes. ‘In a manufacturing company like ours it can lead to total confusion’, said Ken Lever of Tomkins. ‘Fair value information will be useful’, said Richard Reid of KPMG © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  8. 8. The quest for a global language 7 in the UK. ‘But you have to be careful in putting it into income statements and whether people will understand it’. For Sir David Tweedie the answer was to use fair value where appropriate. ‘What we have is a mixture of costs and values on a balance sheet’, he said. ‘The message is that it is not true that we want to put everything at fair value’. The electronic future of financial reporting and XBRL The issue of electronic reporting languages like XBRL and other technology solutions in financial reporting divided opinion. Peter Elwin said he was ‘deeply sceptical’ about XBRL. ‘I have enough experience of data systems to know there is a huge potential to go off the rails’, he said. ‘XBRL looks very desirable. But all it is really doing is saving me the hard graft of digging out the detail myself. It doesn’t change the way the numbers were produced in the first place’. Likewise Philip Broadley of Prudential said that: ‘It would simply increase the possibility of manipulation’. But Robert Herz of FASB was an enthusiast. ‘Once you can tag data and disassemble it that could change things’, he said. ‘Narrative reporting and financial reporting becomes easier with tagging’, he said. ‘Turnover? Would you like to see the six different components of turnover? Click! And so on’. ‘It will be a facilitator’, said Lever. ‘XBRL is just like a giant spreadsheet for data. It is a good thing. But it will take time to get there’. What the future priorities should be The future priorities of the standard-setters should be short, clear, and reinforce the idea of IFRS as the one global financial reporting language. ‘The key point is stability in standards’, said Richard Reid. ‘The more the standards can reflect the economic substance the better’. ‘The priority continues to be how do we get to the overarching goal of creating common high quality reporting across the major capital markets of the world’, said Herz. ‘The immediate goal should be the re-wording of these standards at a fraction of their length’, said Broadley. ‘Simplification is the primary goal’. ‘Let the dust settle’, said Cees Maas of ING group. ‘Let’s see how best market practice will develop’, he said. ‘Freeze’. ‘I think the IASB has to continue to recognise that it is only one player in the process of improving financial reporting and that if accounting standards get too far ahead of other drivers it will fail and the IASB will cease to be the real option’, said John Hegarty. ‘Then countries will start to do their own thing. And that is not always going to be done by the good guys’. Opinions were divided over the idea of an underlying conceptual framework. ‘The most important issue is that the conceptual framework should be agreed and in place’, said Ken Lever. ‘It cannot possibly take ten years to do this. You need a conceptual framework as the base. Currently you are winging it as you go along’. ‘It sounds totally simplistic but we need to know where we are going before we start meddling further’, said Ken Lee. ‘We need a conceptual framework which is as short as the Ten Commandments, not as long as the Old Testament’, said Peter Elwin. But others were not so sure. ‘The conceptual framework takes us into intellectual byways which are not too relevant to the practicalities of reporting’, said Baroness Noakes. ‘It is better to understand what we are currently doing and bed it all down without major change’. But for Sir David Tweedie the real priority is ‘to try and hand back accounting to the practitioners’, he said. ‘We need to get the standards to reflect what people feel intuitively and we need them to be in simple language’, he said. ‘Accounting is not an alien language and it’s not rocket science’. For him simple judgement is what is needed. ‘For example’, he said, ‘why do we need two categories of leases? A pension fund deficit is a deficit. Why should you smooth it? We need to cut through the garbage and provide the raw facts. And that is where narrative reporting comes in. Provide the raw facts and now explain it’, he said. ‘The narrative statement is not an adjunct. It is a key component. That’s where the future is’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  9. 9. 8 The quest for a global language Philip Broadley Philip Broadley has been Group Finance Director at Prudential, the international retail financial services group, since 2000. Influential in the finance director community he is Chairman of the 100 Group of finance directors in the UK and is a member of the insurance advisory group of the International Accounting Standards Board. For him the experience of implementing international financial reporting standards has brought greater overall disclosure. ‘The most notable way in which financial reporting has changed is that while the volume of information disclosed on the face of the financial statements has not really changed, what you notice is that if you compare an annual report and accounts for 2005 with previous years it has become a much larger document’. This is one of Broadley’s central themes. For him the purpose of financial reporting should be explanation rather than just information. But he also stresses that everything he says about the experience of IFRS should be underpinned by his support and optimism for the whole process. ‘Any criticisms I have are made from the standpoint that the goal of IFRS has been a good thing’, he emphasised. Care required For example his answer to a question about whether he sees greater comparability of financial reports becoming a reality is unequivocal. ‘I do’, he said. ‘The benefit of greater disclosure is that for those who are geared up for it the ability to analyse a company is greater than ever’. But that doesn’t mean to say that it is simpler and easier. ‘Care is required by users to recognise that there is often more than one way of reporting comparatively similar activities’. He compares it to the concept of introducing one language across many countries. It might sound the same but you would have to factor in the cultural differences which would make the meaning subtly different country-by-country. The same, he thinks, is true of IFRS. ‘Emerging in year two of IFRS is a realisation that it is the same language applied to different cultures’, he said. ‘And the cultural differences do not disappear overnight’. Like much in the IFRS process he thinks that the right path is being followed but it will take much more time for the real effects to come through. ‘I’m a great believer in the markets’, he said. ‘At the level of the very largest companies you do see a levelling out of differences and greater depth of information over time’, he said. ‘Over time IFRS will provide impetus towards that commonality’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  10. 10. The quest for a global language 9 © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  11. 11. 10 The quest for a global language As for how far IFRS has helped users to gain a better idea of a company’s strategy he is currently unconvinced. ‘I am not sure much has happened yet to help with understanding corporate strategy’, he said. ‘One area where the IASB would create real value-added work would be a standard around narrative reporting similar to the existing UK standard RS1’. And he is an enthusiast for narrative reporting, particularly as IFRS does allow more non- GAAP measures and as greater complexity drives finance directors to a greater reliance on narrative reporting. ‘IFRS has led to a greater use of non-GAAP measures’, he said. ‘IFRS is very permissive. It is only where you come back to national laws that you have guidance about whether you should give equal prominence to non-GAAP or GAAP measures. There is much greater use of non-GAAP measures now’. ‘At the level of the All this leads to difficulties in getting the message across. ‘Complexity is leading to a greater use of narrative reporting’, he says. ‘Narrative reporting is essential for the very largest generalist portfolio manager’. It is very easy to assume that the only people in the analyst community for whom you are providing information are the number-crunchers. Broadley companies you do takes a wider view. ‘Imagine a typical UK fund manager with between thirty and forty see a levelling out of stocks in the fund and a similar number again on which he has to have a view’, he says. For someone like that the niceties of the technical arguments over IFRS are no use. ‘The differences and amount of information we provide doesn’t help him’, said Broadley. ‘He himself will find it greater depth of harder and will find the annual report and accounts a much less useful tool’. This is where greater narrative reporting would be much more useful. information over He felt that, up to a point, companies and analysts had shared objectives for financial time…IFRS will reporting but had taken very different routes towards influencing the standard-setting provide impetus process. ‘The objectives for we preparers is to provide information which is useful to investors to make the market in the company’s shares as efficient as possible. But that is towards that not the same as saying that our job is to provide analysts with answers. Our job is to commonality.’ provide them with information. Analysts want information so they can complete their work’. Stronger engagement Broadley, in his role with the 100 Group of UK finance directors, is no stranger to the arguments over how to influence the process of standard-setting. Analysts, as a user group, have complained more than most about not having the influence they feel they deserve. ‘Get involved early is the answer to influencing the standard-setting process’, said Broadley. ‘There is a desire to hear from users’. But often it is the collective organisation of a particular community which counts. And it is generally accepted that this hasn’t worked to analysts’ advantage. ‘They are more difficult, it seems, to get a hold of’, he said. ‘Some users are not as geared up as, for example, the Big Four audit firms, or preparers or the 100 Group’. He urged people to make more effort. ‘Recently there has been stronger engagement from the user community. There is more that investors could do to produce what they want’. When it comes to the way that the interpretation process for IFRS has developed Broadley is wary. ‘There is an anxiety over the hierarchy of the organisations seeking to provide comment’, he said. At this point in the process of IFRS implementation when the various regulatory organisations involved are still trying to work out a modus vivendi, or are simply jockeying for position, it can be problematic. ‘There is uncertainty on the part of preparers and their auditors on the relative standing of all the organisations commenting on how IFRS is interpreted’, he said. He worries about the role of the auditing firms acting as interpreters. ‘At the moment’, he said, ‘and it may improve, the ability of preparers to take a principles-based approach is to some extent limited by the audit firms’ reluctance to allow a principles-based approach’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  12. 12. The quest for a global language 11 And there are political considerations. ‘The convergence between IFRS and US GAAP is not between IFRS in the EU and US GAAP’, he said. ‘It needs to be understood that IFRS has been adopted in a hundred countries worldwide and not just 27 in Europe’. There is also the confusion about where the US regulator, the SEC, stands in the pecking order. ‘If the SEC provides an interpretation what status do these comments have?’ he asked. But he is optimistic about the process. ‘I am very positive about the speed and range of developments’, he said, ‘I like the idea of US companies being able to adopt IFRS themselves, for example. The very notion of that being discussed is a huge step forward and is a great boost for the whole project’. His view is that the change in US attitudes is part of a wider change which will be beneficial to the IFRS process. ‘It does seem to be linked to a broader project about the scope of financial competitiveness in the US’, he said. ‘It’s all very encouraging’. But the attitude of the SEC towards how companies from outside the US have implemented IFRS will be crucial. ‘I have a slight concern that UK companies have seen comments in language couched around “justify what you have done?” rather than “how have you followed the principles?” We need to see comment letters showing an understanding of the . principles which have been followed’. Like many, Broadley worries there may be a significant difference between announced policy and actual implementation at bodies like the SEC. ‘At leadership level an understanding of the importance of principles is true but it needs to be communicated down to the individuals who are examining the accounts’, he said. ‘These individuals now need to be trained to understand the principles involved’. On the whole issue of the different approaches of principles-based rather than rules-based standards he is optimistic. ‘I hope that the principles-based approach will gain ground’, he said. ‘It does appear there is a desire to do this. Standards would be much shorter and a rules-based approach just provides people with a way of navigating around them’. Explanation not just information He is less convinced that technologies like XBRL have yet found a place in the financial reporting world. ‘It is a question of what should the frequency of reporting be?’ he said. He is a strong supporter of EU internal market commissioner Charlie McCreevy’s oft-repeated view that quarterly reporting will not be introduced in Europe. ‘It would simply increase the possibility of manipulation’, said Broadley. ‘Let’s fix half-yearly reporting first’. And the concept of XBRL, with its ability to pluck figures from a set of accounts and compare them with those from another company, doesn’t fit with the Broadley approach. ‘Accounts should be for explanation rather than information. You need to report what management thinks, not just the numbers. I’d rather focus on getting the narrative reporting right than follow the XBRL approach’. It is down to the culture again. ‘Will XBRL information from a company in Malaysia say the same thing as the information from a company in France?’ On the question of what role there is for fair values in IFRS he is blunt. ‘Their role is to report the value of assets and liabilities where there are deep and liquid markets’, he said. ‘The end’. To which he added his view that ‘annual reports are for stewardship and they are not valuation statements’. As for the future priorities of standard-setters, he is equally clear. ‘The priority should be to make things simpler’, he said. ‘Standards have been developed over a long period of time. The immediate goal should be the re-wording of these standards at a fraction of their length. Simplification is the primary goal’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  13. 13. 12 The quest for a global language Peter Elwin Peter Elwin is Head of Accounting and Valuation Research with JP Morgan Cazenove, (Cazenove Equities), and is also a member of the UK Accounting Standards Board and the Corporate Reporting Users Forum. ‘In essence’, he said of the experience of the first year of IFRS, ‘it’s done what it said on the tin. There is greater comparability and more disclosure, and that is particularly true on the continent of Europe and across Asia’, he said. ‘There are some significant advances in the way things are being accounted for. There is a lot more information, for example on pensions accounting or expensing stock options, than under the old local GAAP systems’. For him there are two negatives. The first has been the change in the UK from a well understood UK GAAP system to the new IFRS. ‘In the UK IFRS has been a slight step backwards in some respects’, he said. ‘Analysts regard the treatment of associates and discontinued operations as less helpful, and the format of the cash flow statement is less prescriptive than before which has resulted in a lack of clarity in some cases.’ The second negative is odd results from the IFRS system which can appear counter-intuitive to preparers and users. ‘You do tend to get more “funny” numbers’, he said. ‘Some of the standards produce numbers which CFOs shake their heads at and say “Why have we produced that and what for?”’. ‘But on balance’, he said, ‘it has been a significant positive’. Greater comparability As for the possibility of greater comparability he has a simple answer. ‘It’s actually there’, he said. ‘It has been a significant advance. For example, in the past if you took a Hong Kong company and tried to compare it to a similar one in Malaysia and Singapore you would have significant difficulties, but you are now able to make much more sensible comparisons.’ Has it become easier to understand the underlying corporate strategy and results? ‘The simple answer’, he said, ‘is no. It hasn’t become easier to understand the underlying business’. But it has made a difference in understanding other things. ‘Local GAAP didn’t identify the risks and allowed companies to flatter their performance’, he said. ‘IFRS is much better at revealing the risks. It is very good at forcing companies to own up to liabilities. That is where the improvements have come. But overall it is no more revealing on corporate strategy than the old local GAAP’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  14. 14. The quest for a global language 13 ‘Where IFRS has produced oddities is in specific businesses, or with esoteric issues’, he said. ‘And a lot of it is related to the requirement to use fair value where the previous GAAP did not. There are potentially large numbers moving through the accounts which analysts sometimes find hard to understand’. There has also been a boost to the use of non-GAAP measures. ‘It has definitely encouraged non-GAAP measures’, he said. ‘It has encouraged companies to explain the underlying issues. And that is an issue. It is not a failing of IFRS as such but it highlights the issue of mixing operating and non-operating information in the performance statement’, he said. ‘It is helpful if companies do use non-GAAP measures. I’m quite a fan of that’, he said. ‘It is management saying how they would prefer to do it this way. It can be useful, particularly where the sector follows the same line, like, for example, property companies’. But there is a downside. ‘The risk is that you start getting earnings before bad stuff and we have had a bit of that. Whenever people are swamped by information they tend to take things as read and not be as critical as they should be’. ‘In the past we have As for the idea that the complexities of IFRS are forcing companies to rely more on narrative reporting, Elwin said that ‘the reality is that it varies. Some businesses are more had a serious problem affected by different aspects of IFRS and so they find ways of explaining the underlying performance of the business. That’s not a bad thing’, he said. ‘I would prefer a company to in that investors just explain, for example, if IFRS has produced a counter-intuitive result. You will always want haven’t engaged in managements to give their view of the world outside accounting constraints’. the standard-setting He also feels that companies and analysts have broadly shared objectives. ‘It does seem to process at all.’ me that some standards start out from the standpoint that companies are dishonest and they have to get them to stop doing something’, he said. ‘But fundamentally most CFOs are people of integrity and want to tell it how it is. It is all about telling the story, so that analysts and investors can get a sense of what management have done with the capital entrusted to them, and thus develop a sense of where will things go in the future.’. Investor engagement But there are problems in getting the investment community’s views across. ‘In the past we have had a serious problem in that investors just haven’t engaged in the standard- setting process at all’, he said. ‘They tend to say “I have got something to do at this precise moment which will help me and my company and so I don’t have time to look at a conceptual framework today” That remains the mentality’, he said. ‘It is only now with IFRS . that they have sat up and looked at strange figures, and now they are trying to make more effort through groups like the Corporate Reporting Users Forum’. ‘It has been difficult to get all groups to talk together, though that is changing’, he said, ‘and the IASB is getting better at going out to talk to them. But the IASB still tends to go out in preaching mode rather than listening mode’, he said. ‘We are all going through a big change process and that’s never easy’. He sees risk in the interpretations process. ‘I follow interpretations much less than I do the main standards’, he said. ‘The risks are that interpretations create rules which in turn create inflexibility. Groups will need interpretations where there seem to be divergent treatments, but it creates risks’, he said. ‘The other risk is local interpretation bodies creating rules on a national basis. It all needs to be organic rather than prescriptive’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  15. 15. 14 The quest for a global language © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  16. 16. The quest for a global language 15 He is also lukewarm on the idea of convergence. ‘I’m not a huge fan of convergence’, he said. ‘Comparability is really useful. But it doesn’t bother me that some companies are doing both US GAAP and IFRS. The differences are not enormous and they can be understood. And you could bring the two regimes closer together and remove the more arbitrary differences’, he said. ‘The problem is that the practicalities of the convergence project can confuse users and preparers if they don’t understand the benefits. The new segmental reporting standard is a good example. It is effectively a US standard imported into IFRS and it has worked perfectly well in the US, but the IFRS standard which preceded it was fine, so that value of changing from one to the other is not immediately obvious. In the short term we will probably find that one or two more US standards are adopted into IFRS because of a political trade with FASB and not because it is better accounting’, he said. ‘The longer term benefit to everyone will be a credible set of standards which the US authorities acknowledge are equal in stature to US GAAP .’ As for reconciliation? ‘Reconciliation is a political issue for the SEC and a cost that only a few companies choose to suffer’, he said. ‘The SEC has always said that US GAAP is the gold standard. So it is hard for it to change. But it could do so overnight. So do we need the convergence project and if we do converge will the SEC remove the reconciliation requirement?’, he said. ‘The convergence process has potentially negative outcomes for companies and investors in the short term. And it is a benefit for relatively few companies’, he said. ‘The convergence agenda determines what the IASB does for the next few years. There are real issues which it could be focusing on and it can’t because it is doing convergence’. Catch-phrases He suggested that the arguments over principles-based standards or rules-based standards were ‘partly a catch-phrase debate’. ‘Really what people mean is that we want standards which are easy to understand and relatively low cost to apply and which provide results which show the underlying reality of a company’s results’, he said. ‘It depends on expecting people to exercise judgements. You will end up with a degree of difference while best practice improves’, he said. ‘You get a marketplace in ideas’. On the value of XBRL and other similar technology he is ‘deeply sceptical’. ‘I have enough experience of data systems to know they have a huge potential to go off the rails’, he said. ‘XBRL looks very desirable. But all it is really doing is saving me the hard graft of digging out the detail myself. It doesn’t actually change the way that the numbers were produced in the first place. I will still need to go back to the company for explanations. We will always have to have some sort of annual report where a company has to tell its story’, he said. ‘It all comes back to communication. XBRL could be helpful at the margins but I am not sure the benefits outweigh the costs’. Fair value is another concept which he is sceptical about. ‘”Fair value” is a phrase which frustrates me’, he said. ‘It is very hard to argue against a fair value. It’s “fair” I prefer other . terms for the concept that explain exactly what is being calculated’. ‘The market does not want a full fair value model. Investors and analysts do not want the balance sheet to simply give you the market cap’, he said. ‘That’s completely bonkers’. He felt that, as a priority for the future, standard-setters should return to practical and pragmatic matters. ‘Their priorities are being distorted by convergence’, he said. ‘What they ought to do is go and ask users what they want. What standards aren’t working? And where are new standards needed? And what do they cost? And then they simply should go about sorting out those issues. That would keep them busy for the next ten years’, he said. And as for creating a conceptual framework? ‘We need a conceptual framework which is as short as the Ten Commandments, not as long as the Old Testament’, he said. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  17. 17. 16 The quest for a global language John Hegarty John Hegarty is Manager, Financial Management, Europe and Central Asia, for the World Bank. He comes to the implementation of IFRS from a different standpoint. One of his roles is to help emerging and developing economies to get to grips with IFRS, both the implementation and consequences. He feels that IFRS itself has been highly successful but around many countries of the world there is still much to be done. ‘I think 2005 was a very important date for listed companies in the EU’, he said, ‘but there are many other countries where IFRS is being introduced. Without doubt there is a greater use worldwide of IFRS for financial reporting by public interest entities. There is a recognition amongst countries around the world that they will move towards IFRS’, he said. ‘Increasingly the default position globally is that IFRS should become the benchmark for countries’ financial reporting frameworks’. But, from the standpoint of Hegarty’s work with the World Bank in emerging and developing economies, there are considerable problems when you move away from the old established financial reporting systems. ‘There is increased recognition of just how difficult it is to switch to IFRS’, he said. ‘Difficult though it is, the political decision is relatively easy, but the practical challenges of implementation are enormous’. Internal capacity Where a country’s accounting infrastructure is not as strong or as well-established as elsewhere there is another problem. ‘Many of the entities do not have the capacity to deliver IFRS implementation internally’, he said. ‘Looking at a large number of IFRS statements in emerging or developing markets there are strong signs that companies are heavily reliant on their audit firms for the production of the statements’. At the time of this interview Hegarty was looking at how the system was working in Azerbaijan, where IFRS is now a legal requirement for public interest entities. ‘We are going in to look at the financial reporting plumbing of these enterprises because the use of IFRS is now the law. And we are finding that managements have no idea what had been in past IFRS statements prepared to comply with contractual obligations, for example under loan agreements. “We got the auditors in to do that” they say’. And now, faced with the , challenge of truly embedding IFRS, the scale of the task going forward is dawning upon them. ‘Suddenly they are realising the millions required to implement the IT systems, for © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  18. 18. The quest for a global language 17 example. And they are realising the consequences for them as management in standing by the statements’, he said. ‘Previous “transformation” exercises, whereby external advisors converted local GAAP financial statements into IFRS have given people a very misleading impression of what is required to implement IFRS, and the costs. The experience in Europe post-2005 provides evidence of how expensive this is, how long it takes, and how much expertise is required in-house’. He is equally worried about the issue of comparability. ‘Certainly the appearance of comparability has improved a lot’, he said. ‘But it is aided by the fact that the financial statements audited by firm A have very similar disclosure wordings and so do the financial statements audited by firm B, and so on. There is a lot of boilerplate creeping in’. This is also creating a divide between genuine understanding and responsibility and the actual figures themselves. ‘You certainly don’t get the impression that the board and the management stand behind these statements because they wrote them. The appearance of comparability may be greater than the substance’, he said. And the strength of the old domestic standards still lingers. ‘German pharmaceutical companies will be more like German car companies than they will be like French pharmaceutical companies’, he said. ‘The actual differences remain. We have to be realistic and accept that all of this won’t work perfectly from today. It will take time’. ‘If IFRS is to be a In the countries with which Hegarty is dealing the issue of non-GAAP measures is less than elsewhere. ‘In a lot of our countries IFRS has not encouraged a greater use of non-GAAP global standard does it measures’, he said, ‘because the enterprises don’t fully own the messages in IFRS and so they don’t feel the need to supplement the figures’. not mean that it would have to slow down to Communication measures He didn’t think that IFRS complexity was motivating companies to put more effort into let the rest of the narrative reporting. ‘This is not the case in the countries I am dealing with’, he said. ‘But it world catch up?’ should be. We have promoted a tool which is very, very complex. But we are not seeing other communication measures being used.’ In these emerging and developing economies things will change. But it will be slow, and dependent on a true IFRS culture taking hold. ‘Without good communication equity markets will not develop’, he said. ‘IFRS is a good thing but the supporting market forces are not yet developed. IFRS is a necessary pre-condition for creating these markets, but not sufficient on its own’. The same is true of the role of analysts. ‘The analysts in these countries generally work for providers of debt finance, which frequently impose IFRS under their loan covenants’, he said, ‘and so for these companies the use of IFRS will be for compliance reasons rather than communication. They see themselves as takers of standards rather than shapers’, he said. ‘The IFRS process tends to be remote from these companies. Probably the only serious discussions they will have had will have been with their auditors. And the local auditors will probably only be communicating the message from a technical department elsewhere’. In such economies the whole issue of interpretations of IFRS is very different. ‘This is an issue which is raised with us a lot by local accounting bodies’, he said. ‘I have a feeling that the impression has risen in the market that only the Big Four firms are plugged into this process. There is a feeling that local accounting bodies do not have access and so are not able to participate’. Hegarty regrets this. ‘If the defining characteristic of a profession is that it is a public marketplace of ideas then you have to conclude that the IFRS interpretations are being carried out in private’, he said. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  19. 19. 18 The quest for a global language On the issue of convergence he is wary of the politics. ‘The impression I get is that IFRS and US GAAP convergence has given rise to political difficulties in Europe’, he said. ‘Convergence has become a major determinant of what goes into IFRS and so decisions are seen as being made in a non-public way as far as the EU is concerned’. He is encouraged, though, by what is happening in US regulatory circles. ‘The SEC seems to be saying that they are not looking for standards to be identical before they drop the need for reconciliation of IFRS statements to US GAAP That suggests they could live with the . differences’, he said. ‘And that has to be a good thing’. Like many people Hegarty ‘would like to see principles-based standards gain the upper hand in the long-term’. ‘But we need to be realistic about the pre-conditions’, he said. ‘It needs highly-trained preparers, users and auditors capable of making these judgements in a sound way. There is a need for regulators to be firm but also to hold back to allow judgements to be applied’, he said. ‘And we would need to be very clear as to who gets to make the final judgement. One party has to say “this is the answer we are going with” And . that’s not fully worked out yet. I don’t think we have finalised enough of these details on an operational basis yet’. Rest of the world There is also a question of the different speeds at which expertise and experience are gained. ‘If IFRS is to be a global standard does it not mean that it would have to slow down to let the rest of the world catch up? The UK is readier than the US to adopt a principles- based system. And both are readier than Tajikistan’, he said. ‘Standards don’t stand alone. But although we are not quite there yet the principles-based approach is absolutely where I would like to get’. When asked what roles there were for fair values he was clear. ‘For people on the international conference circuit there are good roles’, he said. ‘It keeps them all talking’. He was more sceptical. ‘There are issues about the auditability, reliability and suitability of fair values’, he said. ‘There are many people who feel that fair values have an information value but as to whether they should be the primary measurement basis there are a lot of people out there who are quite nervous about it’, he said. ‘People perhaps exaggerate the issues to set up a straw man’. As for the future priorities of the standard-setters he pointed to several. ‘I think that it is clear that IFRS should be used for public interest entities’, he said. ‘But that leaves other organisations which need something else. There is the question of meeting the needs of the SME sector’, he said. ‘Standard-setters need more explicit agreement on what entities need what standards’. He also reiterated his concern that standard-setters were getting too far ahead of other parts of the equation, like regulators, for example. And he thought there were dangers ahead. ‘I think the IASB has to continue to recognise that it is only one player in the process of improving financial reporting and that if accounting standards get too far ahead of other drivers it will fail and the IASB will cease to be the real option’, he said. ‘Then countries will start to do their own thing. And that is not always going to be done by the good guys’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  20. 20. The quest for a global language 19 © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  21. 21. 20 The quest for a global language Robert Herz Robert Herz is Chairman of the US standard-setter, the Financial Accounting Standards Board, and is a key player in the programme working towards convergence between IFRS and US GAAP . While IFRS has obviously had very little impact on US companies directly, the convergence project off the back of the IFRS implementation programme has. And Herz has also keenly observed the IFRS experiences elsewhere. ‘Changes in US reporting have been partially impacted by our convergence project’, he said, ‘which is taking flight’. But it is elsewhere that the real changes are taking place. ‘In other parts of the world IFRS has been a revolution’, he said. ‘In many places capital market reporting didn’t exist before. The figures were produced for a tax-based system, for example. The changes have been exactly what the capital markets needed’. Closing the GAAPs He also praised the growing comparability of financial reports. ‘Over time it will make a huge change’, he said. ‘We are getting down to only having a few GAAPs in standards across the world’s markets. Before IFRS you had a hundred different GAAPs. Now we are down to a small number. There are still differences but those differences will get significantly less over time as more countries come into the IFRS fold’, he said. ‘It is a painful process. But in the space of six or seven years we have got hundreds of different approaches down to three or four. Within those there are still alternative treatments. But going ahead there will be less. And all this adds up to more comparability’. He also felt that IFRS had improved understanding of underlying economic realities. ‘IFRS versus other national GAAPs is clearly superior’, he said, ‘particularly the statutory-based ones. If you are in the world of global investing the ability for comparing major companies, for example across the US, UK and Switzerland, is vastly improved. IFRS is a good portrayal of the underlying economic realities, as is US GAAP and as was UK GAAP before’, he said. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  22. 22. The quest for a global language 21 He was understanding of companies which used non-GAAP measures. ‘Non-GAAP measures get done for two reasons’, he said. ‘One good, one bad. The good reason is that the company is trying to communicate how it looks at things. The bad one is that sometimes it can be used to obfuscate – “I want to paint a picture which isn’t the right one. I want to look six foot tall when I am actually only five foot eight”’, he said. ‘It’s inevitable that different companies will have different ways to look at themselves’. He suggested that once the output of the joint financial statement presentation project between FASB and IASB comes on stream ‘we will have a much richer and fuller display of the company’s financial position, its cash flows and its operating results. It will be a better vehicle for the company to tell their story’, he said. He was not surprised at the growing popularity of narrative reporting but didn’t think that it was the perceived complexity of IFRS which was driving it. ‘It’s not the complexity of IFRS’, he said. ‘Businesses are complex and numbers on their own are never going to tell the full story. Narrative reporting is a vital complement to the figures. We have had it here in the US for many years with our Management Discussion and Analysis reports’. On the subject of how far companies and analysts had shared objectives he felt that they shared some. ‘But there are strong differences too’, he said. ‘They have a shared objective of trying to provide as faithful as possible a picture of the business. The differences come because companies tend to report how they see it while analysts are trying to compare one company to another. They need a good basis for benchmarking by comparisons’. ‘You are getting a lot It was also a question of different attitudes. ‘I still think that a lot of managements say “I’m going to report from my point of view and when things are out of my control, like market of ‘IFRS as adopted forces for example, I’m not going to report that. But analysts will want to know that’, he said. ” in…’ phrasing, and Getting involved that’s a concern.’ He felt analysts could have more say in the standard-setting process simply by putting more effort in and ‘by getting more actively involved, as the preparers are’. In the US he felt this was working better than elsewhere. ‘We have more and more of it here in the US’, he said. ‘We have created a group of technical and expert accountants who work in the investment industry to advise us, for example. The CFA, the Chartered Financial Analyst Institute, has developed a comprehensive approach. All of this has been extremely helpful’, he said. ‘We have developed it to a much higher level here than what is going on in the rest of the world’. On the question of interpretations he was clear. ‘My overall sense is that the IASB is trying to balance lots of demands for interpretations while avoiding what we have here in the US, where we have too many interpretations’, he said. ‘That frustrates people but it may be the right strategy. There is a tendency that instead of thinking about the principle involved people simply say: “Give me an answer”’. He said that the convergence programme was going well and that the SEC was handling the issue of IFRS well. ‘I think that the SEC staff is trying to follow the roadmap to convergence’, he said. There were three points. ‘First, we continue on the convergence programme. Second, on the question of the understandability of IFRS to US investors, I get the feeling that they can handle IFRS. They are not viewed as that different’, he said. Where he felt there were problems was in the differences between different regimes and countries. ‘The difference in consistency of application is a problem’, he said. ‘The EU mandated a carve-out of the financial instrument standard and other parts of the world have carved out other standards. You are getting a lot of “IFRS as adopted in…” phrasing’, he said, ‘and that’s a concern’. Nevertheless he expects the SEC to lift the requirement for a reconciliation between IFRS and US GAAP ‘My guess is that the SEC will recommend to lift . the reconciliation requirement in either 2008 or 2009’, he said. ‘But preferably for people who have adopted full IFRS and not the “as adopted in…” versions’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  23. 23. 22 The quest for a global language © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  24. 24. The quest for a global language 23 This raises the possibility of even more startling developments. ‘There will be a question in the US’, he said. ‘Some companies will say “Why can’t I adopt IFRS?” That’s a tough . question to answer. Some people feel it’s time to set a deadline here in the US to move to full IFRS, just as Canada has set a deadline’. On the debate over principles-based standards versus rules-based standards he said he was ‘somewhere in between’. ‘I don’t like the words “principles-based”’, he said. ‘I like “outcome-based” Tell me what the outcome should be, and maybe I’ll need some rules at . times, but make them consistent with the outcome. “Outcome-based” makes the objectives much clearer’, he said. ‘In the US we are setting principles in the standards and beginning to use bold-facing. And on all the major areas we are working on now, we are working with the IASB so hopefully they will be more principles-based’. He was enthusiastic about XBRL and the use of such technology. ‘The big question over all of this is if XBRL really takes off and gets driven down into companies’ internal reporting systems what influence would that have on IFRS’, he said. ‘You could have a core set of financial standards and then a set which are technology-driven’. This raises other questions. ‘Should the financials just be framed for the shareholders, or all the capital providers?’, he said. ‘The answer could lead to differences in financial accounting. Once you can tag data and disassemble it that could change things. Narrative reporting and financial reporting becomes much easier with tagging’, he said. ‘Turnover? Would you like to see the six different components of turnover? Click! And so on’. “Current” value He dislikes the term ‘fair values’. ‘I call it current value’, he said. ‘Fair value is an emotive term’. But he feels the issue has to be worked through. ‘There is a place for current values’, he said. ‘People would like to understand what the current value of things are. But others would like to stick to historical cost-based accounting. Again with technology it may be possible to do both’. There will be much discussion of this. ‘We have launched a global debate with the IASB over measurement in accounting’, he said. ‘I may have my model but the important thing is to have that debate’. As for what the priorities of standard-setters now ought to be he sticks to his core belief. ‘The priority continues to be how do we get to the overarching goal of creating common high quality reporting across the major capital markets of the world’, he said. ‘That’s the path we set out on and that’s the path we’re going to stick to. My vision has always been this’. On a wider point he suggested that the regulator community also needs to play a role. ‘Standards are only part of that vision’, he said. ‘It is a key ingredient but there is also regulation, quality control, common auditing standards, audit reporting and enforcement. All of these lag behind the standard-setting’, he said. ‘The regulators are behind, but also beginning to pick up the pace. That’s good because they are a key part of the overall programme’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  25. 25. 24 The quest for a global language Archie Hunter Archie Hunter is Chairman of the audit committee of the Royal Bank of Scotland Group as well as Chairman of the Macfarlane Group and a past-president of the Institute of Chartered Accountants of Scotland. He sees the changes which IFRS have brought about as ‘pretty fundamental’ and notes that the process is taking time to bed down. ‘It’s taking people a great deal of time to become familiar with it’, he said. ‘Conceptually the change is OK but we are talking about a whole new accounting framework and it’s very different’. The old certainties have changed. ‘The concept of “substance over form” used to be embedded but we haven’t got anything to replace it’, he said. ‘That is a big one for us’. He sees comparability of financial reports as a goal which is a bit distant yet. ‘The hope is that we will see comparability, in time’, he said. ‘But when IFRS was introduced, companies applying it for the first time had choices. These choices had to be categorised in accordance with IFRS and the application of those choices, for instance categorisation of assets, has deferred comparability. As a prize comparability is a little bit further down the road’. Dealing with the unfamiliar Nor does he think that it has yet made it easier to understand the underlying corporate strategy and results. ‘I think these have not become easier to understand’, he said. ‘Understanding requires familiarity and both users and preparers have not yet got that familiarity. Previously we could look at the figures and say “hold on, there’s something wrong here” It is more difficult to have that comprehension at the moment. But that is now. . In time, the hope is that difficulty will be overcome with experience’. In the meantime other measures need to be taken. ‘Non-GAAP measures have to be used’, he said. ‘The volatility is being stripped out and given explanation in the narrative. For example, movements in investment properties which are now in the profit and loss instead of reserves’. It has meant that more non-GAAP explanation needs to be used. ‘You have to have more narrative reporting to explain these volatilities’, he said. ‘And if you don’t explain there is a charge of lack of fair presentation. Even so, there is a real prospect too that the less than fully informed reader would not pick up some of the impact on earnings’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  26. 26. The quest for a global language 25 He felt that companies and analysts had shared objectives here. ‘Both are striving for understandability’, he said. ‘They can and must have shared objectives and it is very important we work to find common ground’. And he felt that others could help. ‘The Big Four accounting firms have a bit of a role here’, he said. ‘Their experience could be very helpful. They have as much first-hand experience of corporate reporting as anyone. They could identify areas of non-comparability, for example’, he said. ‘and help to promote consistent application and disclosure’. He also felt the Big Four firms should put more effort into the issue of interpretations of IFRS. He felt that at present, after a year of experience, the whole area of interpretations was ‘a bit ad hoc’ and was evolving ‘with difficulty’. ‘This is territory where the Big Four firms could have a very constructive role to play’, he said. He thought that the issue of convergence was worth pursuing if it produced results which were not compromises. ‘I think convergence is something to be sought as long as what we get is principles-based and qualitatively sound and is not a compromise’, he said. ‘The difficulty is that in the US environment it is probably quite difficult to see how they could survive without rules. We should be striving for convergence as long as it is based on principles’. Reconciliations In the meantime the largest companies will have to continue to reconcile their IFRS figures with US GAAP ‘At present reconciliation is quite a big task for some organisations and . probably of little value. Reconciliations tend not to be used by analysts on either side of the water’. And the SEC continues to seek clarification on the way that non-US companies are using IFRS. ‘The SEC does a pretty sound critique’, he said. ‘They are challenging companies. They want an understanding of IFRS and they are asking a lot of questions so they have that understanding’, he said. ‘They seem to have been very responsible and thorough and it is heartening now to hear of their intention to adopt IFRS which will in time overtake the need for reconciliation’. ‘We would like to He returned to the debate on whether principles-based standards or rules-based standards would prevail. ‘What we would like and what we are likely to get are very different things’, see principles he said. ‘We would like to see principles-based standards but if we want convergence it is triumph. But…it’s difficult to see how principles will survive. It goes round in a circle. It is hard to see where the compromise will lie’. going to be a trade for On the role of technology in financial reporting he felt that ‘XBRL does have a value’. ‘It is the people involved.’ not life-changing at this time. We will have more online disclosure’, he said. ‘It’s bound to develop that way’, he said. ‘Where it will go, for example like real-time accounting, I don’t know yet. It is not changing the outputs at the moment’. The extension of the use of fair values gives him some concern. ‘As of now fair value has been introduced and familiarity will aid understanding. Extension raises questions over consistency of measurement. The fundamental is that the concepts meet the needs of users and preparers. I’m sceptical about extension’. He would like standard-setters to make principle-based standards their main priority. ‘We would like to see principles triumph’, he said. ‘But we know that rules are necessary in the US environment. It’s going to be a trade for the people involved. The priority should be to get the best answers from financial reporting rather than compromises’, he said. ‘But it’s going to be a hard one’. © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.
  27. 27. 26 The quest for a global language Kenneth Lee Kenneth Lee is the Head of Accounting and Valuation research for Europe with Citi Investment Research. His view is that IFRS arrived at a benign point in the economic cycle and so it is hard to truly see what the real effects have been. He made three initial points. ‘It is still very early days’, he said. ‘We hear a lot of people talking about IFRS as a “very easy win” IFRS arrived at a time . when corporate performance was good, when earnings numbers were strong and when cash flow was healthy. And that’, he said, ‘really affects the context of financial reporting’. But having said that he emphasised that one of the results was that analysts had ‘certainly seen better disclosure across Europe’. And his third overall view was that ‘financial reporting is getting much more complex’. And as a result: ‘It is very difficult to get a definitive grasp of what is happening’. Asked whether he thought the great goal of comparability of financial reports was becoming a possibility he was enthusiastic. ‘I think it is already a reality to some degree’, he said. ‘For example, take pension cost disclosures across Europe. They are reasonably comparable now whereas there was significant divergence before. Pan-European reporting generally is much better’. But he added a caveat. ‘The challenge to comparability is that IFRS gives an awful lot of choice. For example, accounting for joint ventures under different methods transforms them. The balance sheet, cash flow statements, profit and loss are all completely different’. Despite this the goal was in sight. ‘Overall’, he said, ‘we are on the right road for comparability’. Technical complexity He is unsure whether it has become easier to understand the underlying corporate strategy and results. ‘It is complex’, he said. ‘On the one side there is a comprehensive suite of rules across Europe and that surely means it is easier to understand. But they are very complex and we are still getting used to them. And there are technical things that the market doesn’t understand’, he said. ‘Ultimately it will become more familiar but it takes time’. And in the meantime companies have to try to make themselves understood and non-GAAP measures have often become the answer. ‘Some companies have had to provide alternative profit measures which could be compared to their history’, he said. He was unsure of whether this was nudging companies towards a greater reliance on narrative reporting. ‘I don’t have any evidence of that’, he said. ‘I am not sure how much analysts actually use narrative reporting. People talk to me about the technical bits, not © 2007 KPMG LLP a UK limited liability partnership and a member firm of the KPMG network of independent member , firms affiliated with KPMG International, a Swiss cooperative. All rights reserved.

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