Benefits and Challenges of Adoption of International Financial Reporting Standards

By Gobeze Dessalegn, FCCA Director, HST| Audit

Continued from last week
Part II

Business and financial reporting considerations
Impact of IFRS conversion on external financial reporting
Converting to IFRS will have far-reaching effects on the way financial reporting is conducted. Some of the key impacts include:
Impact on bottom line – Companies should expect a change in earnings and financial position;
Potential for increased volatility of reported results – Adopting IFRS could result in increased volatility of reported financial results, depending on circumstances;
Increased volume and complexity of financial disclosures; and
Increased transparency and comparability -As use of IFRS becomes more embedded and experience in applying IFRS grows, increased transparency and comparability are benefits that should become more pronounced as the deadline for IFRS conversion approaches.
Implications of IFRS conversion for the business
The changes driven by IFRS will not be restricted to the finance function. Converting to IFRS will not merely be a technical accounting exercise but more a widespread change management exercise that will impact many areas of the business. Any business function required to prepare financial information, or impacted by financial information, has the potential for change including, but not limited to:
IT and Data Systems (IT);
Executive and Employee Compensation Plans (Human Resources);
Foreign Exchange and Hedging Activities (Treasury);
Corporate Income Taxes (Taxation);
Ratios and Financial Covenants (Finance and Treasury);
Internal Controls and Processes (Finance);
Investor Relations and Communication to Capital Markets (Finance and Investor Relations); and
Management Reporting (Finance).
All these being said, it is important to note that each company’s concerns and the extent to which IFRS will impact them will be different. For some, the impacts will be pervasive; for others, they may be minimal.
IFRS conversions: What CFOs need to know and do?
Impact of IFRS conversion on management reporting
IFRS will influence the way management runs the business and assesses performance. One of the significant trends reported in Europe was the increased use by management of “non- IFRS” measures (i.e., performance indicators not defined under IFRS) when communicating business performance to the market.
The changes to accounting policies expected from applying IFRS and the need to record and classify information in specific ways to comply with the new standards may impact the financial information generated by the business. Management reporting formats and processes will need to be reviewed and updated accordingly. In addition, management will need to give some consideration to impacts on the key performance indicators used for measuring success and reviewing trends.
Impact of IFRS conversion on tax reporting and tax filings
Tax reporting in financial statements under IFRS will likely change. Converting to IFRS may impact the deferred taxation accounting of the business, particularly in relation to the value of timing differences and the time frame over which these are expected to reverse. Given this different time frame, the corresponding tax rates applicable to these timing differences may significantly impact the effective tax rate borne by the business and, consequently, the net reported earnings.
Consequently, as businesses convert to IFRS for financial reporting purposes, the CFO will need to assess whether this new accounting framework is a reasonable foundation to use as the basis for the income tax calculation or whether some alternate approach will lead to a truer picture of taxable profit.
Comparison with competitors and industry peers
Companies often compare themselves to industry norms and peers, from both a strategic and a business focus as well as from a measurement and results basis. Most companies will want to know what their peers are doing as it relates to IFRS and, specifically, the financial reporting decisions that are being made. This is especially challenging when the selection of accounting policies is influenced by local industry practices and peer group comparisons, both of which are themselves in a state of transition. On the other hand, due to global acceptance of IFRS, availability of information on accounting practices for specific industries may be more readily available. At the same time, investors and market analysts will also want to be aware of the differences in decisions made by peer companies so they can take into account these differences when making decisions.
To remain true and consistent with the IFRS objectives of comparability and transparency, CFOs will need to assess the accounting principles selected by industry peers. Although not all companies within the same industry will select identical policies, management’s analysis would not be complete without this peer assessment.
IFRS training for finance personnel
Based on the experience of other jurisdictions that have converted to IFRS, a shortage of trained resources is a significant challenge companies will face. Addressing the organization’s skill requirements should therefore be an immediate priority for management. For most companies, following the initial impact assessment stage, training is the next big milestone, which should be completed as early as possible in the conversion cycle.
At the same time, due to high demand for IFRS trained resources, the CFO may also decide to develop succession plans for key IFRS-trained technical resources and revisit the company’s compensation strategy to better mitigate the risks of losing their key finance people.
Risks and opportunities
Risk of fraud and misstatement associated with converting to IFRS
The conversion to IFRS is one of the most fundamental changes in financial reporting in Ethiopian history. The potentially pervasive nature of the changes at the accounting, functional, transactional and internal control levels increase the risk of both misstatement and fraud.
A robust system of internal controls is a company’s best method of ensuring reporting integrity and minimizing the risk of misstatement and fraud. A period of change, such as one encountered during an accounting conversion, could lead to modifications in the design and effectiveness of internal controls, hence increasing risk. Following an initial IFRS impact assessment, the next steps entail mapping the significant accounting and financial reporting areas impacting the current internal controls over financial reporting.
Identifying other key risks associated with converting to IFRS
Today’s financial reporting environment has little tolerance for mistakes, and it will be important for companies to get the conversion right the first time. Errors and misstatements as well as missed reporting deadlines present a significant risk to companies which are converting. CFOs should consider what could go wrong and the likely impact and set in place mitigation and management strategies.
Taking advantage of opportunities presented by the conversion to IFRS
The conversion to IFRS presents potential opportunities that CFOs may wish to examine further. The IFRS accounting framework contains numerous instances in which multiple accounting options are permitted. This creates opportunities for CFOs to identify and select options that may result in a more appropriate representation of their financial results and position. However, proper account must be taken of any “global consensus” regarding specific accounting options for their industry lest a company may be seen to be diverging from the norm.
The role of the auditor in the conversion process and the need for a third-party advisor
Many companies will engage a third-party advisor to assist with the conversion process. CFOs cannot, however, delegate away their reporting responsibilities or their responsibilities over the selection of appropriate accounting policies. Some companies will seek assistance directly from their auditors, whereas others will turn to another service provider.
In many cases, the auditor will be able to assist management in various ways. The auditor knows the business, management and current policies. Generally, the auditor should be able to provide diagnostic and training services, advice on alternative accounting options, assist with the interpretation of IFRS, and observe and review project progress.
The extent to which companies request assistance from their auditors will depend on several factors. Obviously, auditors cannot perform services that would be considered proscribed services. Whatever non-proscribed services are offered will depend on maintaining auditor independence, including the perception thereof. Auditors should not be perceived as assuming a management role or auditing their own work.
Lastly, the degree of auditor assistance determined to be appropriate will be a function of the scope of service limitation philosophy as it pertains to auditors providing non-attest services.
Notwithstanding the above, the company’s objectives should be to avoid surprises in the audit process. As such, auditors should at a very minimum be involved in reviewing and commenting on (or accepting) management’s analyses of accounting alternatives and the selection of appropriate accounting policies. In addition, management or the audit committees may ask the auditor for observations regarding management’s assessment of the conversion issues, timeline, and risks.
Summary
Why global convergence?
Benefits for companies
Improved management information for decision making;
Better access to capital, including from foreign source;
Reduced cost of capital;
Ease of using one consistent reporting standard in subsidiaries from different countries/comparison of State-Owned Enterprises (SOEs) across countries;
Facilitated mergers and acquisitions; and
Enhanced competitiveness.
Benefits for investors
Better information for decision making;
More confidence in the information presented;
Better understanding of risk and return; and
Better comparison among peer group of companies.
Benefits for policy makers
Strengthened and more effective capital market;
Better access to the global capital markets; and
Promotion of cross-border investment.
Benefits for national regulatory bodies
Improved regulatory oversight and enforcement;
A higher standard of financial disclosure;
Better information for market participants to underpin disclosure-based regulation; and
Better ability to attract and monitor listings by foreign companies.
Benefits to other stakeholders
Greater credibility and improved economic prospects for the accounting profession;
Enhanced transparency of companies through better reporting; and
Better reporting and information on new and different aspects of the business.
Anticipating the challenge to solve it faster ….
Key decision makers to adopt principles;
Availability of IFRS technical resources;
Cost of bridging gaps in knowledge and budget constraints;
Organization wide training in IFRS principles relevant to entity;
IFRS 1 may also require going back in time to evaluate impact; unless record retention is reasonably effective just gathering information could be a challenge; and
Applying fair values to accounting.
Conclusion
The quality of a company’s accounting numbers is determined by the extent to which proper accounting standards are applied. One of the goals of the IASB is to develop high quality international accounting standards that will be easily understandable and enhance transparency in financial reporting globally.
When faced with a transition to IFRS, the preparers of financial statements might feel overwhelmed by the scale of the task ahead of them and may concentrate on the accounting issues at the expense of considering the wider business implications, both positive and negative. Making use of sound project management techniques will facilitate a smoother transition, from which benefits will accrue, potentially making a difference to business operations by providing an opportunity to overhaul old practices and introduce more efficient ones. Approaching the transition in this way is likely to result in IFRS becoming embedded within the organization, making year-end financial reporting easier on an ongoing basis.

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