Published June 11, 2009

The bottom line: the buck does not stop there

By JOYCE HOOI

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AS MORE companies see the value of their assets for sale taking a nosedive, a long-simmering debate over the application of International Accounting Standard 39 (IAS 39) has heated up even as the stock market has cooled - especially where impairment of assets is concerned.

'With the credit crisis, the stock market has been in significant decline in terms of share prices and most of a company's available-for-sale investments are marked to quoted market price,' says Tan Seng Choon, an assurance partner at Ernst & Young.

'The question is: what happens to the fall in fair value? The first place to put it would be in the statement of changes in equity's fair-value reserve.'

But the issue of whether that fall in value belongs there is a matter of contention for many.

When a decline in fair value is recorded only in the fair-value reserve, there is no impact on a company's profit-and-loss statement.

According to IAS 39, however, a fall in fair value below an asset's cost may be considered evidence of impairment if the decline is 'significant' or 'prolonged'.

And in that case, the loss may be recognised in the profit-and-loss statement: the bottom line monitored by investors.

The problem then lies in how 'significant' or 'prolonged' a loss has to be before a company considers the asset to be impaired - bringing into question the comparability of profit-and- loss statements if one company recognises an impairment's impact on income and another leaves it on the statement of equity.

This has been the indirect result of IAS 39's failure to elaborate on 'significant' or 'prolonged', leading to an E&Y summary on the matter that delicately mentions 'considerable diversity in practice'.

'IAS 39 is rule-based or prescriptive, and many find it complicated to apply or even understand,' says Kok Moi Lre, a partner at PricewaterhouseCoopers' (PwC) accounting consulting solutions division.

Recent tentative guidance from the International Financial Reporting Interpretations Committee (IFRIC) clarified that a decline in value does not have to be both significant and prolonged to be considered an impairment, and that forecasts of expected recovery are irrelevant.

The fact that these areas needed clarification to begin with should be disturbing to investors who take financial statements as gospel.

Ultimately, IFRIC conceded that 'significant' or 'prolonged' is a matter of 'judgment rather than an accounting policy choice', leaving auditors only marginally better off than before.

The potential difference in practices and lack of clarity has major implications for investors who do not pay attention to changes in fair-value reserves, tucked beyond Page 10 in most companies' financial statements.

'Putting the impairment loss on the profit-and-loss statement gives it more prominence. To some extent, it means you are not getting this investment back, even though it is not expressly stated,' says Tham Sai Choy, KPMG Singapore's head of audit.

The International Accounting Standards Board has acknowledged the problems inherent in IAS 39 and, as a nod to turbulent times, has fast-tracked the process to replace it in time for the 2009 year-end reporting season.

Whether this change will result in more companies being obliged to reflect fair-value losses in the bottom line remains to be seen.

'Companies are not in favour of this right now as determination of fair value has become much more challenging in current times. In addition, companies generally do not welcome volatility in their income level,' says PwC's Ms Kok.

In the meantime, what should investors do when trying to decide whether the innocuous-looking figures in a company's fair-value reserve are something to worry about?

Pay attention to the rationale for the company's judgment, says Ms Kok.

'Investors can look out for the auditors' emphasis of matter, which is very useful to determine those judgments and to make the call on whether those judgments are reasonable, whether they can agree with the company's management or if they should ask management about these at shareholders' meetings.'

Now that the value of some investments is less than the paper they are printed on, there is no better time for investors to subject some of the things printed on that paper to greater scrutiny.