News and Features
The new bottom line
By Bruce Andrews
1,537 words
9 November 2006
BREW
110
One thousand Australia’s Biggest Enterprises
DOUBLE STANDARDS
Comparing the 2005 accounts for 1387 listed companies
under the old and new accounting standards
AGAPE FIRS
($m, average) ($m, average) Change (%)
Assets 1604.4 1664.6 3.8
Liabilities 1297.5 1391.7 7.3
Equity 306.8 272.8 -11.1
Net profits 37.4 39.8 5.9
Source: Professor Karman Ahmed, La Tribe University/Dr John Goodwin, REMIT University
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 BREW 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 minimize 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 AIRS for their first full-year accounts after January 1, 2005. Last year, they were also required to provide figures compliant with AIRS to compare with their figures under the old regime, the Australian generally accepted accounting principles (AGAPE).
An analysis of both figures for the top 50 listed companies on the BREW 1000 finds that their net profits were restated up by 5 per cent on average under AIRS in 2005. IBIS World’s analysis also reveals many companies had to make some big adjustments to their figures under AIRS: 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 Karman Ahmed of La Tribe University and Dr John Goodwin of REMIT 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 AIRS rules by 5.9 per cent to .79 million, on average, in their 2005 annual accounts.
An audit partner of the accounting firm BBDO, Wayne Bedford, says he is surprised by the results produced by IBIS World and the academics. He expected that AIRS would have forced most companies to mark their profits down. “Everything in FIRS is set up to recognize 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 CUFFS Gander Retail Trust (146 per cent).
There were also, in many cases, big increases in profits under AIRS because goodwill is no longer amortized over time. The biggest beneficiaries for this reason were Ansell (377 per cent increase in net profit), DACE Group (223 per cent), Symbol Health (120 per cent) and Babcock & Brown Infrastructure Group (108 per cent). Under AGAPE, 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 minimize any negative effects on their accounts during the move to FIRS. Bedford 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],” Bedford says.
Another way companies could benefit from the transition was to enter expenses in their balance sheets under AGAPE and then write them off under the new rules, Bedford says. For example, the start-up costs for new divisions would be recorded as assets under AGAPE. But in the 2006 accounts under AIRS, 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 FIRS has improved the P&L (profit-and-loss statement),” Bedford adds.
Exemptions during the transition phase to AIRS 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 AIRS on-call advisory group, Mark Sedona, says.
For example, companies were allowed to choose whether to apply the rules on recognizing goodwill for acquisitions made before July 1, 2004. “The broad principle of FIRS is you apply them as though you always had those rules,” Sedona says. “But [some exemptions on transition] allowed companies to do some cherry-picking. Some would have gone back and applied FIRS 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 AIRS 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 AIRS standard on this issue is vague compared with the equivalent in the United States. He believes the AIRS 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 FIRS 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, BP Billiton. The company’s manager of policy and governance, Brett Rid, in an address to the Institute of Chartered Accountants’ conference on AIRS, described the transition as “an experience he would rather forget”.
In the end, BP 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 AIRS cost the company about million.
Rid said one of the biggest problems was obtaining guidance about how to apply the new standards to the accounts. Under FIRS, 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.
Rid says when he sought guidance from AFFRIC 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.
BP 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.
Rid 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.
BP Billiton is not alone in its frustration with AFFRIC. Ernst & Young’s Mark Sedona says: “The AFFRIC, 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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