From 2005, all quoted companies in the European Union must prepare their consolidated accounts in accordance with the International Accounting Standards. This is no easy task if one bears in mind the work involved in switching over to new systems and changing internal processes – not to mention the higher costs that come with this. The EU directive could put banks under particular pressure, since their reporting procedures are very strictly regulated. The implementation of standards IAS 32 and IAS 39, which relate to the valuation of financial instruments, are particularly critical for such enterprises. Many companies in the USA are finding it difficult to comply with FAS 133, the US equivalent of IAS 39. This is due primarily to software problems.
Risk Magazine reports that financial managers of many US companies are complaining that the software currently available does not meet the requirements of the new reporting standard. The software vendors counter this claim by insisting that the constant changes to FAS 133 are making it difficult to develop suitable software.
Strict Reporting Standards
FAS 133 contains strict and complex reporting standards for derivatives. This essentially means that companies must perform a mark-to-market valuation for derivative contracts, showing these as assets or liabilities in their balance sheets. Profits and losses are shown in the result for the current period. IAS 39 places similar demands on European companies, while IAS 32 deals with presentation and disclosure provisions relating to interpretation and disclosures. Given the size and complexity of their derivative portfolios, it is vital that banks implement the regulations correctly.
IAS standardizes financial statements of different companies for different regions in order to provide a basis for comparison. This can be expected to intensify the global trade in securities, encourage mergers and international acquisitions and facilitate financing – all of which are good news for banks. Set against this, however, they will need to employ a completely new approach in future when calculating their earnings position if they are to comply with the latest bookkeeping, valuation and collateral requirements. The reporting and controlling processes must be adapted to the new standards. This means that banks must switch over their software and hardware as well as their internal administration processes and train their staff accordingly. All this requires considerable investment, but is essential in order to ensure that companies are stable and profitable.
Introducing IAS in 2003
Banks do not have very much time left to prepare for IAS – the new standards come into force in 2005. The first financial statements based on IAS will need to be prepared as early as 2004, since the standards for the first financial statement, which is due in 2005, must use comparative figures from the preceding year. This means that the introduction of IAS must be completed by 2003.
Banks can either develop the appropriate software themselves or choose stand-alone systems. However, such solutions may not necessarily fit the bill and may not be the most cost-effective solution over the long term. Banks should therefore view their system requirements for IAS in the context of their business management processes. The market perspective of the bank’s financial transactions means that an IAS solution will be an integral part of the bank’s corporate management in the future. This is a fact that needs to be taken into account when structuring the bookkeeping and controlling systems.
Drawing Up Consolidated Financial Statements
The EU guidelines, for example, require quoted companies to prepare financial reports at consolidated level which conform with the IAS standard – this is a tremendous challenge in terms of systems and software. An IAS solution must be able to generate financial reports for independent units which can then be integrated into the consolidated statements. This requires multilingual software and automated processes such as consolidating of investments, inter-unit elimination and currency translation within the group. At the same time, redundant processes in the live systems must be avoided in order to ensure consistent results. To ensure that existing live systems do not need to be converted, IAS accounts, for example, should be calculated in a central IAS subledger which can be used to satisfy all reporting requirements for the balance sheet and accompanying notes.
On a practical level, this means that an IAS solution must be based on a central database that uses standardized methods to generate an IAS result on an extremely detailed level, namely the individual transaction level. Starting from a set of individual accounts, IAS compliant accounts and hedges are calculated for the IAS-relevant business transactions. To avoid profit and loss fluctuations, the IAS solution must meet hedge accounting requirements.
Adaptable SAP Solutions
Through linking an IAS solution for the individual company with the group consolidation, banks are able to draw up IAS-compliant consolidated accounts and thereby meet EU regulations. SAP provides one such solution. However, this is not the only requirement that banks’ bookkeeping systems need to meet in the future. An IAS solution needs to be future-focused and scaleable, since it is apparent even today that the International Accounting Standards are set to undergo continuous development. The IASB has announced additional changes to IAS 39 for 2003. It must therefore be possible to adapt the software at all times to the latest statutory regulations. Furthermore, IAS software must have an extensive range of functions and be easy to use.
Development processes that are well underway long before the new arrangements come into effect give banks the opportunity to familiarize themselves with the IAS solution, to test it and to prepare the implementation process. Feedback from users shows that SAP is able to incorporate changes and thereby ensure the required level of functionality and quality. Ongoing cooperation between SAP and the banks is essential in order to be able to incorporate the latest statutory changes at any one time.
“SAP is committed to help us meet the legislative demands ahead the time, thereby easing the pressure of IAS deadlines”, emphasizes Uwe von Knoblauch, head of Central Accounting at the Landesbank Rheinland-Pfalz in Mainz, whose organization is actively involved in SAP’s IAS pilot project.
Implementing IAS and Basel II Side By Side
However, Europe’s banks find themselves confronted by more than just the new international balance sheet regulations. They also have to comply with Basel II, the new international agreement covering equity capital, which is expected to come into force in 2006. Basel II essentially only applies for international banks at the current time, but the EU is working on a directive that will make it mandatory for all banks within the EU to comply with the new international agreement.
A comprehensive, sophisticated IAS solution will help banks satisfy both these requirements. It needs to be based on a central data pool of financial instruments which, on the one hand, supports management of IAS data and, on the other, supports the valuations – for example capital calculations – required by Basel II. To achieve such synergies, it is important that the software packages for IAS and Basel II are based on the same architecture. “We selected SAP because it offers solutions for both Basel II and IAS based on a common financial database, providing consistent data and methods that create consistent results”, explains Udo Mehrens, Deputy IT Manager of the Hamburgische Landesbank, who is also participating in the pilot project.
There is still plenty of time for the banks to prepare for IAS. The IAS solution can be implemented within the required timeframe. Ensuring the quality of the IAS concept and the methods deriving from this and reducing the development risk during the implementation process are both essential criteria for the quality of the solution as a whole. Close cooperation with proven consulting partners is vital for ensuring implementation of the very highest standard.
The IAS and Basel II solution from SAP is being developed in conjunction with business consultants from IBM Business Consulting Services and BearingPoint (quality assurance) and banks who have already pledged to continue their active participation in the future development of the software.