With the introduction of new International Financial Reporting Standards (IFRS) just over a year or two away, companies should be gearing up for changes that may cause some upheaval.
Largely principles-based, IFRS are part of an ongoing process, leave room for interpretation and require evolving adoption. To manage the massive amounts of needed data and increasingly complex models, companies that have traditionally analysed and reported in their own data silos will need to upgrade their calculation systems. Data management, finance and risk technology will need to be integrated to fulfil regulatory requirements. But how can companies facilitate this progression, remain compliant and minimise duplications and errors?
Mandated for use in over 100 countries, IFRS are a set of international accounting guidelines stating how certain types of transactions should be reported in financial statements.
The standards are issued by the International Accounting Standards Board (IASB) in order to maintain stability and transparency throughout the financial world and they specify exactly how accountants must maintain and report their accounts.
IFRS were established in order to have a common accounting language so that business and accounts can be applied and understood by different companies in different countries on a globally consistent basis. The standards were also created to provide investors and other users of financial statements with the ability to compare the financial performance of publicly listed companies, allowing them to make educated financial decisions when looking at companies they are considering investing in.
With particular regard to the EU, the standards were established so that the EU capital market and the single market can operate efficiently.
IFRS cover a wide range of accounting activities, from balance sheets to profit and loss statements, from statements of comprehensive income to statements of cash flow and statements of changes in equity. Additional complexity is created by the fact that a parent company must create separate account reports for each of its subsidiaries.
An excessive number of standards have been issued over the past three years so company reporters have requested that no major new standards be announced in the next five years. Focus is instead being given to completing outstanding standards and here follows a breakdown of the two which should be a priority given their impending application.
IFRS 15 is the ‘revenue from contracts with customers’ standard and is to be applied as of 1 January 2018, though early application is permitted. The standard states that revenue recognition will have to be derived from changes in assets and liabilities. Firstly, the respective contract with the customer and the specific performance obligations must be identified within this contract. The total transaction price for the contract must then be determined and allocated to the individual performance obligations. The revenue recognition takes place immediately after the specific performance obligations have been fulfilled and in the amount of the correspondingly allocated partial transaction price.
A sector that can potentially be greatly impacted by these changes is telecoms, given the multiple-component contracts which prevail here. For example, a new requirement under IFRS 15 specifies that the individual sale price of the smart phone and the service provision contract must be regarded separately, whereas until now, to be able to consider the smart phone itself as revenue over the entire contract term period, companies would increase instalment payments to reflect the cost of the smart phone. With IFRS 15, the price for the smart phone is recognised as revenue as soon as it is handed over to the customer. The now reduced monthly instalment payments are still recognised as revenue over the term period. And although the total transaction price remains the same, the allocation of the recognised revenue to the individual accounting period changes. This could possibly also have a significant impact on performance based payment schemes.
IFRS users from all sectors are well advised – also with a view toward the retroactive application of the new rules – to evaluate the formulation of their customer contracts as to the effects of IFRS 15 at an early juncture. At most, essential modifications to IT systems are necessary (invoicing, interface to accounting and internal control systems), as well as appropriate checks by the auditors.
IFRS 16 is the ‘leases’ standard and is to be applied as of 1 January 2019, however early application is permitted if adopted with IFRS 15. This standard applies to all leases, except those shorter than 12 months and small assets. It also brings additional disclosure requirements for both lessees and lessors.
Leasing is a key financial solution enabling companies to use property, plant and equipment without needing to incur large initial cash outflows. Existing rules generally require lessees to account for lease transactions, either as off-balance sheet operating or as on balance sheet finance leases. Under IFRS 16, lessees will have to recognise almost all leases on the balance sheet which will reflect their right to use an asset for a period of time and the associated liability to pay rentals. The lessor’s accounting model remains mostly unchanged.
IFRS 16 will have many accounting and financial implications for companies: balance sheets will grow while capital ratios and leverage ratios will become smaller. The new standard modifies both the expense character and recognition pattern, affecting almost all commonly used financial metrics such as gearing ratio, current ratio, asset turnover, interest cover, EBIT, operating profit, net income, EPS, ROCE, ROE and operating cash flows. These rules may require companies to transform their business processes, not just in finance and accounting, but also in IT, operations, tax, treasury and legal among others.
So, how can companies achieve IFRS 15 & 16 compliance without disruption? With the help of technology.
Finding and implementing a solution for IFRS that suits existing processes is going to be a challenge for any company. Data comes from disparate sources and multiple systems and this makes validation more complex. You will need a single, client-specific, end-to-end solution and a modular approach that allows you to manage inventory, modelling and data processes at entity level and that ultimately gives you integration with consolidation, disclosure, reporting and other financial processes.
Building your own solution as a stop-gap could be an option, however an automated system centred on a reporting database is the optimal choice. Reporting needs to be repeatable and auditable on a regular basis and spreadsheets require manual intervention that consumes loads of staff resource, and the evolving nature of regulation means future-proofing will always be required of the software. Are you prepared to keep up with shifting regulations using internal resources?
There are automated solutions available in the market and understanding the pros, cons and level of suitability to your business for each option takes time. Obviously it is essential to conduct a thorough analysis of the options and consider the likely ease of implementation. This analysis requires input both from the finance and IT functions.
Any such solution needs to deliver, at least: (i) reporting that requires minimal effort from the business; (ii) good integration with current IT architecture; (iii) built-in validations and data integrity checks; (iv) ease of use, auditability maintenance and results traceability; (v) consolidation functionality; (vi) flexible configuration ready to adapt to changes; and (vii) operational workflow management.
Many companies may address IFRS 15 & 16 requirements by rushing to create a manual submission first, and then automating the process later. This strategy can, however, be more expensive, more time consuming and less accurate than automating the process from the outset.
Corporates are currently analysing the impacts of these new standards and are starting to implement them.
These projects require a strong involvement from legal and IT departments as more and more data needs to be captured by the reporting. The extent of these projects – especially with regard to the expectations of the auditors – should not be underestimated. The best way to address new and expanding compliance requirements is an automated, agile and non-disruptive approach.
Nick Nesbitt is managing director at Tagetik UK. He can be contacted on +44 (0) 870 851 0540 or by email: info@tagetik.com.
© Financier Worldwide
