The Level of IAS Compliance of BT and NTL
and Consequences on Users
Introduction
This paper aims to analyze and expand the statement that “the objective of financial statements is to provide information about the reporting entity’s performance and financial position that is useful to a wide range of users for assessing the stewardship of management and for making economic decisions”. Such effort will be done by evaluating the financial reports (FS) of two companies in the same industry regarding their compliance with international standards and such compliance added value to users of FS primarily (e.g. equity) investors. It is initially thought that compliance with international standards increase the added-value FS provide to users because such standards have universality and incorporates integration across country preference. This initial idea can also be checked while reading the paper.
Background
British telecommunications (BT) is a UK-based company that operates in 170 countries with principal stakes in networked IT services, telecommunications services and other broadband/ internet products (2005 ). On the other hand, NTL is also a UK-based company and operating in UK soil but is headquartered and listed in the US ( 2005 ). Its businesses are broadband, digital television, telephony, content and communications services with 50% consumer and 85% business customers within UK. Due to this, it is expected that there will be size and policy differences but the focus would on the following policy frameworks. Also, there is no available 2006 Annual Report for NTL and so the two companies will be analyzed based on their 2005 FS. But to note, 2005 FS are not yet based on IAS for both companies that level of compliance would be very low.
First, IAS 1 lays down the presentation, structure and other disclosure requirements of entities with regards to the making of general-purpose FS (IASB 2006). AIS 1 is guided by the principle of fair presentation by which an entity can achieve after diligent compliance with international standards. When fairness is deemed on FS, users of such information can have a useful and pertinent decision-making platform. Also, AIS 1 ensure that FS of an entity is comparable historically to itself and to other entities (e.g. product and capital competitors). With this, AIS 1 sets out guidelines such as basis, formats and minimum requirements in preparing FS (2006).
Another, IAS 8 largely deals with accounting policies and changes to them initiated by the entity. This guideline is much a complementary to IAS 1 because the fact that an entity changes, use or defer to use international standards make its FS incomparable historically to itself and other entities. Fair presentation is also adversely affected. IAS 8 sets out implications of one’s accounting policies especially with changes in accounting estimates and emergence of errors ( 2006). Thus, it aspires to protect users against the risks of misleading forecasts about the past, present and future financial performance of an entity. The leniency of IAS 8, however, is eminent in its submission for an entity’s use of managerial judgment in setting its own policies as last resource.
Body of the Paper and Relevant Discussions
According to IAS 1, minimum content of FS should include balance sheet (BS), income statement (IS), statement in changes in equity (SICE), cash flow statement (CFS) and necessary explanatory notes (EN) (IASB 2006). However, NTL did not have extra-column for every account that requires further explanation. At the end of every FS, it merely reminds the reader to “See accompanying notes” ( 2005). This can tantamount for users to be annoyed and de-motivated in searching for a relevant EN. For example, the necessary notes for the effects of “loss from continuing operations” on average number of shares outstanding is found in f-20 while such account is located in Consolidated Statements of Operations in f-5.
On the other hand, BT complied with such minimum requirements on FS content (BAR 2005 pp. 75-80) avoiding the mistake of NTL in assuming unique FS titles (e.g. IS is tagged as Consolidated Statement of Operations). For EN, BT also complied () assuring that every aggregated account in each FS titles are explained and presented to users in a convenient manner. For example, total turnover under IS is referenced with 2 under notes column which makes it easy to navigate and refer information regarding the company’s geographical, product and area that resulted in sales ). In effect, users and especially potential investors who are not familiar with the FS of the entity can assess performance and other components efficiently.
According to IAS 1, all FS should be presented in accrual basis except the CFS ( 2006). However, NTL accounted for deferred income taxes, deferred finance costs, prepaid expenses, accounts payable, accounts receivable, accrued expenses and deferred revenue under its CFS (p. f7). As a result, real cash assets of the company are not reflected because CFS has elements that are not recorded under cash basis. The amounts of such accrued accounts are huge and are material in nature. For example, accrued expenses and deferred revenue are two of the highest net values that changes operating assets and liabilities (p. f7). In effect, potential investors are caught under dim decision framework especially in evaluating liquidity of the company and its ability to finance day-to-day operations without losing solvency or face litigation.
In the contrary, BT complied with CFS exemption from accrual accounting (p. 79). For example, accounts pertaining to tax deferrals are replaced by taxation paid and further classified in UK and non-UK obligations. This makes BT’s CFS to fulfill the promise of this specific FS to guide investors in determining the certainty and timing of cash flows the firm would expect ( 2006). BT uses indirect method in presenting CFS as well as NTL and both also classified their CFS according to IAS 1 which is categorizing accounts into operating, financing and investing activities ( 2006).
However, both companies failed to disclose the maturity of their investments to confirm that they are cash-earners (. IAS 1 requires CFS accounts to be consisted of investment which have maturity not exceeding three months from the date of acquisition (IASB 2006). But this provision cannot be determined without the entity disclosing related information about the nature and background of a related investment recorded in CFS. BT, which is confirmed earlier as having the upper hand in EN, also failed to explain the nature of CFS components. The lacking is much for NTL. BT includes mere three EN, compared to substantial EN in IS, and the maturity of “returns from investments and servicing finance” is not indicated in either of the notes (p. 79 and p. 88).
In terms of materiality and aggregation coinciding with IAS 1, NTL seemingly outperforms BT as the former indicated separation of accounts in the face of IS (p. f5). The latter, although referenced its aggregation with corresponding EN, IAS 1 is clear that similar items that are material should be separated while dissimilar items can be aggregated if immaterial ( 2006). For example, NTL readily specified the components of costs and expenses like operating costs, selling expenses, administrative expenditures, depreciation and amortization (p. f5). On the other hand, BT aggregated operating costs (p. 75) amounting to at least three-fourths of its turnover. Also, it is noticeable that corresponding EN is not available for “other operating income” and “profit from the sale of fixed asset investments” which are far above the share of minority interests in the bottom-line (e.g. meaning they are material).
Failure to provide ready information about the components of a certain material and aggregated account can post decision problems to potential and current investors. For the former, it would not have clear data in which the company is spending too much or too less and if a significant corporate assets (e.g. trademark on technologies) is executed. Such scenario would have change the current impression and future outlook of the incumbent investor. But since individual elements are not stated or rather located in EN, the company seemingly escapes an adverse investor reaction. For the latter, the given unfamiliarity of corporate operations deepens the ambiguity on what present investors are experiencing.
The above investor adversaries may as well take effect when both companies included in there are accounts which have a face name of “extra ordinary” (2006). In the contrary, both companies did not aggravate this situation because all transactions that affects IS are disclosed may it be gains from foreign currency trading () or interest receivable (). In the contrary, going intensive to the scope of IAS 1, NTL fell behind the requirement that in using functional IS (e.g. cost of sales, selling, administrative), the minimum requirement is to indicate depreciation, amortization and staff cost (IASB 2006). Staff costs is not reflected in its IS (p. f5). Investor ambiguity is confronted with added pressure.
According to IAS 1, the following should be complied in the FS of the entities; namely, separation of enterprise and company, consistent reporting period and similarity of face values of FS across annual reports (2006). All are intended to maintain comparative stances of FS internally (e.g. historic accounts) and externally (e.g. competitor’s FS). The first prerequisite is denied by NTL which clearly stated in every FS that the information contained is for “NTL Incorporated and Subsidiaries” (). The third prerequisite is also tarnished in which NTL under SICE included a dollar amount (e.g. $) to determine the par value of its common stock even if the total amount is in pound sterling (e.g. £). In the contrary, BT did not commit the same mistake. There is no problem for the second prerequisite as both companies either restated or show performances from 2003 to 2005.
The problem of incomparability is the cornerstone of why AIS 1 is created and so the failure of entities to make their FS comparable supersedes the idea that they entirely break down goals and provisions of AIS 1. As a result of incomparability, FS become unfair to its users and their decision-making abilities are not supported, or if ever FS is used, being misled. For potential investors, they can be easily trapped in the inability of an entity’s FS to compare historically and against other entities which can be more eligible for investor’s resources. If this happens, they cannot maximize their investments and also may loose their chance to help their communities through their corporations. For current investors, they can be ensnared in sub-optimal promises and outlooks of the entity (e.g. sub-optimal within industry standards) due to incomparability.
It is also eminent that BT does include SICE explicitly together with other FS in the initial part of its FS. Its SICE is rather located in the EN (p. 96) that is incompliance with format set forth by IAS 1. IAS 1 requires entities to present SICE as a separate component of their FS and not as a negligible FS component ( 2006) that SICE should not be located in EN. On the other hand, NTL have SICE in the location which BT failed to comply (pp. f9-f10). It can be said that BT is hiding something which can cause negative impressions from current investors. In their respective SICE, it is noticeable that their formats and contents vary which is an indication that comparability cannot be held and that one is not diligently coinciding with international standards. In addition, both did not fulfill the need of the SICE results to reflect minority and equity holder interest which is against IAS 1. Investors are uncertain on how much they have stake in both companies that can polish their holding gain targets.
With regards to IAS 8, both companies complied with the provision that accounting policy being applied should be disclosed ( 2006). For BT, it stated that it used Companies Act of 1985 (p. 72) while NTL disclosed US GAAP as basis for FS preparation (p. f12). Although international standards are not applied by both companies, the mere fact that they made explicit the framework used in their FS is already compliance with IAS 8. As a result, potential investors that is new to capital markets can get an accountant or analyst that is qualified in a certain accounting policy. In addition, current investors will be aware if there are any changes in accounting policies which may require change of allocation decisions or hiring of capital market assistants.
IAS 8 also set forth the limitations of managerial judgment in setting the entity’s accounting policies for certain accounts (2006). The general limitation is that an entity can use managerial judgment if international standards, interpretations and recent pronouncements are lacking which means such kind of judgment is a mere last resource ( 2006). However, BT prepared its FS for some accounts such as doubtful debts, long-term contracts and pension costs within managerial judgment without reference to either international or other local standards (p. 72). This is especially true in accounting estimates. In the contrary, BT disclosed the nature and amount of change of estimating certain accounts such as pension costs in EN
Managerial judgment should least be applied in material accounts and material accounts should not be encapsulated in aggregate items. This is what IAS 8 is implicitly notifying concerned entities (IASB 2006). But BT and NTL exercise managerial judgments to substantial accounts without even preventing the impression of manipulation from investors. Such impression can deter motivation to invest funds due to the fear of sub-optimal returns even the company is at its “peak”. When managerial judgment is excessive, accounting standards either international or local can be easily ignored because subjective biases of internal managers have a likely tendency for image and performance building. In effect, the need of investors for fair FS is dimmed.
The intention of BT in showing the consequences of changes in accounting estimates is clearly to guide investor decision-making especially current investors who analyze their allocation based on, say, previously determined market values of certain financial instruments. In the contrary, BT presented and explained changes during 1999-2002 and the year in question is 2005 (p. 98). Due to this, consolation to BT’s effort is only appropriate as investors would be provided by inferior data. Investors are entitled to total disclosure because they are capital providers of the company. However, with this win-loss scenario they are facing due to inability to gather sufficient information, their need to estimate the level of their expected wealth is not supported rather undermined.
On the part of NTL, since it adopted a single-entity FS (e.g. all Group no Company/ subsidiary as opposed to BT), its accounting policy also departed from international standards. As a result, excessive managerial judgment determined such consolidation. Due to incompliance to IAS 8 regarding accounting polices, IAS 1 is also adversely affected. In effect, the performance from the core/ major activities of the firm will not be determined by investors that may hinder analysis of the quality of stewardship of major position-holders within NTL. Also, the use of accounting estimates is in accordance to US GAAP but this reference is a partial departure from international standards. For example, changes in estimating pension plans do not have explanations on them (p. f37) like BT that means investors are not guided and complex computations and analysis are required. The information needs of users are not achieved.
With regards to IAS 8 provision on disclosing and correcting errors through retrospection (2006), both companies exemplified compliance. For example, FS of NTL and BT had conducted retrospection for its errors from 2003 through 2005 executed through restatements. This is a far-reaching effort since IAS 8 only demands retrospection from the most immediate annual report (e.g. 2004 for both companies). However, they included 2003 as well. Such effort can increase the historical comparability of an entity’s performance which indicates that investors can forecast more accurately since the inputs of previous operations are adjusted to accounting policies of present and future transactions.
In the contrary, both companies failed to disclose the nature of prior period error and the procedure used to correct such error (IASB 2006). Such statements could be hiding in other pages which the author is unsuccessful to browse. However, if the company would really want to disclose such information it would have included it in EN. However, both of the companies merely stated that they have adjusted previous reports to coincide with the effects of present changes in accounting standards that they are using (). As a result, investors are supplied with retrospective data without knowing why the operational implications of such changes. It should be remembered that merely saying that their retrospection policy is consistent with authority regulations is a given fact and investors want elaboration.
Conclusions
The above analysis contains the most significant inconsistencies of BT and NTL’s accounting policies against international standards. Small issues such as failure to split accounts especially in the BS or failure to change accounting terms (e.g. delete “net” from the bottom-line of IS) are not discussed. The methodology behind this is the fact that both the 2005 Annual Reports of both companies being analyzed does not yet embrace IAS or other international standards. For example, the 2006 Annual Report of BT includes IAS provisions because that year is its debut in adopting IFRS or by International Financial Reporting Standards. The discussion merely wants to emphasize the implications to investors both potential and current of the inability of FS to embrace international standards.
As a conclusion, failure to use international standards such as IAS provisions makes an entity’s FS less useful to wide range of users. FS based on some other accounting policies and subjective judgment cannot be used for comparability especially to global and well-known companies who already adopted IFRS. This can lead to loss-loss situation for companies and investors. The former cannot assure financing not because of inferior performance within the industry but primarily due in its failure to have comparable FS to the leader in such industry. The latter cannot diversify the risk of its portfolio because it is concentrated to firms that have comparable FS. As a result, there is a need for every growing and competitive firm to adopt IAS provisions to remain in such state or face the problems of internal funding.
Credit:ivythesis.typepad.com
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