Change to IFRS causing issues for analysts

The report – entitled IFRS Adoption in Canada: An Empirical Analysis of the Impact on Financial Statements, and written by three university professors, Michel Blanchette of the Université du Québec en Outaouais, François-Eric Racicot of the University of Ottawa and Komlan Sedzro of Université du Québec à Montréal – notes the accounting treatment of similar items under GAAP and IFRS may vary.

This variance is impairing the ability to compare and analyze trends, says Blanchette: “The same transaction may be reproduced differently” under the two accounting methods.

Furthermore, he says, the “transition notes” to financial statements “are not uniform” and, in some cases, “do no reflect original GAAP notes.” This makes interpretation more cumbersome. Given that both GAAP and IFRS are principles-based, there has been scope, he contends, “for a lot of professional judgment.”

Typically, financial statements provide results for the current year and the previous year, Blanchette says. During the transition period, the previous year’s GAAP results would be restated to IFRS. Although you can easily compare two years of IFRS results, it’s not feasible to compare one year of IFRS results with one year of GAAP results.

Therefore, when evaluating a company and looking at trends in financial ratios, it’s necessary for those who analyze financial statements to pay particular attention to the differences that may result from the changeover to IFRS from GAAP. So, for example, if a company’s 2011 financial statements issued under IFRS include restated 2010 GAAP results, you can find the 2009 and 2010 GAAP results in the 2010 statement for comparative purposes.

The decision to replace GAAP, which historically has embodied the characteristics of the domestic environment, was made in 2006. The move toward the new standards commenced in 2008 and adoption of IFRS became mandatory in January 2011 – although there were some early adopters prior to this date.

The good thing about the changeover to IFRS is that more than 120 countries use IFRS, bringing Canadian financial statements in line with those issued by foreign companies and making comparisons easier. Blanchette, however, advises that it’s important to recognize that although Canada’s largest trading partner, the U.S., “is working with IFRS, [it] still keeps its own set of rules.”

The CGAA study compared the audited accounting figures and financial ratios computed under both IFRS and GAAP for the same period using a sample of 150 companies listed on the Toronto Stock Exchange that adopted IFRS in 2011.

The report recognizes that, although both Canadian GAAP and IFRS use a principles-based approach and have similar conceptual foundations, certain elements of application diverge and several individual standards are fundamentally different.

Based on the sample of companies evaluated, the study found:

– Differences between individual IFRS and GAAP values can be large, particularly in the balance sheet, representing a fairly material impact. For example, overall assets and liabilities are higher using IFRS than GAAP, but the differences are mostly offset in shareholders’ equity.

– The volatility of financial statement figures is, in most cases, higher using IFRS than GAAP – that is, a much wider range of values is observed when using IFRS financial statement figures, as compared with figures reported using GAAP.

– Differences between IFRS and GAAP values are not randomly distributed across industry sectors, indicating differences in impact across industries. For example, the financial and real estate sectors have significantly higher assets and profits using IFRS than GAAP due to the use of fair-value accounting under IFRS. In contrast, the level of assets and liabilities is noticeably higher under IFRS for the management sector as a result of accounting adjustments on financial instruments.

The rationale for the differences between IFRS and GAAP results stems from differences in accounting treatment in several areas, including the use of fair value, accounting for controlling interest of a company, revenue, property, plant and equipment, intangibles, financial instruments, hedges, asset retirement obligations, employee future benefits, share-based compensation, income taxes, foreign currency translation and strategic investments.

In total, says Blanchette, the study identified that adjustments were grouped into 18 categories, but some “were more significant than others.”

Two of these categories include the use of fair-value accounting and the conceptual framework related to accounting for non-controlling interests. Both these areas involve complex considerations; but, put simply, the use of fair-value accounting or “mark to market” under IFRS can increase the value of assets of certain companies substantially, as compared with the “historical cost” method under GAAP.

For example, real estate traditionally has been recorded at historical cost; but, fair-value accounting allows for significantly higher values – an investment property acquired several years ago may be worth much more today, says Maruf Raza, audit and assurance partner in the public markets practice with Collins Barrow LLP in Toronto.

In another example, non-controlling interest, which represents the share of consolidated subsidiaries that is not owned by or attributed to the parent company, was presented as a liability on the consolidated balance sheet under GAAP. However, under IFRS, these non-controlling interest-holders are deemed to have a participating right or residual interest in a portion of the consolidated entity. Therefore, non-controlling interest is presented within shareholders’ equity in the consolidated balance sheet.

Thus, Raza says, you cannot draw conclusions from financial statements prepared using IFRS and GAAP by simply looking at the figures derived under the two methods.

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