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Global Standards offer opportunity. (International Accounting: Europe).

The regulation that would require all European Union (EU) companies listed on a regulated market, including banks and insurance companies, to prepare their consolidated financial statements in accordance with International Financial Reporting Standards (IFRS -- previously known as International Accounting Standards, or IAS has been heralded as a major step. One top European official even says it would bring "the end of the Tower of Babel."

"This eagerly-awaited proposal signals the beginning of a new era of transparency and the end of the Tower of Babel in financial reporting in Europe," says Frits Bolkestein, commissioner in charge of the European Commission's Internal Market. "The use of one global accounting language will greatly benefit European companies. It will help them to compete on equal terms for global capital.

"Investors and other stakeholders will, at last, be in a position to compare company performance against a common standard. Listed companies should start preparing now for this change-over to a single set of financial reporting rules. Although some investment will be needed in terms of training, I am confident that it will repay itself many times in the long run, notably through the reduced cost for companies of raising capital."

This quote contains several interesting and insightful observations on the background to the proposal to require the use of International Financial Reporting Standards (IFRS)/IAS throughout the EU. First, the proposal is primarily driven by market needs, not by a desire for more regulation for the sake of regulation. Second, the proposal is only a part of a much broader series of initiatives needed to reform the European capital markets. Finally, the end goal is a truly integrated, open, transparent and efficient European capital market, resulting in real economic benefits and the reduction of costs of capital for European companies.

It is important for European companies to keep this background in mind when deciding on their approach to converting to IFRS/IAS by 2005. The tendency will be to consider the conversion as a constraint -- as a compliance exercise. It is, but it can also be much more: a truly unique opportunity to take advantage of this fundamental change in external reporting to significantly improve the way the company views itself and measures performance internally, and the way it communicates about itself externally. Why do we think it is appropriate to go beyond what is required, apart from potential internal benefits? Because we believe the move to IFRS/IAS is a reflection of a broader demand from market participants for more transparent information, more often, on a more timely basis. Let's explore these three points.

1. Transparent information is often cited by regulators and investors as a key component of an efficient capital market. However, the term "transparent" is rarely defined precisely, and it does not necessarily mean the same thing to all people. We believe that transparent information essentially information that flows through from the data used internally to manage the business.

As a result, this information has to reflect the underlying economic reality of the business, has to be segmented to highlight the different risks and opportunities facing the company, and has to be understandable and comparable. The conversion to IFRS/IAS represents an opportunity for most EU companies to provide more transparent financial information, as the standards have been developed mainly with these characteristics in mind. This is not the case for the local accounting standards currently being applied in most EU countries (with the exception, perhaps, of the United Kingdom).

However, converting to IFRS/IAS is only one step towards providing more transparent information. Our definition of transparency does not limit itself to the financial information produced under a financial reporting system using standards similar to IFRS/IAS. In fact, traditional financial reporting systems are coming under increasing pressure in many countries, the best example being probably the United States. Increasingly, analysts and investors are demanding more prospective information (e.g., forecasts) and are looking more and more to alternative financial performance indicators rather than those disclosed in traditional financial statements.

Loosely defined concepts such as "pro forma earnings" and "cash earnings" are becoming ever more prevalent in companies' external communications (such as earnings releases) and in analysts' reports. Also, there is an increasing demand for disclosures of non-financial key performance indicators used by management in making business decisions. We think the trend towards disclosure of information beyond that provided in traditional financial reports will continue to evolve in Europe and around the world in coming years.

2. Issuing financial information more often. Regulators are certainly aware of this trend and are acting on it. For example, one of Euronext's criteria for members of its high-quality segments (NextPrime and NextEconomy) is quarterly reporting of financial information. We can imagine that quarterly reporting will become a standard feature for EU-listed companies within a few years. At the same time, it appears that the U.S. regulators will be raising the bar in terms of frequency of reporting.

At a conference last October, Harvey Pitt, the new chairman of the U.S. Securities and Exchange Commission, stated that "our disclosure system is built around the concept of 'periodic' disclosure. But, periodic disclosure -- that is, disclosure every quarter -- implies that information is static, not dynamic, and that allowing companies to wait until the end of a quarter to disclose significant information is the best that we can do for investors." The SEC is now exploring the notion of "current disclosure," which could result in much more frequent reporting by U.S.-listed companies.

3. More frequent reporting. This is a very sensitive issue in Europe. Many believe that this will inevitably lead to a short-term focus by management, hurting a company's longer-term well-being. This is a criticism often addressed to the American reporting model. This can certainly be debated, but it seems clear that most stock exchange regulators around the world support this trend towards more frequent reporting. It also appears unlikely that European capital markets could compete efficiently with the U.S. markets if too large a gap exists in the frequency of reporting between the two regions.

A direct result of reporting information more often is a necessary increase in its timeliness. In today's technological environment, there is no excuse for significant lags in reporting material financial and non-financial information. Again, market participants want to look at the information management uses to make decisions as quickly as possible.

We believe the case has been made for the advent in the EU of a reporting model based on more transparent information, more often and on a more timely basis. This represents a fundamental shift that must be taken seriously by EU companies. As always, there are two ways of dealing with fundamental change: you can either ignore it as long as you can, and eventually react to it, or you can anticipate it, dominate it and turn it into a true competitive advantage.

This new reporting model has several implications for EU companies converting to IFRS/IAS. First and foremost, it requires a holistic approach to the change. This will affect all parts of a company and its environment: accounting, internal and external reporting, communication with internal and external stakeholders (employees, analysts, investors, lenders, suppliers, customers, etc.), performance measures, information systems, structuring of contracts and transactions (including mergers and acquisitions), human resources, etc. In its most basic form, it means changing the primary language the company uses to communicate internally and externally.

We believe EU companies should consider seizing the opportunities arising from the conversion to IFRS/IAS and from the broader trends in reporting by:

* Defining their overall communications strategy to make communication of financial and non-financial information a competitive advantage.

* Reviewing the appropriateness of the key performance indicators used to manage the business and, if needed, changing them.

* Aligning internal and external financial reporting to be in a position to measure and communicate what matters more often and on a more timely basis.

* Modifying reporting systems to make sure that the right information is captured and to reduce the book-closing process.

This comprehensive exercise needs to be undertaken now. It involves making strategic choices about performance measurements, external financial reporting policies and communication; the options must be carefully analyzed before final choices are made. The change-management aspects of this exercise also need to be considered early to avoid any surprises, internally as well as externally.

The conversion to IFRS/IAS is a first and important step in the journey towards the integration of European financial markets. Overall, European companies should benefit from this integration. In our view, companies that position themselves on the opportunity side of this change, rather than the compliance side, will realize these benefits earlier and more fully.

Jeannot Blanchet is Managing Partner of Andersen's Global Professional Standards Group and Managing Partner, Andersen's lAS 2005 Initiative. He is also a member of the International Accounting Standard Committee's (IASC) Standards Advisory Council.
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Title Annotation:financial statement reporting standards
Author:Blanchet, Jeannot
Publication:Financial Executive
Geographic Code:4EU
Date:Mar 1, 2002
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