IFRS: Seven Steps to a Smooth Transition
Author:
John McDonnell
However your transition to IFRS was planned, the best way to tackle each step is to think in terms of the final product – IFRS compliant statements. How ready are you? Has your conversion process taken all matters into account?
Step 1:
Have you assessed the impact IFRS will have on your business?
Moving to IFRS is always going to throw up its fair share of challenges and surprises, even within a thorough and well-researched project. At the start of the transition programme an assessment should be undertaken to highlight the key implications of the change for the business and the possible effects IFRS will have on the reported results and key performance indicators.
We all know there have been stories about companies whose return on investments dropped by over 80% as a result of their conversion to IFRS. However the opposite is also true. For instance, one European company who made the transition in 2001 arrived as an opening group capital and reserves of €20.9 billion under IFRS, more than double the German GAAP equivalent.
Any large movement such as these will lead to questions from analysts and other investors. Indeed IFRS may actually result in companies being differentiated less by their raw numbers and more by their ability to explain why the numbers have moved. Management will need to make sure that they have well-considered explanations for significant movements if they want to maintain good relationships with investors and financial analysts.
Step 2:
Have you decided on your optional accounting policies?
IFRS allows companies choose a number of options on first time adoption. Deciding on the policies most suited to your company is an important step within your IFRS transition program. It is only after such decisions have been made that companies can identify exactly what data needs to be captured.
One crucial question that companies need to ask themselves throughout the conversion process is “Is the cost of conversion worth it?” One company decided sell their convertible bond holdings rather than make all the necessary changes, as the value of their bonds was only €6m out of an overall portfolio of €18 billion. This is an option that many companies rarely take into account and can be important in the content of an efficient transition.
Step 3:
Has missing data been identified?
Another area of significant importance is the identification and collection of missing data. Companies need IFRS data for the whole of 2004 for their 2005 comparatives. Collecting data must be recognised as an on-going task, as retrieving data retrospectively can be complicated and confusing.
One financial services company making the transition to IFRS confessed that product classification was the biggest hurdle they encountered. The finance team were unaware that their IFRS project team did not actually have a complete list of company products. As a result large amounts of data had to be sourced from the operating division before analysing a significant proportion of their portfolio to discern whether policies should be classified as insurance or investment and thus how to account for them. This scenario could have been avoided if proper planning had taken place.
Step 4:
Have your systems been adapted for IFRS?
This step, if completed accurately, can provide companies with a valuable catalyst for evaluating and improving the systems and operations of their business. There are four distinct phases for accurate completion:
1. Quantify all the data requirements (step 3 above) - companies need to have a detailed picture of the all the new data that will be required for IFRS reporting
2. Identify the system sources for this new data and address any data gaps missing
3. Take adequate steps to ensure that the data is consistent and reliable
4. Introduce additional controls where necessary in order to maintain the quality of data
Many large companies have made the substantial progress in this area, while smaller companies appear to be of the view that as their systems are less complex this step can be by-passed. Experience however, has shown that making the necessary system changes is the centre of a successful transition project. By embedding IFRS into a company's everyday systems and processes, IFRS information is generated as part of 'business as usual'.
Step 5:
Have you your processes in place for the conversion?
All companies will approach the conversion in their own particular way. Some companies have recognised that they do not have sufficient time to embed IFRS fully in into their systems in time for their first IFRS reporting period, while others have already made IFRS the basis of their general ledger going forward.
While the latter option may be difficult in the short-term, it will certainly ease the burden in the long-term, particularly when IFRS fully replaces Irish/UK GAAP thereby removing the need for subsequent adjustments.
The former option however, is more 'the norm'. This means that companies primary source of information will not be IFRS compliant, thus necessitating 'workaround' solutions to produce information for the first IFRS financial statements. Experience has shown that these 'workarounds' are often labour-intensive and difficult to control without effective internal control systems. Additionally companies need to ensure that these short-term solutions are robust and acceptable to their auditors.
Step 6:
Have your internal controls been enhanced?
Directors and internal auditors need to be satisfied that the company's internal control systems, including financial controls, are adequate and sufficiently robust. Significant amounts of work will need to be undertaken to determine the data required for IFRS and to adapt the systems to produce this data. The key underlying aspect of the entire process however is that the data being used to prepare the financial statements is accurate, reliable and appropriate.
The move to IFRS is particularly challenging for foreign SEC registrants faced with the additional requirements of the Sarbanes-Oxley Act. These companies need to look to see where they can bring their IFRS and Sarbanes-Oxley projects together, to benefit from interdependencies and to work more efficiently in both areas.
Step 7:
Has IFRS been embedded across each business unit and for management reporting?
IFRS is a change in primary GAAP, which means that everyone in the organisation is learning a new language, and a new way of working. Training finance staff is crucial.
But the training and communications strategy does not stop at the finance function. Board-level understanding and awareness of the likely strategic impact of IFRS is a vital step towards the IFRS project. Buy-in from the Board is likely to be needed in many areas, such as:
- First-time adoption exemptions (e.g. restating, or not, prior business combinations)
- IFRS options (e.g. accounting for investment property at cost
or fair value)
- Use of hedge accounting or other volatility-reduction methods
- Classification of financial assets (e.g. use of the held-to-maturity category)
IFRS has arrived…
IFRS is the biggest accounting change in a generation and it comes at the same time as other significant corporate reporting changes such as the Sarbanes-Oxley and Basel II requirements.
…and with its many accounting benefits
- IFRS has established a global financial reporting language
that enables companies to be understood in a global marketplace
- It allows multinational groups to apply common accounting across their subsidiaries which improves internal communications
- IFRS eases acquisitions and divestments through greater certainty and consistency of accounting interpretation
- This global reporting language allows companies to benchmark themselves against their peers worldwide
John McDonnell, IFRS Services Partner, PricewaterhouseCoopers