As several geographies around the world grapple with the transition from local GAAP to IFRS it is worth pondering whether there are any lessons to be gleaned from the European experience. What history tells us is that IFRS can have significant impacts well beyond interpretation of the pure accounting standards. Indeed, the challenge is multidimensional and a broadly based multi-disciplinary approach, accompanied by detailed attention to planning, is needed if companies are to minimise the disruption of implementing the change, says, Gary Simon, FSN’s managing editor.
The first thing to recognise about IFRS is that you are on your own! Regulators and standard setters have established the base line for each standard but the precise impact on the balance sheet, earnings per share, bank covenants, remuneration/ bonus schemes (if there are any left) and cash flow is down to each company to determine. Naturally the impact of reporting in IFRS rather than local GAAP, whatever it may be, depends on an individual company’s financial position and accounting policies to date, but the onus for explaining away the changes between results reported using one standard and another is firmly in the company’s court.
Naturally the profit and loss or balance sheet effect can be significantly different between one industry and another but the challenge of communicating the effect to shareholders and other key stakeholders requires careful handling. Experience shows that earnings can swing up or down depending on the application of the standard which can have unforeseen consequences for tax payable, cash flow, bonuses and bank covenants.
So what should you do? Well preparation is vital to managing expectations and this involves starting an IFRS initiative well before the implementation date. But diving in at the deep end is not the answer. The most important task is to ensure that the finance function is all on the same page. Detailed training and review of each applicable standard is crucial to developing an understanding of the standards which are material your business and industry. Auditors have an important role to play in providing training and technical support to the group finance function as well as ensuring that there is a conduit of communication and agreed understanding on accounting treatments from a very early stage.
One complication is that IFRS is not cast in stone. Changes to standards during the conversion process have to be absorbed on the hoof, adding to the communications challenge. In Europe the IFRS environment was relatively stable during the implementation period – this may not be the case for companies transitioning to the new standards in North America and Canada.
There are also systems and process issues around the move to IFRS. The first is that IFRS and, say, Canadian GAAP have different bases of measurement – you can’t simply translate from GAAP to IFRS – items such as depreciation may have to be measured differently. Where the data requirement is different this has implications for data capture and the charts of accounts. Decisions will have to be made about the potential need to collect additional information to satisfy new disclosures. Furthermore there will be choices about where in the reporting hierarchy the extra or different data is to be collected. Some matters can be handled at the Group level but others may require changes to data capture from local entities or even underlying operational systems. This raises the question of whether the required data can be readily supplied and what extra effort may be needed to furnish it to group.
During the transition the emphasis in IFRS projects is on explaining away the differences between the old way of reporting the numbers and the new. This means it is important to be able to navigate between old and new numbers making sure that the adjustments between them are separately identifiable. Theoretically this can be achieved through (i) setting up specific entities in the reporting hierarchy to hold the adjustments; (ii) altering the chart of accounts for specific IFRS adjustment accounts, or (iii) a combination of these approaches. In practice it has been found that the easiest approach is to alter the chart of accounts structure and rely on advanced reporting functionality to ‘pull out’ the adjustments, present multi-GAAP accounts and generate reports showing the reconciliation between local GAAP and IFRS.
However, the work involved in implementing these changes should not be under estimated. Whilst the approach outlined above avoids a complete re-write of a consolidation system the changes needed are deeply embedded and require significant application knowledge and keen accounting skills to re-develop the chart of accounts and all of the related validation logic. Great care has to be taken in migrating from the local GAAP based application to IFRS while maintaining the two in tandem and preparing prior years’ comparatives on the new basis.
An added challenge is that the skills needed may be in short supply, exacerbated by everyone’s projects in a certain region starting at the same time. This inevitably leads to an auction for skills with those willing to pay the most snapping up the contractors needed to re-work the consolidation system, help with data migration and write reports. Suppliers will have limited resources and this could leave certain companies exposed at a critical point in time. So can all of this be avoided?
The answer is that it is all down to planning. If you are going to stay on top of the IFRS change then it’s important to assemble a project team early, start training, acquire the necessary sub-contractors and engage with auditors. The good news is that managing this change is not rocket science. But if you leave it too late then it may be difficult to meet key deadlines. In Europe there were plenty of companies that were late out of the starting block. Implementation was on a ‘wing and a prayer’ and most of them had to re-implement properly the following year. Better and less costly to get it right first time!
