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 IFRS transition – Some thoughts

Transformation to IFRS brings about substantial change to the way we treat, present and disclose the figures in the financial statements. These changes often shift the baseline metrics Vis a Vis thestakeholder, often triggering change[s] in the behavior of the stake holders. The change management involves managing the 3rd party interest during and post IFRS implementation – thus larger in scope.

Let me illustrate the above with the following examples.

[1] Let us assume that the existing method of revenue recognition under goes a substantial change as a result the financial KPIs are breached. Employees whose pay [variable pay, incentive etc] is linked to these KPIs will stand to lose for none of their fault. This is bound to lead to morale related problems.  

[2] While arriving at the distributable income meaning dividend etc, it is a common practice to ensure that the solvency related ratios does not breach the threshold. The idea is, the outflow by means of dividend etc should not obscure the solvency of the firm.In some countries the solvency test is mandatory.IFRS sometimes can play mischief here.

IFRS incent higher net assets which include internally generated intangible assets- developmentcosts , for example; recognize the percentage-of-completion method of accounting for construction contracts etc, enable  the measurement of certain financial assets and investment property at their fair value, and provides with a fewer opportunities to recognize the liabilities.

The presentation and disclosure of assets in the financial statement is driven by substance over form. For example the inclusion of leased assets in the Balance sheet is based on facts and circumstances [control,Risk and Reward]; this will impact the dependencies like depreciation.

If the above practices are different from the existing ones, an element of unrealized profit sneaks in; any distributedincome based on such profit is bound to injure the liquidity.

The creditors may perceive this as detrimental to their interests,which could impact the flow and the cost of debts.

The above besides we have plethora of treatments driven by considerations like impairment, hedging, assets held for sale …….

How to manage these issue ?

The best way is to identify the vulnerable areas during the advisory phase of the IFRS implementation project. The “Business”, H R and other relevant stake holders should be extensively involved and the scenarios examined. 

 The scenarios should be added to the impact testing and also be conceived in the future cash flows – both long term andshort term projections.

The KPIs, KRIs etc should be suitably modified so they remain true to the accounting treatments.

IFRS is about number– a globally accepted number. Albeit the stake holders will read the numbers with a different lens meaning IFRS number is riddled with 3rd party perceptions and judgments. So IFRS is also about perceptions. These perceptions have a huge bearing on the firm. It is pertinent that the TQM [ Total Quality Management] initiatives during the eighties were marred by the human perceptions.Thus we have a compelling case to apply these “lessons learnt” to IFRS. 

The effect of distortions owing to conflicts and volatility in recognition, measurement and treatment needs to be factored so the employees and other stakeholders are rewarded fairly. This certainly calls for some structural adjustments meaning changes to the way you make decisions. The top management buy in is critical here.

In my view IFRS transition is about a bit of science [treatment, disclosure presentation] and art –managing people with common sense. A 360* understanding of the issues is the key to success .IFRS transitionis as simple as this.    

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4 Comments

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  1. Gregory Misiorek
    Ramesh,

    i’m glad someone else is picking up the topic. i would like to point two more aspects of transitioning to IFRS.

    one is conversion/convergence and the other is politics around creating and adhering to standards. IFRS have not been created out of thin air, but have resulted from many years of efforts to bring multiple legal regimes into one comprehensive set of principles to ensure consistency on the global scale. just like with any other international initiative, there is a lot of negotiating that goes into first promulgating and then complying with the standards. we have a very long way to go.

    also, from a software project implementation point of view, IFRS is unlike any standard implementation as the audience is not only internal management of the business, but external parties like government agencies and investors who need to make a decision based on the financial state of the company.

    btw, i’m in the middle of answering questions being currently asked by SEC in consideration of adopting IFRS standards in the US.

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    1. Ramesh Ramaswamy Post author
      Thanks Greg for your thoughts.I agree that we have a long way to go in IFRS.you have really driven the nail by mentioning politics as a significant impediment.
      Appreciate your insights.
      Regards
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  2. Muthu Ranganathan
    Ramesh,

    Thanks for sharing your insights on IFRS transitions. Completely agree with you on the science and art aspect of moving to IFRS. There is a good book written by T G Ghosh on ‘Understanding IFRS’. Suggesting that as a good read for everyone
    regards
    Muthu

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