Bank finance articles and tips

As a result of the financial crisis and in a bid to improve transparency, the International Accounting Standards Board ("IASB") recently issued new standards to improve guidance on Off Balance Sheet activities. If material, these may impact the analysis of company risk, lending and investment decisions.

The changes mean that whilst an entity may remain the same in name, its accounting composition could differ. Assets and liabilities that were previously off balance sheet may be brought on balance sheet whereas other interests that used to be consolidated may now only be shown as a net investment if they do not meet new criteria. Changed levels of debt would mean that covenant calculations and test levels may need to be reviewed and forecasts redrawn. Consequently, regular review of borrowers, clients and investments remains key.

Standards must be implemented at the latest for periods starting on or after 1 January 2013 but as they can be applied now a clear understanding is imperative. A summary is detailed below:

IFRS 10 Consolidated Financial Statements states that control is the key factor in determining consolidation. Control is essentially power over an entity and most particularly the power to change any amounts received in returns from that entity. Factors impacting power include the size of holding, spread of holdings, whether other shareholders are passive and whether the entity is controlled by rights other than voting rights. Consequently, even if ownership is less than 50%, an entity could still be controlled if a shareholder can come to an agreement with other shareholders or has potential voting rights.

The new standard provides a much clearer definition of control (than previous standards) and provides more guidance in circumstances when control is difficult to assess. It also states that if there is no clear conclusion of control then it is deemed that no control exists.

This standard is likely to affect specific sectors such as private equity funds, asset managers and financial services including insurance companies which may need to consolidate the funds/assets they manage if they are deemed to be principals as opposed to agents notwithstanding any special purpose vehicle.

IFRS 11 Joint Arrangements - A joint arrangement exists where two or more parties contractually agree to share control but the new standard focuses on the rights/obligations of an arrangement rather than its legal form.

Joint arrangements can either be joint operations or joint ventures. In a joint operation a company has direct rights to the individual assets, liabilities and revenue of the operation and recognises these directly in its accounts. A joint venturer, however, only has rights to the net assets/profit/loss of the venture and consequently, these remain off balance sheet with its interest shown as an investment through a single line in the Profit and Loss and Balance Sheet.

Proportionate consolidation is no longer an option for JVs which should reduce inconsistencies - historically most French and Spanish companies opted for proportionate consolidation whereas UK and German companies generally showed JV interests as an investment.

So who is likely to be affected? Sectors where joint arrangements are common such as real estate, construction, mining and extraction and those using joint arrangements to mitigate risk as they expandtheir market offering and geographic reach. The indirect impact of this may be that deal structures may be adjusted.

In conclusion, as the accounting composition of entities may change going forward risk may also change impacting lending and investment decisions. Consequently, ongoing review remains key.

Delphine Paterson is an independent consultant at Forward Financials specialising in building bespoke financial models for businesses, whether for forecasting or other management purposes, and writing analytical/due diligence reports. Her background as a banker, accountant and city analyst enables her to take a commercial viewpoint to provide businesses with the tools they need to move forward. She is currently helping investors, entrepreneurs, SME's and larger companies in the South East of England. http://www.forwardfinancials.co.uk

By Delphine Paterson
Article Source: http://EzineArticles.com/?expert=Delphine_Paterson