Adopt universal reporting standards to reach financial hub status

Friday, 23 August 2013 00:02 -     - {{hitsCtrl.values.hits}}

By Cheranka Mendis As a small country aiming to achieve regional financial hub status, Sri Lanka would do well to have in place a universal financial language with strict compliance with financial regulations to attract more Foreign Direct Investment (FDI) and portfolio investments. With the country having made it mandatory to follow the International Financial Reporting Standards (IFRS) since the beginning of 2012, Sri Lanka has followed the right track in portraying itself as a country that follows an internationally accepted model. The task now is to overcome or review the drawbacks of the system when applied in a local context and to further promote it within organisations. Local challenges Sampath Bank Managing Director Aravinda Perera speaking at the CEO Breakfast Forum organised by the Institute of Charted Accountants of Sri Lanka on ‘Financial Reporting for Capital Markets’ noted that while the advantages were many in following a universal financial language, there were also issues to be tackled when adapting them into the local business context. With IFRS being recognised as one that is accepted and adopted in many countries, including more than two-thirds of the G20, it requires or allows its listed companies to prepare financial statements using IFRS or national standards based on IFRSs. While the IFRS is advantageous to companies and countries with its uniformity in profit computation and in financial statement formats globally along with the uniformity in asset classification and valuation globally, Perera noted that to fit this into the local system, a lot of effort and training must go in, driven mainly by CEOs and the top level of organisations. “All this time financial reporting has only been with the financial people,” he said. “Now, it includes the CEO, IT and credit departments, business units, etc., and they must all come in and look at evidence for impairments and cash flows – it is not a function of the finance department only anymore. It is good because everyone is aware of what will end up in your annual report.” However, it will also mean more work for the company in training the people, Perera added. Key areas of focus He listed out some of the key issues that need to be focused on in implementing IFRS to Sri Lanka. There is a need to redefine, draw lines and come up with explanations and collective decisions on how to handle this, he acknowledged. “There is substantial room for subjectivity leading to direct uniformity; while some banks have not taken macro factors into account when doing calculations.” He also expressed that the heavy dependence on estimation, judgement, assumption, etc., could be a drawback for a company while different computations on fiscal ration such as impairment related ration published by banks could also pose a problem. “There are also different technologies that are used by companies for provisions and estimations. IFRS has created a substantial amount of manual work, which won’t just disappear. Account managers must go through the list of evidence, looking at the cash flow and seeing if its right, doing the corrections, etc., has to be manual.” IT professionals have not yet come up with packages for IFRS. However on the flip side, thanks to IFRS impairment is provided well before the default occurs – even for performing advances, if objective evidences are present which facilitates easy identification of current value of a business via fair value accounting (lenders). IFRS also has the advantage of being primarily principles-based and the basic calculations on impairment such as future cash flows and previous loss data are company specific and are not ruled based. “It also facilitates easier financial analysis for foreign investors/borrowers in the capital markets,” Perera said. This in turn encourages cross-border trading in securities. IFRS has redesigned the financial reporting process from finance departments to one that encompasses all business units of an entity. Are local bodies ready? While this may be so, are the local regulatory bodies fully equipped to handle IFRS? With the CBSL still insisting on SLAS-based financials in addition to SLFRS financials and the Inland Revenue Department still addressing the issues relating to IFRS, the law have not changed yet, he said. “Going forward, the regulators, auditors and corporates adopting IFRS will be required to deliberate the remaining issues and sort them out as early as possible to reap the full benefits of IFRS implementation.” Speaking on the need for a universal accounting language such as IFRS, Perera noted that financial statements need to be understood by everybody as demanded by the effects of globalisation while it supports investors to understand statements published by the companies without incurring additional cost. “The boards of directors, CEOs and managements should set the tone from the top that the staff in business areas should acquire the necessary expertise in IFRS, as this will not be confined to the finance divisions in future,” he maintained. Perera explained: “We talk about universal accounting language – financial statements that can be understood by all. As a CEO I must state that financial statements are prepared by financial professionals. So we need to ask the questions from the public point of view, not from analysts, lenders and experts in the financial industry. From the laymen point of view, is what we do easily understood or if not, how better can they understand with any changes?” Investor angle As a country that depends heavily on foreign investment and foreign funding for expansion work, the country’s present situation demands that financials and annual reports are easily understood by those who do not reside in Sri Lanka. “Investors depend on financial statements. When they are not in order, there is additional cost that must be borne to convert reports to a format understood by them.” On the specific qualities looked at in financial reporting, there is comprehensiveness (I believe we are trying to be more comprehensive, giving a lot of information whether the investors are asking for it or not), transparency, uniformity and the need to give relevant financial information. “You cannot hide out relevant information looked at by regulators, investors, etc. It is also important that it is prepared according to universally accepted accounting standards.” For a lender or investor, at the time of investment or lending, they will need to know if their money is safe in the investment. In the same way, to continue the lending or investment in the future, they have to ensure that it has adequate financial resources for repayment or return. There is a need to forecast in to the future. When it is in a universal language it is much easier. “I, as a CEO believe it is a must to have such a globally recognised standard system in reporting finances,” he said. Why IFRS for Sri Lanka? Answering the question on why a country such as Sri Lanka must go for IFRS when neighbouring India has managed to turn its back on it, Perera assured that while India is big with larger markets which no investor wants to stay away from, Sri Lanka needs to prove itself in the international competition for investors. “Sri Lanka is too small to be worried about. We must make them interested in our country,” he said. “For one, you must seem compatible with IFRS standards. If we are serious about becoming a financial hub in the region, which is the mission of the Government, it goes without saying that you need to adopt the universal standards. Investors will feel more confident if we maintain IFRS standards here.” Also, as a country with one of the lowest per capital savings in this part of the world, even lower than India, Pakistan and Bangladesh, Sri Lanka needs to clean up its front with such tools that can be beneficial to the country’s economy. “Financial reporting is the financial results of the company recorded in an understandable accounting language. An annual report is the most important part of it even though this includes quarterly reports to the stock exchange, quarterly publications in the newspapers, etc.” With Sampath Bank having embraced the new method successfully, Perera said: “As a CEO I must say a lot of work goes into this. There is a lot of work and training and it’s not going to be easy.” “Now, financial reporting has moved in to all other parts of the bank’s operations. A lot of manual work has to be done by organisations to get in line.” The regulatory bodies still have to prepare growth standards. There is also a cost to all this – things must be re-valued and additional cost will come up in working with auditors, training staff, etc. “As a CEO I am quite comfortable with IFRS and I believe it is the way forward. But what I don’t like right now is the subjectivity inherent in IFRS,” he reiterated. “We need to get in to a situation where subjectivity is minimal. It is not something that CEOs can do; it is where regulators have to come in, bodies like CASL have to come in, bringing in uniformity in the financial system.” Pix by Upul Abayasekera