One lesson to be learned from one of three early case histories under Europe's new International Financial Reporting Standards is that the system will most probably hit long-established companies with heavy exposure to pension liabilities.

Take the ICI Group, a British specialty chemical and paint firm. Working on a pro forma basis under IFRS rules, this former bulk chemicals manufacturing giant found itself having to recognize a post-retirement benefit liability of around $2.3 billion.

Under U.K. generally accepted accounting principles, on the other hand, the matter can be dealt with simply, with footnotes on the annual report. The net effect of transition to IFRS - which came into effect for Europe's 7,000 publicly traded companies on Jan. 1 - is a large negative adjustment in shareholder funds.

In fact, this brings the consolidated group balance of the various operating companies into negative equity. The firm's heavy pension liabilities for its many former workers give some parallels with General Motors, Ford, Legacy Airlines and other large U.S. firms.

For ICI Group plc, the holding company, to be permitted to pay dividends, it has to have retained earnings. In practice, the operating companies pay the dividend to the parent, which does have considerable reserves. It can therefore continue to pay out to the shareholders. But there may be other listed companies across the EU where a similar exposure to pension liabilities could not be dealt with nonchalantly.

Aside from any relevance to American investors in European stocks, the early indications do have another interest. This results from the continuing efforts being made by the London-based International Accounting Standards Board and the U.S. Financial Accounting Standards Board to strive to achieve "convergence."

The obvious implication of the convergence approach is that it could, in a year or two or so, put many American companies in the same position as ICI.

Investors might also note that while the exposure to pensions liability might look terrible, the reality is that the figure is partly due to the current very low interest rates - although not as low as in the U.S. This is more relevant in the EU than it would be in the U.S. In Europe, under IFRS, future liabilities have to be covered by capital reserves, calculated at current interest rates. Higher interest rates, possible in the future, would correspondingly reduce the liabilities.

Here there is a contrast with the U.S. regulations. These overcome the European volatility by adopting a cushion that spreads the pension burden into the future. The same can also be possible under IFRS, but the British company decided not to use the spread option under a deferral scheme, taken out of U.S. rules. Evidently, it thought it more prudent to take the pension impact as a single blow to the chin. It might have had in mind that the IFRS spread option is coming up for review in a year or so, and is likely to disappear under the IFRS rules.

A quite different lesson arises from another of the three case histories, which were all drawn from the U.K.

Vodafone Group plc, the mobile telephone company with a $175 billion market capitalization, would see the transition from U.K. GAAP to IFRS transform an operating loss of $3 billion to an operating profit of approaching $12 billion.

That rise, which is whopping by any standard, applies on a pro forma basis to the six-month period to Sept. 30, 2004. Ken Hydon, financial director of Vodafone, stated that the most significant change with the transition is through the relief of amortizing goodwill.

The goodwill came on to the books via the takeover of Mannesmann's D2 mobile phone company, which is the largest private mobile phone network in Germany, and other acquisitions. Perhaps not surprisingly, Hydon commended IFRS as resulting in a clearer presentation of underlying business performance.

Vodafone is preparing for the adoption of IFRS as its primary accounting basis for the year ending March 31, 2006.

The more things change ...

The third of the triumvirate of examples of firms that have been testing the temperature of the IFRS water is the Anglo-Swedish pharmaceutical group AstraZeneca. It had sales in 2004 totaling $21.4 billion (45 percent in the U.S., 36 percent in Europe), and an operating profit of $4.8 billion under U.K. GAAP.

Its IFRS figures can be taken back to 2003, but for 2004 its operating profit came to a very similar $4.5 billion under IFRS. Earnings per share for the year are $2.28, with a slight setback to $2.18 under IFRS.

This factor could be typical, as IFRS tends to book slightly higher charges. For any change in net assets, one has to look to the fifth decimal place to find any difference in the round-figure, of $14.5 billion. It is the one company in the three test cases not to see a significant move on its operating profits under IFRS. In fact, the majority of companies in the EU are expected to fall into the same general category as AstraZeneca - that is, showing little overall change.

Overall, the deduction from the above-mentioned trio of examples is to expect reporting sunshine under the IFRS regime if the company has made recent acquisitions involving goodwill.

Correspondingly, one could expect bad news if the company could have heavy pension liabilities. This would be especially so if the pensions are defined benefits, as they would be at many of the U.K.'s longer- established firms.

Otherwise, for most companies, the step over to IFRS would not see much change.

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