January 2010
The sultanate's corporate sector has to plan well in advance for smoothly switching over to a new accounting standard - International Financial Reporting Standards (IFRS 9), which will eventually replace the existing International Accounting Standards (IAS 39). The new accounting standard, which will become mandatory across the world with effect January 1, 2013, is necessitated to eliminate the drawbacks of the existing accounting standard as it was partially blamed for the sub-prime crisis in the US.
In order to introduce the new accounting standard within the stipulated timeframe, the reporting mechanism within Omani organisations has to undergo a change as managements significantly rely on profit figures to assess financial performance. IFRS 9 eliminates the exception contained in IAS 39 that allowed unquoted equity instruments to be measured at cost if the fair value is not reliably measurable.
Accordingly, all equity instruments, including unquoted equity investments, will need to be measured at fair value. "This particularly applies to investments that a company makes, for which there isn't any ready market (like investments in private equity or SAOC or LLC companies). Under IFRS 9, the company has to find a valuation for those investments every time they prepare accounts," says Philip Stanton, managing partner, Ernst & Young. Under IAS 39 standards, this investment is measured at actual cost. "A lot of Omani companies have investments in private equities or in companies, whose shares are difficult to assess."
While the mandatory date for adopting IFRS 9 is January 2013, early adoption of Phase I is permitted for reporting periods ending December 2009, if the regulating authorities allow. However, the European Union has decided that no company should adopt the new accounting standard until the whole standard is out. In an apparent move to expedite the replacement of IAS 39, the International Accounting Standards Board (IASB) divided the whole project into phases and the first phase of IFRS 9 introduced in November 2009 addresses the asset side of the balance sheet.
"They (IASB) are looking over the next 12 months to bring out a section on hedging and then move on to another section on fair valuation of liabilities." "The visionary companies will look at the best time for introducing the new standard. I suspect a lot of them will look at introducing it probably in 2011. Some large banks may introduce it in even 2010." The proposed introduction of IFRS 9 will immensely benefit listed companies everywhere. The accounting standards under IFRS 9 are lot more simple and easy to understand as compared to IAS 39, Stanton adds.
"The previous four methods of valuation of equity instruments and financial assets have been reduced to two under IFRS 9 and it is now very clear as to what goes into profit and what does not." The four valuation methods under IAS 39 are held for trade, fair value through income statement, held for maturity and amortised cost.
Under IFRS 9 the valuations are held for trade and amortised cost. The new accounting standard also brought in changes while taking an impairment provision on equity investment. IAS 39 stipulates companies to provide for any 'significant or prolonged' fall in the value.
Citing an example, Stanton noted that when share prices on the Muscat Securities Market (MSM) plummeted last year, public companies and banks had to make provision against any 'significant or prolonged erosion' of value of their investments under the IAS 39 requirement.
The companies, in consultation with the Central Bank of Oman, agreed to define 'significant erosion' as 35 per cent or above from the value of the investment the company bought at and accordingly made impairment provision. "The IAS 39 standard requires the company to make the impairment provision in its income statement. It cannot reverse that provision until it sells the investment. Under IFRS 9, this requirement is no longer there. They can reverse those provisions and bring it back to market value. This has an immediate benefit for companies and banks that carry impairment provisions."
Stanton says as far as recording unrealised gains or losses on investments are concerned, the new accounting standard allows companies to record it along with retained earnings. The danger is that it can be distributed, if the company management wishes to do so.
"However, conservative companies continue to retain reserves for realised movements in investments as a separate reserve." Yet another major change brought in under IFRS 9 is that any income that a company makes from investments that are 'not held for trade' will not go to profit.
Rather, it will go to a separate section called comprehensive income. "There will be a major impact on measuring a company's performance using earnings per share (EPS) as an indicator because any realised gains or losses from non-trading equity investments will not be included in the net profit for the year. This will be included only in the comprehensive income. Therefore, EPS will not necessarily be a clear measure for assessing a company's financial performance once IFRS is in place."
Now-a-days, the performance of companies is measured on the basis of EPS, which is determined by net profit. Finance professionals partly put the blame for the sub-prime crisis, which later triggered a full-fledged economic meltdown, on fair value accounting of IAS 39. In simple words, 'fair value' or 'mark-to-market' concept is the estimated market value of a financial asset.
When the markets go down, and if everything is mark-to-market, there is an instant measurement of how bad the situation is in each company as it comes out with its financial results. And during a crisis situation like the recent one that haunted the financial markets across the world, there are not many buyers and sellers for financial instruments.
Investors continue to hold, resulting in sluggish trend or listless activity on the markets and the bourses can not reflect the real value of financial instruments. IAS 39, which came into effect almost ten years ago, was probably one of the most complicated accounting standards and subsequent amendments worsened the worries of the corporate sector in general and finance professionals in particular. It has been widely criticised as a standard that is complex and often difficult to apply.
As a result, a need was felt for replacing fair value accounting in IAS 39 standards. In April 2009, the G-20 leaders and various other organisations urged the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) to reduce the complexity of accounting standards for financial instruments and make significant progress towards a single set of high quality global accounting standards by the end of 2009. The IASB acted fast and accordingly in November 2009, it brought out the first phase of International Financial Reporting Standards (IFRS 9) to replace the existing IAS 39.
The sultanate's corporate sector has to plan well in advance for smoothly switching over to a new accounting standard - International Financial Reporting Standards (IFRS 9), which will eventually replace the existing International Accounting Standards (IAS 39). The new accounting standard, which will become mandatory across the world with effect January 1, 2013, is necessitated to eliminate the drawbacks of the existing accounting standard as it was partially blamed for the sub-prime crisis in the US.
In order to introduce the new accounting standard within the stipulated timeframe, the reporting mechanism within Omani organisations has to undergo a change as managements significantly rely on profit figures to assess financial performance. IFRS 9 eliminates the exception contained in IAS 39 that allowed unquoted equity instruments to be measured at cost if the fair value is not reliably measurable.
Accordingly, all equity instruments, including unquoted equity investments, will need to be measured at fair value. "This particularly applies to investments that a company makes, for which there isn't any ready market (like investments in private equity or SAOC or LLC companies). Under IFRS 9, the company has to find a valuation for those investments every time they prepare accounts," says Philip Stanton, managing partner, Ernst & Young. Under IAS 39 standards, this investment is measured at actual cost. "A lot of Omani companies have investments in private equities or in companies, whose shares are difficult to assess."
While the mandatory date for adopting IFRS 9 is January 2013, early adoption of Phase I is permitted for reporting periods ending December 2009, if the regulating authorities allow. However, the European Union has decided that no company should adopt the new accounting standard until the whole standard is out. In an apparent move to expedite the replacement of IAS 39, the International Accounting Standards Board (IASB) divided the whole project into phases and the first phase of IFRS 9 introduced in November 2009 addresses the asset side of the balance sheet.
"They (IASB) are looking over the next 12 months to bring out a section on hedging and then move on to another section on fair valuation of liabilities." "The visionary companies will look at the best time for introducing the new standard. I suspect a lot of them will look at introducing it probably in 2011. Some large banks may introduce it in even 2010." The proposed introduction of IFRS 9 will immensely benefit listed companies everywhere. The accounting standards under IFRS 9 are lot more simple and easy to understand as compared to IAS 39, Stanton adds.
"The previous four methods of valuation of equity instruments and financial assets have been reduced to two under IFRS 9 and it is now very clear as to what goes into profit and what does not." The four valuation methods under IAS 39 are held for trade, fair value through income statement, held for maturity and amortised cost.
Under IFRS 9 the valuations are held for trade and amortised cost. The new accounting standard also brought in changes while taking an impairment provision on equity investment. IAS 39 stipulates companies to provide for any 'significant or prolonged' fall in the value.
Citing an example, Stanton noted that when share prices on the Muscat Securities Market (MSM) plummeted last year, public companies and banks had to make provision against any 'significant or prolonged erosion' of value of their investments under the IAS 39 requirement.
The companies, in consultation with the Central Bank of Oman, agreed to define 'significant erosion' as 35 per cent or above from the value of the investment the company bought at and accordingly made impairment provision. "The IAS 39 standard requires the company to make the impairment provision in its income statement. It cannot reverse that provision until it sells the investment. Under IFRS 9, this requirement is no longer there. They can reverse those provisions and bring it back to market value. This has an immediate benefit for companies and banks that carry impairment provisions."
Stanton says as far as recording unrealised gains or losses on investments are concerned, the new accounting standard allows companies to record it along with retained earnings. The danger is that it can be distributed, if the company management wishes to do so.
"However, conservative companies continue to retain reserves for realised movements in investments as a separate reserve." Yet another major change brought in under IFRS 9 is that any income that a company makes from investments that are 'not held for trade' will not go to profit.
Rather, it will go to a separate section called comprehensive income. "There will be a major impact on measuring a company's performance using earnings per share (EPS) as an indicator because any realised gains or losses from non-trading equity investments will not be included in the net profit for the year. This will be included only in the comprehensive income. Therefore, EPS will not necessarily be a clear measure for assessing a company's financial performance once IFRS is in place."
Now-a-days, the performance of companies is measured on the basis of EPS, which is determined by net profit. Finance professionals partly put the blame for the sub-prime crisis, which later triggered a full-fledged economic meltdown, on fair value accounting of IAS 39. In simple words, 'fair value' or 'mark-to-market' concept is the estimated market value of a financial asset.
When the markets go down, and if everything is mark-to-market, there is an instant measurement of how bad the situation is in each company as it comes out with its financial results. And during a crisis situation like the recent one that haunted the financial markets across the world, there are not many buyers and sellers for financial instruments.
Investors continue to hold, resulting in sluggish trend or listless activity on the markets and the bourses can not reflect the real value of financial instruments. IAS 39, which came into effect almost ten years ago, was probably one of the most complicated accounting standards and subsequent amendments worsened the worries of the corporate sector in general and finance professionals in particular. It has been widely criticised as a standard that is complex and often difficult to apply.
As a result, a need was felt for replacing fair value accounting in IAS 39 standards. In April 2009, the G-20 leaders and various other organisations urged the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) to reduce the complexity of accounting standards for financial instruments and make significant progress towards a single set of high quality global accounting standards by the end of 2009. The IASB acted fast and accordingly in November 2009, it brought out the first phase of International Financial Reporting Standards (IFRS 9) to replace the existing IAS 39.
By A E James
© businesstoday 2010
