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International Financial Reporting Standards
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International Financial Reporting Standards
1. International Financial Reporting Standards The challenges facing business A DV I S O RY © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG , logo and name are trademarks of KPMG International.
Foreword The biggest change in financial reporting for a generation is coming to its first stage of fruition. The adoption of International Financial Reporting Standards Mike Rake (IFRS) in financial statements in 2005 will be the result of years of discussions Chairman, KPMG International and negotiations – at times contentious – between standard-setters, regulators Senior Partner, KPMG LLP (UK) and industry. Soon, the real business of adoption begins and financial reporting in Europe will enter a new era. We are delighted to present here the views of a range of top industry figures on what the real impact and implications of IFRS will be. It makes fascinating reading, and it is clear that there are still many different views on several key issues – including the timing of IFRS, the hotly–debated standards on derivatives and financial instruments, and, crucially, the extent to which the capital markets will understand the changes to financial statements that will inevitably arise within the accounts of listed European companies. But one point of consensus does, I believe, ring through - these standards must be made to work. Failure is not an option. IFRS is a major step towards the ultimate goal of having one common accounting language across the world. Many companies still have much work to do in order to successfully implement IFRS, and to effectively communicate the changes to analysts and investors. It will inevitably take a little time for IFRS to 'bed down' and be properly understood - but, in the end, I am sure that their introduction will prove to be a landmark along the path towards a more integrated, more transparent and more comparable global business community. By increasing the comparability of financial statements, IFRS will ultimately play a fundamental role in rebuilding confidence in the capital markets. Uniformity of accounting has to be a hugely positive step forward - for companies, investors, analysts and markets alike. Mike Rake Chairman, KPMG International Senior Partner, KPMG LLP (UK) © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
IFRS - how KPMG can help IFRS is more than just a technical accounting exercise - it is an important business priority. For many businesses the IFRS revolution will have a significant impact on financial statements, directly affecting the outcomes of valuation metrics that analysts use to measure and evaluate company performance. Major areas affected will be financial instruments, business combinations, share based payments and pensions. Ultimately, early adoption and communications may assist competitive advantage. KPMG LLP (UK) has extensive experience working with clients in converting to IFRS, and with clients that are already using IFRS. © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Contents Overview by Robert Bruce 1 The interviews John Coombe 5 CFO, GlaxoSmithKline David Damant 8 Chairman, Accounting Advocacy Committee of the UK Society of Investment Professionals Bob Herz 11 Chairman, Financial Accounting Standards Board Jan Hommen 13 CFO, Philips Huw Jones 15 Director of Corporate Finance, M & G Investment Management Neil Lerner 17 Global Head of Regulatory Issues, KPMG LLP (UK) Paul Rutteman 19 Secretary General, European Financial Reporting Advisory Group Jon Symonds 22 CFO, AstraZeneca Sir David Tweedie 25 Chairman, International Accounting Standards Board © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Overview by Robert Bruce 1 Overview by Robert Bruce The changes in financial reporting rules which come into force in Europe, and elsewhere around the world, at the end of this year are the most fundamental changes for a generation. For the first time all listed companies across Europe will have to follow International Financial Reporting Standards as promulgated by the International Accounting Standards Board, (IASB). This overview provides a wide range of views from senior Robert Bruce is a leading players in this process from standard-setters to CFOs and commentator on accounting, financial reporting, corporate from analysts to regulators. It reveals sharp differences of governance and management opinion and above all it reveals a deep scepticism that the issues. He writes regular articles on accountancy and financial markets will be ready for what will be serious change in reporting for the Financial Times. the figures of some of the largest companies in the world. He also writes regularly for Accountancy and Financial Director magazines and is editor of Corporate Financier, the monthly magazine of the ICAEW’s Financial reporting shocks ahead Corporate Finance Faculty. He was It is clear that the biggest problems will be in the financial markets. “It will cause previously Accountancy editor at some eye-opening things to be revealed, said Bob Herz, chairman of the US ” The Times, and was editor of standard-setting body, the Financial Accounting Standards Board, (FASB). He said Accountancy Age, the UK’s main the whole process would mean “monumental changes for companies in Europe. ” professional weekly, for ten years. “The issue that concerns me, said Jon Symonds, CFO of AstraZeneca and ” He is a Fellow of the Royal chairman of the influential One Hundred Group of Finance Directors, “is not that Society of Arts. companies will do a good job communicating their results. But what will the recipients of hundreds of restated accounts make of it? I am not sure that the investment community really has its mind around what the changes mean. Will there be a knee-jerk reaction on the stock market?” Jan Hommen, CFO of Philips, thought that the users of accounts were just not ready. “Analysts know they understand little about international accounting standards, he said. “So they ” are not ready to see the changes which are coming. John Coombe, CFO of ” GlaxoSmithKline, thought that there is a need to “get the analysts thinking about 2005 well ahead of time. ” Politicians should keep out of the process It is also clear that the process of setting financial reporting rules is something which politicians should not be meddling in. “Politicians shouldn’t generally become involved, said Sir David Tweedie, chairman of the International ” Accounting Standards Board. “The cornerstone of the IASB is its independence. We have to listen and then do our best to find the answer which reflects the economic facts. Change is going to be uncomfortable. Some people will prefer not to have it occur on their watch, he said. Paul Rutteman, Secretary General of ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and , name are trademarks of KPMG International.
2 Overview by Robert Bruce the European Financial Reporting Advisory Group, EFRAG, which advises the European Commission, was adamant that politicians should stay out of the process. “It was the whole point of going down the IASB route , he said. “We ” did that because we had seen how the US process of setting financial reporting rules had been influenced by politicians and we didn’t want to follow that route. ” “It becomes the law of the jungle, said Bob Herz of FASB. “Whoever shouts the ” loudest and has the most money prevails. The result does not serve capital markets very well. “Keep politicians out of it and let the theoreticians get on ” with it, was the view of John Coombe of GlaxoSmithKline. “We have to leave it ” to people who understand the process rather than people seeking leverage for key industries or key regions. “Take the parallel with medicine, said David ” ” Damant, chairman of the Accounting Advocacy Committee of the UK Society of Investment Professionals. “Governments should be very concerned that, for example, doctors are properly trained and disciplinary actions enforced. And governments are very concerned in ethical questions such as abortion. But the issue of how operations are done should be left to the surgeons and technicians. The same structure applies to financial reporting.” Financial instruments cause problems The issue of the two financial reporting standards, IAS 32 and IAS 39, covering derivatives and financial instruments brought controversy. “The problem facing standard-setters, said Sir David Tweedie, “is the sheer size of the market for ” financial derivatives. There are US$ eight trillion worth of derivatives being held which ought to be on the balance sheet, but to date outside a few countries these values have not been recorded. Adopting IAS 39 is going to be a monumental shift with a lot of financial instruments on the balance sheet which weren’t there before. This has not gone down well, particularly with banks and insurance ” companies in continental Europe. And the European Commission has been slow in the process of endorsing the two standards. “Personally, said Paul Rutteman, “I ” would not have offered as a hostage to fortune the idea that we would not take IAS 39 through the endorsement procedure until there was more agreement. As a result you have everyone trying to hold everyone else up. There is a view in some parts of continental Europe that this body in London, so heavily influenced by Americans who don’t use the standards, is pushing through things which don’t take account of the European culture. But others felt that the cultural argument was ” simply a way of making a distaste for disclosure respectable. The charge that the volatility which disclosure would bring should be avoided was refuted by David Damant. “The standards only force the disclosing of the volatility, he said. “They ” don’t cause it. And the capital markets will have a greater degree of confidence, not less, if volatility is not disguised. And Sir David Tweedie argued against the ” pressures of politicians over the standards. “There is a difference in philosophy, he ” said. “Mine is: ‘Tell it like it is and explain it.’ Some politicians would probably prefer to smooth everything in order to reduce volatility. But that means that you run the risk that suddenly problems are there without warning and panic breaks out. Our method should make management’s job easier in the long run - the problems are obvious much earlier. The complaints from the banks over the proposed standards ” were refuted by David Damant. “I believe that if at the time of the old IASB we had seen that standards like IAS 39 were going to cause such controversy we should have worked for more input from the banks and insurance companies at that stage, he said. “But even as it was we were talking to the banks ten years ago. ” They have no cause to say they weren’t being consulted. “It is very strange, said ” ” John Coombe of GlaxoSmithKline. “The UK banks don’t like the standard but they can work with it, he said. “If they can then surely banks elsewhere can. ” ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Overview by Robert Bruce 3 Convergence urged The benefits of convergence of financial reporting rules were seen to far outweigh any temporary inconvenience. “The sooner we can get away from doing reconciliations to other sets of generally accepted accounting principles, (GAAP), the better, said John Coombe of GlaxoSmithKline. “It will lead to more ” efficient markets. Greater comparability will enable investors to make better choices on an international basis. “It will significantly improve the quality and ” transparency of financial reporting around the world, said Jon Symonds of ” AstraZeneca. Jan Hommen of Philips said: “It will result in one worldwide range of standards which are acceptable to the financial community. The financial markets will demand it and companies will demand it. For example at Philips we have a big presence in China. We have to train them to know US GAAP Dutch , GAAP and Philips GAAP he said. “We need just one system and train , ” accountants once and for all. “If international accounting standards of high ” quality can be introduced around the world then we will achieve better informed capital markets, said Huw Jones, Director of Corporate Finance with M&G ” Investment Management. “It will lead to a much more efficient capital market, ” said David Damant. “At present accounts in many countries do not reflect reality and are not transparent. Going over to what I call ‘proper’ accounting will change all that. “It will result in a common capital market across Europe, said Paul ” ” Rutteman. “It will take time but it really will happen and that will mean an improvement in the cost of capital for Europe, he said. “It will also mean greater ” convergence with the US and that will be beneficial but controversial. He also ” suggested that this would highlight divisions in Europe. “Europe is divided, he ” said. “Germany accepts convergence and the idea of US GAAP Many in France . do not want convergence at all. ” The case for slowing down In business there was a belief that too much was being done too soon. “We are doing too much in too short a time, said Jan Hommen of Philips. “And as a result ” we get emotional reactions. It would be very regrettable if a good exercise failed because of this. I think it should all be delayed until 2007” he said. “Leave , companies to apply local or US GAAP for two more years and work towards a deadline of 2007 for international accounting standards, he said. “I’d have ” allowed more time, said Huw Jones. “There has been a degree of unseemly ” haste, he said. “An extra year would have done no harm. Others were keen to ” ” move on. “I will be mightily unhappy if it gets thrown off course, said Jon ” Symonds of AstraZeneca. “We have a long programme of implementation and of course we would have liked more time, said John Coombe of GlaxoSmithKline, ” “but if you don’t set deadlines you don’t get anywhere. ” Greater efforts needed to build understandability Opinions differed widely on whether the process would make financial figures more widely understood or whether such an issue mattered. “The rules are probably becoming less understandable, said Jon Symonds of AstraZeneca. “The ” world is infinitely more complex than it used to be and increasingly it will be the specialists who interpret them, he said. “That is not necessarily a bad thing. ” Large groups and diverse business activities are not going to be understood easily by the layman. “The greater the demand for information the more ” impenetrable reports and accounts will become, said John Coombe of ” GlaxoSmithKline. Jan Hommen of Philips thought the figures were “becoming more difficult. Huw Jones of M&G thought this a worry. “Investors become ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
4 Overview by Robert Bruce nervous when a company says something is too difficult to explain clearly, he ” said. Sir David Tweedie said that this shouldn’t happen. “We wrote the new International Financial Reporting Standards in a completely different way, he said. ” “You have a preamble which gives you the objective in one sentence. Then you have the instruction. The rest of the standard just tells you how to do it. It should be perfectly possible to answer the question: ‘You have one minute - tell me what the standard says.’ You could have complex standards which only four people in the world understand but that is not the way we intend to do it here, ” he said. Bob Herz of FASB agreed. “It does matter, he said. “It shouldn’t be ” something which only technical specialists can understand. It is important that financial reporting is perceived as being understandable and showing the underlying economics. This is the pivotal difference. “Our standards are written ” from an investor and user standpoint, said Sir David Tweedie. “For some ” countries standards used to be written from the standpoint of creditors and other stakeholders. The mindset is different, he said. David Damant agreed. “What ” else could financial reporting be for?” he asked. “It is about the timing and the certainty and the size of cash flows. Several people thought the key to ” understandability was the use of simplified or short-form reports like the UK Operating and Financial Review, (OFR). “It is the responsibility of companies to explain and I think the OFR becomes a pivotal document in financial reporting, ” said Jon Symonds of AstraZeneca. “Investors should understand what is significant, he said. “But, as for our pharmaceuticals, they don’t necessarily need ” to understand the molecular structure of one of our products. “Finance functions ” need to make the short-form accounts more readable and understandable to the average investor, said John Coombe. ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: John Coombe 5 John Coombe The EU should not waver in implementation, according to John Coombe. Communication with the markets and analysts will be key, but the best timing of that communication is difficult to call. Politicians should be kept out the process, while in the US an obsession with legal procedures could be the biggest challenge to convergence. Ultimately, all companies should make their financial statements as user-friendly as possible. John Coombe has been CFO at GlaxoSmithKline since 2001. Before that he was Executive John Coombe is optimistic about the IAS 2005 process. “What I hope will Director for Finance and Investor happen is that the EC will endorse the standards and we will move smoothly and relations for Glaxo Wellcome and seriously to implementation, he said. But there are caveats. “I have the same ” on the board of Glaxo Holdings concerns as everyone else that if IAS 39 continues to cause a problem the EC from 1992. He was also Chairman may waver. The results of that would be very alarming, he said. “It is very ” of the One Hundred Group of strange. The UK banks don’t like the standard but they can work with it. If they Finance Directors in 2000 and can then surely banks elsewhere can. ” 2001 and a member of the UK Accounting Standards Board from He shares the frustrations of many other CFOs in his position. “To introduce the 1996 until 2003. complexity of a partial endorsement having got so far so quickly would be wrong. The sooner we get a common set of international accounting standards the better. Certainly as a company we are geared up and ready. ” He sees the future process as a steady one. “There should be no problem with the implementation if the IAS process goes smoothly, he said. “We have a long ” programme of implementation and of course we would have liked some more time but if you don’t set deadlines you just don’t get anywhere. ” “The challenge is for finance staff throughout the world to know how IAS work and how it will affect them, he said. “Issues like stock options, for example, tend ” to be central issues but other issues are local issues around the world. This also ” has an effect on advisors to the company. “It reinforces the need for us to use big global audit firms and that brings up issues of auditor liability for them. ” Communicating to the markets There is also the issue of communication. “At what point do we alert the markets to the changes in our numbers?” he mused. “In midsummer we will be clear on the restated 2003 figures and we can then use them to explain what is going to happen to the analysts. The whole area is a minefield. Companies need to ” explain what changes lie ahead very carefully to the analyst and investor communities. And it needs to be done at one clear point in the cycle. “Otherwise the financial markets will be receiving information piecemeal - which would not be a good idea, he said. “We need to get the analysts thinking about 2005 well ” ahead of time. ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
6 Interview: John Coombe As for the future Coombe sees big long-term changes ahead. “The prime one will be changes which will bring about convergence with the US, he said. “The ” sooner we can get away from doing reconciliations to other GAAPs the better. It will lead to more efficient markets. Greater comparability will enable investors to make better choices on an international basis.” “It will all lead to more openness and more clarity, he said. “I can’t see any ” downside. There is a short-term risk of people making mistakes but that is just teething problems. But the recurring worry would be the analysts. “Assuming ” the changes to the treatment of stock options do come in, just what will the analysts make of it?” he asked. “For example, it will have no impact on cash flows so it will have no impact on the value of the company. It doesn’t affect the future cash flows of the business. It will be interesting to see if analysts take that line.” It will also change the way that large companies approach issues like financial instruments. “We will be very careful that any hedging stands up to all the tests, ” he said. “We will be very wary of using financial instruments which might make our figures more volatile. ” With hindsight Coombe might have asked for more time for the whole project. “I might have made the deadline one year later. But on the other hand if that had been so we probably wouldn’t have made the progress that we have, he said. ” “People will always say ‘why don’t we give it another year.’ But even if we had been given another year companies should have been allowed to voluntarily change in 2005. I do believe in the benefit of deadlines. ” A non-political process He is also firmly of the belief that politicians should stay out of the process. “They are becoming involved, he said. “But accounting standards should be the ” result of an objective process where people who understand the theories set the standards. Take share options, for example. There has been a lot of noise about exempting employee schemes. But there is no logic in that. They have to be a cost to the company. His conclusion is a simple one. “Keep politicians out of it ” and let the theoreticians get on with it, he said. And he made the point that ” there is already sufficient argument in the standard-setting field to ensure that a robust process achieves robust standards. “There is already good pushing and shoving in the standard-setting arena, he said. ” The process of lobbying, particularly in continental Europe, as in the US a decade ago, only makes things worse. “We were all worried that the European vetting scheme for international standards would lead to separate and different European accounting standards, he said. “We have to leave it to people who ” understand the process rather than people seeking leverage for key industries or key regions. ” He is confident that a global system of financial reporting rules will result. But he does fear that the US approach will act as a dampener. “The US, Europe, Canada, Australia and Japan will come together, he said. “The only worry is that the US ” is still heavily legally-based. It is the old argument between principles-based ” systems and rules-based systems. Coombe feels that with a global system it will become more rules-based but it need not go the whole hog. “The principles- based approach will become more rules-based, he said. “That is the way the ” world is going. But we need the US to become more principles-based. The ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: John Coombe 7 problem is the dominance of lawyers in the US. “Law influences so much of US business, he said. “For example, there is an obsession with having lawyers at ” almost every meeting, he said. “It can be stifling. The US economy is very ” successful at going forward yet there is this obsession with process. This is probably the biggest challenge as we move towards convergence. ” Making the numbers intelligible There is also the challenge of making the improved information understandable. “There is a real issue here, he said. “The greater the demand for information ” the more impenetrable reports and accounts will become. We have slimmed down the GSK document this year but it is still 165 pages long and with the Sarbanes-Oxley legislation it has all become very hard work with the finance director and the CEO having to certify that they have reviewed it. The process ” involved in building legal certainty into the process of producing the accounts has become immense. Yet Coombe is not sure that investors are better protected. “With hindsight if you read the Enron accounts the facts were there, ” he said. “But it was almost impossible for an outsider to understand them and then assess the risks. ” He advocates using short simplified reports alongside the main ones. “The UK system of having main accounts and then short-form accounts is an effective way of making them more understandable, he said. “Finance functions need ” to make the short-form accounts more readable and understandable to the average investor. ” “It is incumbent on all finance functions to comply with the regulations, he said, ” “but in as user-friendly a way as possible. The short-form report is the key. It should communicate not just the numbers but the value accounting. It should tell you where the company is going. ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
8 Interview: David Damant David Damant The IASB will not give way on IAS 32 and 39, predicts David Damant, although it may modify them. The standards force the disclosure of volatility, but they do not cause it. Worldwide convergence will happen, although it is difficult to predict when. Many of the stand-offs and disagreements so far have been caused by the fact that most people do not actually understand the framework the IASB is working to. David Damant is currently Chairman of the Accounting Advocacy Committee of the UK Society of Investment David Damant’s view is that it is obviously very difficult to predict what will Professionals and was a board happen over the coming year. But he is also sure that if the European member of the old International endorsement system does not swing behind the full IASB proposals then there Accounting Standards Committee. will be what he called ‘a stampede’ by the largest companies towards using IASB financial reporting standards regardless of Europe’s concerns. Indeed HSBC has already announced that even if the EU rejects IAS 39 the bank will still apply it. That would mean that Europe would have the worst of all worlds, impeding a pan-European capital market, which it strongly supports. “The IASB will not give way, he said. “It may modify the financial instruments ” standards, IAS 32 and IAS 39. But it will not give way. As a veteran analyst ” he tends to take a strict line on the continuing arguments about the danger of volatility in the published results of banks in particular. “The standards only force the disclosing of the volatility, he said. “They don’t cause it. And the ” capital markets will have a greater degree of confidence, not less, if volatility is not disguised. ” ‘Mongrels’ amongst the standards As for the difficulties ahead he felt that the same two standards would cause long-term problems. “The difficulty is that both IAS 32 and IAS 39 are mongrels, ” he said. “They are compromises between fair values and cost. The correct way forward is full fair value and that, for example, would mean very little hedge accounting. Yet some people may argue that with IAS 32 and IAS 39 they have gone far enough towards fair values and should go no further. The problem is that there are even now US$ eight trillion of derivatives out there and it is not just banks that we are talking about. Large companies are re-organising their balance sheets and users need a full analysis and no netting off.” Damant sees the long-term harmonisation of reporting standards as the result of 2005 but sees another change as more important. “Everyone is talking about harmonisation, he said, “and it is important. But IAS 2005 will also lead to a ” much more efficient capital market. At present accounts in many countries do not reflect reality and are not transparent. Going over to what I call ‘proper accounting’ will change all that.” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: David Damant 9 Looking back he wishes that standard-setters - including himself - had worked more intensely with the banks and insurance companies earlier. “I believe that if at the time of the old IASB we had seen that standards like IAS 39 were going to cause such controversy we should have worked for more input from the banks and insurance companies at that stage, he said. “But even as it was we were ” talking to banks ten years ago. They have no cause to say they weren’t being consulted. He feels that at least some participants to the discussion thought that ” it was all a bit academic and in the future. He clearly feels that you can take a horse to water but you can’t necessarily make it drink. Politicians should take their medicine He is also adamant that politicians should not become involved, still less politicians weighing in with their views after being lobbied by certain bankers who had been caught napping. “Take the parallel with medicine, he said. ” “Governments should be very concerned that, for example, doctors are properly trained and disciplinary actions enforced. And governments are very concerned in ethical questions such as abortion. But the issue of how operations are done should be left to the surgeons and technicians. The same structure applies to financial reporting. ” Despite his pessimism over the political pressures he thinks that if the EU does manage to sort everything out this time around (and possibly even if not) there will be convergence of financial reporting rules worldwide as a result. “Including the US eventually, he said. “I used to say that it would happen in 2007 or 2008 ” but controversies in Europe and the difficulties such as those in the international insurance industry may slow it down. ” A framework misunderstood? As for the understandability of accounts he feels that they are inevitably becoming more complex but that separate efforts to mitigate the complexity should be stepped up. “It looks as though they are becoming more complicated, ” he said. “But to some extent that is due to underlying and existing complications like, for example, the use of derivatives. If companies are swapping long-term debt people’s eyes tend to glaze over. His solution is down to earth. “There ” should be further work on producing results in a simplified form for the front of the annual report or in a separate shorter report, because that is where you can communicate directly with ordinary investors. And that is very important. ” After a long career in the investment analysis profession Damant has a clear view of the issues. “What we are seeing in the IAS 2005 process all stems from the basic principles supported by my profession for 30 years, he said. He quotes the ” objectives set out in the Framework of Principles of the IASB: ‘The objective of financial statements is to provide information about the financial position, performance and changes in financial position of an enterprise that is useful to a wide range of users in making economic decisions.’ And: ‘The economic decisions that are taken by users of financial statements require an evaluation of the ability of an enterprise to generate cash and cash equivalents and of the timing and certainty of their generation. This ability ultimately determines, for example, the capacity of an enterprise to pay its employees and suppliers, meet interest payments, repay loans and make distributions to its owners.’ © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
10 Interview: David Damant “What else could financial reporting be for?” he asks. “It is about the timing and the certainty and the size of cash flows. This change is sometimes characterised ” as moving the purpose of accounts from providing a stewardship report for creditors and others to providing users with information on which they can base decisions. But he feels that this fundamental change to showing economic reality as the objective of financial reporting has not been properly taken on board. Hence the problems. “A very large number of people don’t agree with the decision-making objective, ” he said. “They may not have heard of or read the Framework document which sets it out. The controversy is that the IASB is working to its Framework and 90 percent of the world is not. People argue that the IASB is too theoretical. It is not. The decision-making aim is intensely practical. But so long as people are arguing without understanding the Framework then the stand-offs will continue. ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: Bob Herz 11 Bob Herz According to Bob Herz, a lot of effort is still required to get the standards through intact. It could be a bumpy ride and there may not be sufficient pan-European auditing standards and regulatory controls in place. The creation of truly global standards, and the resolution of the rules versus principles debate, will be still tougher nuts to crack. The success of IAS 2005 is crucial if US appetite for convergence is not to fade. Bob Herz has been chairman of the Financial Accounting Standards Board, (FASB), since Unsurprisingly, Bob Herz sees the whole issue of IAS 2005 as something which July 2002. He was previously has a momentum which would be hard to stop. “It will go through, he said. “I ” a board member of the don’t know if it will go through with the financial instruments standards intact. International Accounting But I don’t think there is any interest in delaying the process. ” Standards Board (IASB). He is a firm driver behind the idea But Herz does not under-estimate the difficulties. “It is going to require a lot of of convergence between the effort, he said. “It is a question of changing thought patterns. And underlining the ” ” rules promulgated by FASB differences in experience and culture he said that it would mean “monumental and the IASB. changes for companies in Europe. ” Where he saw difficulties was in the idea of common financial reporting rules producing comparable figures across different companies, sectors and countries. “There may be different flavours affecting the figures if there is a tendency to implement IAS 2005 in ways that reflect different national generally accepted accounting principles, (GAAP), he said. ” Bumps in the road ahead He saw that there might be problems relating to what he described as “the capacity of the system to deal with implementation. For him one of the big ” questions was “Can the accounting firms cope? Are they equipped to handle all of the change?” And he wondered how effective IFRIC, the International Financial Reporting Rules Interpretation Committee, the body which tries to smooth out differences in interpretations between different countries, might be. He questioned the “overall robustness of implementation. He wondered if there ” would be “enough pan-European auditing standards in place” and also if there would be “sufficient regulatory controls in place. “It all sounds to me that they ” are not there yet, he said. “So there are probably going to be some bumps in ” the road.” As for the long term changes which the whole IAS 2005 process might create, Herz was positive. “I think that it is likely to bring about greater coalescing of the European capital markets, he said. “Having a common accounting language is a ” key first step in that process. And there were other issues which would follow. ” “It will be the spur for pan-European auditing standards and practices, he said, ” as well as “common regulatory mechanisms. ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
12 Interview: Bob Herz He also thought that the initial upheaval would produce some shocks. “It will cause some eye-opening things to be revealed, he said. “When you change the ” numbers it will affect how people view one company versus another and one sector versus another. ” The politics of negotiation With the benefit of hindsight there is not much he would have changed in the process which has brought the IAS 2005 project about. But he accepted that it had not pleased everyone. “It’s a tough one, he said. ‘I think that they tried to do ” things about right, is his assessment. “At the behest of IOSCO, the IASB worked ” on improving a lot of standards. My trepidation is not with the IASB but with all the surrounding things like corporate governance issues, auditing issues and the regulatory framework. He sees the problem as being with the whole picture ” rather than with the financial reporting rules themselves. “My own view is that good standards are not enough, he said. “You need the other elements to be ” working well and that may vary a lot from country to country. ” He is opposed to political factors having too much direct influence in the process. “Politicians should not become involved in the detail of the standard-setting, he ” said. “The role of politicians is to be satisfied that the process was thorough and objective. But he accepts that not everything goes in the way in which you ” hoped it would. “Politicians will become involved, he said, “but I don’t think you ” get the best set of standards when they are politically established. It becomes the law of the jungle. Whoever shouts the loudest and has the most money prevails, he said. “Business information becomes skewed in the end. The result ” does not serve capital markets very well. ” As for a global system of financial reporting resulting from the IAS 2005 process, he is not so sure. “I don’t know that it will be truly global, he said. “One day it ” may be - but certainly across the major capital markets it will be. The markets demand that. It is a lot of hard work, he said, “but we will get there. ” ” Making sense of rules and principles The resulting information available to investors in this process is becoming more complex. Some argue that it doesn’t matter if only specialists can understand it in all its complexity. Herz takes the opposing view. “It does matter, he said. “It ” shouldn’t be something which only technical specialists can understand. It is important that financial reporting is perceived as being understandable and showing the underlying economics. ” One area of difficulty is the perception that American financial reporting rules are dominated by detailed rules whereas the rules promulgated by the IASB are principles-based and so allow greater judgement. “The jury is out on rules versus principles, he said. “I personally think we are headed towards principles. But the ” important thing is that knowledgeable business and finance people are able to understand the figures and the policies that they represent. You don’t want people saying ‘I trust them but I don’t understand them.’The figures have got to help people make decisions. ” Herz sees the whole process of IAS 2005 as being crucial from an American standpoint. “I think we sit here in the US and have a keen interest in supporting IAS 2005, he said. “It needs to be successful and viewed to be successful and ” that is what will keep the momentum going for convergence. If the process is viewed as a failure then the appetite over here for convergence will fade.” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: Jan Hommen 13 Jan Hommen The potential for confusion is high, says Jan Hommen - markets and analysts are not ready for the changes that are coming. The pace of implementation has been too fast, and should be put back to 2007 However, the long term picture . looks better and we will eventually arrive at one truly global system. But everyone has to be clear about the principles underlying the whole initiative if it is to work. Jan Hommen’s view of the IAS 2005 process is not a fully optimistic one. “It will Jan Hommen has been CFO at certainly not go smoothly, he said. “The French have objected to the financial ” Philips, the electronics giant, since instruments standard. There is a very ambitious timetable. The European 1997 and has also, for the last two Commission has become involved. The Americans are saying ‘follow us or we will years, been vice-chairman of the not agree.’ All the standards are not ready. When people realise the effect on, for board of management. He was example, pensions, they will also object.” previously CFO with Alcoa. And that catalogue of difficulties has, he said, important consequences. “There will be confusion in the financial markets, he said, “as to whether people are ” reporting under local generally accepted accounting principles, (GAAP), or international accounting standards, or US GAAP .” More specifically he sees other difficulties ahead. “The markets are not ready, ” he said. “The standards are not ready. And the users of accounts are not ready. ” “Analysts know they understand little about international accounting standards, ” he said. “So they are not ready to see the changes which are coming. ” He sees problems for Sir David Tweedie, chairman of the International Accounting Standards Board, (IASB). “We created the European task force of CFOs to try and get better recognition for the views of preparers in the standard setting process. We need convergence, he said. “European companies need one ” system whatever that may be. When you talk with people from European multinationals, you find that everybody wants convergence towards one set of global accounting standards. Everyone wants to do it in a way which doesn’t create confusion in the financial markets. The rushed introduction of the current standards may confuse the markets. That is the biggest concern that CFOs have. ” Too much too soon? For Hommen it has been the pace which has been the problem. “We are doing too much in too short a time, he said. “And as a result we get emotional ” reactions. It would be very regrettable if a good exercise failed because of this. I think it should all be delayed until 2007 Leave companies to apply local or US . GAAP for two more years and work towards a deadline of 2007 for international accounting standards. ” “We were too optimistic about the time schedule, he said. “For example, there ” was a lot of time and energy wasted on performance measurement, which was © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
14 Interview: Jan Hommen always going to be a non-starter. We need the American Financial Accounting Standards Board, (FASB), and the IASB to get together more. Too much has probably happened behind closed doors, not intentionally, but we need more communication and transparency. ” But the long-term picture looks better. “It will result in one worldwide range of standards which are acceptable to the financial community, he said. “The ” financial markets will demand it and companies will demand it. For example at Philips we have a big presence in China. We have to train them to know US GAAP Dutch GAAP and Philips GAAP We need just one system and train , . accountants once and for all.” Cooperation the key But convergent standards will be hard to achieve. “It is not easy, he said, “and it ” is not a straight line. There will certainly be short term difficulties if politicians get involved. We need better cooperation. ” He castigates his own community for some of this. “CFOs should have been more active and claimed a more pronounced role, he said. “We should have ” flagged the main issues quicker and focused on them. We should have concentrated on 80 percent and not worried about the other 20 percent. It also would have been better if the intention to converge with FASB had been flagged up earlier. But Hommen is realistic about the process. “It is easy to say all this ” with hindsight, he said. “It is a very, very difficult task. ” ” He feels that the process should be freer from outside influences. “I believe you should leave standard-setting to those who have an interest, he said. “There are ” too many academics involved, for example. There is too much concentration on purity, which in principle is fine but you need more practicality. ” Hommen is adamant about the long-term prospects. “We will have a truly global system, he said. “It will not be early. It will take more time than we have given ” ourselves. We need to be able to say that certain things work differently country by country. It will all come about eventually.” And from the Philips perspective it is vital. “For companies like us we would love to have it, he said, “and we will do everything we can to produce convergence. ” If we have it by 2010 we will have done a very good job. ” Principles, not self-protection He is more pessimistic about how understandable the figures become. “They are becoming more difficult, he said. “You have different accounting teams, different ” accounting firms and different interpretations. If people do not have the security to do the right thing then you will have nervous CFOs. And nervous CFOs will be unhappy to sign the figures off. ” It is all down to principles. “If the principles are not clear, he said, “then I am ” afraid that accounting becomes more important than economics. But decision- making cannot be down to accounting rules. It is very complicated, especially where rule-making has to apply to everyone. We need to guard against accountants creating negative shareholder value. ” And in the end there is also the danger of the whole business process solidifying in a legal morass. “There are too many occasions where lawyers tell the accountants what they can and can’t do. There is a danger of everyone becoming so paralysed that it becomes more about protecting themselves than doing the right thing. ” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: Huw Jones 15 Huw Jones The larger the scale, the harder the task - but we will see the creation of international accounting standards in Huw Jones’ opinion. But more time could have been allowed for the IAS 2005 project and there is a danger of over- engineering the standards. A principles-based rather than a rules-based approach will make financial statements easier to understand. Huw Jones’ view is that the IAS 2005 process will go through. “We will see the Huw Jones is Director of emergence of international accounting standards, he said. “It will happen. There ” Corporate Finance with M & G will be brinkmanship but we will get there. ” Investment Management and is a member of the UK Accounting Where he does envisage problems arising, he sees them as the inevitable by- Standards Board. product of attempting to reach international agreements. “The problem is the same with any attempt at agreement on an international basis, he said. There ” will be vested interests. Any international body may become remote from its natural supporters. So it is very important that the standard-setters maintain close links with their constituents. “The contrast with the experience when new UK rules were being introduced in the 1990s is interesting, he said. “Generally David Tweedie enjoyed a lot of ” support. What is now happening internationally didn’t happen in the UK. The increased scale of operations and international differences inevitably make it harder. But investors would like to see the integration completed successfully.” A raising of the bar In the long-term he sees the harmonisation as bringing about a raising of the bar for investor communities around the world. “Investors need proper standards, ” he said. “If international accounting standards of high quality can be introduced around the world then we will achieve better informed capital markets. ” But he had a caveat. “There is a danger that there might be so much complexity that the realities of companies might be obscured, he said. “There are worries ” on that score. The danger is that accounting standards can become over- engineered. ” With hindsight he feels that the whole IAS 2005 project might have been given more time to work. “I’d have allowed more time, he said. “There has been a ” degree of unseemly haste. An extra year would have done no harm. ” And he also regretted that politicians had become involved in the process. “It is important that standard-setters should enjoy the support of elected governments, he said, “but accounting standard-setting is not a natural field for ” politicians to work in. But there was, he felt, an inevitability about it. “If national ” interests seem to be threatened then they will become involved, he said. “It is ” unfortunate. For example, it nearly happened in this country when FRS 17 was © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
16 Interview: Huw Jones introduced. The standard sought to establish more clearly what pension fund liabilities were. It didn’t go down well in some quarters at the time but investors do like the disclosures. ” Global complexity Partly it is a problem of operating on a global basis. “People like to do things differently in different countries, he said. “But the international capital markets ” are not interested in such local preferences. ” This movement towards a global system will, he thinks, continue. “We will eventually see a global system of financial reporting, he said. “Exactly what will ” happen with the issue of US standards and the Securities and Exchange Commission I don’t know. But that is the key. And if the IAS 2005 project were ” to fail then the global system would still come about. “If Europe falters then large companies will simply follow US GAAP,” he said. On the issue of how much more complex financial reporting is becoming and whether understandability is something only specialists can expect, he is adamant. “It does matter, he said. “The strength of principles-based reporting ” rules and a true and fair approach is something we should not lose sight of. A rules-based system would inevitability give rise to complexity. Investors become nervous when a company says something it is too difficult to explain clearly.” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
Interview: Neil Lerner 17 Neil Lerner The IASB needs to give more recognition to the importance of Europe, according to Neil Lerner. The debates over IAS 32 and 39 have slowed the process towards global convergence - but international accounting standards provide the opportunity to move forward with greater clarity and consistency. If you ask Neil Lerner if the process of moving to International Financial Reporting Standards by 2005 will go smoothly he rather doubts it. “Smoothly is not a word Neil Lerner is a KPMG’s Global you would use to describe the process, he said. For many countries and ” Head of Regulatory Issues. He is corporates there will be significant resource and training challenges. also a member of the Board of KPMG LLP (UK) and the firm’s UK The difficulties he sees ahead could be addressed if the IASB changed its ways. Head of Risk Management. He is “The governance of the IASB has to pay more recognition to the importance of chairman of the Ethics Committee Europe as a user of accounts, he said. “If the IASB was not producing standards ” of the ICAEW and a member of for Europe then who would adopt International Financial Reporting Standards?” he the IFAC Ethics Committee. asked. “There would be no big players. Everyone would use US GAAP or their existing country GAAP We need to bring the Europeans fully into the governance. . ” A great leap Lerner predicts that changes will come in the IASB’s consultation process. And there will also be big changes in the quality of European financial reporting. “There will be a tremendous increase in transparency and comparability in many countries, he said. “It will be a great leap forward for many countries, particularly ” those which are less well developed. ” With hindsight he would have liked the process to have focused more on the difficulties ahead rather than trying to get the whole show on the road. “I would have worked out which the difficult standards were going to be and understood from an early point where the preparers were coming from, he said. “And I ” would have tried to understand the economic issues better. It is not just preparers who are unhappy but also some regulators. We needed more and earlier consultation.” Towards convergence As for the involvement of politicians in the process Lerner said that “politicians should clearly not become involved. He said that there was “a long and unhappy ” history of standards being politicised. The Americans got there first. The process should be left to technicians with governance oversight.” © 2004 KPMG LLP the UK member firm of KPMG International, a Swiss cooperative. All rights reserved. The KPMG logo and name are trademarks of KPMG International. ,
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