The Movement towards Convergence with International Accounting Standards - Essay Example

Introduction For many years accounting was about assessing companies' performance in financial terms. Recently it has transformed from a set of regulations to a big industry, which brings us to the question: is financial reporting still a credible source of information on the business performance Of course, regulations of financial reporting have to change ensuring better indication of performance. Currently a serious issue regarding the transparency of financial reports is seen as the most urgent. Indeed, "the purpose of accounting is a practical one: the provision of information that allows matters of financial significance relating to particular firms to be investigated, evaluated and compared Instead, accounting rules place an emphasis on abstractions" (West 2003, p. 84). This essay focuses on the most recent trends in UK financial reporting standards analysed on the example of the Annual Report of BAA plc for 2004/05. The essay argues that the movement towards convergence with international accounting standards is helpful enough to provide shareholders with more transparent information on companies' performance. Yet, changes that are made have their drawbacks, which are also discussed. The first part of the essay deals with introducing international accounting standards. International Accounting Standards Standartisation in accounting becomes of greater importance as business relations continue to stretch over national borders converging into an integrated global international environment. A number of companies operating worldwide increases; therefore it is more effective to prepare one universal report for shareholders of different countries rather than make adjustments along with national accounting regulation policies. It is a global trend with the UK finding itself in the middle of it. "The progress toward attaining a global financial reporting framework has accelerated, and many significant steps have been taken The restructuring program, begun in 2000, is the culmination of a series of movements toward the global convergence of accounting standards" (Casabona and Shoaf 2002, p. 16). While the goal is a decent one, still some people drop the shadow of doubt on the scale of measures taken to ensure rapid transformation to IFRS. The main argument against such a quick transition is that it brings more ambiguities than real use. "The drive for international accounting standards seems out of all proportion to the benefits. Most of the issues are so arcane as to be a million miles from those increasingly rare parts of economy where wealth is actually created" (Hilton 2004, p. 35). Nevertheless the industry (and surely, financial reporting is the one) grows larger and requires additional activities to be implemented by companies guaranteeing their reports will be easily understood throughout the world. For instance, BAA has stated in its annual report 2004/05 the following matters that were changed: - Recognition of the annual valuation surplus on investment properties in the income statement - Recognition in the income statement of fair value gains and losses on derivative financial instruments, subject to hedge accounting - Recognition of derivative financial instruments and related hedge accounting entries in the balance sheet - Separation in the balance sheet of the debt and equity elements of BAA's convertible bonds, and a consequential increased finance cost recorded in the income statement - Recognition of a charge for share-based payments in the income statement - Valuation of the majority of operational land assets on transition and use of this as the deemed cost for future periods, in accordance with the first-time adoption rules of IFRS - Recognition of additional deferred tax liabilities, particularly in relation to temporary differences arising on investment property and operational land revaluations - Recognition in the balance sheet of proposed dividends only when approved - Changes to the format of primary statements. To be more illustrative rather than descriptive the essay goes on with the detailed analysis on three most drastic modifications, that is: interim reporting, UITF 38, and FRS 17. Interim reporting The need for more frequent reports provided to shareholders was generally understood earlier than other two features outlined in the previous paragraph. Half-year, quarterly or monthly interim financial reports give information on company's recent performance to shareholders more frequently. However, some of the details related to interim reporting are decided not with the international, but with regional bodies. "The draft does not mandate which companies must publish interim reports, how frequently they are required or how soon they must appear after the end of an interim period. The IASC decided such requirements are regulatory by nature" (Anonymous 1997, p. 18). As can be seen, ambiguities are still a problem to interim reporting practice: it mainly depends on a certain company what information to include in interim reports. Therefore, power of shareholders is still limited with ethical principles applied by the board. Simply, interim reporting continues to be optional in reality. Meanwhile intervening reports can be a powerful tool for enhancing shareholders' sight in monitoring firms. With financial data more frequently provided to shareholders, it would me much easier for them to trace the recent performance and further on to extrapolate the acquired information on future performance, making forecasting functions more accurate and easier to carry out. That is the weight of shareholders being increased in controlling the company. Additionally interim reporting makes the risk of successful fraud lower, as they are checked by independent accountants. "The objective of the review of interim financial information is providing the accountant with a basis of communicating whether any material modifications would need to be made so that the information is presented according to generally accepted accounting principles" (Ratcliffe 2004, p. 42). Extra controlled by both auditors and shareholders interim reports ca be a guarantee of an honest business policy towards its owners. Corresponding changes made by BAA and illustrated in its Annual Report 2004/05 are as follows. From April 1, 2005 the company will make announcements of the results every six months: interim report on September 30 and a full-year analysis on March 31. The first and the third quarter reports will be replaced by pre-closure trading updates. All the results will be previously reviewed by independent auditors from PricewaterhouseCoopers LLC. The board believes such amendments will bring the company in line with current UK practice and European Transparency Directive. "The timing of this change follows a review of the Group's communications and reporting processes, performed as part the Group's IFRS transition programme" (BAA Annual Report 2004/2005). Interim reporting is one of the rare cases when changes in preparing financial statements are welcomed with regulatory bodies, business companies, and shareholders. While benefits for the latter were stated previously (better transparency and lower fraud risk), interim reporting is seen by companies as a way to demonstrate their good intentions towards shareholders and eventually make them more actively involved in corporate governance processes. Disadvantages can be seen in more intricate reporting procedures: there will be more work for accountants from now on and more funds spent on accounting by companies - the industry is growing and everybody is happy. It must be kept in mind that interim reporting was designed to reduce reporting ambiguities, so more frequent meetings with shareholders also imply more commitment delivered to ethical reporting. Interim reporting is generally approved and is perceived more positively than other changes. UITF 38 In some cases, a change of accounting policy can bring a lot of temporary inconveniences during adaptation period. Urgent Issues Task Force issued abstract 38 (UITF 38) 'Accounting for ESOP Trusts' in December 2003. Its main point was over investments in own shares. "Purchases and sales of own shares, which is consistent with International Accounting Standards, that an entity that reacquires its shares should present them as a deduction in arriving at shareholders' funds rather than as assets" (Holton 2004). While being only a restructuring tool UITF 38 was perceived by many accountants, including those of BAA plc, as a prior year adjustment. Because of reduction of net assets UITF 38 contains potential danger to companies. "UITF 38 may have the effect of reducing net assets below the level of distributable profits. It may prevent a public company from entering into any further transactions involving financial assistance." (Pinsents 2004). In this situation it is vital for regulatory bodies to ensure as harmless transition for UITF 38 accounting standards as possible. The implications caused by UITF 38 to BAA illustrate this statement. Modifications in accounting policy caused UITF 38 required further restatements of the BAA balance sheet, "reducing shareholders funds by 45 million at March 31, 2004" (BAA Annual Report 2004/2005). As the reclassification affects distributable reserves, the company has announced that UITF had no impact on the 2004/05 profit and loss account (Rowson 2005). Nevertheless it required considerable efforts from the company to explain shareholders why net assets have reduced. Of course, it would be to implement UITF if it had no positive effects. Once again it is agued to provide greater transparency to shareholders in the financial statements and therefore enhancing quality of their control. It is about the relations between employee benefit trusts and UITF 38: The guidance in UITF 38 is applied to the sponsoring entity's separate financial statements, rather than requiring the consolidation of the EBT into the sponsoring entity's group financial statements. In effect, UITF 38 treats the EBT as a branch of the sponsoring entity, rather than as a separate subsidiary. (IASB 2004) Thus, while causing inconvenience during adaptation, UITF is seen by accounting setters as a one more step to convergence with international accounting standards. The next modification analysed in this essay has become even more controversial. Financial Reporting Standard 17: Pension Assets and Liabilities On the opposite side of acceptance is the financial reporting standard 17 (FRS17), which has made quite a racket in recent years: "FRS17 has been a widely criticised standard but is seen by regulators as the preferred standard for pensions accounting and will lead to greater transparency for pensions liabilities" (Anonymous 2004a, p. 24). More closely, FRS17 assumes that assets and liabilities of the pension plan belong to corresponding employer, and therefore, must be subtracted from company's assets. The fuss it brings to the balance sheet is related to long-term nature of pension programs. Suddenly financially successful companies have revealed serious deficits causing panic among shareholders. Previous regulations were not as close to international standards as FRS17 is, but the transition (which has already been left out of discussion) can be painful to many companies. Advocates of FRS17 talk about greater transparency of pension schemes, which the financial reporting policy was lacking. Indeed, it must be understood that FRS is not making deficits by itself. It only shows the existing scarcity, which was previously hidden, but nothing more. In this context FRS17 reaches its goal to make financial reporting more transparent and clear to shareholders. However the panic of sudden deficits emerged can be harming to a company's health; that is why the purpose of FRS17 should be explained to shareholders as clear as possible. Additionally, it should be noted that FRS17 can influence the attractiveness of a business in case of selling it. "Assets and liabilities of the pension plan are essentially assets and liabilities of the sponsoring employer. Potential buyers can now see the extent of the deficit on the company's balance sheet, and the financial impact can affect profit forecasts" (Anonymous 2004b, p. 25). Thus, FRS17 is a serious issue that should be treated with respect to shareholders. Being a part of International Financial Reporting Standards, FRS17 was implemented with BAA in its recent annual report. However recent changes will be addressed differently in next company reports: "We have taken steps to bring our reporting in line. This is an ongoing process. In reality our reporting will look different next year, a fact which we have borne in mind when compiling this report" (BAA Annual Report 2004/2005). Currently, FRS17 shows a pension scheme deficit of 138 million is included in BAA's net assets at 31 March, 2005. In 2004 this amount was 111million. From April 1, 2005 the level of contribution paid per annum has increased to 43 million for 2005/06. "The Group remains committed to providing a defined benefit pension scheme to support its employee and talent retention strategy" (BAA Annual Report 2004/2005). Many executives strongly stand against FRS17. "While standard-setters argue they do not create the pensions' shortfalls, but merely reveal them, critics say that it must be acknowledged that the whole ethos of funding is based on the long-term" (Perry 2002). Nevertheless its positive effect is obvious: interested parties are able to see clearly pension assets and liabilities. Alternative Non-Financial Perspective While the financial reporting is still the most accurate source of information on a company's performance, numerous corporate failures occurred in recent decade have significantly undermined their credibility. The need for using non-financial measures of performance as well is now easily understood, as they give more long-term perspective on how a company will be operated in future. Almost every financial report nowadays (and the BAA Annual report 2004/05 chosen as the subject of this essay is not an exception) includes non-financial qualitative indicators along with numbers. This global trend is largely inspired by innovative performance measurement systems using them (e.g. balanced scorecard). Conclusion Overall effect of changes, which were made to the financial reporting in strive to reduce dissimilarity with international standards can be seen as positive. "The UK is heading in the right direction. No one suggests pulling back, and helpful noises are made from time to time" (Charkham and Simpson 1999, p. 199). In a word, business is going global whether you like it or not, so it is better to be prepared for this stage rather than continue to look on the British market separately from the other world. There are still some recommendations can be made. One of the most valuable of them is to implement not restricting, but helping policies in financial reporting. "In some circumstances public officials may have to use measures which regulate corporate activity strictly in order to achieve desired goals. Often, however, the state can achieve desirable results by taking a facilitative approach" (Cheffins 1997, p. 213). Sometimes offering governmental assistance in accounting is much more effective than simply creating limits around the business. References Anonymous. (1997). "IASC Issues Two New Exposure Drafts." Journal of Accountancy, Vol. 184, Iss. 5, p. 18. Anonymous. (2004a). "Legal and Finance: Adopting Standard Could Cost Pounds 500m". The Birmingham Post, July 2, p. 24. Anonymous. (2004b). "Sort out Pension Scheme before You Try to Sell." The Birmingham Post, June 17, p. 25. BAA Annual Report. (2004/2005). Retrieved June 12, 2005 from http://www.baa.com/annualreport. Casabona, P. Shoaf, V. (2002). "International Financial Reporting Standards: Significance, Acceptance, and New Developments." Review of Business, Vol. 23, Iss. 1, p. 16. Charkham, J. Simpson, A. (1999). Fair Shares: The Future of Shareholder Power and Responsibility. Oxford: Oxford University. Cheffins, B. (1997). Company Law: Theory, Structure, and Operation. Oxford: Clarendon Press. Hilton, A. (2004). "Accounting Changes Don't Add Up". The Evening Standard, November 16, p. 35. Holton, A. (2004). UITF 38: Accounting for ESOP Trusts. Retrieved June 12, 2005 from http://www.swat.ltd.uk/modules.phpname=News&file=article&sid=348 IASB. (2004). Accounting for Service Concessions: Agenda Paper 2. Retrieved June 12, 2005 from http://www.iasb.org/uploaded_files/documents/8_135_200407ob.pdf Perry, M. (2002). FRS 17: Friend or Foe Published on March 27. Retrieved June 12, 2005 from http://www.accountancyage.com/accountancyage/comment/2038533/frs-friend-foe Pinsents. (2004). Draft ICAEW Guidance on Employee Share Schemes. Retrieved June 12, 2005 from http://lawzone.thelawyer.com/cgi-bin/item.cgiid=111713&d=205&h=215&f=209) Ratcliffe, T. (2004). "Reviews of Interim Financial Information". The CPA Journal, Vol. 74, Iss. 2, p. 42. Rowson, R. (2005). BAA PLC: Final Results. Retrieved June 12, 2005 from http://www.finanznachrichten.de/nachrichten-2005-05/artikel-4809777.asp West, B. (2003). Professionalism and Accounting Rules. New York: Routledge. Read More