The new international accounting standards will make comparisons more difficult

By Al & Mark Rosen
Investment Executive
Jun 16, 2010

While it’s true that corporate governance has always been a major concern in Canada
because of clubby boardroom atmospheres, the problem has been brought into much
sharper focus by unfolding events. The result is that board directors are now investors’
last best hope for fair treatment in Canada.
A critical concern — starting now, and for years to come — will be Canada’s
switchover to a new brand of accounting rules, known as international financial
reporting standards. Gauging how boards react to the turmoil will tell investors all they
need to know about whether directors are falling short in maintaining their
independence and carrying out their expanded duties to investors.
IFRS was adopted in Canada by the Accounting Standards Board, which is financially
controlled by the audit firms. The board decided it would no longer financially support
separate accounting standards for Canada, so it chose to follow much weaker IFRS
over U.S. generally accepted accounting principles. The AcSB initially argued that
Canadian GAAP was more ideologically aligned with IFRS, a statement since
retracted. Not to be ignored is the fact that the audit firms have received a massive fee
windfall for switching corporate clients to IFRS.
IFRS also embeds much more management choice, a characteristic that auditors can
use to escape legal liability to investors by essentially downloading oversight
responsibilities onto corporate directors.
Meanwhile, our closest trading partner and neighbour, the U.S., has easily grasped
the significant deficiencies of IFRS. To quote one U.S. accounting journal: “IFRS
adoption will usher in an era of financial statement manipulation that is historically
unprecedented. Initially, the Big 4 and the [ American Institute of Certified Public
Accountants] were touting that IFRS would increase comparability. They seldom tout
this today, as it has been convincingly shown that the flexibility and professional
judgment embedded in IFRS will make fuzzy numbers a certainty and comparability
an impossibility.”
Canadian lawmakers and securities regulators are either unaware of the potential
negative results for investors in adopting IFRS or simply do not feel any pressure to
act. Many parts of the new accounting standards throw Canada backward by decades
in terms of appropriate financial disclosure to investors. One example is not requiring
financial services companies to disclose separately the amount of cash coming into
the firm, a critical factor that can alert investors to potential bankruptcy. IFRS also
introduces ideas that are completely foreign to Canadian investors, such as the ability
to revalue assets on a quarterly basis, based on management estimates of their worth.
One company might use pie-in-the-sky estimates of value, while another might stick to
using outdated historical cost figures. Take real estate companies as just one
example. The ability to increase and decrease property values on a quarterly basis
can have an impact on all kinds of key financial ratios, such as debt/market value.
There are so many choices surrounding similar critical areas within IFRS that
companies are almost destined to become completely incomparable in the eyes of
investors, thus severely hampering investors’ ability to value stocks. Most concerning
is that IFRS gives considerable freedom to corporate executives to report the financial
figures they want, especially in order to make their own managerial performance look
good.
Many wonder why IFRS was adopted in Europe and is spreading elsewhere in the
world, given that the standards can be manipulated by management so easily. Europe
was essentially forced by the European Commission to adopt a single accounting
language to unify the disparate financial reporting on the Continent. The creators of
IFRS were given a very tight deadline, which led to some significant holes being left in
IFRS. Given those weaknesses, adoption of IFRS for Canada is actually a step
backward for investors and directors. Canadian accounting, although far from perfect,
includes many more investor-friendly attributes. It was developed over decades — not
mere years, like IFRS — and is the product of many costly lessons learned.
As a result, Canadian corporate directors must now become the “real” auditors, acting
on behalf of shareholders. In turn, investors have to recognize this fact and step up
their scrutiny of a board’s actions.
Investors have to look for tangible signs that a board of directors is carrying out its
duties with vigour. This includes having their own budget to hire independent
specialists to check the appropriateness of key executive decisions. Investigating
management’s choice of accounting rules (from among the numerous alternatives now
allowed by IFRS) has now become a major part of the fiduciary responsibilities of
directors.
A disturbing sign for investors is evident when auditors also advise the audit
committee and board on the acceptability of certain IFRS choices made by
management. Directors should be seeking counsel from independent, non-auditing
advisors.
Above all, specific answers must be sought on whether the board and audit committee
have the ability and financial budget to act, independent of the strong influences of
management and the company’s auditors.
Al and Mark Rosen are forensic accountants with Accountability Research Corp