Switchover to IAS No Smooth Sailing

Following Prime Minister Mikhail Kasyanov’s announcement in July that all Russian enterprises must switch to international accounting standards from Jan. 1, 2004, demand for Western-style auditing in Russia looks set to continue the strong growth of recent years.

The government has made IAS mandatory for all Russian enterprises, rather than just banks as originally intended. The decision will place heavy demands not only on the financial departments of Russian companies, but also on their external auditors. Reconciling Russian audits with IAS will not be easy and the government is well aware of the problems, so it has decreed that companies must be using IAS six months before the new rules actually come into force.

But growing demand for international-standard audits is also being driven by the increasing maturity of the Russian corporate sector.

“The Russian audit market has shown double-digit growth in the last few years, reflecting the overall economic recovery after the 1998 crisis and the increasing need of Russian companies for equity and debt finance, primarily from the Western capital markets,” said Richard Buski, PricewaterhouseCoopers’ senior partner for Russia.

Russian investors now want to increase shareholder value or unlock the value in firms they have acquired or developed by an initial public offering. Dan Koch, CEO and managing partner at Deloitte & Touche CIS, said that in order to be recognized as global players and realize their potential, major Russian companies have been working in recent years to improve corporate governance, transparency and present audited accounts up to Western standards.

“Without an audit by one of the Big Four audit firms, Russian companies cannot raise money on the international capital markets through IPOs and listing on international stock exchanges,” he said. “Nor can they issue shares and bonds, since international investors have little confidence in Russian auditing standards.”

To be listed on an international stock exchange, a company usually has to present two to three years of accounts audited to Western standards and also comply with reporting and filing requirements stipulated by the national financial authorities and the exchange in question. In practice, this means having internal reporting systems that can deliver on a quarterly or six-monthly basis, as well as the pure audit.

Roger Munnings, managing partner at KPMG Russia and chairman of KPMG’s global energy and natural resources practice, said listing internationally represents a series of major challenges, ranging from running and managing the company itself, to the more stringent disclosure requirements to the huge amount of extra work entailed in accelerated reporting standards.

Koch of Deloitte & Touche said that in many countries, IAS-based financials can be reconciled to produce a tax return, but this does not apply to Russia. The result is that Russian enterprises wishing to report in IAS now have to produce two sets of accounts, since under Russian law they are still legally obliged to produce the Russian statutory audit and tax return. Koch said this makes the whole process both much more complicated — and much more expensive.

Another area of growth is coming from the expansion of Russian companies as they diversify at home and acquire assets abroad in Eastern Europe and elsewhere.

Since these large Russian enterprises are mostly holding companies, Hans Jochum Horn, managing partner at Ernst & Young’s CIS practice, sees them and their need for consolidated accounts as Ernst & Young’s major growth area as they continue to expand in line with Russia’s economic recovery. The number of Russian firms listed in the Financial Times rating of the 100 biggest East European companies measured by market capitalization increased from 26 in 2001 to 36 in 2002.

Large and medium-sized Russian enterprises’ demand for audit services looks set to increase considerably, but the international firms are reluctant to forecast what this means in terms of numbers.

Deloitte & Touche has about 500 staff in the CIS, some 350 of whom are based in Russia, with auditing comprising about 60 percent of the overall practice.

“If the company employed the same number of people in Russia as a percentage of the population as it does in the Netherlands, it would have a staff of 80,000 in Russia,” said Steve Henderson, partner in charge of tax & legal services at Deloitte & Touche CIS.

Munnings of KPMG said he is optimistic and sees great potential for growth — “providing we have political stability until 2008 under President [Vladimir] Putin, which seems a good bet right now.”

KPMG has already met the targets of its earlier business plan to build a predominantly Russian practice, with some 80 percent of its Russian business now coming from domestic clients. The company is also investing heavily in training Russian staff, so that expatriates make up only about 50 percent to 60 percent of KPMG’s partners, while 75 percent of the managers and 100 percent of the staff below managerial level are Russian. Munnings said turnover grew 35 percent in the 12 months to September 2002.

“We have worked through scenarios for growth ranging from anywhere between 50 percent to 100 percent going forward,” Munnings said. “We think that audit will account for some 50 percent in the short term before eventually falling to 10 percent to 20 percent annual growth in the longer term.”

The Big Four international auditing companies are likely to maintain their concentration on the larger Russian companies. Horn at Ernst & Young said 99 percent of Russian firms will still be audited by small Russian auditors, among whom consolidation is likely to continue.

Ultimately, he said, there are likely to be 10 to 20 Russian audit firms, “with the Big Four using them to carry out local audits in the far-flung reaches of Russia.”

He also expects more second-tier Western audit companies to move into Russia in the years ahead. “But while this will increase competition among the Western firms, the second-tier companies will just carry out ‘pure audit,’ rather than offer the all-round services the Big Four can offer.”

Ian Pryde

Special to The Moscow Times

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