Moody’s alerts corporates over IFRS ‘distortions’

Rating agency warns that, in the current climate, debt reported under global standards regime may not convey the full picture

EMEA corporates must take far greater care with reporting debt under the International Financial Reporting Standards (IFRS) regime, according to Moody’s.

In a 6 April report, the rating agency warns that, amid a climate of “unrelenting low interest rates and rising currency volatility”, IFRS could actually distort the meaning of debt on corporate balance sheets.

Following research of debt reporting at several major companies – including Anglo American, Imperial Brands plc, E.ON and Sunrise Communications – Moody’s detected unsatisfactory outcomes that had stemmed from five key drawbacks.

Depending on the firm’s underlying conditions, the agency explained, the amount reported as debt…

1. …does not incorporate the hedging of foreign currency risk “Debt denominated in a foreign currency is always translated at the year-end exchange rate. This rule applies even when the year-end exchange rate is of questionable relevance because the currency exposure has been hedged using a derivative instrument.”
2. …loses its meaning when fair value hedge accounting is used for interest rate swaps “Fair value hedge accounting causes debt to be adjusted by an amount that is not actually payable to, or receivable from, the lender.”
3. …may, or may not, include accrued interest payable “Interest owed to lenders but not yet paid at the balance sheet date may, or may not, be included within the amount reported as debt.”
4. …may not represent the sum owed to lenders by an acquired subsidiary “All debt issued by the acquired company must be recorded in the books of the acquirer at its fair value on the date of the acquisition. As a result, the amount reported on the balance sheet is not actually owed to the lenders, and there will be no corresponding cash outflow unless the debt is redeemed ahead of schedule.”
5. …is reduced by the cost of borrowing the money “IFRS requires the cost of issuing debt to be deducted from the liability reported on the balance sheet. Although the resulting understatement diminishes systematically over the term of the borrowing, the lower amount is unhelpful because the principal owed to the lender is unaffected by the expenses incurred to borrow the money.”

Moody’s vice president and senior credit officer, Trevor Pijper, said: “In the current environment, there is a significant risk that the amount reported as debt will fail to represent either the amount owed to the lenders, or the future cash outflow needed to discharge the obligation.”

With that in mind, he added: “Companies voluntarily disclosing additional information not required under IFRS helps us to identify and address the above distortions, and factor them into our credit metrics where material.”