By John Filar Atwood
The board of the International Organization of Securities Commissions (IOSCO) urged companies not to underestimate the extent to which three new financial reporting standards could affect financial statements and related processes. IOSCO said that the new standards may warrant significant system changes, so issuers should conduct an assessment of the possible impact of the new standards, including when and how to implement them within the required timeframes.
New standards. The three new standards issued by the International Accounting Standards Board relate to revenue, financial instruments, and leases. Subject to jurisdictional decisions regarding either adoption or effective dates, IFRS 15, Revenue from Contracts with Customers, and IFRS 9, Financial Instruments, will be effective for annual periods beginning on or after January 1, 2018. IFRS 16, Leases, is effective for annual periods beginning on or after January 1, 2019.
In a new report, IOSCO highlighted the importance of the implementation process by issuers and their audit committees, and the accurate and timely disclosure of the possible impacts of adopting the new standards. Issuers have already commenced or will soon commence the work necessary to implement the new standards, ISOCO noted, so the group felt it was important to issue the guidance.
Revenue from contracts. ISOCO noted in its report that the new revenue standard provides clearer and more detailed principles for revenue recognition and disclosure. The new framework is designed to improve comparability of revenue amounts over a range of industries, companies, and geographical boundaries. The standard can significantly change an issuer’s timing for its recognition of revenue, IOSCO warned.
In IOSCO’s opinion, revenue is not only a key performance measure but also the starting point for other performance measures, such as operating income, net income, and earnings per share. It also drives key analytical ratios such as margins, return on equity, and return on assets, and valuation metrics, such as revenue multiples and price-to-earnings ratios. Consequently, the new revenue standard has the potential to change not only an issuer’s top line, but also its bottom line and investor analyses that depend on the financial statements, ISOCO advised.
Financial instruments. IOSCO noted that the new financial instruments standard introduces changes to the accounting for credit losses, including the related disclosures. It also introduces changes to how financial assets are measured on an ongoing basis to align with the asset’s cash flow characteristics and the business model in which the asset is held.
According to IOSCO, the new standard was developed in response to concerns of many investors and other stakeholders, both during and after the global financial crisis, that there needed to be more timely recognition of expected credit losses for loans and other financial instruments. IOSCO pointed out that in measuring expected credit losses under the new standard, issuers will be required to use reasonable and supportable information that is available to them without undue cost or effort, including not only past events and current conditions but also forecasts of future economic conditions.
Leases. The new leases standard changes the previous lease accounting model so that a lessee will now reflect more assets and liabilities arising from its leases on its balance sheet. The new approach can substantially affect key financial ratios, including ratios related to debt covenants or debt to equity ratios, IOSCO noted.
IOSCO said that given the breadth of the changes due to the new standards, issuers and their audit committees should start now to focus on the possible impact of the new standards on an issuer’s financial reporting. It is also an appropriate time for issuers, including their audit committees, to assess the quality and status of implementation plans so that the implementation of the new standards achieves the financial reporting objectives intended by the IASB, IOSCO added.
Disclosure guidance. IOSCO advised that during the earliest stages of an issuer’s implementation, investors may find it useful to have qualitative disclosures about which aspects of the new standards may affect the issuer’s financial statements. IOSCO believes quantitative disclosures regarding the new standards will increase as the issuer moves forward with its implementation plans, in advance of the effective dates of the new standards.
While quantitative estimates related to the possible impacts of adopting the new standards are inherently subject to change, IOSCO said issuers should not be reluctant to disclose reasonably estimable quantitative information merely because the ultimate impact of the adoption of the new standards may differ. Reasonably estimable quantitative information may still be relevant to investors even while lacking complete certainty, IOSCO said.
IOSCO recommended that issuers, their audit committees, and auditors consider certain specific matters as they implement the new standards. Among the suggestions are that issuers identify system, process, and any associated internal control changes needed to produce information required under the new standards, including the related disclosure, and developing system implementation plans with appropriate accountability mechanisms.
IOSCO also recommended that issuers provide disclosure in MD&A, operating and financial review, or other relevant management commentary if the issuer believes there may be changes in its business practices due to the new standards, and if the issuer is required to disclose its business practices and related metrics. IOSCO suggested that auditors consider their responsibilities to evaluate the changes to an issuer’s accounting policies, the impact of the changes on the issuer’s financial statements, the issuer’s financial statement disclosures, and the issuer’s disclosure of the ultimate impact in the year of adoption.