New International Financial Reporting Standards (IFRS) for accounting, which update the rules on group accounting, will result in a material fall in reported revenues, assets and liabilities in the 2013 financial year for some European corporates, says Fitch Ratings.
The credit rating agency’s (CRA) report, entitled
‘New IFRS Regime for Group Accounting’
states that IFRS 11 Joint Arrangements prescribes new accounting rules that prohibit proportionate consolidation for what are now defined as ‘joint ventures’. For structures that are classified as ‘joint operations’, a method similar to proportionate consolidation is now required. The rules became effective in 2013 and are mandatory from 2014 for European Union (EU) countries.
A Fitch survey of 24 large European non-financial corporates found that 13 of these entities had been using proportionate consolidation to account for interests in jointly controlled entities. IFRS 11 will force companies to use equity accounting instead for structures that are classified as ‘joint ventures.’
The three companies most greatly affected – UK telecoms operator Vodafone, German industrial group Robert Bosch and chemical giant BASF – see revenue reductions of €7.6bn, €7.3bn and €6.6bn respectively. But the changes have the potential to affect any line in the financial statements. Moving from proportionate consolidation to the equity method will reduce revenue and expenses, gross assets, and liabilities, which will be particularly significant if debt sits in the joint venture. However, profitability might increase if the joint venture is loss-making, as the equity method may restrict recognition of losses.
Fitch’s survey also found that IFRS 10 Consolidated Financial Statements, another new standard, will not have a significant effect for most companies. The changes introduced by the standard were targeted in particular at off-balance sheet structured entities and most of the group relationships that non-financial corporates have will be unaffected by the new rules.
The accounting changes introduced by IFRS 10 and 11 should not affect underlying credit quality, so Fitch does not anticipate any ratings effect.
A further range of disclosures will be provided by a third new standard, IFRS 12. These will be useful in assessing the transferability of cash flows within a group and risks arising from interests in structured entities. Where this provides fresh information about these factors it could be relevant to credit analysis and may possibly affect ratings.
Adoption in 2013 of the new rules is common among the large non-financial corporates in the Fitch survey, particularly in the UK. However, analysts and investors should note that many companies in Europe will not adopt the changes until 2014 when they become mandatory in the EU.
The report is available at www.fitchratings.com or may be accessed
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