Governance and Corporate Reporting World Watch*...Philips case study Complexity kills companies...

World Watch*Governance and Corporate Reporting

Financial Reporting 4

Broader Reporting 16

Governance 24

Assurance 30

Diary Dates 36 Issue 1 2008

Reporting Expectations not met

Philips case study Complexity kills companies

Credit crunch Watch for accounting bite

Tax and regulation Can it save the planet?

White collar crime Massive losses

EDitoRiAl

David Phillips, senior corporate reporting partner PricewaterhouseCoopers

Richard Keys, global chief accountant PricewaterhouseCoopers

A rapidly-changing reporting landscapeThe last 12 months have seen acceleration in the convergence of financial reporting, a growing awareness of climate change and its implications for all aspects of decision making, and a growing recognition that no economy can remain competitive without action being taken to streamline regulation.

Taken together, these ingredients pose some interesting challenges for those trying to chart the course of business activity and provide mechanisms for making that activity visible to key stakeholders. It would be easiest to go along with the business-as-usual mantra that says ‘if the reporting model’s not bust, don’t try to fix it’, but this response misses the point and overlooks how the business agenda is changing – the need for real corporate transparency is passing from a luxury embraced by the few to a necessity of business survival.

It is no longer good enough to comply with minimum regulatory requirements. Embracing best practices may help, but the successful companies of the future are rethinking the information set they need to underpin their corporate reputation, to maintain their licence to operate, and to sustain and improve the public’s trust in them.

It is not unreasonable to predict that in 10 years’ time leading companies will be reporting their macro-economic footprint to the external world. This footprint will provide a connected picture of performance and the contributions made to employment, innovation, taxes and pensions. This will be presented along with the impacts on the environment, the supply chain and society at large. For those that create a persuasive and integrated picture of value, the outlook is sunny; for those that don’t, the pressure may be on.

The challenge is for companies to ‘be on the train when it leaves the station’, as it won’t be the regulators driving change. Change will be driven by market forces and by smart management who pride themselves on staying one step ahead of the pack.

World Watch team

Editor: Sarah GreyNews reporter: Steve HughesConsulting editors: Richard Keys, David Phillips, Graham Gilmour, Alison Thomas, Thomas Scheiwiller, Diana HillierContributors: Emma Charlesworth, Bethany Tucker, Elizabeth Georgiades , Kinga Lodge, Liz Fisher, Ron Brown and PwC Staff

The member firms of the PricewaterhouseCoopers network provide industry-focused assurance, tax and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 130,000 people in 148 countries across our network work collaboratively using Connected Thinking to develop fresh perspectives and practical advice.

© 2008 PricewaterhouseCoopers. All rights reserved. ‘PricewaterhouseCoopers’ refers to the network of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent legal entity. Designed by studioec4 19117 (01/08).

Contact usPwC has a strong and effective network of people worldwide who can advise on the developments in reporting, the implications of local regulations, as well as international standards and global trends. If you would like to discuss any of the issues raised in this publication, please contact your local office, the people named in specific articles or the editor.

To subscribe to World Watch magazine (usually published twice a year) or to contribute articles, please email [email protected]

www.pwc.com/corporatereporting

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Contents

Financial Reporting – News4 Fair value measurement

IASB and FASB consider extending use of fair value

5 New chairman of trustees for iASC Foundation Gerrit Zalm succeeds Philip Laskaway

5 Corporate reporting survey Investors expectations are not being met

6 SEC says yes to iFRS Foreign entitles can now use IFRS in the US

6 iFRS implementation SEC and FRC happy with IFRS implementation so far

7 US companies to use iFRS? SEC consults on US entities using IFRS too

7 European CFos find data complex and inadequate Survey shows dissatisfaction with management information

8 israel moves to iFRS Significant challenges for companies

8 Performance statement survey Investors and companies see eye to eye

9 Perspectives on endorsement and iFRS brand Sound bites from key figures in the IFRS arena

9 EU endorses segments standard European Parliament finally adopts but has reservations

9 Accountant turned regulator Ian Wright appointed to new role at the FRC

10 india considers impact of iFRS India to converge fully with IFRS by 2011

10 iFRS for SMEs Criticisms are out of step with reality

11 Private equity Report shows mixed opinions on private equity

11 Deregistration: one-way traffic SEC’s new rule sees many FPIs leave

12 XBRl: time to get on board? Regulators benefiting; companies still shying away

12 iASB has top-rated capabilities Top ranking for transparency and accountability

Financial Reporting – Opinion13 Case study: Philips

Fix complexity – it kills companies

14 Financial statement materiality Guiding principles to cut complexity

15 ‘Credit Crunch’ has accounting bite Companies grappling with IFRS accounting implications

Broader Reporting – News16 Can tax and regulation save the planet?

Companies want tax incentive to become carbon neutral

17 World Bank ‘Paying taxes’ report Transparency helps with responsibility and economics

17 towards transparent tax Tax contribution not well understood

18 Business Review: questions asked Survey highlights areas for urgent action

18 Climate change Green light for carbon offsetting?

19 Malaysia move from CSR to CR Growing trend for focus on broader corporate responsibility

19 New chairman for sustainability association Sam DiPiazza to tackle sustainable development at WBCSD

20 Global Reporting initiative Over 1,000 companies use GRI sustainability guidelines

20 in Briefs Linking climate change with performance Transport cuts emissions Demand for green credentials Agenda change for business

21 Climate change Bali success is critical

21 in Briefs Canadian initiative to store carbon dioxide Tradable index tracks companies fighting climate change 2007 Building Public Trust Awards High streets introduce green initiatives Danish reporting awards

22 New framework for climate risk reporting Board takes action on consistency

22 EU requirements on carbon emissions Three quarters of European aircraft operators not ready

22 Fresh eye on CSR reports Stakeholder panel can help with CSR performance

Broader Reporting – Opinion23 Recasting the reporting model

Essential ingredients for improving the framework

Contents

Governance – News24 Fraud: the many-headed hydra

Survey finds no let up in economic fraud

25 North America: who’s taking over the reins? Executives have no plans for the future of their businesses

25 CEo succession Survey reveals what legacy leaders want

25 Fraud: what can i do? Sitting on the fence not an option for NED’s

26 internal controls Guidance balances Sarbanes Oxley requirements

26 Section 404: cutting out the excess UK-based FPIs enjoy business benefits from 404

26 Direction for directors Guidance on building blocks for better boards

27 Combined Code to change UK proposals to make room for entrepreneurial success

27 Measuring up on directors’ pay EC report finds EU progress on directors pay

27 Commission poised for action on independence EC monitoring independence of non-executive directors

28 Netherlands: revised code of conduct New code to give insight into operations of private equity

28 Guidance on EU transparency Directive New publication explains requirements on periodic reporting

28 Shareholder action gets attention New governance proposals to balance interests of stakeholders

29 Audit committees: the best and worst FTSE 350 survey highlights behaviours and operations

29 Companies lack savvy on it risk Survey shows IT risk higher on corporate agenda

29 Risk: value for money? Companies increase spending on risk management by 25%

29 Fear of unnatural disaster Excessive regulation biggest risk for insurance industry

Assurance – News30 Auditor choice: prepared to invest?

Changes to audit firm ownership rules suggested

31 Group audit iSA will impact the audit ISA 600 will raise the bar

31 iSA updates continue IAASB approves 17 EDs in last six months

31 When iFRS is not quite iFRS ED proposals for when companies don’t use full IFRS

32 Summaries iSA proved controversial What auditors should say about summary statements

32 Strategic review underway IAASB looks to determine its future strategy

32 iSA 620: will current draft add to audit cost? Optimism that it will contribute to audit quality

33 iFiAR strengthens its ranks Paul Boyle and Steven Maijoor appointed to the board

33 Unlimited liability on last legs? Plans for guidance on limited liability agreements

34 100 not out for iSAs Many countries incorporate ISAs into national standards

34 EC questions ethics France asked to amend its national independence rules

34 Malaysia enhances audit quality Oversight board to be set up to monitor auditors

Assurance – Opinion35 A single set of global auditing standards

Assessing what’s needed to reach the goal

Financial ReportingFAiR VAlUE MEASUREMENt

Will IASB grant investors’ wishes?

Views on fair value have tended to be polarised. There are those who argue that it is an essential measurement tool to communicate what is going on in our increasingly complex business world. In contrast, others insist you can’t take the measurement model too far away from its historic roots.

Responses to the IASB’s discussion paper on fair value measurement suggest strong support for the project, although some fundamental areas of disagreement remain.

The discussion paper, which was essentially a collation of proposals developed by the FASB, attracted 136 comment letters. While most agreed that the project was needed, one of the biggest areas of debate is whether entry or exit price is the best approximation of fair value. While the US fair value standard is based on exit value, respondents to the IASB paper argued that there were many situations where entry price would give a superior answer. The IASB itself is sceptical that exit price would work internationally.

Respondents also asked the IASB to be more specific about the measurement bases it was discussing, as there was a general view that ‘fair value’ referred to a family of measures rather than one specific notion.

The IASB has agreed that the next project objective would be to complete a review of its existing standards contain current values, to assess whether the basis is entry or exit price. Before that analysis begins, however, the Board will have to agree on a working definition of fair value. The latest estimate of IASB staff is that an exposure draft will not be released before the middle of 2009.

Investors clear about what they want PricewaterhouseCoopers’ research with investors in Australia, Canada, France, Germany, the UK and the US has uncovered significant insight into how this community is thinking.

According to PwC director Alison Thomas – who conducted much of the research – investors expressed concerns about the more widespread use of current values. This, they think, could impede their ability to calculate returns on invested capital and increase the subjectivity of valuations. They also voiced concerns about the potential impact on the income statement.

‘Where current values are given, analysts and investors want to be told about key assumptions to enable comparisons across companies and assessments of reasonableness,’ explains Ms Thomas, a former analyst herself.

Both the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB) are considering extending the use of fair value in financial reporting; this could have significant implications for companies.

News & Opinion

Research findings

Investors do not think of •performance as the difference between two balance sheets. With the exception of financial services, they want a performance statement where operating performance is measured at historic cost and, where appropriate, the impact of changes in fair value are reported, but isolated from the operating numbers.

Investors believe that financial •assets and liabilities are generally best measured at fair value.

Investors are more relaxed •about having fair value information presented in the form of disclosures, rather than being presented in the primary statements.

For fair values to have real •information worth, all the underlying factors and assumptions that underpin the values need to be made visible.

Current value of operating •assets is best presented through additional disclosure, and not in the balance sheet.

5World Watch Issue 1 – 2008

Financial Rep

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Gerrit Zalm, the former finance minister of the Netherlands, has been named as the new chairman of the trustees at the IASC Foundation. The trustees are the oversight body for the International Accounting Standards Board.

Mr Zalm, who began a three-year term as chairman from 1 January 2008, was Dutch finance minister between 1994 and 2002, and 2003 and 2007. He also served as the country’s deputy prime minister between 2003 and 2007. Mr Zalm is currently chief economist of DSB Bank and a consultant to PwC in the Netherlands.

Philip Laskawy, the outgoing chairman of the trustees, said that Mr Zalm had been a leading advocate of IFRS and would bring to the organisation his extensive experience in the field of international cooperation on economic policy issues. Mr Zalm said it was an honour to be selected as chairman of the trustees. ‘The IASC Foundation and the IASB have made extraordinary progress in a short period of time,’ he said. ‘In the coming months I will work with my colleagues to continue to implement a number of oversight initiatives already under way and to advance the establishment of a broad-based financing programme.’

IASC FOUNDATION

Dutch finance minister to chair trustees

There is a very significant expectation gap between the importance investors attach to key information and the adequacy of the information they receive from companies, according to a recent PwC survey, Corporate reporting: is it what investment professionals expect? This raises the question of what impact this is having on investors’ assessment of risk and the consequences for the cost of capital.

There was a striking uniformity in the views revealed by investment professionals around the world – from Australia, Canada, France, Germany, the UK and the US. The chart below summarised their views.

Results showed that required financial reporting standards (GAAP) remain the bedrock for financial analysis. In particular, investors value the profit and loss account, the balance sheet, the cash flow statement, segmental information and the notes in the financial statements. They are less impressed with the nature of the information they currently receive in these areas in the annual report, but they are clear about the improvements they would like to see in corporate reports.

What investors really, really wantincome statement:

More detail on the income statement, which they use to •assess operating performance

Revaluations of assets and liabilities should not be allowed •to obscure underlying operating performance

Continued use of subtotals, such as a net income or •earnings numbers

Balance sheet:

To be able to use this as an input into the cashflow model, •for assessing debt levels and working capital, and for determining return on invested capital

To retain historical costs for certain assets, such as those •used in ongoing operations

To have current values for liquid financial assets and •investments, and to be told about key assumptions to enable comparisons and to assess reasonableness

Segment reporting:

To see segments identified by product line or business unit•

To avoid frequent changes in segment definitions and •grouping of very different products

To remove inconsistencies between annual reports and •investor briefings

To provide more performance measures reported per segment•

Non-GAAP information:

To continue to provide non-GAAP information, but consistent •ground rules governing their use would increase confidence in reported data

Management commentary:

Information to put the financial numbers in context, such as •market information. There are concerns that the information provided in the annual report may reflect management biases, and may be insufficiently timely

For copies of the report, please email: [email protected]

CORPORATE REPORTING SURVEY

Not meeting investors’ expectations

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Adequacy

Importance vs adequacy of key aspects of financial reports

Importance

Profit and

loss account

Balance

sheet

Cash flow

statement

Historical

summ

ary

Segm

entalinform

ation

Deb

t payout

schedules and

term

disclosures

Other notes

to the financial statem

ents

Managem

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iscussion and

analysis (MD

&A

)

Corp

orate governance inform

ation

Zalm: tackling oversight

6 World Watch Issue 1 – 2008

The ‘reconciliation removal’ moment has been debated for years, and finally the US SEC has voted unanimously to approve the long-awaited rule amendments. This means that financial statements from foreign private issuers (FPIs) in the US will be accepted without reconciliation to US Generally Accepted Accounting Principles (GAAP) – but only if they are prepared using International Financial Reporting Standards (IFRS) as issued by the IASB.

The rule applies to financial statements for years ended after 15 November 2007. It includes a two-year transitional provision for FPIs that apply Europe’s IFRS carve-out. These FPIs may reconcile the carve-out version of their financial statements to IFRS as issued by the IASB, instead of reconciling to US GAAP. However, after the two-year period FPIs still using the carve-out will have to reconcile to US GAAP.

The move has been widely welcomed. European Commissioner Charlie McCreevy said: ‘…this decision will benefit EU companies with a US listing… we are making major strides towards one global accounting language and many more countries are likely to follow’. And Dave Kaplan, PwC’s leader of US International Accounting and SEC Services, commented: ‘It is an important step in the ultimate move toward the

use of IFRS by US-based companies. We are also pleased that the SEC has decided to allow foreign private issuers to apply IFRS without reconciliation as early as for the upcoming 2007 year-end reports.’

The SEC itself has positioned this as a move to help US investors compare and analyse financial information from the US-registered foreign companies in which they invest. And there are now record numbers of US investors who own the securities of foreign companies – two thirds of US investors own securities of foreign companies, which is a 30% increase in the past five years.

But we can’t assume that the curtain will close on this particular epic without further drama. Despite the weight of support for eliminating the reconciliation requirement, not everyone will be happy. Some want local variations of IFRS to be accepted on the basis of sovereignty, for example, but the SEC is adamant that allowing variations of IFRS undermines comparability: ‘The purpose of the requirement to use the IASB-approved version is to encourage the development of IFRS as a uniform global standard, not a divergent set of standards applied differently in every nation.’ The IASB and the US Financial Accounting Standards Board (FASB) support this stance.

SEC

IFRS: that’ll do nicely for FPIs in the US now

IFRS IMPLEMENTATION

The regulators’ perspectiveThe US Securities and Exchange Commission (SEC) and the UK Financial Reporting Council (FRC) appear broadly happy with the standard of IFRS implementation, after taking stock of recent filings. However, it is worth remembering that regulators are on a learning curve with IFRS, just as companies have been. Certain regulators have indicated that their approach might toughen up in future.

From June 2006 through to June 2007, SEC comment letters for 77 foreign private issuers (FPIs) filing under IFRS were finalised and posted to the SEC website. As a result of the comment letter process, not one company was required to restate its accounts, just three companies amended previous filings, 57 companies agreed to revisions or to include additional disclosures in future filings and 17 companies made no changes. The points raised by the SEC were all about disclosure and not issues of recognition and measurement.

Late last year in the UK, the Financial Reporting Review Panel published its preliminary report on the implementation of IFRS by UK listed companies. While it ‘identified a good level of compliance with IFRS’, it also highlighted a number of recurring issues to point companies in the right direction for future filings.

The Panel found – among other things – a tendency to use ‘boiler plate’ descriptions for disclosure of accounting policies, irrespective of whether those policies had been applied in the accounts. ‘More focused and thoughtful approaches to these areas might reduce their length and increase understanding of the complexities which are inevitable in sophisticated commercial operations,’ the report stated.

Regulators around the world are already cooperating with each other and sharing information to foster consistent enforcement approaches to IFRS reporting, but there is still widespread concern that different national regulatory regimes will result in national variations in IFRS implementation that could undermine international consistency.


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The SEC held two roundtables in December, to collect more feedback from the public on the issue of giving US domestic issuers the same option that foreign issuers have to use either IFRS or US GAAP.

Many see IFRS in the US as almost inevitable because the globalisation of business and finance has already led to the successful mass adoption of IFRS by more than 12,000 companies in over 100 countries. IFRS may also offer a partial solution to the complexity of current US standards and provide cost efficiencies for international companies.

National pride and fear of losing the power to set standards are likely to run high in the US as the IFRS debate gains traction. Many will initially balk at the idea of abandoning US GAAP, long held to be the gold standard. But wariness runs on both sides: parties outside the

US fear the long reach of the SEC interfering with IFRS and interpreting it in a narrow, prescriptive manner that could make IFRS less relevant for reporters in smaller and medium-sized economies.

Equitable global standard setting US perspectives are already represented at the IASB, through three American board members and five American trustees, although some believe that with half of the world’s equity value resident in the US, this under-represents US interests.

We can expect growing pains as the IASB begins to address the world’s largest, most sophisticated capital market directly. Key concerns include ensuring that the IASB’s processes can withstand any particular territory’s influence. A well-designed, equitable funding mechanism is needed to ensure

the right leadership, staffing, resources, and independence at the IASB.

As the movement toward IFRS advances, it’s unlikely that the US will cede all control to an international body, no matter how effective it proves to be. The SEC may consider developing its own approval process for new IFRSs to be used in the US. But it is still early days and it will be some time before the mechanics of this is decided.

The initial IFRS conversion will come at a cost. That one-time cost will vary depending on the size and operating structure of individual companies. However, long-term benefits are expected for US companies, such as: better global comparability; more efficient capital allocation; reduced complexity and the risk of errors; and process and cost efficiencies.

SEC

Move to allow US companies to use IFRS

There is a widespread dissatisfaction with management information, according to a survey of European chief financial officers by CFO Research Services for PwC.

CFOs want faster and more relevant information and reported noticeable differences between the quality of financial and non-financial information. This is likely to be linked to the fact that the responsibility for the quality of non-financial information is often scattered throughout the organisation. CFOs said they want to become ‘a clearing house’ for both financial and non-financial information to oversee its quality.

When CFOs were asked ‘what does finance need to do to become a valued business partner?’ – the top three answers were: improve management information (41%); improve the performance of management processes such as budgeting, planning and forecasting (28%); and improve the quality of finance staff (14%).

Top barriers to high-quality information

41% of respondents see 1. organisational complexity – such as different product lines, reporting structures etc – as the biggest barrier to producing good management information

17% said there were insufficient 2. resources to create the information

16% cited technology issues3.

12% identified complexity in the 4. business environment, such as globalisation and mergers

10% mentioned poor data quality 5. and coding errors at source

4% fault the lack of accountability 6. or buy-in as a barrier

The report – Management information and performance – finds that many CFOs have noticed a heightened expectation within their organisations that finance should ‘move beyond traditional low-value transaction

processing to pro-actively share the wealth of knowledge that sits within finance around the strategy table’.

The study includes responses from 193 senior European finance executives. All respondents were from companies with more than $750m in annual global revenue. The top three most represented sectors were automotive/industrial/manufacturing (15%), financial services (14%) and retail (10%).

For further information on the survey please contact [email protected]

EUROPE

Data is complex and inadequate, say CFOs


PERFORMANCE STATEMENT SURVEY

Do investors and companies see eye to eye? Debate about reporting performance and earnings measures is heating up with the performance statement under review by the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB).

PricewaterhouseCoopers has asked both investment professionals and preparers of financial statements from the corporate community about the key elements of information that need to be visible in the income statement. The results of this research – entitled Performance statement: Coming together to shape the future – show a striking degree of congruence between the views of both types of respondents. They also expose some fundamental issues that need to be considered in reshaping the performance statement.

Key survey findingsRespondents from both the corporate •and investment communities rank the income statement as the most important of all the primary statements. In their opinion, it offers the best insight into the performance of a company over a given period of time.

Both investment professionals and •companies stress the need to be able to distinguish ‘underlying’ earnings from both one-off events (such as a gain from the sale of a business) and the impact of the re-measurement of assets or liabilities.

They believe that the earnings number •is useful and largely agree upon how that number should be defined.

Non-GAAP information is considered •valuable by the vast majority of respondents from both the investment community and from companies, though it was widely held that some ground rules should govern their use.

The only key areas of divergence lie in •tax reporting and how segments should be identified.

‘With such a high level of agreement between the preparers and users of corporate information, a practical solution to the performance reporting conundrum must be within reach,’ said Alison Thomas, PwC corporate reporting director. ‘The result would be a performance statement that everyone agrees gives a clear understanding of corporate performance.’

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Rated Most Important Ranked 2nd Ranked 3rd Least Important

IncomeStatement

Rank the income statement, balance sheet, cash flow statement and segment analysis in order of priority for your assessment of financial performance

BalanceSheet

Cash FlowStatement

SegmentAnalysis

ISRAEL

IFRS required this yearAll public companies in Israel are required to report their financial information using IFRS from this January. The decision to move to IFRS was taken by the Israel Accounting Standards Board two years ago, while the terms for transition were set by Standard 29 a year ago.

‘This is all about being part of the international community and speaking the same language,’ said Moshe Peress, PwC IFRS partner in Israel. ‘IFRS will help our companies’ ensure that their financial information is internationally credible and comparable.’

Israel started to adopt IFRSs one standard at a time by incorporating them into Israeli GAAP in the 1990s when the independent standards board was first set up. This process of convergence has continued during the last two years – some have found this challenging because the standards are changing continuously. Making the change bit by bit has also thrown up unpredictable issues where IFRSs cross-reference other standards that had not yet been adopted. Despite this, not many Israeli companies chose to adopt full IFRS early.

Several elements of the transition have posed challenges for companies in Israel. They have not previously had a financial instruments standard, for example, and there has been some uncertainty around the date that inflation accounting ended in Israel.

The securities authority is adapting to the new IFRS environment too, having been used to operating in a more rules-based way with less scope for judgement. IFRS 1, for example, has thrown up some exemptions that have not traditionally been acceptable to the regulator.

To help this process of adjustment, the securities authority has required companies to include IFRS notes with their 2007 accounting, including a condensed IFRS balance sheet and income statement and descriptions of the main differences between Israeli GAAP and IFRS.


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Ian Wright has been appointed to the new role of director of corporate reporting at the UK Financial Reporting Council (FRC). He is also appointed as a deputy chairman of the Financial Reporting Review Panel.

Mr Wright will lead the FRC’s work to ensure that corporate reports increasingly meet investors’ needs for relevant, high-quality information. ‘I am delighted to be joining the FRC,’ he said. ‘The UK is in a very privileged

and influential position to alter how global standards develop. We need to simplify and improve on what we have today in a measured way, without alienating the audience.’

Accountant turned regulator

IFRS 8

EU endorses segments standardAfter lengthy debate, the European Parliament finally adopted IFRS 8, Operating Segments, in November 2007, a year after the standard was published by the International Accounting Standards Board (IASB). This means that entities within the EU can now adopt IFRS 8 for use in their December 2007 year-end financial statements.

The length of the endorsement process for this standard raises questions about whether IFRS will function effectively as global accounting standards. Success will depend on consistent and timely adoption by all regions and territories that use the standards. The European Parliament clearly had some reservations about the standard, and to reflect these it has taken an unusual step and imposed some requirements on the European Commission (EC). The Parliament:

Has asked the EC to discuss with the •IASB a concern that the geographical information under IFRS 8 is less than that under the predecessor standard, and to report back within six months.

Is not convinced that IFRS 8 is a superior •standard for all users, especially small and medium-sized entities.

Has instructed the EC to support the •development of a standard that requires extractive industries to provide country-by-country reporting. It is not clear how the EC will be able to influence this.

Has instructed the EC to analyse the •application of IFRS 8 in the EU in many areas, including the reporting of geographical segments and the use of non-IFRS financial measures. The EC is required to report back to Parliament on these matters by no later than 2011.

The IFRS 8 effective date is for years beginning on or after 1 January 2009. Early adoption is permitted.

Perspectives on IFRS Key figures in the IFRS arena were interviewed for the ‘IFRS 2007’ conference organised by PwC France in October.

Interviewees: Charlie McCreevy, European Commissioner; Sophie Baranger, AMF deputy chief accountant, IOSCO, IFRIC and EC Roundtable Observer; Stig Enevoldsen, chairman of EFRAG’s Technical Expert Group; and Sir David Tweedie, IASB chairman.

Do you expect that the European Parliament will regularly oppose future IFRSs? McCreevy: The European Parliament plays an important role in the endorsement process, and this will always take a certain amount of time. But it is part of the democratic process. So everybody will have to get used to this. Baranger: I think the Parliament wants to position itself and keep sovereignty over the adoption of standards. The Parliament is a new player and must be taken into account in the adoption process. It won’t be simple, it means lobbying among parliamentarians so that they do not intervene at the end of the process in the way that has happened with IFRS 8.

Does the endorsement process take too long? Baranger: The process is clearly prolonged; it can now take eight months before a standard is formally introduced to EU law. With IFRS 8, it has taken a year. Enevoldsen: Of course it takes longer now that we involve the Parliament, but is that a European problem? The IASB needs to consider that it is now a global player; it is setting the rules for the world. It should ensure there is sufficient lead time in the standards − a year or so − to allow companies to prepare and to allow law-makers around the world to put it into the legislation, including the US in the future. Do I think that the SEC will ever accept IFRSs without a scrutiny procedure, like we have in the EU? I don’t think so.

Taking into account the different adoption processes of IFRS around the world, is the ‘IFRS brand’ under threat? Tweedie: Yes. We have to decide if we want a set of global standards, or regional or even national standards. One of the problems, which is also of concern to the regulators, is that the markets are now getting confused. If countries state ‘IFRS as adopted by X country’, and make one or two changes, the markets don’t know what the changes are. If people think it’s not a global standard, they may well choose US GAAP.


The Confederation of Indian Industry (CII) has tentatively welcomed the announcement that India will converge fully with IFRS by 2011, stating that it is ‘assessing the decision’.

While the CII seems to accept that adoption of IFRS ‘would improve comparability, transparency and credibility’, it notes that a ‘big challenge for countries adopting IFRS is a shortage of resources, particularly IFRS-trained professionals’. In addition, the CII worries that ‘since IFRSs are fair value driven, unlike Indian GAAP, India would need a large pool of valuation experts’.

With this in mind, it plans to organise a series of interactions with various stakeholders to help draw up a roadmap for integration. ‘The formal introduction of IFRS requires thorough deliberation and unanimous acceptance by regulators,’ said the CII. In addition to the National Advisory Committee on Accounting Standards (NACAS), it points out that the Ministry of Corporate Affairs, the Securities and Exchange Board

of India, the Reserve Bank of India and others must all support the convergence.

The Council of the Institute of Chartered Accountants of India announced that India will converge fully with IFRS for accounting periods starting on or after 1 April 2011. It will work with NACAS and various other regulators towards this date. The Institute also plans to conduct IFRS training programmes in the run-up to implementation.

CONVERGENCE

India considers impact of IFRS

The International Accounting Standards Board (IASB) has started to analyse the comments from a wide range of stakeholders on its draft standard for small and medium-sized entities (SMEs). Comments have included submissions from entities that have ‘field tested’ the draft standard. The standard is intended only for smaller entities whose users tend to be focused on shorter-term cash flows, liquidity and solvency issues.

One of the clear messages the IASB will be considering is whether its proposals do enough to reduce complexity for unlisted companies.

European Commissioner Charlie McCreevy made the EC’s position on the proposals clear in September when he gave a speech on the simplification of the business environment. ‘We have repeatedly

emphasised that accounting for SMEs must be simple and reflect the nature of the business of small companies. The feedback we have received…is that the current IASB draft is not simple enough to be applicable for the bulk of SMEs in the EU. At this stage, therefore, I do not intend to propose that the IASB draft be endorsed for application in the EU.’

Simplification was a key message in a comment letter from PricewaterhouseCoopers too: ‘We welcome the simplifications proposed in the exposure draft... but we do not believe the simplifications go far enough.’ Suggestions for simplification in the PwC comment letter, relate primarily to: financial instruments, deferred taxes, employee benefits, goodwill impairment and discontinued operations.

Hugo van den Ende, PwC member of the IASB SME Working Group, told

World Watch: ‘It would be a missed opportunity not to further simplify the standards. The IASB has already made great efforts to get the project to this stage. Whatever the technical merit of the current proposals, this lightly-diluted version of full IFRS will not be voluntarily adopted by the market. But further simplifications can readily be made because the idea of balancing the cost and benefit is already embedded in the principles of the exposure draft. Moving towards the user needs in this way will help take this project where it deserves to go – defining financial reporting for non-publicly accountable entities.’

The IASB working group for this topic is expected to make its recommendations to the board in April 2008. The IASB project plan currently states that a final IFRS for SMEs is expected in the second half of 2008.

IFRS FOR SMEs

Pressure grows for more simplicity

New blood from the investment community is expected to make a significant difference to financial reporting standard setting.

Although investors have always been key users of financial reporting information, it has traditionally been difficult to involve them in standard-setting. Three recent appointments should help.

Stephen Cooper of UBS – while continuing to work as an analyst – has been appointed as one of two part-time members of the International Accounting Standards Board. Similarly, Nick Anderson of Insight Investments has joined Peter Elwin of JP Morgan Cazenove on the board of the UK Accounting Standards Board.

All three individuals are active members of the Corporate Reporting Users’ Forum (www.cruf.com) a prominent user group.

INVESTORS

New blood set to make a difference in standard setting


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The private equity (PE) industry should become more open in its reporting, but popular criticisms levied at it are out of step with reality, says a PricewaterhouseCoopers report.

Claims that the PE industry pays unreasonably low taxes and is always ready to lay off staff are not necessarily justified, argues the report. PE executives are operating within the tax regulations, and the low capital gains taxes are consistent with the risks individuals take with their own money. Criticisms relating to low corporate tax payments, on the other hand, are simply outdated.

‘The government clamped down and changes were put in place in 2005, so that a full tax deduction is not available for highly leveraged deals,’ explained PwC tax partner Pam Jackson. ‘The first tax returns reflecting the new regime are only now being processed by the Revenue, hence public awareness of the change is lagging behind.’

The report argues that, in reality, the total tax contribution of a major PE house will often compare very favourably to that of a large private company. Significant amounts of tax – other than corporation tax – are being paid. In addition, PE

houses often increase employment in their portfolio companies and drive up capital expenditure.

‘The PE sector should use such information to improve its public image by benchmarking against major quoted companies,’ said Ms Jackson. ‘This could really help the industry to show the positive impact that it has on the UK economy.’

PwC head of corporate reporting David Phillips agrees. ‘The public is asking PE houses to stand up and be reported on. It is better for them to come up with their own solutions – which everyone buys into – rather than allowing the regulators to do it for them.’

PRIVATE EQUITY

Stand up and be counted

Walker guidelines for private equity

The British Private Equity and Venture Capital Association’s (BVCA) working group – under the chairmanship of Sir David Walker – has published final guidelines and recommendations on transparency and disclosure for the private equity industry. The guidelines are voluntary and have immediate effect in the UK.

They recommend that portfolio companies meeting certain size criteria should publish an annual report and a mid-year update and provide data to the BVCA. Some of the data will be used for an economic impact study. The guidelines call for information on the private equity fund owners of the company; a business review covering narrative reporting information (similar to the provisions

of the Companies Act 2006); and a financial review covering risk management objectives and policies in the light of the company’s principle financial risks.

Private equity firms are also asked to improve reporting. Recommendations include publishing an annual review with enhanced disclosures (using established guidelines) and communicating promptly and effectively with employees, particularly in times of strategic change.

The plan is to set up the group that will monitor and review the guidelines in 2008. Data collection is already underway.

For further information see www.walkerworkinggroup.com

DEREGISTRATION

One-way trafficIf you open a road block, you might expect the traffic to come and go in both directions. But since the US SEC amended its capital market deregistration rules, the traffic has been going mainly one way. The new rules allow for smoother deregistration of foreign companies from the US stock exchanges, should they find that access to US capital markets no longer meets their needs.

The SEC’s new rule has seen large numbers of Foreign Private Issuers (FPIs) – including British Airways, United Utilities, ICI and Telekom Austria – file deregistration documents with the US regulator, as expected. As of 30 September, 2007, 89 companies had deregistered under the new rules; 55 of these were European.

But so far, the correspondingly large increase in new listings and registrations on US markets, also expected, has not materialised. Invesco is one of the companies bucking the main trend – its board recently recommended to shareholders that the company moves its primary listing to New York.

‘[De-listing] will save on unnecessary costs but it won’t mean we’re going to be any less transparent to our shareholders,’ said Peter Zydek from Telekom Austria in IR Magazine recently. ‘US investors have started looking for European equity and going to the home stock exchanges, where liquidity is higher than in the US. Our experience is that travelling to see investors is a far better way to increase our profile and get international investors to buy stock, rather than just going for a dual listing. A dual listing only creates a new market place; it doesn’t get the customers to buy the shares.’


According to experts, the time has come to harness the usefulness of Extensible Business Reporting Language (XBRL), an international internet standard for electronically tagging business information. It is widely acknowledged that XBRL has the potential to reduce time and cost for the reporters and the users of financial information.

Many companies are still shying away from the technology, and this is thought to be because of a lack of understanding and misconceptions about the cost and availability of required resources. However, this does not seem to be slowing the momentum of regulators and standard setters that continue to require or support its use. Seventeen out of 27 EU member states have already decided to adopt XBRL. The Dutch government, for example, is using it to help reduce the administrative burden of the state on business by enabling all filing to public authorities (including tax) to be done through one system.

Many regulators have already dedicated significant money, time and effort to encourage its use because of the savings they expect. A taxonomy is being developed by the Committee of European Banking Supervisors for regulatory purposes and will be provided free to national supervisors. At the same time, the IASB has developed a taxonomy to fit the full set of IFRS.

There are some companies that have already adopted XBRL and are singing its praises. ‘The tools are available, the resources are there to assist, and the potential benefits are tremendous… now is the ideal time to begin,’ said John Stantial, director of financial reporting for United Technologies Corporation. Mr Stantial has explained that the initial tool cost his company $1,000 and took staff 80 hours to install and learn how to use. This has enabled him to save 150-200 man hours in the reporting process for every subsequent quarter.

‘Taking no action is a significant risk for companies,’ said PwC partner Mike Willis. ‘It leaves market adoption and related benefits solely to regulators and investors.’

XBRL

Time to get on board?

SEC fighting legalese and gobbledygook

SEC chairman Christopher Cox told the Financial Times recently that XBRL was part of the solution for tackling complexity and would enable investors to find what they need quickly and reliably, without having to pore through pages and pages of documents. ‘I’ve been fighting against legalese and gobbledygook for years,’ he said.

IASB promoting XBRL around the world

Olivier Servais has been appointed XBRL activities team leader at the International Accounting Standards Committee Foundation. His mission is to develop and maintain an XBRL version of the bound volume of IFRS. ‘I look forward to… advancing the development and promotion of XBRL.’ There is already a close correlation between countries adopting IFRS and those beginning to use XBRL – Canada, for example, is expected to adopt both the standards and the technology at the same time.

IASB

Top-rated transparency and accountabilityAccording to a report on global accountability, the International Accounting Standards Board (IASB) has the best developed external stakeholder engagement capabilities and is a high performer in both transparency and evaluation.

The report, published by the One World Trust, is an annual assessment of the capability of 30 of the world’s most powerful global organisations from the inter-governmental, non-governmental and corporate sectors and their accountability to civil society, affected communities, and the wider public.

The IASB topped global rankings across all assessed organisations for stakeholder participation. It was ranked first among international non-governmental organisations for evaluation and second for transparency, sharing the ‘high performer’ assessment with Christian Aid.

Phil Laskawy, then chairman of the IASC Foundation, said: ‘Transparency and accountability have been cornerstones of the standard-setting process since we started in 2001 and recent enhancements to our due process have further strengthened this commitment. We welcome this independent assessment of our progress to date.’

A copy of the One World Trust 2007 Global Accountability Report can be downloaded from www.oneworldtrust.org


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Gerard Ruizendaal from Philips talks to Carolyn Canham and makes a strong case for reducing complexity, calling on standard setters to fix it

CASE STUDY: PHILIPS

Fix complexity – it kills companies

Complexity in financial reporting was a factor contributing to the near-bankruptcy of Dutch electronics giant Royal Philips Electronics in the 1990s, according to Gerard Ruizendaal, a member of the company’s group management committee.

Mr Ruizendaal, a certified public accountant, addressed the issue of complexity in financial reporting at the PricewaterhouseCoopers Meet the Experts event in London in October. He explained how Philips, which has a multi-national workforce of 125,000 employees, manufacturing sites in 28 countries and sales outlets in 150 countries, was founded in 1891 and therefore had to invent much of its financial reporting itself, while making sure it was consistent in dozens of countries.

After the presentation, Mr Ruizendaal told World Watch about the first comprehensive law on financial reporting in Europe, introduced in about 1984. ‘Before 1984, there was only one sentence in Dutch law and that said you have to report “in a good way”; that’s all.’

As the reporting requirements grew, so did the complexity. Philips’ management reporting was different from its external reporting and consequently the company used various combinations of its own GAAP, Dutch GAAP and US GAAP.

Mr Ruizendaal explained that during the early 1990s, Philips skimmed close to bankruptcy and, in one year, was forced to fire about 50,000 people. ‘We analysed, of course, what had happened to make sure it never happened again. One of the many conclusions was that all our [internal] reporting was too sophisticated and not really understood. That was one of the factors – that the company was not financially managed in the best way.’

He added that Philips’ operational managers who had to use the internal reporting systems did not really understand them, and that there were challenges resulting from using different systems for internal and external reporting. ‘It did not help that properly communicating with financial markets is difficult when you only use external reporting standards for your external reporting.’

From 2009, Philips expects to use IFRS for both internal and external reporting. However, Mr Ruizendaal warns that ‘we’re not out of the woods yet’ because there is still the very real possibility that Philips, which has a shareholder base that is about half European and half US and other, will be forced to

report under IFRS as endorsed by the EU and interpreted by Dutch regulator AFM, as well as IFRS as issued by the International Accounting Standards Board (IASB) and interpreted by the US SEC.

Mr Ruizendaal said this issue has become more pressing with the SEC’s recent announcement that it will only drop reconciliation requirements for companies that report under IFRS as issued by the IASB. ‘So if the European politicians create more changes than the existing IAS 39 carve-out, then it would really have [a significant impact].’ He added that the options would then be to either report under the various standards ‘or de-list and de-register so that you don’t have to file the statements anymore’.

Philips is not currently looking at de-listing, according to Mr Ruizendaal. ‘But if things really get worse in terms of all we’re currently seeing, it could come on the table, like it has for many other European companies that are dual-listed.’

Mr Ruizendaal has a number of suggestions about how to bring simplicity to financial reporting. He calls on the European Commission not to add complexity: ‘I think it is up to the European Union to make sure that they keep aligned with the IASB to avoid [the situation where we] will get to at least two different versions of IFRS.’ He also has a job for the IASB: to keep the standards simple and to talk more with the users of financial statements to understand their requirements.

‘If they make IFRS too complex, then I cannot use it for my operating unit. I cannot expect the sales manager, the factory manager and the mid-level controllers to be accounting specialists. So I see a danger that, before we know it, I’m back in the situation we were in the 1990s.

‘I think it needs to be as simple as possible so that it can be used by operational people in smaller units. Is it also usable by the people who have to live day by day with the accounting information? Because if companies don’t use it and investors don’t use it, then I don’t know what the purpose of the whole circus is. [IFRS] should be much more driven by the users of financial statements.

‘Sometimes it has to be complex, like pension accounting – I don’t know how to make that one simpler, but luckily that is something you can handle centrally.’

In Mr Ruizendaal’s view, financial reporting is moving towards being too much about compliance and not enough about adding value. ‘Companies will spend tens of millions, in the case of a company our size, to produce the information to comply with the regulators, but there is no economic benefit.’

Carolyn Canham is deputy editor of The Accountant.


OPINION

Financial statement materiality When is an omission or a misstatement considered ‘material’? With a common understanding of financial statement materiality still some way off, PwC partner Steve Meisel proposes a few guiding principles to cut complexity

Financial statement materiality means different things to different people, to different business cultures and to different regulatory bodies. As global standard setters continue to move towards principle-based standards, inherent variations in the application of judgements will inevitably increase. This may produce results that vary from what regulators have come to expect. Furthermore, the public may not fully appreciate the issues surrounding financial statement materiality, when preparers and their auditors encounter omissions or misstatements after financial statements have been published.

In the context of financial statements, an omission or misstatement is generally considered material if investors’ economic decisions would have been changed or influenced by the inclusion or correction of the item. The lens through which materiality judgements are viewed is heavily dependent on the context – considering magnitude in light of the surrounding circumstances. But what does that really mean? Can an item that is large in magnitude still be considered immaterial due to its qualitative characteristics? And how should materiality be evaluated in the context of interim financial reporting?

In my view, restatement for omissions or misstatements discovered after the financial statements have been issued

should be reserved for omissions and misstatements that are material to investors. For the most part, items that originated in a prior period but do not impact on the trend of reported results should be corrected in the current period with transparent disclosure. In jurisdictions where restatements are permitted (or required), investors should be entitled to receive revised information about material misstatements or omissions in financial statements on which they relied or are still relying. If restated financial statements are not permitted for legal or regulatory reasons, alternative communications should occur.

While the debate will, no doubt, continue, the fact remains that reaching a common understanding of financial statement materiality is an important component of the broader convergence initiative, and will help reduce complexity in financial reporting. Until this common understanding is achieved, however, it would be a step in the right direction if regulators endorsed the principles discussed here and supported the use of judgement by preparers and auditors in their consideration of financial statement materiality.

To comment on these principles, please email Steve Meisel: [email protected]

Guiding principles to cut complexityGeneral principles for analysing financial statement materiality:

Quantitative and qualitative factors

Financial statement materiality should be focused on the financial statements taken as a whole and should consider both quantitative and qualitative factors. It may be that qualitative factors indicate that a quantitatively small omission or misstatement is material. However, the analysis can and should work both ways. Qualitative factors may indicate that an error which is large in magnitude is, nonetheless, immaterial. This could be the case, for instance, where the large amount does not mask a change in earnings or other trends, does not affect a high-profile business segment, and does not hide a failure to meet analysts’ expectations.

Impacts on value drivers and market influence

Financial statement materiality analyses should be viewed from the perspective of the investor and should consider whether a particular omission or misstatement reflects on the integrity of senior management or impacts on the relevant value drivers of the business, including (but not limited to):

Whether the omission or misstatement impacts on the •

predictive value of the financial statements for purposes

of assessing expected future cash flows

The impact of the omission or misstatement on •

key performance indicators (ie, measures the

market considers important, which could include

non-financial measures)

Likely marketplace reaction to the disclosure of the item•

Whether investors are still relying on the incomplete or •

misstated information

Full year vs half year

The materiality of an omission or misstatement in interim

financial statements should primarily be based on its

impact on the full year. The expected level of precision

inherent in interim financial statements is less than for

annual financial statements – a situation recognised in the

level of detail required by regulators and in the level of

external assurance that investors receive. And while

omissions and misstatements should be evaluated for

materiality against the interim and annual periods in which

they arose, out-of-period corrections should be related to

the expectations of the financial statements for the year

of correction.


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FINANCIAL REPORTING OPINION

‘Credit crunch’ has accounting biteThe ‘credit crunch’ has led to significant volatility in the financial markets across the globe. Richard Keys, PwC chief accountant, and Pauline Wallace, PwC’s financial instruments leader, explain some of the IFRS accounting implications

Many people around the world are feeling the impact of a widespread shortage of liquidity and a widening of credit spreads – not just financial institutions. This ‘credit crunch’, which started by rising defaults in the US sub-prime markets, has led to significant volatility in the financial markets across the globe, with implications for users, preparers and auditors of financial statements.

In the current climate, tough questions are being asked of companies in the process of their year-end reporting, such as:

How is it possible to establish the fair value of financial •instruments if there are no longer active markets?

Should development projects be curtailed, and will this •result in the impairment of an intangible asset?

Will goodwill or intangible assets need to be impaired?•

Will key assumptions have to be adjusted for a decrease in •future growth and an increase in discount rates?

Are more sensitivity disclosures needed in an environment •where ‘reduced headroom’ is likely?

Companies face a significant challenge to communicate the effects of all of this to the market at a time when the new disclosure standard for financial instruments (IFRS 7) asks you to disclose information about financial risks. This means reporting amounts used in internal treasury systems for identifying financial risks and measuring the related financial positions.

Companies should be prepared for investors to ask tough questions, particularly where new disclosures highlight areas that are dealt with differently from business to business. Here are just some of the issues that company managers are having to tackle during the year-end reporting process.

Fair valueThe recent illiquidity in some markets has led to difficulties in establishing the fair value of some financial assets and liabilities. The best evidence of fair value under IAS 39 is quoted prices in active markets. Where these are not available, entities use valuation techniques to estimate the fair value. A valuation technique must incorporate all factors that market participants would consider in setting a price. Determining fair value therefore requires consideration of current market conditions, including the relative liquidity of the market and current credit spreads. Entities cannot ignore current information about how the market would price the instrument.

Impairment of financial assetsIAS 39 focuses on having objective evidence of impairment before a loss can be recognised. Companies will need to consider whether recent market conditions imply that there is objective evidence of impairment for their financial assets. Loans to sub-prime customers or loans to other entities with

sub-prime exposures will have objective evidence of impairment as those customers default. However, if an entity has available-for-sale debt securities whose fair value has decreased because of rising risk-free interest rates, that on its own is not considered objective evidence of impairment under IFRS.

Hedge accountingCompanies may be experiencing some hedge ineffectiveness as a result of recent market conditions. For example, if entities had designated fair value hedges of fixed rate assets using interest rate swaps, ineffectiveness may arise due to the re-pricing of the floating leg of the swap. If entities had not designated their hedged risk carefully, they may have hedge ineffectiveness arising from changes in credit spreads that are not mirrored in the hedging instrument. Others that have hedged forecast debt issuances, including the rollover of commercial paper, will need to ensure that the hedged debt issuance is still ‘highly probable’. If not, the criteria for hedge accounting are no longer met, and the hedge accounting should cease.

Impairment of non-financial assetsThe significant amount of mergers and acquisition activity prior to the recent turmoil may well have resulted in significant amounts of goodwill and intangible assets being recognised on acquisition. The recent volatility could impact on impairment calculations in several ways, including triggering impairment reviews, affecting key assumptions (growth and discount rates) and requiring more sensitivity disclosures.

Pension valuationsThe recent market conditions can have an effect on the value of both pension plan assets and plan liabilities. Pension plans may have invested in assets backed by sub-prime exposures; therefore, the value of their plan assets may have fallen. Looking at the liability side, one of the assumptions used in the projected unit credit method is a discount rate that references market yields. Given the volatility in the markets, it is possible that those rates may have changed.

Quantitative and qualitative factors

The Global Public Policy Committee (GPPC) has issued a paper to enhance awareness of IFRS requirements covering the determination of fair values of financial assets and liabilities and related disclosures in the context of current market conditions. ‘It is important that the large firms are working on these issues,’ said Dick Kilgust, GPPC chair. ‘The valuation issues are complex and it is the first time that IFRS has been applied extensively in difficult market conditions.’ Email: [email protected] for a link.

Broader ReportingENViRoNMENt

More tax and regulation please

Around two thirds of companies surveyed said they would welcome using the tax system to incentivise them to become carbon-neutral. However, current environmental incentives in the tax system are criticised for being unclear, too complex and failing to motivate behavioural change.

Three quarters of respondents said they would like money from environmental tax and regulation directed towards green initiatives. Currently, few say they are confident that this is actually happening.

PwC UK managing partner Glyn Barker recently told FT.com: ‘It might seem surprising that businesses appeared to welcome further regulation. But corporate leaders recognise that customer and investor pressure is not enough to change their behaviour fast enough, given the urgency and scale of action required.’

Despite the perceived lack of government action, the survey noted that 71% of companies said climate change and environmental issues are already affecting corporate behaviour. And nearly all businesses surveyed (97%) said they expect to make more changes in the way they do business in the next two to three years. Many (42%) expect to make a lot of changes.

Pressure for more regulation in the US

In the US, federal agencies are also under increasing pressure to provide guidance on climate risk disclosure. The push comes mainly from investors.

Despite the increasing trend among businesses to voluntarily disclose risks associated with climate change, there are two strong arguments for SEC guidance, according to the Legal Intelligencer magazine. First, without mandatory directives, a number of companies opt out from providing disclosure on climate risks. Second, the climate risk disclosures currently provided are inconsistent in their substance and quality; which in turn fails to provide the information investors need to make informed decisions.

‘Businesses would like to see a more streamlined regulatory environment globally; 80% of CEOs we surveyed around the world are calling for governments to take the lead in this

area and provide a clear direction on the what and how of climate change mitigation,’ said Thomas Scheiwiller, PwC sustainability leader. ‘At the moment regulation is very fragmented – it is different in each country, which makes it onerous for companies to comply with and less effective at tackling the climate change.’

Businesses are looking to government to encourage them to do more to protect the environment. That was the clear message to emerge in a new survey by PricewaterhouseCoopers in the UK – Saving the planet: can tax and regulation help? – which found that half of all companies do not think that current government policy instruments encourage significant behavioural change.

Saving the planet survey identifies a number of areas where government and business can work together to tackle environmental issues:

Agree the best mix of •incentives and penalties that ensure a consistent approach in the long term

Understand the relative merits •of different carbon emission trading schemes and taxation

Overseeing environmental •tax and regulation policy needs to be a board-level responsibility

Business needs to be more •involved in developing policy initiatives to improve consistency and clarity

Issues need to be considered •in their international context by business.

For more information, email: [email protected]

News & Opinion


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Business should be more transparent in the way it communicates total tax contributions, according to the latest review of global tax systems.

The second Paying Taxes report – compiled by PricewaterhouseCoopers and the World Bank – says transparency helps governments to ensure taxation fits corporate responsibility strategies and to assess the economic footprint of business.

With growing concern that the tax burden inhibits competitiveness, the report says that transparency has never been more important – for both business and society in general. A combination of transparency and better dialogue between business and government is seen as essential in building trust and confidence for stakeholders to invest in business. Conversely, an increased regulatory burden can affect the ability – and willingness – of businesses to invest and grow.

The report emphasises that governments need to review all types of taxes that companies pay when reforming their systems, rather than confine themselves to corporate income tax.

Paying Taxes compares the ease of paying taxes in 178 countries and provides data that helps governments and industry to ensure tax systems have effective tools for collection and are efficient for business. Overall, the survey shows that tax reform is widespread. During the last three years, 65 countries

have improved their tax systems, around half that number in the last 12 months. The most popular reform is to reduce corporate income tax. Recommendations to come out of this year’s report include boosting tax revenues by simplifying systems and compliance obligations.

Tax reporting is not currently achieving a good understanding of companies’ total tax contribution. Companies themselves have recognised this for some time – for example, a few years ago 99% of FTSE 100 tax directors said that there was insufficient understanding of their tax reporting, and 97% were concerned about negative press coverage of corporate tax, according to a PricewaterhouseCoopers survey.

To respond to this concern, a framework for better tax reporting has been developed by PwC. This aims to enable companies to better meet stakeholders’

varied needs, including: tax risk management (company management); taxable business (government); tax contribution to society (employees); the sustainability of tax numbers (investors).

The Tax Transparency Framework suggests tax needs to be reported by companies under three broad headings:

Tax strategy and risk management – •to include tax objectives and strategy, discussion of how tax is managed and disclosure of major tax risks.

Tax number and performance – •to include explanations of the tax rate, reconciliations and forecasts for future tax rates, all to include some

breakdowns of the figures beyond the global results, into country or regional statistics.

Total tax contribution and wider impact •of tax – to include how tax has an impact on a company’s wider business strategy and shareholder value and to provide clear communication of the economic contribution made by all the taxes with which the company is involved.

‘The clearer and more complete the picture that stakeholders obtain, the less chance there is of misunderstanding what the company is really doing,’ said PwC tax partner John Whiting. ‘Improved internal management of tax risks will also flow from better reporting.’

The ‘easy to pay’ league table

1 Maldives 2 Singapore 3 Hong Kong, China 4 United Arab Emirates 5 Oman 6 Ireland 7 Saudi Arabia 8 Kuwait 9 New Zealand 10 Kiribati

At the other end of the scale… 169 Panama 170 Jamaica 171 Mauritania 172 Bolivia 173 Gambia 174 Venezuela 175 Central African Republic 176 The Congo 177 Ukraine 178 Belarus

Note: Rankings are the average of the country rankings on the number of payments, time and Total Tax Rate. Source: Doing Business database.

REPORTING

Towards transparent tax

TAX SURVEY

Tax transparency – more important than everMost common reforms of 2006/07Reduced profit tax Azerbaijan, Bulgaria, Colombia, Cote d’lvoire, Greece, Israel, Kazakhstan, Kyrgyz Republic, Lesotho, FYR Macedonia, Malaysia, Mauritius, Mexico, Moldova, Mongolia, Netherlands, Portugal, Slovenia, South Africa, Spain, Syria, Trinidad and Tobago, Tunisia, Turkey, Uruguay, Uzbekistan, West Bank and Gaza

Reduced labour taxes or contributions Albania, Bulgaria, Israel, Kyrgyz Republic, Mexico, Moldova, Netherlands, Romania, Seychelles, Slovenia, South Africa, Uzbekistan

Simplified process of paying taxes Azerbaijan, Bulgaria, Colombia, Lesotho, Malaysia, Netherlands, Turkey, Uzbekistan

Revised tax code Moldova, Mongolia, Sierra Leone, Syria, Turkey, Uruguay

Eliminated taxes Colombia, Israel, Kyrgyz Republic, South Africa, Uruguay, Uzbekistan

Source: Doing Business database.


CLIMATE CHANGE

Green light for offsetting?

In the race to be ‘carbon-neutral’, many companies are turning to carbon trading as the attractive option. But is it that simple?

A growing number of companies are demonstrating their corporate responsibility by going ‘carbon-neutral’ and offsetting the carbon that their businesses produce. But carbon trading is not without its critics, and those using this option need to take care that their good intentions and their cash are really making a difference.

Carbon offsetting gives companies the chance to balance their own carbon-generating activities against carbon-reducing ones elsewhere. Under the Kyoto protocol, projects that cut greenhouse gas emissions are awarded carbon credits that can be traded. Fortis Bank recently paid more than €13m for the rights to emit 800,000 tonnes of carbon dioxide – rights that it plans to sell on to clients. The credits were held by the city government of Sao Paulo in Brazil in relation to a project to prevent methane escaping from a 30m tonne rubbish tip in the north of the city – the largest landfill site in Latin America.

Such transactions are fuelling the carbon trading market – estimated by the World Bank to be worth around £15bn last year. Most trading currently involves the sale of allowances under the EU’s emissions trading scheme, which covers large carbon emitters. However, the voluntary market is also hotting up as companies seek to prove their green credentials.

Companies such as Swiss Air, Lufthansa, TUIfly.com and Kuoni, for example, have joined the ‘myclimate’ initiative, which is seen as one of the leading providers of voluntary carbon-offsetting measures. Some organisations have also opted for the Gold Standard Foundation quality label, which is intended to identify those projects that make a genuine reduction in CO2 emissions and benefit sustainable development in the host country.

But carbon trading has also been criticised. Some say the mechanism just gives rich businesses permission to carry on emitting carbon rather than change behaviour. Also, some carbon credit money may be going to projects that would happen anyway or which do not actually cut carbon emissions.

Such concerns are being addressed. The Climate Group, one of the leading NGOs working on climate change, has initiated a debate on standards and governance in the offsetting market, proposing the formation of a carbon stewardship council to oversee the sector. In the UK, the government has consulted on a Voluntary Code of Best Practice for offsetting, including proposals to establish an accreditation system for offset providers.

Richard Gledhill, PwC’s head of climate change, believes there is no reason for companies to disregard offsetting as one element of their climate strategy, but it isn’t the starting point. ‘Companies will want to ensure that their strategy starts with monitoring, measurement and active management to reduce their carbon footprint before they look to offsetting,’ he said.

NARRATIVE REPORTING

Business Review: questions askedAdditional information required by the UK Business Review legislation is set to throw up some challenging questions about the quality of management. New research – focused on the narrative reporting of FTSE 350 companies – provides insight into where the most urgent action is needed, as we move into another reporting cycle.

For example, in companies’ annual reports:

Only 35% of FTSE 350 companies •support their strategic statements with targets – qualitative or quantitative.

Less than half of companies (42%) •clearly align their key performance indicators with their strategic priorities.

Just 41% provide information on •the factors likely to have an impact on their market place.

Having said that, the Business Review seems to have had a beneficial effect on the standards of narrative reporting in the UK:

93% (66%)* of companies provide •some disclosure around their strategic objectives.

75% (19%)* clearly disclose their KPIs.•

75% (22%)* clearly set out what they •consider to be their principal risks and uncertainties.

*2006 survey findings in brackets Source: PwC survey Business Review – has it made a difference?

‘Box-ticking compliance is no longer an option – reporting is a critical business activity,’ PwC senior corporate reporting partner David Phillips told World Watch. ‘High-quality information on corporate activity is an essential ingredient for the successful functioning of today’s capital markets and the societies in which they operate. As societies’ expectations increase, companies understand the need to be more transparent – it is an intrinsic part of their licence to operate. The challenge for them is to explain, in a strategic and integrated way, their total contribution to society from the wealth they create to the impact they have on the environment.’


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MALAYSIA

From corporate philanthropy to strategic corporate responsibilityThere is a growing trend in Malaysia for greater focus on Corporate Responsibility (CR) as distinct from philanthropy or Corporate Social Responsibility (CSR). CR covers a broader spectrum; besides the social aspects, it emphasises environmental and economic elements and focuses on a sustainable future.

A key CR initiative in Malaysia is the government’s Silver Book, published by the Putrajaya Committee on GLC High Performance. The book is a guide to help Governmental Linked Companies (GLCs) implement their CR initiatives. It is driven by Khazanah Nasional Berhad (Khazanah), the Government’s strategic investment holding arm and the key agency driving shareholder value creation in GLCs.

The Silver Book has three key objectives:

to clarify expectations of GLCs’ •contribution to society

to guide the GLCs in the evaluation of •their starting positions for contributing to society

to provide the GLCs with a comprehensive• set of tools, methodologies and processes to contribute proactively to society in a responsible manner

Khazanah is advocating the move towards strategic CR to make policies more relevant in the current business environment. By focusing particular attention on the GLCs, this move is expected to have a significant impact on the Malaysian community, the environment and the economy (see box below).

GLCs are being encouraged to move away from ad-hoc philanthropy, towards initiatives that are structured and linked to corporate strategy, leveraging their organisational strengths. GLCs are also expected to measure the impact of their work.

Khazanah, together with the Malaysian Securities Commission and the stock exchange, Bursa Malaysia, is a founding adviser to Malaysia’s Institute of Corporate Responsibility (ICR Malaysia). Its chairman Johan Raslan, who is also PwC Malaysia executive chairman, told World Watch: ‘The Silver Book is an excellent and practical guide for any company globally looking to design and implement a corporate responsibility strategy that concentrates on building capacity for a sustainable future.’

SUSTAINABILITY ASSOCIATION

New chairman to tackle sustainable developmentThe World Business Council for Sustainable Development (WBCSD) has appointed Sam DiPiazza, PwC global CEO, as its next chairman. Mr DiPiazza took over from the previous chairman, Travis Engen of Alcan, on 1 January 2008 for the next two years.

The World Business Council for Sustainable Development is a CEO-led, global association of some 200 companies dealing exclusively with business and sustainable development.

‘I’m honoured that I have been selected to lead the WBCSD at a time when the critical issues of sustainable development, climate change and the environment are at the forefront of the business and social agenda,’ Mr DiPiazza said. ‘I believe businesses must act responsibly as global citizens and play a lead role in building a more sustainable world. The WBCSD is the best organisation to help business achieve this.’

Mr DiPiazza believes that leading global companies of the future will be those that provide continually improving goods and services and reach new customers in ways that address the world’s major challenges.

three steps to strategic corporate responsibility1. Corporate Philanthropy

Ad-hoc or reactive contributions with very limited governance or guiding principles•

Traditional corporate contributions, often driven along religious lines•

Typically the corporate giving reflects the personal affiliations of the founder or chief executive•

No links to corporate strategy•

2. Corporate Social Responsibility

Corporate contributions are structured and linked to corporate strategy and leverage •organisational strengths

Companies focus on specific areas and develop programmes around key themes•

Personal affiliations are less marked•

Contributions policy or guiding principles set up•

Contribution spend is identified•

3. Strategic Corporate Responsibility

Economic sustainability

Organisations develop their triple-bottom-line reporting•

CR policy is fully aligned with core business and strategic mandate•

Social sustainability

Addresses the social concerns at a more strategic level and contributes to nation-building•

Provides platform for long-term or sustainable solutions to social issues•

Environmental sustainability

Minimises internal and external impact to environment•

Source: Khazanah Nasional Berhad. Visit www.khazanah.com.my for more information.


In contrast with other European countries, there are no mandatory rules for charities to report in Germany. So the Transparency Awards, organised by PwC in Germany, aim to distinguish charitable organisations that attain

high standards in voluntarily sharing information with their donors. This year the top three prizes were awarded to: Kindernothilfe, Médécins sans Frontières – Ärzte ohne Grenzen and CARE International Deutschland.

Transparency Award 2007

GLOBAL REPORTING INITIATIVE

Stepping in a more sustainable direction At present, over 1,000 companies are reporting under the Global Reporting Initiative (GRI) Sustainability Reporting Guidelines. And, according to the Interbrand and Business Week survey, four out of five of the top 15 Global Brands report on their economic, environment and social performance based on GRI. The top five – Coca-Cola, Microsoft, IBM, General Electric and Nokia – all follow the guidelines.

The Swedish government is ahead of the game in the public sector: from 2009, it will require all 55 state-owned companies to file an annual sustainability report based on the GRI G3 guidelines. Its aim is to improve the sustainability performance of state-owned enterprises, as well as to ensure the effective and transparent use of public funds. The Swedish government is the first government in the world to pioneer such reporting measures.

Missing the pointCompanies seem to be underplaying the risks posed to them by climate change, but are happy to report the opportunities, according to a GRI survey of sustainability reports. Two thirds of companies refer to new business opportunities – such as the development of energy-efficient consumer products, or the potential to set up carbon funds and engage in emissions brokering.

However, mentions of business risks are less frequent. Most commonly reported is the risk of increasing energy costs, noted by one fifth of companies. Very few report on risks of business disruption due to events such as floods, storms, droughts or forest fires.

‘For sustainability reporting to add the most value to stakeholders and to companies themselves, it is critical that it is not viewed as a tick-box compliance or PR exercise,’ said Klaas van den Berg, PwC sustainability leader in the Netherlands. ‘The best reporting in this area comes from those companies that clearly link their sustainability reporting with their strategic imperatives and key risks for the organisation.’

Linking climate change with performanceInvestment research and advisory firm Innovest has developed the Carbon Beta risk model to analyse companies’ net financial risk exposure from climate change against 1,500 companies worldwide. The analytical platform identifies and quantifies carbon risk exposures on a company-specific basis, as well as for the whole portfolio. The higher a company’s ‘carbon beta’ rating is, the greater its net exposure to climate risks.

Innovest’s research in this area claims to be the first to help investors to link climate change with financial performance. The report – Carbon Beta and Equity Performance, An Empirical Analysis: Moving from Disclosure to Performance – found that over the last three years, companies in high carbon-producing industries with climate-change risk-management already in place generally out-performed companies that lacked these policies.

For more details see www.innovestgroup.com

Demand for green credentialsCompanies wishing to join or remain within the FTSE4Good Index will soon have to demonstrate green credentials. The index, which encompasses companies demonstrating good standards of corporate responsibility, has introduced new eligibility criteria relating to climate change.

Companies already in the index must meet these criteria in full by certain deadlines – starting with 1 January 2008, when high-impact companies must comply with specified policy, governance and disclosure requirements, if they want to stay ‘4Good’.

Meanwhile, the Dow Jones Sustainability World Index (DJSI World), set up in 1999, captures the companies with the world’s best sustainability records. The index covers the top 10% of the world’s largest 2,500 companies, based on their long-term economic growth and their environmental/social records.

In India, credit rating agency Crisil, Standard & Poor’s, KLD Research & Analytics and the Confederation of Indian Industry are working on the Environmental, Social & Governance (ESG) index for India’s top 500 listed companies. It is expected to rate companies on: corporate governance, ownership structure, shareholder rights, transparency and disclosure, use of natural resources, response to climate change, labour rights, employee and customer relations, and corruption levels. It is expected to be launched in 2008.

Transport gets goingBoeing is planning to cut a quarter of the emissions from its fleet by 2020 through revised designs, including the use of lightweight materials and improved engines. The aeroplane maker is also working with General Electric and Virgin on a possible ‘biojet’ that would run on fuels derived from plants. On the ground, Land Rover is aiming to cut the average CO2 emissions of its vehicles by around 20% by 2012. Among a range of initiatives, the brand is expanding its diesel offering and developing a full hybrid car. And Nissan recently kicked off the Tokyo Motor Show with the Pivo 2 – a battery-powered, zero-emissions car.


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Lessons from CanadaCould a Canadian initiative to capture and store carbon dioxide be replicated around the world? The Integrated CO2 Network is a proposed system for the capture, transport and storage of CO2. It could cut the carbon impact of thermal energy plants, oil and gas facilities and cement, chemical and other industrial plants – or any large emitters of CO2. The idea is to capture CO2 at source, transport it via pipeline and then inject it into deep underground geological formations, such as saline aquifers or depleted natural gas and petroleum reservoirs, stopping it from diffusing into the environment. For more details see www.ico2n.com.

Greening the high streetIt seems that retail and consumer businesses are going green. Many have recently taken steps to introduce sustainable practices or encourage environmentally-friendly behaviour:

Casino, the French food store group •has launched an initiative to add additional information to packaging about recycling, the product’s CO2 content and the distance it has travelled to reach the shelf.

Monoprix (Galeries Lafayette Group) •has designed its ‘ideal store’ in terms of sustainability and will benchmark all its other stores against this. It has also organised river transport instead of trucks for part of its supply chain, thereby saving tons of CO2.

Marks & Spencer launched Plan A, a •£200m eco-initiative across the entire company. Plans include becoming carbon neutral by 2012, opening model ‘green’ stores and converting clothing ranges to 100% fairtrade cotton.

Green growthInvestor interest in green business has been recognised by the recent launch of a new tradable index tracking 300 companies worldwide that make money from fighting climate change. Since January 2004 the 300 companies included in the HSBC Global Climate Change Index have generated nearly twice the profits or returns of other world stocks.

2007 Building Public Trust Awards‘There is an argument that regulators’ attempts to enforce transparency, particularly in complex areas such as pensions and tax, can actually make reporting harder to understand,’ said John Coombe, chair of the judging panel of the 2007 Building Public Trust Awards. Despite this, the winners of this year’s awards were celebrating their triumph over the complexities of the reporting system in London’s Dorchester hotel recently.

And the winners of the BPT Awards for ‘telling it how it is’ were:

Reporting the measures of success – Severn Trent Reporting of executive remuneration – Lonmin Tax reporting – Vodafone Group Pensions reporting – Cookson Group FTSE 250 – Great Portland Estates FTSE 100 – The Capita Group Public sector – The Ministry of Defence

See www.bptawards.com for more.

Danish reporting awardsMeanwhile, in Denmark, the Børsen newspaper and the association of public accountants have held their own reporting awards. Here, reporting on broader issues such as sustainabilty is all part of an annual report. The awards therefore recognised the quality of both financial and non-financial reporting.

2007 Winners were: Annual reporting award – Danfoss Best for quoted companies – Danske Bank and Norden Special prize for transparency and stakeholder-oriented reporting – PwC (the first of the large firms in Denmark to report an ‘Operating Financial Review’) Best non-financial report – Novo Nordisk Best first timer – DONG Energy Best SME report – Ældre Sagen

CLIMATE CHANGE SUMMIT

Bali kick-starts negotiations The UN Climate Change Conference in Bali has kick-started negotiations that aim to finalise a new climate treaty in Copenhagen in December 2009. In particular, the Bali roadmap includes consideration of quantified targets by developed countries as well as mitigation actions by developing countries.

However, not everyone will consider that the summit did enough. Business does not yet have the clear and explicit framework it has lobbied for on measurement, reporting and compliance; nor does it have clear long-term targets.

There was a sense of urgency in the build up to the summit last year – not least because in mid-November 2007, the Intergovernmental Panel on Climate Change published its latest report, warning of ‘abrupt or irreversible’ impacts on the planet. The summit also comes at a critical juncture for the Kyoto Protocol, whose first commitment period ends in 2012.

Implications for businessBali provides a strong signal that there is significant momentum to address the climate change issue in both developed and developing countries. In the negotiations over the next two years, business will need to keep an eye on developments in the following key areas:

US climate policy• – will a change of Administration produce a shift in approach at the UN climate negotiations?

targets• – how stringent are the targets and which countries are taking them on?

Markets• – the Bali roadmap gives a good indication that emissions trading will be part of any subsequent climate treaty.

Sector-specific actions• – power generation and other energy intensive industries may face specific regulations or opportunities in countries that haven’t taken on reduction targets to date.

Forestry• – this sector will need to understand the nature of any incentives for reducing deforestation and forest degradation.

The real ‘success test’ will come in two years’ time when delegates sit down in Copenhagen to finalise a new treaty for the post-Kyoto period.


EMISSIONS

Not ready for take off Only a quarter of European aircraft operators have assessed the business impact of the European Union’s Emissions Trading Scheme (EU ETS) – despite half of them expecting it to have a major impact on their business costs.

The lack of preparedness was revealed in a report by PwC, Ready for take-off? The inclusion of aircraft operators in the EU Emissions Trading Scheme. It found that less than 10% of operators were active in trading carbon credits.

The initial reach of EU ETS was limited to the carbon emissions of stationary sources, but the European Commission now proposes to extend the scheme to target the CO2 emissions of aircraft. The EC takes a market-based approach to

carbon regulation, which expects companies either to cut their own emissions, trade them in the new European market or invest in emission reduction projects.

Aircraft operators need to treat their inclusion in the EU ETS as a strategic business issue rather than merely a matter of environmental compliance, the report advises.

‘We encourage operators to act immediately – to integrate carbon trading into long-term planning – if they are to meet the requirements of the scheme when it is adopted,’ said Hans Schoolderman, PwC director of the sustainability team in The Netherlands.

CLIMATE DISCLOSURE STANDARDS

Action on climate risk reportingA new international partnership is set to create a clear framework to help companies produce consistent and standardised climate risk reporting.

The Climate Disclosure Standards Board (CDSB), launched at the 2007 World Economic Forum in Davos, plans to encourage companies to disclose information in their annual reports on total emissions, assessments of the physical and regulatory risks of climate change and strategic analyses of climate risk and emissions management. The CDSB will provide ‘materials, information, advisory services and templates’ to assist reporting companies.

The board noted that the accounting community and regulators remain at an early stage of dialogue in establishing carbon-related financial accounting standards. It therefore plans to act as a channel for discussions among industrial, financial, accounting, government and other relevant communities to establish a generally accepted practice for climate-related disclosure in mainstream corporate reporting.

Founding members include the California Climate Action Registry, the Carbon Disclosure Project, Ceres, The Climate Group, International Emissions Trading Association, the World Economic Forum Global Greenhouse Gas Register and the World Resources Institute. PwC is a WEF member that contributes actively to the CDSB.

Richard Samans, managing director of the World Economic Forum, welcomed the CDSB’s formation: ‘Consistent and comprehensive disclosure frameworks for climate-related issues are important for our capital markets and should be included within the main corporate report, rather than be seen as something separate. The CDSB provides a focal point for development of climate reporting, acting to enhance consensus and maximise opportunities for harmonising different regimes. The board will help to consolidate best practices into a single, unified framework so that reporting entities and their stakeholders have much greater clarity and consistent information.’

STAKEHOLDER PANELS

Fresh eye on CSR reports Using a stakeholder panel – in addition to an assurance provider – can give a more complete picture of a company’s Corporate Social Responsibility (CSR) performance, according to a new survey by PwC.

The global survey of PwC clients found that stakeholder panels now play an important part in CSR reporting by enhancing credibility. While an assurance provider can comment on whether a company is ‘reporting things right’, the stakeholder panel can say whether the company is ‘reporting the right thing’.

Companies also believe that panels provide a useful link between strategy and business goals and stakeholders’ expectations. Independent auditors – as assurance providers – can support the panels’ opinions and provide expertise and training on standards.

‘Stakeholder panels are a promising new dimension in enhancing the credibility of sustainability reports,’ says Klaas van den Berg, PwC sustainability leader in the Netherlands. But to ensure a combined effort is effective, assurance providers and stakeholder panels must avoid confusing readers by mixing up their competences, Mr van den Berg warned. ‘Both are of great value for the legitimacy of sustainability reports.

A good definition of the scope of work and a conscientious use of definitions are the first conditions to avoid misunderstandings.’

Award winner

Nexen Energy’s annual sustainability report – which uses a stakeholder panel in its ‘dual assurance’ process – has been recognised by the Canadian Institute of Chartered Accountants.

Nexen’s report received the Award of Excellence in Sustainable Development for the way it ‘clearly reflects how the company has embedded sustainability principles into its business to create value’. As well as asking a multi-stakeholder group to review the narrative sections of the report, Nexen also asked PwC to review and provide assurance on the document’s performance indicators and quantitative information.

The dual assurance approach was noted by the judges, who commented that the ‘reporting of performance targets and benchmarks, as well as regulatory compliance, adds to the sense of transparency’.


OPINION

Recasting the reporting modelMarket awareness, a real understanding of stakeholder needs and expectations and a little plain speaking are far more important than high-handed regulation in the drive to improve the reporting framework, argues David PhillipsObjective and relevant information on corporate activity is essential to sustain and grow healthy capital markets and the societies in which they operate. As societies’ expectations increase, companies are required to provide clearer information on a wider range of business activities. But today’s reporting model is too financially-orientated, too technically complex, omits many critical aspects of business information and is subject to multiple regulatory requirements that are globally inconsistent.

However, recasting a new model will not be achieved by prescriptive regulation, which, at best, could diminish its critical value as a dynamic catalyst of change, and, at worst, could act as a drag on economic performance and competitiveness through the creation of a ‘compliance malaise’.

Cohesion, communication and complianceSuccessful companies recognise that transparency is a critical element of what’s expected – a part of their ‘licence to operate’. However, the current reporting model has evolved in a piecemeal way and does not provide a logical, cohesive framework for communication that is relevant to the 21st century. Currently, companies’ reporting is dominated by financial outputs and is too often seen as regulatory compliance. While some companies use it effectively to communicate all corporate activity, the majority do not properly explain their strategy, what drives value and what are the critical key performance indicators for understanding their business and its success.

A new blueprintPolicymakers have a critical role to play in sponsoring the creation of a new market-driven blueprint for reporting, one

that is designed to harness market forces and so stimulate a healthy and vibrant business environment. Furthermore, the creation of a new blueprint for a more holistic reporting framework could facilitate a ‘lighter touch’ by governments, reducing the need for prescriptive regulation by leveraging the natural checks and balances that exist in a transparent market – through interventions by stakeholders, public-interest organisations and the media.

Critically, the current financial reporting model will need to be recast to remove some elements of its current complexity. To achieve this, the relative value of information, the costs of preparation and the demands of investors all need to be considered. This may prove difficult, but it is fundamental to the success of reframing the whole model.

Economic and social development in the 21st century demands a new blueprint for reporting with which policy makers, standard setters and key stakeholders can engage. Piecemeal regulations superimposed on the current reporting model will not make the grade. It is in the interests of the G8 finance ministers, the World Bank and the IMF, to jointly sponsor the development of a market-driven initiative to create a global blueprint for improved corporate reporting, ensuring that market mechanisms are harnessed to continually enhance its value.

David Phillips is senior corporate reporting partner at PricewaterhouseCoopers. See his corporate reporting blog at pwc.blogs.com/corporatereporting

A new set of parameters needs to be established, including:

User-centric focus

A real understanding of investors’ and other key stakeholders’ needs should drive the reporting framework, reflecting the relevance and reliability of information, how it is used to assess performance and governance, and the cost/benefit of its preparation and audit.

Principles-based reporting

This is critical to the scope and quality of information communicated around economic, environmental and social performance. This approach requires a sound conceptual framework – recognising the value derived from industry and company-specific information. By avoiding a rigid rulebook, the risk of boiler-plate compliance, which can undermine information value, will be reduced.

Ease of preparation, understandability and access

External reporting should flow from relevant internal management information, with minimum reconfiguration. Subject to minimal rules and exceptions, reporting principles should be simple to apply, and transparent disclosures should be written in plain language.

Integration of financial, contextual and non-financial information

The information-set being demanded of companies is much broader than that historically provided by regulation. Financial information is only part of the performance picture with a built-in bias towards recording short-term results. More emphasis is needed on longer-term value creation with information hardwired into the reporting model on strategy, markets, executive remuneration, customers, innovation, people and environmental impacts.

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News & Opinion

GovernanceFRAUD

The many-headed HydraCompanies are losing money hand-over-fist to white collar criminals, through accounting fraud, asset misappropriation, money laundering or plain old bribery and corruption.

The latest PwC Global economic crime survey reveals that there has been no let up in so-called economic crime since 2005, with 43% of companies surveyed admitting to being victims. And the scale of the losses has soared in that period, rising from an average of $1.7m to $2.4m today. That represents a $4.2bn total loss just for the 5,400 companies that took part in the survey.

But financial losses are just the tip of the iceberg. Of those who’d suffered fraud, 88% said their brand had also taken a hammering, as had staff morale. Fraud also damaged relations with regulators, other companies and, in over two thirds of cases, had taken the share price down as well. Interestingly, those companies that went public – reporting crimes to the

authorities – did not suffer significantly more collateral damage than those keeping it under wraps.

Fraud seems to be intractable, or, as PwC’s global investigator Steven Skalak puts it, rather like ‘the mythical Hydra’. Cutting off one form of fraud, he says, only allows others to grow. Despite this, companies remain confident in the ability of their control measures to combat fraud. In the UK for example, where 48% of companies reported that they had suffered fraud in the last two years, only 17% thought they were ‘very’ or even ‘quite’ likely to suffer it in the future.

Generally, catching fraudsters appears to be largely a matter of luck. The most common means of detection – accident or chance – account for 41% of cases,

which is an increase on 2005. Meanwhile the effectiveness of whistleblowing schemes is increasing – they now detect 8% of reported frauds. This represents a threefold improvement in two years. And although companies with more controls in place were more likely to detect fraud, those that backed up compliance regimes with ethical guidelines were less likely to be victims.

‘Companies need to support their controls with a culture of clear ethical guidelines – one that builds loyalty and identifies sanctions for fraudsters regardless of their position in the company,’ said Mr Skalak. Indeed, seniority seems to be no barrier to fraud – half of the fraudsters identified were employed by the company and over a quarter were in senior management.

Fraud actually reported in E7 countries

The so-called Emerging Seven (E7) – Brazil, China, India, Indonesia, Mexico, Russia and Turkey – accounted for 45% of the $4.2bn losses reported in the survey.

Asset misappropriation Accounting fraud Corruption & bribery Money laundering IP Infringement

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NORTH AMERICA

Who’s taking over the reins?In Canada, more than half of all executives (54%) have no plans for the future ownership of their businesses, according to PwC survey Business Insights Pulse.

In PwC’s experience, owners often delay making difficult succession decisions because they are too caught up in the day-to-day running of their businesses. However, many exit options exist. The top three choices, according to the survey, were: selling the business to employees or externally; taking a stock

listing; or passing it on to a family member. And the top reasons for transferring ownership are retirement, death or illness of a primary shareholder, or competitive pressures.

CEOs at the fastest-growing companies in the US were similarly unprepared. PwC research found that of those CEOs planning to step down during the next five years, only 22% had given succession planning a lot of thought, and 19% had not thought about their successor at all.

FRAUD

What can I do?Recent crime statistics (see opposite) make it clear that sitting on the fence is not an option for non-executive directors (NEDs) when it comes to fraud – especially when a significant proportion of offenders are senior managers.

New regulations extending directors’ responsibilities and liabilities, such as those seen in recent changes to the Companies Act in the UK, are making the ‘do nothing’ approach increasingly difficult anyway.

There is often a lack of clarity among executives and non-executives about their responsibilities for preventing and responding to reports of fraud, according to PwC. Many board members admit they are uncertain about their ability to influence events positively if the whistle is blown.

‘Most fraud in the UK goes unreported as businesses seek to settle matters away from the public eye, or it goes undetected because processes and controls are just too weak,’ said Sean Holohan, director of Protiviti, internal audit consultants.

‘NEDs must show their value in this area by leading from the front,’ PwC’s Andrew Gordon added. ‘It is the tone at the top that often determines the fate of the entire organisation. CEOs who set anything other than an impeccable standard will, inevitably, see their companies overtaken by other forms of malpractice at more junior levels.’

Action to consider in a crisis:Conduct a swift internal investigation. •It allows the company to maintain some control over the scope of any action and may limit disruption associated with an investigation by the authorities.

Action to prevent a crisis:Work to ensure that the organisation’s •values are ‘lived’ by all employees and go beyond the company handbook that is dished out to new joiners.

Practices may vary across cultures, so •aligning values and practices internationally can be well worth the effort.

For copies of Crisis to Strategy, email: [email protected]

CEO SUCCESSION

Gone but not forgotten

Leaders would like to be remembered for developing their people more than anything else, a new report reveals. But the emergence of a generation of employees with new aspirations requires a fresh approach to talent management.

The People Agenda: Optimising Performance at the Front Line reveals that the number one legacy most CEOs hope to leave to their organisation is the ability to develop the required talents and skills of their people through training and creating a great working environment. Long-term financial success and market/industry domination rank only third and fourth respectively.

But despite these worthy ambitions, the report reveals that managing a workforce can be a Herculean task.

‘A new generation of individuals – which some have characterised as the millennials – are emerging that have different aspirations and expectations from the organisations that they want to work for. Taken together, these factors mean that a new approach to talent is needed,’ the report concluded. It’s only by creating precisely the right incentive model, correctly managing top performers on international assignment and understanding the financial value of talent that retention rates can be maximised.

Measuring the success of people policies can also be a minefield: ‘…a company of 20,000-plus employees is likely to have a minimum of 50 sources of data that relates to people and performance,’ says the report. And not only that: ‘Measurement capabilities need to be real time or close to it. At the very least, businesses need to be using people data that is less than 30 days old.’

When over 1,000 CEOs were asked what one thing they would want to stand as their legacy, their top five responses were:

1. Employee development (eg, talent and skills in the business, staff education, creation of a great working environment)

2. Social and ethical goals

3. Long-term financial success

4. Market/industry domination

5. Maintaining/defending current position

See more at www.pwc.com/peopleagenda

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INTERNAL CONTROLS

Guidance to balance SOX requirementsThe Public Company Accounting Oversight Board (PCAOB) has issued AS5 – new guidelines for auditors testing a company’s internal controls. The move represents another attempt by the US accounting watchdog to reduce the most burdensome elements of Sarbox while still helping to prevent material misstatements.

‘The internal control reporting requirements of the Sarbanes Oxley Act are a key reason why the reliability and accuracy of financial reporting has improved over the past few years,’ says PCAOB chairman Mark Olson. ‘The renewed confidence in financial reporting is critical for the health of our markets. The new standard is more risk-based and scalable, which will better meet the needs of investors, public companies and auditors alike.’

PCAOB chief auditor and director of professional standards Tom Ray is equally enthusiastic: ‘The new auditing

standard, by focusing the auditor’s attention on those matters that are most important to effective internal control, presents another significant opportunity to strengthen the financial reporting process.’

The PCAOB is continuing to develop tailored guidance for applying the new standard for auditors of smaller public companies.

BETTER BOARDS

Direction for directorsDirectors’ work is never done. They now face greater liability, increasingly difficult questions from investors and have become, more than ever before, the last line of defence against corporate wrongdoing.

In light of this, a new report – Building blocks of effective corporate boards – serves to point directors in the right direction. ‘Executive leaders truly committed to running organisations of high integrity understand that a pro-active board management relationship is vital for setting a tone at the top that fosters an ethical working culture,’ the PwC report says. The report gives some guidance on how this can be achieved in the following key areas:

Eight building blocks to better boards

Create an open and engaging •boardroom atmosphere

Maximise the value of the board’s time •commitment by establishing clear roles and responsibilities within an appropriate structure

Determine the information the board •needs and ensure it is delivered on a timely basis

Dedicate time to strategic issues•

Create a transparent, explicit and •accountable executive pay process

Actively engage in the CEO •succession process

Access the strength of the company’s •management talent

Monitor the company’s enterprise risk •management system

See www.globalbestpractices.com for more information.

SECTION 404

Cutting out the excessUK-based foreign private issuers (FPIs) claim to be enjoying business benefits from their first year’s compliance with Section 404, but believe there’s considerable room for improvement, according to a new survey.

More than three-quarters of those surveyed stated that they identified excessive controls within their organisation, and 91% think there are opportunities to automate processes and controls further, with a view to reducing time and cost.

The survey found that respondents were generally upbeat. They reported a considerable increase in levels of financial control awareness within their organisations and identified wider benefits to the business such as specific process and control improvements.

The survey, One year on – evaluating experiences with Sarbanes-Oxley, polled the views of Sarbanes-Oxley project leaders from 22 FPIs registered with the

SEC. The sample represents 35% of the entire UK FPI community.

Positive but costly

A risk-based approach to internal controls is a ‘positive step’ to creating a strong auditing profession, according to US Treasury secretary Henry Paulson. In a recent letter to the Financial Times, Paulson admitted that the implementation of internal controls in the light of Section 404 of Sarbox had ‘proven more costly and burdensome than originally anticipated.’

Textbook regulationSarbanes Oxley certainly has its supporters. One such is retired Goldman Sachs partner Thomas Healey. In a recent Wall Street Journal article he wrote:

‘The last five years have made it irrefutably clear. Sarbanes-Oxley (Sarbox) is a textbook case of how regulation should ideally work in a democracy: A scandal is addressed through strong legislative reaction, followed by fine-tuning by relevant agencies (in this case, the SEC and the Public Company Accounting Oversight Board).

‘Is it any wonder that variations of Sarbox and its rigorous internal controls are being adopted in Japan, France, China, Canada and other countries around the world?’


EUROPEAN COMMISSION

Measuring up on directors’ pay

The European Commission has published a progress report on the director’s pay recommendations it made a few years ago that called for improved pay disclosures and greater involvement of shareholders in remuneration decisions.

The Commission says that pay disclosure is now widespread, but reluctance to involve shareholders fully in remuneration policy decisions remains. Commissioner Charlie McCreevy reported that only a third of member states have recommended that shareholders have more say. Only two member states have remuneration

policies that are subject to a separate shareholder vote.

A large majority of member states have high disclosure standards on the remuneration of individual executives, but fewer have met the guidance to disclose remuneration policy. Furthermore, only a few countries have recommended that shareholders vote on the remuneration criteria for the board, though most have recommended or imposed shareholder approval for share-based incentive schemes, which the Commission sees as a positive way of managing the inherent risks of such schemes.

INDEPENDENCE

EC poised for action The European Commission has looked into the EU’s progress on the independence of non-executive directors on listed company boards and is now considering whether to take further action. The Commission has said it will work with the European Corporate Governance Forum to closely monitor market developments before deciding exactly what it needs to do.

A key measure in its official recommendation was the separation of the roles of the chief executive and the board chairman. But there is still room

for improvement on this point, according to commissioner Charlie McCreevy. It’s his view that too many CEOs are still being appointed as non-executive chairmen without any cooling off period.

The July report found that member states, for the most part, have introduced the principles of the recommendation into their national corporate governance codes. However, it seems that some member states do not have a sufficient number of independent non-executive directors on remuneration and audit committees.

COMBINED CODE

Making room for entrepreneurial successFollowing a review of the Combined Code on Corporate Governance to assess its facilitation of entrepreneurial success and risk management, the Financial Reporting Council (FRC) is consulting on two proposed amendments covering:

Removal of the restriction on an •individual chairing more than one FTSE 100 company; and

Permitting a chairman of a smaller •listed company to be a member of the audit committee, where he or she was considered independent on appointment.

Consultations are beginning as World Watch goes to press and, if agreed, a revised Code will come into effect in June 2008.

The scope of the review was determined after a series of meetings between the FRC and company chairmen and institutional investors. This led to a public consultation exercise inviting views on any aspect of the implementation of the code, but focusing on:

Does the Code support better board •performance over time?

Is the ‘comply or explain’ approach •working effectively?

What impact has the Code had on •smaller companies?

Do disclosures on the Combined •Code in annual reports provide useful information to shareholders at proportionate cost to companies?

The review found that the Combined Code continues to have a broadly

beneficial impact. In its comment letter on the code, the Association of British Insurers wrote: ‘The operation of the Code has been a powerful spur to increased professionalism of boards and to ensuring that the unitary board system works well in a practical way that is consistent with its objectives.’

While the ‘comply or explain’ approach is working reasonably well, the review found that the day-to-day operation is causing a good deal of frustration. Investors and other observers still perceive that there is considerable scope for improvement in the overall quality of disclosure by companies. In addition, there is little support for smaller companies to be allowed certain exemptions from the full Code.

McCreevy: shareholders need more say

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NETHERLANDS

NVP code of conduct The Dutch private equity and venture capital association (NVP) has issued a revised code of conduct to provide more insight into its members’ operating methods.

Recent public and private debates have shown that there is discontent about the limited transparency private equity firms provide to the public and the media, and demonstrate that there is little understanding of how private equity firms consider other parties’ interests.

The code’s basic premise is that NVP members adhere to the applicable laws and directives. The code includes transparency guidelines and recommends that its members follow the European Venture Capital Association’s guidelines on corporate governance, valuation and reporting. Finally, the code recommends that directly-involved parties (such as shareholders, investors and management) reach specially-adapted reciprocal agreements in certain areas and, where necessary for sound management, puts these agreements into formal contracts.

‘The private equity sector is increasingly aware that as their portfolio of companies grows and they play an ever-greater role in the fortunes of the Dutch economy, so the sector’s social responsibilities increase,’ PwC’s Martijn van den Berg told World Watch.

The Board of the NVP has adopted the revised code for a trial period of one year.

NETHERLANDS

Shareholder action gets attention the 2003 Dutch Corporate Governance Code is still thought to be meeting its primary objectives – to build trust and confidence in Dutch businesses. However, the increasing levels of shareholder activity – including a few disputes about company strategy between management and shareholders – have attracted the attention of the Code’s Monitoring Committee and prompted new proposals to balance the various interests involved.

The Monitoring Committee, set up by the Ministry of Finance to monitor the operation of the Code and its implementation by listed companies and shareholders, brought several issues to the Government’s attention in its 2007 annual report that it believes are not sufficiently dealt with in the original Code.

Although the Committee does not suggest that there is any reason to fundamentally change the governance system, it has recommended further rules to regulate the company/shareholder relationship and ensure that the best possible balance is struck between the various interests – the management board, the supervisory board and shareholders.

The most significant proposals cover:

Response times for management •to notify shareholders of important governance issues, such as changes of management or strategy (generally 180 days)

Disclosure of change-of-control •clauses in contracts with (prospective) management board members

Shareholders’ duties to disclose their •interests. Proposals recommend that the current 5% threshold for disclosure of interests should be reduced to 3%, and there should also be a duty to report every change of 1%

The threshold for having a right to put •items on the agenda should be raised from 1% to 3% (in line with the disclosure threshold)

The Monitoring Committee has also stressed the importance for Dutch companies of sustaining their attractiveness to investors, particularly foreign investors, while avoiding falling prey to short-term investment strategies in the financial markets. But it warns that increasing use of (structural) anti-takeover measures is not an adequate way to achieve this objective.

EUROPEAN UNION

Transparency Directive Listed companies required to implement the EU’s new Transparency Directive rules on periodic reporting requirements can refer to guidance in a short publication issued by PwC. It addresses key issues such as:

Reporting deadlines•

Quarterly reporting requirements•

How directors can address the •requirements to provide ‘responsibility statements’

Content of a typical quarterly report•

The content of the narrative report •accompanying the half-yearly financial statements.

The EU Transparency Directive is available on www.pwc.com/ifrs

The EU Transparency Directive July 2007

Periodic reporting requirements


AUDIT COMMITTEES

The best and worst The recent survey of FTSE 350 audit committees looks at the best and the worst elements of their behaviours and operations. The report is based on PwC audit partners’ experiences of interacting with audit committees of FTSE 350 companies over the past year.

A lack of detailed knowledge of technical accounting matters, the prevalence of a tick-box attitude on compliance matters and avalanches of briefing papers are just some of the factors conspiring to hinder their effectiveness. It’s not all bad news: the

number and behaviour of the members, their challenging interactions with management and auditors, well-run meetings and robust agendas are all picked out for plaudits. The survey throws up some surprising results, though: the quality of the chairman crops up in both best and worst camps, as does the degree of engagement and enthusiasm of committee members.

For more information on this and two further surveys on internal control reporting and board performance email [email protected]

RISK

Fear of unnatural disasterForget payouts for flash flooding and hurricanes of ever-increasing intensity – the global insurance community is more frightened of regulatory overkill than anything Mother Nature can throw at it.

More than 100 respondents to a Centre for the Study of Financial Innovation (CSFI) survey said that excessive regulation is endangering the insurance industry by loading companies with costs, distracting management and creating barriers to competition and innovation. The problem is particularly acute in North America, Europe, South Africa and Asia Pacific.

Only then did other high-level risks such as natural catastrophes, climate change and management quality enter the consciousness of the sector. These, combined with other risks such as growing human longevity and the soundness of assumptions used to price life policies, raise concerns about the profitability of the industry as a whole.

Some risks are receding, however. Asbestos was once the scourge of the industry, but insurers now feel they’ve finally got to grips with this particular risk.

Insurance banana skins 2007 What insurers said were the highest risks

1 Too much regulation

2 Natural catastrophes

3 Management quality

4 Climate change

5 Managing the cycle

6 Distribution channels

7 Long tail liabilities

8 Actuarial assumptions

9 Longevity assumptions

10 New types of competitors

…

32 Too little regulation

33 Asbestos

See www.pwc.com/csfi

RISK

Value for money?Almost a quarter of financial services companies were found to have increased spending on risk management by over 25% annually for the past three years, according to a study by the Economic Intelligence Unit and PwC. But despite this investment in managing risk, they did not seem confident about the value this is adding to their businesses.

‘Much of the investment has been focused on meeting regulatory requirements,’ said PwC partner Mark Train. ‘This has helped companies manage their capital better, but has meant that some companies are too

focused on the regulatory agenda and have perhaps taken their eye off the strategic risk management issues.’

Only 46% of respondents said there was a structured assessment of risk around strategy development. 66% of risk managers thought that more value could be added to risk management if it was seen as a strategic function.

‘Looking ahead, you can expect risk management to be a more integrated function,’ Mr Train predicted. ‘People will know much more about it, regardless of what part of the organisation they are in.’

RISK

Where’s your IT savvy?Ill-planned IT projects can be more than slightly inconvenient. But despite high-profile failures – and even though IT risks now feature higher on the corporate agenda than ever before – company boards still lack real understanding of what’s at stake.

This worrying news, unearthed by a recent survey performed for the UK Institute of Internal Auditors, showed that more than two thirds of heads of internal audit believe boards do not understand the risk they face in this area. Nearly half of this group – as well as a third of senior

management – feel that IT professionals lack the ability to communicate IT risk and its potential business impact in a way that a board can understand.

See IT risk – Closing the gap www.pwc.com/risksurvey

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News & Opinion

AssuranceiNtERNAtioNAl StANDARDS oN AUDitiNG

Auditor choice: prepared to invest?

In the UK, the Financial Reporting Council’s (FRC) Market Participants Group (MPG) published recommendations that it hopes will contribute to increased auditor choice ‘while at least maintaining audit quality’. However, it accepted the ‘strong preference among stakeholders for market-led solutions’, prompting some critics to bemoan a slow pace of change.

The MPG – among its other recommendations – suggested that the FRC should explore the possibilities of changes to audit ownership rules. This could open audit firms up to external investors and enable smaller firms to raise capital for expansion more readily.

Other recommendations include requiring firms to disclose the financial results of their work on statutory audits and directly related services ‘on a comparable basis’, and encouraging more transparency surrounding auditor choice.

The European Commission’s Internal Market Directorate published a similar report shortly after and was even more explicit about changes to ownership rules. Its key conclusions argued that ‘…an audit firm owned by external investors, instead of auditors, might take more easily the decision to expand into the market of large audits. One of the reasons is that existing ownership structures are estimated to increase audit firms’

cost of raising capital by perhaps as much as 10%.’

The issue is also receiving high-profile attention in the US. The US Treasury has asked former Securities and Exchange Commission (SEC) chairman Arthur Levitt and former SEC chief accountant Donald Nicolaisen to serve as co-chairs of a non-partisan committee to address auditing industry ‘concentration’, among other things. Given US Treasury secretary Henry Paulson’s recent letter to the Financial Times in which he noted there are ‘legitimate questions about the sustainability of the auditing profession’s business model’, we can expect more of the same when findings are published during 2008.

Questions relating to auditor choice are a concern to company management teams as well as the audit profession – they are being examined in the UK and Europe, as well as in the US. But it looks likely that it will be up to the free market to initiate change.


The International Auditing and Accounting Standards Board (IAASB) has approved the much debated group audit standard – ISA 600 (Redrafted and Revised), Special Considerations – Audits of Group Financial Statements (Including the Work of Component Auditors).

The new ISA is broadly seen to ‘raise the bar’ and will have an impact on how group audits are planned and conducted in practice. The ISA is based on the premise that the group auditor bears the full responsibility for the audit report of the consolidated accounts. This is consistent with the EU 8th Directive’s requirements.

It defines the work and involvement deemed necessary to fulfil that responsibility. While still allowing for judgement, it is more prescriptive about the work required in relation to: the evaluation of component auditors; the design of the audit strategy and plan; and the group auditor’s involvement in the work of component auditors. This is very consistent with the March 2006 exposure draft.

The Public Interest Oversight Board endorsed the new ISA in September, as it was satisfied that the IAASB had followed due process. The new ISA will not become effective until 2010 audits, along with the Clarity ISAs.

INTERNATIONAL AUDITING AND ACCOUNTING STANDARDS BOARD

Clarity on scheduleIn its July, September and December meetings, the IAASB approved a total of 18 Exposure Drafts. Clarity redrafts have now been issued for comment for all extant ISAs, and 11 ISAs in Clarity format have already been finalised – this bodes well for the IAASB being able to meet its objective of completing the Clarity project by the end of 2008.

In July, the IAASB approved nine exposure drafts including those on: reporting; quality control (ISA 220 and ISQC 1); initial audit engagements (ISA 510); and sampling (ISA 530). The comment periods have now closed. All of these are Clarity redrafts and, for the most part, non-controversial.

In September, the IAASB approved exposure drafts of two revisions, which may prove more controversial: ISA 620, Using the Work of an Auditor’s Expert, and ISA 505, External Confirmations.

‘It is well worth having a look at these and sending comments to the IAASB before the deadline on 15 February,’ said Diana Hillier, PwC partner for global assurance standards.

In December, the board approved four more Clarity redrafts on: terms of engagement (ISA 210); specific items (ISA 510); analytical procedures (ISA 520); and comparative information (ISA 710).

The board also approved a proposed new ISA on communicating deficiencies in internal control, which clarifies auditors’ responsibilities for communicating to management and those charged with governance deficiencies identified in the course of the audit.

Finally, the board approved a proposed revision to ISA 402 on audit considerations when an entity uses a third party service organisation, as well as a companion Assurance Standard on reporting on controls at a third party service organisation. Until now, the US SAS 70 has been used broadly for such reports, so this proposed ISAE 3402 will be of particular interest.

The IAASB also confirmed last year that the effective date for all of the ISAs in Clarity format will be for audits of financial information for periods beginning on or after 15 December 2009.

INTERNATIONAL STANDARDS ON AUDITING

Group audit ISA will affect the audit

ISA 700

When IFRS is not quite IFRSCompanies in many countries are required to comply with a reporting framework described by reference to IFRS (eg, IFRS as adopted in the EU), so there is significant interest in both the IAASB’s and IASB’s activities on when IFRS is not quite IFRS.

The ISA 700 exposure draft (ED), for example, includes guidance on what auditors need to consider when the entity’s financial reporting framework is described by reference to IFRS, but is not in full compliance with IFRS. The IAASB, the IASB, the International Organisation of Securities Commissions (IOSCO) and others have been discussing how to address this issue in the best interests of the capital markets.

In October, the IASB released for comment, as part of its annual IFRS improvements ED, a proposed revision to IAS 1 that will require qualitative disclosures where the framework used is described by reference to IFRS, but the entity does not make an unreserved statement of compliance with ‘IFRS as issued by the IASB’.

The ISA 700 ED, The Independent Auditor’s Report on General Purpose Financial Statements, proposes new guidance for auditors based on the IASB’s proposed requirements. The auditor’s concern is that a user may be misled into thinking that the financial statements comply with IFRSs when they don’t.

The ED also gives guidance where an entity refers to compliance with two financial reporting frameworks, such as IFRS as adopted in the EU and IFRS as issued by the IASB. This is significant in the light of the SEC decision to remove the US GAAP reconciliation for entities complying with IFRS as issued by the IASB.

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The wording of the auditor’s opinion was one of the controversial issues in finalising ISA 805, Engagements to Report on Summary Financial Statements.

In the extant ISA 800, the auditor’s conclusion on summary financial statements is about their consistency with the audited financial statements.

The proposed opinion is that the summary financial statements are a fair summary of the audited financial statements in accordance with the applied criteria. Where criteria for preparing the summary financial statements do not exist in law,

regulation or a financial reporting framework, management would be expected to develop and apply their own criteria and include a description of them in the summary financial statements.

The auditor’s role here is not to ‘audit’ the summary financial statements, per se, but to apply procedures to ensure they agree with or can be recalculated from the financial statements. The auditor needs to be satisfied that the summary does not distort the financial information, but many auditors believe it is a stretch to conclude on the ‘fairness’ of that summarisation.

ISA 620

Will current draft add to audit cost? There were some concerns that earlier drafts of the revision to ISA 620, Using the Work of an Auditor’s Experts, would add unnecessarily to audit costs. Certainly the revisions garnered much debate within the International Accounting and Auditing Standards Board (IAASB). But there is now some optimism that the current draft will be more widely acceptable and, if implemented pragmatically, will contribute to audit quality.

The ISA discusses when the use of an expert’s work is necessary and how to determine whether that work is adequate for the purposes of the audit. It covers a broad range of circumstances, including both experts within an audit firm and external experts engaged for the purposes of a particular audit.

The challenge for the IAASB has been to craft requirements that will bring necessary expertise to bear in an audit without imposing unnecessary process across that broad range of circumstances.

the comment period for the ED ends on 15 February 2008.

The International Accounting and Auditing Standards Board (IAASB) approved its draft strategic plan at its September meeting and is now considering public comments on the draft. This follows two forums that have already sought stakeholders’ views on what the strategy and priorities should be.

The board will work to promote acceptance of ISAs as an appropriate benchmark of audit quality by the world’s capital markets, and to facilitate the implementation of ISAs to the extent possible and consistent with the role of an international standard setter.

The future strategy of the IAASB focuses on:

Contributing to the effective operation •of the world’s capital markets;

Assisting with the implementation of •standards; and

Addressing the needs of SMEs.•

The IAASB intends to develop assurance standards for those services most relevant to the world’s capital markets. It also plans to make the case for the acceptance of ISAs by market regulators for use in cross-border offerings and the continuing reporting obligations of foreign issuers.

The IAASB recognises that the effective implementation of standards is as important as their development, and that it has an important role to play in addressing the practical implementation challenges experienced by those that have adopted, or are adopting, ISAs (either as written or locally adapted). These challenges, however, require a joint effort by the IAASB, other IFAC boards and committees, IFAC member bodies, regional professional accountancy organisations, the Forum of Firms, national standard setters, regulators and development agencies.

The IAASB intends to contribute to this joint effort in several ways. First, it will provide auditors and national standard setters (and other adopting authorities) with a period of at least two years when no new auditing standards will become effective. This will start after the effective date of the redrafted ‘Clarity project’ ISAs, which means for audits of financial statements for periods beginning on or after 15 December 2009.

Second, the board will develop a process for assessing the effectiveness of the implementation of new standards, to determine whether further refinement is needed to achieve the intended objectives. Third, it will consider how else it can facilitate the implementation of its standards, particularly for the audit of SMEs.

ISA 805

What’s your opinion on summaries?

IAASB

Strategic review gets green light


REGULATORS

New chairman steers IFIAR towards greater knowledge sharingThe International Forum of Independent Audit Regulators (IFIAR) has strengthened its ranks with two senior appointments, a year after its formation. Paul Boyle, chief executive officer of the UK Financial Reporting Council (FRC), has been named chairman and Professor Dr Steven Maijoor, managing director of the Netherlands Authority for the Financial Markets, is the new vice-chairman.

They will help IFIAR to meet its objectives of sharing knowledge and expertise in audit regulation on a global scale. Its aim is to promote greater collaboration on regulatory activity.

This was evident at IFIAR’s latest meeting in Toronto in September, where members discussed the impact of current market turbulence. They agreed to look further into the possible implications for audit regulators.

Audit quality also remains a hot topic. Recent discussions have focused on what drives this, drawing on a recent report Promoting audit quality, published by the FRC. IFIAR is considering how the audit inspection process can best maintain and enhance audit quality. At workshops held recently in Amsterdam, members discussed audit inspection techniques and shared practical experiences. A second series of audit quality workshops is set for Berlin in early 2008.

IFIAR was established in September 2006 by a group of 18 independent audit regulatory organisations from across the globe. Commenting on its formation, FRC chairman Sir Christopher Hogg said: ‘Given the international character of both corporate reporting and the audit industry, the creation of IFIAR will contribute to the FRC’s ability to fulfil its own responsibilities within the UK.’

IFIAR meetings are attended by invited observers as well as members. These include representatives from the US Public Company Accounting Oversight Board, the Financial Stability Forum, the World Bank and the European Commission.

IFIAR is set to meet next in Oslo in April 2008, where a taskforce will report on recommendations for its future direction, organisation, resourcing and governance.

The Financial Reporting Council (FRC) in the UK has established an independent working group to draw up guidance on the use of agreements to limit the liability of auditors of public companies. Like auditor choice, the issue remains a hot topic in the UK and elsewhere.

The guidance is aimed at auditors who, under the Companies Act 2006, are able to negotiate with companies

to limit their liabilities by contract to an amount ‘that is fair and reasonable in all the circumstances’.

The group’s draft guidance for consultation – due as World Watch goes to press – will address the form such agreements will take and the process by which they will be agreed. However, they will fall short of defining what ‘fair and reasonable’ actually is.

‘We agreed to [prepare guidance] only if the proposal was also acceptable to the corporate and investment communities, and that remains the basis on which we will proceed,’ said FRC chief executive Paul Boyle. ‘The FRC will only give its endorsement to guidance that enjoys broad support from all market participants.’

In Europe, commissioner Charlie McCreevy made plain in a speech to the Congress of German Public Auditors in November that auditor liability is an issue that he would like to see resolved in the near future. ‘In Germany,

a cap on liability has existed since 1931 and nobody in Germany seems to feel that this undermines audit quality,’ he said. ‘In Europe we are still debating on this question.’

In June, the European Commission published its summary of replies to a public consultation on auditors’ liabilities. All audit professionals who responded called for EC regulation on the matter, whereas other respondents were divided. Nor did the results indicate any clear preference for a particular method of limiting liabilities. However, the EC remains keen. Its recent study on ownership rules for audit firms listed liability risk as a potential barrier to growth for small firms.

For its part, the US has commissioned a non-partisan committee (see also auditor choice article on page 30) to examine sustainability of the audit profession’s business model. Its findings, due early in 2008, are expected to pave the way for a more financially sound US profession.

AUDITOR CHOICE

Unlimited liability on its last legs?

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INTERNATIONAL STANDARDS ON AUDITING

100 not outOver 100 countries have adopted or are in the process of adopting International Standards on Auditing (ISAs) and incorporating them into their national auditing standards. This is a significant milestone for the International Auditing and Assurance Standards Board (IAASB), which sets the standards. The board itself has also hit the 100 mark – having recently held the 100th meeting of its 29-year history in Warsaw.

The IAASB, originally named the International Auditing Practices Committee (IAPC) is an independent standard-setting board within the International Federation of Accountants

(IFAC) that works to enhance the quality and uniformity of audit practice globally and to strengthen public confidence in the global auditing and assurance profession.

The Board has published 32 International Standards on Auditing (ISAs), approximately 20 International Auditing Practice Statements (IAPSs) as well as other pronouncements, such as those on quality control. Over its 29-year history, the ISAs have been developed with increasing input from the public to ensure that auditors have the appropriate guidance to address issues of concern to the public and the markets.

FRANCE

Ethics questionedThe European Commission has formally asked France to amend its national independence rules relating to international networks of audit firms.

The Commission considers that some elements of the French Code of Ethics restrict the freedom of an auditor and its network to provide worldwide non-audit services. Specifically, Articles 24 and 29 deem that providing a large number of non-audit services to any company that is either a parent or a subsidiary of a company audited in France contravenes the French statutory auditor’s independence requirements. According to EUROPA, the portal site of the European Union, this presents a significant problem: ‘Due to the fact that these presumptions cannot be challenged, an auditor and its network are not in a position to demonstrate that the independence of an audit is unaffected.’

The Commission, taking the view that the rules in question ‘go far beyond’ what is required for independence in the EU, may refer the matter to the European Court of Justice, if there is ‘no satisfactory response’.

MALAYSIA

Enhancing audit quality through oversightAn oversight board to monitor auditors of public companies is to be established under the supervision of the Securities Commission of Malaysia to enhance the quality and reliability of audited financial statements.

This announcement, made by Malaysia’s finance minister in his recent Budget speech, was well received by the investing public.

Auditors of public limited companies have a duty to the investing public to provide reasonable assurance that management makes ‘true and fair’ disclosures in the financial statements; and that such disclosures are not materially misstated. It is therefore essential for the quality of auditors and accountants to be maintained at the highest level. The Malaysian government feels the oversight board is the mechanism to make this happen.

Speaking for PwC Malaysia, Johan Raslan, executive chairman, came out in strong support: ‘PricewaterhouseCoopers is supportive of this initiative, which pushes audit firms to enhance the quality of work. This is crucial in today’s complex environment. Auditors must be equipped with the right skills and be up to speed with regulatory and corporate reporting changes. They must understand the industry they audit. The days of accounting as purely a self-regulated profession are over.’

The oversight board is expected to enhance the quality of audit, and hence public trust in the quality of audited financial statements in Malaysia. Its success is dependent on careful planning and effective implementation, which is said to be in safe hands with Zarinah Anwar, the Securities Commission chairman, driving the project.

‘There is quite a lot of work that needs to be done,’ Ms Anwar said. ‘We have to amend the laws to enable the board to be set up, besides looking into how it should be structured.’ She added that the commission will be looking at various models before deciding how many members will be appointed to the new board. However, she expects to be able to move forward quickly. Appointment of board members is expected early in 2008.

iAASB milestones in 29-year history

1978 IAPC held its first meeting in New York

1985 IAPC members asked to act in the public interest

1987 IOSCO adopted international auditing guidelines

1991 IAPC recodified guidelines as International Standards on Auditing (ISAs)

2005 IAASB came under the oversight of the Public Interest Oversight Board (PIOB)

2007IAASB 100th meeting held in WarsawSurvey identifies more than 100 countries that use IAASB standards

Anwar: driving the project


OPINION

A single set of global auditing standardsInvestors and other capital market participants want to know that the quality of audits is the same everywhere so that they can rely on the information to inform their decisions. But at the moment standards and their enforcement vary internationally, which means that ‘risk premiums’ are likely to be charged. Jim Lee looks at where we are and what needs to change to reach the goal – a single set of global auditing standards

The globalisation of our capital markets requires a single set of global auditing standards designed to promote uniformity in audit quality across the world. Such standards do not currently exist. In large part, this is because national auditing standards are incorporated in national laws, or in legislation that expressly delegates the setting of those standards to national standard setters.

Another complicating factor that gets in the way of everyone using one set of auditing standards is the national differences in the oversight of auditors and enforcement of auditing standards, including variations in the rules for how auditors should conduct their activities.

Some progress towards a single set of global auditing standards has been made, however. The largest firms have adopted audit methodologies based on International Standards on Auditing (ISAs).

The price of varying standardsPricewaterhouseCoopers supports the development of global auditing standards and a consistent system of auditor oversight and enforcement of those auditing standards. Investors in global markets and other stakeholders want to know that the quality of audits is the same regardless of where they are conducted. Otherwise, investors and lenders will inevitably demand a ‘risk premium’ before they will be induced to lend to or purchase a security from companies in countries that have demonstrably weaker audit standards or, perhaps worse, where the quality of audits is unknown.

The path to a single setPwC’s view is that a single set of global auditing standards should have the following attributes:

Principles-based to facilitate appropriate use of professional •judgement and scalability to all companies

Understandable and clear to support consistent application •and performance

Stock audits to meet the expectations of users of the •auditor’s report

Support the performance of audits that provide •reasonable assurance that the financial statements present a ‘true and fair view’

The path to a single set of global audit standards is likely to be staged. It should begin with the development of ISAs with broad applicability and clear distinction between principles, requirements and guidance. In recent years, the International Auditing and Assurance Standards Board

(IAASB) has made substantial progress in the development and enhancement of ISAs as part of its ongoing ‘Clarity Project’. However, substantial work remains and there continues to be a significant risk that the IAASB will tend towards requirements in certain areas that are more prescriptive than needed.

The next step is for harmonisation of auditing standards among international and national standard setters. Several national standard setters are already in the process of harmonising their standards with ISAs. For example, the body responsible for establishing auditing standards for US private companies has committed itself to harmonising with ISAs. However, the same commitment has not been made by the standard setter for US listed companies.

What does this mean?A single set of global auditing standards is critical to provide investors and lenders with consistently high quality financial information to make investing and lending decisions across capital markets. However, to reap the full benefit of global standards, we need greater consistency around the inspection of auditors and the enforcement of auditing standards in different countries. Varying requirements raise the costs of performing audits and decrease the comparability of audits performed in different countries.

Collaboration among national regulators overseeing auditors will reduce the costs of regulatory oversight on the capital markets and can work to increase investor confidence that information quality is globally consistent across the capital markets.

Global auditing standards should reduce the cost of audits. It would allow global networks of firms to train their people on a single set of auditing standards, thereby reducing the cost of delivery. It would also facilitate the mobility of professionals from country to country and allow for sourcing of work in parts of the world with highly qualified workforces and lower delivery costs.

At PwC, we will actively advocate a single set of global auditing standards that will contribute to high quality audits consistent with the needs of the capital markets. We will also support development of a consistent system of auditor oversight and enforcement of compliance with the auditing standards.

Jim Lee is the global chief auditor at PricewaterhouseCoopers.

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Date Key upcoming events location / Contact Sponsors / organisers

11 – 13 Jan 2008 18th World Congress on Total Quality

Delhi, india+44 20 7872 5784www.qualitymillennium.com

World Council for Corporate Governance

14 – 15 Jan 2008 4th Global Public Policy Symposium

New York, US Email: [email protected] www.globalpublicpolicysymposium.com

BDO, KPMG. Deloitte, Ernst & Young, Grant Thornton & PwC

29 – 30 Jan 2008 IASC Foundation Trustees Meeting

Rome, italy +44 207 246 6434 www.iasb.co.uk

International Accounting Standards Board

13 Feb 2008 IASB meeting with the Analyst Representative Group

to be confirmed +44 207 246 6434 www.iasb.co.uk


10 – 12 Feb 2008 The Forbes CEO Middle East Forum

Doha, Qatar +1 212 367 2504 www.forbesconferences.com

Forbes

14 – 15 Feb 2008 Standards Advisory Council to be confirmed +44 207 246 6434 www.iasb.co.uk


April 2008 Global Business Summit for the Environment

Singapore Lila Karbassi ([email protected]).

The Global Compact

24 – 25 April 2008 Conference on International Macro-Finance

Washington, US +1 202 473 7272 www.imf.org/external/

International Monetary Fund World Bank Group

26 – 27 April 2008 GARP’s 9th Annual Risk Management Convention & Exhibition

New York, US +44 20 7626 9300 www.garp.com/events/garp2008

Global Association of Risk Professionals

4 – 6 May 2008 FEI Summit 2008 Arizona, US www.financialexecutives.org/summit

Financial Executives International

7 – 9 May 2008 Global Conference on Sustainability and Transparency

Amsterdam, the Netherlands www.globalreporting.org

Global Reporting Initiative

29 – 30 May 2008 TBLI Conference Bangkok, thailand www.tbli.org/pagina/TBLI+Conferences/703/en

TBLI

18 – 20 June 2008 13th Annual International Corporate Governance Network Conference

Seoul, South Korea +44 20 7612 7098 www.icgn.org/conferences/index.php

International Corporate Governance Network

30 June 2008 6th International Conference on Corporate Governance

Birmingham, UK+44 121 414 6530 www.business.bham.ac.uk

Birmingham Business School

06 – 11 July 2008 17th IFAC World Congress Seoul, South Korea www.supelec.fr/invi/ifac/events.html

IFAC

17 – 18 November 2008

Current Financial Reporting Issues Conference 2008

New York, US www.financialexecutives.org

Financial Executives International

Diary Dates

pwc.com

Richard Keys, PwC global chief accountant, is continuing the firm’s dedicated IFRS blog. He has picked up the blogging reins from

Ian Wright who has left PwC to join the UK regulator (see page 9).

The blog looks at the hot topics in financial reporting and draws attention to issues that company management needs to consider before ‘ideas and proposals’ become a practical reality. It also indicates how companies can help to shape IFRS and gives tips on strategic implementation issues.

‘Lively debate is the lifeblood of high quality standards that meet the needs

of all those who have to use them. All our different perspectives on the impact of proposed changes need to be heard early on. Please do keep sharing your views with me via the IFRS blog.’

If you’d like to receive email alerts when the IFRS blog is updated, email [email protected]

IFRS blog – pwc.blogs.com/ifrs

Governance and Corporate Reporting World Watch*...Philips case study Complexity kills companies...

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