Managing the Risk of Fraud in the Conversion to IFRS Fernando Cancino, CFE, CIA BPO Executive Americas Amicorp
A Road Frocked with Risk Conversion to IFRS Conversion Risk of Fraud Risk Mitigation Strategy Integration with Sarbanes-Oxley Act Integration with enterprise risk management
Key characteristics of IFRS Principles-based approach that places greater emphasis on interpretation and application of principles, Need to assess the substance of transactions and evaluate whether the accounting presentation reflects the economic reality There is renewed focus on the need for professional judgment Greater use of fair value as a measurement basis placing emphasis on obtaining reliable measurements
IFRS Conversion for the US It is not a matter of if it will occur, but rather a question of when and how SEC and AICPA support the conversion More than 113 countries around the world, including all of Europe, currently require or permit IFRS reporting. Approximately 85 of those countries require IFRS reporting for all domestic, listed companies. Exceptions
IFRS Conversion for the US SEC Roadmap Source: PwC
IFRS Conversion for the US Empirically more than just a change of accounting standards affecting the finance function Fundamental change of accounting mindset from rules based (US GAAP) to principles based (IFRS) Paradigm shift of accounting and financial reporting from a compliance-based approach to an economic value approach
IFRS Conversion Risk of Fraud The shift will call for management to use judgment in presenting financial statements, which poses a human element risk factor leading to a higher risk of financial statement fraud and misstatement The IFRS conversion increases the opportunity to commit financial statement fraud, as accounting policies and internal controls over financial reporting undergo change
IFRS Conversion Risk of Fraud Dr. Steve Albrecht s Fraud Propensity Scale Situational Pressure RATING High Perceived Opportunity High Personal Integrity Medium Total Propensity for IFRS Fraud Medium High to High
Financial Statement Fraud Core Principles 83% of financial statement fraud is committed by senior managers COSO study Why? To conceal true business performance To preserve personal status/control To maintain personal income/wealth How? Playing the Accounting System Beating the Accounting System Outside the Accounting System
IFRS Conversion Risk of Fraud Changes in Timing Internal Controls Recognition Procedures Valuations Policies Revenue recognition Expense recognition share based payments, employee benefits Assets financial & non-financial Liabilities taxes & other Financial liabilities and equity Derivatives and hedging Consolidation Business combinations De-Recognition
Lessons Learned From Europe Concerns About Development Costs: We are concerned about the capitalization of some internally developed intangible assets, not least because only some of the costs of developing the assets are capitalized. When applying the criteria for the capitalization of development costs, the scientists can run rings around the auditors. BDO Attitudes to IFRS
Lessons Learned From Europe Cost varied (from average of $500k to $5,000k) The impact on technology was significant and clearly underestimated Project planning and assessments started too late System versus Data issues Several situations where the solutions were short-term and/or quick-fixes (e.g. spreadsheets, etc.) Many conversions were done at group level, i.e. not all embedded in a sustainable way into the systems
IFRS Conversion Fraud Schemes Generally, the schemes perpetrated will involve the manipulation of policies, procedures and internal controls causing: Fictitious revenues Timing differences Concealed liabilities & expenses Improper disclosures Improper asset valuations
IFRS Conversion Fraud Schemes The valuation of accounts receivable may be altered by failing to establish appropriate reserves and allowances and recognize related expenses Manipulation of the methods to value inventory creating an overstatement of inventory quantities and unit costs
IFRS Conversion Fraud Schemes When preparing IFRS opening balances, the writing off of inventory when future value exists Misclassifying investments to gain or to avoid recognizing losses in current results Depreciating fixed assets using unreasonable methods and assumptions Overstating the value of assets
IFRS Conversion Fraud Schemes Manipulation of restructuring, purchase accounting, and other reserves Misclassifying lease structures Inappropriate recognition of revenue and/or expenses Inappropriate recording of journal entries to reduce expenses or cost of goods sold
IFRS Conversion Fraud Schemes Not disclosing related party transactions and balances appropriately Failure to appropriately disclose significant accounting policies and estimates and changes thereto Improper accounting for business combinations
IFRS Conversion Fraud Schemes Manipulation of financial statements to manage the perceived value of the company. The restatement of the opening balances
IFRS Conversion Fraud Risk Mitigation A COSO Approach The five components of COSO s Internal Control Integrated Framework (the COSO Framework) work in tandem to mitigate the risks of an organization s failure to achieve those objectives.
IFRS Conversion Fraud Risk Mitigation A COSO Approach Creating a control environment including setting the tone at the top, code of conduct/ethics and whistle-blower hotline embedded in the conversion project and linked to the enterprise risk management program Performing an IFRS conversion fraud risk assessment that includes the identification of fraud risks, schemes and mitigating controls Designing and implementing antifraud control activities that link or map to identified fraud risks to control activities Effective communication of antifraud programs and controls both during conversion and in steady state Monitoring the effectiveness of antifraud programs and controls both during conversion and in steady state
Integration Across the Enterprise ERM COSO Thread SOX Projects IFRS Conversion
Risk Management in Action
Flawless Execution
Conclusion Risk is real and so is the likelihood of occurance COSO based control framework and risk management strategies will provide risk mitigation