IFRS – The Impact on First Nations and Other Aboriginal Organizations
Armand Capisciolto, Partner
BDO Dunwoody LLP
September 2008
In March 2006, the Accounting Standards Board (AcSB) adopted a Strategic Plan calling for the adoption of International Financial Reporting Standards (IFRS) by publicly accountable enterprises in Canada. In February 2008, they confirmed January 1, 2011 as the changeover date. Although 2011 seems like a long ways away, it is much closer than you think. Therefore, publicly accountable enterprises must start preparing now for this changeover.
Why Should You Care About IFRS?
As you know the Indian and Northern Affairs Year-end Reporting Handbook requires First Nations, Tribal Councils and First Nation Political Organizations to report using the Public Sector Accounting (PSA) Handbook. Therefore, why should First Nations care that the AcSB is requiring the adoption of IFRS?
First Nations need to care about IFRS because many First Nations own and operate for profit entities. Most of theses entities meet either the definition of a Government Business Enterprise (GBE) or a Government Business Type Organization (GBTO) as defined by the PSA Handbook. A GBE is defined as an organization that has all of the following characteristics:
- It is a separate legal entity with the power to contract in its own name and that can sue and be sued;
- it has been delegated the financial and operational authority to carry on a business;
- it sells goods and services to individuals and organizations outside of the government reporting entity as its principal activity; and
- it can, in the normal course of its operations, maintain its operations and meet its liabilities from revenues received from sources outside of the government reporting entity.
A GBTO is a government organization that has all of the following characteristics:
- It is a separate legal entity with the power to contract in its own name and that can sue and be sued;
- it has been delegated the financial and operational authority to carry on a business; and
- it sells goods and services to individuals and organizations as its principal activity.
Unlike government business enterprises, government business-type organizations may sell goods and services within the government reporting entity or they may rely on subsidies from the government or other organizations in the government reporting entity to maintain their operations or meet their liabilities.
The PSA Handbook states that GBEs and GBTOs are deemed to be publicly accountable enterprises and should adhere to the standards applicable to publicly accountable enterprises in the CICA Handbook – Accounting. Since standards applicable to publicly accountable enterprises in the CICA Handbook will become IFRS in 2011, GBEs and GBTOs will have to adopt IFRS in 2011. This will impact the financial statements of the relevant GBEs and GBTOs, as well as impact the financial statements of the First Nation.
In the case of GBEs, the impact on First Nation financial statements results from the fact that investments in GBEs are accounted for using the modified equity method. Under the modified equity method, the investment in the GBE and the income from the investment in the GBE are based on the financial statements of the GBE, which come 2011, will be required to be prepared in accordance with IFRS. In addition the PSA Handbook requires disclosure of condensed financial statements of the GBE. The numbers in the condensed financial statements will also be required to be in accordance with IFRS come 2011.
In the case of GBTOs, they are fully consolidated into the First Nation financial statements. Therefore, the requirement for the GBTO to use IFRS will require new consolidation adjustments in 2011 and an understanding of PSA – IFRS differences will be required.
What is IFRS?
International Financial Reporting Standards are globally accepted, high quality standards which are issued by the International Accounting Standards Board (www.iasb.org). IFRS applies to general purpose financial statements of profit oriented enterprises. They set the recognition, measurement, presentation and disclosure requirements for transactions and events that are important to general purpose financial statements.
Over 100 countries currently require, permit or have a policy of convergence with IFRS. The use of IFRS has grown substantially over the past number of years and continues to grow due to the increased globalization of trade and capital markets. Globalization has created pressure to harmonize accounting standards worldwide in order to reduce inconsistencies in financial reporting.
When does IFRS Apply?
IFRS becomes applicable for year ends beginning on or after January 1, 2011. Therefore, for most First Nation related entities, the changeover date will be April 1, 2011 and the first year end impacted will be March 31, 2012. With three and half years to the first annual reporting date, the adoption of IFRS still seems like a long ways away, however this 2011 date is very misleading.
To truly understand when an entity has to be ready for the adoption of IFRS, we need to look at IFRS 1 - First Time Adoption of International Financial Reporting Standards. IFRS 1 defines the following dates:
The transition date – “the beginning of the earliest period for which an entity presents full comparative information under IFRS in its first IFRS financial statements.” For an enterprise with a March 31st year end, the transition date is April 1, 2010. The entity is required to prepare an opening IFRS balance sheet as of the transition date.
The reporting date – “the end of the latest period covered by financial statements or by an interim financial report.” For an enterprise with a March 31st year end, the reporting date is March 31, 2011.
We believe an entity should be prepared for the adoption of IFRS by the transition date, which for a March 31st year end is April 1, 2010; this is two years earlier than the first annual reporting date. The requirement to prepare comparatives creates the need to be ready by this time. There are many recognition, measurement and disclosure differences between IFRS and Canadian GAAP, so the most efficient way to build the March 31, 2011 comparative statements is to maintain a set of Canadian GAAP and a set of IFRS statements in the 2011 fiscal year.
More than an Accounting Exercise!
It is very important to stress that the adoption of IFRS is much more than just an accounting exercise. In fact all areas of an organization will be impacted by IFRS, not just the financial statements. Although the main focus will be on the financial statements, an entity that only focuses on the statements may not adequately be focusing on all of the required areas. Areas that will have to be considered include the following:
Human resources
The most important change in the move to IFRS will be to an entity’s accounting resources, as teams will need to be built to champion the conversion process. Therefore, one of the first decisions that has to be made relates to human resources - does the organization have adequate resources on staff? A plan for developing IFRS capabilities will be required. Organizations will also have to consider if the existing accounting group has the resources to maintain the existing reporting requirements, as well as start to develop the IFRS information. This will be a significant challenge to smaller organizations which are already stretching their accounting resources to their limits. In fact, many organizations both large and small will have to look to outside consultants.
Contractual arrangements
Many of an organizations contractual arrangements are linked to its financial statements. For example, the changes in recognition and measurement requirements could result in non-compliance with existing debt covenants or other financial requirements. To ensure these are adequately dealt with, an organization needs to review its contractual arrangements and identify where these situations will arise. The organization must then discuss these situations with the relevant users of the financial statements and stakeholders well in advance. This will allow the users to understand the impact of IFRS before it happens and enable them to modify contractual arrangements appropriately.
Compensation plans
The measurement and recognition requirements of IFRS will have an impact on earnings and in many cases, will result in increased volatility in net income. To the extent which compensation plans such as bonuses and incentive plans are tied to Canadian GAAP, companies will need to consider what impact the IFRS reporting requirement may have on existing plans. Like the other contractual arrangements mentioned above, it is important the impact on compensation plans be dealt with well in advance.
Information Systems and Controls
The conversion to IFRS will create a demand for new information to comply with the disclosure and presentation requirements of IFRS, as well as for decision making. Therefore organizations will have to implement new internal controls to ensure the information is reliable, and in some cases, implement new systems to gather and report data under IFRS.
If the conversion to IFRS is treated as more than an accounting exercise, benefits beyond financial reporting can be achieved. The conversion should be looked at as an opportunity to review and improve information systems, improve communication with financial statement users and other stakeholders and to benchmark against international companies in the same industry.
The Need for Project Planning
As mentioned above, the conversion to IFRS is much more than an accounting exercise. The conversion will require involvement from individuals from all areas of the organization, each with different skill sets. For this reason, we believe it is crucial that entities treat the move to IFRS as a project and manage it as such.
We believe that any project plan should encompass the four stages of Preliminary Impact Assessment, Detailed Planning, Implementation and Post Implementation Review.
This document will only look in more detail at the Preliminary Impact Assessment and Detailed Planning phases of the project, as we believe it is crucial that all entities required to adopt IFRS complete these two stages as soon as possible.
Preliminary Impact Assessment
The key step in Preliminary Impact Assessment is to assemble a steering committee and implementation team who will ultimately be responsible for the IFRS conversion project. In smaller organizations, this may only be one or two people and may not be a formalized project management structure. However, the key point is someone needs to lead the conversion project.
Once these individuals are identified, they need to receive IFRS training. Once this training is complete, the steering committee and implementation team will be able to understand the complexity of the assignment. It is also important to note that when providing training, individuals are being trained on the standards which will exist in 2011. The IASB has many projects in process which will result in significant changes to standards between now and 2011. Therefore, it is not appropriate to train individuals on all the standards that exist today; some training will have to be delayed until the revised standards have been finalized.
Detailed Planning
The key step in the Detailed Planning stage is the gap analysis. The gap analysis will identify the differences between an entity’s current accounting policies and practices and those required by IFRS. At this stage of the project, many organizations tend to focus on recognition and measurement requirements. However, we feel it is important that organizations also consider presentation and disclosure at the gap analysis stage. We feel addressing presentation and disclosure requirements at this stage is critical due to the extent of disclosure required by IFRS, which in many cases will create new information needs.
This gap analysis is also needed to properly assess the main business impacts such as the impact on information systems, which contractual arrangement may need to be modified, which processes are required to change, etc. All of these considerations must be known so they can be built into a detailed project plan. The detailed project plan can then be used to determine timelines and resource requirements.
An organization does not know how much time the IFRS conversion will take, or the resources needed, until the Detailed Planning stage is completed. For some organizations, particularly in certain industries, the work effort will be significant and the Detailed Planning stage will identify the need to start the implementation phase of the project immediately. For other organizations, the differences may be rather insignificant and they may not need to begin the Implementation phase of the project immediately. This is why it is critical that organizations complete the assessment stage of their project as soon as possible.
In both the Preliminary Impact Assessment and the Detailed Planning stages, we feel that IFRS 1 - First Time Adoption of International Financial Reporting Standards should be given significant prominence. IFRS 1 provides transitional guidance and relief for entities adopting IFRS for the first time. As such, it has an important role to play in any IFRS conversion project. In general, IFRS 1 requires retrospective application of the standards which are applicable on the IFRS reporting date. However, it also provides relief from this retrospective application in certain situations. This relief comes in the form of mandatory exemptions (situations where retrospective application is prohibited and prospective application must be applied) and optional exemptions. Understanding the optional exemptions is very important in preparing the project plan as the options chosen will impact the information needs and alter the steps needed to complete the IFRS conversion project.
As mentioned above it is critical to complete these two phases of the project as soon as possible. On completion of these two stages an entity should have:
- Identified and trained its IFRS conversion team;
- completed a gap analysis;
- selected the appropriate IFRS 1 options; and
- completed a detailed project plan
At the completion of these phases you can then move onto Implementation, which includes making the accounting policy choices, calculating the required adjustments and drafting financial statements. Proper planning and assessment are essential to the success of the Implementation phase. It is also important to note that the conversion to IFRS will eventually have to move beyond a project and become a sustainable part of an entity’s process. This should be considered throughout the project and is one of the explicit goals of the Post Implementation Review.
The Devil is in the Details!
Both IFRS and Canadian GAAP are principle based frameworks and from a conceptual standpoint many of the general principles are the same. However, the way those general principles are applied in IFRS can be significantly different than how they are applied in Canadian GAAP. Therefore, to truly understand the magnitude of the differences between IFRS and Canadian GAAP, it is essential to look beyond the general principles and look at the detailed guidance provided in the standards.
This document will not cover in detail any of the IFRS – Canadian GAAP differences. It will, however, briefly cover three areas where IFRS are significantly different to Canadian GAAP. These areas are derecognition of financial assets, impairments, fair value options and provisions.
Impairments
In both IFRS and Canadian GAAP, the requirements regarding when to test long lived assets for impairments are very similar. The major difference between IFRS and Canadian GAAP relates to how the test is performed. The first difference relates to the level at which the test is performed. Under Canadian GAAP, testing for impairment is a two step process:
- Compare the carrying value of the asset group to the expected undiscounted cash flows.
- If the carrying value is less then the undiscounted cash flows, compare the carrying value to fair value and record an impairment loss if the carrying amount is less.
IFRS uses a one step test. The carrying value is compared to the recoverable amount, which is defined as the higher of the fair value less cost to sell or the value in use. The fact that IFRS does not consider the undiscounted cash flows results in more impairment losses being recorded under IFRS, than would be required under Canadian GAAP. This difference is one of the reasons why it is said that the use of IFRS results in greater volatility in earnings.
Fair Value Options
Fair value concepts exist in current Canadian GAAP in various standards, including:
- Initial recognition of financial instruments and subsequent measurement of held-for-trading and available for sale financial instruments;
- Measurement of stock based compensation;
- Purchase price allocation on business combinations; and
- Impairment testing for long lived assets, intangibles and goodwill.
Under IFRS, fair value will continue to be used in the situations described above. However, IFRS also allows for property plant & equipment, intangibles and investment property to be re-valued at each balance sheet date to fair value.
Investment property consists of property held to earn rental income or for capital appreciation or both. IFRS provides two accounting models for investment property: At cost depreciated over its useful life or at fair value with changes in fair value included in profit and loss. Even if the cost model is chosen the fair value of investment property must be disclosed. In the case of real estate companies it is very common for the fair value option to be used.
In the case of property, plant & equipment and intangibles, the mechanics of the option to record at fair value is very different than it is for investment property. The change in fair value is recorded in a revaluation reserve, which is a separate component of equity, as long as the revalued amount is greater than the original depreciated cost. If the revalued amount is less than the original depreciated cost, the change in fair value is recorded in profit and loss. Property, plant & equipment and intangibles with finite lives continue to be depreciated, however depreciation is based on the revalued amount and the entire amount of depreciation goes through profit and loss. Furthermore, in the case of intangibles, the fair value option can only be used if an active market exists for the intangible. This rather complicated bookkeeping has resulted in very few entities using the fair value option for property, plant & equipment and intangibles.
Provisions
Provisions is not a term that is described in current Canadian GAAP. Under IFRS, a provision is defined as a liability of uncertain timing or amount. In some cases, items which would have been considered contingent liabilities under Canadian GAAP would be considered provisions under IFRS. This creates a very significant difference as contingent liabilities are recognized under Canadian GAAP if they are likely, while provisions under IFRS are recognized if an outflow of resources is probable, which IFRS defines as greater than 50 per cent. Therefore, more of these types of liabilities will be recognized on the balance sheet under IFRS, than under Canadian GAAP.
The differences described above only scratch the surface. As mentioned above, to truly understand the differences you must look at the detailed guidance provided in the individual standards, as the devil is in the details!
Conclusion
The conversion to IFRS will be a significant project for all entities impacted. Therefore, we recommend you begin planning your projects and assessing the impact as soon as possible. If you require further IFRS information or reference sources, please contact your local BDO Dunwoody LLP office or visit www.bdo.ca/ifrs.
This material is general in nature and should not be relied upon to replace the requirement for specific professional advice.
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