Risks ahead!

Peter Williams on the implications for auditors of IFRS adoption

Auditors whose clients are involved in moving from local Generally Accepted Accounting Practice (GAAP) to international GAAP as laid down by the International Accounting Standards Board (IASB) should be aware of the pitfalls that lie ahead.

The switch from national accounting standards to International Financial Reporting Standards (IFRS) represents a substantial increase in the risk that the audit may go wrong. And it is a risk that is faced by auditors all over the globe.

According to the IASB, over 90 countries will either require or permit the use of IFRS for publicly traded companies before or during 2007. For many countries, including Australia, Russia and the 25 member states of the European Union, IFRS adoption is now a matter of weeks away. Plus China and India have a formal policy to pursue convergence of national standards with IFRS. So many countries equates to a lot of companies and a lot of auditors.

The conversion to IFRS is complex and detailed and recent surveys suggest that the state of companies' preparedness for this important change is not all it could be. Many companies will struggle to be ready by 2005. Auditing those numbers is going to be more than usually difficult.

There will be a major change in the format of the accounts; different accounting policies need to be formulated, and there are more extensive disclosure requirements. To achieve all this entails a significant project for companies that will affect their entire reporting process and may result in changes in their accounting systems.

When companies first adopt IFRS it is obvious that their auditors will have limited practical experience in dealing with these standards. The application of national accounting standards is based on experience built up over many years by both the company's finance staff and the audit team. Such an accumulated knowledge base will have to be rebuilt for IFRS. Even countries which have been using IFRS for some years will find that recent substantial changes pushed through by the IASB means few auditors will be conversant with the application of IFRS.

As well as having to come to grips with new measurement and disclosure rules, auditors will have to be aware that their clients may need to make changes to their financial reporting system and the financial controls in order to produce the basic information for the newly styled financial statements. Such system changes increases the opportunity for fraud. Transition to IFRS will involve complete restatement of the opening balances and potentially more volatile accounting measures. This increases the opportunities for deliberate misstatement of the first set of financial statements under IFRS; auditors need to respond to this.

Auditors should look out for some particularly difficult areas that they may not have met before even in national GAAP. For instance, many auditors may not be familiar with valuation of employee share options and non-traded financial instruments.

Given all this, it seems highly likely that some 2005 financial statements will be delayed and some audit reports will be qualified.

Auditors will want to help their clients comply with IFRS. They will no doubt spend much time not only with the finance director and the finance staff but will also talk through the issues with others responsible for governance, such as the audit committee. However many auditors have a natural inclination to help, they must also remember the need to maintain their independence and their integrity. There is pressure from governments and capital markets to make sure the introduction of IFRS is a success. But whatever the pressures, auditors need to ensure that their work remains of the highest quality and that they use their professional judgement and professional scepticism. The introduction of IFRS is a learning curve and auditors are expected to ensure that not too many mistakes are made.

Peter Williams is a freelance journalist and a chartered accountant and has written on accounting, financial reporting and auditing issues for many years. He is a former editor of Accountancy Age and Financial Director magazines and he currently edits titles concerned with on-line learning and knowledge management. He has twice won the Institute of Internal Auditors UK Award for excellence in Business and Management Press Journalism.