Ten leading UK institutional investors have gone public and issued a plea for the UK authorities and the European Commission to rethink what they say are “fault lines” in International Financial Reporting Standards (IFRS).
At issue for the investors is whether accounts prepared under IFRS are founded on the principle of prudence and deliver a true and fair view of a company’s financial position, concerns raised again after recent accounting problems at an online gambling firm.
In a press notice accompanying the statement, the investors said: “The importance of this matter was highlighted just last week when Betfair plc admitted it had paid illegal dividends out of capital.”
The investors, who include the in-house asset manager of the Universities Superannuation Scheme (USS), RPMI, the Environment Agency Pension Fund and the Local Authority Pensions Fund Forum (LAPFF), say they are “concerned that a faulty accounting framework, which has contributed to market instability and economic hardship in recent years, has not been properly addressed”.
They go on to demand that the UK regulator, the Financial Reporting Council, revises its formal guidance on the true and fair view to address their concerns.
They also called on the European Commission to “confirm the meaning of the true and fair view with regard to the vital goal of capital maintenance as defined in EU company law”.
The investors argued: “We believe the reason IFRS has become disconnected from requirements for true and fair accounts as set out in EU Company Law is that IFRS accounts have different goals.”
“Accounting requirements in EU Company Law are there to ensure directors are able to fulfil their legal duties to protect capital,” they continued, referencing duties under the 2006 UK Companies Act.
Recent woes at Betfair have lent urgency to investor concerns. Although Betfair reports under UK GAAP rather than IFRS, the problem, the investors argue, is the same in that its accounts fail to depict a true and fair view.
Despite reporting £134.7m (€158m) of potentially distributable reserves (retained profit) on its balance sheet in 2010, it was not in fact a true profit for the purposes of the Companies Act.
Betfair is now in a position where, since 2011, it has paid out over £80m in dividends and share buy-backs that it did not in fact have.
UK investor dissatisfaction with the accounting framework is longstanding. Last year, the LAPFF, USS and others asked George Bompas QC for his opinion on the legality of accounts prepared under IFRS.
Bompas concluded that it was “questionable whether statutory accounts prepared in accordance with international accounting standard […] will always give a true and fair view.”
The Association of British Insurers, the Investment Management Association and National Association of Pension Funds have also pointed to the true and fair view override, as well as the concept of capital maintenance, as further areas of major concern for investors.
Investors argue that statutory accounts are used as the basis for both executive remuneration and distributions to shareholders. And if accounts prepared under IFRS permit management to recognize unrealized gains as income, a company could end up insolvent.
The IASB removed references to prudence, or caution, from its conceptual framework in 2010. It substituted instead the concept of neutrality.
The move was supposed to bring the IASB’s conceptual framework closer to the US GAAP framework, which makes no reference to prudence.
The IASB has in the past defended the move vigorously. In a speech to the Federation of European Accountants, IASB chairman Hans Hoogervorst argued that IFRSs are inherently prudent.
Major bank disasters, such as the collapse of The Royal Bank of Scotland, IFRS supporters note, happened with the pre-2010 framework in place.
At the heart of the debate over prudence, and the parallel issue of whether accounts prepared under IFRSs show a true and fair view, is the conflict between long-term company owners or shareholders and other investors with a short-term horizon.
The IASB has in recent months, however, appeared to soften its rhetoric on prudence. In May, IPE obtained leaked documents showing sympathy among IASB quarters for the concerns of long-term shareholders over what they say are major shortcomings in financial reporting.
Following that meeting, IASB members duly voted at their May 2014 meeting to reintroduce the notion of prudence into its conceptual framework.
The IASB is expected to release an exposure draft for public comment of a proposed update to its conceptual framework during the first quarter of next year. The project was originally slated for completion by mid-2015.