Significance of International Financial Reporting Standards (IFRS) NIRC - Conference on Accounting Standards and IFRS New Delhi 3 February, 2007 JITENDRA AGARWAL
The Reporting Landscape • Global Markets – the Services Revolution • Accountability • Cross border Capital flows • Bases for business decisions • Corporate Reporting failures • Corporate Governance • Regulatory Framework • Changes in Technology and Products
Accountability • A business enterprise receives capital from outside investors, lenders, and other creditors. • It is accountable to them – it has an obligation to keep them informed about performance, conditions, and prospects. • Also accountable to others who provide resources or environment in which to operate: Employees, government, community at large.
Bases for business decisions • Capital Market transactions • Mergers & Acquisitions • Employee Stock Options • Borrowing and Lending
Company failure – director failure !! January 31, 2002 October 16, 2001 March 28, 2002 June 20, 2002 Issue: Off-Balance Sheet Accounting and Financial Reporting Fraud Impact: $3 billion in undisclosed losses Issue: Financial Reporting Fraud through improper revenue recognition Impact: $12.4 billion in overstated earnings Issue: Financial Reporting Fraud and embezzlement Impact: $2.5 billion of hidden debt Issue: Financial Reporting Fraud Impact: $9 billion in unreported expenses
Corporate Governance Pillars Corporate Governance Primary characteristics D I S C I P L I N E D I S C I P L I N E T R A N S P A R E N C Y I N D E P E N D E N C E A C C O U N T A B I L I T Y R E S P O N S B I L I T Y F A I R N E S S S O C I A L R E S P. N T R A N S P A R E N C Y
Regulatory Framework • Sarbanes Oxley • Reporting in the financial services sector • Quotas, obligations, etc. • Taxation • Eligibility for business transactions
Changes in Technology and Products • Intangible Assets – Licenses, Rights, etc • Tangible Assets – component accounting • Barter transactions • Options and Swaps • Futures • Complex arrangements – BOOT, BOT, BOMT, Service concession agreements, etc
Relevant Transparent Reliable Comparable Accountability • This is what corporate accounting is all about. • Accounting standards help ensure the financial information is: Understandable
Evolution of Accounting Standards • Historically accounting standards have evolved country by country. • Standards set by government, or accounting profession, or independent board. • In the USA:Independent board – Financial Accounting Standards Board (FASB) since 1973. Before that – accounting profession. • In Hong Kong:Accounting profession – Hong Kong Society of Accountants. • In China: Government – Ministry of Finance.
Evolution of Accounting Standards • National standards made sense when companies raised money in, and investors looked for investment opportunities in, only their home country. • But that is no longer the case.
Global Accounting Standards Are Needed • Big change in 4th quarter of 20th century: Globalisation of capital markets. • Now, investors seek investment opportunities all over the world. • Companies seek capital at the lowest price anywhere. • Cross-border mergers. • Accounting differences can completely obscure comparisons.
Global Accounting Standards Are Needed World: 51 stock exchanges, 2700 foreign (cross border listings) out of 40,000 companies
Globalisation of Capital Markets Capital inflows Capital Outflows Source: IMF Workpaper
Global Accounting Standards Are Needed • On many stock exchanges foreign listings are a large % of total - USA October 2006: • NASDAQ: 10% (329 cos., 36 countries). • NYSE: 20% (453 companies, 47 countries). • Foreign is 33% of market value. • US SEC total: • 1981: 173 foreign companies listed in US. • 1991: 439 foreign companies listed in US. • 2002:1,400 foreign out of 16000 total • 2004: 1,236 foreign companies from 53 countries • 2005: 1240 foreign companies from 55 countries
Global Accounting Standards Are Needed • Foreign companies that sell securities publicly in the US must either: • Prepare their financial statements using US Generally Accepted Accounting Principles (GAAP), or • Use their national GAAP and include a reconciliation of earnings and net assets to comparable US GAAP figures. • The 1,240 foreign companies registered with the SEC use about 55 GAAPs!
Global Accounting Standards Are Needed • Even with the reconciliation, perhaps 95% of the financial figures in a foreign company’s annual report are based on their national GAAP – not comparable to US GAAP. • Pity the poor investor who has to compare foreign GAAP companies with US investment alternatives. • Pity the SEC staff reviewer, too.
Global Accounting Standards Are Needed • Same problem all over the world. • And these exchanges do not even require a reconciliation to national GAAP. • London Stock Exchange (Jan 2006): • 17% of companies are non-UK. • 550 foreign companies, 65 countries. • 66% of market value is non-UK. • Euronext: 25% foreign (345 / 1,392) • Switzerland: 32% (132 / 419) • Germany: 21% (182 / 866)
Shortcomings of Old IASC • Weak relationships with national standard setters. • Lack of convergence of IAS and major national GAAPs. • Part-time Board, full-time work load. • Needed broader sponsorship than accounting profession. • Needed recognition by regulators. • Needed resources. Structure review 1999-2000. Results . . .
Topics Covered by Existing IASs • IFRS 1 First time adoption of IFRS • IFRS 2 Share based Payment • IFRS 3 Business Combinations • IFRS 4 Insurance Contracts • IFRS 5 Non-current Assets held for Sale and Discontinued Operations • IFRS 6 Exploration for and Evaluation of Mineral Resources • IFRS 7 Financial Instruments: Disclosures (issued 18 August 2005)
IFRS 8 Operating Segments • Issued [30 November] • Effective 1 January 2009 • Earlier adoption permitted • Replaces IAS 14
IFRS 8 • No significant changes from ED • Adopts FAS 131 approach to determining segments—’management approach’ • Focus on the information presented to the ‘chief operating decision maker’ • Vertically-integrated operations can have segments • Measurement • Based on measures reported to chief operating decision maker • No requirement for IFRS-based measurement
IFRS 8 • Disclosure • Enhanced from those in IAS 14 • Reconciliation to IFRS-based reporting required • IAS 34 disclosures amended
IFRIC developments • Group and Treasury Share Transactions – IFRIC 11 • Service Concession Arrangements – IFRIC 12
IFRIC 11 – Group share plans • Issues: • Share-based payments involving own shares • Share-based payments involving shares of the parent • Intra-group transfers • Share-based payments involving own shares • Will always be equity-settled if equity-settled under IFRS 2
IFRIC 11 (ii) • Share-based payments involving parent shares • Parent offers its shares to employees of the subsidiary • Always equity-settled • Subsidiary offers its employees shares of the parent • Cash-settled in the individual accounts of the subsidiary • Intra-group transfers—non-market vesting conditions
IFRIC 12 • IFRIC 12 Service Concession Arrangements • Approved, to be issued [30 November] • Effective date 1 January 2008 • Public-to-private arrangements only • Grantor controls or regulates what services are provided; to whom; and the price • Grantor controls any significant residual interest in the infrastructure • Whole life assets are within the scope if the Grantor controls services, intended customers and price • Operator’s pre-existing PP&E • Grantor accounting is not addressed
IFRIC 12 (ii) • Some significant issues • Arrangement consideration • Financial asset vs. intangible asset • Repairs, restoration and maintenance • Borrowing costs • Applicability of other IFRS • Amends IFRIC 4 • Scope exclusion for concession arrangements subject to IFRIC 12
The IFRIC’s agenda—status • Draft—comment period closed • D19 - The Asset Ceiling: Availability of Economic Benefits and Minimum Funding Requirements • D20 - Customer Loyalty Programmes • In development • IAS 18 - Real estate sales • IAS 18 - Initial fees received by a fund manager • IAS 18 - Identifying agency arrangements • IAS 38 - Advertising and promotional costs • IAS 41 - Recognition and measurement of biological assets
The IFRIC’s agenda (ii) • Early stages • IFRS 2 - Accounting for employee benefit trusts • IAS 11 - Allocation of profit in unsegmented contracts • IAS 17 - Sales and leasebacks with repurchase agreements • IAS 21 - Hedging a net investment • IAS 39 - various hedge accounting issues
Recent and Emerging Trends in International Accounting Standards • Greater use of fair values in measuring transactions: • Impairment recognition. • Prohibit poolings. • Non-monetary exchanges. • Fair values on balance sheet for both financial and non financial assets: • Financial Instruments. • Agriculture. • Investment property. • Commodity inventories.
Recent and Emerging Trends in International Accounting Standards • More unrealised components of income: • Performance reporting becomes key. • No income smoothing, cost deferrals, general provisions: • Remove corridor approach to pensions. • Balance sheet approach to deferred tax. • No accruals for future losses. • Rigorous hedge accounting rules.
Recent and Emerging Trends in International Accounting Standards • Eliminate off-balance sheet items: • Derivatives. • Special purpose entities. • Stock compensation. • More disclosure, especially judgements, plans, assumptions: • Judgement in applying accounting policies. • Risk management policies. • Sensitivity analyses. • Eliminate accounting choices. • Convergence with US GAAP.
“Endorsement” of IFRS in Past Few Years • International Organization of Securities Commissions: 100 securities regulators (including the US SEC). • Basel Committee: Global bank regulators (including the US Federal Reserve) • The World Bank and IMF. • The G7 Finance Ministers. • And many others. These are non-binding endorsements.