IFRS: turning confusion to competitive advantage.

• Author: Thomas, Alison
• Position: Global VIEWS - International Financial Reporting Standards

A change in accounting standards sounds like the bread and butter of finance directors, the kind of thing they can fit in around their day jobs. But the move to International Financial Reporting Standards (IFRS)--which is to become mandatory across the European Union (EU) countries, as well as in Australia, Russia, parts of the Middle East and Africa--is no small tweak of the numbers.

This is a conversion that will shake the whole basis of reporting for many corporations, affecting not just their external communication of performance, but also their internal management reporting and data collection systems.

If this sounds rather alarmist, take the example of a European company that recently prepared its first financial statement according to IFRS. Management was shocked to see that its return on investment under the new requirements fell from 16 percent to 3 percent. Add to this the potential for the new "fair value" provisions, which would increase substantially the volatility of reported financial numbers in certain situations, and it is clear that IFRS conversion will challenge preparers and readers alike.

This is more than the stuff of nightmares for investor relations managers. Apply these principles within the organization, and the perceived contribution of any given product or team to total corporate profitability could be transformed overnight. The potential financial, structural and cultural implications of this transition are pervasive.

Amidst the many changes that conversion to IFRS might entail, one challenge dominates the agenda of investors and directors alike: how to evaluate corporate performance. This begs the question: How, in a world of greater earnings volatility, can I differentiate good management from bad, luck from skill?

In all fairness, this problem is not unique to reporting under IFRS. Indeed, many would argue that the ability to evaluate the financial performance of a company is far easier when fair value, rather than historic cost principles, are applied. However, the additional volatility that might creep into the financial performance of a company will make far more visible the danger of relying on purely financial numbers to communicate company performance.

As long as the primary tools of managerial assessment are financial in nature, boards and investors alike will struggle to assess both the quality and sustainability of corporate performance. And the impact of that uncertainty is tangible; empirical...