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It’s more than the numbers issue three | july 2012

Diversity in the boardroomWhy it’s important for boards to be open to different points of view

Addressing governanceThe challenges facing companies in the Middle East

How do sports clubs account for the ever-changing value of their stars?

The numbers game

Welcome to Issue 3 of Reporting – Ernst & Young’s international magazine that is designed to bring together a range of insights and ideas that will interest business executives involved in

communicating their organization’s performance to diverse, geographically spread stakeholders.

As we go to press, the oppressive and continual instability in global financial markets, and the slowing growth in virtually all business sectors, provide a harsh backdrop for corporations around the world.

Front of mind is, of course, the banking sector providing the liquidity business needs. That there were some failures in regulation of the sector is widely accepted. Going forward, there is a broader principle at stake: we accept the need for stronger governance, but should it be proactive or protective? How can it be engineered on a global scale, given that contagion since 2008 has illustrated starkly the irrelevance of national borders? On p14, Brooke Masters examines the impact of financial services regulation in more detail from her perspective as Chief Regulation Correspondent on the Financial Times.

In the last few years’ turmoil, the accountancy profession has also been criticized. In a recent speech on sovereign debt to the IFAC (International Federation of Accountants), Ernst & Young’s Chairman James Turley pointed out that rules create incentives, and incentives drive behavior. The proliferation of stocks in the dot.com era aligned workers’ interests to investors’, but also led to short-term price increases to drive personal wealth. Compensation and bonus systems incentivized traders to create larger and larger profits for the banks, but neglected to factor in longer-term risk. Prior to the introduction of international accounting standards, many benefits, such as workers’ pensions, were not included on the P&L, so in the US, the steel companies, airlines and automotive industry stored up future costs – which eventually destroyed them.

Our view is that accounting standards – and the continuous efforts of the standard-setters to improve them – play a key role in providing transparency on the long-term impact of business decisions, and the governance and accountability for those decisions. On p32, we summarize the changes to business combinations under IFRS that are designed to improve the clarity on control and liabilities in complex corporate entities.

In the context of the sovereign debt crisis, a key area of focus is public sector accounting. In our current rule set, elections and budgetary cycles incentivize governments to concentrate on short-term reporting. They often lack the processes and systems to take stock of the assets and liabilities they hold. Governments are taking decisions regarding allocation of resources that will have an impact for years to come, with limited discussion of, or disclosure on, the long-term consequences. Governments, bond markets and investors need better information to make investment decisions. Adopting international accounting principles and improving the transparency in government accounting should, as has happened with business, support better government decision-making, improve the confidence of stakeholders and contribute to long-term fiscal stabilityand economic growth. You can watch highlights of James Turley’s speech on ey.com/government

Our article on accounting for sports (p16) takes a different perspective on accounting for intangibles in a sector where valuation of assets and forecasting returns can be highly volatile.

We hope you find Issue 3 a stimulating read – please send us your comments via www.ey.com/reportingmagazine/feedback. Your views will be very welcome.

CHRISTIAn MOUILLOnChristian Mouillon is the Global Vice Chair of Assurance at Ernst & Young

ernst & youngAssurance | tax | transactions | Advisory

About Ernst & Youngernst & young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential.

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this publication contains information in summary form and is therefore intended for general guidance only. it is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither eyGM limited nor any other member of the global ernst & young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

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publIcaTIons

EUROzOnE FORECASTOur latest forecast predicts a 0.6% drop in Eurozone GDP this year and the slowest recovery from recession since the 1970s. Shareholders, lenders and analysts all over the world are asking management teams what the Eurozone crisis

means for them. The report discusses the issues affecting governments and businesses and responds to questions senior executives are asking about risks and opportunities.ey.com/eurozone

HOW SHOULD BUSInESS APPROACH CARBOn nEUTRALITY? THE SOLUTIOnS AnD BEnEFITSIn what scenarios does going carbon neutral make sense for a business? Our paper looks at the issues and some case studies of

how businesses have approached this question.ey.com/sustainability

TURn RISkS AnD OPPORTUnITIES InTO RESULTS: ExPLORInG THE TOP 10 RISkS AnD OPPORTUnITIES FOR GLOBAL ORGAnIzATIOnSMarket volatility, pricing pressures, variations in market performance and demanding stakeholders have all contributed to a global economy that encourages competitive drive. With that drive comes opportunity. For that reason, this year’s business risk report looks at both the top 10 business risks and the top 10 business opportunities.ey.com/top10challenges

FInAnCIAL REPORTInG BRIEFInGSErnst & Young hosts the annual Financial Reporting Outlook conference in London on Monday, 5 november 2012. Reporting readers have the opportunity to register at a discounted cost of

£300 (normally £695). Sign up for the event on financialreportingoutlook.com and use the promotional code REPORT.

How should business approach carbon neutrality?The solutions and benefits

13582 EY Carbon Neutrality_v9.indd 2 06/06/2012 15:50

Financial Reporting Outlook 2012

Monday, 5 November 2012Park Plaza Westminster Bridge, London

Recent publications from Ernst & Young

Culture Shock: A Business Handbook for Radical Changeby Will McInnes (Wiley, August 2012)Fueled by advancing technology and a volatile global economy, business has changed profoundly. But most organizations remain closed, secretive, conservative and deeply hierarchical. social business pioneer Will Mcinnes argues that it’s time to burn up the old and start something new, and maps out ways to create a radical and uplifting work culture.

Good Strategy/Bad Strategy:The Difference and Why It Mattersby Richard Rumelt (Profile Books, paperback June 2012)Back in 1972, rumelt was the first person to uncover a statistical link between corporate strategy and profitability. he dispels popular misconceptions by showing that a good strategy focuses on the challenges a business faces, and provides an insightful new approach for overcoming them.

Sleeping with your Smartphone: How to Break the 24/7 Habit and Change the Way You Workby Leslie A. Perlow (Harvard Business Review Press,May 2012)ethnographer Perlow delves into the new, connected world of work and challenges the notion that you must be constantly plugged in to be successful. her research suggests that this 24/7 mentality is actually counterproductive. she recommends a radical yet simple idea: take “disconnected” time off and both individual and team members will benefit.

on the shelfnew and recently published books

For webcasts, podcasts and the latestupdates on IFRS, visit ey.com/IFRS

... and more

Editor tim turnerAssistant Editor rob MorrisSenior Designer jenni DennisAccount Director emma KingProduction Director john Faulkner

For Ernst & Youngjosy roberts-Pay, Marketing Director, eMeiA Assurancejoan Fulton, Program Manager

Printed by Newnorth

For more information about Reporting, please contact [email protected]

Reporting is published on behalfof ernst & young by

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Steering Group

Ernst & Young Assurance Leaders

Christian Mouillon, Global Vice Chair, AssuranceDon Zimmerman, Assurance servicesFelice Friedman, Director, Global Public PolicyPhilippe Peuch-lestrade, Assurance servicesr. Balachander, Assurance Markets leader, indiarichard Wilson, Assurance servicesruth Picker, Global leader, iFrs services, Global Professional Practicestephane Kherroubi, Financial Accounting Advisory services leader, eMeiAWarmolt Prins, Assurance Markets leader, eMeiA

eMeiA – Felice PersicoAmericas – tom houghAsia-Pacific – Clive saundersonjapan – yasunobu Furukawa

july 2012 Reporting [34/35]

contents

24

20

045 things I’ve learnedyoshiaki Fujimori of js Group Corporation shares lessons from his successful career

06Diversity in the boardroomMany corporate boards still lack diversity. We investigate initiatives that aim to change this

10The pollernst & young’s latest Global Fraud survey

11Shining light on group reportingWe examine the implications of new iFrs standards on group reporting

14The consequences of regulationBrooke Masters of the FT on how increasing financial services regulation affects business

16The numbers gamehow do sports clubs reflect the value of their stars on the balance sheet? We investigate the complexities of this risk-filled sector

20Addressing governance in the Middle Eastthe challenges for corporate governance in this rapidly evolving part of the world

24The buy sideFrancis Daniels of Africa Opportunity Partners outlines the factors that influence his investment fund’s decisions

26Bridging the perception gapKazakhstan is an attractive destination for investors; the challenge is to persuade companies yet to invest there to do so

28Taxing issuesthe question of how much tax information to report continues to be a topic for boards – not least because of increased media attention

32IFRS changes for 2013 and beyondA snapshot of the new standards that ongoing iFrs preparers need to be aware of

34My wish listPhil hodkinson, non-executive director of Bt, on where he sees room for improvement in corporate reporting and governance

35… and morerecent publications from ernst & young, plus books that may be of interest

Investing in Africa

Corporate governance in the Middle East

Boardroom diversity

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1The first 100 days are criticalWhen i was at General electric, we all changed jobs every two or three years. i quickly learned a couple

of things that were necessary for me to succeed. First of all, you need the best CFO and the top hr executive you can get. they are your left hand and your right hand, because being successful is a question of your numbers and your people. i bring those people in within the first 100 days of joining a company. the next thing i make sure i do is not to spend much time in the office in the first 100 days. you need to get out and listen to the customers. you make changes in the first year and get results in the second.

2 Delivering a difficult message does not haveto be difficultWhen communicating with stakeholders, it’s quite

straightforward; you have to be transparent and you have to be honest. you must not be defensive and you have to be confident. the communication has to be clear and crisp. Overcommunicate the vision and the strategy. Do not commit to a stretched target, but do set a goal that you have a high probability of achieving. start low and move it up.

3 Your potential is unlimitedthe only limit that exists is the one in your head. [Former CeO] jack Welch taught me that when

i was at Ge and it is something i have kept in mind ever since. everyone has the potential to achieve a higher target. the key to management is to extract the

5Yoshiaki Fujimori has taken the road less traveled by Japanese executives, preferring to test himself and his organization by constantly looking to step out of the comfort zone. The turning point, he says, was an MBA in the United States that he was initially reluctant to embark uponInterview: julian ryall photography: Alfie Goodrich

things I’ve learned

maximum potential from your staff and help them to be successful. if you set the target at a higher level, then a person’s potential can be much greater. if the target is harder to reach, then people will go beyond the simple target and stretch for the higher one.

4 Don’t over-analyze your mistakesPeople always say you should learn from your mistakes, but i believe that over-analyzing errors is

of limited use. i don’t like to go back, whether something has been a success or a failure. in the same way as it is difficult to take lessons from a success because the identical situation will not crop up again, it is hard to learn a great deal from your errors. that is because the world is constantly changing. instead of hindsight, you need to develop the ability to know what is happening here and now, to adjust to that changing environment, and to see around corners.

5 Globalization can only be achievedthrough localizationA company’s international business should be

run by local people, but only as long as they share the same values and visions as the headquarters. sending japanese executives all over the world and making them run the local business makes no sense at all. the japanese head office must be good at managing a diverse organization and fostering a culture of diversity within that unit. the head of the company has to treat all his employees around the world equally and ensure that each member of the organization is evaluated fairly. n


Yoshiaki Fujimori is President and CEO of Tokyo-based JS Group Corporation and President of LIxIL Corporation. A graduate of Tokyo University, he joined nissho Iwai Corporation before going on to earn an MBA from the Tepper School of Business at Carnegie Mellon University in Pittsburgh, USA. He joined General Electric Japan Ltd. in 1986 and rose through its healthcare, plastics and GE Money Asia divisions to become chairman of GE Japan Corporation in March 2011. He took over at the JS Group in August 2011.

InspIraTIon: YosHIakI fujIMorI

“You make changes in the first year and get results

in the second”

Diversity

Research has repeatedly shown that the most effective teams feature a range of skills, experience

and perspectives, yet this diversity is still absent from many corporate boards. Serge Debrebant examines

a variety of initiatives that aim to change this

in the boardroom


sluG: XXXXXXXXXXX XXXXXXXXXXX

“An indispensable characteristic of an effective board is its openness to different ideas, ways of thinking and

points of view”William R. Rhodes, G30 Steering Committee

In April 2012, the Group of thirty (G30), the international forum of public and private sector financial leaders, published a report entitled Toward Effective Governance of Financial Institutions, the core research for which was conducted by tapestry Networks. One of the themes of the report was the need for diversity in the boardroom.

Commenting on the report, William r. rhodes, a Vice Chairman of the G30 steering Committee and President and CeO of William r. rhodes Global Advisors, said: “We rejected the suggestion that boards need to have a very high concentration of financial specialists. We believe that the most effective boards are diverse ones, both in terms of the range of business experiences of the members, but also in terms of gender and ethnic considerations. An indispensable characteristic of an effective board is its openness to different ideas, ways of thinking and points of view.”

the business case for board diversity is partly based on academic research about group dynamics. According to a wide array of studies, diverse groups tend to outperform homogenous groups if they are well managed. “in soccer, you need a goalkeeper, defenders, midfielders and forwards. likewise, on boards, you need directors with different skills and strengths,” says Karina robinson, Principal of board-level search firm robinson hambro.

Another argument focuses on the folly of ignoring potentially valuable talent, particularly when it comes to the gender makeup of boards. statistics in many Western countries show that women not only make up half the workforce, but also have more, and better, university degrees. “if you mostly nominate men, you fish from only half of the talent pool,” says ruth sealy, Deputy Director of the international Centre for Women leaders at Cranfield school of Management in the uK.

And yet, despite this, corporate boards around the world still tend to be “male, pale, frail and stale,” in the words of Chris Pierce, CeO of advisory firm Global Governance services.

THE CHAnGInG LAnDSCAPEBoard structure and composition vary internationally but, traditionally, boards tended to be filled with circles of friends and business partners with similar backgrounds and experience. sometimes these “old-boy networks” made boards work ineffectively, though investors didn’t always seem to notice or care. “Only 20 years ago, business leaders didn’t focus much on the role of the board,” says Pierce.

this changed after a series of bankruptcies and corruption cases in the 1980s. in 1992, Adrian Cadbury, the former Chairman of Cadbury schweppes, produced a report on The Financial Aspects of Corporate Governance that influenced guidelines in europe and North America and at the World Bank. After the enron and WorldCom scandals, the sarbanes-Oxley Act of 2002 improved reporting standards in the us, while the role of diversity on corporate boards was highlighted in The Tyson Report on the Recruitment and Development of Non-Executive Directors, which the British Government commissioned in 2003.

these reports and codes have begun to change not just the racial and gender composition of boards, but

InsIGHT: boardrooM dIvErsITY

other aspects too. traditionally, board directors were mostly people with executive experience, but nowadays, experts such as Karina robinson urge companies to recruit directors with a variety of skills. “some companies only value experience in their own sector, but you don’t have to be an engineer to check the books of an engineering company,” as she puts it.

similarly, global businesses might find that it pays to appoint directors with international experience, particularly from developing countries, who can offer insights about target markets. travel companies and retailers might find it valuable to nominate female candidates, given that an estimated 80% of household decisions are made by women. And any company competing for talent might do well to seek out a female or minority director in order to showcase its commitment to progressive employment policies.

however, the message is taking time to filter through. in the us, the National Association of Corporate Directors (NACD) tracks the professional diversity that boards seek when adding directors. in its most recent survey (see chart, below), over half of respondents, when asked to select two attributes they look for in directors, named leadership experience and specific industry experience, while fewer than 10% chose expertise in risk, it, government, marketing, hr or legal issues. “this is probably because internal management reports and

“You don’t haveto be an engineer to check the

books of an engineering company”karina Robinson, Robinson Hambro

advisor reports can provide this expertise, whereas the quality of judgment and discretion that comes from leadership, and from work experience, cannot be obtained by reports,” explains Alexandra reed lajoux, the NACD’s Chief Knowledge Officer.

InTERnATIOnAL VARIATIOnSChris Pierce, who advises companies around the world, observes that diversity issues vary greatly from country to country. in south Africa, significant progress has been made in the past two decades in terms of black empowerment, and the country has one of the most inclusive corporate governance codes in the world. At the other extreme of the continent, in tunisia, a corporate governance code was developed in 2008, which recommends that 30% of directors of a company should be under 40 years old and another 30% aged between 40 and 60.

“the idea was to pass old wisdom on to the next generation by integrating young people on the board,” explains Pierce, who advised the institute that published the code. “As far as i’m aware, it’s the only such example worldwide.”

Progress is slower in the Middle east, where family businesses have traditionally dominated. however, many larger family businesses have now started forming boards and inviting independent members to join them. (For more on this topic, see p20.)

even in the closed world of japanese business, things have started to change. in the past few years, a growing number of japanese companies have appointed foreign CeOs, although it hasn’t always worked and some have since left. even so, Pierce thinks business leaders there are recognizing that

Q. Which attributes and experiences are the most important when recruiting directors?(NB: respondents were asked to select two from the list)

leadership experience

specific industry experience

Financial expertise

strategy development

international/global

risk assessment

Medical/scientific/technical

information technology

Government experience

Marketing

human resources

legal expertise

Source: NACD Public Company Governance Survey 2011

61.9%

54.2%

46.6%

28.8%

17.9%

7.4%

5.9%

5.5%

4.2%

4.1%

2.1%

1.6%

InsIGHT: boardrooM dIvErsITY

norway’s 40% ruleIn 2003, the norwegian parliament passed a law requiring publicly listed companies to fill at least 40% of seats on the board with women by 2008, making norway the first country to introduce a gender quota for corporate boards.

The move was controversial. some critics feared there wouldn’t be enough qualified women, while others suggested it would ruin the country’s economy. but the sanctions for non-compliance were harsh, so companies did as they were told. by 2009, the target was achieved nationwide – up from just 7% in 2003.

not only did norway’s economy not collapse, but it has fared better than many others in the past few years. and it wasn’t hard to find qualified women. on the contrary, even in non-listed companies (which weren’t subject to the law), the number of female directors had risen to 17.2% by 2011. More than 1,000 women in norway now have board experience, and although the number of female chief executives is still low, it has increased since 2008.

Morten Huse, professor of organization and Management at the bI norwegian business school in oslo, says his studies have found that the presence of female directors improves a board’s work on corporate social responsibility and on strategy, but doesn’t fundamentally change its approachto budget or operational control.

other countries have followed the norwegian model. spain passed a quota law in 2007 and france followed suit last year, while Eu justice commissioner viviane reding and other top Eu representatives are also talking about mandatory quotas. It seems that norway’s legislators may have kick-started a major shift in boardroom culture.

their country has to open up. “it will happen, but only slowly,” he says, adding that a foreign director there will do better if they respect the japanese custom of avoiding open conflict in public.

in europe, the debate still largely centers on the integration of women on boards. since the introduction of a gender quota in Norway (see panel, right), the pros and cons of mandatory quotas have been hotly debated. Prominent businesswomen such as Alison Cooper, Chief executive of imperial tobacco, oppose female quotas. “i find that rude to women,” she told The Daily Telegraph in 2010. “Boards should make selections on the basis of merit.” Many women fear that, in a system of quotas, female board directors would be perceived as token members. in that case, quotas wouldn’t promote women’s careers, but stigmatize female directors and limit their influence.

THE SLOW PACE OF CHAnGEin the us, a quota law is still a distant prospect. in 2009, the securities and exchange Commission published a new code of conduct that requires nomination committees to disclose their selection process and use diversity as a criterion. But the Dodd-Frank Act, which was introduced in 2010 in reaction to the financial crisis, didn’t contain any rules or recommendations related to board diversity. instead, large pension funds have started to use their influence to challenge board composition. According to the non-profit organization As you sow, more than 40 shareholder proposals targeted us companies for their diversity policies last year.

simply reporting on diversity can be another way to promote change. For instance, the Australian

securities exchange requires companies to disclose information on gender diversity, while in the uK, lord Davies’s report Women on Boards 2011 recommended that companies report on board composition in their annual reports. Beth Brooke, Global Vice Chair, Public Policy at ernst & young, approves of this drive for transparency. “sunlight does have a way of catalyzing action,” she says.

in 2009, Brooke launched a report on women in business at the World economic Forum in Davos. the financial crisis was about to turn into a full-blown recession that threatened the global economy, and revelations in the world of finance clearly showed the need for control and supervision of companies. Brooke felt that most business leaders didn’t make the connection with diversity, but she is hopeful that, three years later, this has changed. “Progress is still slow on that issue, but we are starting to see momentum,” she says. “People are starting to realize that diversity is an untapped economic engine.”


THE rEsulTs of ErnsT & YounG’s laTEsT Global fraud survEY sHoW THaT THErEIs sTIll MucH Work To do To sTaMp ouT brIbErY and corrupTIon, parTIcularlYIn rapId-GroWTH MarkETs

the pollernst & young’s 12th Global Fraud survey interviewed more than 1,700 top executives in 43 countries. CFOs, chief compliance officers and heads of internal audit and legal departments shared their views on fraud, bribery and corruption and outlined the actions their organizations are taking to mitigate the risk. While many companies have intensified their efforts to combat bribery and corruption – partly in response to more aggressive enforcement – much remains to be done.

15%9%

Does not apply Applies

30%20% 13%

17%Cash payments to win/retain business

entertainment to win/retain business

senior management has strongly communicated its commitment to our ABAC policies

We have an ABAC policy and code of conduct

there are clear penalties for breaking our ABAC policies

the guidance on ABAC is available in local languages

there is training on our ABAC policies

People have been penalized for breaching our ABAC policies

16%6% Personal gifts to

win/retain business

5%3% Misstating company’s

financial performance

53%56%

None of these

3%13%

Don’t know/refused

Ethical standards are strained by hard timesOne of the most troubling findings of the survey is the increase in acceptance of unethical business practices since the last survey in 2010.

Of course, there are regional differences beneath the totals. For example, in the Far east, 15% of respondents think that misstatements of financial performance can be justified.

Which, if any, of the following do you feel can be justified if they help a business survive an economic downturn?

Awareness of, and response to, the risks of new markets is varied

Business leaders should examine their anti-bribery/anti-corruption controlsCost-cutting may have led to cuts in internal audit and compliance, communications and training, which affects a company’s ability to identify issues and allegations and take appropriate action.

For each of the following, please tell me whether it applies or does not apply to your organization?NB: in the table below, ABAC stands for ‘anti-bribery/anti-corruption’; the ‘Don’t know’ percentages have been omitted to allow better comparison between the given responses

For full details of ernst & young’s 12th Global Fraud survey, visit www.ey.com/globalfraudsurvey2012

63%of respondents agree that planned investment in new markets will open them up to new risks.

39% of respondents perceive that bribery and corrupt business practicesoccur frequently intheir country.

42%of respondents are not aware of anti-bribery and corruption policy training in their organizations.

52% agree that their boards need a more detailed understanding of the business if they are to be an effective safeguard against fraud, bribery and corrupt practices.

2012 results2010 results

84%

81%

71%

63%

55%

45%

24%

31%

42%

44%

InforMaTIon: nEW accounTInG sTandards


New IFRS standards for group reporting will transform many companies’ balance sheets. Sally Percy explains why and examines

the effects of the new standards on two major industry sectors

Shining lighton group reporting

Among the many nasty surprises that came out of the financial crisis was the frightening amount of debt left off company balance sheets.

in a bid to improve the reporting of group financial statements and the transparency of the information, the international Accounting standards Board (iAsB) issued three interrelated accounting standards in May 2011. these three standards – iFrs 10, Consolidated Financial Statements, iFrs 11, Joint Arrangements and iFrs 12, Disclosure of Interests in Other Entities – are effective for annual periods starting on or after 1 january 2013 (1 january 2014 in the eu). early adoption is permitted and retrospective application is required, with some relief provided in circumstances where the effort and cost of restating figures in prior years would be unreasonable.

Although iAs 27, Consolidated and Separate Financial Statements, and siC-12, Consolidation – Special Purpose Entities previously covered off-balance sheet items, there was what luci Wright, executive Director, Global iFrs services at ernst & young, describes as “wriggle room” between the definitionsof “control” in both standards.

the iAsB has tried to remove this wriggle room with iFrs 10, which replaces siC-12 and parts of iAs 27. it combines their definition of a “controlling interest” in an entity and broadens it to allow for a complicated ownership structure.

Industry focus: Mining and metalsfor the mining and metals sector, along with other extractive industries such as oil and gas, it is Ifrs 11, rather than Ifrs 10, that is the biggest headache. The substantial risks and costs involved with projects in these industries mean that joint arrangements are common.

Terminology has proven to be one of the biggest causes of confusion with Ifrs 11. “What a company considers a ‘joint venture’ in practice is not necessarily the same as the definition of a ‘joint venture’ in the new joint arrangements standard,” explains Tracey Waring, Global Ifrs leader for Extractive Industries at Ernst & Young.

In addition, the way in which a number of other common terms are defined may not be obvious. The three types of joint ventures under Ias 31 – jointly controlled operations, jointly controlled assets and jointly controlled entities (jcEs) – have been pared down to two types of joint arrangements in Ifrs 11 (joint operation and joint venture). Meanwhile, the new definition of control in Ifrs 10, and additional clarification in Ifrs 11 as to how “unanimous consent” is achieved for the purposes of demonstrating that there is joint control, means that some structures that were considered joint ventures under Ias 31 might not be considered joint arrangements under Ifrs 11. They may instead be considered subsidiaries or associates (influenced, but not controlled, by the parent company).

of the various arrangements that currently exist, it is jcEs that will be hardest to classify under Ifrs 11. some proportionately consolidated jcEs may now be classified as joint ventures and will have to be accounted for using the equity method. conversely, some equity accounted jcEs may now be classified as joint operations, requiring the joint operator to recognize its share of the joint operation’s assets, liabilities, revenues and expenses on a line-by-line basis. Inevitably, these changes will affect the presentation of financial statements and could involve measurement differences that affect profit or loss and net assets.

How the jcE is classified depends largely on its structure and the rights and obligations that the contract gives to each of the parties to the arrangement. “However, some contracts can be up to 10 or 20 years old and were never written with modern accounting standards in mind,” Waring points out. “There is a risk that two parties to the arrangement may come to an entirely different conclusion as to whether they should classify a jcE as a joint venture or a joint operation.” also, one party could produce a set of accounts at an earlier point in time from the other party, thereby introducing data to the market that could affect share prices. In addition, it is possible that the parties may wish to re-negotiate the contract to make the classification clearer.

The lack of detailed guidance for Ifrs 11, particularly on accounting for joint arrangements held through separate vehicles, has been frustrating for Michael lepore, vice president, financial reporting, at canadian gold miner barrick Gold corporation. “It is not clear when such arrangements should be classified as joint ventures, and therefore accounted for using the equity method of accounting, or as a joint operation, whereby each partner would account for their share of revenue, expenses, assets and liabilities separately,” he says.

barrick is reviewing all its operating agreements relating tonon-wholly owned ventures, talking to its venture partners toensure consistency in interpretations and conclusions, and working with the Mining Industry Working Group to develop consistent application guidance.

iFrs 10’s definition of a controlling interest focuses on power rather than just percentage equity ownership, encompassing factors such as the scale of return on investment and the link between power and returns – i.e., to what extent can the parent company use its power to achieve certain returns?

A nEW DEFInITIOn OF COnTROLthis new definition of control may draw more entities into a consolidated group, effectively expanding it and requiring more and different line items from these additional entities to be included in the income statement and balance sheet. And, since many off-balance sheet arrangements exist to keep debt out of the balance sheet, bringing them onto the balance sheet will visibly increase the company’s gross liabilities. it will also have an impact on the company’s revenue and expenses, and therefore its profit or loss. sectors such as private equity and banking, which are already highly leveraged, could find that their leverage ratios change as a result.

in addition to the new consolidation requirements of iFrs 10, iFrs 11 (which supersedes iAs 31, Interests in Joint Ventures) takes a more realistic view of joint arrangements by looking at the rights and obligations of the arrangement, i.e., the substance of the arrangement, and not just itslegal structure.

Further, to enhance the information provided by both iFrs 10 and 11, iFrs 12, an entirely new standard, combines and now demands more in-depth disclosures from companies about their interests in other entities – particularly where judgments were made to not consolidate an entity. this disclosure requirement alleviates some concerns of users and preparers that the application of the new definition of control in iFrs 10 requires considerable judgment.

Although the transparency offered by the new standards will benefit investors, companies that have previously set up complicated legal structures precisely to keep their other interests off the balance sheet probably won’t welcome them. Nor will they welcome the amount of work that could be involved in adopting them. however, if the standards help to improve the information provided to users and end up flagging potential future financial crises, this must surely make them worthwhile.

Industry focus: InsuranceThe new definition of “control” in Ifrs 10 is a concern for insurers with interests in investment funds linked to life assurance polices. They need to review the requirements and use their judgment to assess whether they control those funds.

for a number of funds, the insurer will be the fund manager and will own over 50% of the fund. as the insurer clearly has a controlling interest in the fund, that fund will appear in its consolidated accounts. This was the case under Ias 27 and will remain so under Ifrs 10.

but for other funds, where the insurer owns between 20% and 50% of the fund, the situation is less clear-cut and the insurer will need to apply more judgment as to whether it has a controlling interest or not. as such, insurers may find that they have to consolidate funds under Ifrs 10 that they did not consolidate previously. Insurers with less than 20% ownership in a fund are less likely to have to consolidate, but there are still other important factors to consider, such as the link between power and returns.

dutch life insurer aEGon expects that the most significant impact of the new consolidation standard will be on its investment funds and structured entities. “We may have to consolidate some entities that we don’t consolidate now and vice versa,” says Geert Ewalts, Head of Ifrs policies. The company will also have to switch from proportionate consolidation to equity accounting for its joint ventures under Ifrs 11 and make the additional disclosures that are required by Ifrs 12.

so far, the process of assessing the impact of the changes has been time-consuming and the standards have thrown up plenty of questions. “It’s not always clear how the standards should be interpreted,” says Ewalts. “The new consolidation standards are highly judgmental and the application guidance does not always support us on how the standards should be interpreted. Guidance for complex structures is not always at hand.” as a result, aEGon has been talking to other insurers to see if consistent interpretations can be adopted across the industry.

The Iasb is proposing to exempt certain investment entities from Ifrs 10 where the entities are in the business of pooling investments from a wide range of investors, for capital appreciation and other investment returns. “However, it is not clear whether insurers will benefit from the exemption and if so, whether it would be the investment fund or the insurer that would have the exemption,” says Hans van der veen, senior Manager, financial accounting advisory services at Ernst & Young in the netherlands.


sluG: XXXXXXXXXXX XXXXXXXXXXXInforMaTIon: nEW accounTInG sTandards

“It’s not always clear how the standards should

be interpreted”Geert Ewalts, AEGOn

Brooke Masters, Chief regulation Correspondent for the Financial Times, examines the impact of

growing financial services regulation on business

Com

ment

The consequencesof regulation

in the four years since the financial system teetered on the brink of collapse, politicians and regulators have fallen over each other to draft new and tougher rules that they hope will prevent a recurrence of the crisis.

From higher capital and liquidity requirements to bans on short-selling and limits on high-frequency trading, governments around the world are hitting out at anything and everything they think could pose a danger. By one recent count, compliance officers are having to cope with as many as 60 new regulations every working day.

Few of the proposals are well coordinated, despite early promises by the Group of twenty nations to work together. Many national regulations actively conflict with provisions being put forward in other countries. Almost all of the rule changes have profound consequences for the banks, brokers and insurers who have to operate within them.

industry groups complain, with some justification, that the constant changes and conflicting requirements make it virtually impossible to plan ahead. they also warn that tighter controls on banks and derivatives

PROFILEBrooke Masters is the Chief regulation Correspondent for the Financial Times. she covers the uK Financial services Authority, the Basel Committee on

Banking supervision and the Financial stability Board. she also works with reporters around the world to cover global financial regulation and white-collar crime cases.

will drive up the cost of credit and make it prohibitively expensive for corporates to hedge interest rate and currency risks. the industry-funded institute of international Finance, for example, predicts that the cumulative effect of the Basel iii bank reforms will result in world economic output being 3.2% lower by 2016 than it would have been, and that the stock of new jobs created will be smaller by 7.5m.

in fact, the truth is much more complicated. regulation is changing some banks’ business


coMMEnT: brookE MasTErs

models, and that can be quite painful. the Basel reforms that boosted capital requirements for trading books and securitizations have clearly led to cuts in both types of activity, and us banks are complaining bitterly that the Volcker rule against proprietary trading will force them to exit profitable businesses and cut liquidity in many markets. At the same time, it is unwise to ignore the dangers of leaving the rules unchanged: in a lightly regulated world, financial groups are routinely tempted to underprice risk and leave themselves open to massive unexpected losses.

Many eurozone banks are blaming regulatory changes for their decisions to scale back previously profitable business lines, such as trade finance in Asia, but the evidence suggests that the main problem is that they cannot get their hands on the us dollars that are needed for this type of lending. that shortage, in turn, reflects investor fear that the banks are not strong enough to withstand another crisis.

to my mind, this points up a lost opportunity. if eurozone regulators had been tougher earlier, and required their banks to shore up capital stocks in 2008 and 2009, they might not be having so much trouble now. Andrea enria, Chairman of the european Banking Authority, makes the same point, arguing that it is the banks with low capital levels that have cut back lending and are shedding assets, not those that are already strong.

in some ways, it is actually a good thing that european banks are selling off their far-flung businesses, such as aircraft leasing and infrastructure projects. the fire sale has created opportunities for Asian and us banks who, previously, could not compete with the europeans on price. Many of them, particularly in japan, are now stepping up and taking a much bigger role in financing trade and infrastructure projects in the region.

taken together, these developments mean that Western banks will play a much reduced role in worldwide economic growth. regulators have been struggling for years to solve the “too big to fail” problem. Asset disposals are doing part of the work for them. n

“If Eurozone regulators had been tougher earlier, they might not be having so much trouble now”

The business of banking is the business of taking risks. banks earn a return from taking various risks, including credit risk, market risk, liquidity risk and operating risk. risk governance makes sure banks take the right risks at the right price in the right way.

so getting risk governance right is critical. regulators are insisting on it. so are investors.

bank boards should concentrate on three big issues. first, aligning the return target to the bank’s risk target. banks are confronting a wave of new regulation. This sets a cap on the overall risk that a bank can take. In credit terms, it is roughly equivalent to stating that the bank should be able to keep an investment-grade credit rating on a stand-alone basis throughout the business cycle, and especially at the trough. The target return on investment has to be consistent with that risk target, but it also has to exceed the bank’s cost of equity capital. boards will want to ensure that the bank’s business model makes this risk-return equation work.

second, setting the bank’s risk appetite. This cannot exceed the bank’s risk capacity (the absolute amount of money the bank could lose and still remain at or above its target risk level/credit rating). as risk capacity contracts, so should the bank’s risk appetite. but in order to remain competitive (e.g., in wholesale markets), a bank may need to be able to take significant risks. The board needs to ensure that the bank has the capacity, as well as the appetite, to do so.

Third, getting a sound risk process in place. When it comes to risk, banks have three lines of defense: line management, risk management/compliance and internal audit. Each has a role in managing risk and all need to work together in a cohesive way.

Two recent studies, Toward Effective Governance of Financial Institutions (published by the Group of 30) and Progress in Financial Services Risk Management (a joint publication by Ernst & Young and the International Institute of finance), spell out how this can be done.

Viewpoint

Getting risk governance rightThomas Huertas, Financial Services Risk Practice, Ernst & Young

Valuing sportspeople has always been a difficult exercise because of the large number of variables involved. Michael Anthony Makaab, CeO of sports licensing agency Prosport international, lists the factors that will affect the market value of a player in a sport such as soccer or rugby union; they include age, injury record, current and expected remuneration, position played, bonuses, buyout clauses, agent fees and structure of payments.

these are relatively easy to itemize, but Makaab adds that less tangible factors also need to be taken into account, such as a player’s personal characteristics, reputation and desire to represent their current club or a new one.

then there are relevant legal rulings, such as Bosman and Webster. the former stipulates that professional footballers in the eu have the right to a free transfer at the end of their contract; the latter formalizes the “buyout” rules in the case of disputed transfers of players who are still within their contract term.

Finally, in a team sport, the value of the individual is inextricably tied to the club they play for – and the clubs that want to buy them. Among the issues here, Makaab cites the number and type of clubs interested in acquiring the player, their buying power, their need to sign, the player’s current club’s need to sell, other activity in the transfer window, the availability of alternative players, promises made and the sizes of the clubs involved.

With so many factors to take into account, it’s clear that when the media report that a certain player is worth €50m, say, they’re really just taking a stab in the dark.

ACCOUnTInG FOR PLAYER VALUEso how are players valued? srini Krishnamoorthy, Professor of Management science at the richard ivey school of Business at the university of Western Ontario in Canada, suggests that a player’s worth should be considered in terms of how they increase the value of the team that owns them. “the goal of a professional team is to make money,” he says. “One of the

primary sources of money is ticket receipts from fans who attend the games. Attendance depends on the performance of the team. so we have to value a player based on the incremental wins that he/she brings by playing for the team – and there are ways to measure how many wins a player brings.”

he adds that athletes should be treated as prospects – with their value dependent on corresponding probabilities. “using a single hard number to value them is a mistake,” he insists. “By treating them as prospects, we can incorporate shock random events like injuries and scandals.”

But for sports clubs that produce annual reports, hard numbers are required. sanjay Kallapur, Professor of Accounting at the indian school of Business in hyderabad, says that, where soccer teams are concerned, the most common way of accounting for individual players is at “cost,” i.e., the price paid to sign the player. According to ueFA’s 2010 Club Licensing Benchmarking Report, when a player registration is sold, the sale price is compared with the remaining value (net book value) in the balance sheet and the difference taken as profit in the financial period during which the player is sold.

“the income part arising from these transfer accounting treatments is that each club will have a profit or loss when they sell a player in the accounting period of sale,” says the ueFA document. “the cost parts are the amortization or impairment charges from transfer signings made not just in the current year but also in previous years.”

DEPRECIATInG ASSETSjust like a business, a sportsperson possesses both tangible and intangible assets, with factors such as hand-eye coordination and natural talent coming under the latter heading. in fact, differentiating between players’ tangible and intangible assets is not as complicated as is assumed when it comes to financial reporting, says Kallapur. he explains that the club owns only the contract with the player, which gives them the right to exclude

The numbers game

Millions of people around the world watch major sports events, making the athletes who take part valuable

properties for advertisers and sponsors as well as their teams. But assessing that value on the balance sheet can be a complicated task, as Alex Miller and Lawrie Holmes explain


InspIraTIon: accounTInG In THE sporTInG World

“If a player has his career ended, he

no longer has an economic value” Mike Cheston, sports financial consultant

that player from appearing for other teams. “such rights are treated as intangible assets, just as a patent – which is a right to prevent others from making and selling a product – is an intangible asset,” he says. “At the club level, therefore, there is no distinction between players’ tangible and intangible talents.”

Another challenge is ensuring effective value depreciation of those assets over time and deciding how this is covered in an annual report. Kallapur says that, having originally recorded the players at cost, the club depreciates the cost over the contract period. “in addition, the club checks whether the players are impaired. if the worth of the player to the club is less than the depreciated cost, the player’s value is written down to its lower worth, and an impairment charge is recognized as an expense,” he explains.

InJURIES AnD SCAnDALSthe impairment takes into consideration two factors that make valuations in sport particularly volatile: injuries and scandals. “injuries are always a risk,” says Mike Cheston, a sports financial consultant and former head of Finance at Premier league soccer club everton. “if a player has his career ended, he no longer has an economic value, so clubs are forced to write off the value of the player – in the year it happens, or as soon as it is clear that the player is unable to continue playing, after medical investigations and so on.”

Otherwise, the cost of the player is written down over the length of the contract. “According to accounting convention, a player signed for €15m on a four-year contract will have a value of nil at the end of the contract. this written-down cost may not be reflective of the market value on the balance sheet date.”

But Vijay setlur, lecturer in sports Marketing at york university’s schulich school of Business in toronto, Canada,

says the area of reputational risk is the biggest threat to value (see panel, opposite). he cites the example of golfer tiger Woods, who was stripped of several lucrative sponsorship deals after a series of exposés of his private life. similarly, professional road cycling was badly affected by the Festina scandal in 1998, when one of the leading teams in the tour de France – the sport’s biggest event – was revealed to have been giving its cyclists performance-enhancing drugs. (Anti-doping measures are the responsibility of the international Cycling union.) More doping revelations have followed since, and, as a result, cycling teams have had to work harder than before to capture the large sponsorship deals they rely on.

“Both cases demonstrate the nervousness of sponsors when confronted with scandal,” says setlur. “relatively few players affect a club’s fortunes, and therefore its value,” adds Kallapur. “to that extent, reputational risks do have a greater impact on financial value in the sporting world. it is hard to find examples in the corporate world where a few people’s individual reputations have so much effect on corporate value.”

Of course, as far as sports clubs are concerned, the individual players are just one line on the balance sheet.

“It is hard to findexamples in the corporate world where a few people’s individual reputations have so much effect on

corporate value”Sanjay kallapur, Indian School of Business

InspIraTIon: accounTInG In THE sporTInG World


A cricketing scandalThe most prominent example in recent years of how reputational damage can affect the values of sports stars was the spot-fixing scandal that hit pakistan’s cricket team in 2010.

Three members of the team – salman butt (pictured), Mohammad asif and Mohammad amir – were accused of taking bribes from a bookmaker to underperform deliberately at certain times in the 4th Test match against England that year. The trio were found guilty and jailed in november 2011 (butt for 30 months, asif for a year and amir for six months), and subsequently banned for five years by the International cricket council.

This meant that their value on the balance sheets of their clubs (in pakistan and elsewhere – international cricketers often represent teams in more than one continent) fell to zero. The damage to their reputations also had personal repercussions; for example, the ban denies them the opportunity to play in the Indian premier league, where salaries start at us$20,000 fora season lasting less than two months.

The reputational damage was not limited to the individuals concerned. Even before the players had been convicted, reuters reported that boomboom, official kit supplier to the pakistan cricket board, was reviewing its contract and suspending its commercial relationship with amir.

“like everyone else in the cricket world, we are truly saddened and shocked by these match-fixing allegations. I sincerely hope they are not true,” said boomboom managing director ali Ehsan in september 2010. “[However] we cannot allow our brand to be associated with any whiff of corruption or suspicion of foul play.”

jan van der Geest of ernst & young in the Netherlands, a former member of the supervisory Board of Dutch soccer club NeC Nijmegen, says the valuation of a club is based on future cash flows. “it is essential to look at the total cash flows generated from all activities,” he explains. “these include, among other things, sales of players, attendance at the stadium, sponsorship arrangements, concessions, merchandise and catering sales, advertising contracts and media-related incomes.”

UnCERTAIn RETURnSBut he adds that the high risks involved, such as an insecure transfer market, mean discount rates can be as high as 20%-30%. “individual players may have a material impact on the cash flow, but there is a big uncertainty about returns. With the volatility of income, the idea that sports clubs can be run like other businesses is a big mistake,” he says. sports clubs can mitigate these uncertainties by developing a firm organizational structure around their activities; for example, in the areas of development of a thorough scouting system, training programs for young talent and, of course, building a strong relationship with supporters and business partners.

Kallapur agrees. “the financial risks are similar to those of the intangible assets in the corporate world – but there is a greater uncertainty about the relationship between costs paid and future benefits of intangible assets as compared to those of tangible assets,” he says.

For the spectator, the unpredictability of sport is one of its main attractions. But for those whose job it is to report on the value of those stars, unpredictability is a major headache. there can be few areas of business where an individual’s broken toe, or the revelation of an extramarital affair, can have such a damaging effect on the balance sheet.

Addressing governance

in the Middle eastDr. Henry Azzam, former Chairman and CEO of Deutsche Bank in the MENA

region, tells James Gavin about the challenges for corporate governance in this

rapidly changing part of the world

InforMaTIon: corporaTE GovErnancE In THE MIddlE EasT

Corporate governance is still largely a work in progress in the Middle east, says Dr. henry Azzam, former CeO of Deutsche Bank in the Middle east North Africa (MeNA) region, now an advisor to the bank. “these are developing countries that are in an early stage of development, and the regulators are still learning on the job,” he says.

Dr. Azzam has taken a close interest in the issue in a career that stretches back 30 years, much of it spent in senior positions at some of the region’s largest investment banks.

Although awareness of corporate governance has increased in boardrooms from the Gulf to the Maghreb in recent years, the learning curve is steep. As crises such as the defaults of two major saudi Arabian family conglomerates in 2009 illustrate, there is little room for complacency. two large saudi corporates ended up owing billions of dollars to creditors in a case that highlighted generally inadequate levels of scrutiny and disclosure among lenders and borrowers alike, particularly relating to family-run businesses. the scandal revealed more than us$20b of debts and reinforced the case for bolstering transparency and accountability in a corporate culture that has largely been dominated by family firms.

in saudi Arabia and beyond, cultural traditions have accentuated secrecy, rather than openness, in business life. Fortunately, the message from boardrooms and regulators alike is that attitudes are slowly changing, while governments are making a concerted push to raise standards of corporate governance and reporting.

“there’s a lot of hunger among companies that are at the beginning of the learning curve, but know there’s some urgency to do something about it,” says imelda Dunlop, executive Director of the Pearl initiative, a private sector-led not-for-profit organization set up in 2010 to improve transparency, accountability and business practices in the Arab world. “the dynamics of the region are leading to calls

for greater transparency generally, and the business community has a responsibility within that as well. that is a major regional driver behind this project.”

REGULATORY CHAnGEBetween 2005 and 2009, MeNA governments introduced 11 corporate governance codes, as well as specialized guidance for state-owned enterprises, banks and family-owned companies. According to an OeCD survey on corporate governance in the region, voluntary recommendations have, in some instances, been incorporated into regulatory and legal frameworks. For example, in egypt, board independence requirements first stipulated in the governance code were subsequently incorporated into the listing standards of the egyptian stock exchange.

since the start of 2012, saudi Arabia’s Capital Markets Authority has introduced a regulation that requires the boards of listed companies to include independent directors who are not shareholders. the listing rules now expressly provide that, in certain circumstances, an independent financial advisor and an independent legal advisor must be appointed.

Policy is shifting from the voluntary to the mandatory. For example, securities regulators in the uAe, saudi Arabia, jordan, Oman and Qatar all now insist that corporate disclosure complies with local corporate governance codes.

Disclosure frameworks are also being revamped. iFrs is now a required reporting standard for listed companies in Oman, while Morocco and saudi Arabia demand it for banks.

AREAS FOR IMPROVEMEnTAs a result of these developments, says Dr. Azzam, best practice is slowly seeping into the corporate fabric. “Companies and regulators are looking at what is done in the West and trying to copy the requirements here,” he explains. “Nevertheless, not all the reporting or governance is up to international standards. they are trying to get there, but we still


PROFILEDr. henry Azzam is currently an advisor for Deutsche Bank, having served as Chairman and, before that, as CeO of the MeNA region, until 31 March 2012. he has held many prominent roles in financial services in the Middle east over the past 30 years. until 2007, he was Chairman

and a board director of Dubai international Financial exchange. he is the author of five books on the region’s economy and capital markets, including The Arab World Facing the Challenge of the New Millennium. he holds a PhD in economics from the university of southern California and a BA and MA from the American university of Beirut.

“Companies and regulators are lookingat what is done in the West

and trying to copy the requirements here”Dr. Henry Azzam

see companies which, by the end of March 2012,had not published their 2011 results.”

More needs to be done to consolidate the improvements and sustain the pace of change. According to a joint survey by hawkamah (the Dubai-based institute for Corporate Governance) and the international Finance Corporation (iFC – the arm of the World Bank that encourages private sector development in developing countries), 42.3% of companies in the Middle east still combine the function of chairman and CeO, and only 25% of banks and listed firms provide information on their dividend policies online. just 12% provide online informationon key executives’ remuneration.

“Many companies still refuse to publish quarterly results that are as detailed as one would like them to be, and often they are only in Arabic,” adds Dr. Azzam. “if you’re talking about non-listed companies, forget it. if they don’t have to issue bonds, then they don’t have to publish any kind of results – so they don’t.”

As it stands, international companies active in the region are not directly affected by these issues. so long as they abide by the corporate governance standards in the jurisdictions within which they are domiciled, there is no real problem. Deutsche Bank, for instance, is listed on the Frankfurt and New york stock exchanges, so it abides by the governance standards in place there.

“in the case of branches of international banks, there are certain requirements relating to capital, and exposure to loans and to deposits, but other than that, it is more about the regulatory bodies in their respective countries,” adds Dr. Azzam.

BOARD COMPOSITIOnPressure continues to build on regulators and companies in the Middle east to strengthen standards.

One area of focus is improving board composition. Bringing in independent, non-executive directors to serve on boards has risen up the corporate governance agenda recently.

“the idea of independent board members is not yet common in the region,” Dr. Azzam explains. “Most companies have members on the board representing large shareholders, and they talk about the need for independent board members. the regulators talk about it more, but although they try to enforce it,it’s still not up to the level we need.”

even more critical is the need for truly independent regulators. “Now that we have capital market authority regulators in most Arab countries that supervise listed companies, these set out the rules and regulations. Most of them tend to abide by international best practice, but of course, it all depends on how well staffed these institutions are.For example, can they attract the best staff if theyare only paying public sector salaries?”

Giving regulators more power is particularly important. “i’ve been living here for the past 40 years, and only now am i seeing more authorities following up and making sure that things are put in place according to internationally followed norms.”

FAMILY BUSInESSESGovernance in family companies presents the most intractable challenge. encouraging family businesses – which dominate economic life in most Arab countries – to improve internal controls will take time. Most family-owned groups are only now taking the first steps toward institutionalization, as succession issues come to the surface. the hawkamah/iFC survey reveals that only half of listed family-owned enterprises have adopted a family constitution, while

InforMaTIon: corporaTE GovErnancE In THE MIddlE EasT

The importance of hawkamahraising corporate governance standards in the Middle East is a tough job, acknowledges dr. nasser saidi, executive director of Hawkamah, the Institute for corporate Governance.

“Hawkamah” actually means “corporate governance” in arabic, but the word has only emerged in the past 10 years. dr. saidi’s organization was formed seven years ago with a mission to promote corporate sector reform and good governance, in order to help countries in MEna and south East asia to develop sustainable corporate governance strategies adapted to national requirements and objectives.

The challenge is immense. In a region where state-owned enterprises (soEs) and family-owned businesses dominate, secrecy is a fact of business life. “There’s a culture of not wanting to lose face,” says dr. saidi, who is also the chief Economist at the dubai International financial centre authority. “If problems emerge, people tend to want to keep it within the company or the family. If there’s a financial problem, they try to deal with it with the banks behind closed doors.”

at the family business level, Hawkamah is encouraging the delegation of responsibility based on merit and not bloodline. one of the biggest issues is communicating the message that transparency and disclosure don’t just apply to listed companies. The shareholders in soEs and family firms all stand to gain from better standards of accountability.

so how does Hawkamah try to raise standards? “We’re here to fill the corporate governance gap,” says dr. saidi. “I like to think of us as not just a think tank, but a think and do tank.”

Hawkamah provides training, advice, technical assistance and advisory services to companies and regulators. according to dr. saidi, there is no “one-size-fits-all” solution to the region’s corporate governance challenge: “You can’t cut and paste a solution that suits everybody, or import solutions developed for advanced market economies.”

His organization works at two levels: the governance level, cooperating with regulators, state agencies and central banks to set up frameworks for supporting best practice; and the micro level, working to boost standards within companies and the implementation of good corporate governance practices, including via Hawkamah’s sister organization the Mudara Institute of directors, which focuses specifically on board-level issues and building capacity at the level of board directors.

one key challenge is to avoid corporate governance becoming a box-ticking exercise, where the principles and values of good corporate governance are not fully internalized.

bolstering corporate governance standards is a win-win for the Middle East’s business community. “We’re not attracting a lot of capital into this region,” says dr. saidi, “and the main reason is that foreign investors still see it as a risky place to do business. We’re not providing investors with the protection, transparency and disclosure they require. our aim as an organization is to make that happen.”

only 25% have family councils in place. three-quarters of family firms said that the majority of their board consisted of family members.

however, many of the larger family businesses have started forming boards and inviting independent board members onto them, and are generating audited financial results – even if they are not yet ready to publish these.

“i sit on the board of a family business where i am considered an independent board member, and i can see that proper governance sometimes works better than with listed companies,” says Dr. Azzam. “they are doing it at their own pace, but they are introducing proper governance measures.”

With most of the region’s governments having issued corporate governance codes, the challenge for the next few years is to support implementation. hawkamah’s Chief executive, Nasser saidi, identifies the next challenge for the region’s regulators as

supporting effective implementation of corporate governance in listed companies, especially in the areas of transparency and disclosure, board practices and risk management (see panel, right).

the Pearl initiative tries to spread the message about good governance and effective reporting by using best practice examples from both inside and outside the Middle east. “everything we do has to take the regional context into account – it has to be applicable, realistic and work in this part of the world,” explains imelda Dunlop. “take integrated reporting, where we are partnering with Accounting for sustainability, the Prince of Wales’s initiative in the uK. Building a framework for integrated reporting is still in its developmental stage, with no integrated reports being produced in the region, but there is strong interest.”

Overall, the message about corporate governance in the Middle east is that much has been done, but there is much still to do. “On paper we are there, but putting it into practice requires enforcement, implementation and follow-up, and this will take time,” says Dr. Azzam. “But we are on the right track.”


“We’re not attracting a lot of capital into this region, and the main reason is that foreign investors still see it as a risky place

to do business” Dr. nasser Saidi, Hawkamah

francis danielsis a director ofafrica opportunity partners (aop), the investment manager of africa opportunity fund ltd, an investment fund

listed on the aIM market of the london stock Exchange. He has more than a decade’s worth of investing experience in africa. born in Ghana, he moved to north america, where he trained as a lawyer before working at new York city firm Milbank, Tweed, Hadley & Mccloy. He moved into fund management and, in addition to aop, he is now a director of investment companies Ta Holdings ltd andMasawara plc.

The buyside

The signs and signals of investment opportunity vary from country to country across the continent – one cannot speak of “the African market” in that sense.

As a general proposition, in the case of companies other than natural resource companies, we do not like to pay a price-to-earnings multiple exceeding 11x for any African business. We also like our investments to have a high real return on assets, preferably matching, if not exceeding, the yield on local government debt.

these criteria substantially reduce the universe of investable companies at any given point. they force us off the beaten track. thus, we look at companies in small, ignored sectors, such as agriculture in Nigeria, or look at a market after it has declined sharply in value in us dollar terms.

that decline often emanates from the

collapse of that country’s currency. For example, the collapse of the egyptian and Kenyan markets last year created lots of interesting investment opportunities today. the disappearance of a currency, such as the Zimbabwe dollar, implies several years of investment opportunity in that country, because the cost of capital will be higher than it would be if the dollar had been retained.

CURREnCY DEPRECIATIOnWe worry about the probability of currency depreciation against major currencies such as the euro, the us dollar or the pound sterling. Another important signal is whether a country has foreign exchange controls. We prefer countries without those controls, such as Botswana, Zambia and Mauritius.

We also pay particular attention to drought, historical patterns of political

FRAnCIS DAnIELS, DIRECTOR OF AFRICA OPPORTUnITY PARTnERS, OUTLInES THE MAnY COMPLEx FACTORS THAT InFLUEnCE HIS InVESTMEnT FUnD’S DECISIOnS In AFRICA

Africandevelopments


InsIGHT: THE buY sIdE

succession and literacy levels. Drought can be a major source of macroeconomic turbulence in Africa. For example, one factor behind the weakening of the Kenyan shilling in 2011 was a drought that reduced its hydroelectric power, forcing Kenya to increase its diesel imports. since there is little irrigated land in Africa, we pay attention to rainfall patterns and water levels.

Military coups, as a form of political succession, have been prevalent in West Africa but almost absent from southern Africa. One has to ask whether this is a danger in a West African country in which one is investing. On the other hand, in southern Africa, one has to assess whether a company in the agricultural sector may be subject to a risk of land claims. Namibia, south Africa and Zimbabwe all face these issues as a result of their histories.

literacy levels are another challenge. For example, the speed at which data revenue becomes an important part of a telephone company’s income depends on this. senegal has significantly lower literacy than Kenya, so one cannot simply extrapolate from the rate at which data revenue is growing for a telecoms company in Kenya to a similar growth rate for one in senegal.

FACTORS TO COnSIDERWhen it comes to looking at individual countries, we like democracies that abide by the spirit of the rule of law and are genuine free societies, especially those with long traditions of peaceful elections, such as Mauritius and Botswana.

We also tend to look at the degree of control a government has over its economy. Countries that don’t possess their own central bank strike us as much safer than countries that do, because the lack of control of a central bank implies an

incapacity to create high levels of inflation. Zimbabwe, for instance, does not have a central bank. Consequently, the power of the Zimbabwean Government, regardless of the powers of its president, is much more constrained than it was during the Zimbabwe dollar era.

We also like countries with low inflation growth records; most of the French-speaking African countries come into this category.

As for industries, we prefer those that produce goods that are in short supply in Africa. that scarcity should be manifest in a high return on assets for the best companies in those industries, many of which are vital to the emergence of a modern, urban Africa.

Consumer finance is one such area. to reach the level of financial sector maturity of countries in the developed world, the African financial sector has to grow at a rate even faster than the respective national GDP growth rates. that is the only way, over time, for the services sector to become the largest sector in a typical African country. in turn, this implies that the best financial services companies will sport a high real return on assets.

ASSESSInG GROWTH POTEnTIALin the case of established companies, we pay great attention to their cash flow

statements. We tend to look at those first, then their balance sheets, and finally their income statements. We like to see financial statements that cover a period of at least five years, if possible, in order to get a sense of a company’s performance over cycles. We hope to see a pattern of free cash flow generation supported by high returns on assets.

yet that historical cash flow data does not constitute a linear guide to future possibilities. For example, rubber and palm oil trees both increase their yield in specific patterns based on their age. An investor should be aware of those patterns; otherwise, historical data from one stage of a plantation’s life can serve as an inaccurate guide to future production and revenue levels.

in the case of development companies, which are often found in the mining and oil and gas sectors in particular, forward-looking data is more important than historical financial statements. We tend to study technical reports and build financial models, based on anticipated production levels, for those kind of investments. n

to read Building bridges: Ernst & Young’s 2012 attractiveness survey – Africa,go to www.ey.com/ZA/en/issues/Business-environment/2012-Africa-attractiveness-survey

“In the case of development companies, forward-looking data is more important than historical

financial statements”

the johannesburg

stock exchange

Bridging the perception gapA recent report reveals that companies that have invested in Kazakhstan find it attractive, but there is still work to be done to persuade those that have yet to do so. Tim Turner reports

It may come as a surprise to learn that Kazakhstan was the third most rapidly growing economy in terms of annualized GDP growth between 2000 and 2010, according to ernst & young’s Rapid-Growth Markets Forecast – but it shouldn’t. the ninth-largest country in the world, with a land area greater than the whole of Western europe, Kazakhstan has vast natural resources and sits at the crossroads between russia, europe, the Middle east and China.

the importance of rapid-growth markets – which now account for 60% of the world’s population – to the global economy is rising steadily. statistics confirm that corporate commitments are growing: total foreign direct investment (FDi) inflows to rapid-growth markets make up 50% of the global total and have more than doubled, from us$210b in 2000 to us$445b in 2010.

Kazakhstan has been particularly successful at attracting FDi, partly as a result of its natural resources. “the exploration, mining and export of these resources has underpinned the strong economic growth that the country has enjoyed since its independence in 1991,” says lars Nyberg, President and CeO of telecoms company teliasonera, a long-term investor in Kazakhstan. “however, the country needs to diversify its economy.”

An ATTRACTIVE DESTInATIOnthe challenge for Kazakhstan, as revealed in a recent ernst & young report (Bridging the perception

gap: Ernst & Young’s 2012 attractiveness survey – Kazakhstan), is to persuade companies that have yet to invest there to do so. Among the established investors surveyed, 85% see it as the most attractive destination in the Commonwealth of independent states (Cis). in contrast, only 18% of companies that don’t yet operate in Kazakhstan share this view, which suggests that there is still a lot of work to do to persuade investors of the country’s attractiveness as a place to do business.

Despite their enthusiasm, existing investors do find the country’s business environment challenging. On the positive side, 44% of respondents said that labor costs in Kazakhstan are attractive for doing business. But this is undermined by a small technological skill base; 28% of investors say the country needs to develop highly skilled human capital, focusing on economic needs and innovation.

taxation is another issue where improvements are required. investors need sustainable tax planning, and 37% of respondents assess the overall tax burden as competitive. A few years ago, Kazakhstan

85%of companies that invest in kazakhstan see it as the most attractive destination in the cIs

kazakhstan fact fileLand area: 2.7 million square km (1.1 million square miles)Population: 16.7 million people at 1 December 2011Capital: Astana (737,650 people at 1 December 2011)Languages: Kazakh is the state language; russian is the official language and a means of interethnic communicationCurrency unit: Kazakhstani tenge (KZt)Inflation rate: 7.4% in 2011Current account balance (% of GDP): 9% by end sep 2011Sovereign credit ratings: standard & Poor’s: BBB+, stable; Fitch ratings: BBB, Positive; Moody’s: Baa2, stable


kazakhstan has a more robust legislative base than many other countries in the region. It welcomes best international practices and, during the 20 years of its independence, the country has demonstrated remarkable progress in implementing structural, economic and regulatory reforms.

but there is still room for improvement; people are concerned about the lack of transparency in the regulatory system and the inconsistent application of laws in different regions. compliance processes are burdensome, which contributes to the overall cost of doing business and causes frustration for some foreign investors in particular.

Tax reporting in kazakhstan is viewed as complicated. The reporting requirements are broadly the same as in many developed markets, but taxpayers are required to extensively support and document every transaction; otherwise, expenses will be disallowed for deduction and the tax authorities may ask for more documentation and follow up with questions.

The Government continues to work on streamlining the tax compliance system. for example, a tax reform is in the pipeline that will cut back on the number of different tax returns and forms that need to be filed regularly and introduce other measures to make the compliance system more user-friendly.

as for accounting standards, Ifrs was introduced back in 2006, although there are still certain smaller businesses that can follow kazakhstan accounting standards (which are mostly similar to Ifrs anyway). The transition was challenging, but contributed significantly to strengthening business transparency, developing the professions of accountant and financier and ensuring access for kazakhstan’s corporate sector to international capital markets.

Viewpoint

A robust legislative baseErlan Dosymbekov, Tax & Legal, Ernst & Young kazakhstan

introduced favorable tax rates in a number of areas; for example, the corporate income tax rate is 20%.

the compliance burden appears to be high, though. tax audits may be frequent and burdensome, and penalties are often disproportionate to the offense. the tax administration system is viewed as punitive, rather than focusing on prevention and taking a consultative approach with taxpayers. Moreover, some respondents feel that this system is lacking in technical objectivity and is selective when auditing specific companies.

AREAS FOR IMPROVEMEnTthe report identifies four key factors that investors see as necessary to enhance Kazakhstan’s attractiveness:• Developing a more transparent and predictable

regulatory environment: in particular, strengthening the independence of the court system would prevent charges of financial, political or other undue influence.

• Building quality infrastructure: 31% of investors would like to see more investment in infrastructure and urban projects to relieve bottlenecks in the Kazakhstani economy. this is crucial to reducing the cost of doing business and improving connectivity.

• improving professional, business and innovation skills: the state also needs to focus on stimulating the business environment, including enhancing the culture of entrepreneurship.

• implementing an FDi strategy, with a focus on diversification, investor attraction and retention: 23% of respondents would like to see Kazakhstan take a proactive approach to attracting investors.this diversification away from extractive industries is

under way. Although most respondents see industries such as oil and gas, and mining and minerals, as having the highest growth potential over the next three years, other sectors are beginning to emerge as attractive investment options. these include infrastructure, logistics, utilities, consumer products and real estate.

ultimately, a proactive FDi promotion strategy that helps the diversification of the economy by highlighting opportunities across sectors may be the key to bridging the perception gap and encouraging those who are yet

to invest in Kazakhstan to do so.

InforMaTIon: kazakHsTan

TaxingTax continues to be one of the hottest topics for boards, with the potential for increased media

attention on corporate tax payments to damage a company’s reputation. Lawrie Holmes reports

issues

The issue of how much tax companies pay has become one of the most controversial topics facing corporates the world over. Campaigners are locked in battle with companies over perceptions that tax avoidance is rife. For multinational businesses wrestling with varied tax regimes in many jurisdictions, the definition of how much tax should be paid, where it should be paid and when is not straightforward.

At the same time, individual tax authorities are becoming more robust in their enforcement practices as public finances are strained. As a result, the tax information provided in the annual report and interim statements is attracting more attention from a rangeof stakeholders.

the ability to meet the demands for openness made by tax campaigners and tax authorities is tempered for many large companies by the difficult task of gathering and presenting comparable tax information from across the world. Complexity is created by the large number of jurisdictions and different tax regulations involved for companies with integrated international operations. international guidelines and country legislation are also becoming more detailed, adding to the challenge.

Matthias Nnadi, an accounting lecturer at Cranfield school of Management in the uK, says this complexity has been on the increase as international accounting standards have taken hold. that applies to standardization on both current and deferred taxes as well as withholding taxes. “Another immediate tax implication of iFrs on corporate tax is that some items that ordinarily would have been treated as ‘off balance sheet’ are now being reflected on the balance sheet,” he says.

William Dantzler, head of law firm White & Case’s tax practice in the Americas, agrees that, despite calls for simplification, “there’s a lot of talk about it and no

action. For example, in the us, tax law is so complicated that it is very hard for the irs to enforce the law and for it to train its employees. its response to a perceived abuse is often to publish 10 pages of regulations.

“On top of this, the us is looking to implement a mini version of a general anti-avoidance rule (GAAr) called the economic substance Doctrine, under which a transaction must have an economic purpose aside from reduction of tax liability in order to be considered valid.”

InCREASInG InFORMATIOnMeanwhile, the amount of information companies have about their tax position is increasing as the collecting becomes more efficient in response to increasing tax risk across numerous tax regimes, according to Andrew lee, Global Director, tax Accounting and risk Advisory services at ernst & young.

“We are moving from a time when multinationals allowed their subsidiaries to deal with their own tax affairs to a more centralized function,” he says. “this allows companies to monitor and better understand the level of tax risk in different countries.”

the push for greater returns by tax collecting agencies has compelled companies to be more open about their tax strategies. the backdrop is the financial crisis that has forced governments’ tax collecting agencies to work harder to fill shrinking tax coffers by pursuing perceived tax avoiders. “since the financial crisis, we’ve seen a marked increase in the level of activity on tax regulation,” says lee. “We are seeing a more aggressive approach from tax authorities around the world.”

this approach means that companies that practicetax optimization across borders now have to weighup whether they risk ending up in court as a result, according to Bradley Phillips, a senior tax Partner at


sluG: XXXXXXXXXXX XXXXXXXXXXXInsIGHT: TaX rEporTInG

“When details are leaked, newspapers will often leap to the conclusion that any tax planning scheme is illegal, when that is often

not the case” Bradley Phillips, Herbert Smith

london-based law firm herbert smith. “litigation can be expensive and time-consuming,” he says. “Also, in the uK, hM revenue & Customs [hMrC] is displaying renewed vigor for fighting cases, so the chance of going to court is higher. Courts are tending to make more decisions in favor of hMrC, so the atmosphereis getting tougher in that respect.

“While there is an argument for enhancing shareholder value by using aggressive tax schemes and defending them in court, they may not pay off in the long run. reputational damage in the courts may, in the end, prove counter-productive.”

A COLLABORATIVE APPROACHthe world over, companies are finding that tax authorities are also demanding greater transparency from companies. this may be in the form of increased reporting requirements, such as the “uncertain tax Position” reporting now required in the us; while sometimes the demands are technology-based, such as the requirements of some tax authorities to provide data in standard electronic formats. Perhaps the biggest challenge for corporates is the growth in joint audits, where tax authorities in several countries share information from the same company.

A more collaborative approach between corporations and tax authorities could well become the trend, according to lee. some tax authorities provide the benefit of less extensive audits if companies implement tax control frameworks and make information available to tax authorities on a real-time basis, rather than only when audited. “the result is that companies are offering information about tax planning on an ongoing basis, where data is immediately available to authorities, in return for them being less intrusive,” he says.

Companies also seek to avoid controversy by completing “forensics” on their tax accounts before they become the focus of undue attention. Forensic accountants use accounting, auditing and investigative skills to look beyond the numbers and deal with the business reality of a situation, producing a detailed analysis that would be suitable for use in a court of law.

james Frederickson, Professor of Accounting at Melbourne Business school in Australia, says: “Forensic accounting could potentially be beneficial for identifying situations where prior tax decisions may look questionable, given the actual events that have occurred subsequent to the initial tax decision. What may have been quite justified, given the information available at the time of the decision,may look quite different with hindsight.”

But Dantzler is skeptical. “i don’t see companies undertaking self-audits ‘after the fact’,” he says. “that would be wasteful, because ‘after the fact’ forensic

Technology and tax reportingIn the past few years, there has been a drive toward real-time tax reporting that has been encouraged by tax authorities worldwide. The rationale is that the use of real-time information exchange in machine-readable form, using technologies such as Xbrl and automated analysis, is making tax auditing increasingly accurate and efficient.

It also creates the potential for governments to raise more corporate tax revenue, as reuven avi-Yonah and oz Halabi of the university of Michigan law school in the us argued in a paper last year.1 They said: “raising the income tax rates is politically difficult and may lead to further loss of jobs. In this political situation, it is important to try to find ways to raise more revenue without raising tax rates. one possibility of doing so is ‘real-time audit’: auditing transactions when they occur, rather than months or years later.”

The demand for real-time reporting is certainly there. “We have an environment where tax technology can really help, and we’ve had many companies wanting to centralize the finance function, which they can do through this technology,” says chris sanger, leaderof Ernst & Young’s Tax policy Group.

james frederickson of Melbourne business school adds that real-time reporting raises a whole host of ethical and legal issues. “It would allow tax officials to potentially match up accounts from different companies – say, a supplier and procurer,” he explains. “The technology would allow you to look at both companies’ sets of statements at the same time, which would then allow the authorities to better assess the appropriateness of how the companies accounted for certain items.”

1 Real Time Audit – It is the Time to Act? by reuven Avi-yonah and Oz halabi, published by university of Michigan law school, june 2011.

InsIGHT: TaX rEporTInG

Rules vs. principlesThere is a complex relationship between rules-based tax systems, where there is scope for finding gaps, and principles-based ones, where the need to comply or explain avoids the defense of acting “within the rules.”

“The financial reporting standards of the Iasb compared to those that apply in the us are a good example of the pros and cons of rules-based versus principles-based systems,” says james frederickson, professor of accounting at Melbourne business school. “but first, it is important to realize that, at their heart, all systems are principles-based. The issue is whether rules are provided to define, limit and control how the principles are applied in practice.

“The upside of rules-based systems is that they provide clearer guidance on what is and is not allowed,” he continues. “The implication is that with a rules-based tax system, there should be less second-guessing by the tax authorities of how the company treated a particular item. This is potentially a major problem with principles-based systems; there is less clarity for companies about what is and what is not acceptable, which increases the likelihood that they could be challenged by the tax authorities on certain issues. on the other hand, rules make it clear to companies what they need to do in order to achieve a desired tax treatment.”

frederickson argues that principles should be the guiding force because they indicate the spirit or intent of the regulation or standard. However, a principles-based system relies on managers acting ethically and following the spirit of the regulation, or on extensive enforcement to ensure that companies are not abusing the discretion inherent with the system.

William dantzler of law firm White & case explains that the us system is particularly complicated. “We have an intrinsically rules-based provision, but overlaid are judicial principles that trump rules-based decisions,” he says. “so when we’re planning, we have to jump through both hoops. We have to ensure that we have complied with rules, but also be confident that we are consistent with the principles. That then becomes an expensive and complex burden on our clients.”

audits are costly. All that is achieved is picking up ‘below the radar’ information. i don’t think we’re even seeing forensic audits for those companies that are being scrutinized in the press over their tax matters.”

nEGATIVE PUBLICITYPublic concerns about the amount of tax companies are paying – concerns that are often played out in the media – can be damaging. legally permissible tax efficiency is sometimes conflated with immoral tax avoidance and leads to unfavorable press coverage, says Phillips.

“A lot of focus has recently been on companies’ reported tax paid compared to profits,” he explains. “But the number given is only an amount of tax paid, rather than revealing what the companies are actually up to in terms of how they operate and plan their tax affairs. so when details are leaked, newspapers will often leap to the conclusion that any tax planning scheme is illegal, when that is often not the case.”

lee says that rising tax activism, and increasing numbers of questions about the amount of tax companies actually pay, are leading to calls for more extensive tax disclosure by public companies. “One response is for companies to increase the amountof information about taxes paid in individual countries,” says Phillips.

Given the amount of attention this topic is now receiving, companies are having to take a considered view about how much detail they include in the annual report about the amount of tax they have paid. tim steel of ernst & young’s international tax practice says that, while there is enthusiasm for adding detail, there are also problems with this approach.

“there will be a wider set of stakeholders than just shareholders interested in the annual report,” he says. “But are you going to put more detail in? lots of extra information, without much more detail on the context, could mean far greater scope for misinterpretation. And too much detail means that the message gets lost. this would undermine the intention.”

it seems that, for the time being, what tax information should go into the annual report will remain a subject for debate.

“Since the financial crisis, we’ve seen a marked increase in the level of activity on

tax regulation” Andrew Lee, Ernst & Young


Do you have subsidiaries? Do

you have interests in other entities

(including structured entities) that are

not currently being consolidated?

Consolidation(IFRS 10, IAS 27)

Disclosure of interests in other entities(IFRS 12)

Fair value measurement (IFRS 13)

Employee benefits(IAS 19)

Joint arrangements (IFRS 11, IAS 28)

Broader definition of “control” may result in changes to a consolidated group on transition to iFrs 10.

extensive qualitative and quantitative disclosures of interests held in other entities and how control is determined.

Applying the new principles on determining fair value may lead to changes in fair values of assets and liabilities, thereby impacting financial statements.

For defined benefit plans: higher balance sheet volatility in some cases; P&l no longer reflects expected return on plan assets; actuarial movements permanently bypass the P&l; revised disclosures on inherent risk and uncertainties.

Considerable change for those currently applying the proportionate consolidation method.May change accounting for arrangements previously classified as “jointly controlled entities.”

• Comprehensive understanding of the investors’ rights and exposure; and the investee purpose and design

• Procedures and internal controls to identify and assesscontrolled entities

• input from business units, legal and other departments

• Additional procedures and changes to information system to gather information for new disclosures

• examining how fair value is determined and disclosure information recorded and assessing whether additional valuation expertiseis needed

• Assessment of communication with stakeholders and discussions with actuaries

• Additional procedures and actuarial information for therevised disclosures

• significant judgement on existing arrangements to assess whether joint control exists and to confirm correct classification as a “joint venture” or a “joint operation”

IFRS changes for 2013 and beyondBelow is a snapshot of the new iFrs standards, amendments and interpretations that are effective for reporting periods beginning from 1 january 2013 and that ongoing iFrs preparers need to address in the next few months, if they have not done so already.

Do you have joint arrangements? (More prevalent in insurance, oil

and gas, real estate, power

and utilities, and pharmaceuticals)

Do you have interests in structured entities?

Do you measure assets or liabilities at fair value or provide

fair value disclosures? (More prevalent in real estate entities, financial servicesand agriculture)

Do you have defined benefit plans or other

categories of employee

benefits?

EFFECTIVE 1 JAnUARY 2013

XXXXXXXXXXX

Do you incur stripping costs for your mines during

the production phase?


Production stripping costs in mining(IFRIC 20)

Offsetting financial instruments(IAS 32 Amendment)

Classification and measurement of financial instruments(IFRS 9)

Disclosures of financial instrument-offsetting(IFRS 7 Amendment)

A change to accounting for production phase stripping costs may impact when costs are capitalized and subsequently expensed.the life-of-mine strip ratio may no longer be acceptable, especially for large and complex mines.

May change financial assets and liabilities eligible fornet presentation.May impact leverage ratios and regulatory capital requirements.

Change in the measurement and presentation of many financial instruments depending on their purpose and nature.impact of changes in own credit risk on financial liabilities designated as at fair value, no longer reflected in the P&l.(iFrs 9 is currently subject to potential amendment. Further, new hedge accounting and impairment requirements are under development.)

Additional disclosure requires information for evaluating the effectof netting arrangements and collateral.

• Potential changes to processes for tracking of actual cost at appropriate level of detail

• Assessment of the capitalization criteria and appropriate depreciation method

• Potential review of settlement procedures and legal documentation to ensure that offsetting is still possible

• judgment, including assessment of the business model and the characteristics of contractual cash flows

• Potential modification of management information systems and related internal controls, including the linkage of credit systems to accounting systems

• immediate gathering of information for 2012 and 2013 reporting, including the interims for comparatives

New iFrs pronouncement

trigger questions Key financial statement impact

Assessing process impact requires …

this snapshot includes new iFrs standards, amendments and interpretations (pronouncements) in issue at 30 April 2012 that are required to be adopted for years commencing on

1 january 2013 and beyond by an ongoing iFrs preparer. these pages highlight some of the general implications of these pronouncements. Companies should refer to the relevant

literature to make a full assessment of the impact on their financial statements. Our publication IFRS Update of standards and interpretations 31 March 2012 provides a complete list of

the new iFrs pronouncements, along with an overview of the requirements. Our iFrs publications can be accessed at www.ey.com/ifrs

Do you have netting arrangements for financial assets and liabilities?

(Primarily financial institutions)

Do you have netting arrangements for financial assets and liabilities?

(Primarily financial institutions)

Do you hold financial

instruments?



InforMaTIon: nEW Ifrs sTandards

PHIL HODkInSOn, A nOn-ExECUTIVE DIRECTOR OF BT GROUP PLC, OUTLInES THE AREAS WHERE HE SEES ROOM FOR IMPROVEMEnT In CORPORATE REPORTInG AnD GOVERnAnCE

Mywish list

RISk AnD DISCLOSUREthe most important thing on my wish list is to see a continuation of the recent positive trends in the areas of risk and disclosure. Annual reports today, compared with five years ago, are much more specific about the risks facing companies. Alongside that, companies have begun to provide better disclosure on the sensitivity of their financial results to some of the key judgments and assumptions that underpin those results.

i’d hope to see that continue, with reports improving to include each of the key risks that the business feels is critical to its success, and then the directors estimating the sensitivityof the company’s results if those risks wereto be realized.

CELEBRATInG BEST PRACTICEi would like to see companies that improve the reporting of their performance get plaudits for doing so. that there are awards for this is a good thing, and commentators are increasingly praising best practice, which is encouraging.

Progress will need careful stewardship from regulators: in my view, when enough companies have adopted best practice, it’s only fair that regulators and policy-makers then insist on all companies meeting those standards. that combination of carrot and stick works extremely well, and should carry on.

LET COMPAnIES LEAD THE WAYWhen regulation has failed to have the desired impact in the past, it has usually been the consequence of it being introduced before companies have had a chance to road test what’s required. it’s much better when companies are allowed to show how it can be done, to demonstrate what works and what doesn’t. Doing that proves to everyone that it

can be done, and regulators are right then to demand best practice of all companies.

THE LIMITS OF TECHnOLOGYtechnology has undoubtedly made telling a company’s story easier, and there’s now no physical reason why you can’t tell all your stakeholders the same story at the same time using video/teleconferencing and similar tools.

While this speed of information flow is helpful, the key issue is that shareholders and markets still want to make their investment decisions based on interactions with management. technology certainly makes it easier to communicate, but it doesn’t replace the need for that dialogue to take place.

MARGInALIzInG nOn-ExECSthe guidelines on how non-execs should work within companies have helped by setting a clearer view of what’s expected of them. But over the past three or four years, it’s become increasingly evident that some influential people and bodies outside the boardroom still have a poor understanding of what non-execs and audit committees in particular do and don’t do – and it’s remarkable that this lack of understanding is still present among those who make a noise about what good corporate governance should be like.

there has been talk recently of those that engage with the board – external auditors and regulators, for instance – reporting directly to shareholders, rather than to the board for its consideration and, if appropriate, inclusion in its onward communication to shareholders. to me, that undermines the role of non-executives, and the board generally. After all, the board has been elected to run the company, so demanding that those from outside provide separate reports to investors suggests that the board cannot be trusted or relied upon. that’s not healthy. n

Profilephil Hodkinson is a non-Executive director of bT Group plc. He has been on the uk telecom company’s board since february 2006, and was chairman of the audit & risk committee until the start of this year. He is also the chair of the Equality of access board and a member of the nominating & Governance committee, the committee for sustainable & responsible business, and the pension scheme performance review Group. In addition, he is a non-Executive director ofHM revenue & customs, Travelex, resolution and business in the community. prior to his retirement, his roles included Group finance director of Hbos, chairman of Insight Investment and clerical Medical, and chief Executive of zurich life and Eagle star life. He is a fellow of the Institute of actuaries.

MY WIsH lIsT: pHIl HodkInson

Welcome to Issue 3 of Reporting – Ernst & Young’s international magazine that is designed to bring together a range of insights and ideas that will interest business executives involved in

communicating their organization’s performance to diverse, geographically spread stakeholders.

As we go to press, the oppressive and continual instability in global financial markets, and the slowing growth in virtually all business sectors, provide a harsh backdrop for corporations around the world.

Front of mind is, of course, the banking sector providing the liquidity business needs. That there were some failures in regulation of the sector is widely accepted. Going forward, there is a broader principle at stake: we accept the need for stronger governance, but should it be proactive or protective? How can it be engineered on a global scale, given that contagion since 2008 has illustrated starkly the irrelevance of national borders? On p14, Brooke Masters examines the impact of financial services regulation in more detail from her perspective as Chief Regulation Correspondent on the Financial Times.

In the last few years’ turmoil, the accountancy profession has also been criticized. In a recent speech on sovereign debt to the IFAC (International Federation of Accountants), Ernst & Young’s Chairman James Turley pointed out that rules create incentives, and incentives drive behavior. The proliferation of stocks in the dot.com era aligned workers’ interests to investors’, but also led to short-term price increases to drive personal wealth. Compensation and bonus systems incentivized traders to create larger and larger profits for the banks, but neglected to factor in longer-term risk. Prior to the introduction of international accounting standards, many benefits, such as workers’ pensions, were not included on the P&L, so in the US, the steel companies, airlines and automotive industry stored up future costs – which eventually destroyed them.

Our view is that accounting standards – and the continuous efforts of the standard-setters to improve them – play a key role in providing transparency on the long-term impact of business decisions, and the governance and accountability for those decisions. On p32, we summarize the changes to business combinations under IFRS that are designed to improve the clarity on control and liabilities in complex corporate entities.

In the context of the sovereign debt crisis, a key area of focus is public sector accounting. In our current rule set, elections and budgetary cycles incentivize governments to concentrate on short-term reporting. They often lack the processes and systems to take stock of the assets and liabilities they hold. Governments are taking decisions regarding allocation of resources that will have an impact for years to come, with limited discussion of, or disclosure on, the long-term consequences. Governments, bond markets and investors need better information to make investment decisions. Adopting international accounting principles and improving the transparency in government accounting should, as has happened with business, support better government decision-making, improve the confidence of stakeholders and contribute to long-term fiscal stabilityand economic growth. You can watch highlights of James Turley’s speech on ey.com/government

Our article on accounting for sports (p16) takes a different perspective on accounting for intangibles in a sector where valuation of assets and forecasting returns can be highly volatile.

We hope you find Issue 3 a stimulating read – please send us your comments via www.ey.com/reportingmagazine/feedback. Your views will be very welcome.

CHRISTIAn MOUILLOnChristian Mouillon is the Global Vice Chair of Assurance at Ernst & Young

ernst & youngAssurance | tax | transactions | Advisory

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this publication contains information in summary form and is therefore intended for general guidance only. it is not intended to be a substitute for detailed research or the exercise of professional judgment. Neither eyGM limited nor any other member of the global ernst & young organization can accept any responsibility for loss occasioned to any person acting or refraining from action as a result of any material in this publication. On any specific matter, reference should be made to the appropriate advisor.

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publIcaTIons

EUROzOnE FORECASTOur latest forecast predicts a 0.6% drop in Eurozone GDP this year and the slowest recovery from recession since the 1970s. Shareholders, lenders and analysts all over the world are asking management teams what the Eurozone crisis

means for them. The report discusses the issues affecting governments and businesses and responds to questions senior executives are asking about risks and opportunities.ey.com/eurozone

HOW SHOULD BUSInESS APPROACH CARBOn nEUTRALITY? THE SOLUTIOnS AnD BEnEFITSIn what scenarios does going carbon neutral make sense for a business? Our paper looks at the issues and some case studies of

how businesses have approached this question.ey.com/sustainability

TURn RISkS AnD OPPORTUnITIES InTO RESULTS: ExPLORInG THE TOP 10 RISkS AnD OPPORTUnITIES FOR GLOBAL ORGAnIzATIOnSMarket volatility, pricing pressures, variations in market performance and demanding stakeholders have all contributed to a global economy that encourages competitive drive. With that drive comes opportunity. For that reason, this year’s business risk report looks at both the top 10 business risks and the top 10 business opportunities.ey.com/top10challenges

FInAnCIAL REPORTInG BRIEFInGSErnst & Young hosts the annual Financial Reporting Outlook conference in London on Monday, 5 november 2012. Reporting readers have the opportunity to register at a discounted cost of

£300 (normally £695). Sign up for the event on financialreportingoutlook.com and use the promotional code REPORT.

means for the . The report discusses the issues

how businesses have approached this question

How should business approach carbon neutrality?The solutions and benefits

13582 EY Carbon Neutrality_v9.indd 2 06/06/2012 15:50

£300 (normally £695). Sign up for the event on

Financial Reporting Outlook 2012

Monday, 5 November 2012Park Plaza Westminster Bridge, London

Recent publications from Ernst & Young

Culture Shock: A Business Handbook for Radical Changeby Will McInnes (Wiley, August 2012)Fueled by advancing technology and a volatile global economy, business has changed profoundly. But most organizations remain closed, secretive, conservative and deeply hierarchical. social business pioneer Will Mcinnes argues that it’s time to burn up the old and start something new, and maps out ways to create a radical and uplifting work culture.

Good Strategy/Bad Strategy:The Difference and Why It Mattersby Richard Rumelt (Profile Books, paperback June 2012)Back in 1972, rumelt was the first person to uncover a statistical link between corporate strategy and profitability. he dispels popular misconceptions by showing that a good strategy focuses on the challenges a business faces, and provides an insightful new approach for overcoming them.

Sleeping with your Smartphone: How to Break the 24/7 Habit and Change the Way You Workby Leslie A. Perlow (Harvard Business Review Press,May 2012)ethnographer Perlow delves into the new, connected world of work and challenges the notion that you must be constantly plugged in to be successful. her research suggests that this 24/7 mentality is actually counterproductive. she recommends a radical yet simple idea: take “disconnected” time off and both individual and team members will benefit.

on the shelfnew and recently published books

For webcasts, podcasts and the latestupdates on IFRS, visit ey.com/IFRS

... and more

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Steering Group

Ernst & Young Assurance Leaders

Christian Mouillon, Global Vice Chair, AssuranceDon Zimmerman, Assurance servicesFelice Friedman, Director, Global Public PolicyPhilippe Peuch-lestrade, Assurance servicesr. Balachander, Assurance Markets leader, indiarichard Wilson, Assurance servicesruth Picker, Global leader, iFrs services, Global Professional Practicestephane Kherroubi, Financial Accounting Advisory services leader, eMeiAWarmolt Prins, Assurance Markets leader, eMeiA

eMeiA – Felice PersicoAmericas – tom houghAsia-Pacific – Clive saundersonjapan – yasunobu Furukawa


ReportingA new generation will

soon change our world. Understand what this

means for yours.

Rapid-growth markets are on the cusp of a consumer revolution. The number of middle-class households in China will grow from 1.6m in 2010 to 26m by 2020. To understand how demographic change might help your business to bloom, read the Summer 2012 Rapid-Growth Markets Forecast at emergingmarkets.ey.com.

See More | Opportunity

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It’s more than the numbers issue three | july 2012

Diversity in the boardroomWhy it’s important for boards to be open to different points of view

Addressing governanceThe challenges facing companies in the Middle East

How do sports clubs account for the ever-changing value of their stars?

The numbers game

Documents

Reporting: Issue 3 - ey.comFILE/... · statistical link between corporate strategy and profitability. he dispels popular misconceptions by showing that a good strategy focuses on