IFRS accounting standards: what financial analysts. should know

Transcription

1 IFRS accounting standards: what financial analysts should know Michel Blanchette, FCMA, CA Professeur titulaire, Université du Québec en Outaouais Financial Management Institute of Canada Ottawa, 24 November

2 Objective Overview What financial analysts should know About IFRS adoption in Canada In particular Impact on financial statements and ratios 2

3 Outline 1) What is IFRS? 2) Evolution of Canadian GAAP towards IFRS 3) Fundamental characteristics of IFRS 4) What analysts should know 3

4 1) What is IFRS? Accounting standards International Financial Reporting Standards 29 IASs + 9 IFRSs + 27 interpretations Developed by... International Accounting Standards Board (IASB) Members from all continents IFRS dominates international accounting Outclasses US GAAP Used in more than 120 countries 4

5 IFRS in the World > 120 countries (...) South Africa Australia European Union China Brazil Argentina Canada Mexico Japan Source : 5

6 Outline 1) What is IFRS? 2) Evolution of Canadian GAAP towards IFRS 3) Fundamental characteristics of IFRS 4) What analysts should know 6

7 2) Evolution of Canadian GAAP towards IFRS 2a) History 2b) Advantages of Canadian GAAP home-made 2c) Why change for IFRS? 2d) The IFRS solution 7

8 2a) History of Canadian GAAP Creation of the CICA Handbook US influence Convergence towards IFRS Changeover to IFRS 8

9 2b) Advantages of Canadian GAAP home-made Principle-based Professional judgment and ethical considerations Adapted to the Canadian context For particular topics For industries 9

10 CICA standards adapted to particular topics Topics Accounting practices specially adapted Long-lived assets Straight-line depreciation and other (CICA, ) Long-term contracts Percentage-of-completion method and completed-contract method (3400) Foreign currency translation Leases Capitalization of capital-leases (3065) Amortization of exchange gains and losses when using the temporal method and optional hedge accounting ( ) Pension costs Actuarial liability on defined benefit plans ( ) Abnormal gains/losses Separate presentation of extraordinary items (3480) Research and development Capitalization of development costs ( ) 10

11 CICA standards adapted to industries Industries Accounting practices specially adapted Banks Write-offs on impaired loans (CICA, 3025) Insurance companies Entities subject to rate regulation Actuarial liabilities and smoothing of gains and losses ( ) Assets and liabilities adjusted for rate regulation (AcG-19) Mining companies Capitalization based on successful-efforts method or fullcost accounting (AcG-5 and AcG-16) Not-for-profit organisations Deferral method and restricted fund method (4410) Pension plans Actuarial liability on defined benefit plans (4100) 11

12 Character of Canadian GAAP Income smoothing and Professional judgment 12

13 2c) Why change for IFRS? Adapt to Canadian context vs Adapt to international context 13

14 Comparability Capital markets become more integrated worldwide National standards worked well in Canada when it was a reasonably self-contained economic unit (...) But the increased flow of international trade in today s global economy represents a break with the past. The issue at present is how Canada can best integrate itself into a global realm, while maintaining the representational gains made on a domestic level. The case for a wholesale set of distinctively Canadian standards has been significantly weakened in recent years. (CGA, 1999) 14

15 2d) The IFRS solution Advantages of IFRS for Canada High-quality Principle-based (similar to Canadian GAAP) Recognized worldwide Better comparability on international scene "Not only will the adoption of IFRS improve the clarity and comparability of financial information globally; ultimately, it will also prove more efficient and cost effective by eliminating the need for reconciliations of information reported under separate national standards. " (CICA, 2009) 15

16 Comparability in the literature Financial statements can be compared as long as... Standards are understandable Not too many arbitrary choices and estimates Application is consistent throughout companies Threats on comparability Earnings management Lack of enforcement Regional interpretations Alternative sets of standards 16

17 Alternative sets of standards in Canada Public entities Private enterprises Not-for-profit, GVTs, etc. mandatory choice (...) IFRS Standards for PEs Other sets of standards... 17

18 Standards available in Canada CICA Handbook - Accounting Part I: IFRS Part II: Standards for private enterprises Part III: Standards for not-for-profit organizations Part IV: Standards for pension plans Part V: Pre-changeover accounting standards Public sector accounting Standards for governments 18

19 Outline 1) What is IFRS? 2) Evolution of Canadian GAAP towards IFRS 3) Fundamental characteristics of IFRS 4) What analysts should know 19

20 3. Fundamental characteristics of IFRS 3a) Principle-based 3b) Priority on balance sheet 3c) Fair value orientation 3d) New concept of comprehensive income 3e) Consolidation 3f) Transparency 20

21 3a) Standards principle-based Rule -based Principle -based US GAAP "accountants are becoming or have become rule checkers, applying the myriad of FASB pronouncements and clarifications rather than using their judgment as to what is a fair presentation of financial statements" (Hills, 2003) IFRS Canadian GAAP "IFRSs and Canadian standards are based on conceptual frameworks that are substantially the same. With some exceptions, they cover much the same topics and reach similar conclusions on many issues." (CICA, 2009) 21

22 Comparison of structures IFRS vs CICA vs US Conceptual framework Standards Interpretations IFRS (IASB) Yes (Conceptual framework for financial reporting) 38 standards (29 IASs + 9 IFRSs) 27 texts (11 SICs + 16 IFRICs) Canadian GAAP (CICA Handbook) Yes (standard 1000) 70 standards 134 texts (13 AcGs EICs) US GAAP (FASB, 2011) Thousands of rules (codified in about 90 topics) GAAP: generally accepted accounting principles CICA: Canadian Institute of Chartered Accountants IASB: International Accounting Standards Board FASB: Financial Accounting Standards Board IAS: standards issued before 2003 by the IASB (International Accounting Standards) IFRS: standards issued since 2003 by the IASB (International Financial Reporting Standards) AcG: accounting guidelines EIC: interpretations issued by the Emerging Issues Committee SIC: interpretations issued before 2003 by the Standing Interpretations Committee IFRIC: interpretations issued since 2003 by the International Financial Reporting Interpretations Committee 22

23 Repercussions of the principle-based approach of IFRS Repercussions Standards principle-based Professional judgment Unstable terminology + Disparate methods 23

24 Terminology of financial statements Canadian GAAP IFRS Balance sheet Statement of financial position Stat. of comprehensive income Stat. of comprehensive income e Income statement Income statement (optional ) Statement of retained earnings Statement of changes in equity Cash flow statement Statement of cash flows 24

25 Freedom of expression in IFRS! FINANCIAL STATEMENTS: "An entity may use titles for the statements other than those used in this Standard."(IAS 1.10) ASSETS: "This Standard uses the term non-current to include tangible, intangible and financial assets of a long-term nature. It does not prohibit the use of alternative descriptions as long as the meaning is clear." (IAS 1.67) FINANCIAL INSTRUMENTS: "The entity may use other descriptors for these categories or other categorisations when presenting information in the financial statements." (IAS 39.45) RESULTS: "Although this Standard uses the terms other comprehensive income, profit or loss and total comprehensive income, an entity may use other terms to describe the totals as long as the meaning is clear. For example, an entity may use the term net income to describe profit or loss." (IAS 1.8) 25

26 Range of methods available in IFRS for identical operations Joint ventures Hedging 50% of companies applied proportionate consolidation 50% applied the equity method 91% applied hedge accounting Cash flow statement 92% applied the indirect method in the operating section (8% the direct method) 74% presented interests paid in the operating section (25% in financing; 1% in investing) Source: KPMG and Keitz (2006) 26

27 Other discrepancies in presentation IFRS vs Canadian GAAP Ranking Choice, liquidity order or reverse-liquidity order in IFRS Deferred tax Long-term only in IFRS Extraordinary items Prohibited in IFRS But special or unusual items = permitted 27

28 3b) Priority on balance sheet Priority on income statement Priority on balance sheet Matching Allocating revenues and expenses over time Consequence = balance sheet more or less realistic --- Canadian GAAP --- Fair values more relevant than historical costs If balance sheet is well measured at beginning and end Then performance = Δ B/S 2 B/S IFRS

29 Users Canadian GAAP Priority on investors and creditors (CICA, standard ) IFRS Priority on investors (IASB, 2001; Chua and Taylor, 2008) Consequences More measurement based on markets (instead of historical cost) Fair value accounting 29

30 3c) Fair value orientation Traditional measurement in accounting Historical cost Less: loss-in value (impairment, conservatism) Plus/less: some gains/losses on financial instruments Major change in IFRS Priority on balance sheet + investors Fair value accounting But problems with consistency + reliability + complexity 30

31 Diversity of fair value methods IFRS requirement Fair value mandatory Impaired assets (IAS 36) Financial instruments held-for-trading (IAS 39) Financial instruments available-for-sale (IAS 39) Derivatives not used in designated cash flow hedges (IAS 39) Derivatives used in designated cash flow hedges (IAS 39) Biological assets (IAS 41) Agricultural produce at the point of harvest (IAS 41) Minority interest at initial recognition (IFRS 3) Fair value optional Property, plant and equipment (IAS 16) Intangible assets (IAS 38) Investment property (IAS 40) Selected items on IFRS transition (IFRS 1) Method Through profit Through profit Through OCI Through profit Through OCI Through profit Through profit One-time FV Through OCI Through OCI Through profit One-time FV 31

32 Optional methods PP&E and intangibles Investment property Cost or Fair value through OCI Cost or Fair value through profit 32

33 Methods available, financial instruments Cost Assets held-to-maturity Loans and receivables not quoted Unlisted stocks held Liabilities (unless designated held-for-trading) Shareholders equity items Fair value through OCI Assets designated available-for-sale Some elements of cash flow hedging Fair value through profit Assets held-for-trading Liabilities held-for-trading Derivatives (except where cash flow hedging is applied) 33

34 Impairment and reversals Financial instruments, property, plant and equipment, intangibles and goodwill, inventory, receivables Write-down (impairment): Loss in IFRS > Loss in Canadian GAAP Income statement Reversal write-up (gain-in-value): > Possible Prohibited in in IFRS Canadian GAAP (=0) 34

35 Fair value in practice 100% 58% 55% 70% 98% 100% Not fair value Fair value 0% 2% 0% PP&E Intangible assets 42% 45% Investment property Financial assets 30% Financial liabilities Source: KPMG and Keitz (2006) 35

36 Problem with reliability of fair value Fair value estimates Reliable if markets are active and liquid But subjective if markets are illiquid IFRS response Disclosure of three levels of fair values Level 1 = quoted prices (unadjusted) Level 2 = models based on adjusted market data Level 3 = estimates by management 36

37 Problem of complexity with fair value Unrealized gains/pertes Lobbying to bypass income statement Concept of comprehensive income Fair value accounting 37

38 3d) New concept of comprehensive income Covers a period Two components: 1) Traditional profit/loss Accumulates in equity Retained earnings Through income statement 2) Unrealized gains/losses excluded from traditional profit/loss Accumulate in equity too separate component OCI Without going through income statement...! Remark: transfer from OCI to I/S On realization 38

39 Importance of comprehensive income in IFRS: an example M$ Year 2008 Year 2009 Thomson Reuters Profit Comprehensive income/loss 39

40 3e) Consolidation Entity theory Measurement of subsidiaries acquired Full fair value Presentation of minority interests Balance sheet = in shareholders equity Income statement = no expense 40

41 Measurement of subsidiaries acquired in the consolidated balance sheet Canadian GAAP Balance sheet at acquisition IFRS PS of FV PS : proportionate share FV : fair value Assets Liabilities Shareholders equity 100% of FV 41

42 Presentation of minority interests in the consolidated balance sheet Canadian GAAP Balance sheet at acquisition IFRS Assets Minority interests or Liabilities In-between Shareholders equity Minority interests 42

43 3f) Transparency Disclosure in notes Transactions realized Positions unrealized and risk exposures Commitments Examples Segment information Related party disclosures Key management personnel compensation Details of subsidiaries Assumptions underlying estimates Reconciliation of shareholders equity components Problem: information overload 43

44 Outline 1) What is IFRS? 2) Evolution of Canadian GAAP towards IFRS 3) Fundamental characteristics of IFRS 4) What analysts should know 44

45 4) What analysts should know about IFRS... Currently applied since 2011 in Canada Public entities = mandatory Private enterprises = optional Principle-based Professional jugdment Comparability!?! misleading improved 2009 backward Canadian GAAP Transition to IFRS 2012 forward IFRS 45

46 Higher volatility in IFRS Choices and disparate methods Judgment and estimates Lack of detailed guidance Regional interprétation Risk of manipulation (earnings management) Challenge for analysts: MORE VOLATILITY in IFRS 46

47 Preliminary evidence in Canada Comparison of ratios IFRS vs Canadian GAAP Early-adopters of IFRS before 2010 Differences observed, but not statistically significant Mean and median of ratios in IFRS Statistically significant differences Variance of ratios in IFRS vs > Mean and median of the same ratios in Canadian GAAP Variance of the same ratios in Canadian GAAP (except for ratio based on cash flows...!) Source: Blanchette, Racicot and Girard (2011) 47

48 Canadian IFRS early-adopters (before 2010) Standard-deviation of ratios Canadian GAAP IFRS Current ratio Debt ratio ROA Cash flow coverage Differences 1% n.s. Source: Blanchette, Racicot and Girard (2011) 48

49 A Canadian example: Eastern Platinum Early-adoption of IFRS in 2009 Comparison Original FS in Canadian GAAP issued in 2008, vs Comparative 2008 FS in IFRS (issued in 2009) Main differences Revenues Impairment loss Deferred tax 49

50 Eastern Platinum 2008 Differences Canadian GAAP vs IFRS M$ Canadian GAAP IFRS Profit (loss) Total assets 50

51 Advices to analysts Comparisons around the transition date Read notes on the transition to IFRS Comparison with industry or peers Read accounting policies Pay attention to consistency of calculations (e.g. gross profit, operating profit) Fair value accounting Treatment of unrealized gains/losses (income statement vs OCI) New ratios = comprehensive-roa and comprehensive-roe Cash flow statement More reliable because CF are not affected by accrual accounting 51

52 A quotation from the Director of Accounting Standards Board About the implementation of IFRS in Canada: "The devil is in the details." (Martin et al., 2008) Thanks for your attention! 52