This is an interview taken from RSM Reporting - Issue 26, with RSM Reporting's editor, Marco Mongiello
As last year marked the first decade of international accounting and reporting widely applied in Europe and a continuously growing number of other countries, it seems natural that we start the New Year reflecting on what the next decade of international accounting may look like and how we can influence it. To this end, I am grateful to Dr Nigel Sleigh-Johnson, Head of the Financial Reporting Faculty at ICAEW and co-author of ‘Moving to IFRS reporting: seven lessons learned from the European experience’, for sharing his personal views with us.
With one eye on his publication and the other on my first question, which is about his insights into the next decade, Nigel starts in a very positive way:
NSJ: The progress we have experienced in the past ten years is remarkable. While we are not going to see an easy journey towards universal accounting standards, there are very good signs of incremental change.
I have just been in Japan and the interest in moving towards the adoption of IFRS is tremendous. I recently met the chairman of the Indonesian accounting standard setters, who too showed a commitment towards the adoption of IFRS. They do have different paths towards adoption. They have different challenges and the timetables are not always clear. However, I think that those who are looking at the lessons learnt from the European experience find very positive messages. And, of course, the lessons do not come just from Europe, there are other countries too, for example, Australia, South Korea and South Africa. The story is different in each case, but what they all have in common is that they are moving in the right direction. For example, in India they have a conversion process, where the deadlines moved several times. Nevertheless, the Indian commitment in moving in the direction of IFRS reporting is there. Similarly, we see the same commitment in China, where they are very close to a full convergence plan. There are still differences, but there is no doubt that Chinese accounting standards are close to IFRS.
In terms of the US, that remains a real challenge. It is very significant and encouraging that the SEC has permitted foreign companies to file accounts using IFRS without reconciliation. As the SEC is one of the largest IFRS regulators in the world and the US is one of the largest economies and capital markets in the world, the convergence achieved is very significant. The US interest in moving towards IFRS remains a long term ambition though, because the US has a very strong tradition of accounting and a distinctive regulatory and legal environment.
I feel encouraged by the comments that the SEC Chief Accountant, James Schnurr, made in December 2014, when he was relatively new in the job. He talked about allowing US domestic registered companies to publish information using IFRS, alongside US GAAP filings, without reconciliation. He touched on that again in other public talks in May and in September 2015. So, although we are not going to see a switch to IFRS in the US any time soon, nevertheless this idea of non-reconciliation is potentially a major concession. One current concern with converged standards like IFRS 15, is the likelihood that we will see the SEC and other US bodies issue reams of amendments and guidance to solve interpretation challenges.
On this note, a slight worry is that other jurisdictions, like Japan, which have a rules-based approach similar to the US, are looking with some interest at these forthcoming amendments and guidance, creating the possibility of a new layer of IFRS interpretative material in those jurisdictions.
MM: Will this lead to major adaptations in the adoption processes of jurisdictions that are new to IFRS? Is there a danger that large economies like China or India may look at the European endorsement process and, imitating its principle, end up making significant changes to the IFRS when adopting them?
NSJ: One of the lessons that emerged from the study of the past decade of IFRS implementation in Europe is that the endorsement and adoption process has so far almost invariably resulted in full endorsement. It is, however, very tempting for governments to make significant changes. This is why we need to promote an understanding of the drawbacks of doing this. When I was in Japan recently, I spoke with Japanese regulators in these terms. We are currently doing so in other countries like Indonesia, and we are not the only ones disseminating this message.
In fact, the debate about IFRS started in the early 70’s; it has taken decades to reach the point where we are now and the debate is still ongoing. Taking a historical perspective, 100 years is not a long period of time, let alone a decade. So, as much as I would like to live long enough to see IFRS adopted universally, I am not sure this will happen! In the meantime, there will be an emergence of different dialects of the international language of accounting, which will bring a basis for common understanding. There is not any easy global analogy to be drawn here; having a set of standards issued by a single private organisation and being adopted globally has never happened and we cannot predict the outcome. It is nevertheless extraordinary what has been achieved so far; jurisdictions around the world adopting IFRS is a huge step forward, which can only improve global prosperity and stability. Financial reporting is, after all, an economic fundamental.
There has also been great progress in the direction of exchanging information and networking among standard setters around the world. There is a lot more to be done, though, in terms of coordination with countries that are now approaching IFRS. If you look back at 2005, there has been a tremendous transformation and I like to think that one instigator of this change is ICAEW, which has played an important role in the development of IFRS since their initial conception in the 70’s, providing independent and unbiased contributions to the IFRS debate. The key for us [ICAEW] in all of this has always been to promote the public interest.
MM: Speaking about public interest, there are interesting developments in international reporting, which are very effectively championed by the International Integrated Reporting Council1 and their proposed approach to reporting that integrates financial, social, environmental and other aspects of companies’ impact and performance in one place. Is this contradicting the efforts towards reducing the length of the annual reports?
NSJ: It is a complex situation. Business transactions have become much more complex over time. You have to ensure that the information is available for investors using it to form their judgements, but you can certainly go too far in trying to tackle complexity. Nonetheless, it is very important for the IASB to acknowledge the need to make the standards as clear as possible, still always keeping in mind the overarching principle of cost/benefit in reporting. A good example is the enormous complexity of the old draft standard for leasing; the message has certainly been heard and the new standard on leasing in its final form has gone through a massive simplification. On the other hand, you are never going to eliminate complexity from financial reporting. Discussions have taken place, particularly through the Lab2, where investors and preparers provide very different answers to the challenges and needs of reporting, but everyone agrees on writing and signposting more clearly. There are remarkable examples of listed companies large and small that report in an easy-to-follow way, even though their businesses may be complex.
Especially if you look at the front end of the accounts, the ideas of better reporting of strategy and KPIs (Key Performance Indicators) have been around for a long time, but now they are coming to fruition in a more joined-up way, providing a very clear picture of where the company is, where it is heading and what its challenges are. I was very impressed by some of the smaller quoted companies’ reports I have reviewed recently.
To your question, if you have improvements at the front end, consistency throughout, the IASB keeping complexity to a minimum and an acceptance that accounts are not going to become much shorter – these are ways of improving annual reports. The IIRC has an even wider view of integration in corporate reports; and there are, of course, demands for major companies to be more accountable in many ways (environmental impact, taxation, social impacts and so on). It is a good thing that there are movements to encourage greater transparency and accountability. However, we do have a view at ICAEW that it is important not to clutter the traditional annual reports and accounts with regulatory requirements that are not primarily directed to the information needs of investors. So, one can see improvements taking place within UK annual reports, but we are going to see integrated annual reporting developing in different ways around the world, depending on existing frameworks and cultures in different jurisdictions; in some jurisdictions mandating integrated reporting may be the most effective way of encouraging people to apply it, in others, like the UK, where the annual report is well developed and generally informative, mandating would not be helpful.
MM: So, what are your predictions for the next ten years?
NSJ: Taking the perspective of the next ten years, I think that the future of IFRS presents challenges that are as great as those of the past ten years. In a sense, phase one has been completed successfully, but it is one of many phases on a journey towards global reporting. There is a huge amount to aim for and there are very good signs that we will make substantial progress over the next ten years, but this must be coupled with recognition that things are unpredictable in many ways. For example, we cannot be sure of the direction in which the US will move. The world is a tremendously diverse place and although there are trends towards globalisation, there are strong traditions and cultures which we are not going to overturn in our lifetime. Hence, although I believe that there will always be a degree of diversity in interpretations, what we have achieved in the first ten years is a huge step forward and puts us on a good path for the next ten years.
MM: We talk about the challenges of globalisation because of differences in jurisdictions’ cultures and regulations, but another aspect of the challenge is the differences in sectors and industries – in particular, new high-tech and highly innovative companies. With regard to some of these companies, investors are no longer interested in looking at traditional measures like the operating profit or gross profit. Take the examples of Tesla Motors, LinkedIn and Facebook, where investors are not looking at the same ratios as they would for more traditional companies in established industries. Should IFRS suggest sets of KPIs that may be more useful for different companies?
NSJ: I think that this is an important area that calls for different stakeholders to come together and discuss a solution. Having some sort of forum to achieve that would be tremendously beneficial. I am not sure that including KPIs in IASB’s Standards is the right answer, though. However, a wider group of stakeholders could potentially agree on relevant KPIs for particular sectors. Initiatives in this area would be very sensible; this could indeed be a theme of the next ten years.
In this debate, we, at ICAEW, tend to think that the IASB should not be writing different standards for different sectors. It should be possible to establish principles and concepts that can apply to all reporting entities. This is achieved by principles being tested across widely different sectors during the development of a standard to ensure they can be applied consistently and without practical difficulties across sectors. On the other hand, major companies tend, in practice, to keep a close eye on each other’s annual reports, which should create and promote not just a degree of consistency but even some convergence of industry norms. In some circumstances at least, companies in the same sectors talk to each other to exchange views on reporting; this is terribly healthy and there is a case for doing more in this direction. Perhaps exploring accounting norms for specific sectors is something to be debated during the next phase.
I’d just add, though, that the companies you mention are still start-ups or fairly young, so they either haven’t made a profit yet or their current profits are not what investors hope to see from them in the future. I don’t think in those circumstances it’s just about sectorial issues.
Nigel is Head of ICAEW’s Financial Reporting Faculty. He has responsibility for overseeing the development of ICAEW policy on financial and non-financial reporting issues and is a regular media commentator and speaker on financial reporting issues. Nigel was a major contributor to ICAEW’s 2007 study for the EU, ‘EU Implementation of IFRS’ and co-author of ICAEW’s publications ‘The Future of IFRS’ (2012) and ‘Moving to IFRS reporting; Seven lessons learned from the European experience’ (2015).He is a member of FEE’s Corporate Reporting Policy Group and since 2014 has been a member of the Department for Business Innovation & Skills’ expert working group on UK company law, the Accounting Directive Stakeholder Group. Nigel is an ICAEW Chartered Accountant and has a PhD from London University.