FSN: IFRS keeps systems on the move again

IFRS keeps systems on the move again

20th March 2006
Many companies have implemented IFRS without incident in 2005 but have relied on spreadsheets and informal methods to manage the impact of the changes. But this does not provide a firm foundation for the future and the convergence of US-GAAP and local GAAP to IFRS, together with continuing change, such as the proposals in ED 8 Operating Segments, will increase the pressure on systems. Gary Simon, FSN's managing editor explains why now might be a good time to implement systems changes.

For many quoted companies in Europe and around the world, the first full year of IFRS (International Financial Reporting Standards) compliance has drawn to a close. For the most part its implementation, in a strict accounting sense, has been well managed and communicated to the capital markets so that much of the predicted share price volatility has failed to materialise. However, whether IFRS has met its broad aims is an entirely different matter. Many financial directors that FSN has spoken to over the period of transition question whether the new accounting standards have really met their objective of greater comparability between companies' results and whether the overall transparency and effectiveness of financial statements has been affected adversely by the complexity surrounding the new disclosures.

Regardless of these technical and political considerations many companies are counting the true cost in terms of time, effort and management distraction. Research has shown that countless finance departments have been thrown off-course from their normal agenda and contribution to their companies' strategic and operational effectiveness by the sheer effort of understanding, assimilating and implementing IFRS.

IFRS has also been a struggle from a systems point of view. For the most part, companies have managed the systems implications using the modern day equivalent of the ‘back of an envelope'; that is, the ubiquitous spreadsheet. Given the levels of uncertainty that have surrounded the introduction of IFRS such an approach is understandable. Few have been willing to commit to systems changes against the background of so much, procrastination, uncertainty and regulatory change – even if they had the time to make the changes. The reality is that the true implications of IFRS for most participants did not become clear until the latter part of 2005 so that in most cases, making systems changes was not a practical proposition in the timescales allowed. Furthermore, the cumulative effect of individual IFRS changes on, for example, reported earnings, depended on the circumstances of individual companies and the characteristics of their industry. For example, manufacturers with large investments in research and development were impacted differently by the standards from capital intensive businesses or financial services organisations.

So, for the most part, any thought of systems changes were abandoned and spreadsheets fulfilled the role of modelling the impacts of IFRS and reconciling the differences between local GAAP (Generally Accepted Accounting Practice) and IFRS. Notwithstanding the undesirability and inherent audit risks of spreadsheets at the heart of their financial reporting processes, many companies concluded that they could afford to wait until the dust had settled on IFRS and they had had the opportunity to assess fully the implications of IFRS on their systems and processes before making changes. Afterall, in systems terms, the IFRS issue was not of the proportions of the famous “Y2K bug” and few were suggesting that implementing IFRS would require wholesale changes in systems.

There were of course exceptions to the ‘wait and see' approach and for example, those companies that had particularly flexible and modern group reporting systems were more easily able to take IFRS in their stride. Nevertheless, even those companies were faced with a reasonable degree of systems redesign, build and testing. So what are the major systems implications of IFRS?

For reasons given earlier the precise impact of IFRS depends on the circumstance of the company and the industry it operates in. At its most basic level, IFRS can affect the data collected from subsidiaries and therefore the underlying ‘mapping' and validation of data from ledger and operational systems into whatever data collection mechanism is used to submit data to the centre for group consolidation.

However, the group consolidation tool itself is more likely to be affected. The chart of accounts may need to be amended to reflect new IFRS specific accounts and IFRS adjustments to local GAAP accounts. These structures are necessary to ‘pull out' IFRS results and compare them to prior years comparatives in IFRS or local GAAP.

In addition, many companies will be confronted with the challenge of multi-GAAP processing under IFRS. Whilst a number will be required to report under local GAAP and IFRS for the foreseeable future others, with a U.S. parent, may be saddled with reporting under three GAAP conventions simultaneously. Here the flexibility of the chart of accounts structure and the multi-dimensionality of the group reporting system can be pivotal to the ease with which management can report in multi-GAAP terms.

Segmental Reporting, IAS 14, is another example of where IFRS can impact on data collected right through to the multidimensional structure of the group consolidation system. The ‘primary' or main segment can be based on a geographical analysis or some form of business grouping such as revenue from external customers by product division. The primary segmental analysis also needs to disclose the carrying amount of, for example, segment assets and segment liabilities. In addition, IAS 7, ‘Cash Flow Statements' encourages disclosure of the amount of cash flows arising from the operating, investing and financing activities of each reported business and geographical segment. The ability to ‘slice and dice segmental' information rests heavily not only on the ability to capture segmental detail from every reporting entity in the group, but also the flexibility of the central system and its reporting tools to display the segments as required and reconcile the segmental analysis to the figures in the financial statements, drilling down to lower levels where required.

It is clear that the breadth and complexity of IFRS rules out the use of spreadsheets as a long term solution to the problem. Also, having successfully transitioned to IFRS at a group level most companies are much better prepared and positioned to implement IFRS fully in their group reporting systems. Whereas, modern consolidation systems should have the flexibility to deal with multi-GAAP processing, segmental analysis and reporting, older applications that are not fully multidimensional or have inflexible reporting may need to be replaced. This is especially important in the light of continuing changes and proposed changes to IFRS. The notion that there will be any lasting respite from change is misplaced.

Consider for example the impact of Exposure Draft (ED8) Operating Segments that was published on the 19 th January 2006 by the International Accounting Standards Board (IASB) and is designed to replace current requirements for reporting segment information under IAS 14 Segment Reporting. The proposal is part of the IASB's efforts to converge IFRS and US-GAAP and involves significant changes that could result in the use of non-IFRS measures for external reporting of segment information.

As well as the impact of the continuing drive towards the convergence of US-GAAP and IFRS there is the broader agenda of local GAAP convergence and IFRS in each member state of the EC. Until it is made mandatory, companies will have to decide whether their subsidiaries should report in IFRS or local GAAP. In this context, tax implications are coming to the fore because IFRS can accelerate or decelerate tax liabilities depending on the circumstances of individual companies. This could lead to the bizarre situation that some subsidiaries should report in IFRS terms and others in local GAAP in order to defray tax liabilities. So not only will group systems need to handle multi-GAAP reporting at the group level but potentially, they will also need to manage multi-GAAP modelling of subsidiaries accounts as well.

Against this background, deferring the decision to implement IFRS fully in reporting systems is looking increasingly unwise. Uncertainty and change remain a real prospect for the foreseeable future and managing the consequences of this will become increasingly unmanageable and risky using spreadsheets. Most companies have managed the initial implementation without incident and the worst has passed. Now seems a good time to take stock of the changes and implement a flexible systems foundation that will allow future regulatory change to be more readily accommodated.

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