In this new FSN white paper, Gary Simon, FSN's managing editor, takes a comprehensive look at the the business and technology issues surrounding U.S GAAP to IFRS convergence and explores how these can be tackled in Agresso, a popular and flexible ERP system. The white paper will be especially useful for any readers contemplating the transition to IFRS and will also be valuable background for readers contemplating a migration to "Agresso Business World".
CONTENTS
IFRS – the background and timetable for convergence
How serious is the impact of IFRS?
Swings and roundabouts
Underestimate the people issues at your peril
The process and technology issues
Heterogeneous versus homogeneous groups
Is there a positive side to IFRS?
Responding to the implementation challenge
What level of granularity?
Data capture
Reporting
So why is Agresso a better fit than traditional ERP in relation to IFRS?
Information warehouse
Business Processes
Analytics/Reporting
So what are the next steps?
Summary
IFRS – the background and timetable for convergence
Nobody should underestimate the enormity of the task facing international accounting standard setters. The goal of achieving harmonised financial reporting right across the globe using one set of high quality accounting standards is an undertaking of enormous complexity and scale. Yet this is exactly what the most powerful economies the “G20” have signed up to and re-affirmed in 2009 following one of the deepest financial crises that anyone has encountered.
IFRS to US-GAAP convergence has its roots in the so called ‘Norwalk Agreement’ which followed a joint meeting of the US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) in Norwalk, Connecticut, following which the parties pledged to make their respective financial reporting standards “fully compatible as soon as is practicable” and ensure that “compatibility is maintained”.
Presently, there are approximately 11,000 companies whose securities are registered with the U.S. Securities and Exchange Commission (SEC), of which about 1,100 are non-U.S. companies. Since 2005, non-U.S. companies have been allowed to submit their financial statements to the U.S. SEC in compliance with either U.S. GAAP or IFRS, as long as they reconcile discrepancies in the results between the two. But following Europe’s success in implementing IFRS, there has been renewed impetus in the U.S. to merge U.S. and international accounting standards and in November 2007, the U.S. SEC dropped the reconciliation requirement.
But the severe downturn which started in 2007, has complicated matters with FASB noting that “…the financial crisis has revealed a number of significant deficiencies and points of stress in current accounting standards…” So FASB and IASB set up urgent projects under the auspices of the Financial Crisis Advisory Group (FCAG) to deal with specific concerns related to the role of financial reporting in the crisis.
The result is that listed companies, preparers and readers of financial statements now have to endure a high level of change and uncertainty on top of the ‘regular’ or planned convergence activities. This has caused heightened concerns about the cost of compliance and possible delays to the convergence timetable. Nevertheless, in November 2009, the IASB and FASB reaffirmed their commitment to bring about convergence by 2011/12.
Private companies too are not immune from the rigours of international reporting standards. Mid-2009 has seen the publication of International Financial Reporting Standard for Small and Medium�sized Entities (IFRS for SMEs), bringing the prospect of even more change to this previously untouched segment of the economy. As one would expect IFRS for SMEs is a much simplified version of the full IFRS standards with substantially fewer disclosures.
But the overall message is clear - regardless of size or geographical domain virtually all businesses face a period of regulatory change, complicated by local company law, domestic standards and timelines for implementing standards. However, with appropriate financial systems that offer flexibility in underlying coding structures, dimensions and reporting, the whole transition from local GAAP to IFRS can be considerably less daunting.
How serious is the impact of IFRS?
Swings and roundabouts
A study of 131 companies in 2006 (when the SEC still required companies that used IFRS to reconcile their financial data with U.S. GAAP) shows wide variations between profits recorded under IFRS compared to net income recorded using U.S. GAAP. The difference in net earnings between IFRS and U.S. GAAP, expressed as a percentage of U.S. GAAP net income, varied from more than plus 80 percent in some industries to minus 60 percent in others. But why is this important?
The answer lies in the fact that IFRS is much more principles-based than U.S. GAAP. So it is left to individual companies and their management teams to explain away the key differences in results generated under the two different regimes to investors, fund managers, analysts and other readers of financial statements. Therefore it stands to reason that companies are highly reliant on the capability of their underlying financial management systems to yield the insights and supporting analysis necessary to reconcile results between the two systems of measurement and provide convincing explanations.
Underestimate the people issues at your peril
So migrating to another accounting rule book is game-changing for the company and the finance function. As noted above, the implementation of new methods of measurement can have a material impact on the way that profits are reported (up or down) and have profound consequences for the balance sheet. While it is tempting to dive straight into the systems and process issues, if the European experience is anything to go by then the first port of call should be education and training for the finance function, i.e. people issues.
Without a deep understanding of the principles and their impact it is impossible to formalise an implementation strategy. For example, companies that are lightly affected may be able to get away with a handful of group adjustments. By contrast, other businesses may need to implement more extensive changes and at a much lower level of granularity - affecting the information they capture, their general ledger account structures and dimensions.
It is important not to confuse a few major impacts that may be financially very material with more pervasive changes that do not amount to much individually - but are collectively significant. Each situation will drive a different implementation approach. Leveraging the technical accounting knowledge of the major accounting firms at an early stage is important. They can help companies navigate their way through the transition to IFRS, distilling the important changes that hit pension funds, bank covenants and profits from the minor changes that do not have a material impact. In a group finance environment everyone with responsibility for financial (statutory) accounting needs to be on the same page as early as possible.
The process and technology issues
The process and technology issues are fairly well compartmentalised. Looking at them in rough process order, i.e. from local reporting entity to consolidated group accounts, they relate to;
- Data collection – specifically the potential need to collect additional or different information for analysis reflecting the difference in the basis of measurement between IFRS and U.S. GAAP.
- Chart of Accounts – potentially additional chart of account lines to accommodate the new information to be collected or to trap adjustments and reconciling movements between IFRS, U.S. GAAP or local GAAP.
- Dimensions – to help organise different bases of measurement in a multi-GAAP environment, for example, in the transition period before full adoption of IFRS when it is necessary to produce comparatives.
- Entity structures – reflecting the possibility of segregating IFRS and U.S GAAP reporting entities in order to simplify the transition period
- Consolidation structures – similar to the justification for altering the chart of accounts, dimensions and entity structures above, but this time at a group level in a consolidation ‘engine’ rather than in local entity general ledgers
- Reporting – the need to adjust reporting capability to rapidly compare prior years’ results in local GAAP or U.S. GAAP with IFRS and to capture the adjustments between them.
- Business Intelligence/Dashboards – to re-assess performance measures (key performance indicators) that may have been affected by the different basis of measurement in local GAAP or IFRS.
Heterogeneous versus homogeneous groups
The complexity and scale of the group reporting is quite different for a heterogeneous group, say, an industrial conglomerate which spans several different industries and a homogeneous enterprise that focuses almost exclusively on one business sector. For example, a hotel group, comprising hundreds of properties throughout the world may be able to introduce a standard group chart of accounts, whereas this is rarely feasible for a geographically dispersed engineering conglomerate, with various different service divisions,spanning several market sectors.
Furthermore it is often the case that a homogeneous business, which is strongly vertically aligned, can more readily take advantage of standardised processes and standard chart of accounts. However, group reporting systems are rarely this simple and for most companies the reality is that local charts of account are different from the group reporting pack and require a ‘mapping’ or translation table to move data between them. Homogeneous businesses are clearly at an advantage when transitioning to IFRS.
Whether a group has a homogeneous or heterogeneous IT policy ( as distinct from organisational structure) also has consequences for the introduction of IFRS. A homogeneous IT policy based around a single ERP platform confers a number of advantages when aggregating financial results and implementing IFRS. Provided the ERP system can cope with the inherent complexity of IFRS then the ability to merge and summarise data in the same computing environment, without specifying interfaces, is a significant bonus, especially if all reporting entities can share the same chart of accounts. On the other hand, the ‘Best of Breed’ (heterogeneous) approach where group IT policy is to pursue the best application for the job can lead to significant additional complexity. Mapping from reporting systems to group systems has to cope with different IT platforms as well as different data collection tools, interfaces and consolidation engines. This can severely impact process flows, data quality and ease of reporting. IFRS adjustments, for example, to charts of accounts, data collection forms and reports may have to be implemented several times in different ERP, business intelligence, consolidation and reporting tools. In general, the more that can be accommodated within a single platform the easier it is to implement IFRS.
Is there a positive side to IFRS?
The most commonly cited advantage of IFRS is the harmonisation of global reporting which is intended primarily to benefit investors and other users of statutory accounts. But the move from local GAAP to IFRS also holds more subtle advantages for individual companies embarking on the change, principally because it provides the opportunity to tighten and improve their group reporting process. For example;
- Review and close down dormant companies that have been allowed to clutter up the group reporting structure
- Revise the chart of accounts which could have become unwieldy because of successive legislative changes introduced on an ad-hoc basis and develop a consistent data dictionary for group reporting.
- Reduce physical layers of consolidation, i.e. sub consolidations (regional or divisional) that may have been a legacy of older systems.
- Iron out different accounting policies, such as depreciation, that may have crept into the group but were masked by materiality levels.
- Confirm standing data, such as exact shareholdings and ownership which may have become ‘lost’ in Groups with several hundred subsidiaries.
In effect, IFRS can act as a catalyst, speeding up the review all of those jobs that nobody has had the time to deal with but, if tackled, could significantly improve the speed of group reporting and the quality of data captured.
Responding to the implementation challenge
There is no blanket or ‘one-size-fits-all’ approach to the implementation of IFRS, as can be seen from earlier paragraphs much depends on a group’s particular circumstances, the nature of its business, recent history, preparedness for change and systems architecture. Nevertheless there are certain key themes to explore.
What level of granularity?
This is a key decision to make early on in an IFRS migration strategy since it is a major determinant of the amount of implementation effort needed. Essentially, there are three critical areas;
- Does IFRS need to be deeply embedded in individual reporting entities’ charts of accounts?
- Can the IFRS changes be confined to data capture at the group level?
- What impact does IFRS have on the generation of statutory reports?
The European experience suggests that many companies failed to plan sufficiently for IFRS and underestimated the effort involved. As a result many left the changes until too late (not helped by the fact that IFRS standards were also changing at the same time) and did not have time to implement changes to reporting entities’ charts of accounts. As a result, adjustments were hurriedly introduced at the group consolidation level and had to be passed back down the line. In subsequent years, companies were forced to reconsider what they had done and re-implement their general ledger systems.
Data capture
It may be necessary as part of IFRS to capture additional information (change the information model) because of, say differences in depreciation policy or perhaps segmental reporting. What some companies overlook is whether the additional information that is required under IFRS is actually available.
Process change
Furthermore when dealing with new dimensions or new information requirements the impact on data capture (process model) can be profound.
Data capture screens, validation checks, consolidation logic can all change as a result of even the simplest modification and it should not be assumed that data capture changes are confined to the general ledger. Increasingly information requests for statutory purposes may fall outside of the scope of the general ledger and require interfaces to fixed asset ledgers, HR or other systems.
Even where it is decided that data capture changes should be confined to the group reporting pack rather than the general ledger the same principles concerning the availability of information and validation apply.
Reporting/Analytics
The ability to report quickly and flexibly is paramount in the transition to IFRS – not simply to comply with statutory filings and deadlines but as a tool to prove the integrity of the migration, understand its impact on earnings releases and assess its effect on key performance indicators.
Since IFRS is principles-based the burden of reporting and communications to shareholders falls squarely on the shoulders of management and as shown earlier, IFRS can cause significant swings in earnings compared to U.S. GAAP. So it is vital to use reporting as the basis for ‘teasing’ out the differences between the two regimes and explaining them away. This is especially important during the earlier transition years when statutory filings will require comparatives between the two standards to be published.
A further consequence of the differences in accounting measurement under the two sets of standards is that it can throw up unexpected impacts on banking covenants, employee remuneration and performance indicators used to manage the business. So it is a good idea to revisit an earlier accounting period and determine what impact IFRS would have had on the reported results had it been the prevailing standard at the time.
Additionally it is important to get an early grip on reporting structures that readily allow management to generate multi-GAAP statements, i.e. the two standards side by side, but with the ability to isolate the adjusting or reconciling entries between the two.
Reporting also needs to be flexible to change. IFRS is constantly being revised and adapted to meet new circumstances such as the fall-out from the credit crunch. Change will be a constant feature of the group reporting landscape and should be anticipated in any reporting structure that is developed.
So why is Agresso a better fit than traditional ERP in relation to IFRS?
The Agresso VITA architecture was designed from the very outset with self-sufficiency in mind. VITA is a ‘reverse-engineered’ architecture; unlike other solutions it is designed for ease of getting data out rather than focusing on getting data into the system. The data, business process and delivery methodology (reporting and analysis) are intelligently tied together and synchronised, making the process simple, quick and efficient.
More importantly, thanks to VITA changes to support regulatory requirements are typically made at the graphical user interface (GUI) level, by business users with little or no IT intervention. This has always given Agresso a distinct business advantage over ERP systems that were built up through acquisition, but the capability is especially beneficial when dealing with the stretching demands of IFRS.
We have seen that data capture, consolidation structures (general ledgers) and reporting are inseparable parts the group financial reporting process. In effect, Agresso Business World mimics this structure so that IFRS changes implemented in one place automatically inform the others. This allows the information warehouse, the business process model and the analytics/reporting capability to be kept in step automatically without re-architecting the system or causing business disruption.
This is in sharp contrast to ERP vendors that rely on third party reporting solutions or less tightly bound in-house approaches. Superficially, information may flow between them, but in practice, a change to one aspect inevitably requires a change to the other - quite often accompanied by skilled IT intervention.
Information warehouse
Agresso's core design rests on an integrated data model --an information warehouse that supports data throughout the system. The applications reside within a single shared environment in which metadata is defined once and made available immediately to every other application such as, financial management, procurement, project costing, HR and payroll applications. This data model not only serves as a shared repository of information for the applications but also acts as an automatically defined 'catalogue' for Agresso's wide range of specialised reporting and information delivery tools.
Take for example the situation of a U.S. registrant that decides to implement IFRS equivalent accounts as additions to the existing chart of accounts or as a new dimension for segmental reporting (IAS 14). In Agresso Business World, the new accounts (new metadata) are immediately exposed to the information warehouse, business processes model and reporting/analytics engine. This means that the new accounts automatically conform to business rules, say validation routines held within the information warehouse, are included in manual data entry screens used to populate the general ledgers and can be surfaced in reports and enquiries from anywhere in the reporting environment. Furthermore, none of the changes require coding changes or specialised IT intervention.
Where information needs step outside of the general ledger, say the capture of additional asset information manually or automatically from a fixed asset register in the case of (IAS 16 Property, Plant and Equipment), Agresso's architecture ensures the integrity of information across the enterprise by allowing user-defined additions to the data model, automatically providing maintenance routines around them, as well as facilitating links to any desired external applications.
Business Processes
Agresso extends both business process support and user productivity through deeply embedded workflow, business alerts and document management, which in line with its design philosophy, are integral part of the VITA architecture that can immediately leverage structures and data held in the information warehouse. The work flow is especially important in a group reporting context which requires considerable collaboration across the finance function.
Any additional IFRS information added to the information warehouse is available to the workflow engine and the document management system provides the ability to link any new information (transaction or master file element) to non-Agresso documents, which could include, for example, scanned images, Excel workbooks, Word documents, Notepad documents, Hyperlink/web pages or other Agresso reports. These attached images and files can be stored within the information warehouse or in an external document archive and can be viewed in context on any drill down inquiry.
Analytics/Reporting
Agresso's ABW reporting and presentation tools have an immediate 'understanding' of the underlying data structures and unlike third-party tools in other ERP systems, there is no need to define a data dictionary or catalogue, or provide ongoing maintenance as business requirements change. Change is simple and transparent: new information is available immediately to a broad spectrum of users, while terminology and structures remain consistent across the business.
Agresso Business World allows organisations to define a broad range of analytical parameters attached to core and transactional information so that it is easy to segregate information in a multi-GAAP environment. Just as important it is easily possible to isolate the adjustments between local GAAP and IFRS.
Reporting hierarchies allow information to be viewed in a practically limitless number of different dimensions which is valuable when using dimensions to hold different GAAP regimes. Using the standard reporting within ABW, users can report separately for each GAAP or combine figures prepared under each approach on a single report showing the differences between them.
Agresso’s concept to information delivery (reporting and analytics) in contrast to other solutions on the marketis that the definition of the information need is done once whereas the presentation of it can be done in any kind of form and shape using various tools such as:
- Excelerator, Agresso Business World's dynamically linked spreadsheet tool; or
- Agresso Business World's "Analyser," which provides a wide variety of graphing options.
- "Information pages" allow groupings of favourite IFRS reports and inquiries to be displayed as excecutable options on a start-up page.
- More traditional production reporting is supported through tools such as Agresso Report Writer, a text based reporting tool that is ideal for audit reports, or
- Agresso Report Creator, a graphical reporting tool that can apply more imaginative graphics and formatting to regular production reports.
The tight integration between information delivery and the underlying data model means that changes to metadata within the model are immediately exposed in the information layer – no matter which one is used.
So what are the next steps?
It is important to start the migration to IFRS as early as possible. Good planning is key to delivering a robust and adaptable solution. Here are the most important steps.
- Work with you external auditor to deliver education to the finance function around the U.S. GAAP to IFRS migration and work out the most material areas of disclosure for your company and sector.
- Assemble a project team comprising, technical financial accountants, systems implementers and personnel skilled in the underlying business systems to propose changes.
- Decide on the level of granularity for the changes identified and modify systems to incorporate multi-GAAP amendments at the appropriate level.
- Develop reporting capability to expose reconciliation differences between different GAAP measurements together with the ability to drill down on the results
- Produce key performance indicators and evaluate changes
Summary
The convergence of U.S. GAAP and IFRS is becoming more of a certainty with both the major accounting boards re-affirming their commitment to a timetable that should deliver a unified standard in the 2011/12 timeframe. However, with standards still being modified as a result of the financial crisis the implementation task is complicated by the threat of constant change. Private companies too will also need to face up to the prospect of IFRS implementation.
IFRS migration is often viewed as a systems issue but the European experience shows that education of finance personnel and a deep assessment of the impact of IFRS is the best place to start. Earnings reported under IFRS can differ markedly from U.S. GAAP and the burden of explaining swings in profitability (up or down) falls on management alone. This means that decision makers must be supported by robust systems that allow the differences to be accurately identified and explained.
No two companies are alike but the systems and process challenges generally fall into recognisable categories, such as data capture, the chart of accounts and reporting. Homogeneous groups probably have an easier time of the migration than heterogeneous groups that cannot standardise on one chart of accounts. Furthermore, a homogeneous IT policy leads to more streamlined process flows and fewer IFRS challenges than companies pusuing a Best of Breed approach.
The positive side of IFRS is that companies can take a systematic approach to catching up with all of the tasks that have previously been neglected, such as clearing out redundant chart of account lines, clarifying the group structure and eliminating dormant companies.
Responding to the implementation depends on a realistic assessment of the accounting impacts coupled with a decision on the level of granularity at which to implement IFRS, for example, local entity general ledger or group consolidation. Commonly, IFRS can cause changes to data capture, general ledgers and reporting.
Agresso Business World is particularly accommodating to IFRS changes because of its unified information warehouse, process engine and reporting capability. Unlike traditional ERP systems it means that changes made in one area are automatically reflected in another, saving time, cost and the necessity to call in specialised IT resource.
Experience of IFRS in Europe shows that many companies overlook the time needed to implement IFRS. Early planning, involving the major accounting firms and software suppliers is essential to ensuring that changes are effective and that systems do not have to be constantly re-implemented.
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About FSN |
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FSN Publishing Limited is an independent research, news and publishing organisation catering for the needs of the finance function. The report is written by Gary Simon, Group Publisher of FSN and Managing Editor of FSN Newswire. He is a graduate of London University, a Chartered Accountant and a Fellow of the British Computer Society with more than 23 years experience of implementing management and financial reporting systems. Formerly a partner in Deloitte for more than 16 years, he has led some of the most complex information management assignments for global enterprises in the private and public sector. His bestselling book, “Fast Close to the MAX” was published in 2008. Whilst every attempt has been made to ensure that the information in this document is accurate and complete some typographical errors or technical inaccuracies may exist. This report is of a general nature and not intended to be specific to a particular set of circumstances. FSN Publishing Limited and the author do not accept responsibility for any kind of loss resulting from the use of information contained in this document. |
