With Canadian public companies adopting new financial reporting rules this year, financial advisors need to understand how their clients’ investments will be affected by the changes.

Canadian public firms are required to use the new international financial reporting standards for fiscal years starting on or after Jan. 1, 2011, and to provide IFRS-comparable numbers for each quarter in the previous year. The exceptions: investment-management and rate-regulated companies don’t have to make the change to the IFRS until 2012.

The IFRS system has major differences compared with the generally accepted accounting principles that had been used in previous years.

The IFRS system is designed to provide information that’s useful to investors and creditors, and to give a “true and fair view” of the economic substance of the business, says Peter Martin, director of accounting standards with the Canadian Accounting Standards Board in Toronto. The new IFRS system is principles-based, which means companies are supposed to adhere to the principles by making appropriate judgment calls rather than blindly following rules.

Leading up to the changeover, you should read the portion of the “management discussion and analysis” section in interim and annual statements that pertains to the IFRS for firms in which your clients have invested.

“It’s a great place to start to familiarize yourself with the status of the conversion and the impact,” says Diane Kazarian, national leader of the banking and capital markets practice of Pricewater-houseCoopers LLP in Toronto.

In the final fiscal quarter before a company moves to the IFRS, there will be numbers reflecting how the change will affect the firm if it is far enough along in the conversion process to provide them. In the first interim reports after the changeover, Kazarian says, it’s critical to look at the section on reconciling the two accounting standards, which will include a table showing the adjustments required to get from GAAP to the IFRS and a description of all the items affected, so you can see where the big changes are for both income and equity.

Kazarian notes that the quality and frequency of communication by companies with their stakeholders is critical. If stakeholders don’t get a good understanding of how the change to the IFRS is affecting a company’s statements, they may avoid investing in it.

With the IFRS, there are more accounting policy choices than with Canadian GAAP, so it’s essential to read the footnotes to financial statements. These choices — such as whether to use “fair market value” or “book value” for assets on the balance sheet — may also make it harder to compare companies in the same sector. However, Martin says, the CASB expects that individual industries will tend to gravitate over time to approaches that allow comparisons, not just nationally but globally.

In addition, there may be a good deal more volatility in earnings, particularly if companies choose to go with FMV rather than book value on their balance sheets. Using FMV means assets are priced each quarter and the changes from the previous quarter are included in “net income” or, in some cases, in “other comprehensive income.”

However, there are a number of pluses to using the IFRS. There is more disclosure than previously, as companies explain their financial assumptions. In addition, there could be greater detail about the assets and liabilities, as well as analysis of the causes of changes in these balances during the reporting period.

In terms of the bigger picture, there may also be more liquidity for Canadian stocks because foreign investors will be more willing to consider investment in Canadian firms when they report the same way as the rest of the world.

More detail will be provided in various areas, such as acquisitions, with any costs related to the purchase expensed when they occur, and any contingent consideration estimated and recognized as of the acquisition date.

There may be more impairment writedowns with the IFRS because all asset cash flows have to be discounted using current interest rates rather than just looking at the nominal value. This can affect many things, including receivables. But these writedowns will generally be smaller and can now be reversed, says Martin, which wasn’t the case under GAAP.@page_break@Non-controlling interests in subsidiary companies and other entities also are treated differently under the IFRS. They are now part of “consolidated shareholders’ equity” and are subtracted (along with “preferred equity”) to determine “common equity.” Net income must also be reported before any deduction for non-controlling interests, which will now share the net income with common shareholders.

All accounting systems continually change as issues arise that accounting standards boards feel must be addressed. This will happen with the IFRS, and it’s critical to keep up to date, warns Karine Benzacar, managing director at accounting and financial consulting firm Knowledge Plus Corp. in Toronto. In addition, there are a number of critical components of the IFRS that are still in the proposal stage. These include the treatment of insurance contracts and leases.

To give you a feel for how the changes can affect individual companies, here’s a look at Toronto-based firms Brookfield Asset Management Inc., which moved to the IFRS as of the first quarter of fiscal 2010; and CI Financial Corp., which will be adopting the IFRS as of Q1 2011:

Brookfield moved earlier than required because the company’s executives believe the IFRS system better reflects its business. Brookfield owns or partially owns hard assets, such as real estate, power generation, timberlands, agricultural land and infrastructure. These are all long-term assets that can generate cash flow for many years — in some cases, for 100 years or more.

Under Can-adian GAAP, these assets were valued on a “cost” basis on the balance sheet. As a result, all are undervalued in terms of their current value and their cash-flow generation capacity, says Sachin Shah, managing partner for finance at Brookfield.

As of Dec. 31 2009, Brookfield’s shareholders’ equity using GAAP was $7.5 billion; using the IFRS and FMV, it was $23.2 billion. Part of the increase — $10.2 billion — is non-controlling interests, reflecting the many investors or partners who have co-ownership in Brookfield’s assets and projects. But the remaining $5.5 billion comes primarily from moving to FMV.

The impact of the changes on Brookfield’s net income is also large, with a loss of $898 million reported for the year ended Dec. 31, 2009, under the IFRS vs earnings of $454 million under GAAP. The main reason for the difference was $1.3 billion in higher depreciation and revaluation charges, resulting from the higher value of their hard assets using FMV.

It should be noted that Brookfield doesn’t believe net income is a good measure of how it’s doing because of the depreciation required for its hard assets, which reduce its reported earnings even though the assets themselves continue to generate as much or more cash flow. The firm emphasizes cash flow, a measure that is not very affected by the change to the IFRS. As Shah says: “Cash is cash.”

The biggest change for CI is the treatment of deferred sales commissions, says chief financial officer Doug Jamieson. In the past, the company amortized DSCs on a “straight-line basis.” Now, under the IFRS, CI will have to adjust its amortization by including all the remaining unamortized DSC of funds redeemed early during the period in question. CI has chosen to go back over the past seven years to adjust “retained earnings” using this new methodology; the result will be about a $50-million reduction in retained earnings and, thus, in shareholders’ equity.

The next biggest impact for CI relates to “contingent liabilities” — specifically, the liabilities arising from litigation. Under Canadian GAAP, the firm didn’t have to “book” such potential liabilities unless there was an 80%-90% chance they would come to fruition. Now, CI has to make a provision for them on its income statement if the likelihood is more than 50%. Jamieson notes that this could produce more volatility in earnings, particularly for dealerships, which have more direct customer contact than fund managers and are more prone to litigation. He estimates that CI will probably take a $10 million-$15 million one-time charge in Q1 2010 to account for current potential liabilities.

Jamieson notes that the IFRS requires annual “impairment testing” for all cash-generating units rather than testing just the company as a whole. The odds of one of these smaller units becoming impaired is higher than for all the operations taken together.

Canada is a laggard in adopting the IFRS, with most other countries already on the system or in transition to it. The U.S. is the major exception, but it is working with the International Accounting Standards Board to bring U.S. GAAP in line with the IFRS. IE