A surprise gift for Christmas Accounting

Wednesday, 01 December 2004


    Christmas is just around the corner and in the world of corporate reporting there are some things wrapped up in paper and tied with ribbons under the tree that just might surprise you.

    A surprise gift for Christmas

    Christmas is just around the corner and in the world of corporate reporting there are some things wrapped up in paper and tied with ribbons under the tree that just might surprise you.

    Take for instance the fact that once you open the wrapping of one box an accounting standard you thought only came with one way of doing things actually comes with another two - thanks to a recent decision of the Australian Accounting Standards Board.

    The standard setter has reversed a decision it had made on accounting for employee benefits that results in companies being able to choose from three options of accounting for defined benefit superannuation plans rather than the one option that would have maintained domestic consistency between financial statements.

    This becomes important in the new reporting environment because companies are required to show the surpluses or deficits in their defined benefit funds on balance sheet. Movements on balance sheet need to be accounted for as gains or losses but there are now several ways of determining the manner in which things can be presented.

    Board members initially restricted companies to the use of one method of accounting for the differences between the book value of existing superannuation fund deficits or surpluses and any new actuarial assessments of employer obligations to take all gains and losses to the bottom line.

    In some cases such an accounting treatment would create a substantial degree of volatility because the gains and losses will be determined on the basis of the conditions of the defined benefit fund at the time and how much is actually needed to cover the obligations a company would have to its employees. Those differences can be great in some cases because of the large deficits in defined benefit funds that exist in large companies.

    The two methods that will be introduced would offset the impact on the bottom line in one of two ways. There is a method known as the 'corridor method' of accounting for defined benefit superannuation plans. This method allows companies to engage in smoothing of results, which is essentially removing some of the volatility associated with movements in actuarial assessments if the gains or losses are within a certain buffer based on a percentage.

    This means any hit to the bottom line will not occur if the movement represents under 10 percent in either direction.

    The other method, which is being introduced because the UK Accounting Standards Board has lobbied the IASB, requires full recognition of gains or losses but it allows them to be recognised in the equity part of the financial statements. In other words, full recognition on balance sheet occurs but there is no profit impact.

    What are the implications for companies in this situation? Some entities could entertain the notion of revisiting decisions just made in relation to the accounting treatment at some point in the near future. Those that have not gone too far into their transition projects on international accounting standards are in the strongest position here because they will be able to take advantage of the revised requirements.

    A change in accounting policy could be necessary for those companies that have already moved ahead and implemented the full recognition of gains and losses to the bottom line.

    There is an interesting impact on directors and their internal corporate advisers. A change in the standards means a potential need to revaluate certain issues as a part of the process of moving to the standards.

    It may be seen by some directors on company boards and the senior managers as an opportunity to limit financial statement volatility related to the introduction of international financial reporting standards.

    While companies might find some way of coping with the surprise change that has emerged from the standards board there is a fundamental question about what this so-called "flip-flop" situation has done for the standard setters reputation.

    The initial and understandable reaction of some corporate executives has resembled a mix of bemusement to intense annoyance. Why on earth would a board that has paraded itself in front of the community as one that is concerned about comparability within the Australian jurisdiction do an about face on this particular issue? That question can only be answered by understanding some of the board's logic for the deletion of options in accounting standards.

    The "corridor" method was only one of two methods in the initial standard the IASB had in place. Members of the AASB took a punt when they chose to prohibit the "corridor" approach on the eventual result of the IASB's deliberations in the area of employee benefits.

    Board members believed the IASB would eventually choose the method of accounting that forced companies to place all of the gains and losses through to the bottom line, but that this would occur in conjunction with the development of a different way of reporting company performance.

    Not everybody is comfortable with the notion of changes in actuarial estimates of obligations related to superannuation hitting the bottom line directly without readers understanding the changing fortunes of the company as reported in financial statements relate to factors that are sometimes beyond the control of the managers of the business.

    Some work has been done by the IASB on developing a model for improved reporting of company performance, but that project has been stalled. No improved model of reporting performance was available at the time the AASB made its decision to ban the "corridor".

    Companies were then left in the position where they thought only one method would be available to them, which was the message given to them by the AASB's suite of standards that was made last July. The change made during the board's November meeting creates a situation where change to the accounting standards needs to be expected at any point in time.

    It adds an unnecessary element of uncertainty to the environment during a period in which companies are expected to comply with local equivalents of international accounting standards.

    The other Christmas present under the tree companies need to be wary of is the large swathe of unexplained consequences of adopting the

    new standards. Companies are, according to several experts, starting to realise that adoption

    of international accounting standards is a misleading term.

    Take, for example, the domestic requirement that companies fair value assets they shuffle between subsidiaries within a corporate group. This results in goodwill being booked in one entity and the assets moving to another with a figure on balance sheet reflecting a contemporaneous value.

    European entities just do not do any of this at all. They have a culture that is extremely suspicious of anything that looks remotely like internally generated goodwill and it is for this reason that you do not see them doing the same kind of accounting as Australian entities.

    Imagine the fun you might have if you are a company that took the standards board on its word in relation to adoption and find that you begin to get different accounting results because of the way the standards have "grown up" in Australia.

    There is another trend unravelling itself that is causing some angst among a few of the business community as well. The news that no Australian was appointed to a financial instruments consultative committee was greeted with some surprise.

    There is also the fact no Australian was appointed among the two individuals that filled the vacancies on the International Financial Reporting Interpretations Committee, particularly curious because one of the spots filled was that once occupied by Australian valuation expert Wayne Lonergan.

    It is a symbolic of the globalisation of standard setting and a warning that further loss of direct involvement on committees could be on the way if Australian companies and others fail to engage with the international standard setter.

    AICD continues to be concerned about the transition to IFRS in January 2005 and believes that some measure of relief for smaller companies in relation to IFRS is appropriate


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