Financial Literacy For Audit Committees: What Does This Really Mean in an IFRS World? John Hughes, CA December 7, 2010

Transcription

1 Financial Literacy For Audit Committees: What Does This Really Mean in an IFRS World? John Hughes, CA December 7, 2010

2 IFRS conversion current state Canadian public entities will be converting from Canadian GAAP to IFRS for fiscal years beginning on or after January 1, 2011 The first IFRS financial statements issued by calendar-year end entities will be for March 31, 2011 (30 days extension on filing deadline proposed by CSA) Because the conversion covers the comparative period, the transition date for calendar-year-end entities is January 1, 2010 Escalating detail on progress provided in MD&A, now often including quantified information the CSA is actively reviewing these disclosures

3 Audit committees regulatory requirements For TSX issuers, audit committee members must be independent and financially literate: For the purposes of the Instrument, an individual is financially literate if he or she has the ability to read and understand a set of financial statements that present a breadth and level of complexity of accounting issues that are generally comparable to the breadth and complexity of the issues that can reasonably be expected to be raised by the issuer s financial statements. In our view, it is not necessary for a member to have a comprehensive knowledge of GAAP and GAAS to be considered financially literate. The appropriate level of understanding varies with the business: For example, if the issuer is a complex financial institution, a greater degree of education and experience is necessary than would be the case for an audit committee member of an issuer with a more simple business.

4 Audit committees what does IFRS mean? The CSA has not actually proposed to amend the audit committee rule as a result of converting to IFRS: the core requirements are unchanged These include (among other things): Reviewing financial statements, MD&A and annual/interim earnings press releases before public disclosure Overseeing work of external auditor, including pre-approving all nonaudit services provided Establishing procedures for external complaints received by the issuer and submitting anonymous concerns by employees All of these could be affected by moving to IFRS, but how?

5 Preserving financial literacy under IFRS Even though IFRS is essentially principles-based, current version of bound volume still fills 3,000 pages! Concept of principles-based really relates more to the structure of the standards than to their length and degree of detail IASB intends it to be clear how all detailed conclusions flow from a clearlyarticulated core principle Standards still contain a substantial amount of prescribed treatments and requirements - possibility of overlooking a specific item, without adequate grounding/awareness, would be high

6 Preserving financial literacy under IFRS - continued Audit committee members do not need ability to prepare financial statements or to personally implement the accounting, but need ability to think what could go wrong and engage on that basis with management and auditors

7 What does principles-based actually mean? The core principles would have to be clearly stated. Other sub-principles should be related to these in a treelike structure. Inconsistencies with other standards should be dealt with. Principles should be tied to a sound conceptual framework. Any departure would have to be explained. It may be necessary to depart from the framework if emerging transactions indicate that the framework is out of date. Any exception to the framework, however, should provide a basis for elimination of the exception by later changes to the framework itself

8 What does principles-based actually mean? - continued The use of principles should eliminate the need for anti-abuse provisions. It is harder to defeat a well crafted principle than a specific rule which financial engineers can by-pass. A principle followed by an example can defeat the tell me where it says I can t do this mentality. If the example is a rule then the financial engineers can soon structure a way round it. For example, if the rule is that, if A, B and C happens, the answer is X, the experts would restructure the transaction so that it involved events B, C and D and would then claim that the transaction was not covered by the standard. (David Tweedie, IASB Chair, speaking in Toronto in April 2008)

9 IFRS a principles-based set of standards cont d Principles-based nature of IFRS is easy to distort/caricature, especially relative to US GAAP: What frightens me is not the globalization aspect itself (scary all on its own of course) but the principles idea that is IFRS. Whereas GAAP comes with encyclopediasized rules for just about every transaction you can dream up, IFRS leaves the interpretation open to the accountants. ( September 2010)

10 Limitations of a principles-based approach Inevitable that no matter how much diligence and integrity are applied, different practitioners will occasionally approach similar transactions in a different way IASB would likely argue that market participants need the discipline to accept this as the minor price of overall success and not assume one or the other must be wrong Provides a test for regulators, auditors and others

11 Challenges of IFRS financial statements Much of the knowledge, insight and experience gained under Canadian GAAP no longer directly relevant to and in fact could mislead about what is appropriate under IFRS For example, years of looking at Canadian financial statements would provide no basis for identifying missing additional disclosures required by IFRS, or for assessing the different models for impairment, provisions, property plant and equipment etc. Presentation issues such as non-gaap measures also differ under IFRS

12 Challenges of IFRS financial statements - continued Some of the impact on practice is subtle and may not be picked up in standard summaries of differences (e.g. IFRS has more commentary on making cash flow estimates for impairment testing and other purposes greater emphasis on using a true probability-weighted present value) Details of application may often be unclear (e.g. forestry companies and others must measure biological assets at fair value, but standard does not address issues relevant to presenting gross margin and other logistical issues) May not yet be clear how much Canadian regulators will intervene to limit application of judgment on a particular matter.

13 Some recurring themes of IFRS Greater use of fair values - Results in more frequent measurement changes for some items and greater volatility in income Sharper focus on core concepts - Some relatively basic items may be analyzed differently under IFRS Greater focus on disclosure as a window into the processes, assumptions and risks underlying the financial statements - Means the notes provide more information that may be useful, but also that they become longer and potentially more challenging to work with

14 Challenges of IFRS African Copper PLC

15 Challenges of IFRS Brick Brewing Co. Ltd.

16 Challenges of IFRS Oncolytics Biotech

17 Challenges of IFRS Indigo Books & Music Inc.

18 WestJet Airlines Ltd.

19 First-time adoption a specific challenge The general principle is that the first IFRS financial statements are prepared as if IFRS (based on standards in effect at the reporting date) had always been in place. Because of cost/benefit considerations, there are various exceptions to this principle, some of which may considerably change the reported numbers and/or the underlying work involved, depending on the choices management makes. Areas affected include property, plant and equipment; business combinations; foreign subsidiaries; employee benefit plans.

20 First-time adoption a specific challenge - continued There is no way to review management s first-time adoption approach in a big picture manner because the requirements are so specific. Canadian regulators will place special scrutiny on the initial IFRS reporting Disclosure requirements for the changeover are extensive, but must also ensure these do not obscure the portrayal of the underlying business.

21 First-time adoption a specific challenge - continued Some of the items identified as IFRS transition disclosures may in fact point to previous errors under Canadian GAAP. For example, although the approach to recognizing and measuring impairment is different under both, a highly material impairment loss in the transition-date balance sheet might raise questions about whether this was adequately assessed under Canadian GAAP Major new provisions/obligations, even if arising from items not as specifically identified under Canadian GAAP, may represent items that should have been previously identified under its basic principles Deficiencies in Canadian GAAP should be dealt with through the regular 2010 filings (and if necessary by restating and refiling previously issued documents) rather than as IFRS changeover adjustments

22 Transition disclosures materiality considerations Many of the matters examined may not ultimately be significant and other circumstances would not be sufficiently material to warrant disclosure However, regulators, auditors and others have particular expectations about the degree of transparency they expect to see in these disclosures It may be prudent to treat disclosure of this exercise as a separate stand-alone exercise standing outside normal materiality judgments

23 Challenges of IFRS MD&A Need to strike balance between focus on underlying operations and explaining impact of accounting changes Changes in format of financial statements provides challenges for existing MD&A format Greater use of management estimates etc. needs to be explained in MD&A Both a communication and a compliance challenge May need to be supplemented with broader communication initiative stakeholder information sessions, other website materials, etc.

24 Challenges of IFRS MD&A - continued In the short term the major focus is on the transition disclosures closely monitored by CSA Although quantitative disclosures not required by rule prior to issuing the first IFRS financial statements, CSA has set out expectation that they be disclosed if the information is available Somewhat more quantified information provided in Q2 and continued to escalate in Q3

25 Rogers Communications Inc.

26 Rogers Communications Inc. - continued

27 Challenges of IFRS certification/controls Despite best efforts, may be more difficult to support fair presentation assertions because of less familiarity with format and content Numerous challenges for controls: tone at the top board/senior management may be less equipped to detect errors constraints on resources and/or timing may provide challenges for segregation of duties, quality of review procedures, and other components of control possible reporting difficulties of determining what is a material weakness under IFRS relative to Canadian GAAP

28 A possible approach to financial literacy Three-stage process: (1) General grounding in structure and broad contents of IFRS (could be obtained generically) (2) Industry-specific training on common issues and challenges (suitable programs may or may not be externally available) (3) Focused workshop to identify entity-specific implications (best carried out with external facilitator; generally half a day to one day depending on complexity of organization)

29 A possible approach to financial literacy - continued Also recommend annual focused refresher: IFRS has a heavy project schedule and some very fundamental aspects of the standards (including even basic balance sheet/income statement presentation) will evolve over the next few years Understanding of IFRS in Canadian context will evolve heavily as (for instance) regulators and others issue comment letters and notices

30 Some conclusions IFRS should plainly have been a prominent portion of every audit committee meeting agenda for some time now Experience from other jurisdictions indicates overwhelmingly that management tends to start conversion project too late and/or underestimate work involved audit committee should look for specific information on progress against defined milestones Audit committee arguably cannot adequately engage with management, or meet a financial literacy standard, without focused training

31 Questions?

32 For more information John Hughes