Creating Value From Compliance
Mandated by the European Commission in 2002 to build a strong financial Europe, International Accounting Standards (IAS) call for common accounting principles and methods to be implemented for consolidated accounts by 2005 for most European-listed companies. Exceptions are few and their deadline is earlier. Companies quoted on Next Prime and Next Economy indexes of the Euronext market must implement IAS by 2004.
Though compliance deadlines are near, only 40 percent of affected companies have begun planning their conversion to the new standards,1 and only 20 percent have adapted their financial systems, even if they are considered strategic to a successful transition. Many companies tend to underestimate the impact the changes will have on data capture and reporting. Therefore, they set a low priority to such analyses and can be caught off-guard.
By harmonizing various local accountancy standards, standardizing financial operations and introducing new mandatory rules for more comprehensive information, the implementation of IAS will give future investors and third-party partners better visibility into business performance and companies potential for value creation. Based on common international standards, cross-company benchmarks also will be simplified.
The key principles of IAS will have a significant impact on the way financial information is viewed. IAS requires that financial information be published more frequently and in greater detail. The new standards provide a general framework with a limited choice of restricting options. Moreover, some of these currently are not considered in local accounting rules (such as financial instruments for French GAAP) or are calculated differently.
In brief, IAS changes can be categorized as follows:
- Different presentation of financial statements (IAS1, IAS38);
- New valuation rules, such as IAS36 — asset depreciation, IAS37 — present value of reserves, and IAS38 — fair value method for intangible assets;
- Additional mandatory information (IAS7 — cash flow statement, IAS17 — information on leasing operations); and
- Different methods for mergers and acquisitions (IAS22 — goodwill valuation methods and progressive elimination of pooling of interest).
Three Key Areas
Implementing these new requirements will have major impacts in three areas: performance and financial communication; financial processes and organization; and information systems (Figure 1). However, the magnitude of these changes on a companys current operations will depend on the applicability of standards and the gap with existing practices.
Figure 1: Assessing the Impact of IAS
Performance and Financial Communication
The new standards and valuation methods, such as fair-value adjustments, are intended to provide investors and external readers of financial information with significantly more information regarding a companys fair value, debt levels and liquidity, capacity to distribute dividends to shareholders, and on the whole, its true performance. The published information will be uniform across companies.
Communication changes include:
- Measurements of exposure and the impact of marketplace volatility;
- New performance indicators;
- Additional management reports and information on interim accounts;
- Annual report improvements, including additional disclosures;
- Publishing of cash flow statements that distinguish operating, investing, and financing activities;
- Publishing of forecasts using a consistent format;
- Publishing of analyses and other analyst reports on a regular basis; and
- Corporate governance.
Financial Processes and Organization
While the move to IAS will affect consolidation, it also will affect accounting processes and reporting. This impact may require major actions or evolutions to adapt local books to the new rules at both the financial processing and organizational levels. Key changes to financial processes include adapting the accounting methods used for transaction processing, updating and harmonizing financial reporting, and converging local accounts to IAS (see Figure 2).
Figure 2: Required Changes to Financial Processes
These changes must take place at each level of the companys structure (holding, subholding, and subsidiaries), but not necessarily at the same scale. In addition, more data will have to be collected, validated, and sent in a shorter period of time, thus requiring greater involvement from departments typically not associated with closing and consolidation. For example, new valuation methods will affect the cash management, controllers, and asset management departments, but the accounting function will continue to deal with managing several accounting standards. The controllers function also will need to be involved in verifying the coherence of segment data as well as in analyzing performance management.
These process changes can be successful only if an organization recognizes that the volume of entries and processes will increase, that information will be published more frequently, and that greater involvement will be required from a variety of players across the company.
Information Systems
IAS compliance also requires reviewing and potentially modifying one or multiple tiers of a companys financial information systems. Its a common misconception that IAS will only affect consolidation tools. Unless the underlying financial transaction systems can capture and track the required information, consolidation tools will not help with compliance. Information systems will need to handle:
- New valuation methods, including financial instruments, tangible and intangible assets;
- New or modified financial statements, including segment reporting and cash flow statements;
- Tracking of additional information, including commitments and risks; and
- Accelerated generation of financial data and statements.
Further, a companys financial systems will need to manage different categories of adjustments. Depending on the existing financial application architecture, changes can be limited to updating accounting definitions or master data structures. However, companies most likely will be faced with one or more of the following changes:
- Adding detail for transaction processing;
- Configuration updates;
- New reports;
- New interfaces;
- Software updates or upgrades; and
- New applications.
Depending on the amount of change a company can absorb, several scenarios are possible to implement the new accounting standards efficiently (see Figure 3). These scenarios present a transition in which 2004 opening balances are restated in IAS format, local GAAP and IAS reporting is added, and full compliance is achieved as early as the last quarter of 2004 in most cases.
Figure 3: Possible IAS Deployment Scenarios
As companies close the gap between current practice and IAS compliance, they will face several key challenges. For example, even though the standards will continue to evolve, accounting entries must be reprocessed as though they had always conformed to IAS, with only a few exceptions. Therefore, companies must decide if their historical accounting entries must be reprocessed as well.
Compliance to Transformation
Despite these challenges, however, IAS compliance provides the necessary focus for many organizations to structure transformation initiatives already under way. Banks and insurance companies, for example, are currently engaged in improving accounting and finance functions with a view to catching up with the performance standards already achieved in other industries. These include:
- Lowering finance function costs, which were cut in other industries by up to 50 percent in the 1990s;
- Reducing delays in producing results against a greater number of deadlines;
- Increasing emphasis on analyzing information (two-thirds time spent) rather than on producing it (one-third time spent);
- Setting up shared services;
- Reducing the complexity of financial systems inherited from recent acquisitions;
- Harmonizing internal and external reporting procedures; and
- Making financial information transparent.
Facing IAS regulations, financial institutions are approaching the task in one of two ways. The first is a tactical approach, which limits the transformation of information systems and processes to consolidation functions. The second is a more ambitious approach, which seizes the opportunity inherent in the changeover to implement a truly integrated financial reporting system (see Figure 4).
Figure 4 Global and Tactical Approaches
The tactical approach, which maintains the existing architecture, adapts accounting and financial information at all levels of the production chain for transmission in IAS format to the consolidation system.
The more ambitious approach puts in place an integrated financial architecture. Typically, it comprises a single interface between the operational and financial systems, integrated financial data marts, and a single general ledger. This approach ensures the production and sharing of consistent information at all levels of the group, including multi-GAAP management, automatic reconciliation of different reporting items, and the possibility of cross-domain multidimensional analysis. Standardizing data also facilitates the integration of new entities in group reporting procedures. A more advanced option involves using a so-called fat ledger, a single entity for storing all reporting information.
Naturally, there are several variants of these two approaches. Criteria for choosing the most suitable approach depend chiefly on assessing investment priorities (financial systems compared to other systems) and the capacity to manage the complexity of additional work while respecting the 2005 deadline.
Some large financial institutions have chosen the global approach, which allows them to begin transforming the finance function while benefiting from the insights and investments brought about by the changeover to IAS. For similar reasons, banks that are in the process of converting to Basel II requirements by 2006 have selected the global approach to capture the synergies of both IAS and Basel II.
Two Ways to Succeed
Accentures experience has shown that a simple and efficient IAS deployment includes two phases:
Phase 1: Analysis and Preparation
- Understand the new standards: Companies should work closely with external and internal auditors to identify the areas of IAS that apply to their enterprise.
- Analyze the impact: Companies must determine how current practice differs from IAS requirements and how the information needed can ultimately be identified, captured, and reported. This is a critical and iterative phase. It must include an assessment of materiality and feasibility before taking positions on certain standards. For example, before deciding on the companys business segments, the company must ensure that data for such reporting are available, consistent, and reliable. Often, the methods and data sources used for the controllers function or internal business segment reporting are different from the consolidated accounts, and in many cases are not reconciled. Ultimately, the impact analysis will determine the necessary changes to the companys business processes, organization, and information systems to comply with the new standards.
- Devise an action plan: The action plan should be driven by a business case, because often there are multiple ways to reach a satisfactory solution.
Phase 2: Implementation
- Execute short-term compliance projects: Time is of the essence for companies that have yet to begin their projects. These companies — and others that choose the tactical approach — will identify a number of projects that need to be implemented quickly, such as changes that need to be in place by the end of 2003 in order to restate opening 2004 balances using IAS.
- Execute projects beyond the scope of IAS: Companies wanting to maximize their return on investment will seize the opportunity to identify enhancements to accounting and financial processes and organizations beyond IAS compliance.
New Value Propositions
The move to IAS creates an opportunity to optimize the finance function. Companies not only comply with IAS, they also streamline and improve their reporting and performance management processes and systems.
Consider these external benefits:
- Greater convergence increases consistency between internal and external reporting;
- Enhanced reputation leads to better brand recognition, corporate image, and relationships with investors and financial analysts;
- Improved transparency means straightforward comparability and benchmarking with international competitors;
- Higher shareholder value results from the promotion of value-based management;
- Increased market capitalization can occur through improved transparency and greater trust from international investors; and
- Improved risk rating results from easier comparability of group reporting and consistent evaluation of the insolvency risk by external rating agencies.
And consider these internal benefits:
- Groupwide harmonization supports changes in the group structure by integrating legal and management reporting entities;
- Faster reporting speed results from automating manual activities, providing actual financial information promptly, and shortening reporting cycles;
- Improved performance management occurs when key performance metrics are clearly defined and easily accessible;
- Superior planning and forecasting results from improvements in the quality, speed, and scope of planning, forecasting, and performance management activities;
- Management support becomes proactive across business units, and all legal entities and business units receive consistent reports;
- Reduced costs result from minimizing manual and non-value-adding activities on all company levels; and
- Greater synergies are realized with other company initiatives, such as group reporting and Basel II compliance.
In short, IAS requirements create an opportunity for finance to add value throughout the organization, making now an ideal time to rethink the processes, organization, and information systems that management needs to run the business most effectively.
