IFRS: A Perfect Storm of collateral impacts for CMAs

Rather than being an ideal time to plan retirement, especially if you have already survived Sarbanes Oxley implementation and rationalization, the downstream collateral impacts of new or more detailed financial disclosures may make this an ideal time for CMAs, who possess the strategy, management and accounting skills necessary to smooth the transition.

By Colin Shaw, CMA

Given catchy titles already available on the topic of International Financial Reporting Standards (IFRS), also known in their earlier form as International Accounting Standards (IAS), I struggled with a working title for this article.

I looked to my children and fondly recalled the ageless car question — “Are we there yet?” However, it soon dawned that “when” has been defined (Jan. 1, 2011) but not necessarily “where.”  While principles-based Canadian GAAP is arguably closer to the IFRS than rules-based U.S.-GAAP, there are still a number of IFRS that will in all likelihood be modified by 2011.

After several equally unsuccessful trains of thought, from academia to sport, I finally turned to the movies. The Day After Tomorrow — no. Tomorrow Never Dies — no.  It then hit — A Perfect Storm. 

From good to great

To paraphrase best-selling author Jim Collins from his book Good To Great, management need to get the right people in the right seats on the bus and get the wrong people off the bus. When the Canadian Accounting Standards Board confirmed in February 2008 that Canada would join some 100 other countries in adopting IFRS, rather than U.S.-GAAP, the bus left the depot. As a result, CMAs need to jump on and even drive the bus, or risk being left behind.

If not yet started, comprehensive diagnostics should soon be underway to support the “grooming disclosures” required by the Canadian Securities Administrators for fiscal 2008 (qualitative) and 2009 (quantitative). While the time and cost will vary by company, based on capital structure, complexity of transactions and global footprint, the devil appears to be in the detail. Also, there appear to be a number of “made-in-Canada” questions currently lacking tangible answers.

Although a number of academic studies suggest that Canadian financial reporting is already of a high quality, take for instance research coming out of Queen’s University, a lot of work may still be required to support management’s opinion that any differences are not material. If you have not yet started your journey or identified the key milestones, I hope this article provides pause for thought now and a new slant to the prerequisite of disciplined change management.

The best route

In the noble and endless pursuit of seamless capital markets, lower cost of capital and streamlined reporting processes, where parents and subsidiaries might one day be able to apply the same accounting principles and avoid cumbersome reconciliations, what will be the best route to implement IFRS for your company? There are fewer bright lines and more professional judgment, so there are no right or wrong answers.

In addition, an answer does not exist in a vacuum but rather some IFRS are still a moving target. Notwithstanding these challenges, you will need to establish priorities defendable to the external auditor and perhaps also regulators — standards needing attention now; standards needing attention later; standards that are part of ongoing convergence projects. In order to select appropriate accounting policies and make the elections for first year adopters at the date of transition, the single most important ingredient will be the availability and quality of data, otherwise you might end up reporting under the GIGO basis of accounting — garbage in/garbage out.

Also high on the list of priorities of early adopters and companies who have started their conversion projects have been people and education to implement IFRS, both quantity and quality. Enter from stage right CMAs, who drive value creation and lead the advancement and integration of strategy, management and accounting. The value of a CMA in a smooth transition to IFRS will hopefully be illustrated through the following collateral impacts, a term coined by Deloitte.

Collateral impacts

Within the pervasive constraints of cost and materiality, as set out in the IFRS conceptual framework, IFRS seek to enhance the qualitative characteristics of the financial information for users and preparers. At the extreme however, 25 per cent of companies in an Ernst & Young survey in Europe indicated that IFRS impacted the way the business was run. With this in mind, consider the following that details what companies will need to do when determining where they might reside between the extremes of the impact continuum.

Information systems

Is the costing system capable of collecting, retaining and reporting the level of disaggregation or aggregation required to support componentization or identify cash generating units?  Is there complete and accurate data capable of interpretations, and supportive of retroactive application of IFRS to prior business combinations? These are a good fit with the domain of CMAs. Whether stand-alone or integrated and big or small, does the financial reporting package have the capability to support two books of record in 2010 — IFRS and C-GAAP?  For this reason and to get the conversion behind them, financial institution Credit Suisse adopted early.

Performance measurement/budgets and forecasts

Before jumping into content, let’s first consider presentation.  If preparing a five-year budget now, there will be three years of disclosures under Canadian GAAP and two years under IFRS. So, are CMAs not well placed to add value to management and draft what the new disclosures may look like in 2011?  The same applies to the so-called “grooming disclosures” in management’s discussion and analysis in 2008 and 2009.

Greater emphasis on fair value

Since more assets can be reported at fair value (land, building, investment property and other capital assets), management will need staff with a sound knowledge of risk-adjusted cash flows and present value calculations, especially within a robust modeling environment. We are not talking bean counters but rather Creative Accountants with access to real-time, reliable and relevant data, including but not limited to interest rates country-by-country. 

Executive compensation

Hot on the heals of the stock-option backdating scandals in the U.S. and “say-on-pay” proposal in financial institutions in Canada, this is a sensitive topic before even considering a switch to IFRS. With the focus now on the balance sheet as opposed to the income statement, where volatility is the natural by-product or flip side of fair value, new compensation measures may be required. As demand for scarce resources increases, consider also retention bonuses for IFRS project staff.

Investor relations

When all is said and done, how will companies explain potentially new revenue recognition, measurement and disclosure to analysts, rating agencies and Canada Revenue Agency? At a strategic level, companies will also need to decide if they want to be the first in an industry to early adopt. At an operational level, companies will need to engage bankers now to determine if triggers embedded in loan covenants may still require two books of record long after 2011. Based on the body of education and examination to develop and evaluate core competencies, the answers to the questions above may likely come from a CMA.

Seeking to know the unknowns

I liken the challenge here to my hobby as a representative rugby referee, trying to understand the skullduggery in play at the tackle or in the front row of the scrummage — perhaps unanswerable. In the context of GAAS and whether external auditors are seeking the truth, a March 2007 article in the UK Financial Times spoke of the transatlantic squabbles over the external audit opinion. It is unclear if we are moving from “fairly present” the financial position of an organization in North America to the “true and fair” in Europe. 

The Canadian Accounting Standards Board published the 2,400-page Omnibus Exposure Draft (containing the bound volume of IFRS as at Jan. 1, 2007). Make no mistake that you will have to keep abreast on “minibuses” from the accounting standard setters between now and 2011.  Like London buses however, there may be large gaps when you see nothing and many may all show up at once, so be flexible to assess the impact quickly.

Just as the dust was beginning to settle, and to paraphrase David Tweedie at the recent IFRS Conference in Toronto, we have seen a European carve-out over hedge accounting and the potential for IFRS to morph back to local-GAAP. Conversely, the Canadian Accounting Standards Board is currently sticking to a no-tinkering policy. However, you don’t have to look too far to see political strains on accounting principles — oil and gas drilling and accounting for inflation in the 1970s; stock-option expensing and accounting for derivatives in the 1990s; and recent mortgage-bailout plans. 

Auditor liability remains as an unwritten chapter of the story. Unlike year one SOX, external auditors appear more open to discussion around management’s accounting policy choices. However, there may be a premium attached to this discussion, so be sure to have done your homework.

Disciplined change management

Perhaps IFRS may be the much needed catalyst to convince senior management and the Board to upgrade to a new financial system. Unless accounting can be pushed down to the transaction level, one company recently concluded that 15,000 top-side journal entries would be needed. For those familiar with published year one SOX internal control deficiencies, the renewed prospect of spreadsheet accounting (a.k.a. “end-user computing”) will send shivers down spines.

All of the project management paradigms remain unchanged. Early in the journey, perform a thorough diagnostic and then focus on priorities, both impact and ease of implementation. Finally, consult and communicate, internally and externally.

A clean start ...

... but be careful what you wish for.

To conclude, IFRS are not just a technical accounting issue — the devil does appear to be in the detail. While a change in revenue is inevitable, surveys conducted in Europe by the large public accounting firms would suggest that the quantum and impact is varied and unpredictable. Conversely, I am not suggesting that you throw the baby out with the bathwater, since there are many similarities between C-GAAP and IFRS. However, small differences might have a material impact and this may be a price that management is not willing to pay. At the recent IFRS Conference in Toronto, a CFO spoke of life before, life during, and life after IFRS. Other organizations, such as Bombardier, indicated that they are looking to use internal resources as opposed to costly external consultants. Given their competencies, these arduous trips may be easier with a CMA at the wheel of the bus.

Colin Shaw is director, public accounting with CMA Ontario (cshaw@cma-ontario.org).  In addition to his CMA, he is an ACMA (UK), CFE and CIA. Prior to CMA Ontario, he held senior positions in the finance internal audit group of CIBC and the dispute analysis and investigations group of PricewaterhouseCoopers, where he dealt primarily with GAAP and GAAS issues.

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