IFRS – Importance for Analysts and Investors IBS, Hyderabad
AGENDA Agenda
Overview of IFRS Key points for investors Live examples to highlight importance of understanding IFRS Accounting differences – Impact on multiples Mitigating accounting differences Moving to IFRS – Impact on share prices
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Overview of IFRS •
Stands for International Financial Reporting Standards
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The IASB is the independent standard-setting body
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IASB Objective - To develop a single set of high quality, understandable, enforceable and globally accepted international financial reporting standards (IFRSs)
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Currently there are 9 IFRS, 29 IAS and 29 interpretations
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Developing standards
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IFRS across globe
Towards one set of global accounting standards
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Why important to understand IFRS Top 10 Global Capital Markets US
US GAAP – moving towards IFRS
Japan
Convergence to IFRS
UK
IFRS
France
IFRS
Canada
Convergence to IFRS
Germany
IFRS
Hong Kong
HKFRS (equivalent to IFRS)
Spain
IFRS
Switzerland
IFRS or US GAAP
Australia
AIFRS (equivalent to IFRS)
AGENDA Agenda
Overview of IFRS Key points for investors Live examples to highlight importance of understanding IFRS Accounting differences – Impact on multiples Mitigating accounting differences Moving to IFRS – Impact on share prices
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Some key points for investors (1/2) Accounting policy choices – Impairs comparability
IFRS is principle based standard and offers accounting policy choices to companies.
Accounting policy choices are offered in financial instruments, property plant and equipment, investment property, joint ventures etc
Income statement - Cognizance of certain gains/losses
Gain on bargain purchase is recorded in income statement under IFRS. This is a one time gain and not operating in nature.
Unrealized gains/losses due to fair value changes is recorded in income statement for certain financial instruments.
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Some key points for investors (2/2) Management judgement/estimates – Infuses subjectivity
IFRS does not allow goodwill amortization. The same has to be tested for impairment. This brings in subjectivity from management.
Fair value estimation
OCI– To be reviewed for income statement impact
Analysts/investors should look both the income statement and other comprehensive income (OCI) when forecasting future cash flows. Some portion of income/loss recognized in OCI is recycled back to income statement in future years.
AGENDA Agenda
Overview of IFRS Key points for investors Live examples to highlight importance of understanding IFRS Accounting differences – Impact on multiples Mitigating accounting differences Moving to IFRS – Impact on share prices
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Example 1  Accounting requirement to fair value the remaining investment in case of loss of control. (Moving from consolidation to equity method of accounting)  Please refer the case of Bezeq
Bezeq Press Release
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Example 2  Accounting requirement to measure the own debt at fair value  For accounting purposes, Banks values its issued debt (e.g. bond issues) at the current market price. Changes in this value are recorded in profit or loss. FV of own debt
Example 3 EY research findings (Real Estate)
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More than 90% of the surveyed companies have adopted the fair value option available in IAS 40 for the measurement of their investment properties 57% of the companies have disclosed the assumptions applied in valuation of investment property 40% of the companies did not disclose information on impairment testing Of those companies that have joint ventures (82%), 42% apply the equity method and 58% apply the proportionate consolidation method. This suggests that, with the forthcoming changes under the new standard Joint Arrangements (IFRS 11), we may expect some changes in accounting, e.g., changes from proportionate consolidation to equity accounting.
Report of one of leading Investment Bank pointed out the management subjectivity in impairment testing
AGENDA Agenda
Overview of IFRS Key points for investors Live examples to highlight importance of understanding IFRS Accounting differences – Impact on multiples Mitigating accounting differences Moving to IFRS – Impact on share prices
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Accounting differences – Impact on multiples
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Consider two identical companies with 20 of goodwill on the balance sheet and 10 in pre-goodwill profit. Company A does not amortise goodwill while Company B amortises over 10 years (amortisation of 2 per year). (Assume share price of 200) Will this impact the multiples?????
Since both companies have identical cash earnings they have the same value and should trade at the same share price (same number of shares assumed). This implies an earnings multiple of 25x for Company B. But it clearly would be wrong to conclude that Company A is cheaper than Company B. In fact, there is no information content whatsoever in the difference between the two multiples.
AGENDA Agenda
Overview of IFRS Key points for investors Live examples to highlight importance of understanding IFRS Accounting differences – Impact on multiples Mitigating accounting differences Moving to IFRS – Impact on share prices
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Mitigating accounting differences (1/2) Restate accounting data to a common format Depreciation – Can be largely unrelated to the economic consumption of the asset. Factor maintenance capex to mitigate these differences for cross-border equity analysis Goodwill Impairment – Exposed to subjectivity by management. Consider an earning number before impairment Leases – Operating leases currently are shown off balance sheet. Capitalization of operating lease required for analysis purpose Income from associated – Should be considered as Non Core income for arriving at core EBITDA Exceptional items – Should be excluded from EBIT/EBITDA for analysis purposes
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Mitigating accounting differences (2/2) Focus on key statistics less affected by Accounting differences Focus on cash flows when comparing companies instead of earning metrics Comparing revenues (Still limitations will be there, not a preferred approach) Using EBITDA – Has become the most common measure of performance (Ignores Capex and taxation)
Using OpFCF – Modified version of EBITDA (EBITDA – Maintenance Capex)
‘Maintenance capex’ is the amount an analyst estimates must be spent on fixed assets to maintain the profitability and competitive position of the company in real terms.
AGENDA Agenda
Overview of IFRS Key points for investors Live examples to highlight importance of understanding IFRS Accounting differences – Impact on multiples Mitigating accounting differences Moving to IFRS – Impact on share prices
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Moving to IFRS – Impact on share prices Convergence to IFRS will result in changes in the reported numbers be they revenues, costs, assets and/or liabilities. New disclosures, changes in measurement and clearer performance and risk measures all potentially impact valuations. IFRS can also impact cash flows that can impact the DCF valuation, e.g. change in accounting policy for revenue recognition. IFRS can impact cost of capital if new disclosures changes investor perception for a company and the same getting reflected in investor’s required rate of return.
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Moving to IFRS – Impact on share prices “Changing accounting standards to better reflect economic reality, is like buying a new pair of glasses to see the world around you. Just as new glasses can change your view of the world, a change in accounting standards impacts perception of economic transactions. Although you know that the world has not actually changed, it might be that you are better able to read signs with a new pair of accounting glasses”
Source: UBS