Print article April 2011 - frontiers in finance – previous issues – December online – articles in this issue –  IFRS News

The move towards a single set of high quality, understandable and enforceable global accounting standards - IFRS - has been given added impetus by the financial crisis. While progress inevitably varies between jurisdictions, depending on local circumstances and history, there is a need to look at this project from a wider perspective than purely accounting. One of the key challenges is the cultural implications of moving from a rules-based to a principles-based approach. Here Hiroyuki Yamada, Andy Kenins and Ramon Jubels present snapshots of the position in three contrasting countries - Japan, Canada and Brazil.

Japan
Accounting standards in Japan have been extensively developed over the last 10-15 years, and are internationally recognized by many industry commentators as high quality. Movements towards convergence between Japanese GAAP and IFRS were agreed by the ASBJ² and the IASB in 2005. In August 2007, ASBJ and IASB reached the 'Tokyo Agreement', under which 26 major differences between Japanese GAAP and IFRS would be eliminated by the end of 2008, with the remaining differences being removed by June 2011.

Listed companies whose financial or operational activities are conducted internationally may use IFRS in their consolidated financial statements from the fiscal year ending in March 2010. Full-basis parallel disclosure of Japanese GAAP information will be required for the first year, and explanatory notes of significant differences between IFRS and Japanese GAAP results will be required thereafter. Around 2012, the decision will be taken on whether IFRS should become mandatory for Japanese listed companies, to take effect from around 2015-2016.

Since Japanese companies adopting IFRS will have to report their Japanese GAAP results in parallel - and there are in fact three different domestic regimes already - IFRS will impose a fourth approach, a significant extra burden, until the domestic requirements can be simplified and harmonized.

Moving from the rules-based Japanese GAAP to the principles-based IFRS presents a significant cultural challenge. For this reason, IFRS still attracts some disquiet in Japan. Many Japanese companies, regulators and external auditors are unfamiliar with the basic concepts and how they should be interpreted. Moreover, successfully operating a principles-based system depends on substantial prior experience and judgment.

There is a potentially more fundamental cultural barrier. Japanese GAAP historically considers significance using a 'through the cycle approach' and doesn't focus on short-term fair value movement. Many Japanese companies believe that the IFRS focus on fair value and mark-to-market valuation reflects a snapshot approach which could encourage excessive short-termism. In addition, a principles-based system allows potentially greater flexibility, opening up the possibility of regulatory arbitrage, which the country's authorities wish to prevent.

Language is a final barrier, since IFRS are written in English. Those using the standards will have to learn English to understand IFRS, while the language barrier can make it even more difficult for concerns to be effectively communicated in international discussion on the development of IFRS.

Canada
Following decisions taken in 2006, listed companies and regulated financial institutions will be required to adopt IFRS in respect of reporting years beginning on or after January 1, 2011. The actual date of impact - and the time remaining for completion of the necessary preparations - will of course depend on individual companies' reporting dates. For historic reasons, the six biggest Canadian banks have October year-ends, which gives them some additional leeway. However, other foreign-owned and private banks, and most insurers, report to December 31 and will be affected sooner.

Given these timetables, many large organizations have had the IFRS conversion process under way for three years or so. Some smaller firms have been a bit behind the game, but the Canadian regulator OSFI³ has introduced regular status reports on progress, which has helped to stimulate greater activity.

Historically, Canadian accounting standards have tended to emulate those of the United States. Some of these, for example in relation to securitizations, remain in place, which is particularly relevant since all of the large Canadian banks are US SEC registrants. Conversion of these standards is proving to be one of the more intractable problems. But in other areas steps have been taken in recent years to bring standards more into line with IFRS. For example, since 2007 standards on financial instruments have been written in emulation of IFRS. Other standards reflect a compromise between the two approaches.

Overall, the conversion process has to deal with a mix of domestic standards, some which are similar to IFRS, some which are quite different. To the extent that existing standards reflect the rules-based US approach, the switch to the principles-based approach of IFRS is generating some disquiet. Some commentators have criticized what they see as the lower quality likely to result from greater flexibility of interpretation.

The process is not helped when the IFRS themselves are subject to change, as is the case currently in relation to financial instruments, impairment and hedging. Here the challenge requires hitting a moving target.

Overall, IFRS conversion appears so far to be progressing well. The big challenge will arise when the process moves beyond small specialist project teams and into the re-education and re-training of much larger numbers of operational finance professionals.

Brazil
Efforts to introduce IFRS in Brazil are very different from those in Japan and Canada. Whereas they are already highly-developed economies, with individually advanced GAAPs, Brazil is an emerging economy which, over the last couple of years, has been thrown into the mainstream of the global economy.

In 2007, CVM (Commissão de Valores Mobiliários - the Brazilian Exchange Commission) and the Brazilian Central Bank (BACEN) decided to require all listed companies and certain financial institutions to move to IFRS starting in 2010, to create more transparency and comparability, improve quality of reporting and facilitate the integration of Brazil's capital markets into the global market with the objective of making it easier to attract capital to finance the country's significant growth objectives.

Towards the end of 2007, a law was passed by congress that significantly changed Brazilian corporate law. The changes include the introduction of a requirement for audit of the financial statements of large sized companies and various steps towards creating a regulatory environment in which adoption of IFRS in local accounting standards would be facilitated. Standards are now rapidly being issued in the local environment that are almost literal copies of IFRS.

These changes should be expected to bring big challenges. Historically, Brazil has never really focused closely on financial reporting (apart from reporting for tax compliance purposes). The country has very many large but non-listed companies, who have had no requirement for general purpose financial reporting in the past. On top of this, the change from essentially a rules-based system to a system based on principles is proving culturally very difficult. Many companies, auditors and regulators need to learn how to operate in an environment where substance overrules form.

Many companies are preparing themselves in some way for the changes. However companies are still looking at IFRS as another requirement to comply with, perhaps showing less appreciation of the potential effects of the conversion on systems, processes, training requirements and business models, than perhaps they should and underestimating the potential benefits that high quality general purpose financial reporting can bring to a company and the economy as a whole.

In conclusion
Adopting new reporting standards was never going to be easy and the challenges are as diverse as the countries that are looking to adopt IFRS in the near future. However, companies should not let their focus deviate from the benefits that harmonized reporting standards can bring to enhance transparency and comparability and overall improve the quality of financial reporting.

Article Authors

*.  IFRS Now: Transforming the finance environment, KPMG International, May 2009.
2. Accounting Standards Board of Japan.
3. Office of the Superintendent of Financial Institutions.