At the 18th Meet the Experts conference, delegates received a regulatory update from a European, UK and USA perspective before they could ask questions to the panel. Questions were posted live on an online platform and read to the panel by PwC partner Dave Walters, here are some highlights. Compiled by Vincent Huck
Chair: Dave Walters, partner accounting consulting services group PwC
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Participants:
John Hitchins, Deputy Chair of the UK FRC’s Financial Reporting Review Panel
Andrew Watchman, CEO and TEG chairman at EFRAG
Wayne Carnall, partner national professional services group PwC USA
Dave Walters: Andrew, can EFRAG potentially reject an IFRS? Has this ever happened? And would it be more reasonable if EFRAG was involved in the IFRS discussions before the standard’s issued?
Andrew Watchman: The answers are kind of yes and yes. We’re not the final decision-maker. We can, and indeed we have, recommended non-endorsements. Probably for nothing too major. But a recent example is our endorsement advice on IFRS 9, it was basically positive except for the impact on the insurance industry which shouldn’t have to apply IFRS 9 a few years before it’s about to get a new insurance standard. The IASB came forward with a solution to that problem.
Looking to the second question. We are very much involved in the debate pre-issuance through our comment letters, through our formal interaction with the standards advisory forum. And if we’re effective in this upstream activity, then the downstream endorsement activity should be simpler. But there are legal conditions to be observed for a standard to become a part of the European framework.
You can question whether the endorsement process is exactly how you might design it. To me anyway, the idea that you completely outsource to a private organisation is rather unaccountable. So some form of endorsement mechanism I think might construct an appropriate balance between independent standard-setting and democratic accountability.
Walters: Next question to both John and Wayne. How would the regulators view a company that significantly reduced its accounting policy disclosure giving only information that is really material? And really is in block capitals there. So it’s really material, it’s not just borderline.
John Hitchins: Well, I think the starting point has to be as a regulator, I don’t recognise the concept of really material. Things are either material or they’re not. In terms of accounting policy disclosures, we are in favour of reducing the boiler plate. And actually, we’re in favour of accounting policies that indicate where you make actual choices. But there is a requirement still to give your significant accounting policies. In many ways, as a personal view and not a FRC view, I would be very happy if you, rather than copy a standard out, actually said we follow this standard and in our case we don’t have to make any significant judgments under that standard. That’s a personal view.
Wayne Carnall: I actually have a fairly similar view. Again, comparing IFRS to US GAAP, a typical company under IFRS will have far more pages in their accounting policy than anything you’ll see in US GAAP. And I think, John, to your observation, a lot of times it does seem like it’s a mini textbook where you’re just copying, maybe a summary of every single accounting standard. And when you ask the company, well, you don’t even do anything in this particular area, why are you mentioning that accounting policy? They’ll say, well, we may at some point in the future. That might be relevant in the future.
At least limit the accounting policies to those policies that are applicable to you today, not what might be applicable to you in the future.
Walters: Back to you, John. Will the FRC expect full compliance with ESMA and disclosure on non-GAAP information?
Hitchins: We regard ESMA as a codification of good practice on that. But our remit is to be a proportionate regulator. So we will assess companies against ESMA, but if we think that you’ve left out something because it’s not particularly relevant and it’s clear that it’s not relevant, then we won’t chase you for apparent non-compliance. So, for example, if your only Alternative Performance Measures (APM) is that you have a genuinely exceptional item, but it is disclosed in your IFRS numbers anyway, then the fact that you don’t have a little table that reconciles back to IFRS is not something we’re going to get agitated about.
Walters: But are you expecting there will be more letters to companies this coming year-end on their strategic report?
Hitchins: Yes. I would expect that. I mean we’re already writing more, so I would expect that.
Walters: And what sorts of responses are you getting to those at the moment?
Hitchins: Well, like most issues, most companies will genuinely try to cooperate. It depends a bit on what the issue is.
Walters: Maybe a question for all three of you. Why do you think the APM have seen increasing popularity?
Carnall: I think there’s a variety of reasons why they’re increasing in popularity. I think a part of it is companies want to present their message according to how they want to present it. Basically they don’t want to be restricted by what the GAAP results show. And there are a couple of companies in certain industries, the pharmaceutical industry in particular, that have been fairly creative in non-GAAP. A lot of it relates to the acquisitions they’ve made where they have paid a very large purchase price. They have a lot of amortisation expense, and they want to eliminate that amortisation expense.
I mean there are companies with people whose full-time job is actually preparing non-GAAP information. It’s becoming that pervasive in the USA, and it can be fairly complex. Just a really quick story, if I may, about a company that was charged and where a guy was arrested. What that actual issue related to was one where I could see a number of companies making a very honest mistake. In fact, this company actually made an honest mistake, but then they continued it after they knew they were wrong.
And that has to do with the non-controlling interest. What the company was doing is they were making various adjustments in the reconciliation between GAAP and non-GAAP. And then some of them related to the subsidiaries where there was a non-controlling interest, and they didn’t do the allocation properly between what related to non-controlling interest and what related to the parent company or the company. And it wasn’t until the amounts in total were correct there was the allocation between the two that were incorrect. That could cost them and he’ll probably go to jail.
Walters: So let that be a warning to anybody doing this. Do you expect an increase in the use of APM with the application of new more complicated IFRS accounting standards increasing the gap between cash and accounting?
Watchman: We have in our work on IFRS 16 so far had some suggestion that if companies just don’t agree with the accounting answer it gives you they will produce pro forma and non-GAAP information that eliminates the effect. We’ll see in due course whether that actually happens. But I think there is some sense that in our work with investors, it’s quite clear that investors do seem to be craving what some APM are trying to do, which is give a sense of core earnings or underlying earnings. And these are all difficult terms to rally around that aren’t defined.
Hitchins: So I think my observation on APMs would be that typically APM give two pieces of information. One is a different way to explain, and the adjustments are reasonable. It gives you a clearer insight on how the company is performing. There is also another piece of information it gives to investors, which is these are the sort of things that we would like to be adjusted out of the actually reported numbers. It does, in some cases, tell you something about management as well.
Carnall: Just one short observation. And in terms of whether we’ll see a proliferation even more so about non-GAAP, just with the new standards with IFRS 15, if you are adjusting revenue, I would do so very, very cautiously. One of the CDIs that the staff has issued cautioned against that, that basically you cannot make up numbers. It seems fairly obvious that you should not be able to make up a number, but there were a number of companies that in their non-GAAP presentations would say and start off with, here’s the revenue. Here’s what we would like to have reported at revenue if we could. Those don’t go over that well.
Walters: To be honest, Wayne, with your story about the likely impacts of APM leading to at least one individual going to jail, I would imagine the use of them might be tailored down a little bit as it pertains to any reporting in the USA. There’s a question here on EFRAG. Why do you duplicate the IFRS standards? Is it just to keep your jobs?
Watchman: I wouldn’t be doing it if I wasn’t a believer in the idea of a single set of international accounting standards. But having, if you like, a single standard-setter, creates the risk that you get a monotony of thinking about international accounting standards. And EFRAG was the first regional organisation to be set up, a European regional organisation. In more recent years we found other regions that had moved to IFRS. So the Americas and also Asia also set up regional organisations to try and create that regional perspective to the IASB. So I think they’re making a valuable contribution to the overall mission of international standards that work internationally.
Walters: One for John, has the fallout from high-profile accounting errors raised concerns for the FRC that it may be missing or it’s impossible to see above compliance in established companies?
Hitchins: Well, I think given our remit, yes, we’re always going to miss things because we only look at what’s on public record and we don’t have the power to go in and investigate. We can call for documents from companies, but we don’t have the power to send our own investigators. We rely on the auditors, actually, to spot accounting errors.
Walters: That is really different from the USA…
Carnall: The SEC division of enforcement does have the power to do investigations. They have subpoena authority. Now subpoena authority outside the USA is a little bit different. But they have relationships with their counterparts all over the world. So they basically, in most cases, can get the information they request. But they will go much more in depth.
And in fact, the case I mentioned ealier with potential jail time, that’s not a SEC situation. The SEC has also filed a civil action against him. But that’s actually through the Department of Justice, and they are looking at things formally. And basically, even the SEC, they will look at emails and also at some documentation. It’s not just simply asking for a response.
Walters: A question for all of you. Do you think regulators should have a role in fostering the development of integrated reporting?
Hitchins: I think it depends on the remit of the regulator. So the FRC is involved in that, but for the FRC that’s very much something our Financial Reporting Lab is doing. That’s where the regulator is trying to foster innovative financial reporting in a safe environment. That is way outside the remit of my bit of FRC. We are tasked with looking at the compliance to the existing standards, so it’s not about developing future ways of reporting.
Watchman: EFRAG doesn’t currently have remit either. But putting that aside, I wonder if the best way forward for the next few years would not be to allow companies to experiment and innovate without regulators getting too involved unless there are particular abuses, which require some kind of intervention. There might come a time where some need for greater standardisation arises. I don’t think we’re there yet.
Carnall: The SEC has the authority to do that. They have complete authority over establishment of GAAP, over auditing standards, etc. But for the most part they defer that authority, or responsibility I should say, to others.
