Viewpoint:
Toward a single global accounting standard
Ernst and Young believes there should be a single set of high quality
global accounting standards adopted globally, and Sri Lanka should not
be left behind.
Convergence
with International Financial Reporting Standards is an important step
towards this goal.
Hence the introduction of new Sri Lanka Accounting Standards (Sri
Lanka Financial Reporting Standards, comprising SLFRSs and LKASs)
equivalent to International Financial Reporting Standards by the
Institute of Chartered Accountants of Sri Lanka is considered a gigantic
step taken towards transparency in financial reporting.
Application of Sri Lanka Financial Reporting Standards is mandatory
for all entities from January 1, 2012.
This has given rise to a number of concerns regarding the impact of
the new principles on operations of the entity’s any how, they will be
reflected in the financial statements.
Managing expectations of shareholders, employees, financial analysts,
and maintaining debt covenants will be some of the key issues in 2012
for most CEOs.
The assurance leader of Ernst and Young Manil Jayesinghe says the
biggest governance challenge facing most of the listed companies in Sri
Lanka in recent times will be the conversion to Sri Lanka Financial
Reporting Standards.
Although a handful of companies have commenced work on the
conversion, most of the companies are still labouring under the illusion
that Sri Lanka Financial Reporting Standards is not much different from
current accounting standards.
But nothing is further from the truth. He also adds, among the key
issues for boards and CEOs is how to monitor the quality and integrity
of companies’ internal conversion process, and how to ensure that the
communication to investors of the impact of SLFRS on reported results
does not have an adverse share price impact that is not justified by the
underlying facts.
Jayasinghe stresses that it is imperative that Board of Directors,
Audit Committees and key senior officials need to understand the
implications of accounting requirements on the business organization.
They need to gear up the operational teams to face the consequences
of accounting reporting. Further, organizations should not pass up the
opportunity presented through the conversion in strategically steering
the entity to maximize the benefits.
Challenges
The fact that many of the standards are new, and the interpretations
and guidance on them are evolving further complicates the matter and
increases the implementation risk, while the increased earning and
equity volatility that arises from the fair value approaches required by
the standards increases the investor relations risk.
A glimpse at what is ahead
* Application of accounting standards require input from various
business units as opposed to the traditional method of application of
accounting standards by the finance department * Currently entities
apply accounting requirements to the trial balance in preparing
financial statements. With the new accounting standards this will not be
feasible. It will be necessary to reengineer business processes and IT
systems to capture data at the initiation of transactions.
* The application of certain accounting principles will heavily
involve expertise in order to comply with measurement requirements.
Role of the Board and Audit Committees
Who is Responsible?
Although no board would deny that it has ultimate responsibility for
the quality and integrity of the financial statements and with the new
financial reporting requirements, the SLFRS conversion.
It would be the responsibility of Boards to manage the impact and
most importantly to communicate such impact to the capital markets and
manage expectations.
Our experience is that there are very different views among boards
and audit committees about how this responsibility should be discharged.
The more commonly held view, however, is that audit committees must
understand the rationale behind management decisions for selecting
particular accounting policies, in addition to understanding and
monitoring the process.
As one chairperson put it, The accounting change is huge. Significant
resource is needed. Internal controls need to stand up to these new
standards.
Another explained, as audit committee chair, I have been interested
in this as a communication process. There is also a behavioural
component about how to manage the company differently.
IFRS conversion is far more than a technical accounting exercise.
Clearly, it is important for the board to be confident that the
finance personnel in the group have an appropriate degree of SLFRS
financial competence, that appropriate guidance on the application of
the company’s SLFRS accounting policies is made available, and that the
SLFRS conversion project is well planned and managed.
However, the responsibility of board members goes beyond monitoring
the IFRS conversion process. Conversion is not just a technical
accounting exercise because it may have significant impacts on the way
companies operate and how SLFRS may affect transaction structures.
For example:
* Sales contract pricing may include embedded derivatives that need
to be accounted for separately.
* Information systems must be able to collect data to meet the new
accounting recognition and measurement requirements in relation to
revenue recognition on long-term contracts or components of fixed assets
previously regarded as single assets.
* Treasury operations and systems may be affected by the highly
prescriptive SLFRS hedge accounting rules. Far greater use of valuation
models, together with the data required and the assumptions to be
employed, will be required in order to apply SLFRS.
* Pensions, share-based payments, asset impairment, and financial
instruments will all require the use of models and assumptions about
future performance and cash flows.
* Capital instruments previously classified as equity may have to be
classified as debt under SLFRS (or bifurcated with an element being
treated as debt and the balance as equity), thereby affecting gearing.
Of great importance for senior management and boards, the accounting
recognition and measurement changes brought about by SLFRS will affect
the measures used by companies and investors to assess the performance
of companies and, as a consequence, may lead to a realignment of
management’s performance targets and performance-related remuneration.
Boards will have to assess the impact of the changes resulting from
SLFRS on dividend policy.
Boards need to understand the significance of these issues in order
to assure themselves that management has addressed them properly.
For example, boards or their audit committees need to be able to
assess the appropriateness of the assumptions used by management, as
quite small adjustments to the underlying assumptions may give very
different results.
It is therefore essential that those charged with governance should
develop a good understanding of the organization’s approach to
conversion and receive regular progress reports and summaries of key
issues.
Are you already late?
The management in every company will be responsible for the
operational planning and implementation of the SLFRS transition, but
ultimate responsibility lies with those charged with governance. Time is
fast running out for boards which have not so far played their full
role.
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