The introduction of a regime of financial reporting standards is making its mark on the accounts of Australia’s biggest enterprises, and surprising many.
Speak to chief financial officers of companies on the BRW 1000 list about the new international accounting standards and you will see a lot of hand-wringing and hear a lot of complaints about how difficult the transition was this year. But what they do not often mention is that they had a lot of scope to minimise the effect of the new Australian equivalent international financial reporting standards on their accounts. On average, companies were able to adjust their net profits up under the new rules -some by more than 100 per cent.
All listed and most private companies had to adopt AIFRS for their first full-year accounts after January 1, 2005. Last year, they were also required to provide figures compliant with AIFRS to compare with their figures under the old regime, the Australian generally accepted accounting principles (AGAAP).
An analysis of both figures for the top 50 listed companies on the BRW 1000 finds that their net profits were restated up by 5 per cent on average under AIFRS in 2005. IBISWorld’s analysis also reveals many companies had to make some big adjustments to their figures under AIFRS: their revenues and net profits were adjusted (both up and down) by 10 per cent on average and assets restated by an average of 12 per cent.
Two academics, Professor Kamran Ahmed of La Trobe University and Dr John Goodwin of RMIT University, undertook an analysis of the 1387 companies listed on the Australian Stock Exchange to see how they coped with the transition. Their research found that companies adjusted their profits up under the AIFRS rules by 5.9 per cent to .79 million, on average, in their 2005 annual accounts.
An audit partner of the accounting firm BDO, Wayne Basford, says he is surprised by the results produced by IBISWorld and the academics. He expected that AIFRS would have forced most companies to mark their profits down. “Everything in IFRS is set up to recognise costs earlier and delay the recognition of revenue. So it is really strange [to see] statistics that say profit has gone up.”
But Goodwin says further analysis shows most companies had to reduce their reported net profit under the new rules. However those that adjusted up, did so by amounts that more than outweighed the majority of companies adjusting down.
Listed property companies marked up their profits substantially in 2005, because under the new rules, changes in the market value of their properties are now reflected in their profit-and-loss statements. Beneficiaries included Centro Properties Group (whose profit increased by 331 per cent), Westfield Group (216 per cent) and CFS Gandel Retail Trust (146 per cent).
There were also, in many cases, big increases in profits under AIFRS because goodwill is no longer amortised over time. The biggest beneficiaries for this reason were Ansell (377 per cent increase in net profit), DCA Group (223 per cent), Symbion Health (120 per cent) and Babcock & Brown Infrastructure Group (108 per cent). Under AGAAP, goodwill bought in from an acquisition was written down over a 20-year period, which was counted in the company’s profit-and-loss statement.
Accountants say it should not be underestimated how much companies were able to minimise any negative effects on their accounts during the move to IFRS. Basford says property developers had a “lucky one-off windfall” by being able to count some of their sales twice during the transition. He says developers always try to sign big deals shortly before the end of the financial year to boost revenue. But when the rules changed, they were able to restate the property sales in their 2005 accounts for deals signed at the end of 2003-04 that were already recorded in their 2004 accounts. Adjustments were made in the 2005 accounts by reducing the retained earnings in the balance sheet, which would have gone unnoticed by many.
“Analysts would have to be aware of the underlying trends. You could definitely have that revenue in twice [if comparative figures from the previous year's accounts are not checked],” Basford says.
Another way companies could benefit from the transition was to enter expenses in their balance sheets under AGAAP and then write them off under the new rules, Basford says. For example, the start-up costs for new divisions would be recorded as assets under AGAAP. But in the 2006 accounts under AIFRS, those costs would be restated in the 2005 income statement. The profit results in 2006, and the following years, would be boosted because the start-up costs were recorded in the past rather than in future years. “There are lots of presentation issues that would lead you to believe that IFRS has improved the P&L (profit-and-loss statement),” Basford adds.
Exemptions during the transition phase to AIFRS also gave companies opportunities to improve their profit results and balance sheets. “It is going to take two or three years before we clear the decks of these exemptions,” a partner of Ernst & Young’s AIFRS on-call advisory group, Mark Seddon, says.
For example, companies were allowed to choose whether to apply the rules on recognising goodwill for acquisitions made before July 1, 2004. “The broad principle of IFRS is you apply them as though you always had those rules,” Seddon says. “But [some exemptions on transition] allowed companies to do some cherry-picking. Some would have gone back and applied IFRS to an acquisition they did two years before [the transition date] so they could get a better-looking balance sheet or result.”
Another area of AIFRS that companies might look to exploit is when revenue is recognised for bundled contracts. Andrew Archer, an audit partner at accounting firm Grant Thornton, says the AIFRS standard on this issue is vague compared with the equivalent in the United States. He believes the AIFRS standard leaves ground for companies to record revenue earlier than they should. For example, an information technology company that wins a contract to deliver a software product may try to book revenue in the current year’s accounts for providing support in subsequent years. “More aggressive companies may look to argue that it is all part of delivering the contract to bring forward the timing of the recognition of that income,” he says. “There is not the same level of detail within IFRS on revenue. It is a little bit looser and that gives people the latitude to argue a more aggressive policy.”
A question of interpretation
Shifting to the new international financial reporting standards was not easy for the accountants at Australia’s biggest company, BHP Billiton. The company’s manager of policy and governance, Brett Rix, in an address to the Institute of Chartered Accountants’ conference on AIFRS, described the transition as “an experience he would rather forget”.
In the end, BHP Billiton’s net profit for the 2005 financial year was adjusted down by $US2 million (.6 million) and its net assets reduced by $US427 million (or 2.4 per cent of its total). The three-year project to move to AIFRS cost the company about million.
Rix said one of the biggest problems was obtaining guidance about how to apply the new standards to the accounts. Under IFRS, the International Financial Reporting Interpretations Committee in London is responsible for issuing interpretations of how the standards should be applied. Its track record has been to issue very few compared with the requests it receives.
Rix says when he sought guidance from IFRIC on whether royalties and similar arrangements were captured under the accounting standard on income tax, the committee responded that it could not form a conclusion based on the principles in the relevant standard.
BHP Billiton was left to devise its own policy. It classifies petroleum resource rent tax as an income tax, a decision endorsed by the Australian Accounting Standards Board, but different to all other Australian companies paying the same tax.
Rix comments that if his company – and others, such as rival Rio Tinto – are interpreting the rules differently, then it defeats the purpose of international reporting standards because it becomes difficult to compare their accounts.
BHP Billiton is not alone in its frustration with IFRIC. Ernst & Young’s Mark Seddon says: “The IFRIC, more often than not when asked to consider a particular issue, has been somewhat unhelpful by saying, ‘the standard is quite clear’, but yet not providing any great insight into why they think the standard is clear.”
Credit:ivythesis.typepad.com
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