The tension between commerce and regulators is as old as humanity itself.
People naturally resist being told how to do things and when it comes to running their businesses, when serious money is on the line, this is especially so.
One of the key requirements for good regulation is transparency. If a regulator is to assess an industry fairly and accurately, and govern it, it must have access to information. But this has become increasingly difficult as financial borders blur under a rapid globalisation.
Political pressure for regulators to move away from their light-touch approach and become more stringent after the financial meltdown has also increased the urgency for commonality at the very core of how companies are run — their reporting.
The International Accounting Standards Council developed a set of accounting standards to assist developing countries and over time the more developed countries themselves began adopting common international reporting standards that suited the cross-border trade developing within the newly formed European Union. But, at the same time, the United States developed its own set of reporting standards.
The introduction of the Sarbanes Oxley Act, after the corporate and accounting scandals of companies such as Enron and Worldcom, placed some fairly restrictive reporting requirements on companies operating in the US. Although the purpose of this act was ultimately to increase financial disclosure, many global companies shied away from the US as an investment region because of its somewhat onerous requirements.
Ever mindful of the need to attract money across its borders, the US finally agreed to leave behind its Generally Accepted Accounting Principles (GAAP) and move towards the more common International Financial Reporting Standards (IFRS). This accounting convergence has picked up momentum and in September last year the Group of 20 countries called on international accounting bodies to complete their convergence projects by June 2011.
The good news for South African companies is that we have always been ahead of the adoption curve when it comes to accounting standards. We were one of the first countries to adopt IFRS and have been reasonably comfortable in reaching global compliance. But this does not mean that everyone is completely satisfied with our reporting methodologies.
‘The biggest problem is the extent of change. New requirements are constantly being added to an already complex set of accounting standards,” says Garth Coppin, national director of accounting at Ernst & Young. Coppin is also deeply sceptical about the South African predilection for using headline earnings as a measurement tool.
Some companies, in addition to JSE requirements, publish alternatives to headline earnings, an example of which is normalised headline earnings. And therein lies the rub for Coppin. He believes that there is too much that can be arbitrarily written off, including once-off costs of a bad acquisition.
‘Headline earnings is just one measure, but it is not intended to be a measure of sustainable earnings. While it may be less volatile than fair value, you will struggle to find a senior technical partner who will be in favour of it.”
Coppin says that this fixation with headline earnings means we are also using this measurement to work out price/earnings ratios, which places us outside the global norms and could lead to confusion for foreign investors.
Globally, p/e ratios are based on profit after tax, not on headline earnings. Like it or not, we need some measurement tools to assess a company’s performance. A quick look at today’s financial statements shows just how many variables are at play.
Auditors and analysts alike admit that statements are now just too long to read all the way through and they seek common measurement tools to make their assessments.
But what if there was a magical translator we could apply to the financial gobbledygook spewed out by companies? What if there was a numerical Babel Fish we could use to see company reports in a language we all understood?
Well, if we are to believe the über-geeks who understand both coding and accounting, there is. Extensible Business Reporting Language (XBRL) is a version of Extensible Markup Language (XML) defined to meet the requirements of business and financial information. By applying unique identifying tags to information data items, XBRL shows how these items relate to each other and allows data to be extracted, searched and analysed.
Graham Terry, senior executive strategy and thought leadership at the South African Institute of Chartered Accountants (Saica) and chairperson of XBRL South Africa, says this powerful new language will allow for greater transparency and ultimately less regulatory interference.
‘XBRL is one of the most powerful tools we have at our disposal when it comes to transparency. The JSE and the FSB [Financial Services Board] are both working with it and we will see it become a standard programming requirement for electronic reporting soon,” says Terry. Adoption of XBRL has been slow and some reports of its integrity have been less than flattering.
A 2009 study by North Carolina State University to evaluate the accuracy of XBRL in 22 companies taking part in a US Securities and Exchange Commission voluntary assessment found that there were still errors in signs, commands, labelling and classification. But these bugs seem to have been ironed out and the commission requires all companies to be using XBRL by the end of the year.
Terry says the implications of using XBRL will probably not even be felt by many smaller South African companies, as most software companies are working it into their existing functionality.
‘XBRL is certainly on our agenda. Open standard software languages like XBRL are great tools for companies in the payroll software world. As an integral part of the reporting chain, payroll must be compliant and compatible with global standards. Fortunately, South Africa has always been exceptionally innovative and open to change and I expect many companies will be up and running on XBRL systems well ahead of any regulatory requirements,” says James McKerrell, chairman of the South African Payroll Association.
Global regulators are looking for ways to make accounting convergence simpler and quicker. Experience has shown that allowing firms too much leeway can lead to boundaries not only being pushed but also mangled and tossed aside.
But despite the age-old tensions between commerce and lawmakers, political meddling and resistance from states such as China, convergence will happen. We can also be sure that, given South Africa’s reputation as an early adopter, other countries will be keeping an eye on us to see how we fare under the new reporting regime.