Financial Reporting Standards (FRS’s) were without exception framed in expansionary times. While the content dealt with accounting issues relevant to both growth and Recession, the subsequent application of the accounting principles by the Financial Accountant usually dealt only with the challenges that the Celtic Tiger brought.
E.g.

• Provisions required to dampen excessive growth 
  
• Revaluations of Fixed assets to reflect bulging surpluses and support new borrowings. 
  
• Recognition of Pension Fund surpluses in the host entity’s financial statements. 
  
• Valuation of dubious Intangible assets on the Balance Sheet.
  
• The in-definite deferral of Goodwill amortisation.
  
• Recognition of Share Options granted to top employees as an expense in the financial statements. 
  
• “Front loading” of Revenue in service & technological start ups

The Financial Director was largely overlooked.

The Board operated in a highly leveraged environment where analysts and financial institutions were only concerned with Turnover and Growth.
Balance Sheets were irrelevant, loan covenants rarely mattered and working capital ratios ignored.

Accounting Policies were dictated by the needs of Investment Bankers (The Celtic Tiger’s equivalent of the used car salesman)

How the Wheel has turned!
 
Welcome back the Financial Director to pick up the pieces! The accountant’s opinion is now once again highly valued at the boardroom table.

Radical Surgery of the Financial Statements is required.

Attention must revert back to the Balance Sheet.

The Profit & Loss account must deliver and losses seen for what they are rather than a “platform” for future growth.

Cash-flow statements will be the “primary financial report” rather than a poor third.

The Accountant now needs a new set of skills and experiences. The FRS’s need to be revisited to investigate the areas that deal with the downturn and the emerging upturn

How do the FRS’s deal with these new problems?

Some of the key questions that need to be addressed include:

When do we recognise provisions for anticipated losses and liabilities? When can we provide for planned restructures? How do we deal with impairment losses on previously revalued properties? What do we do with Over-valued acquisitions, which have lead to bloated Intangibles and Goodwill on the Balance Sheet.

The list is endless - - -

Project 2009 - Clean up the Balance Sheet!

The stakeholders expect bad news in 2009 with a tentative return to better days in 2010. Accountants should take an up-front approach and recognise all the problems in 2009.

Clean up the Balance Sheet and start 2010 with a clean slate whereby steady sustainable profits can be reported in the future

Fortunately, the FRS’s deal with all these issues in great detail and provide comprehensive answers to the problems arising.

FRS 12 -”Provisions” is the main standard bearer. It is entirely consistent with International Standards and  subsequent FRS’s refer to it to justify their selected principles.

Future Operating Losses
FRS 12 is clear that it is not permissible to recognise “Future Operating losses” until they are incurred. However, such anticipated losses may indicate an “Impairment of Assets” and the related write-downs can be made at the Balance Sheet date (thereby achieving the desired result).

Restructuring Provisions
Restructuring Provisions are allowed in advance where there is a clear obligation by the year-end to complete the Restructuring. This obligation is reflected in a comprehensive plan, approved by the board and communicated to the effected parties. There must be a valid expectation that the “Restructuring” will be completed in a reasonable timeframe.

Plan the restructuring now and get it agreed by the Board and the employees before year-end. Make adequate provision in 2009 accounts.

Provisions for Onerous Contracts
Is the company committed to any onerous contracts? Is it renting vacant properties or idle plant & equipment?

If so, provide for the net future losses over the life of the contract in 2009 under “provisions for Onerous Contracts in FRS 12”

FRS 11 – Impairment of  Fixed Asset Carrying Values
Take a fresh look at carrying values in the Balance Sheet. Are the values impaired? Is the recoverable amount of the asset less than the current Carrying Value?

Impairment Losses on Fixed assets (tangible & intangible) can be first written off against related Revaluation Reserves and additional losses written off in the Profit & Loss account.

Subsequent depreciation of Fixed Assets and amortisation of Intangibles will be based on the reduced carrying values.

FRS-17 Company Pension Schemes
FRS 17 highlights the risks attached to Defined Benefit Schemes. Such schemes are not feasible going forward. Companies need to address this problem by freezing any new entrants into existing schemes and/or by closing existing schemes and transferring existing employees to Defined Contribution Schemes. (Prior service entitlements protected).

FRS- 20 Share Options
Given the recent stock market performance, existing share options may no longer act as an incentive for retaining & motivating staff. Such options may need to be revisited and the “execution price revised”
This may result in an extra cost in the Profit & Loss account, the additional cost being amortised over the remaining vesting period.

However, it may have a positive effect on cash flows as key employees are retained in the business.

FRS-25 Financial Assets & Financial Liabilities
Cost of funds was rarely lower. However, nothing is more certain than Interest Rates will rise again as mainland Europe recovers & Banks need to replenish their Balance Sheets through retained profits.

Companies need to look at hedging their interest rate exposure by utilising Interest rate caps or swaps rather than fixing their existing facilities with their bank, thereby losing the benefit of their tracker borrowings.

These derivatives will have an intrinsic value, which will be recognised in the Financial Statements and revalued annually.

FRS 10- Goodwill
Companies who took advantage of FRS 10 and omitted to amortise Goodwill are now facing large Impairment losses.

Revisit this Accounting Policy and commence annual amortisation on the “slimmed down” Goodwill.

FRS 1 Cash-flow Statements
Accountants should spend time interpreting the Cash-flow statement. Additional notes may be required to enable the user to understand the inflows and outflows. Cash-flow statements prepared on the traditional “Direct Method” may be far more useful than the current favoured “Indirect method” which involves convenient netting off of different cash streams.

The list is endless - - - -

Conclusion.
The need for strong expert financial advice was never greater as the challenges facing companies are numerous.
With challenges come an equal number of opportunities.
The accountant should now re-familiarise himself with the Financial Reporting Standards and lead his organisation into this new era.

“We do this not because it is easy, but because it is hard” John F. Kennedy 1962

Christy Kearney

Christy is a Fellow of the Institute of Chartered Accountants.  He is currently a self-employed business consultant and was previously a financial controller of a large multi-national company in Cork.

Christy will be presenting the “Financial Accounting – Trouble Shooter Workshop” in Cork on 18 November, Dublin 19 November and Galway on 20 November 2009.  Click here for further details. To book a seat at this event please contact Sinead Keating at: 059 91 83888.