Prepare now for upcoming changes to IFRS compliance
In the near future, three major areas of financial statements prepared in accordance with International Financial Reporting Standards (IFRS) are changing: revenue recognition (IFRS 15), financial instruments (IFRS 9) and leases (IFRS 16).
Complex tasks must be completed by deadlines
The compliance deadlines are not immediate, but due to the need for comparative year information and the amount of work required to implement the new standards, time is of the essence. These are complex standards that will require significant time for an entity to fully understand what is needed and then more time to implement. For example, the new revenue standard includes many new examples that need to be interpreted and applied to an entity’s specific revenue arrangements.
Entities should not underestimate the impact of these changes on their financial reporting, related processes and performance measures such as EBITDA or debt leverage. Those that get started toward compliance with the new requirements early will have an advantage over those that leave it until closer to the deadlines. They will be able to determine and keep investors informed of any significant financial statement changes expected, and they won’t be challenged by a last-minute rush to gather information or make process changes.
The new IFRS revenue requirements (IFRS 15) differ from current Canadian practice in many ways, with potential impact on the amount and timing of when revenue is recognized in the company’s financial statements. This may impact profit, possibly even turning a previously profitable year into a loss situation (or vice versa).
One of the key aspects of adoption is that revenue streams and contracts will need to be reevaluated for both the 2018 fiscal year and the previous fiscal year - 2017, and this may stretch many accounting departments’ staff capacity.
The adoption of the revenue standard may be a particular challenge for companies with complex or tailored revenue streams. For example, consider a software company whose revenue varies according to the number of users under each license, how many customers opt into an update and whether there is any service or customization revenue. The software company will need to perform a detailed analysis of each contract to determine key performance obligations, the transaction price, whether there is variability in the transaction price, whether there have been any modifications to the contract since inception and how to allocate the price over the various performance obligations.
Beyond the example above, many other industries are expected to feel the impact of the new requirements. These include pharmaceutical/healthcare, software, real estate, construction and manufacturing.
Requirements for financial instruments (IFRS 9), a very complex accounting area, are also changing. These changes will impact not just financial entities (e.g., lending and leasing entities) but may also impact non-financial entities. For example, an entity that holds equity investments that are not held for trading, can no longer measure these in the financial statements at cost. These instruments must be measured at fair market value.
Another significant change for financial assets has been made to the impairment model. An entity will need to somewhat predict the future, as the impairment model is an expected loss model whereas today’s model is an incurred loss model. An entity today is looking at what the probability is that a customer has defaulted on the amount receivable whereas in applying the new requirements an entity will be looking at what is the probability that a customer will default.
Hedge accounting requirements have also changed, with more opportunity for entities to reevaluate and apply hedge accounting.
Companies have an extra year to comply with the new lease requirements. A company can adopt earlier, however they will also need to adopt the new revenue requirements at the same time.
Many companies today hold their leases of assets off their balance sheet through an operating lease arrangement. Following the new standard, generally all lease arrangements will be included on the balance sheet through recognition of a right of use asset and lease liability. This is seen to provide investors more clarity on debt levels.
Payments of the lease obligation will impact the income statement through depreciation of the right of use asset and interest charges on the financing element of the lease. This results in a front loading of expenses through net income. However, it also improves EBITDA as the depreciation and interest payments will be excluded from an unadjusted EBITDA calculation.
Recommendations for complying with the new IFRS
Some suggestions for companies to develop an implementation plan to comply with the new IFRS standards are:
Understand your business/industry and how likely the standards are to result in change
One of the first steps is to get a clear understanding of the potential level of impact for each new standard. Talking to colleagues in your industry or your auditor may provide insight into expected implementation challenges and areas of process change. It is important to identify and communicate any changes that may impact financial measures, such as EBITDA, sales commissions, executive bonuses and others.
Determine whether the skills and resources available are up to the job
The standards have many detailed examples of how the rule changes are applied to different business situations. If the accounting department is already operating at or near capacity, it may be necessary to increase the headcount, perhaps on a contract or temporary basis, to do the legwork required. The new requirements will also require extensive training for existing staff, which may require a company to bring in temporary or contract personnel, or commissioning an external accounting firm.
Become familiar with the requirements and commission appropriate professional support
An external accounting firm with a focus on IFRS compliance can go a long way toward helping you learn and understand your priorities, and can coach you through the transition process. Formal training sessions or informal company-focused discussions are often also available.