Israel Securities Authority Warns New Accounting Standard Could Trigger Loan Defaults
Israel's Securities Authority has issued a warning to companies regarding the upcoming International Financial Reporting Standard (IFRS) 18, which will replace IAS 1 and take effect for periods beginning January 1, 2027. While the standard primarily concerns the presentation of financial data rather than its underlying value, the changes in reporting could significantly impact contracts and obligations tied to accounting metrics. The authority noted that the implementation "may require adjustments to information systems, reporting processes, and the way corporate performance is presented in directors' reports and other public disclosures."
The new standard, published by the International Accounting Standards Board in April 2024, introduces a major structural change to the profit and loss statement. It mandates new requirements for classifying revenues and expenses into operating, investing, and financing categories, and requires more uniform intermediate figures, particularly operating profit. This reduces the flexibility companies previously had in classifying various items. Additionally, IFRS 18 introduces disclosure requirements for management-defined performance measures (MPMs), such as adjusted EBITDA or non-GAAP profit, which may need to be included in financial statement disclosures and aligned with the new standards.
A critical aspect is the standard's retrospective application. A company reporting on a calendar year basis in 2027 will need to restate its 2026 data according to the new format, meaning the comparison year is already underway. The primary concern highlighted by the authority lies outside of accounting itself, specifically within financing agreements. Companies that have committed to banks or bondholders to meet certain financial ratios, like net debt to EBITDA or debt to operating profit, are measured against figures derived from financial reports. If IFRS 18 alters the classification of an item, thereby changing the reported operating profit or EBITDA, these financial ratios could shift even if the underlying business operations remain unchanged.
The Securities Authority is urging companies to address the "material effects of the standard's implementation on other business matters, including compliance with financial benchmarks, the impact on executive and employee compensation derived from accounting metrics, and other engagements affected by accounting data or metrics." This raises questions about the basis for calculating financial benchmarks post-IFRS 18. Companies must clarify whether financial benchmarks will continue to be tested according to the accounting standards in effect before IFRS 18's adoption, as stipulated in their financing agreements. Some agreements include a "freeze clause" that locks in the calculation method based on the standards at the time of the agreement. Where such a clause is absent, companies must explain their intended approach and the basis for it.
Disclosure requirements are already in effect. Under IAS 8, companies must provide information in periods preceding the initial application, including interim reports, that allows investors to understand the expected main impacts of the standard. Even if full information is not yet available, companies must explicitly state this. The required disclosures should cover anticipated changes in the profit and loss statement structure, their impact on intermediate figures, areas requiring significant judgment, and MPMs the company expects to define. The authority also seeks disclosure on whether a company plans to discontinue using certain metrics or introduce new ones. The first reports where significant disclosure on IFRS 18's implications is expected are the third-quarter reports due in November. This necessitates that many companies begin assessing the standard's impact on their reporting systems, financing agreements, trust deeds, and compensation policies now, as the standard may alter reported operating profit and related metrics without changing the actual business performance or net profit.
