01 November 2006

FT: Litmus test shows gap between reporting regimes

One of the biggest questions in financial reporting looks as if it is going to receive a pretty negative answer. Earlier this year saw the full implementation of international financial reporting standards (IFRS) for the first time in Europe and around the world, and publication of the first full sets of accounts under the new regime.

Analysts and preparers have had their say. But what the financial reporting community was really waiting for was an indication of how the regulators, crucially the US regulators, perceived them.

International companies are eager for a regime that enables them to publish one set of figures that will be accepted by stock markets wherever they list. At present, there is still a complex system of regulatory hurdles and two separate systems.

There is now IFRS in Europe and elsewhere around the world, and US Generally Accepted Accounting Principles (US GAAP) in the US. The all-powerful Securities and Exchange Commission in the US has always claimed US GAAP is the most rigorous system. But efforts have been under way to allow, first, a reconciliation system between IFRS and US GAAP that would lift the regulatory burden of companies effectively having to report under two systems. This would be followed eventually by a full reconciliation and an effective merger of the two systems.

For UK and European chief financial officers there was always going to be a litmus test of how well this process was going – this would be the attitude of the SEC after it had scrutinised the first IFRS-based reports and accounts. The hope was that the SEC might show it was moving to a basis whereby the underlying principles of IFRS were seen as paramount rather than the lawyer-driven, rule-based haggling that typified the SEC approach in the past.

Earlier this year, in a KPMG report on IFRS, this was outlined by Jon Symonds, the influential CFO at pharmaceuticals company, AstraZeneca. “The SEC reviews which take place in the first half of 2006 will set the tone,” he said. “If they say: ‘How have you applied the principle?’, then we will know that things have changed. If it is: ‘What about line y in paragraph x?’ then we will be on the road to rules again.”

So CFOs have been awaiting comments, queries and specific questions from the SEC, and now the first communications have come through. The litmus test suggests the news is not good. At the recent Euromoney IFRS conference Mr Symonds said that among the communications he had received from the SEC there were several that showed it was still clinging to specific and detailed questioning about how one paragraph of a particular financial reporting standard had been applied.

It has become clear this has happened to many, if not all, the UK companies that, having listings in the US, come under the regulatory eye of the SEC. One FTSE100 company received some 66 specific queries. “The SEC becomes the judge and jury,” said Mr Symonds. One company was questioned about a particular accounting treatment it had specifically cleared ahead of time with the UK accounts watchdog, the Financial Reporting and Review Panel. The consensus among CFOs was that the SEC was sending exactly the wrong signal to the financial reporting community.

There are several reasons for this setback. The first is the dominance of lawyers in the US financial reporting and regulatory systems. Parodying Abraham Lincoln, Robert Herz, the chairman of the US Financial Accounting Standards Board, which promulgates US financial reporting standards, told the same conference: “Auditors, preparers and regulators all need to act on the principles issue.” But he warned of the upcoming difficulties: “We have become a nation of lawyers, governed by the lawyers, and for the lawyers.”

© Financial Times