COMPLIANCE, PROFIT-SEEKING BEHAVIOR AND USER NEEDS: THE THREE CRITERIA OF ADAPTING A NEW ACCOUNTING POLICY
As the global economy matures, there is a need to globalized and integrate accounting polices for efficient and effective cross-border trading. However, it is still questionable that companies apply internationally-accepted principles due to profit-seeking stance. More so, the emphasis given to situate FS structure to a wide-range of users may be undermined. But it is assumed that when international standards are used, the usefulness of FS on general users is assured. This paper discusses the ability of Financial Statements (FS) to reflect corporate performance and position that can be useful to a wide-range of users. The ultimate question is that “What will be the core objective of the reporting entity?”
The IAS Framework
IAS 1 accounts compliance of an entity in presenting, structuring and satisfying disclosure requirements for general purpose FS (IAS Plus 2006). Its purpose is to provide users a decision-making platform and covers guidelines in completing balance sheet, income statement, statement in changes in equity, cash flow statement, and if necessary, notes to FS. It is suggested that fair presentation is achieved when an entity follows the provisions of International Financial Reporting Standards (IFRS) in which IAS 1 aids in reminding entities to be explicit and make no reservation on reporting (IAS Plus 2006).
On the other hand, IAS 8 largely set out disclosure requirements and possible adjustments in related FS due to changes in accounting policies which give rise to change in accounting estimates and emergence of errors (IAS Plus 2006). Its purpose is to inform and protect users against the risks of misleading forecasts about the past, present and future financial performance of an entity due to the changes in accounting policies. To achieve this end, the provision lays two priorities for the reporting entity to use Standards and Interpretations as references for accounting framework prior to last resort of managerial judgment or recent pronouncements from standard-setting bodies (IAS Plus 2006).
Vodafone: Analysis of Compliance
According to IAS 1, disclosure of entity’s judgments and own policy in FS as well as non-compliance of IFRS should be justified according to its nature, reasons and impact (IAS Plus 2006). The company reflects compliance in the portion pertaining to risk factors, trends and outlook primarily due to the shift to IFRS from UK and US GAAP. For example, there is a risk in broader and global scope of IFRS governing body as it may significantly affect business performance and operations unlike the narrower view of national and regional policies (p. 43). It also forecasted future growth and performance of the company under new accounting framework as far as 2007. It closed the section by stating some cautions regarding the forward-looking statements as well as admitting non-GAAP information (pp. 46-47). This is beneficial data for non-speculative and wealth-conscious investors as they tend to have a more long-term relationship with the company than speculators/ players in the stock market.
Vodafone used IFRS in its consolidated FS for the year ended 31 March 2005 although the European Parliament already required companies for its usage since 2002 (Vodafone 2006 p. 25). Due to this lagged, the firm is liable for retrospective application (IAS Plus 2006) which it is complied by showing comparative amounts and substantial explanation of the former (US GAAP) and new framework used in estimation (IFRS) (pp. 26-28). Stating that the shift resulted to major effect in future performance and activities of the company (p. 25), the report presented restatements (note 40) and reconciliations (note 38) which sufficiently follows necessary disclosures required in policy change. As the firm also uses UK GAAP apart from its US operations, (note 40) not only shows restatements of UK GAAP to IFRS but also revised the account format and labeling (e.g. turnover to revenues). The latter move in a coinciding compliance with IAS 1 because UK GAAP that allows “exceptional non-operating items” in the P/L account is classified (e.g. non-operating income and expense, investment income, etc.) when converted in IFRS format (p. 128).
The company is operating and reporting in a global scale that it uses at least two accounting policies (e.g. UK and US GAAP). However, by shifting to IFRS, the burden of adjusting to dissimilar reporting regulations is minimized by using a generally-accepted accounting standard. Shareholders and potential investors are the groups that primarily benefited from these methodologies reflected in FS report of the entity. The company warned them initially about the risks associated with policy shift and elaborated them with restatements. As an illustration, (note 40) ended a loss for year ended 31 March 2005 using UK GAAP £ (7.5B) but IFRS bottom-line showed a profit £6.4B primarily due to measurement and recognition differences. In addition, the bottom-line format of IFRS explicitly admits that the “profit for the financial year is attributable to equity shareholders” which provide a partial marketing clause to invest in the company unlike the implicit UK GAAP format of “loss for financial year” (Note: This may be more welcomed by the company because noone would like to gain a net loss).
The presentation of UK GAAP and IFRS reconciliation is also done following IAS 8 guidelines for errors (IAS Plus 2006). Since the company adapted IFRS only in 31 March 2005, it is obliged by the provision to restate the opening balances for 2004 and 2005 (p. 126) because they are part of the retrospective scope. In this regard, shareholders and potential investors will not be anxious that past FS inconsistencies might affect the application of IFRS in the current FS report for 2006. This will solidify the FS going public scrutiny in terms of credibility and efficiency in reporting.
Perhaps, the most frequent result of managerial judgment, accounting estimates require elaborated presentations especially when accounting policies which serve as conceptual frameworks for managerial decision-making are on a change. This endeavor will benefit creditors as well as suppliers in determining the accurate size of assets of the company for credit rating and customer contract purposes. In addition, Vodafone belongs to telecommunications industry which is a high-tech sector. Assets and new developments/ inventions are necessary to remain competitive. With the depth and dominance of Vodafone in the global arena, buying rights and patents including licensing is a common strategy. In effect, even the government hosts to the technology of Vodafone can determine the applicable licenses or taxes that can be shouldered by the latter. Without disclosing changes in accounting estimates, creditors, suppliers (e.g. technology) and host government will not fully understand the costing of the company which can lead to lost opportunity on both sides (refer to RIM vs NTP on patent infringement cited in CNET News 2003).
The preceding admonition is illustrated in shifting US GAAP to IFRS format and its impact on critical accounting estimates which in turn serve as the basis for completing the consolidated FS. The two policies is largely separated by impairment methodologies with tax, estimation of asset’s useful life and determination for allowance on bad debts are pegged in managerial judgment (pp. 26-28). As IFRS requires annual test of impairment, the company resulted impairment looses of several million pounds contrary to the US GAAP comparison of carrying value to undiscounted future cash flows. This can affect valuation from possible licensees that seek to acquire or share the assets of Vodafone. In the contrary, the company did not elected to apply IFRS on business combinations because of the difficulty of applying the requirements to the large number of business combinations it undertook (p. 27). Such is evidence that the FS of the firm continued to benefit from the leniency of “impracticable clause” of IAS 8 which in accordance to global operations and size of the firm. Company employees and resources are saved from this simplicity.
As IAS 1 applies to all FS that complies with IFRS, Vodafone incorporated basic guidelines. There are far more notes than FS per se (e.g. from pp. 75-139 against pp. 72-74 respectively) and they are cross-referenced to the account concerned. In addition, the format of notes mimic the policy of IAS 1 like prioritizing basis of preparation and accounting policies being used. “Net” is excluded in identifying the bottom-line account or the Profit/ Loss for the financial year. The minimum requirement for specific accounts to be reflected in the Income Statement is also accounted for (e.g. there is revenue, finance costs, share of associate’s undertakings, tax expense). The balance sheet is also unflawed with regards to IFRS conformity. Accounts are categorized as current and non-current and minimum items required at the face of the balance sheet (e.g. intangible assets, inventories, etc.) (IAS Plus 2006). However, there are many “other accounts” especially on non-current assets and current liabilities. Statement on Changes in Equity is also followed with regards to IAS 1. This positively impacts the comparability of the company’s FS with other companies especially within the same industry. This will aid investors in allocating their capital on a homogenous decision platform.
France Telecom: Analysis of Compliance
The situation of France Telecom (FT) with regards to its adaption of IFRS is congruent to Vodafone. Perhaps this can be associated as the two are major players in the regional and global telecommunications industry. FT also applied IFRS during its 2005 operations and used 2004 as comparative figure. Initially, the firm presented how it transformed historical data to comparable data particularly financial results for 2004 (FT 2005 p. 11). This is in accordance to IAS 8 but the manner it was elaborated is more extensive than Vodafone. Perhaps, the bigger font size of the web document of FT FS report plays significant role. As a thoroughly explained situation can provide users substantial facts about the accounting policy shift, there is also the risk of de-motivating them to read the document due also to the substantial effort needed.
But when observed closely, Vodafone has also the tendency to elaborate extensively the cause to historical figure of policy shift but FT is more detailed from one account to the other. This can be primarily affected by the ongoing critical project of the company called “Ambition FT 2005” which started in 2002 (p. 15). As a result, many accounts attributable to the project are adjusted to IFRS in reference to retrospection and its practicability because the project is attended so closely that it became part of the company’s major endeavors. In effect, it is indeed practical to be retrospective and thorough explanation of comparative figures is inevitable.
The company is implicit that there are risks associated with the accounting policy shift. This is evidenced by merely pinpointing “outlook” immediately after the changes in historic accounts (particularly 2004) are identified. It informed the users about its customer-oriented plans like the 2006-2008 NEXT program which aims to introduce innovations, unify customer serve and adaptation of simplified brand architecture (p. 22). Unlike the more aggressive cautions of Vodafone, FS is more customer-oriented which implicates that customers using the products and services of FS will greatly benefit in the FS report apart from potential and current investors who have financial stake on the firm. The future trends of FT like the “development of new DSL, use of Live Box” are an obvious opposite of “impact of new competitors, downward pressure on termination rates from regulatory action”. In effect, IAS 8 is undermined because the company fails to account the primary users of FS which are the shareholders and investors.
The customer-oriented balance sheet of FT can positively or negatively impact shareholders. Positive as the report embodies a strategy on how to maintain and increase market share while there is adverse effect on shareholder impression on financial stability and consistency. However, similarities are eminent. The opening balance sheet of FT under French GAAP is compared with IFRS version. Adjustments such as net value of properties for IFRS figures reduced the value of assets of French GAAP-quoted accounts (p. 215). There are notes to serve as reference for adjustments not only on computations but accounts names. For example, deferred income taxes is changed to deferred tax assets as well as “other” accounts are specified which is a compliance with IAS 1 and 8. In addition, most of the notes pertain to implications to FS of IFRS adaption which complied with disclosures in accounting policy changes like the cause of change, amount of adjustment and retrospective applications (IAS Plus 2006).
The company applied the carrying amounts of the IFRS that affects most of its accounts especially the properties which resulted to reduction in impairment (p. 221) looses unlike Vodafone who increased impairment losses after adapting IFRS. This shows that there are winners and gainers within the telecommunications industry in the effort to integrate operations to the needs of a globalized economy. In turn, this indicated that Vodafone gripped in prioritizing standards, interpretations and recent pronouncements from regulatory bodies (IAS Plus 2006) before implementing managerial judgment. This is because the company can use the managerial leniency in making flexible arrangements in accounting policy reconciliation but seemingly opted not to do so.
Parallel with Vodafone, FT stated specific provisions not in IFRS policy but is suitable to managerial decision making. As observed, this is in compliance with IAS 8 particularly with regards to stating the reasons of adapting a different accounting policy (IAS Plus 2006). With this, investors will not be discouraged and distrust the credibility if the company’s FS due to their “additions” in the on-going IFRS policies. They are justified and the governing-bodies allowed justification as a part of managerial judgment. For example, provision for pension plans and similar benefits is not a universal method to motivate employees and as such excluded in explicit IFRS policy. In the contrary, the company had justified its use and compatibility with its current strategy including its significant effects when not accounted for.
Lastly, it can be proved that FT diligently follows IFRS even with a more customer focus as its report accounted for expenses incurred during stock option grants which in French GAAP are not allowed to be compensated. However, this are not cash transactions but only “entry” transactions. This is in accordance to disclosure regarding capital transaction with owners and reconciliation of share capital account (IAS Plus 2006). To investors and also internal employees, this can be an eye-opener that not all IFRS adjustments to country-based GAAP lead to increase in cash and in turn their gains and incomes. There are some transactions that cannot increase the bottom-line that closer look to the effects of IFRS shift should be taken into account.
It is earlier noted that when an FS is presented using the framework of IFRS, financial performance and position of an entity is assured to obtain fair representation. An FS is useful to specific users if it embodies their concerns such as earnings per share to shareholders, cash flows for suppliers, research and development feats for customers, provision for environmental liabilities for environmentalist, tax profit/ loss for the government and provision for pension benefits for employees and retirees. More generally, FS should be useful and understandable to a broad-range of users because IFRS is biased on general purpose financial statements. Vodafone and FT are both compliant with IAS provisions which are a segment of IFRS and show that it can obtain general benefits to users (e.g. clearness, simplicity, thoroughness). However, they seemingly concentrated to one primary beneficiary of FS report and two to five secondary beneficiaries. Environmental impacts of their operations are excluded to the loss of environmentalists and other authorities. Then, the question in the introduction is finally answered… it depends on managerial judgment, perhaps, accounting knowledge and experience.