A New Day: Responding to the International Financial Reporting Standards
By Irving Low
The Business Times, 9 October 2017
The imminent switchover to a new accounting framework, coupled with the adoption of new financial reporting standards for revenue recognition and financial instruments, is expected to bring a tidal wave of change for listed companies in Singapore.
The adoption of a new international accounting framework – specifically, the International Financial Reporting Standards (IFRS) – will have a dramatic effect beyond just replacing the ‘S’ in our SFRS (Singapore Financial Reporting Standards).
Likewise, the new model for revenue reporting will impact the revenue profile of companies, i.e. how much revenue will be recognised in what period. And for financial institutions, the changes in accounting standards for financial instruments will be the most significant of the last decade as impairment loss numbers are expected to be much larger.
Dealing with the changes
The changes become effective for the coming financial year 2018. This means that listed companies that have not yet started evaluating the impact of the new standards, should do so immediately.
A typical response might be to just focus on getting it over with and done with quickly, hoping to only make minor changes. But there is a better approach.
Companies have to choose how to adopt the new accounting requirements. For example, when switching over to the IFRS equivalent, companies could make use of the policy choices available in the standard to minimise change and to preserve as much of the accounting status quo under SFRS as possible.
Companies may wish to consider certain accounting policies that help to better position their financial statements. Why? Because the new regime allows for many accounting policy choices at the date of IFRS adoption.
For example, it is now possible for foreign exchange translation reserves that are currently sitting in equity as a result of previous consolidation exercises to be reset to nil and re-classified as retained earnings. If this is not done, these foreign exchange translation reserves will be included in the computation of the gains/losses when the subsidiaries are disposed in the future.
Another example is that fair value can now be used to account for selected assets in the opening balance sheet so that the revaluation impact, as of the date of IFRS adoption, is reflected in retained earnings.
The changes to revenue recognition give companies an opportunity to review existing contracts and renegotiate terms with their customers.
How marketing activities are being accounted for, and whether revenue for long-term construction projects can be recognised over time, may also change.
Marketing activities that result in additional goods or services being provided to customers – for example, a free notebook when customers subscribe for a company’s services for two years – will now result in revenue being not completely allocated to the services. Instead, some revenue will have to be allocated to the “sale” of the notebook.
For construction contracts, the legal clauses which spell out the company’s rights to payments will now determine whether revenue can be recognised while construction is ongoing, or only once construction is complete, whereas today these clauses are not the deciding factor in determining revenue recognition.
Role of the audit committee
Audit committees (ACs) play an important role in the financial reporting process of listed companies. They need to have a strong grasp of what’s at stake, and the options available. Specifically, they should demand a gap analysis, assess the available options, be aware of the potential impact on the company’s financials, and be involved in every key step along the way.
A comprehensive analysis of all accounting gaps and recommendations, on what options the company should select, alongside a quantification of the potential impact, needs to be prepared and discussed at the AC level. With little time left, it is critical to focus on those aspects that will have a material impact on the financials. Once the decisions are made, the appropriate changes to systems and processes can be put in place.
The AC also needs to know where the industry is trending towards and to consider the effects on investors and other stakeholders. For that reason, management and the external auditors should provide the AC with a concise overview of the options that are relevant to the company. What the ACs and companies want to avoid is to be the odd one out with their accounting policy choice.
Stakeholders and investors should demand that companies and their ACs be on top of the changes in order to maximise the benefits of the new regime.
Communication with stakeholders is particularly important. Financial markets do not like to be caught by surprise, and given the scale and reach of the new regime and the implications on key performance indicators such as EBITDA or net profits, it is vital to prepare stakeholders for what is to come. An approach of communicating the impact of the changes upfront builds trust with stakeholders.
Irving Low is a member of the Governing Council of the Singapore Institute of Directors.