European consumer products IFRS survey

European consumer products IFRS survey

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While International Financial Reporting Standards (IFRS) are now generally well understood and embedded within companies’ operations, IFRS compliance remains an ongoing effort for management.

In our latest survey of the 2011 financial statements of 20 leading consumer products (CP) companies in Europe, we:

  • Identify the operating and performance trends of the companies surveyed
  • Outline some emerging issues in accounting and reporting
  • Provide some indications of the effects these issues may have on CP companies in future
  • Provide a high-level summary of the revised IAS 19 Employee Benefits, effective from 1 January 2013
  • Summarize the developments of the IASB’s projects on financial instruments, revenue recognition and leases

Key observations

  • Performance review

Performance in 2011 was mixed. Revenue increased for all the companies in our survey, but only half were also able to achieve profit growth.

On average, EBITDA (earnings before interest, taxes, depreciation and amortization) margins were slightly higher than in 2010, while return on equity levels declined slightly compared with the previous year. Almost all companies were able to reduce their long-term debt.

From an operational perspective, performance also varied widely. Luxury and apparel and tobacco companies improved their return on assets as they proved relatively immune to the weaknesses in demand that affected other subsectors.

Within other CP subsectors, operational performance was mixed. While some companies enjoyed very high asset utilization, others had a higher EBIT (earnings before interest and taxes) margin, but a low level of asset turnover.

  • Risks and key performance indicators (KPIs)

Consistent with last year’s survey, we find that the links between communicated strategic priorities, KPIs and risks are not always clearly established in the annual reports.

Better communication would enable management to demonstrate that the chosen metrics are designed to measure achievement against the designated priorities and that the risks of achieving the stated priorities are identified and appropriately mitigated.

Availability and cost of raw materials is rated as the number one risk in our Disrupt or be disrupted: creating value in the consumer products brand new order publication. This is confirmed in our survey, where we observe that commodity price risk and supply chain agility and resilience are among the most frequently mentioned risks.

While most of the surveyed companies see the relevance and opportunities of new media, just three address a risk from the failure to use social media effectively.

  • Intangible assets, including goodwill

Brands and goodwill represent significant economic value for CP companies — in some instances they amount to more than half of total assets.

Therefore, there is a potential significant risk of impairment should CP companies fail to respond to changing consumer tastes or spending patterns.

Only one company recorded significant impairment losses in the sample of companies surveyed.

For impairment testing purposes, companies generally continue to allocate brands and goodwill to the same cash generating unit (CGU), which is usually defined at or below a segment level.

To establish the recoverable amount of brands for the purpose of impairment testing, most CP companies either treat brands as individual assets, and their fair value less cost to sell (FVLCS) is estimated by applying the relief from royalty method. Otherwise, brands are tested as part of a CGU and its value in use (VIU) is estimated by discounted estimated future cash flows.

Although desirable, detailed sensitivity analyses, including both potential risks associated with intangible assets as well as past experiences about their occurrence, are not provided by many companies.

  • Sustainability reporting

Sustainability reporting was addressed by all the CP companies in our survey. A majority of them either use or base their own reporting guidelines on the Global Reporting Initiative’s (GRI) G3 Guidelines in 2006.

Furthermore, most companies in our survey obtained external assurance on their sustainability report.

  • Expected changes from new and proposed accounting standards

New standards and application guidance represent an ongoing challenge for those preparing financial statements under IFRS. Not only can the impact on key financial statement performance measures be considerable, there is also the need to implement new processes in the company’s financial reporting systems to gather the relevant information.

With the forthcoming changes, we encourage management to keep an eye on the shifting IFRS landscape and to start the analysis of the impact of new and proposed standards, which will help avoid surprises and ease the transition process.