Law and Accounting Matters - March 2010
Managing the Risks of IFRS Conversion
Starting in January 2011, CSE-listed entities – like all Canadian public issuers – will be converting from Canadian generally accepted accounting principles (Canadian GAAP) to International Financial Reporting Standards (IFRS). Like any significant project, this carries both risks and opportunities, not necessarily in equal measure for all entities. For smaller public issuers, some of the most prominent potential benefits – easier access to global capital markets by using a common financial reporting language – may not seem particularly relevant, at least in the short term. The risks, however, are clear for all.
Canadian regulators are already taking an active interest in IFRS adoption. CSA Staff Notice 52-320 Disclosure of Expected Changes in Accounting Policies Relating to Changeover to International Financial Reporting Standards sets out expectations for MD&A disclosure between now and conversion, focusing on an issuer’s changeover plan and its progress against that plan. Some small companies have already received letters from regulators, questioning the adequacy of the activities disclosed to date and asking for more information on what steps they are taking to ensure they can make the transition to IFRS on schedule and continue to meet all their regulatory obligations. Even now, therefore, IFRS needs to be an active part of an issuer’s communication plan.
Generally speaking, of course, smaller companies will encounter fewer significant conversion issues; however, it will also be relatively more likely that some of the matters identified might be material to the financial statements as a whole. For many topics, increased note disclosure under IFRS will shine a brighter spotlight than exists under Canadian GAAP. To take just one of many examples, it’s clearer under IFRS that a “provision” has to be recognized, at its best estimate, for the obligation arising from an uneconomic or “onerous” business contract. In addition, the notes provide a breakdown of the movement in each significant class of provisions between the opening and the closing balance, disclosing key uncertainties (including major assumptions) relating to their measurement. This transparency might, for instance, provide a better basis for regulators to question whether liabilities should have been recognized earlier than they were, or to challenge their amounts.
Certifying officers of non-TSX-listed entities do not need to report on the design and effectiveness of disclosure controls and procedures and internal control over financial reporting. However, they must still certify on the fair presentation of the key financial information, and this may mean something very different under IFRS. Using the same example, provisions may not be “fairly presented” without making changes both to the core financial statements and to the notes. In turn, the MD&A will often need to expand to address these changes. This should not be at the cost, however, of drowning out the key decision-critical information: this would likely not result in a fair presentation either.
Similarly, audit committee members of non-TSX-listed entities are not subject to the same requirements for independence and financial literacy; however, they still play a key risk management role and must think about their individual fiduciary duties and potential individual liability. Relying on experience gained under Canadian GAAP will not provide an adequate basis for overseeing management’s IFRS-related decisions, since so much of IFRS has no direct precedent in Canadian GAAP. This is not to say audit committee members necessarily need to receive the same degree of training as the financial reporting staff. But they do need a sufficient awareness to identify what could go wrong, given the company’s specific operations and activities, and to engage with the explanations management provides for its decisions. It’s likely many audit committee members have not yet focused on this personal challenge.
Lenders and other finance providers have not to this point said very much about IFRS, although we know for instance that some of the banks are receiving training and thinking about how the transition should impact on their loan assessment criteria. IFRS will often change the calculation of key performance measures: on occasion it may even change something as “objective” as cash flows (for example, different entities may be consolidated). Some finance providers will take the impact on covenants in their stride; others may not. At least for some entities, managing the risks of such collateral impacts will be the most important direct impact of the IFRS conversion.
All of this said, even small entities can find benefits from IFRS conversion too. The risks described above allow a fresh look at procedures that may have grown stale. In some areas – provisions might again be an example – preparing the information for external reporting may provide a better internal focus for management as well. But in IFRS as in other things, the best offense starts with the defense.
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David Danziger is a National Head of Public Company Accounting at MNP LLP. He serves in both the audit function and as a compliance adviser to various public companies, and private firms looking to become public. You can find David as well as more information on MNP LLP at MNP LLP - David Danziger.
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