International Accounting Standards

• impact
• IASB diversity?
• weight of the Revenue
• internet fraud

impact

With international standards now upon us, the impact on multi-nationals' bottom line remains unclear. But dire warnings are being issued.

Royal Dutch/Shell is one of the first of the world's major companies to state in detail what impact IFRS will have on its profits. The overall effect, says the group, is that net assets recorded on the balance sheet will decrease by $4.7bn and total debt will increase by $200m. It is the recognition of unrealised pension fund losses that will most severely hit the group, with a reduction of retained earnings of $4.9bn. But this is partially compensated for by the group's retained earnings increasing by $1.2bn.

Royal Dutch/Shell's energy reserve statements are also changing through IAS, with some assets previously shown as impaired now being reversed. The overall effect is to increase net assets by $400m. The expensing of share options will have a further impact, reducing net income for 2004 by $100m.

Cable & Wireless has also declared what its last year's profits would have been, recalculated under IFRS. C&W says pre-tax profits of £14m might have fallen to a mere £5m, using IFRS. The difference was attributed to a potential reclassification of an operation currently classed as part of the group.

Munich Re became an early convert to IAS, the impact of which it disclosed in March and described as 'significant', though it welcomed them as adding transparency. The new treatment of derivatives cut Munich Re's profit for 2003 from 887m euros to 434m euros.

Meanwhile, Northern Rock has found itself in conflict with analysts at Credit Suisse First Boston on the impact on its profits of IFRS. While the UK bank said that the affect on profits would be less than 5%, CSFB predicted a larger reduction in profits. CSFB said that Northern Rock earnings could fall by 8% to 10%, with up-front fees paid by mortgage customers being spread across the life of the loan.

Tom Seidenstein, spokesman for the IASB, said that the Board had not conducted any research into the impact of the new standards on companies' profits. But he added: 'We are encouraging companies to discuss the effects among managers, investors and other interested parties, so the marketplace knows what effects there will be.'

Despite speculation of big changes to reported profits, Peter Moizer, professor of accountancy at Leeds University, suggests these are being exaggerated. 'I think it will not be as bad as people are predicting,' he argued. 'The changes are significant, but not as significant as some are saying.' This view was apparently backed by a study published earlier this year by Halliwell, which found that while Diageo's profits last year would be cut from £76m to £43m, average profits of FTSE100 companies would be about 5% down.

But there are clear signs that most companies remain unprepared for international standards - hardly surprising given the uncertainty and delay in finalising the standards after months of dispute between the European Commission and the IASB. A review conducted by KPMG found that almost half of city analysts admitted they have little understanding of the new standards, while most believed share prices were not yet adjusted to reflect the impact of IAS on profits. The lack of readiness by many UK businesses was recognised by the Financial Services Authority when it allowed companies an extra 30 days to prepare their first interim accounts under the new rules.

Difficulties, though, are far from over. Another survey, conducted by the Economist Intelligence Unit, concluded that IT systems compliance with international standards has become a major priority for multi-nationals' IT departments. And it is reported that at least one of the Big Four firms has consulted a QC to seek clarification of the meaning of a new standard.

The Big Four's work has become much more complex as a result of the international standards which - along with the introduction of more demanding corporate governance standards flowing from Sarbanes-Oxley and other legislation around the world - has led to increased revenues for the firms, despite their loss of much non-audit work.

IASB diversity?

The conflict between the International Accounting Standards Board and the European Commission is leading to fundamental reform of the responsibilities and make-up of the International Accounting Standards Committee, which oversees the work of the Board.

A paper from the IASC Foundation proposes that the Committee comprises people from a wider background, taking more from outside the accountancy profession. Reflecting complaints from the European Commission that the Board and Committee are over-influenced by the United States and the United Kingdom, the membership will become more geographically diverse.

In future, IASC decisions will require a 64% majority, rather than a simple majority - possibly preventing a repetition of the approval of such contentious standards as those on hedge accounting and fair value treatment of financial liabilities. And a much broader consultation process will be embarked on in the future before major proposals are agreed, responding to criticisms from the French banks and the French President at the way in which measures to introduce greater use of fair value were approved. More consideration will also be given to the needs of SMEs and how standards affect them, says the paper.

The IASC concedes, though, that the areas in which it has hit difficulty are challenging intellectual concepts 'on which there is little or no consensus'. This appears to accept that even the major changes to governance arrangements may not resolve deep-seated problems. This applies not just to hedge accounting and fair value, but also, predicts the IASC, to forthcoming consideration of accounting standards regarding insurance, leasing, pensions and financial instruments.

Failure to achieve agreement between the IASB and the European Commission has led to criticisms that the Committee and its trustees have not been sufficiently involved in predicting and resolving conflict. This has provoked the comment from the Committee that one purpose of the proposed changes is 'to recognise and express more clearly the trustees' responsibilities for oversight of the IASB's processes'.

The new measures would have the effect of increasing Asian representation on the committee to six from four, coinciding with negotiations with Japan for it to adopt international standards.

Richard Martin, ACCA's head of financial reporting, welcomed the moves. 'The underlying issue is Europe's unhappiness with the way the IASB has been operating,' he said, adding that 'it is hard to argue against' the proposals. 'A lot of effort has gone into this.' The result is not just a structure which continental Europe finds more acceptable, but is also one which reflects the evolving balance of world trade power. 'There is a recognition that there are some very important countries in Asia, which are going to be big in the future,' said Martin.

The Board has belatedly accepted what ACCA said at the outset - that its composition did not reflect a wide enough range of interests, particularly geographically. 'We said it was not good enough, that there was too narrow a group of interests,' explained Martin. While the proposed changes do not cause problems for ACCA, Martin expressed caution that the needs of the private not-for-profit sector should not be ignored.

But Michael Bromwich, professor of accountancy at the London School of Economics, is not confident that the governance changes will work. It is correct, he said, that 'the UK, America, Australia and UK-orientated countries have been dominating', with Japan and Germany, in particular, complaining that 'they have not been looked after properly' by the Board and Committee. However, he feared that the adoption of a more nakedly geopolitical approach may encourage conflict, rather than resolve it.

The question is whether broadening the base of the trustees can deal with fundamental disagreements where consensus may be impossible. Professor Bromwich commented: 'Both France and Germany believe in smoothing income as far as possible. The world has different financial markets and accounting systems reflect that. I don't believe the IASB can survive in the longer run.'

weight of the Revenue

The Inland Revenue should be given extra powers to chase unpaid taxes, UK MPs have said. The House of Commons Public Accounts Committee has recommended that the Revenue should be given access to all government departments' databases to search for up-to-date contact details for taxpayers, while all citizens should have a legal duty to notify the Revenue of their current contact details, including address and phone numbers.

'Tax debt stood at around £12bn at the end of March 2004,' explained Edward Leigh, chairman of the Public Accounts Committee. 'Much of this will be collected within a year, but a core of £3bn was more than a year old and around £700m of uncollected debt is written off each year. These are large sums to be tied up at any one time, or lost to the public purse altogether, when they could be paying for public services. It is vital that the Inland Revenue steps up its efforts to speed up debt recovery, through using other departments' records to trace those who owe tax, pursuing all debts owed by the same person at the same time, and seeking greater powers of recovery.'

Among other proposals put forward by the Committee was a surcharge on persistent late payers, with businesses obliged to pay tax and contributions deducted from employees into a designated bank account. Of the £3bn of debt over one-year-old, £1.2bn is owed by insolvent companies or individuals, much of which was deducted by employers from employees' pay. Companies known to be at high risk of default might be required to pay a bond to the Revenue to guarantee future payments.

The Revenue should adopt debt management systems similar to those of large companies, the MPs said. Where utilities companies collect 90% of debt within 90 days, the figure for self assessed tax collected by the Revenue was a mere 59%. There should be more use of phone chasing of arrears, integrating the collection of all taxes, with taxpayers permitted to make payments by credit card. The Revenue should be given the power to recover debt by salary or bank account deductions without needing to go to court, said the Committee.

Chas Roy-Chowdhury, ACCA's head of tax, was concerned at how the Revenue might use additional powers. 'We already have a lot of big sticks out there,' he suggested. 'Where we have people deliberately evading or not paying tax, then I agree these measures are justified. But these are the people getting off scot free. It's ordinary taxpayers who have the powers used against them.'

Roy-Chowdhury urged the Revenue to consider why they were having problems in collecting tax before rushing into tougher action. The focus should be on serial offenders and people setting up phoenix companies to avoid tax, not on being unreasonable with individuals who wanted to comply with the system. He added that he feared MPs were marking out ground to allow the Revenue to take on the stronger enforcement powers held by Customs, when the two bodies' merger is completed.

John Whiting, tax partner at PricewaterhouseCoopers, shared the worries. 'This is very topical,' he said. 'The framework rules [for Revenue & Customs] are just being considered. If this is just about getting the evaders, it's hard to disagree. But you don't want 'kick the doors in' powers for people who are late with their tax returns. I have this cautionary feeling that it's not just about the powers, but about how the powers are used. One would not want these powers to be used bureaucratically just to police and harass, in particular, small businesses trying hard, but making innocent errors.'

internet fraud

Financial services suppliers have been warned to improve information security after a dramatic increase in on-line fraud and security lapses by banks. Smaller firms may have less well developed security defences, the UK Financial Services Authority has suggested.

'Firms will have to run to stand-still if they are to protect their assets and those of their customers,' warned Philip Robinson, financial crime sector leader at the FSA. Although the volume of losses through internet fraud was, to date, low in absolute terms, both firms and customers must take a more proactive approach to prevention, he said. The FSA identified companies relying on legacy systems as especially vulnerable, with another serious risk posed by weak protocols on employee access to databases. 'There is evidence that organised crime groups deliberately target firms to place staff to commit financial crime, particularly identity theft,' said the FSA.

The warning from the FSA followed days after it emerged that Cahoot - owned by Abbey, which has just been taken over by Banco Santander - had inadvertently opened up a security hole on its on-line banking website enabling users to access other customers' account details. And HFC - part of the HSBC group - unintentionally released details of customers' personal e-mail accounts to other customers, potentially assisting fraudsters in targeting so-called 'phishing' e-mails.

Increased prevalence of 'phishes' - e-mails sent on blanket 'fishing' exercises, requesting personal bank account details - have become the biggest short-term problem for banks. According to the Association for Payment Clearing Services, APACS, phishing incidence has risen 4,000% in the past year. RBS became so concerned at the rise in phishes directed at its NatWest customers, it temporarily disabled some on-line functions.

There are now concerns that some banks may no longer continue to underwrite the cost of on-line frauds to their customers. But Barclays, Cahoot, Citibank, HBOS and HSBC all told us that personal and business customers were protected by on-line guarantees and anyone who was a genuine victim of fraud would be recompensed and each said it was not planning to review this policy. HSBC added that its guarantee may not apply if the fraud was the result of someone having lost password information that had been written down.

Lloyds TSB said it would reimburse customers for losses caused by fraud, but would not provide a blanket guarantee to cover every circumstance. RBS advised it 'would review [customers' situations] on a cases by case basis'. Gemma Smith of APACS said that all claims for losses resulting from phishing frauds had so far been met by banks. She conceded that at some point banks might regard phishing fraud to be so well known that banks could begin to consider customers who fell victim had not taken care, 'but at the moment this is a new type of fraud'.

Mark Hemingway of HBOS said that the growing threat now is of fraud conducted through Trojan viruses, enabling fraudsters to take control of another person's computer - perhaps to copy on-line security information. 'This is perhaps even more of a risk and we have warned customers of this,' he said.

Banks and other financial services firms must also respond to the risks posed by websites offering fake identification papers. Charlotte Walker-Osborn, of Eversheds solicitors, said: 'Identity theft in its present guise is a relatively new legal concept and is not specifically dealt with in law - which also makes it difficult to secure justice for victims.' But, she added, this would be corrected under proposals contained in the UK Government's new legislative programme.

Companies face serious problems and conflicting advice in deciding how to respond. It is certainly not something that can be ignored, given the findings of a study conducted for Alliance & Leicester by the Future Foundation, predicting that 80% of banks' customers will use the internet for banking transactions by 2020.

Professor Neil Barrett, one of the UK's leading experts on internet security, has said that banks' security failings are so widespread that he would not bank on-line. But his university, Cranfield, told us that Professor Barrett was speaking in a personal capacity and that it disagreed with him.