As Canadian companies transition to IFRS during 2011, CEOs and CFOs must continue to provide their control certifications throughout this period. Most companies have begun working on their changeover to International Financial Reporting Standards (IFRS), because IFRS will replace Canadian generally accepted accounting principles (GAAP) for fiscal years beginning on or after January 1, 2011.
Most Canadian-listed domestic issuers will be required to report their first set of IFRS financial statements in the first quarter of 2011. At the same time, certifying officers of non-venture issuers will also need to certify on the design and implementation of disclosure controls and procedures (DC&P) and internal control over financial reporting (ICFR). How will companies maintain effective control throughout the IFRS conversion and beyond?
This blog is one in a series of 3 blogs, which addresses the following important considerations with regards to IFRS and NI-52-109 CEO and CFO Certifications:
• Regulatory (Part 1 of 3).
• Initial reporting under IFRS (Part 2 of 3).
• Ongoing certifications (Part 3 of 3).
A portion of this information is based on my personal observations and opinions. This has been augmented with information publicly available from KPMG. Therefore, acknowledgements are hereby made to KPMG.
Initial reporting under IFRS
For calendar-year-end issuers, the first reporting period under IFRS will be March 31, 2011. Several significant activities are required in 2011, including:
• Preparing interim and annual IFRS financial statements,
• Certifying design of DC&P and ICFR on an interim basis,
• Certifying operating effectiveness of DC&P and ICFR on an annual basis.
• Prepare for the implications the IFRS changeover will have for many disclosures and their controls.
• Changes made for IFRS transition may represent ICFR changes that require disclosure.
Potential Impact of IFRS on Internal Control over Financial Reporting
Management will be required to make significant choices in the selection of accounting policies and elective exemptions as part of the company’s transition to IFRS. This blog highlights ICFR considerations regarding the design of controls for certain IFRS accounting policy choices and elective exemptions available on transition to IFRS. The blog includes only a sample of ICFR considerations and does not represent a complete list. In addition, these considerations are directional in nature only, as specific control impacts will depend on the facts and circumstances of each company.
Preparing IFRS financial statements
In the first interim reporting period, the condensed set of interim financial statements for the first reporting period must not only meet the requirements of IAS 34 Interim Financial Statements, but also contain:
• A complete set of significant accounting policies, including the selection of various ongoing IFRS accounting policy options and the elective exemptions at the transition date made under IFRS 1 First-Time Adoption of IFRS (IFRS 1).
• A reconciliation of equity from Canadian GAAP to IFRS at the date of transition (January 1, 2010), the end of the comparative annual period (December 31, 2010), and the end of the comparative interim period (March 31, 2010).
• A reconciliation of comprehensive income from Canadian GAAP to IFRS for the annual period ended December 31, 2010, and the three-month period ended March 31, 2010.
• Additional financial statement disclosures.
Annual financial statements require further financial statement disclosures.
Accounting policy selections
The conversion to IFRS requires numerous accounting policy selections. Some choices are required in applying IFRS for the first time through IFRS 1, while others relate to on-going accounting policies.
In many areas, a company’s choices can have significant and wide-ranging implications for the design of its controls. As an example, a choice that will affect all companies—the IFRS requirement for financial statement presentation…
IFRS accounting treatment: IFRS requires, as an accounting policy choice, that expenses be presented either by nature or by function on the face of the statement of operations. This requirement as well as other aspects of IFRS can result in significant changes to captions in the statement of operations.
Implications for controls: Having made its choice, a company may need to put in place controls over the creation of general ledger accounts and the mapping of these accounts to the financial statements. In addition, the company may need to consider any program change controls required for consolidation software and the related IT application controls.
Communication of accounting policies
The company will need to communicate new accounting policy selections to all affected parties throughout the organization. To the extent that written policy documents exist, they will require updating and distribution on a timely basis. The form of communication should be tailored, depending on the complexity of the changes being communicated. For example, simple changes may be handled via e-mail communication, while complicated changes should be communicated via in-person training sessions to facilitate knowledge sharing.
Reconciliations to previously reported Canadian GAAP
The first interim financial statements must include comparative figures restated to IFRS, and reconciliations between IFRS and Canadian GAAP. Controls should be in place over both the creation of the opening balance sheet and the reconciliation process. The reconciliation process will need to be repeated for each quarter and for the annual financial statements. The reconciliations are most transparent and informative when done on a line-by-line basis.
The nature of the controls over the reconciliation process will depend on the number of reconciling adjustments expected and how your company chooses to track its accounting records concurrently under IFRS and Canadian GAAP. Your company’s current information systems will largely determine the available options. Adjustments will be required to convert from Canadian GAAP to IFRS.
• It is crucial that the accounting personnel responsible for approving the IFRS adjustments are appropriately knowledgeable of IFRS
• Only appropriate personnel have the authority to approve the adjustments.
If Excel spreadsheets are used to track the adjustments for the reconciliation, then detailed review over entries may be necessary, and end-user controls such as locking formulas and password protecting contents should be considered for implementation.
Additional financial statement disclosures
IFRS has significant additional disclosure requirements compared to Canadian GAAP. For example, additional disclosure is required when impairment losses are recognized or reversed at the date of transition, or material adjustments are made to the statement of cash flows. Possible additional disclosures may also be required around significant judgments made in applying IFRS accounting policies and new key sources of measurement uncertainty.
• Ensure effective controls over the reconciliation process. Controls may be complex, depending on the company’s information systems.
Companies will need to establish a process to:
• Identify the required quarterly and annual disclosures,
• Ensure the information is appropriately gathered,
• Consider whether the required disclosures are fairly presented.
To illustrate, controls over such a process might include the following elements:
A responsible person obtains, from the company’s auditor, a disclosure checklist to identify required disclosures. The person then amends any reporting package templates so that the required information is obtained from operating locations upstream for external reporting. Relevant controls could also be added at these locations to review the information provided for completeness and accuracy. At the time of external reporting, the disclosure checklist would be completed and approved as part of the financial statement review process.
For financial statements produced in compliance with IFRS, the CEO and CFO of a non-venture issuer will be required to certify for the first quarter of 2011 on the design of their DC&P and ICFR. “Design” refers to both developing and implementing the controls, policies and procedures that comprise DC&P and ICFR, and encompasses the documentation of these controls. As noted earlier, Exhibit 1 illustrates some accounting areas in which we anticipate the conversion to IFRS may necessitate changes in the design of ICFR. Companies should put in place plans that will allow certifying officers to assess whether newly designed controls have been implemented. An assessment may be accomplished, for example, by completing a walkthrough. Plans should also consider how the documentation required to support the certification of design will be updated.
Certifying operating effectiveness
For financial statements produced in compliance with IFRS, certification of the operating effectiveness of DC&P and ICFR will be required for the first annual period ending after January 1, 2011. However, in both 2010 and 2011, companies will need to address the impact of the IFRS conversion on the nature, extent and timing of testing required.
Testing considerations in 2010
In making risk assessments in 2010, certifying officers should consider whether the risk of error or fraud has increased due to resource constraints, system conversion projects or other ongoing change management issues arising out of the IFRS conversion project. Changes to the assessed risk of fraud or error may, in turn, require testing plans to be amended.
• Be prepared — IFRS requires significantly more disclosures than Canadian GAAP.
• For the first quarter of 2011, focus on controls introduced or redesigned for IFRS.
If controls that affect the 2011 financial reporting year have already operated in 2010, companies may be well advised to complete the testing of these controls in 2010. For example, if new IFRS accounting policy selections were approved in 2010, the approval of these policies could be tested as part of the 2010 test plan. Similarly, controls over IFRS systems development projects that were completed in 2010 could be tested as completed. This approach may contribute to both efficiency and effectiveness by reducing resource constraints in the year of transition, allowing for early detection and remediation of any DC&P or ICFR issues, and facilitating interviews of individuals involved in the conversion process while the details are still fresh.
Testing considerations in 2011
In 2011, a company should reconsider its previous risk assessments, particularly in areas that have undergone a significant change in accounting policy or a retroactive restatement when IFRS was adopted. Management should consider whether the prior testing approach needs to be modified because employees’ level of knowledge of IFRS will not immediately approach their previous familiarity with Canadian GAAP. This knowledge difference may have particular impact when a company previously relied heavily on monitoring controls to reduce the extent of detailed process-level testing. In general, IFRS is less predictive than Canadian GAAP because IFRS uses more fair value measures, thus creating more earnings volatility, particularly in areas such as provisions and stock-based compensation. These factors may reduce the effectiveness of monitoring controls.
For example, as part of the certification process, management may have relied on centralized monitoring of the operating performance of subsidiary results in order to reduce or eliminate the need to test process level controls at certain locations. As results will be reported under a new framework, management should consider whether the amounts are sufficiently predictable, and whether they have sufficient technical expertise in IFRS to perform an effective review at a level that would detect a material error. Until management becomes well versed in IFRS, and expectations and trends are predictable, management may choose to lower the threshold for amounts requiring investigation, so that more matters are investigated. Alternatively, management could reduce the extent of reliance on monitoring controls and introduce some testing of process level controls.
• Conduct control testing early, if you can.
• Recognize the IFRS learning curve for your employees and its potential impact on control testing.
In 2011, the monitoring of actual results versus budget will be effective only to the extent that relevant budgeting was also completed under IFRS. Management will need to put in place a process to ensure that employees developing budgets in 2010 are appropriately trained in IFRS and also receive appropriate communications regarding final approved accounting policy selections. Management must proactively make the appropriate changes to the company’s budgeting process. A flawed process may lead to significant budget to actual variances and make the monitoring of such variances a much less effective control.
In developing test plans, companies may, to be prudent, adjust their test plans in areas where more significant changes in processes have occurred or where new knowledge of IFRS is required because of increased risk. Adjustments could include:
• Testing earlier. This approach will allow for remediation efforts if required, such as additional training, or the identification and testing of additional controls. In particular, areas with new controls or significant accounting policy choices should be targeted for early testing.
• Testing more. The extent of testing should reflect risk assessments. The extent of testing can be adjusted by either testing more of a particular control or by testing more than one control related to an assertion. For example, testing both a preventative control and a monitoring control might be appropriate.
• Changing the nature of a test. More persuasive evidence should be gathered as the degree of risk increases. For example, re-performance of revaluation adjustments is more persuasive than inquiry and inspection directed to such judgments.
I hope this helps. This is one of a series of blogs that is meant to convey information relating to Canada’s transition from Canadian GAAP to IFRS, specifically as it pertains to CEO and CFO Certifications.
For further information, please refer to the ongoing series of IFRS blogs on the Edelkoort Smethurst Schein CPA’s LLP web-site or send me a note, and please remember to contact your accounting professional for further guidance.