PwC IFRS - Internal Audit Considerations

IFRS - Internal Audit ConsiderationsPresenters:

Duaine Smith/Saad Bounjoua – PricewaterhouseCoopers

NYIIA’s 36th Annual Audit SeminarMarch 20, 2009

PricewaterhouseCoopers

This session’s objectives

High level overview of the following;

1. What is IFRS?

2. Context and market trends

3. Key differences between IFRS and US GAAP

4. The case for conversion

5. Potential role for Internal Audit

6. IFRS implementation – Challenges and Lessons Learned

7. Key Messages

8. Q & A

Objectives

What is IFRS?


Where is all of this going?

“…The ultimate goal, we believe, is a common, high-quality global financial reporting system that can be used for decision-making purposes across the capital markets of the world.”

“Thus, we believe that planning for a transition of U.S. public companies to an improved version of IFRS would be a logical way forward to achieving the goal of a set of common global standards.”

Why is IFRS going on?

-Robert Herz, Chairman of the Financial Accounting Standards BoardOctober 24, 2007, Senate Hearing on Global Reporting Standards


Why IFRS?

• Create a global accounting language • Allow companies access to global capital markets• Serve information needs of investors• Convergence with US GAAP and elimination of US GAAP reconciliation

requirement by Foreign Private Issuers is driving the move to IFRS acceptance in the US

Why is IFRS going on?

Context and market trends


The world has chosen IFRS

More than 100 countries require or permit the use of IFRS, or are converting

Top 10 Global Capital Markets

US US GAAP

Japan Converging to IFRS

UK IFRS

France IFRS

Canada Converting to IFRS

Germany IFRS

Hong Kong IFRS

Spain IFRS

Switzerland IFRS or US GAAP

Australia IFRS


Countries seeking convergence with the IASB or pursuing adoption of IFRSs

Countries that require or permit IFRSs

Countries with no current plans to convert to IFRS


Key standard setters - Global• Standard setter—International Accounting Standards Board (IASB) founded in 2001 and

based in London

- Goal: Provide the world’s integrating capital markets with a common language for financial reporting

• International Accounting Standards Committee (IASC) Foundation

- Appoint IASB members

- Exercise oversight

- Raise funds

- Similar to Financial Accounting Foundation (FAF)

• International Financial Reporting Interpretations Committee (IFRIC)

• Standards Advisory Committee (SAC)

• Predecessor organization was International Accounting Standards Committee (IASC) founded in 1973



Key standard setters - National

SEC – Securities and Exchange Commission• Protect investors, maintain fair, orderly, and efficient markets, and facilitate

capital formation

FASB – Financial Accounting Standards Board• Designated organization in the private sector for establishing standards of

financial reports• Officially recognized as authoritative by the Securities and Exchange

Commission and the American Institute of Certified Public Accountants

EC – European Commission



Catalysts of the US transformation

• Creation of IASB in 2001• October 2002 Norwalk Agreement• Convergence was the pathway to create one global set of high-quality standards which are

robust and transparent• April 2005 SEC “roadmap” – goal to eliminate reconciliation• Reports on competitiveness of the US capital markets• SEC roundtable discussions in March and December 2007 • Focus on simplicity in US financial reporting• March 2008 SEC accepts IFRS from Foreign Private Issuers without reconciliation• August 2008 SEC proposed roadmap of mandatory adoption of IFRS beginning in 2014 by

issuers in the US• August 2008 SEC proposed to allow the optional use of IFRS by certain qualifying domestic

issuers• November 2008 SEC published for public comment a proposal, titled Roadmap for the

Potential Use of Financial Statements Prepared in accordance with International Financial Reporting Standards by US Issuers



Expected timeline for US transition



Is there a case for IFRS in the US?

• Globalization will drive a change to IFRS in the US• Domestic registrants should have the same option as FPIs• Ultimately the US markets should have only one GAAP• Transitioning to IFRS will be at a cost, but it will be worthwhile

- Enhance efficiency of capital allocation- Cost savings for harmonized global reporting systems- Competitiveness of the US capital markets- Simplicity in financial reporting- Elimination of the US GAAP reconciliation for non-US registrants- Return to a more purely, principles-based framework in the US


The earlier a company plans strategically for this transition, the better


Benefits and first-mover advantages

The case for conversion

IFRS:Uniform GlobalAccountingLanguage

Reduced cost of financial reporting for global companies

Industry perception of market leadership

Sufficient time to adequately debate strategic first time adoption – in particular with “look back” provision

Streamlined

M&A activity

More effective procurement with vendors and customers reporting under IFRS

Improved transparency and comparability for investors and rating agencies

More efficient access to capital for global corporations

Ability to analyze impact on tax-related issues

Ability to understandinteraction with strategic initiatives to generate value from synergies

Ability to secure scarce IFRS knowledge resources and optimize human capital deployment decisions

More room for management’s judgment and truer reflection of economic reality with principles-based GAAP

Key differences between IFRS and US GAAP


Major differences between IFRS and US GAAP

Principles vs. rules• Both frameworks built under principles-based methodology• However, US GAAP is more prescriptive and rules-based addressing

specific industries and types of transactions in many areas• 2,500 pages vs. 25,000 pages• Simple vs. complex

Fair value accounting• Greater use of FV under IFRS than US GAAP (e.g., revaluations of PP&E,

Investment Property and Intangibles)



Principles versus Rules

Criteria for

principles-based

standards

Faithful presentationof economic reality

Responsive to users’needs for clarity and transparency

Consistency with aclear conceptual

framework

Based on an appropriately defined scope

Written in clear, concise and plain

language

Allows for use ofreasonable judgment

IFRS vs US GAAP key differences




Business CombinationsBusiness Combinations Tax accountingTax accounting

Recognition and measurement of provisions

Recognition and measurement of provisions

Derivatives and hedge accountingDerivatives and hedge accounting

Consolidation of entitiesConsolidation of entities

Impairment testing methodsImpairment testing methods

Capitalization of R&DCapitalization of R&D

Asset retirement obligationsAsset retirement obligations

Securitizations / DerecognitionSecuritizations / Derecognition

Revenue recognitionRevenue recognition

Measurement of inventoriesMeasurement of inventories

Classification and measurement of financial instruments

Classification and measurement of financial instruments

AccrualsAccruals Debt and equity classificationDebt and equity classification

Employee stock compensationEmployee stock compensation LIFOLIFO


This information is derived from Form 20-F

IFRS vs. US GAAP Number of

Entity Net

income Equity reconciling

items Key differences

BASF -4% 2% 6 Pensions Acquisitions Deferred taxes

Akzo Nobel -13% 73% 16 Income taxes Derivatives Pensions and OPEB

Syngenta -21% -11% 13 Purchase accounting Grant of put option Pensions and OPEB

Rhodia -76% 19% 8 PensionsCumulative translation adjustment

Capitalized development costs

Sinopec 1%n/a 2Depreciation on revalued PP&E Capitalized interest n/a

Sanofi-Aventis 1% 1% 8 Application of IFRS1 Business combination Restructuring

Eni 9% -4% 10Successful efforts accounting Inventory valuation Gain of sale of business

Royal Dutch Shell -3% -6% 8 Retirement benefitsCurrency translation differences Reversals of impairments

Total SA -3% 78% 10 Acquisition Financial instrumentsTax effect of intercompany transfers

IFRS vs. US GAAP differences & benchmarking information


Transition IFRS conversion methodology

• Developed and refined over 10 years of successful conversions in Europe, Asia and the US

• Implemented by a broad network of experienced conversion specialists. • Considers the broader impact on the business - accounting policies,

people, financial reporting, tax and other business processes and systems, stakeholder management, statutory reporting and communications

• Used by more than 1,300 companies• Scalable and responsive to the unique complexities of each client’s

business• Establishes clear objectives with the client in the planning stage• Applies a phased approach to IFRS conversions• Is a framework that is supplemented by deep business process and

technical accounting and systems skills.



TransitionIFRS methodology



What does a conversion impact

Changing People

(a new business language)• Communication

- Internal- External

• Training:- At different levels- Not only Finance people

Changing Numbers

Addition of another GAAP and/or change in primary GAAP - Accounting policies determination; Chart of Accounts review, Opening Balance Sheet,….

Changing Processes• Existing processes to be enhanced:

- Not adequate with volume- As alternative to system change

• New processes created• Budgeting & forecasting• Internal controls revisited

Changing Systems• Data availability and system

requirements• New systems components: data

warehouse, calculation engine• Re-alignment of management

information systems• Multi-GAAP solutions• Primary GAAP changeover

Changing Business• Performance management to be embedded across :

- Performance measure/KPIs- Management accounts - Remunerations/bonuses - Budgeting/forecasting- Financial and Business impact analysis: debt covenants- Different valuations


Potential Internal Audit Roles



Now – Before the process begins, serve as a resource for

• Board / Audit Committee• Finance Staff• Business Unit Personnel

Phase 1 – Preliminary Study• Assist in planning / Scoping the project• Ensure all aspects (people, processes, systems, operations)

are addressed• Review diagnostic questionnaires / summaries prepared• Ensure all significant constituencies participate in the process• Monitor progress• Participate in report to the Board / Audit Committee /

Stakeholders



Phase 2 – Project Set Up; Component Evaluations and Issue Resolution; Initial Conversion

• Review project governance structure / related responsibilities • Monitor completion of detailed component evaluation• Review management assessment of alternative policies / issue

evaluation process• Monitor plan for training/ knowledge transfer• Review prioritized plan for process / system changes • Monitor plan for dual reporting periods• Review controls over initial IFRS conversion• Monitor progress and report to stakeholders



Phase 3 – Integrate Change

• Monitor implemented process / system changes• Ensure process and control changes are embedded in organization• Ensure contractual agreements/ financial covenants reflect the new

basis of accounting• Review revised SOX scope, based on process/ systems changes• Monitor SOX testing of new control environment• Monitor progress and report to stakeholders

IFRS Implementation – Challenges and Lessons Learned


Key Challenges in an IFRS Implementation

• Underestimation of time required- Project management essential

• Not enough focus on correlative effects- Investor relations and market communications- Contracts and agreements- Tax related issues- Bonus and compensation plans- Effects on IT systems

• Lost opportunities- Too many workarounds- IT not used as effectively as it could have been


Key Challenges in an IFRS Implementation

• Inefficiencies- Not enough coordination between the parent and subsidiaries- Lack of knowledge transfer

• Increased risk over financial reporting- Need for topside entries- Ensuring process and controls reflect the changed accounting

standards and language• Focus on recognition and measurement

- What will the accounts actually look like- Education around depth and extent of new disclosures


Accounting changes that impact more than Financial reporting

• Suppliers• HR• IT

• Acquisition Integration


Business Consideration

•IFRS is not simply a financial reporting issue - it is pervasive across the business

•An IFRS conversion can take on average 18 to 30 months

•IFRS resources are scarce and companies should begin to increase their IFRS knowledge

•Audit Committees and Boards are starting to ask about IFRS

Policy Consideration

•IFRS could be impacting you today if a subsidiary is adopting IFRS and determining certain first time adoption exemptions

•There are numerous policy choices within IFRS; these need to be strategically analyzed

•It takes time to resolve any issues that may arise, e.g., redesign of debt covenants

•IFRS requires comprehensive and clear documentation on Day 1 e.g. hedges

Market Consideration

•Additional flexibility in capital raising initiatives

•Cross border acquisition and divesture activities may require IFRS knowledge

•Increased investor interest; effective market communications

•Benchmarking with peers

•Take steps to influence regulators and tax authorities around the impact and acceptance of IFRS

•Being seen as a front runner in the adoption of IFRS in the US


Financial reporting process considerations• Opportune time to address any issues or enhance financial reporting processes

• Potential for reduced cost of compliance

- Centralized IFRS policies and shared services department can be developed and used by all in the Group

- Potential to reduce the number of reported GAAPs and costly conversion efforts (converge the statutory reporting)

• What is the most efficient method to incorporate multiple GAAPs in the financial reporting processes and systems

• Synergies with other business initiatives and the opportunity to build IFRS reporting capability

• Consistent policies among the group can help improve quality; one version of the truth

• Ensure that the IFRS policies have adequate processes and controls (Sarbox)



Financial reporting challenges

• Companies enhancing standardization (challenge and benefit)

• Application of judgment within a “principles”-based GAAP IFRS versus “rules”-based US GAAP

• Policy setting difficult because IFRS provides options

• Finding many more differences than initially expected

• US GAAP reporting often done using “global” materiality

• Local IFRS reporting done using “local” materiality

• Data gaps resulting from significantly increased disclosures



Financial reporting challenges (continued)

• Multi-GAAP reporting (systems capability, many different reporting systems and processes within the reporting units)

• Many “hand-offs” are required to prepare consolidated financial results (A lack of automation in the transfer of financial information)

• Different sets of data and process flows are used to support statutory, regulatory and management reporting requirements

- A lack of standard processes and systems in the recording and consolidation of financial information across the Group

- Varying levels of ownership of the consolidation processes at Operating Company level



Other organizational aspects

• Significant effort to integrate a new accounting language throughout an organization

• Numerous tactical workarounds versus strategic fixes

• It takes time for companies to get comfortable with the new principles - Maintain previous GAAP for a period of time - Non-IFRS measures still widely used to

communicate performance- Level of transparency varied- New performance standards (e.g. job

descriptions, hiring practices)- Communication needs across organization- Local regulatory reporting requirements

As several multinational Fortune 50 companies have already discovered, transition-related changes have the potential to deliver future dividends, such as streamlined operations and reduced costs. With this outlook, companies can approach their conversion efforts strategically (e.g., overhaul an inflexible information technology system or rethink accounting choices), not just treat them as a compliance exercise

Two birds, one stone



IFRS – Lessons learned from 100 countries • Establish a clear vision and plan at the start

• Establish the tone at the top and set up the right governance structure and clear decision-making powers.

• Plan and execute appropriately considering impacts across the business.

• Don’t “outsource” the conversion process – grow your own resources.

• Develop a conversion plan that takes into account peaks and valleys of activity (e.g. quarterly reporting).

• Consider how IFRS will impact KPIs and your internal and external communication strategy.

• Take steps early to communicate with and influence regulators, tax authorities and other stakeholders around the impact and acceptance of IFRS.

• Become knowledgeable with the standard-setting process, as IFRS will continue to evolve during implementation.

• Make the most of opportunities for other project efficiencies (e.g. faster close process).

• Consider opportunities for reporting rationalization/streamlining (e.g. multi-GAAP reporting, tax balances).

• Implement at the business unit level using a top-down and bottom-up approach, with business units involved earlier rather than later, as the impact can be profound.

Driving value through an IFRS conversion

Key Messages


So What Now?

• Strategically plan for the change

- Transition date no more than three years away

- Three years of audited financial statements required

• Consider IFRS impact on business processes

• Focus on subsidiaries adopting IFRS earlier than parent

• Consider tax consequences


Time to act is now

• The SEC outlined its roadmap to convergence in August 2008

• Stakeholders will be asking questions

• There are significant differences between US GAAP and IFRS

• Benefit of a realistic timeline, without the pressure of mandatory adoption deadlines

• IFRS resources are scarce


Remember the key messages…

• IFRS – The world’s GAAP


• A business transformation, not just debits/credits


• Key challenges in an IFRS Implementation

• The potential Roles for Internal Audit in an IFRS Implementation


Final message: When you wake up tomorrow…..

• Keep abreast of the SEC’s actions concerning IFRS;

• Engage in the debate on the IASB’s (and FASB’s) agenda;

• Add IFRS talent to your organization;

• Do your own analysis of the costs and benefits of transition.


Contact Information

Duaine Smith 1 646 471 4440

[email protected]

Saad Bounjoua 1 646 471 1088

[email protected]

mailto:[email protected]

© 2008 PricewaterhouseCoopers. All rights reserved. “PricewaterhouseCoopers” refers to PricewaterhouseCoopers LLP (US) or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.

PwC IFRS - Internal Audit Considerations

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