When the numbers don't stack up

Billions of dollars of value have vanished from balance sheets, along with the retirement savings, jobs and homes of millions of people.

In the midst of the chaos have come calls for measures to ensure such a crisis cannot happen again. The spotlight has fallen on the International Financial Reporting Standards (IFRS) and whether they could, or should have, offered more protection to potential investors.

IFRS are principle-based standards, based on a framework. The framework is designed to ensure that an organisation’s financial statements provide a wide range of users with information about an organisation’s performance, financial position, and any changes in that financial position. The aim is to ensure that users have enough useful information when making economic decisions.

Developed by the International Accounting Standards Board (IASB), IFRS are used in over 100 countries, including New Zealand. The US, however, has its own standards framework, maintained by the US Financial Accounting Standards Board.

The two boards combined late last year to set up the Financial Crisis Advisory Group (FCAG) to investigate the implications of the global financial crisis for standards-setting bodies, and to identify any changes that might be needed.

Jane Diplock, chairwoman of New Zealand’s Securities Commission, is the only representative from Australasia on the FCAG, and is also chair of the International Organization of Securities Commissions (IOSCO), whose members regulate more than 90 percent of the world’s securities markets.

The goal of one set of financial reporting standards around the world is an important one, she believes.

“It is a huge contribution to transparency, and adoption by New Zealand issuers means our financial reports are more easily understood by international investors. But it is a work in progress, and the IASB is putting a huge amount of effort into making them even clearer. There is still some work to be done there.”

Jane Diplock makes the point that disclosure is not necessarily the same thing as transparency. She emphasises that financial reporting should reflect not just the numbers, but what managers are thinking about the management of a company.

“Reporting should allow potential investors to understand the business and its drivers, and give them an opportunity to really understand what the financial statements tell you about the business and the industry.

“Accounting is about expressing economic reality at a point in time. To do that, it’s not enough to follow the rules slavishly. It’s about understanding where management thinking is coming from. Sometimes managers tend to see financial reporting as an exercise – an add-on rather than integral. It should be seen as part of the whole business process.”

IFRS are designed to paint a much clearer picture of what a company owns and how much it is potentially worth.

A key difference between IFRS and their predecessors is that they aim to give assets a fair value based on the present economic conditions, rather than just taking the figure paid for an asset and adjusting it over time according to depreciation rules. The value of intangibles such as brands, customer relationships and financial instruments must also be included on balance sheets.

“Accounting expresses an economic reality at a point in time,” says Jane Diplock. “It’s not enough to follow the rules slavishly – if the numbers don’t give a clear picture, then managers need to add a note to the reporting.”

The FCAG is considering these issues, along with questions of fair value accounting, market-to-market issues and, particularly, the consolidation of assets related to special purpose vehicles held off balance sheets.

“These products were designed to be complicated. Financial institutions hid financial instruments off balance sheet, and when they had to pull them back on, they were full of toxic debt, which was disastrous.