Global Business

Slow Progress of International Standards

Gilles Zancanaro, corporate director of information systems and finance at €24 billion French conglomerate Bouygues, laments ''unresponsive'' behav...
Eila RanaMarch 21, 2007

Two years ago, Gilles Zancanaro was feeling bullish about accounting standards. Back then, the corporate director of information systems and finance at Bouygues, the €24 billion French conglomerate involved in construction, telecoms and media, was celebrating the successful completion of a project for the Conseil National de Comptabilité, the French accounting standard setter. In just six months, Zancanaro and his project colleagues had come up with a common set of national standards on the presentation of financial statements under IFRS. His work won him a place on the project’s international equivalent — the Joint International Group (JIG) on Financial Statements Presentation — set up jointly by the IASB and its U.S. counterpart, the FASB, to advise them how to handle this thorny area of accounting. Flash forward to today, however, and Zancanaro is more downbeat about the JIG, lamenting its slow, and at times frustrating, progress.

First and foremost, Zancanaro pities the investor community. Although investors now have more information about company performance than ever before, he says, the lack of common international standards on presenting financial statements means that it’s impossible to compare corporate performances in different jurisdictions.

It’s against this backdrop that the SEC wrote to U.S.-listed European companies last autumn, demanding additional information about how their IFRS-based filings translated into U.S. GAAP. The request elicited an angry response from some European CFOs, who accused the U.S. financial regulator of interference in foreign companies’ financial statements.

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The JIG’s work, if successful, could ease these tensions. However, it has its own hurdles to clear first, notably to get the IASB and FASB to be more responsive to its advice.

Previous attempts to create common standards on financial statements presentation and performance reporting have failed. Should the finance community feel more positive about the latest attempt?

The last attempt at setting up a standard presentation format for performance reporting was in 2003. The IASB came up with a matrix format, which was rejected by a majority of Europe’s constituents. A new joint project with the FASB started in 2004 and the JIG was set up to advise the boards on improving their due process and knowledge of company and market practices. Despite some progress, we consider that the boards are still rather unresponsive to our opinions. For example, the IASB issued an exposure draft [consultation paper] proposing major evolutions to IAS 1, the Presentation of Financial Statements, such as eliminating the income statement as a primary statement. Up to 130 constituents responded to the paper and the majority opposed the changes, yet staff at the IASB recommended that the board amend IAS 1 nonetheless. This was very surprising. There is a problem of governance. Why issue an exposure draft if you’re not going to listen to most of the responses?

Have any of the JIG’s proposals been taken up by the IASB and the FASB?

The IASB has listened to our ideas in two interesting fields, so this is positive. The first is categorization. They have decided to introduce a distinction in financial statements between business and financing costs, and within the business category, there will be two sub-categories — operating and investing costs. The distinction between business and financing seems basic but documents were not presented as clearly in the past. There is a consensus on this point as most investors use the tried-and-trusted Modigliani Miller model to calculate “enterprise value” using cost of capital. A presentation that clarifies which items are “financing” and which are “business” is positive.

The second field is cohesiveness. Cohesiveness implies consistent presentations between the different primary statements. For example, operating assets should be identified and grouped together in the balance sheet and corresponding revenues and expenses should be consistently classified as “operating profit” on the income statement. We have no consistency between the different documents at the moment so this is a great principle.

What is the JIG’s biggest challenge?

The key problem is how to present company performance. The JIG has very different views to the majority of the IASB and FASB on this. The boards define performance as “comprehensive income,” which is roughly the difference between two balance sheets — one at the beginning of the period and one at the end. This difference will increasingly include fair value items — assets and liabilities valued at market and not historical value — which the boards encourage. But in the majority of cases those assets are not liquid and no market value exists. So within comprehensive income, there will be a number of items that will represent hypothetical gains and long-term gains on assets.

Companies are reluctant to accept this because these hypothetical and long-term gains may never turn into actual profit. The present earnings indicator — net income or earnings — is still valid and better reflects performance.

The boards are saying “earnings” is not defined and is not a relevant key line so they want to eliminate it. They support the comprehensive income approach because they consider it to be the best conceptual approach and because they believe companies sometimes hide their bad results below the net income line.

We are saying we don’t want to hide anything but more importantly, please don’t mix a performance reporting system with a value reporting system. They’re different things.

Analysts and investors use valuation models based on earnings, such as P/E ratios. We don’t know what will happen if we suppress earnings. Do we suppress P/E ratios? The IASB is not addressing the issue and it’s important.

Is the JIG’s 2010 deadline on common standards achievable given this disagreement?

2010 is feasible but we need consensus on this fundamental issue of performance. On such fundamental subjects, standard setters should pay more attention to market needs and practices.