Stakeholders and IFRS

With IFRS, financial results should be more transparent to analysts,investors and regulators. But have Canadian companies done their part to help external stakeholders make sense of IFRS?

By John Lorinc
Illustration: Baiba Black

In November 2009, Waterloo, Ont.’s DALSA Corp., a digital imaging and semiconductor firm with 2009 revenue of $162.5 million, invited financial analysts to an investor presentation with CFO Wajid Ali. One discussion topic was the new international financial reporting standards (IFRS) and the anticipated impact on the firm’s numbers.

At varying speeds, all Canadian publicly traded companies have been moving through the transition from Canadian GAAP to IFRS over the past two-and-a-half years in anticipation of the January 1, 2011 launch. The process has involved the creation of new accounting and IT systems, bulked-up financial teams, enhanced disclosure and employee training.

At DALSA, at the time pushing to recover from a tough recessionary year, Ali’s group and an outside consultant had scrutinized the new standards to determine their impact on cash flow, depreciation, amortization and even management compensation plans.

But that day spent with analysts proved to be an eye-opener. “They didn’t have a lot of knowledge about IFRS,” Ali says. “Their big concern was what would be the impact on operating earnings. I think what’s more valid is looking at its impact on cash flow.”

In its annual financial statements, DALSA had published a six-page qualitative summary of each of the 12 items that would be affected, and the company’s executives used a day-long session last summer to explain the relevant details and stress which were the important metrics. A few months later at the end of their November meeting, they made an in-company pledge to reconvene in the fourth quarter of this year, at which point Ali will provide the analysts with a guided tour of the expected impact on the opening balance sheet and the elections DALSA has taken.

As corporate Canada headed into the final pretransition year, however, such stories of proactive outreach appear to be the exception and not the rule. Many companies, still scrambling to deal with the fallout of the 2008 credit crisis and last year’s recession, have been slow to launch their internal IFRS conversion systems and slower still when it comes to explaining what they’re doing.

At the same time, the consumers and disseminators of financial information — shareholder groups, investor relations managers, financial analysts and business journalists — haven’t exactly been clamouring for information about the shift to a global standard that promises greater transparency and broader coverage of publicly traded shares.

“I think some people [in the stakeholder community] will be caught unawares,” says Irene Wiecek, FCA, co-director of the ICAO Rotman Centre for Innovation in Accounting Education at the University of Toronto.

Certainly, the changeover hasn’t made headlines in the investment press — both the Globe and Mail and the Financial Post have published only a handful of stories about IFRS. “It’s kind of a big black hole,” says one investment reporter, who asked not to be identified. “There doesn’t seem to be any systemic attempt to educate journalists about this.”

The point about the information gap was brought home in no uncertain terms by the Ontario Securities Commission in February. In May, 2008, the OSC guided issuers to begin disclosing information on their IFRS transition plans, as part of satisfying their securities act requirements to disclose accounting policy changes in the Management Discussion and Analysis (MD&A). The conversion “is not just an accounting exercise,” the regulator said, noting the importance of explaining its impact on business functions to investors.

But an OSC review of 2008 and 2009 filings of 106 issuers found that fully 40% had failed to include anything on the transition in their MD&As. Of the 60% that did provide IFRS information to investors, half offered nothing more than boilerplate language, while four-fifths failed to provide time lines or other milestones about the conversion process. As the OSC warned, “While the focus of our current review was education and awareness, we caution issuers that we may request re-filings of MD&A in the future if disclosure obligations are not met.” Says OSC chief accountant Cameron McInnis: “This is a critical year for providing disclosures of IFRS transition information given the limited amount of time that remains before the 2011 changeover.”

The regulator’s critique is reflected in the sobering results of a KPMG survey of Canadian financial analysts conducted last November. The findings, the report notes, “drive home how little this community currently knows about IFRS.” Researchers in Australia, which converted to IFRS in 2005, concluded in a study published last year that companies providing a greater level of proactive IFRS disclosure benefitted from more accurate analyst forecasts. “The reality,” says KPMG’s national IFRS practice leader Doug Reid, “is the state of readiness was not there.”

Canada’s analysts seem to have less understanding of IFRS than their UK and Australian counterparts did in the run-up to the 2005 changeover in those countries. Eighteen months before the transition, KPMG found that almost a quarter of Canadian analysts said they were “not knowledgeable at all” about IFRS compared with 2% for UK and Australian analysts surveyed.

In fact, Canadian preparedness seems to be more on par with what happened in Europe in the run-up to 2005, says Michael Welker, KPMG faculty fellow in accounting at the Queen’s School of Business. “Companies didn’t do a great job of letting analysts know of the changes that [were] coming.”

Other key findings from the Canadian KPMG survey:

57% of the Canadian analysts didn’t know if they understood the impact IFRS would have on the companies they follow;
53% felt IFRS would improve investment decision-making in capital markets and 70% believed IFRS would boost the reliability of financial statements;
96% said it was fairly or very important for publicly traded companies to communicate “actively” with investors and
analysts about the changes.

The report recommends that issuers place a high priority on stakeholder communications, learn from early adopters, understand the impact of key performance indicators, and focus on issues the markets care about, such as explaining key issues of 2010 opening balance sheets and quarterly financial statements restated in IFRS from Canadian GAAP. As Reid says, the regulatory minimum disclosure isn’t sufficient. “It needs to be supplemented by a lot more” information and stakeholder education.

George Kesteven’s priority in the lead-up to the IFRS transition year is figuring out “how to explain the delta.” As manager of corporate and investor relations for Calgary’s Sterling Resources, Kesteven deals mainly with a relatively small group of sophisticated institutional investors who have bought into the offshore oil and gas exploration firm. With a large project coming on stream in 2012, the significant shift in Sterling’s financial statements will move from full-cost accounting to successful effort. But he knows that Sterling will have to restate some 2010 results and explain its exemptions when the firm releases its opening balance sheets for 2011. “That’s when the explanations are going to come,” he says.

Even though it’s small and closely held, Sterling isn’t leaving the communications issues up to chance. “We’ve tried to mitigate the surprise factor by mentioning IFRS in every report to warn people it’s coming,” Kesteven says, noting that the board’s audit committee chair has led an effort to educate Sterling directors with geophysics or geological backgrounds. “Usually, [accounting] changes happen first in the US and we can learn from their mistakes. This time, we are leading instead of following.”

Yet as firms increasingly turn their attention to reporting the anticipated impact of IFRS, some appear to be struggling to find the right balance between prudent disclosure and risky prediction. “Some companies have to be cautious about what kinds of [forward-looking] statements they’ll put out there because they’ll be judged later,” says Wiecek, noting that this tension may explain why so many firms have opted to rely on boilerplate language when discussing IFRS in their MD&As.

In general, Wiecek points out, investment analysts, many of whom have CA or CMA designations, are trained to strip away these sorts of accounting explanations and figure out what’s happening in the underlying business. Those who follow cross-listed companies or have US clients will also have experience quantifying and explaining the differences between Canadian GAAP and other standards.

But this transition is a different story as it involves the identification of the important IFRS elections and exemptions for each issuer, then an analysis of whether the difference with Canadian GAAP represents anything more than an accounting change.

Wiecek is concerned that some companies may take advantage of the confusion by trying to slide through writedowns on assets during the transition year that have nothing to do with IFRS restatements — an example of the so-called big bath theory. “An analyst who isn’t savvy may think it’s just an IFRS change,” she says.

The OSC in recent months has organized investor roundtables with the Canadian Financial Analysts Institute and other groups to provide input on important aspects of the proposed securities rules to accommodate IFRS changeover “so we can understand what their needs are,” says Kelly Gorman, the OSC’s deputy director of corporate finance.

At Toronto’s Veritas Investment Research Corp., efforts to prepare its supply-side analysts for the changeover have been underway much longer, although the company’s executive vice-president Anthony Scilipoti, CA, CPA, freely admits his firm is a bit unusual. Perhaps it’s because he sits on the Canadian Accounting Standards Board and because accounting disclosures is a fundamental part of Veritas’ research process so its analysts have been preparing for IFRS since the transition was announced. “We’re a poor example of what the average [firm] is doing,” he says.

In his assessment, the short-term focus of most analysts has prevented many from paying more attention to next year’s transition. “What analyst teams should be doing is beginning to familiarize themselves with the changes,” Scilipoti says. “You don’t want any surprises come the changeover.” He has urged his colleagues to scrutinize the financial statements of companies that are further along in the conversion, and there are a growing number of early adopters. “I think we’ve started to see some companies give better disclosure,” he says.

The sluggish response may actually prove to be a competitive disadvantage to Canadian investment analysts. Lorne Gorber, vice-president of global communications and investor relations for CGI Group in Montreal, notes that Canadian equity analysts will want more US and international clients. “They’ll need to create a primer for where the changes are,” he says. “That will take some work for some of the big investment shops.”

(Welker’s research suggests that IFRS transition yields only a modest increase in the number of foreign-analyst coverage for issuers. A study of firms in 25 countries that moved to IFRS in 2005 showed that firms had, on average, 26% to 46% increase in foreign analysts before the transition.)

In fact, it’s unclear how larger investment research shops are managing the transition. Requests for interviews with equity research managers at two major bank-owned underwriters (RBC Dominion Securities and BMO Nesbitt Burns) went unanswered, while CI Investments, the large fund firm, declined to comment. But KPMG’s Reid says his firm has noticed that major investment banks are starting to provide more training and education to their in-house equity analysts.

Banks have also benefited from the intensive regulatory scrutiny applied by the Office for the Superintendent of Financial Institutions (OSFI), which has focused on a handful of key issues, such as financial instruments and loan impairment, that relate to its mandate to protect depositors. “We knew not to take it lightly,” says Karen Stothers, CA, senior director of OSFI’s accounting policy division, adding that her team consulted counterparts in France, UK and Australia. “We feel very comfortable that our institutions are well prepared. We’ll be ready to accept new IFRS financial data [from financial institutions] in January, 2011.”

Indeed, in its 2010 second-quarter report, BMO informed its investors that the main accounting areas IFRS was expected to impact were securitization, consolidation, pensions and other employee benefits, as well as capital ratios. In 2008, it established a corporation-wide project with an executive steering committee to oversee the transition and organize its implementation activities into 25 separate work streams. By the end of this second quarter, the bank had worked through almost seven of the identified areas and found no major red flags.

Regulators and those who have studied other IFRS conversion say the key is that firms must recognize that it is to their benefit to educate stakeholders properly. “Issuers that provide sufficient information about their conversion process and its effects prior to the changeover will reduce the level of investor uncertainty,” the OSC said in its February directive. “Ultimately, this should lead to a more stable and less disruptive transition to IFRS, which will be beneficial to both issuers and their investors.”

For his part, Reid is cautiously optimistic that such messages, and the results of the firm’s survey, are beginning to sink in as the countdown to 2011 grows shorter. Audit committee agendas increasingly include updates on IFRS projects, and larger firms are reporting increasingly granular detail to investors. In the past, disclosure was slow, but now it’s accelerating. There will be a sea-change by the third quarter, Reid predicts.

John Lorinc is a freelance writer based in Toronto