International financial reporting standards (IFRS) constitute a broad, complicated subject that will, by all accounts, require a great deal of preparation and training to understand and successfully implement well in advance of the 2011 deadline in Canada.
To ease that process, CGA-Canada partnered with the U.K.-based Association of Chartered Certified Accountants (ACCA) to present a series of conferences designed to educate CGAs and others in the business community as they prepare for a successful transitioning to IFRS.
“We felt very strongly that the ACCA should have a voice in the process especially since it has been a leader in promoting IFRS in other countries,” says Lynn Beauregard, head of administrative operations at the ACCA in Toronto. In light of the Mutual Recognition Agreement signed in 2006 between the two organizations, the alliance with CGA-Canada made perfect sense, she adds.
The seminars were held in four cities across the country - Moncton, Toronto, Calgary, and Vancouver. Provincial CGA affiliates from the presenting cities and representatives from the ACCA welcomed attendees at each of the conferences.
Amar Goomar, director of accounting standards at CGA-Canada and one of the chief organizers of these events, discussed how market forces and the business environment have made the standard setting task complex – and why these factors have pushed standard setting tasks away from a domestic setting to the international arena. He also explained why moving to IFRS from Canadian GAAP makes financial and business sense.
While the two-day event could only touch the surface of material that is so wide ranging and complex, the presenters nevertheless attempted to “drill down to the core of standards” in key areas of IFRS, notes Goomar.
“By the time 2011 rolls around, we’re not looking at a quantum change in what we’re doing,” insists Stephen Spector, FCGA, a lecturer in accounting at Simon Fraser University in Burnaby, B.C., who was one of the presenters. “The single biggest area where there are differences at this point is in the extent and nature of the disclosures that are required by international standards. These disclosures are far more extensive, detailed, and focus on increased transparency. IFRS requires you to tell all the news – good or bad,” he says.
For instance, Spector notes, “new business combinations will require far more extensive disclosure about the relationship between the acquirer and the acquiree prior to the business combination.”
Spector says a key element of IFRS is that accountants can elect to account for property, plant, and equipment under International Accounting Standard (IAS) 16 – Property, Plant and Equipment using a fair value model, unlike Canadian GAAP where only historical cost is permitted. This allows them to revalue each year – but with one caveat, he points out. “Under (IAS) 16, the only requirement is that you can reasonably and justifiably estimate fair value.” Tangible assets need to be estimated with “reasonable certainty,” but the exercise associated with obtaining a fair value can become a challenge for intangible assets that don’t have an active market, he explains.
Spector addressed the issue of investment properties that are only partly owner occupied, with the balance used for earning rental income or selling for capital gain. That, he says, is a special category of investment, which might become problematic under IFRS, at least in part because of the fair value option. There are “a whole bunch of issues related to the nature of the holding,” Spector says. These could include how to apportion earnings or capital gains when the owner chooses to use part of that property for their own purposes; or how to deal with gains and losses; as well as how to recognize revenue.
Spector also spoke about the impairment of assets, including the circumstances and extent to which impairments can be reversed under IFRS. “IAS 38 – Intangible Assets gives you the ability to reverse impairments if circumstances change, but establishes a limit – the amount the property would have been if there had been no impairment,” he says, noting that under Canadian GAAP, which is based on historical cost, it is not possible to reverse impairments.
Another area Spector spoke on was IAS 23 – Borrowing Costs, under which the capitalization of interest will become mandatory. In the past this was optional for firms following U.S. or international rules. “This is all new territory since there are no current standards for borrowing costs in Canada,” he says.
Joint ventures can be expected to have an impact on resource and exploration oriented firms, says Spector. Joint ventures are currently accounted for under ED-9, which presumably will be renamed IFRS 9, and is scheduled to replace IAS 31 – Interests in Joint Ventures.
A big change under ED-9 is that proportionate consolidation, which requires equity method accounting for all joint ventures, is being eliminated. IFRS will require an examination of rights and obligations for joint assets and joint ventures; those involved in joint ventures could conceivably end up with a new dual approach consisting of “a joint venture and joint asset of the same thing,” he says. If, for example, four individuals partner up in an exploration venture on adjoining property and pool their efforts and resources, they may qualify as having a joint venture by virtue of contributing property and rights, as well as joint assets via the exploration rights, adds Spector.
Gary Porter, CA, FCGA, co-founder of Porter Hetu International and a practitioner in Toronto, who also addressed attendees, notes that under IAS 11 – Construction Contracts, the completed contract method is no longer allowed. Only the percentage of completion or the rarely used cost-plus methods are now permitted.
“The main point here is percentage of completion. Essentially you’re generating revenue as you incur expense – similar in that respect to Canadian GAAP,” though a couple of things are going to be handled differently, he says. If losses are probable, they need to be recognized immediately. And “if you can’t reasonably measure revenue or its collectability is not reasonable assured, then all you recognize are recoverable costs in the period until you can estimate revenues.”
Porter noted that under IAS 18 – Revenue, interest revenue needs to be calculated using the effective interest method. “A simple example is if I buy a bond with a 10 per cent coupon, but current market yields are 8 per cent. I’m going to buy that at a premium, and have to take that premium into account as I realize revenue, not just the coupon. A lot of people do that already, but it’s mandatory under IAS 18,” he says.
Another key challenge is the current joint International Accounting Standards Board/Financial Accounting Standards Board (U.S.) project on revenue recognition, with a new focus on how assets and liabilities change, Porter says.
“The framework for the presentation and disclosure of financial statements in IAS 1 concentrates on the measurement of assets and liabilities, and changes in assets and liabilities become the basis for revenue and expense recognition.” This might lead to significant differences in revenue recognized compared to Canadian GAAP, Porter adds.
Furthermore an “asset and liability based measurement of revenue and expenses” will result in a lot of deferred charges and deferred credits that don’t qualify as assets or liabilities and will therefore be eliminated under the new concepts, he says.
Moreover, under international standards an asset needs to have a future benefit that is likely to occur and is reliably measurable. If there is an impairment, this needs to be recognized immediately if it is reasonably likely to occur and the write-down is reasonably measurable, Porter notes.
A key difference in IAS 2 – Inventories is that there are basically three types of items that can be inventoried: the materials purchased to produce inventory; the costs of the process to create inventory; and the costs incurred to bring it to its present location and condition, excluding certain costs that might otherwise be inventoried. “For example, the cost of a warehouse where things are sitting around isn’t really part of inventory anymore, because it’s already at its present location,” Porter notes.
IAS 33 – Earnings per share concentrates on determining how earnings are to be divided, says Porter. A very important point is that only earnings per share (EPS) that are dilutive are permissible; as such “you have to assume everything that can be converted into ordinary (common) shares is converted. Ordinary shares are the lowest share whose rights come after every higher class of shares.”
Also under IAS 33, financial statement preparers don’t need to present EPS for income before discontinued operations and extraordinary items. That provision is quite significant, because it represents a “reduction of requirements” from current Canadian GAAP, says Porter. “Basically what IAS 33 says is you have to present EPS at three levels – net income, fully diluted and, if presented in the financial statements, operating income,” he adds.
Joan Phillips, CGA, Quality Control Manager with chartered accounting firm Meyers Norris Penny LLP in Toronto, presented on IFRS 1 – First Time Adoption, which establishes transition requirements for entities that are converting to international standards, but is also designed to ease the transition for those entities.
“The most important part of IFRS 1 is that it’s the map for first time adoption. It allows for a number of choices that can only be made at that point in time, and those decisions will have a long-term effect on the balance sheet,” she says.
A key premise of IFRS 1 is that the financial statements, including all comparative periods, are prepared as though the entity had always used IFRS. As such, preparers need to apply retrospective accounting at the date of transition. There are, however, several optional exemptions from that rule, for items such as business combinations and pension liabilities, among others, on the grounds these could be more costly to prepare than the benefits they are providing to users. Take business combinations, for instance. “With large corporations that are constantly acquiring businesses, it would be too difficult to go back and restate every single business acquisition,” Phillips says. These exemptions need to be extensively disclosed, however.
There are also four mandatory exceptions to retrospective accounting; these involve the types of transactions where statement preparers would likely use hindsight, explains Phillips.
Hedges are an exception, because “you can’t look at hedge accounting with hindsight and change it,” she says. A second exception involves assets classified as being held for sale or from discontinued operations; preparers can’t go back and reclassify those because they subsequently find out operations were discontinued.
Retrospective application of IFRS is not allowed with respect to management’s judgment about past conditions after the outcome of a particular transaction is known. For instance, if there is “an estimate of a contingency that by hindsight you realize is not right, you can’t change that estimate and go back to retrospectively account for it,” Phillips stresses.
Certain financial assets and liabilities will need to be reclassified to comply with IFRS. For example, computer software under Canadian GAAP is normally treated as a capital, tangible asset. But “under IFRS, if it is not attached and part of a piece of equipment, it is considered intangible. So you have to recognize it as an intangible asset,” says Phillips.
“I had a number of people say they didn’t realize how much of a project it was going to be until the presentation on IFRS 1,” Phillips recalls. They noted there were small differences in all the sections, and when they examined them one at a time it didn’t seem that complex. But when they looked at IFRS 1 and all their choices as a whole it became clear to them they had to start planning now, she adds.
Over 450 people attended the four CGA/ACCA conferences. A similar event is scheduled for Montreal in September; a year-end “capstone” seminar will be held in Toronto in November. The latter will provide a more high level view of IFRS as a business issue, says Beauregard.
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