International FinancialReporting StandardsThe European Commission's initiative to develop aneffective and transparent single capital marketdepends on companies in member states adopting asingle set of accounting and reporting standards—International Financial Reporting Standards (IFRS). By2005 at the latest, almost all listed companies inEuropean Union (EU) member states are required toadopt IFRS and must apply it in their consolidatedfinancial statements. This change brings about moretransparency and a higher degree of comparability, bothof which benefit investors and are essential toachieving the goal of a single European capital market.The clock is ticking!Experience strongly suggests that major conversions to IFRScan take 18 months or more, and less complex conversionscan take between six and 12 months. Early adoption givescompanies the opportunity to make time their ally and enablesthem to anticipate challenges, manage outcomes, andimplement the best solutions.Financial reporting requirements also require comparativeinformation for 2004 to be presented in accordance withIFRS. Therefore, in order for a company to complete thecomplex task of converting to IFRS from its present financialreporting system in time to meet the 2005 deadline, it needs tobegin the process now, if it has not already started.Beginning IFRS conversion work now—even for companiesthat do not plan to publish their IFRS results until 2005—means companies can anticipate and resolve issues before thenew requirements are enacted. Senior management will havetime to understand the full impact of IFRS on the companyand can develop the messages appropriate for investors,employees, and the marketplace.Early adoption means competitiveadvantageConverting to IFRS is more than changing from one set ofaccounting principles to another. It means that there are anumber of significantly different financial accounting anddisclosure requirements that will result in material financialreporting differences.Converting is not just a technical exercise. It presentscompany executives with opportunities to challenge the way inwhich the company is viewed and evaluated by investors, otherkey stakeholders, and competitors. Every important decisionthat a company makes will be affected by IFRS, and it isessential that management is able to anticipate changes inmarket perception.Converting to IFRS presents companies with theopportunity to: Re-shape internal management reporting systems toeffectively manage financial accounting and financialstatement generation within the new regime, and to provideessential management information required internally. Improve the metrics that evaluate company and executiveperformance, particularly in terms of increasing shareholdervalue. Enhance and improve communication of the company'sfinancial results and position—together with otherperformance indicators—to analysts, investors, and otherkey stakeholders. Benchmark the company against its global peer group,gaining a broader and deeper understanding of thecompany's relative standing by looking beyond country andregional benchmarks. Potentially reduce its cost of capital.C ONVERSION TO I NTERNATIONAL F INANCIAL R EPORTING S TANDARDS
Financial accounting and reportingAt a minimum, an IFRS conversion generally will have a material financialstatement impact—either in recognition, measurement, or disclosure, andoften in all three—in these areas: Greater segment reporting is required, including sales, profits, and taxes bysegment, and this must be consistent between internal and external reporting.Corporate finance and structured financial productsTax planning Existing hedging strategies may become ineffective, and IAS 39 also requires that derivativesand many other financial instruments be re-measured to fair value, resulting in greater earningsvolatility. Consolidation rules will require that some investments previously excluded from the consolidated financialstatements now be included. Accounting for business combinations as unitings of interest will be severely limited, and potentially prohibited.Therefore, assets and liabilities from most business combinations will be fair valued, goodwill will be created and, undercurrent rules, amortised against earnings. The criteria for recognising intangible assets are different from most national accounting requirements, andcompanies need to choose their approaches to measurement and treatment. Deferred taxes must be calculated based on the balance sheet approach, which is significantly different fromexisting accounting requirements in most EU countries. Special considerations for certain industries may have a significant impact—for example, insuranceliabilities and long-term construction contracts. Some companies contemplating new capital market transactions are already experiencing pressurefrom investment banks and venture capitalists to provide IFRS-based information. The transparency and comparability afforded to investors can translate into preferential rates of interestand greater success in attracting investors. To maximise this opportunity when the results under IFRSappear less favorable, companies must be able to articulate the reasons for these differences. If a business is also being restructured as part of the conversion to IFRS, it may be necessary to review and rewriteat least some of the existing debt agreements. Companies planning to divest a significant operation may be pressured by the potential purchaser during duediligence to provide financial statements that are IFRS compliant. Fair values and valuation models will be increasingly important under IFRS—for example, valuations oftangible and intangible assets in business combinations, valuations for impairment analyses, andvaluations of share-based payment awards. Companies that are using or selling structured financial products must ensure that theyhave a full understanding of the accounting and financial reporting impact underIFRS, including the potential for consolidation for both existing products as wellas new products under consideration. A thorough review of existing tax planning strategies is essential totest their alignment with any organisational changes created by IFRSconversion. The financial statement tax impact—as well as the tax risks andregulatory issues—should be considered in connection with anybusiness combination, structured financial product, or other majorbusiness initiative.Performance indicatorsIFRBusinIssu Management must understand the differences in the waythe company's performance will be viewed, both internallyand in the marketplace, and agree on the key messages tobe delivered to investors and other stakeholders. Reported profits may be different from perceivedcommercial performance as a result of the increased useof fair values and the restrictions on existing practicessuch as hedge accounting. Consequently, the indicators forassessing both business and executive performance needto be revisited.
Management reporting systems Financial accounting and reporting systems must be able to produce robust and consistentdata for reporting financial information. The systems must also be capable of capturing newinformation for required disclosures, including, among others, segment information, fairvalues of financial instruments, and employee benefits. As financial accounting and reporting systems are modified and strengthened todeliver information in accordance with IFRS, companies need to enhancetheir IT security to minimise the risk of business interruption, particularlyto address potential fraud, cyber terrorism, and data corruption.SessesInvestor relations Conversion to IFRS means that a company is likely to find that a significant proportion of itsstakeholders may view it in a different light. Companies will be challenged to capture and retaininvestor loyalty while making investment decisions using data that is, for the first time, comparableacross country boundaries. For the first time, information will be published by segment, and thus, great emphasis will be placedon segment results. Management must be able to articulate its strategic plans, the reasons for thedifferences between past and current performance, and the implications for key ratios andperformance indicators. Companies also should be aware that they will be required to prepare and publish a reconciliationbetween their previously reported profit and loss account and their restated IFRS profit and lossaccount. Gaining an early understanding of these differences enables management to anticipateand plan for discussing the differences with analysts and other users of their financial statements.Employee and executive compensation The amount of compensation calculated and paid under performance-based executive andemployee compensation plans may be materially different under IFRS because the company'sfinancial results may be materially different. Significant changes to the plans might be requiredto reward activity that contributes to a company's success within the new regime. Share-based payment disclosures will be more detailed and accessible to investors, customers,works councils, and other stakeholders, resulting in a loss of privacy. Further rule changes torecognise an expense for such plans also have been proposed.Benefit plans Pensions and other post-employment benefits and liabilities willbe calculated differently, and liabilities that may previously havebeen unrecognised will be recorded. Any underfunding of thebenefits must be highlighted. IFRS brings a stronger focus on the full cost of pension and postretirementbenefits, and many companies will be faced withdifficult issues concerning the future of such arrangements.Reporting under IFRS is a requirement withwidespread implications for your company.Ernst & Young's business-based approachpositions your company to manage boththe technical accounting issues and themarketplace challenges that heightenedtransparency brings.
How Ernst & Young can helpWithout careful study, the full impact of converting to IFRS is not clear. The Ernst & Young approach to IFRS conversions—diagnostic, design and planning, solution development, implementation, and post-implementation review—enables managementto find out in advance the extent to which their business will be affected by these fundamental issues, and to address thesebusiness issues appropriately.Phase 1Phase 2Phase 3Phase 4Phase 5DiagnosticDesign andplanningSolutiondevelopmentImplementationPostimplementationreviewDiagnosticWe start with diagnostic assessment of the effects of IFRS on your company. This impact study should last no longer than threeweeks for even the largest business and considerably less for smaller ones. The basic elements of the diagnostic includecollecting financial reporting information, assessing the IFRS impact of changes in financial reporting on your company'sbusiness, and conducting a comparison with your industry peer group.Design and planningFrom the diagnostic impact study, we produce a customised report that enables us to work together with you in mapping out thecritical path from your current state to full IFRS implementation. We also pinpoint business issues of importance tomanagement. This report forms the basis of a practical transformation report and project plan that facilitates conversion withminimum disruption to your business.Solution developmentThe company's demonstrated readiness for conversion determines the next steps. Ernst & Young will work with you indeveloping appropriate solutions to the issues identified during the diagnostic. These solutions may address issues in the areasof training, reporting, model accounts and policies, functional and technical design, and building and testing systems, processchanges, and internal and external communications.ImplementationWe will work with your company to implement solutions and provide training, as needed,to relevant personnel. We will assist you in implementing system and process changes,communicating with investors and other stakeholders, restating prior year financialstatements, or auditing restated financial statements.Post-implementation reviewOnce your company's IFRS conversion is complete and your financial statementsunder IFRS are prepared, we will undertake a post-implementation review and auditof those statements. We can also provide on-going support for other business issuesthat may arise as a result of the conversion.
Ernst & Young resources to help meet the challenges of conversionConversion to IFRS presents companies with challenges to completethe conversion efficiently and effectively, with sufficient time to testsystems, train people, and deal with enterprise-wide changemanagement issues. Your Ernst &Young advisor can help you toaccess our IFRS resources which will help you in meeting thischallenge.Through Ernst & Young Online, our secure global portal, we provideclients and others with continuous access to relevant IFRSknowledge and tools at www.eyonline.com, including:UK & International GAAP plus(subscription) is the mostcomprehensive text dealing withreporting under IFRS. The textalso is fully linked to theunderlying IFRS standards andour E&Y illustrative IFRS financialstatements, both of which areincluded in the subscription.IAS Reporting Digest (free)keeps you informed of currentdevelopments in IFRS as well asforewarning you of what is beingplanned by the IASB. It alsoincludes Ernst &Young's IASThought Center with our variouspublications and materials.Global GAAP Comparison (subscription) is the only comprehensivecomparison between the major GAAP frameworks, allowing instant anddetailed comparisons. (Printed versions of the IAS/US, IAS/UK, and US/UKcomparisons, published jointly with the IASC, are also available.)E RNST & YOUNGwww.ey.comErnst &Young has an integrated network of centres of IAS expertisethroughout Europe and the world. Clients can be sure that wherever they aredoing business, the Ernst &Young global IAS network will deliver consistenthigh-quality IFRS financial reporting expertise. Please contact your Ernst &Young advisor for further details about how Ernst &Young can help youprepare to report under IFRS.© 2003 Ernst & Young.All Rights Reserved.Ernst & Young isa registered trademark.