International accounting standards may seem an unpromising place to seek a revolution, at least one that would extend beyond the rarefied world of finance officers and auditors.
Yet over the past 18 months a revolution has indeed been taking place, and airline boardrooms are starting to take careful note. Their interest is straightforward. If airlines are to get the best value from international capital and equity markets, they need to meet the increasing demands of investors and lenders for clear, comparable, financial reports.
The starting point is the hard fact that world markets are now global. The way that the financial crisis in South East Asia rippled around the world, to harm economies of countries as far away as Russia and Latin America, has been a vivid reminder of just how interdependent economies have become. It is also a dark warning of how quickly financial markets can turn sour once lack of confidence starts to spread. And, in all of this, the credibility of financial performance and corporate reporting has its part to play.
The Asian crisis may not have been a result of poor accounting controls, but the speed with which world stock markets lost confidence in the region was certainly not helped by a lack of consistency and familiarity with the way that firms within many of the affected nations handled their accounting.
Pressure for standards
The issue is hardly new. Five years ago a previous article in Airline Business outlined the problem, warning that much needed to be done in the industry to make airline financial reporting more comparable - requiring a harmonised, worldwide, approach to accounting standards and disclosures.
The need is more pressing for the airline industry than most. Although the aviation market is truly international, it is still largely dominated by national carriers. Each of these reports to national accounting standards, making deep comparisons almost impossible.
And, outside the USA, there are few sizeable domestic rivals with which to compare these major carriers.
As argued five years ago, there is a basic need to make airline accounts more comparable: to give analysts, lenders and other stakeholders a better basis from which to assess the relative performance of major carriers worldwide.
Carriers themselves are beginning to feel those demands more acutely - with shareholders to satisfy and private funding to raise. As a consequence, many boardrooms are looking to find "cheaper money" on global markets and there is growing frustration that incomparable accounts may be holding that back. It is this frustration, rather than any pressure from accountants, which has started to push for change.
Start of a revolution
So what has happened to help resolve the issue? Most importantly, there has been a meeting of minds between the national regulators who oversee corporate reporting - represented here by the International Organisation of Securities Commissions (IOSCO) - and the accountants who do the reporting - in the shape of the International Accounting Standards Committee (IASC).
IOSCO recognised that consistent accounting standards were essential if cross border capital deals and stock market listings were to take place efficiently around the globe. Consequently, in 1993, it reached an important agreement with the IASC.
Essentially, IOSCO undertook to champion the use of International Accounting Standards (IAS) by securities authorities around the world, provided that, for its part, the IASC helped to put in place a set of suitable standards.
Set up 25 years ago, the IASC is potentially a powerful force, made up of 142 accounting bodies, covering something like 2 million accountants in over 100 countries. Yet the standards it has produced have always taken second place to the domestic rules for company filings demanded by the national securities authorities. Hence a US-registered airline is required to report to its Securities Exchange Commissionunder US Generally Accepted Accounting Principles (GAAP), regardless of any commitment to international standards.
However, an ever increasing number of companies is searching beyond national boundaries to tap into a wider base of shareholders on foreign stock markets and to gain access to the lowest possible cost of capital from international bond issues (see tables). That means filing accounts and raising finance across a number of international markets. An increasing number of stock exchanges is therefore allowing foreign companies to file accounts in line with international rather than domestic accounting standards.
IASC's web site notes that there are almost 40 countries where national securities legislation permits foreign companies to prepare their consolidated financial statements using IAS.
Within the last three, under the IOSCO agreement, the IASC has created a set of 40 core standards. Given that a single accounting standard has traditionally taken two or three years of hard consultation to complete, that represents phenomenal progress - even if some were already in place. The standards have been grouped under five main headings dealing with:
* general concepts;
* income statements,
* balance sheets;
* cashflow statements;
* and other areas.
These core standards represent an important step towards breaking down national accounting differences, but they do not ensure full comparability.
Even within the framework of international standards, there is a good measure of flexibility for individual companies to define specific accounting policies best suited to their business. That reduces the level of uniformity and companies can report a range of different results, simply through changes in the way they set these policies.
Depreciation rates are a prime example. Despite employing universal standards, airlines use individual accounting policies to create vastly differing depreciation charges, which then affect earnings and balance sheet values. In short, core standards provide a firm foundation, but the next step is to see harmonisation in practice. That is likely to be a slow process.
A measure often put forward to balance the needs of flexibility and standardisation is to increase the level of disclosure made in accounts, perhaps through detailed notes. These can yield real benefits to those using accounts, helping investors to compare companies and understand what represents "best in class". Such transparency has tended to have a less enthusiastic welcome from companies, concerned that they may be forced to give away competitive advantage through detailed disclosure, such as notes on the performance of individual business segments.
Yet the airline industry may have more to gain than lose from improving the transparency and consistency of its accounts. Alack of common ground in airline reporting can have a direct impact on the confidence of financiers as they assess the risks of lending to the industry as a whole, and to certain regions in particular.
Policy task force
The issue has also been growing in equity markets over the past decade as more airlines seek out public share listings. Without comparable accounts, investors cannot feel confident in evaluating the opportunities and risks of owning airline stocks.
The International Air Transport Association (IATA) has become increasingly aware of such problems and, over the past four years, its Accounting Policy Task Force has made considerable progress in producing a set of guidelines to cover accounting issues for the industry.
In bridging the gap between international and national accounting standards, the IATAtask force has followed three principle objectives. The first is to provide Airline Accounting Guidelines on specific airline industry issues. The second is to monitor the development of general international standards, particularly by the IASC. Finally, it has set the aim of establishing "greater consistency between airlines in relation to financial information reported to IATA for industry comparison purposes".
The task force has so far put forward six guidelines on specific areas of accounting importance to airlines. The topics covered include accounting for:
* frequent flyer liabilities;
* translation of long term foreign currency borrowings;
* components of fleet acquisition cost and depreciation;
* leases of fleet assets;
* revenue recognition;
* maintenance.
Each of these areas provides a pause for thought for airline board meetings particularly when they need to consider the impact and possible benefit in reporting under IAS.
There are areas of operation in an airline that need to be appropriately controlled and financially reported upon, to help safeguard company assets, evaluate future performance and to identify where there are either risks or opportunities.
A brief summary of the areas already considered by the IATA Accounting Policy Task Force will highlight some of the typical financial reporting issues that airline executives need to consider in determining their airline's accounting policies:
Frequent flyer liabilities: These can be accounted for under two bases: provision for incremental costs or deferral of revenue. The former requires a marginal cost provision to be made at the time the frequent flyer award is reached. The latter is likely to require a much larger provision to reflect the value of the revenue arising on the flight when the award is used. One of the triggers for switching from the incremental costs method to deferred revenue is the level of awards given - particularly if
fare-paying passengers are materially displaced in favour of award-takers. This requires significant control over an airline's network management to limit the number of seats made available for use of frequent flyer awards.
Foreign currency debt (still an exposure draft): The international nature of the industry requires careful management control over foreign currency positions. Apart from best matching cashflow exposures, one of the other significant areas of risk relates to differences arising on exchange positions between accounting periods.
Fleet acquisition costs and depreciation: Probably the most significant transaction any airline makes is the acquisition of its flight equipment. The accounting is done on an historic cost basis, but the variety of methods of amortising these assets over their economic life is one for management to decide, based on the expected use and residual values they put on such assets.
Accounting for leases of aircraft fleet assets: For many years, the application of the subject over form principle has resulted in a mix of some leased assets being recognised on airline balance sheets, where they benefit from the asset for the majority of its lifetime cost, or kept off balance sheet where this is not the case. The requirement to have related debt on or off the balance sheet has created the need within the industry to develop complex leasing structures
However, the big question facing accounting standard setters is whether, in the future, all leases will be categorised as "on balance sheet" with its impact on gearing ratios and possible costs of capital.
Recognition of revenue: Currently the most complex part of airline accounting has related to revenue accounting. Accounting standards require that revenue only be recognised in the profit and loss account when the service has been provided, with associated commissions similarly deferred to be recognised at the same time. However, appropriate treatment of refunds, exchanges of tickets, interline settlements and systematic recognition of non travelled revenue are all significant elements for which accounting policies need to be set.
Accounting for maintenance costs (still an exposure draft):
Many accounting standard setting bodies worldwide have been focusing on the conceptual theories of allowing the deferral of costs across accounting periods. This would affect airline maintenance accounting where the general principles have been for larger airlines to recognise the cost of major overhauls on an arising basis, while smaller airlines defer and amortise costs on a flying hour basis. This is so as not to distort any one particular accounting period when a majority of their aircraft may require a major overhaul.
There are still further areas that might require guidance by IATA, such as segmental reporting, slot valuation, or a review of the impact of joint venture accounting in the light of alliances.
So where does airline financial reporting now stand in the light of the IASC revolution in completing its core standards; the need for better uniformity in reporting and disclosure; and the application of the IATA guidelines?
Well, on the back of both the core standards and the use of the IATA accounting guidelines, comparability across airlines will be ahead of many other industries. While there is a role for IATA's Accounting Policy Task Force to play in giving guidance to the industry on how it should react to the work done by the IASC, it will be up to airline boards to take the next step and, together with other industries, begin a programme of creating comparable accounts under the IAS umbrella. And thus benefit from accessing world securities commissions for least cost finance.
Source: Airline Business
