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					IFRS and Internal Audit
- A Perspective

Sumesh Edakkalathil
December 2008

     IFRS- Global Scenario and Impact for India

           IFRS Impact on the Organisation

      Some Lessons from Previous Adopters

     Role of Internal Audit in IFRS Convergence
IFRS – Global Scenario

• Most widely accepted financial reporting standard
• Growing integration of Global Capital Markets
• Used by over 100 countries worldwide
  – Expected to reach 150 by 2011
• Most significant market - United States
  – FPIs can report IFRS without GAAP reconciliation
  – Announced roadmap to adopt between 2014 and 2016; 110 large
    global companies to be permitted to use IFRS from 2009
• IFRS evolved significantly in 2005 when several
  countries adopted it or converged their local
  standards to IFRS.
IFRS – Global Scenario
IFRS – Global Scenario

• IFRS - developed by the International Accounting
  Standards Board (IASB), based in London which
  began operations in 2001.

• Principles & objective based; less voluminous

• “Framework” setting out principles – discusses 5
  elements – assets, liabilities, equity, income,
IFRS – Global Scenario

   The IFRS framework

   IFRS is primarily principle based and
   therefore far less voluminous as
   compared to US GAAP, which is
   primarily rule based. IFRS
   comprises of:
      Conceptual Framework
      IFRS – 8 standards
      IAS – 29 standards
      IFRIC Interpretations – 16
      SIC Interpretations – 11
IFRS – Global Scenario

• Conceptual Framework applied when no specific
  guidance in any standards

• Substance over form

• Specific standard that deals with First time
  adoption of IFRS
Adoption of IFRS in India

• Goal of several standard-setters is to have a single
  globally accepted financial reporting system.

• ICAI, in 2007, released a concept paper detailing:
   – approach for achieving Convergence with IFRS
   – Laying down a road map

• Adoption for all public interest entities and large
  entities for accounting periods beginning on or after
  1st April 2011.
Adoption of IFRS in India

• All public interest entities required to transition to
  IFRS by 2011
   – All listed companies
   – Insurance and banking companies
   – Companies with turnover > Rs 100 crores
   – Companies with borrowings > Rs 25 crores
  2012 IFRS reporting timetable for a 31 March year-
  end company

IFRS transition date                                               IFRS reporting date

                   2010/11                           2011/12

        Comparative year under IFRS         First effective year under IFRS

           Q1          Q2    Q3     Q4         Q1
                                                      30 June 2011
                                   31 March 2011      First quarterly   31 March 2012
   1 April 2010                                     report under IFRS
                                  Last local GAAP                       First IFRS
  IFRS opening
                                      financial                         financial
  balance sheet
                                    statements                          statements
Adoption of IFRS in India

• Presently certain legal & regulatory
  pronouncements contradict IFRS.

• Changes in the regulatory regime and laws are
  expected to be made over the next two years for
  IFRS to be effectively implemented.

• Presently no clarification on impact on taxation of
  fair values and other IFRS specific accounting.
Adoption of IFRS in India

• IFRS – the good news….
  Reporting under IFRS will;
   – bring about better comparability with other businesses reporting
     under IFRS in similar industries,
   – better acceptability of financial statements in international capital
   – Reduce the cost of raising capital in international markets and
   – Assist your companies in being more competitive through access
     to international markets and wide investment opportunities.

• Convergence to IFRS will help Indian companies
  achieve the position as true international players.
IFRS- Global Scenario and Impact for India

     IFRS Impact on the Organization

 Some Lessons from Previous Adopters

Role of Internal Audit in IFRS Convergence
Wider business issues
IFRS conversion – not just an accounting issue…

         It’s an enterprise-wide change process
• Impacts all constituents:
   –   Board of Directors
   –   Management
   –   Investors and Analyst
   –   Finance Function
   –   Business Operations
   –   IT
   –   Geographical Locations
Accounting issues

• GAAP differences
• Policy selection decisions
  – Choices available
  – IFRS 1
• Disclosure requirements
Systems issues

                 A key decision is whether to
                 to 'embed' IFRS or to adjust
                 information produced by
                 existing systems

                 Collecting the necessary
                 data is at least as challenging
                 as applying the rules correctly
                 to 'work out the numbers'
Systems issues … balancing flexibility and cost

      Option 1                Option 2               Option 3

       Topside               Embedded                  Fully
     adjustments            workarounds              embedded

Systems impacts – Low   Systems impacts –      Systems impacts – High
Workarounds – High      Medium                 Workarounds – Low
Flexibility – Low       Workarounds – Medium   Flexibility – High
Investment – Low        Flexibility – Medium   Investment – High
Oper. cost – High       Investment – Medium    Oper.cost – Low
                        Oper cost – Medium
Financial issues

• Dividend policy modifications:
   – IFRS impacts on retained earnings
   – Profit volatility on adoption of IFRS
• Loan covenants and impact on critical ratios
   – Borrowings limits exceeding
• Tax impact
Organisational issues - people and skills

• Training requirements
   – Training and hiring decisions
• Performance management
   – Impact on remunerations?
• Skill enhancement
   – Valuations (in-house vs. outsource)
IFRS- Global Scenario and Impact for India

     IFRS Impact on the Organisation

 Some Lessons from Previous Adopters

Role of Internal Audit in IFRS Convergence
General observations

• in general IFRS conversions have been judged a
  success around the world…

 "The Australian Securities and Investments Commission
 (ASIC) has announced that its conversion to the
 Australian IFRS equivalent (AIFRS) is running smoothly"

 (source: quote)
General observations

• but this has been accomplished through hard work
  and investment
  "larger companies especially had prepared early, and had devoted
  considerable resources to educating and training their boards, staff
  and investors"
  "a broad estimate of the typical cost of preparing the first IFRS
  consolidated financial statements of publicly traded companies is
  0.31% of turnover for companies with turnover below €500m"

  (source: EC report on implementation of IAS Regulation)
General observations

• for many countries IFRS is both more complex and
  requires greater judgement than local GAAP

  "it was evident that in many jurisdictions the increased
  amount of judgement required by IFRS as a generally
  principles-based set of standards presented considerable
  challenges, and some concerns were expressed about
  consistency of application"

  (source: EC report on implementation of IAS Regulation)
General observations

• the impact on profits is often not so great but there
  are wide variations

  One analysis, of 27 blue chips which restated their 2004
  figures, has shown profit swings of 12 per cent on average
  – BUT some up, some down. Ranging between the
  extremes of 93% up on earnings (ICI) to 22% down
  (Telecom Italia).
  (source: ICAEW research)
Lesson 1 - run conversion as a project..

 Road Map : Think Step-by-Step
 IFRS Conversion
 Preliminary    Preliminary study and diagnostic review of impact on all areas of the
    Study       business

   Project      Assess impact on the enterprise, formulate detailed
    Set-up      and compartmentalized project plan. Define responsibilities and authorities.

 Conversion     Preparation of subsidiary and stand alone accounts and access impact.

 Implementing   Embed IFRS in the organization and assess post implementation impact .
Lesson 2 - get the right people involved

                                                   Board/Audit Committee

  Steering Committee                                        Technical Review Committee
  Overall Project Direction & Accountability                      Technical Accounting Quality

                                                                  Project Teams

  Project                                                     Accounting Team
                                               Systems Team                         Business Units
                                               Systems Design &                      Conversion of BU
                                                Implementation                      Financial Statements
Lesson 3 - break it down into appropriate
milestones and deliverables

• main GAAP difference analysis
• financial impacts analysis
• peer comparison
• training plan
• communication plan
• systems gap analysis
• conversion project plan
• IFRS dry run
Lesson 4 - communication is key

  A comprehensive investor communication plan
               is essential to avoid
      uncertainty and unwelcome surprises
Potential pitfalls – communication

                       - April 2005

  "Home credit company Cattles is a prime example of
  what could mark out the year ahead. In March, the
  company warned that its annual profits would have been
  30 per cent lower under IFRS, causing a steep drop in
  its share price..
  … What analysts are looking for is clarity of presentation
  in dealing with the transition."
    IFRS- Global Scenario and Impact for India

         IFRS Impact on the Organisation

      Some Lessons from Previous Adopters

Potential Role of Internal Audit in IFRS Convergence
Potential role for Internal Audit

•   Assist Board and Audit committee
•   Risk assessment on conversion process
       Fundamental change in organisation process = risk
•   Controls over conversion process
•   Assess compliance with corporate governance codes
•   Assist in evaluating alternatives
•   Review interplay between business process and IFRS
•   Monitor the entity wide IFRS embedded.
•   Post implementation review of new controls
IFRS Conversion

Why the Phased Approach?

                       •   Enormity of conversion exercise
Compartmentalisation   •   Effects all components
                       •   Effective project management

                       •   Clarity on way forward
India Focus            •   Assess direct / Indirect tax impact
                       •   Effective utilization of resources

                       •   Dynamic nature of standards
World Focus
                       •   IFRS USGAAP convergence

                       •   Multi discipline impact
Resource Allocation    •   Manage skill constraints
                       •   Leverage knowledge from group experience.
Potential role for Internal Audit

Preliminary Study

 Preliminary                      •   Understand entity specific IFRS requirements
                Understanding     •   Bridge gap between impact assessment
                                      group and accounting function.


                                  •   Conversion project & related aspects
                Risk Assessment
                                  •   Impact on operations

                                  •   Assess impact on the business process and
                                      existing controls.
 Implementing     assessment
                                  •   Communication to Board
Potential role for Internal Audit

Project Set Up

 Preliminary    Project Oversight
                •        Review of allocation of roles and responsibilities
                •        Compliance with business and governance codes
                •        Reporting to the board on specific aspects
                •        Review of impact and bench mark
                •        Review of draft conversion plan to access impact on
 Conversion              other projects

                Planning and Scoping
                •        Assess areas of involvement
 Implementing   •        Priorities project and allocate resources for suggested
                         process changes.
Potential role for Internal Audit


                  •   Testing the outcome of new process & controls
     Study            implemented
                  •   Suggest alternatives, if any
                  •   Monitor dual reporting during dry runs
     Project      •   Interplay between contracts and new business processes
     Set-up           are achieved


   Conversion     •   Timely monitoring of the project to avoid overruns
                  •   Assess impact of Conversion on other critical projects
                  •   Report on impact of identified issues on budgets or
                  •   Provide independent report to the board, audit committee
                      and other stakeholders on a timely basis
Potential role for Internal Audit

Project Implementation

                  Assess Risks and Align Controls
                  •   Performing detailed review of the new business processes
                  •   Suggest improvements to new process or controls
                  •   Align controls with the company's business strategies
      Set-up      Change Management Process
                  •   Evaluate IFRS process "embedded" into the organization
                  •   Ensuring that contractual agreements of the company reflect the
    Conversion        new basis of accounting

                  Reporting to Management
                  •   Updating the Board/Audit committee and the senior management
                      on the convergence process
                  •   Effective follow up on significant matters
Challenges Ahead…

 • Enhance skill levels on IFRS
 • Awareness of the practicalities of implementation
   and possible issues that may arise during
 • Resource availability
    – Prioritise Internal audit responsibilities &
      convergence related responsibilities
 • Stakeholders communications

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