New $Num,ber.ss Language Coming Soon

Posted on | November 12, 2009 | 2 Comments

Attention CEOs & Business Owners: the language you are using in your financial statements to ‘talk money numbers’ is about to change – so start saying goodbye to GAAP!

IFRS is coming and it will cause a big change to how your financial statements are constructed. Consequently, what and how you communicate your company’s financial situation will have to change. And importantly, you may have to enact this change as early as 2010 if you are in Canada and by 2013 for those in the US.

Because of that, now is the time when your company needs to start getting ready to report your financial numbers differently!

IFRS is a new ‘accounting language’,  and if your company is of any size or hopes to be, you will be using it to talk to your shareholders, tax collector, banker and other important groups, including those inside your organization. So, you need to know that IFRS represents a big change, one that will in subtle but important ways significantly alter the way you handle the economic and financial management aspects of your business.

To put IFRS in a context most people can understand, here is an explanation I got just last week from a Canadian Chartered Accountant who does a lot of audits for publicly traded companies. He described the IFRS induced change that’s coming as equivalent to having to switch the language you use from English to Portuguese or Chinese.

Now, if you are in a private company, don’t go thinking you can avoid having to do things differently even though IRFS is primarily a financial reporting standard for ‘publically accountable enterprises’. That’s because private company accounting rules are going to be changing as well. Either you will have to adopt IFRS for one reason or another or you will have to conform to new IFRS-impacted Private Enterprise GAAP rules. The later are new guidelines that accounting standard setting bodies have or will have under development that respond in some measure to the whole new way of communicating a company’s financials that is gaining such wide acceptance all around the globe.

IFRS: What It Is and Why It’s Needed?

IFRS is an acronym that stands for ‘International Financial Reporting Standards’. As the full name implies, IRFS represents a new global agreement between local country accounting authorities about how companies need to communicate their economic and monetary performance and position. This is why today’s status quo in accounting and financial reporting will no longer be an option for you.

IFRS is a global standard that is spreading throughout all developed and developing economies. So far, as the following diagram clearly shows, most of the world has or will soon move to using IFRS as THE reporting standard for companies issuing financial statements.

The goal behind IFRS is to achieve global financial reporting convergence (i.e. sameness). Much of this has been achieved already because IFRS has been adopted by 110 countries so far. In just over 12 months time, three more first world countries will join this group as companies in Canada, Japan and India will be required to use these standards when issuing financial statements for 2011. And a year later, in 2012, Mexico will follow. Then, two years after that comes the US who are slated to start reporting using IFRS in 2014.

So what’s so different? IFRS are financial reporting standards that are "principles based", meaning they establish broad rules as well as dictating specific treatments. The previous approach called GAAP or ‘Generally Accepted Accounting Principles’ unfortunately deteriorated over time, particularly in the US, into a mind-numbing maze of far too narrowly focused, specific ‘rules’ which obscured and even compromised the purpose of financial communications.

The truth of this statement can easily be seen if you consider all the ‘doctored results’ and accounting scandals we’ve seen in the last 10 to 20 years. While no approach to accounting can or will prevent new frauds from being perpetrated by white collar criminals and shady accountants, experience since 2005 from Europe suggests IFRS will significantly cut down the risk of such fraud while making financial statements more consistent and understandable by a greater number of users.

IFRS’s Impact on Private Company Reporting

Now, mistakenly in my opinion, private Canadian companies (and maybe US ones too) are going to be given a choice whether to adopt IFRS or GAAP for Private Companies.

GAAP for Private Companies is a new set of standards being formulated in Canada for ‘non-publicly accountable enterprises’. As currently proposed, these are a hybrid set of standards that take some from the old Canadian GAAP and some from the IFRS concepts. Personally, I see this move as an unreasonable and needless proliferation of rules which undermines, even compromises, the IFRS objective. I say this because I thought the debate over ‘Big (company) GAAP’ and ‘Small (company) GAAP’ ended basically some ten years ago when only limited ‘differential accounting’ practices were allowed for private companies, which is something that will be eliminated under the new financial reporting standards being proposed. The better alternative for dealing with private company financial reporting, in my view, would have been to adopt a less intensive or rigorous version of IFRS, something that may yet come to pass in some five years time when GAAP for Private Companies is next scheduled for re-evaluation.

As of mid November 2009 in Canada, the situation for private companies is that we are waiting for the Canadian Accounting Standards Board (AcSB) release of their finalized Generally Accepted Accounting Principles (GAAP) for Private Enterprises now that the comment period on their exposure draft has been closed off. So this will result in a situation where, beginning with financial reporting years commenting January 1, 2011, Canadian private enterprises will be required to choose between following International Financial Reporting Standards (IFRS) or Generally Accepted Accounting Principles (GAAP) for Private Enterprises. Given how the prior year’s comparative statements will have to conform to the same standard, it effectively means that private companies will need to be able to report their 2010 financial statements in the new way as well.

Importantly, take note that the decision about which reporting standard a private company should use is not so straight-forward and nor is it something that owners will get to decide all on their own. That’s because the principal users of a private company’s financial statement are to be the ones effectively calling the shots, not issuers or just their shareholders. Even beyond that, there are a number of other reasons why IFRS may be the best or desired alternative for a private company, namely if you:

1. have an ownership exit strategy that involves getting acquired by an IFRS reporting entity, be it public or private;
2. have plans (firm or tentative) to sell or raise more capital by going public;
3. have key suppliers or customers in jurisdictions that have adopted IFRS;
4. are a subsidiary of a publicly accountable enterprise;
5. have international operations in IFRS only jurisdictions;
6. have or could have significant dependency on external sources of financing;
7. have competitors which use IFRS, or
8. decide voluntarily to hold the company to publicly accountable enterprise reporting standards.

Why CEOs Should Care About IFRS?

Here are five reasons why CEOs (and boards of directors) should care about IFRS and the change it will cause:

1. IFRS related change is change your organization cannot avoid.
2. IFRS will reduce opportunities to manage or manipulate financial results.
3. IRFS will make performance comparison between companies easier and quicker.
4. IRFS will materially increase investor and lender understandings and confidence.
5. IFRS will help cut your and the market’s average cost of capital through better communications-based risk identification and reduction.

As such, IFRS will help focus owners, directors and their management on getting their businesses to go right, not on getting their numbers to look right.

How Much Change Does IFRS Represent?

IFRS represents a significant, multi-level change to how your company compiles and presents its financial results and its financial position. The reasons that drove this change are that Accounting Standards Boards came to see (i) how the existing presentation guidelines have made i too difficult to understand the relationships between the various financial statements and (ii) how the information shown in different statements is inconsistently presented. Because of these factors, it is too difficult for GAAP financial statement users to properly or fairly assess the financial health of an organization.

In developing IFRS, the International Accounting Standards Board had three objectives they sought to achieve in the new financial reporting standards for publicly accountable enterprises. These were that that under IFRS, financial statements should:

1. present a cohesive financial picture of an entity’s activities (meaning that there should be a clear and observable relationship between items across all financial statements and that all of an entity’s financial statements should complement each other as much as possible);
2. present disaggregated information so that what is presented is useful in predicting an entity’s future cash flows; and
3. present information in such a way that helps users assess an entity’s liquidity and financial flexibility.

In comparison to GAAP accounting, this means:

1. IFRS changes the way companies compile their financial reporting numbers;
2. IFRS changes the way companies organize their financial reporting numbers; and
3. IFRS changes the way companies present their financial reporting numbers.

1) Let’s first talk about how IFRS changes the way companies compile financial reporting numbers.

While the overall logic of IFRS is similar to that used under GAAP, there are many situations in which IFRS differs from GAAP in application. Most people will notice much more change on the Income Statement than on the Balance Sheet or Statement of Financial Position. That’s because there has been general agreement for a long time about what is thenature of assets and liabilities, though under IFRS there is more application of revaluations to report fair values as of a particular reporting date with gains or losses from such showing up in the Statement of Comprehensive Income.

To get a sense on how much of a change IFRS represents, let’s consider just one area, revenue recognition. Considering things from a high level point of view, be aware how the IASB (the International Accounting Standards Board – the arbitrator of what is and is not in IFRS) and the US Accounting Standards Board are currently working together on a revenue recognition focused project, one which seeks to change how revenue is defined from something that is a consequence of the occurrence of critical events to something that is the result of changes in assets and liabilities.

As to a more detailed comparison about how GAAP and IFRS currently define when and how revenue is recognized, consider the following charts showing respectively the situations in the US and Canada:

In summary, under IFRS there will be a much greater focus on recognizing revenue when the risks and rewards of control have been transferred to the acquiring counterparty, which will do away with the all-too numerous rules for specific types of transactions and industries.

As for differences in other areas of accounting and financial statement reporting, such as for expenses, taxes, equity, etc, there are as well many situations where the two sets of standards differ at the application level while still keeping the overall logic the same or similar. These are too numerous and detail oriented, however, to discuss here.

2) So let’s now consider how IFRS changes the way companies organize their financial reporting numbers.

The most evident change under IFRS most people will notice quickly is how the names IFRS uses for the statements presented are different. The following diagram summarizes these changes:

3) Because the way IFRS sets out the numbers in their statements is so obviously different, let’s now lastly consider how IFRS changes the way companies’ present financial reporting numbers.

The new financial statement names are just the beginning of how a company will present its financials differently. In order to achieve the objective of cohesiveness between the statements, the format of the statements will change. All statements are to be subdivided into the same general categories:

1. a business section (subdivided further into operating and investing components),
2. a financing section,
3. an income taxes section,
4. a discontinued operations
5. an other section, and
6. an equity section.

Here is a quick peek at how the two main financial statements will look under IFRS:

As for the Statement of Changes in Equity under IFRS, it is similar to the GAAP Statement of Changes in Retained Earnings, but it will be much more comprehensive. It will show the balance of each component of equity at the beginning and end of the period and identify the changes resulting from income, each item of other comprehensive income, transactions with owners (such as contributions, dividends, and changes in ownership interests of subsidiaries) and retrospective application or restatements.

Turning finally to the Statement of Cash Flows, while its name does not change under IFRS, the content will for most companies. That is because in future, it will only report cash balance changes directly. No use of the indirect, or what I think of as the reconciliation approach, will be permitted. While a reconciliation of income to cash flow is still considered important and relevant, under IFRS it is information that will be reported only in the notes to the financial statements.

The bottom line is that IFRS represents both big change and global evolution in best-practice financial reporting. Consequently, wherever you are in business, you won’t be able to avoid its impact.

How IFRS Will Benefit Us All

Based on post implementation experience to date, IFRS will benefit to everyone by:

1. Enhancing worldwide company comparability for investors;
2. Ensuring more efficient capital allocation through better risk-based decision making that results from clearer, more informative financial communications;
3. Enhancing credibility of local markets to foreign investors through globally consistent financial communication;
4. Providing for a more company receptive securities market for foreign listings; and
5. Removing need to develop and maintain separate national accounting standards.

Judging from the positive reaction of investors in Europe to their 2005 IFRS adoption, I expect IFRS will fully deliver these benefits in Canada, Mexico and the US as promised.

Recommendations

The biggest recommendation I have for you is this: make sure you and your organization jump on board the IFRS band wagon as early as possible because these seemingly behind the scenes changes will have a big impact on all your accounting and internal and external reporting activities. To put it another way: these are changes that will change your bottom line!

Additionally, if your company is a private (Canadian) one that could opt for the about to be proposed GAAP for Private Companies, I recommend you chose IFRS because that’s the standard big public-market companies will be using, and not going with it will stunt your company’s growth potential.

How to Learn More About IFRS & Private Enterprise GAAP

If you want to learn more about IFRS and GAAP for Private Companies, here are some great sources to turn to:

Four of the best high-level overviews of IFRS I found were:

1. IFRS Brings a Radical Change to Financial Statement Presentation is anarticle by Karine Benzacar, MBA, CMA, CPA (Del.) that was published in the Feb 2009 CMA Management Magazine – http://www.knowledgeplus.org/pdfs/CMA_IFRS_statements_February09.pdf
2. IFRS – The Next Accounting Revolution is earlier article by Karine Benzacar, MBA, CMA, CPA (Del.) published in the Jun 2008 CMA Management Magazine – http://www.knowledgeplus.org/pdfs/IFRS_CMAmagazine_june_08.pdf
3. IFRS / International Financial Reporting Standards overview from Wikipedia – http://en.wikipedia.org/wiki/International_Financial_Reporting_Standards
4. A very informative and more detailed, US-oriented May 2009 presentation on IFRS on The Major Differences Between US GAAP and IFRS can be found at – http://www.swensonadvisors.com/assets/MajorDifferencesBetweenUSGAAPandIFRS.pdf

The best overview of Canadian Private Enterprise GAAP vs IFRS I found was:

• Canadian GAAP or IFRS? An important choice to be made by private companies by PriceWaterhouseCoopers, a 4 page whitepaper – http://www.pwc.com/en_CA/ca/private-company-services/publications/gaap-or-ifrs-canada-2009-05-en.pdf

Other sources for IFRS information are:

1. Comparison of IFRS and Canadian GAAP as of July 31, 2008 – http://www.acsbcanada.org/international-activities/ifrs/item18492.pdf
2. IFRS In Canada: Evolution Or Revolution? Which is an insightful overview online article written in 2007 by Michel Blanchette, CMA – http://www.allbusiness.com/legal/banking-law-banking-finance-regulation/10586395-1.htm
3. International Accounting Standards Board – http://www.iasb.org/Home.htm
4. American Institute of Certified Public Accountants IFRS Resources Website – http://www.ifrs.com/

© Blog.TonyJohnston.biz & Compass North Inc. 2009

Article by –

Tony Johnston, CMC, CGA, MBA, BA (Econ)
President
Compass North Inc.
18 Balding Court
Toronto ON
M2P 1Y7
Office:  416-342-5652
Mobile: 416-346-4140
www.CompassNorthInc.com
www.CNiRapidResearch.com

Tony Johnston is a top level executive & management advisor who is a business results specialist with success in 4 turnarounds and many significant other operations, deal making and finance oriented accomplishments to his credit. He helps companies drive:
  › top line growth (revenue)
  › bottom line improvement (profits)
  › cashflow management (credit line control)
  › growth strategy (more / new)
  › financing & stakeholder relationship management (debt / equity)
  › enterprise value maximization (mkt price)
  › acquisition planning & execution (find / close)
  › divestiture preparation & execution (prep / negotiate)
  › information gathering (competitive intel / market research)
  › crisis control (turnarounds & wind-downs)
  › enterprise leadership (CEO / CRO / CFO)

Compass North Inc. is a management & advisory services firm that helps companies achieve important, challenging operational, financial and transaction oriented goals. Examples of what we do include helping companies and their owners:
   – make better decisions by providing customized competitive intelligence,
   – grow by crafting strategic plans and implement them,
   – get turned around by dealing with their debt or other business problems,
   – borrow more money and/or raise more equity, and
   – plan, prepare, negotiate and close acquisitions, divestitures and ownership
      transitions.

Bottom-line: The benefit that Tony and Compass North Inc. deliver is helping company owners maximize both what they earn while they own their business and what they bank when they sell.

> Follow me on Twitter @CompassNorthInc

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2 Responses to “New $Num,ber.ss Language Coming Soon”

1. bizsugar.com
   November 12th, 2009 @ 2:13 pm

   [NEWS] New $Num,ber.ss Language Coming Soon | Biz Money Matters |…

   Say goodbye to GAAP and hello IFRS because the language companies use to ‘talk money numbers’ is changing. Read why there’s nothing inconsequential about it….

2. New $Num,ber.ss Language Coming Soon | Online MBA
   November 12th, 2009 @ 6:07 pm

   [...] the original post: New $Num,ber.ss Language Coming Soon VN:F [1.5.2_773]please wait…Rating: 0.0/10 (0 votes [...]

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