Financial Accounting in 2008: A look at the important emerging trends

The worldwide trend towards international financial standards

After Thomas L. Friedman's The World Is Flat came out in 2005, it became a bestseller in North America, Europe, Asia and other parts of the world as well. No member of the global village, it seemed, could deny the fact that "the world is flat". And "flatness", in Friedman's sense, is not restricted to economic activity, as it also applies to the financial accounting field: Financial accounting standards in countries the world over are headed towards global unification.

Recent years have seen nearly every country's financial accounting standards begin to align step-by-gradual-step with international accounting standards (i.e., International Financial Reporting Standards, or IFRS). As early as 2005, the European Union began requiring all its member states to adopt IFRS, with Australia, Hong Kong and South Africa quickly following suit. Brazil is expected to adopt IFRS beginning in 2010, and Canada, Japan, South Korea and India will do so in 2011. Altogether, 102 countries have now adopted IFRS, and by 2011 the number is expected to grow to 150. Even the United States – the behemoth of global capital markets – decided in November 2007 to allow foreign-registered companies to begin using IFRS to compile financial statements for U.S. financial reporting purposes.

Expensing stock-based compensation: a big step in Taiwan's alignment with international accounting standards

Taiwan's government has taken a very active interest in, and put much emphasis on, alignment of local financial accounting standards with international standards, and in 2008 it will take a great stride towards that goal when it implements expensing of stock options and other equity-based compensation. Past accounting treatment of stock-based compensation viewed it as part of earnings distributions, and employee remuneration costs were not properly reflected in income statements. Companies that issue employee bonuses in the form of stock will no longer use face value to calculate the number of shares they can issue for employee profit sharing and bonuses; instead they will use fair value (which for publicly listed companies is the closing price on the last day of the accounting year, factoring in ex-rights/ex dividend effects, and for unlisted companies is net value). Implementing this new system in Taiwan will affect all industries at every level, but the impact will be greatest on the high tech industry.

Apart from the impact on corporations through financial statement bottom lines, one of the deepest effects will be on employee income, which stands to shrink by large amounts, with an especially large impact among companies with high stock prices that have been using employee stock-based profit-sharing to reward employees. In order to dampen the impact of the new system on employee retention, the Securities and Futures Bureau has formulated a set of complimentary measures to loosen restrictions on stock options issued by listed (or yet-to-be-listed companies): The subscription price may be below the market price (or net value per share); and shares redeemed by listed companies may be transferred to employees at a price below the average redemption price.

The Accounting Research and Development Foundation of the ROC (ARDF) has been timely in promulgating new accounting standards – Statement of Financial Accounting Standards No. 39 "Share-based Payment" (SFAS 39) – which follows IFRS 2 closely and became effective January 1 2008. Under SFAS 39, all plans using corporate equity products to reward employees can, in principle, apply fair value to recognize them as employee compensation cost. Examples include transfers of treasury stock to employees, issuing employee stock options, carrying out a capital increase under the Company Law and retaining 10~15% for subscription by employees, and major shareholders placing stock in trust and transferring trust earnings to employees.

Staying abreast of international trends means gradually adopting consolidated financial statements as the principal means of reporting financial information.

If you look at the regulations on financial statements in effect in major countries around the world, you find that most give priority to "consolidated financial reports". Taiwan, on the other hand, constrained by Company Law regulations, puts the main emphasis on corporations' separate financial statements, supplemented by consolidated statements. Listed companies are required to file separate financial statements on a quarterly basis, and before 2008 they needed to file consolidated statements only in the second and final quarters. Given that Taiwanese companies have increasingly adopted the diversified conglomerate business model, the Financial Supervisory Commission has ruled (Directive No. 0960034217 dated July 9 2007) that listed companies must additionally file consolidated financial statements in the first and third quarters, beginning in 2008. This was done to allow a better understanding of corporations' financial conditions and business results, and in general to strengthen the transparency of financial information.

Also, to strengthen the timeliness of financial information by shortening the "open window" period for making financial information public, the Commission has drafted an amendment to Article 36 of the Securities Exchange Act that reduces the time companies can wait to file annual financial reports from four months after the end of the year to three months. The amendment is currently awaiting passage.

The method used to value inventories will be the lower of cost and net realizable value, as opposed to the lower of cost and market, and comparisons will be done on an item-by-item basis.

An amendment to Taiwan's accounting standards on the treatment of inventories (Statement of Financial Accounting Standards No. 10 "Inventories") was approved in 2007, for implementation beginning January 1 2009 although it may be applied before that date. The amended standards follow IAS 2 "Inventories", with the main changes being that the last-in, first-out (LIFO) method will be scrapped in favor of other methods. In so doing, inventory cost must be recalculated along with the cumulative effect of changes in accounting principles, but it is not necessary to redo prior-year accounting statements. Valuation of inventories will drop the lower-of-cost-and-market method in favor of lower of cost and net realizable value, and comparisons will be done on an item-by-item basis.

Few businesses have adopted LIFO in practice, so dropping it is expected to have a narrow impact. The impact from using lower of cost and net realizable value is expected to be broader, however, because when companies at present compare which is lower, the cost of inventory or its market value, most do so by comparing total amounts. Losses on some products may be offset by gains on others, so that one can reduce or avoid recognized losses. Adopting an item-by-item approach, as long as individual items have lower net realizable values than costs, losses must be recognized. As a result, recognized losses are expected to be higher when comparisons are done on an item-by-item basis.

New standards on the accounting treatment of insurance contracts

In October 2007, the ARDF issued an "International Accounting Standards Alignment Plan", the strategy behind which is to establish dynamic targets following the working plans of the IASB (International Accounting Standards Board). The ARDF plan calls for completion, by 2010, of amendments based on IFRS 4, 6 and 8, and IAS 40 and 41. The portions of current standards that differ from IFRS will be revised accordingly based on the results of convergence plans involving the IASB and the U.S. Financial Accounting Standards Board (FASB).

The ARDF's plans for 2008 include formulating and issuing SFAS 40 "Standards for the Accounting Treatment of Insurance Contracts" based on IFRS 4 "Insurance Contracts", and revising SFAS 34 "Financial Instruments: Recognition and Measurement". These revisions are expected to take effect in 2009. Due to the diverse nature of insurance accounting treatments in practice, there are no clear-cut relevant standards, either internationally or in the U.S. For this reason, the IASB has been laboring since 1997 to promote the establishment of insurance accounting standards.

However, the scope and complexity of the subject are such that the IASB decided to divide the plan into two stages. The first stage went into effect on January 1 2005, but the IASB is still soliciting opinions on the second stage, and application may be put off until 2011. As a result, the insurance contract-related standards being drawn up in Taiwan for application next year (2009) will be determined with reference to the first stage version of IFRS 4, which primarily gives accounting standards for classifying, recognizing and valuing insurance policies, and information on insurance policy-related values that insurers must disclose, as their significance warrants recognition and explication in financial statements.

Since the applicability of first-stage IFRS 4 rules is based on whether enterprises have issued financial instruments in connection with insurance contracts, it is not limited only to the insurance industry. If a company issues financial products in connection with the terms of an insurance contract, then there is no getting around the new rules, especially where disclosure of insurance contract-related information is concerned.

Revision of standards on treatment of financial instruments, including application of "original loans and receivables"

Revision of SFAS 34 "Financial Instruments: Recognition and Measurement" is expected to include "original loans and receivables" that had not come under the original statement's scope of application. "Original loans and receivables" had been excluded to dampen the impact of applying SFAS 34 to the financial industry. In the interest of harmonization with international accounting standards, the revision reduces differences in the accounting treatment of those items originally excluded. Consequently, where financial industry firms, and in particular those in the banking industry, have claims whose collection is doubtful, they will not be able to recognize bad debt losses according to their own accounting estimate policies. Instead, they will need to estimate impairment based on SFAS 34 rules. This change is expected to affect how financial reporting is expressed, so corporations need to decide in advance how best to respond.

Revision of "Criteria Governing Information to be Published in Annual Reports of Public Companies" to increase transparency of executive compensation

In addition to the revisions being made in financial accounting standards, the information that listed companies need to make public in their annual reports is being revised as follows:

• Strengthening information on senior executive compensation: In order to promote sound governance, and in particular to encourage corporations to set reasonable levels of compensation for directors, supervisors, general managers and deputy general managers, the transparency of compensation-related information is to be strengthened by gradually bringing the current voluntary disclosure approach under mandatory disclosure rules. Hence, the disclosure method will be revised in favor of a summary disclosure with names matched to compensation level intervals, and companies will be encouraged to adopt disaggregated disclosures on named individuals.
  
  
• Strengthening information disclosure on relationships between the top ten shareholders by shareholding percentages: To strengthen information disclosure, firms will be additionally required to disclose information on familial relationships (first- and second-degree relatives, etc.) on the ten largest non-corporate shareholders.
  
  
• Strengthening information disclosure on the benefits of private placements: Information openness will be used to allow the investing public to assess the effects of private placements. Information disclosure will be strengthened so that shareholders can examine the effects of private placements, increasing the transparency of information on the execution of private placement initiatives.