The Continent was gripped by the hottest summer on record this year.

Temperatures soared and as Europe enjoyed better weather than the Caribbean, the heat wave soon became a source of tragedy as it took its toll on the frail and the old, and forest fires took lives and caused hundreds of thousands of euros worth of damage.

However, in the world of accounting the heat wave will not be the only reason that this summer will go down in history. Temperatures were rising across Europe before the heat wave struck, as debates over adoption of International Financial Reporting Standards became increasingly intense.

Although the European Union will not adopt IFRS for its listed companies until January 2005, European companies must begin to implement IFRS at the beginning of the fiscal year in 2004 if they are to have comparable financial reports for the official adoption deadline. As Accountancy went to press last month the International Accounting Standards Board had made new proposals in an attempt to find solutions to the problems of the summer.

However, it is clear that at the moment a smooth transition to International Accounting Standards in 2004 cannot be guaranteed.

During the summer months the IASB received criticism from all quarters.

Its uneasy relationship with Europe's financial services industry reached a climax when the European Commission's Accounting Regulatory Committee decided to adopt 38 of the IASB's core 40 standards, rejecting the IASB's two financial instruments standards,

IAS 32 and IAS 39. In a remarkable development French president Jacques Chirac weighed into the argument over financial instruments. Usually it takes an economic disaster for a head of state to take notice of accounting issues. What made this development so unusual was that the head of a European country was attempting to influence the debate on standard-setting, one of the most arcane aspects of accounting.

Letter to Prodi

Chirac wrote to the EC president, Romano Prodi, urging a review of the EC's mechanism for approving accounting standards. Though the letter was not made public, it was leaked to Reuters. It was widely reported that Chirac told Prodi that the IASB is writing standards that threaten not only the stability of European companies but also the stability of the European economy.

Antoine Bracchi, chairman of the French Accounting Standards Board, says that the French banking sector felt it had the most to lose over the IASB's initial proposals on hedge accounting because it is conventional in France for banks to lend at fixed rates of interest. Bracchi says that under the IASB's initial proposals on hedge accounting French banks would have been particularly vulnerable to national and international interest rate fluctuations. Small German banks and mortgage lenders in the UK would have been affected in the same way, while the banking community across Europe had numerous other problems with the hedging proposals.

The debate over financial instruments has become politicised throughout the EU. At a meeting of the EU Council of Economics and Finance Ministers (the Ecofin council) in July, EU member states' finance ministers asked the European Commission to 'request the IASB to continue its dialogue with representatives of European industries in order to find a satisfactory and timely solution for the revised

IAS 32 and IAS 39' Accountancy, September, p95).

IASB chairman Sir David Tweedie welcomed the ARC's decision to endorse 38 of his standards, saying that the decision to postpone adoption of

IAS 32 and IAS 39 came as no surprise. 'It makes sense because although a number of the standards are not quite complete, they are in a final draft stage, whereas financial instruments are still very much in a state of flux.'

Concern over disagreements

Publicly, EC internal market commissioner Frits Bolkestein welcomed the adoption of the 38 standards as 'crucial to the Financial Services Action Plan', which is the EU's programme for creating a European capital market that can rival the US. However, in a leaked letter written to Tweedie prior to the ARC decision, Bolkestein expressed concern that discussions on financial instruments had not resulted in agreement between the IASB the banking and insurance sectors.

Bolkestein was referring to the IASB's two financial instruments standards, and the board's proposal for a temporary standard on accounting for insurance contracts. Subsequently the latest amendments to

IAS 32 and IAS 39 and an exposure draft on a temporary insurance contracts standard ('phase 1') have been put out for comment (see boxes). However, throughout the spring and the summer the IASB was criticised by the banking community in Europe and the international insurance industry for not following due process and failing to consult with its constituents.

In his letter to Tweedie, Bolkestein said it would be difficult for the EU to endorse more IASs in the future, unless the IASB's standard-setting process becomes more open to, and inclusive of, constituents. According to Bracchi, there is a feeling amongst some elements of the EU business community that they could replace

IAS 32 and IAS 39 with the US GAAP standard on derivatives, FAS 133, if the IASB's changes to the financial instruments standards are not acceptable.

Karel van Hulle, EC head of financial information and company law, said the problems between the IASB and the financial sector were complicating the move towards IAS adoption in Europe, but dismissed them as inevitable teething problems, saying that he remains optimistic that all 40 standards will have been adopted by March 2004. However, a source close to the EC commenting on Chirac's intervention said: 'When a head of state gets involved in something as esoteric as accounting standards it shows that something has gone seriously wrong.'

Tweedie denied that the board is writing impractical standards and that it is failing to communicate with its constituents, saying: 'What do you think we've been doing with the banks on macro-hedging? We've spent eight months reworking this standard, making practical amendments.' Tweedie added: 'We're trying to get an intellectual argument, we're not interested in political threats and posturing.'

Nevertheless, the IASB's board of trustees is taking seriously allegations that the standard-setter has become an 'ivory tower', cut off from business realities. Under the IASB's constitution, its trustees must set up a review of its activities every three years, with the first review scheduled for March 2004. The trustees have decided to begin the review early in response to the events of the summer.

Learning process

The board and its constituents are going through a learning process according to Saskia Slomp, technical director of the European accounting association, Federation des Experts Comptables Europeens (FEE). FEE is going to make suggestions to the IASB on the ways to improve its approach to consulting with its constituents. In March the board held a series of roundtables so that constituents could talk about

IAS 32 and IAS 39 face to face with the board. Slomp says it would be helpful if the board were to hold more roundtables, or public hearings on issues where wider socio-economic impacts are anticipated, such as share-based payments, pension accounting and performance reporting. 'At the moment, the meetings are open, but you can only listen,' says Slomp.

Bracchi, says the IASB, made a mistake in dismissing the banks' arguments as political delaying tactics 'when, as the talks with the European Banking Federation have shown, they were in fact genuine technical concerns'.

Bracchi warns that if the IASB makes the same mistake with insurers it could compromise the adoption process next year.

The board may have a lot of detractors, but it is not short of allies either. Five of the IASB's seven liaison boards, the German, Canadian, Australian, US and UK standard-setters are all convinced that it has done everything possible to follow due process and elicit comments from its constituents. Klaus Pohle, president of the German national board (DRSC), says that the people who complain about the IASB's approach 'haven't bothered to take part in the discussion for the last two years and have suddenly woken up to the realisation that they have to implement IAS in March 2004'.

'It's easy to say that the board is not taking business realities into account,' says Pohle, 'but the reality is that there are companies in Europe that have changed and adapted to the modern business environment, while others have not. The procedures that the latter consider business realities are outmoded.'

The IASB's latest proposals on macro-hedging are the result of months of discussions with the European Banking Federation and appear to be the compromise everyone has been looking for. However, the IASB is certainly not out of the woods yet. Peter Holgate, technical partner at PricewaterhouseCoopers, says: 'Endorsement is not the only option, it's not a foregone conclusion.' Even if the banks accept the macro hedging proposals, they still disagree with the IASB on how current account savings, or demand deposits, should be treated in the financial instruments standards (see box 1). Holgate points out that without a standard on financial instruments, the EU could not seriously hope to build a strong capital market.

Accounting for insurance contracts is another issue that threatens to derail the adoption process in Europe (see box 2). Paul Cherry, chairman of the Canadian Accounting Standards Board, says: 'The global insurance industry is extremely divided and if the insurance contracts project isn't managed properly it has the makings of a monster.' Van Hulle says that the EC has done a lot to bring the banks and the IASB together to settle their differences, and 'if the IASB and the insurers are unable to come together on this then the Commission will insist that they sit around the table'.

'No standard is ever finished - there is always room for improvement,' he adds, explaining that Europe must adopt a full set of international standards by March 2004, even if some of them are not as polished as the IASB would like them to be. However, Mary Keegan, UK ASB chairman, and Bracchi point out that the EU's ARC has adopted the IASB's core standards as they were in 2001. The ARC has yet to adopt eight of the standards in their amended form, which were altered under the improvements project over the last two years. Keegan says she would be disappointed if UK financial reporting is unable to benefit from Tweedie's improvements project because the EU sticks with the 2001 versions of the standards.

•   Financial instruments viewpoint, p83

•   Macro hedging ED, p84

1: FINANCIAL INSTRUMENTS

In its latest proposal on

IAS 32, Financial Instruments: Disclosure and Presentation, and IAS 39, Financial Instruments: Measurement and Recognition, the IASB will permit macro hedging - a bank can use fair value hedge accounting for a portfolio of interest rate risk. This approach is a departure from the IASB's original position and results from discussions with the European Banking Federation. Industry observers are optimistic that the banking community will accept the proposal.

However, the IASB has not granted any concessions to the banks over how they are required to account for current accounts and savings accounts, or 'demand deposits'. The banks say that the board should consider the behavioural rather than contractual nature of demand deposits - generally people leave deposits in the bank over an extended period of time and do not withdraw the balance of their accounts days after they have made a deposit.

2: INSURANCE CONTRACTS (phase 1 and phase 2)

Patricia Plas, deputy director of the European Federation of National Insurance Associations (CEA), says that the board's temporary standard on insurance contracts, phase 1, is unacceptable because it requires insurers to value insurance contract assets at fair value (according to

IAS 39) and liabilities according to local GAAP. This approach, according to Plas, will cause unacceptable volatility in companies' equity statements.

The IASB wants to introduce a comprehensive insurance contracts standard, phase 2, between 2007 and 2010, which will use a full fair value measurement method for both assets and liabilities. European insurers say that valuing insurance liabilities at fair value is theoretically appealing but is impossible in practice, particularly in the case of the life insurance contracts (see Accountancy, August, p84).

Mary Keegan, chairman of the UK ASB, says the IASB's current proposal for phase 1 allows preparers too much freedom in the way they account for liabilities and recognise profit. Angus Thompson, chairman of the Australian ASB, says that the current ED represents a frustrating backward step for Australia, which will adopt IAS with the EU in 2005. Australia currently uses a type of fair value to measure insurance contract assets and liabilities.