October 2005

The law of unintended consequences is one law that has stood the test of time and it is coming to bear on the impact of International Financial Reporting Standards (IFRS) on how companies determine the extent to which they can distribute their profits to shareholders - which is a legal issue, not one that concerns the accounting standard-setters.

We are in the middle of a period of significant change in accounting standards, the rules by which companies prepare their accounts. However, while accounting standards focus on communicating performance to owners of the business, company accounts are also used for various other purposes in law, including determination of what is a realised profit and hence distributable to shareholders.

The biggest change in accounting relates to the move to IFRS in Europe, compulsory from this year for listed company group accounts. Listed and unlisted companies also have the option of switching the accounts of all subsidiaries and the parent company's own accounts to IFRS, and it is these that are used to calculate what dividends can be paid up the group and to the ultimate shareholders in the parent, not the group accounts. It has become apparent that companies taking up this option are finding that it can have severe adverse consequences for distributable profits, often creating dividend blocks, even though the overall financial position of the company in question has not changed. This is particularly so where a group has been acquisitive or undertaken group reorganisations.

This is an extract from an article by Kathryn Cearns, who is the Consultant Accountant at City law firm Herbert Smith. To read the full article please click here.

Herbert Smith Document

Kathryn Cearns and her colleagues at Herbert Smith LLP have also produced an excellent document which provides a guide to the legal and regulatory issues associated with IFRS. Herbert Smith LLP is a legal practice with a 1,100-lawyer network across Europe and Asia. Please click here to view the document in full.

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