IFRS: more than simple conversion, this is transformation
| by Simon Gealy 17 Dec 2003 Topic: IAS |
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In an ideal world, all EU-listed companies required to report under International Financial Reporting Standards (IFRS) from 2005 would be well underway by now with projects to support the changes. But Simon Gealy discovers that, in reality, most companies have not made much progress, and some are seriously behind. The most pressing obligation is the need to include a note in all accounts after December 2003 indicating to investors how the company plans to achieve the transition to IFRS It is surprising just how few people within the companies required to adopt IFRS actually understand the impact of the standards. The introduction of IFRS represents a fundamental change to financial reporting. The challenge for companies is in generating awareness of the impact, and then managing the required change to a successful conclusion in the time available. These are key tasks that confront both the finance function and business managers. The introduction of IFRS is not simply the conversion from one financial reporting standard to another, but will influence the entire language used to share financial information throughout the organisation. The impact moves beyond the finance function to all aspects of management within the business. Such widespread change means IFRS is not something that can be handled in the few weeks prior to adoption. It will take considerable management commitment and time to achieve a successful transition. For many, the biggest challenge will be to collect enough reliable data in order to produce IFRS-compliant financial reports. Experience shows that businesses looking at IFRS for the first time are surprised by the breadth and volume of additional data they need to gather. Although, in many cases, the relevant information is being captured somewhere in the business, it is often not subject to an acceptable level of control as it is outside of the core financial reporting systems. Successfully embedding IFRS involves planning, implementing and managing a substantial data-capture process. For this process to be effective and produce a solution that ensures long-term repeatability, two separate but related approaches need to operate:
Taking it from the top The top-down approach necessitates a thorough understanding of the accounting policies and associated data requirements required to achieve IFRS-compliant financial reporting. This type of examination helps to develop a �shell� set of IFRS financial reports early in the conversion process and to identify gaps in currently available data. But it is not sufficient simply to arrive at a theoretically perfect model and watertight set of accounting policies. Commitment to the top-down definition of the IFRS requirements must be matched by �bottom-up� efforts at the business level. Such an approach should ensure that the �shell� of reporting requirements can be populated with the right level and quality of information within an acceptable time period. A second key challenge is understanding the impact of IFRS on the numbers themselves. IFRS represents a further step away from the traditional historical cost approach to accounting towards a framework which embraces the concept of fair value. One important consequence of this is the introduction of greater volatility to the P&L account. Given the reality that stakeholders generally place greater emphasis on results in a particular financial period than on performance over the longer term, volatility is one feature that must be well understood. Failure to understand and adequately communicate the impact of IFRS on a business� financial results could affect its cost of capital. Management needs to explain to analysts and ratings agencies the background to any changes in what may often have been a smooth earnings curve, to prevent any shocks to the market and consequent rising cost of capital. Understanding the numbers early is also a key ingredient in the implementation of change. Most businesses with any degree of complexity, particularly in the area of Financial Instruments, will find that the adoption of IFRS has a very tangible and direct impact on various business functions. Experience has shown that it is easier to grab the attention of the business units with details of the impact of a particular �accounting issue� once the nature of the change and its effect on product profitability has been explained. Showing them the numbers usually results in people getting engaged. Transformation This is not just about compliance. IFRS conversion offers businesses the opportunity to address aspects of the finance function that are not operating as efficiently as they could. It can provide the opportunity for businesses to address changes that have been put in the �too difficult� pile for too long, e.g. problems caused by operating with numerous parallel information systems - perhaps the result of past acquisition activity. Under present reporting requirements, the diversity of financial systems creates complexity for the finance function in terms of year-end financial close and the preparation of annual reports. In some UK companies the year-end close processes through to reporting can take up to four months. The result is that by the time one reporting cycle is completed the next one is about to start. This lengthy reporting cycle hinders the performance of higher-value analytical work by the finance team. The move to IFRS could be used as a lever for system rationalisation, leading to swifter financial close processing ultimately producing significant benefits for the finance function and, by implication, the entire organisation. In tandem with the potential transformation benefits that go along with IFRS implementation, there are also significant penalties for failure. These are not simply confined to regulatory breaches or penalties as a result of failing to produce information of the appropriate quality (although these will be substantial if reporting standards are not met, particularly under Sarbanes Oxley for US-registered companies). Of greater concern for many organisations will be reputational damage resulting from the inability to produce numbers under IFRS in a timeframe to match that of their peers. In a recent survey conducted in financial institutions by PricewaterhouseCoopers and the Economist Intelligence Unit (Taming Uncertainty: Risk Management for the Entire Enterprise), reputational risk emerged as the number one concern, ahead of both credit and market risk. Act now, or repent at leisure Subject to regulatory approval, the change to IFRS is non-negotiable and runs to a specific and immovable timetable. Failing to address the challenges of IFRS adoption is simply delaying the inevitable. As the deadline looms resources to support conversions become increasingly scarce. If businesses who have yet to address the implications of IFRS for their financial systems do not do so soon, they will quickly discover that their inaction could prove very costly. Prompt action by businesses now will position them to manage - and even profit from - this challenging change to the financial reporting environment. Simon Gealy is a partner at PricewaterhouseCoopers. | |