Challenges under IFRS.

Steven Brice, Head of IFRS for Mazars in the United Kingdom. reflects upon the challenges facing European companies in light of the impending requirement for European Union (EU)-listed companies to prepare their consolidated financial statements under IFRS, beginning in 2005. The views expressed are based upon the results of a recent Mazars survey of 425 European companies and Brice's own deliberations on the latest developments issued by the International Accounting Standards Board (IASB).

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One of the biggest issues facing European-listed companies at the present time is the conversion of their current generally accepted accounting principles (GAAP) to the "full" weight of international standards. Some entities, such as those in the banking, energy or financial services sectors, to name a few, certainly face an uphill struggle, but many companies in these sectors have already recognized the complexity of International Financial Reporting Standards (IFRS) for their business and have well-advanced conversion projects underway. As well as cross-sector complications, the IFRS "assault course" certainly introduces more obstacles in some countries than it does in others.

The prize at the end of this course--a high-quality set of global standards leading to greater transparency, improved comparability across borders and, ultimately, more informed investment decisions--is certainly a valuable one. It's much like working out in your local gym: it's a case of "no pain, no gain," if this prize is to be obtained.

Confidence in reporting is seen as critical for the stability of European capital markets, and the requirement for EU-listed companies to use IFRS from 2005 is seen as an important step towards reaching that goal. Mazars European IFRS survey results showed 73 percent of listed companies believed that applying IFRS would result in a greater degree of transparency, and nearly 79 percent of them think that IFRS will contribute towards making financial statements more reliable.

Transparent reporting--based upon a principles approach, combined with robust auditing under International Auditing Standards--will hopefully help to ensure that there are not too many hidden surprises waiting to jump out of the financial statements of European companies. If greater trust in reporting can be established, then this will surely lower investment risk, and companies will benefit from a resulting fall in the cost of capital.

Respondents to the Mazars survey clearly expect greater volatility in reporting. The accounting world is without doubt moving increasingly towards fair values and away from the use of historical cost as a measurement basis. It's "Catch 22" for most companies on the transparency/volatility issue. Few users of financial statements would not put transparency at the top of their "wish list," and thus it is up to companies to clearly explain performance in order to avoid knee-jerk reactions to volatility in results.

IASB Chairman Sir David Tweedie seems to have a habit of leaving early Christmas presents for companies. Before he left the UK's Accounting Standards Board (ASB) at the end of 2000 to join IASB, he left three new standards on pensions, accounting policies and deferred tax. This generosity seems to have continued; in December 2003 the much-awaited revised versions of IAS 32 and 39 on financial instruments were issued. It is the much-debated IAS 39 that companies fear the most, being the number one area identified by European companies surveyed as having the most impact on their financial statements.

It should be remembered that the EU regulation does not include all international standards as published by IASB; it is IAS as endorsed by the European Commission (EC). The endorsement mechanism itself is not merely a "rubber stamping" exercise by the EC, and the debate on financial instrument accounting has now clearly moved away from IASB and into the political arena.

It was perhaps surprising that only 20 percent of European listed companies surveyed were involved in lobbying IASB (either directly or through professional organizations), especially given the controversial nature of some of the recent topics tackled by IASB. Lobbying in the U.S. in the early 1990s prevented plans for the mandatory expensing of share options at fair value. IFRS 2, "Share-based payments," issued by IASB in February 2004, requires exactly that.

Transparency has once again shone through in the approach adopted by IASB. However, on this occasion, the U.S looks set to follow suit by issuing an equivalent accounting approach for option accounting.

Harmonization of accounting, not just within Europe but also with the U.S., is clearly important. Companies listed on a European exchange cannot be seen to be disadvantaged on accounting rules compared to those listed on U.S. capital markets. IASB is undeniably also working hard on convergence with U.S. GAAP, but at this stage there is clearly a long way to go, although everything is moving in the right direction.

International standards are on the way, and while acknowledging that there is a price tag attached to this change, the price of non-compliance, come 2005, may ultimately be even higher. The message to companies at this point must be: "embrace the change." Hopefully, it is just a case of fine-tuning at this late stage, but if the Mazars survey is a fair reflection of readiness, then there is still a lot of work to do for many companies out there. Finance directors are clearly going to be busy over the coming months.

Copies of Mazars IFRS survey are available in both French and English; they can be downloaded from www.mazars.fr.