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IFRS: The Technology Impact How BPM Can Ease the Transition to the Coming International Financial Reporting Standards

By Craig Schiff October 2008

© 2008 BPM Partners, Inc. All material contained in this document remains the property of BPM Partners and cannot be published or duplicated without the express written consent of BPM Partners, Inc.

Table of Contents Executive Summary .............................................................................. 1 US GAAP vs. IFRS ............................................................................... 1 Current Financial Reporting Approaches......................................... 1 Changes Required for IFRS Compliance ........................................ 2 The New Y2K ....................................................................................... 2 New Rules for Performance Management ......................................... 3 Multiple Reporting Formats ................................................................ 3 Calculation Changes, Added Detail, Expanded Consolidations .. 3 Multi-Dimensional Reporting and Analysis ...................................... 4 Selecting a BPM Solution for IFRS ..................................................... 5 Meeting Financial Consolidation Requirements ............................. 5 Complex Rollup and Ownership Requirements .............................. 6 Tracking Data Status........................................................................... 6 Evaluating the IFRS-Readiness of Vendors .................................... 7 Why You Should Start Now with BPM for IFRS ............................. 7

IFRS: The Technology Impact

Executive Summary IFRS (International Financial Reporting Standards) will be adopted by the U.S. over the next few years, and even sooner in Canada. The timing varies based on company size and other factors. However, no matter when a company chooses to or is required to make the transition, there are technology aspects that should be addressed sooner rather than later. Our analysis has concluded that a solid business performance management (BPM) system implemented company-wide could ease the transition to IFRS.

US GAAP vs. IFRS Current Financial Reporting Approaches Today most U.S. companies follow a set of accounting rules and guidelines collectively referred to as U.S. GAAP. IFRS is a similar collection of rules and guidelines, but one that is used more widely across the world, particularly in Europe. Eventually, moving to this more global standard should simplify things as it relates to the financial processes and systems at many of the large multi-nationals that today have to handle multiple local reporting requirements. Other companies will benefit as well since international investors will be better able to understand their financials and compare them on a like basis with other potential investments around the world. In addition, for some companies (currently estimated to be about one third), these new accounting rules will actually result in an improved bottom-line compared to the same data presented according to U.S. GAAP rules. How technology will help or hinder this transition is a function of where your company is today as it relates to BPM (business performance management), and more specifically the financial consolidation and reporting processes within financial performance management. There are essentially four approaches companies have taken when it comes to legal and management financial reporting. 1) First, there are companies using a home grown system with many of the accounting rules hardcoded into the programmed solution by IT. 2) Then there are those that rely almost entirely on spreadsheets to meet their financial reporting requirements. 3) A third group is taking advantage of packaged BPM solutions to address their needs in this area, but not on a standard platform company-wide. Different divisions may use different products and corporate may have yet another solution it uses to pull it all together. 4) Lastly, and probably in the minority, are those companies that have adopted a single packaged BPM financial consolidation and reporting system across the entire organization. Although there has been tremendous growth in the implementation of BPM over the last several years, the focus has been on

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budgeting/planning and performance dashboards, not necessarily integrated with a financial consolidation system.

Changes Required for IFRS Compliance How difficult it will be to make these changes is a function of which of the four camps described above your company falls into. In some areas, more detail will be required. This translates into being able to easily add more accounts or sub-accounts to the chart of accounts that will then roll into the total. In addition, if you already have a very large chart of accounts some of these additions could cause you to hit up against account limits. Some line items will need to be reclassified. That is, they’ll need to be moved out of their current placement on reports as well as totals and sub-totals and moved to a new area. Multi-dimensional views of significant data will be required under IFRS. Your system will most likely need OLAP or OLAP-like capabilities to handle this. Certain rules may require you to set up additional entities in your organizational hierarchy to facilitate the consolidation process. How some line items are calculated will differ from U.S. GAAP and you will need to go in and modify the underlying calculation logic in the system to handle this. Perhaps the most challenging aspect for some companies will be the requirement to produce and reconcile results under both IFRS and U.S. GAAP over a predetermined period of time. How you handle this is a function of your technology solution. As you’ve probably come to realize by now, the companies that will have it the easiest are those with an enterprise-wide BPM system. For them adding accounts, entities, and revising calculations is a relatively simple matter that they only have to do in one place. Most BPM systems also contain a multi-dimensional analysis capability. Other companies may have to make changes to multiple systems or mountains of spreadsheets – more work, and more opportunity for errors. That’s still better than the group with home grown systems that probably needs to make changes to the underlying code (unless almost everything was designed to be table-driven). If the system is many years old it could also be a challenge to track down the original programmers and related documentation.

The New Y2K There is some similarity here to the “Year 2000 fix” in that many systems will need to be changed by a certain date to accommodate these new requirements. There are two important differences though which could make this a more widespread challenge. While some programmers may have had the foresight to code their systems so that they were able to handle Year 2000 without requiring any changes, there are no systems in the U.S. today coded to support IFRS without some changes. All financial systems will need to be modified. Now for some, the changes may only be in some configuration and logic tables and the creation of new reports. For others, the work required could be more extensive. The other difference is that I believe the move to IFRS will drive significant purchases of new software, more so than Y2K did. Having to focus significant attention and resources on the accounting and process challenges being brought on by the move to IFRS, more companies will look to move to a unified BPM solution to at least streamline that aspect of the transition.

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New Rules for Performance Management Now let’s delve into some of the details to help you better understand how and where BPM could help. If you already have a BPM system in place, these specifics should help you determine if your particular performance system is up to the task to migrate to address these new reporting requirements.

Multiple Reporting Formats Let’s start with perhaps the most difficult transition requirement. For a period of time companies will need to report in both U.S. GAAP and IFRS formats. Beyond the period that is required, some executives may still choose to continue this for their own comfort. So, what does this mean for your BPM system? Well, as previously discussed, IFRS will require some new detail accounts, reclassifications of existing accounts, consolidation of additional entities, different calculations, and alternate report formats and analysis. How do we accomplish this without running two systems in parallel? One approach would be to create alternate roll-ups, one for IFRS and one for U.S. GAAP, each with its own top-level entity to store the consolidated results. Ideally, the base level data would be captured once with enough detail to support either accounting method. Then, during the consolidation and roll-up process, consolidation logic could be applied uniquely in each roll-up path. Data could be moved from one account to another when appropriate, calculations could be performed specific to the accounting method being rolled-up, detail could be left as is or summed up as required by the particular method and so on. Once this is done you will have a Total Company-IFRS and Total Company-GAAP consolidated entity. You can now write reports formatted as required for each approach. Those reports would display data from the entity that corresponds to the accounting method of the report. One final step is to create a reconciliation report that pulls data from both top level entities and highlights the variances. If both IFRS and GAAP reporting is required at lower levels in the hierarchy you can push this approach down and create, for example, a Region 1 – IFRS roll-up entity and Region 1 - GAAP roll-up entity. An alternative would be simply to do these calculations, re-classifications, etc. in the report itself. In this approach the data and logic of the system is left alone for the time being and new reports are written that manipulate the data to correspond to IFRS requirements. The issue here is one of performance and maintenance. If a line item that has to be re-calculated for IFRS appears in multiple reports then that calculation will be done multiple times instead of once during the alternate roll-up approach. In addition since it exists in multiple places if there is a modification it has to be done in every report, not just in one set of consolidation logic.

Calculation Changes, Added Detail, Expanded Consolidations A potentially simple change required by IFRS relates to the way the cost of inventory is determined. Under U.S. GAAP companies can use LIFO (last in, first out) or FIFO (first in, first out) methodologies. Under IFRS the LIFO approach is not permitted. Without getting any deeper into accounting details the result of this is that if your company uses the LIFO approach then you need to update the calculation. If you are using a custom-coded

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system or a collection of spreadsheets then this simple change can become a not so simple task. If your BPM system has end user modifiable calculation logic then the business people in Finance can change the logic themselves. If your system has logic that is written in a programming language vs. a more user-oriented method, perhaps IT or the product’s consultants will have to help with this. The Property, Plant, and Equipment (PP&E) section of the chart of accounts will require more detail under IFRS. This is an area of the chart that is already fairly dense because for each component of PP&E today we track details related to additions, reductions, and related depreciation. What was a single PP&E category under U.S. GAAP will multiply under IFRS. For example, ‘buildings’ is a single element of PP&E today. Under IFRS it has to be broken out into its major components such as ‘elevators’, ‘heating systems’, and so on. Cost and depreciation will need to be tracked for both tax and financial reporting purposes. From a systems perspective this creates added complexity and the need for expansion of the chart of accounts. If you are running up against account limits (more common in home grown or older BPM systems) this could present a problem. Some companies may need to consolidate in entities that are kept off the balance sheet today. Under IFRS the requirement to consolidate an entity is based on the financial and operating control the parent company has. This will probably result in more companies having to be consolidated. This is an area where your BPM system can shine. Adding in a new consolidating entity should be a piece of cake.

Multi-Dimensional Reporting and Analysis IFRS will fully leverage the multi-dimensional capability found in most BPM systems today that have OLAP or OLAP-like functionality. Segment reporting by product and by geography, for example, will be part of the requirements if the data is significant enough. In addition, the P&L and Balance Sheet will need to be viewed by category: operating, investing, financing. It’s not obvious how all of this could be reasonably accomplished without a multi-dimensional engine. Of course you could always create a cumbersome matrix of sub-accounts and sub-entities to segment the data and a series of specialized reports to do the analysis. However, for most companies, the need to move to IFRS will be the final straw that gets them to at long last make the move to company-wide BPM.

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Selecting a BPM Solution for IFRS We have looked at the coming accounting changes related to the International Financial Reporting Standards (IFRS) and their potential impact on business performance management (BPM) technology. It is clear that the companies that will be in the best position for a smooth transition to IFRS are those that have implemented a BPM financial consolidation system company-wide. Since there are still many companies that have not implemented that aspect of BPM, we will now outline how to go about addressing this need.

Meeting Financial Consolidation Requirements There are two main challenges when looking at a financial consolidation system. First, the knowledge regarding what is involved and what is required is scarce in most companies. Unlike budgeting, which typically involves many people throughout the company, financial consolidation is usually the focus of a small group of people in the finance department. While there may be many consumers of the reports that come out of the system, few people are aware of what went into getting to that point. The other main challenge is that there are few vendors that truly understand, and therefore deliver, financial consolidation systems. Many vendors will claim to provide consolidation capabilities, but most simply mean that their systems can add things up. While this fits the description of consolidation found in a dictionary, it is not true financial consolidation by any means. A financial consolidation system needs to be able to handle a number of specific tasks while it is “adding things up.” It needs to allow for the creation of consolidating journal entries. Separate from journal entries made at the transactional level, these entries relate specifically to adjustments that need to be made as part of the consolidation process. The system needs to be able to execute consolidation logic. These are calculations and allocations that can only be performed during consolidation and are critical in handling the move to IFRS. For example, depending on the consolidation path chosen, certain automatic reclassifications of the data may need to take place during this roll-up process. Also, there are calculations that need to be performed on consolidated data only. If you did these calculations on base-level data and added up the calculated results, you would get the wrong answer. Most financial ratios fall into this category. Currency conversion is an important consolidation capability. The system needs to be able to automatically translate base-level data from local currency to the currency used for management reporting. Usually it needs to create an additional base-level entity for each local currency unit to store the data in multiple currencies. Intercompany eliminations are another complex area of consolidations. This is where companies eliminate transactions between their own business units. The system needs to allow for this special type of data entry. Users need to be able to enter a company name along with an amount when entering intercompany transactions. The system then needs

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to be able to automatically match, or reconcile, this data. That is, if company A says they sold $100 worth of product to company B, company B needs to have entered an equivalent purchase amount related to company A. The consolidation system needs to validate that there are matching transactions, generate automatic eliminations (to remove both sides of the transaction from the totals), produce a matching report and highlight any mismatches. This becomes even more complex if the transacting entities have different local currencies.

Complex Rollup and Ownership Requirements Some other key capabilities include partial, date-related and alternate roll-ups. Let’s say that your company owns 50% of another company. While that company may enter its full results into the system, during consolidation you only want to pick up 50% of that data. This capability can also be used if you have a cost center whose expenses need to be shared amongst several revenue groups. During consolidation, they can each roll up an equal percent of the base-level cost data. If expenses are allocated based on a formula (such as revenue contribution), then you would need to use consolidation logic instead. Acquisition and disposition dates are useful for running consolidations at different points in time. For example, you may have a full year of data for a recently acquired company. However, you should only consolidate them in starting with the month you acquired them. If someone needs to re-run a prior period consolidation (financial restatements), the system should know not to include them prior to the date of acquisition. Alternate roll-ups are very important. Base-level data is commonly rolled up in a management reporting path and a legal reporting path. For IFRS in particular, this will be critical to be able to share the same data for simultaneous U.S. GAAP and IFRS reporting.

Tracking Data Status A couple of other features that are nice to have are workflow and impacted consolidations. Workflow, in this case, is simply a way to track which data is in. Whether the data is manually entered or fed in from a transactional system, you need to know that it’s in and ready to be consolidated. Impacted consolidations grow in importance with the size and complexity of your business. If you have hundreds or thousands of entities to roll up for many line items, with multiple roll-up paths and numerous calculations, the consolidation process can take quite a bit of time. Suppose at the last minute, after you have already consolidated, someone needs to make an adjustment to one base-level piece of data. Without the impacted consolidation feature, you would have to re-run the entire consolidation process. With that feature, the system would figure out, based on where the base data was modified, just which paths and entities need to be reconsolidated, greatly reducing the time required. For example, if you changed data for Chicago, the system may need to reconsolidate your Midwest Region, Total U.S., and Total Company. Europe and Asia, in this example, would not need to be re-run. You, of course, could just selectively reconsolidate parts of the organization on your own, but sometimes it’s quite complex to figure out and certainly risky.

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Evaluating the IFRS-Readiness of Vendors When evaluating consolidation vendors, particularly as it relates to IFRS, there are certain traits to look for. First, consolidation probably won’t be the only element of BPM you implement over time. Make sure the vendor offers most of the other capabilities that are part of your long-term BPM road map. Most consolidation products being sold today have the functionality to support both current U.S. GAAP as well as IFRS – be sure to confirm this is the case with your chosen product. In addition, you want to make sure that the vendor’s staff has experience in helping companies make the move to IFRS. Vendors with a large installed base in countries that have already moved to IFRS have an edge over primarily U.S.-focused vendors.

Why You Should Start Now with BPM for IFRS While IFRS appears to be quite a way off for U.S. companies (although Canada’s target transition date is much closer), there are several reasons to start the technology transition process now. Selecting and implementing a new BPM system is not a quick and easy process. You want to be able to take the time to get it right to avoid a last-minute rush where you may potentially be forced to settle and take shortcuts. In addition, your executives will want to become comfortable with the new system prior to the new accounting rules being implemented. If you are going to make the investment in time and resources anyway, why not do it sooner rather than later so you can start enjoying all the other benefits of BPM today?

About BPM Partners BPM Partners is a vendor neutral advisory services firm that focuses exclusively on business performance management and business intelligence. Services are offered on a fixed-fee basis with set deliverables. BPM Partners’ expert advisors have a minimum of 20 years experience in this area, and have been involved in hundreds of performance management deployments. BPM Partners helps companies prepare for IFRS adoption by providing a suite of low-cost, fixed-price services including: IFRS Systems and Process Readiness Assessment, BPM and IFRS Roadmap Development, Requirements Definition, Vendor Evaluation and Selection, and Deployment Management. For more information: www.bpmpartners.com .

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