Accounting for trouble?

As Canada moves from GAAP to IFRS, some see it as a licence to swindle.

Canada is in the midst of a seismic shift in accounting standards — one that will tie the country more tightly to international commerce, but might also result in investors being taken for a ride.

Starting this year, Canadian public companies will issue financial statements using international financial reporting standards (IFRS) instead of the generally accepted accounting principles (GAAP) that have been in place for decades. Many countries have unique accounting standards that are difficult to reconcile. In part to remedy this, the European Union began to implement IFRS to harmonize reporting among member countries. Others have signed up in the past few years, including Australia and Chile. The Accounting Standards Board in Canada, which oversees financial reporting methods, decided in 2006 to replace Canadian GAAP with IFRS. (The U.S., meanwhile, is incorporating aspects of the international standards over the next few years, but wholesale adoption is still in debate.)

“In the end, we feel IFRS makes more sense for us,” says Ron Salole, a director of the AcSB. The primary benefit of a common set of accounting principles is the increased comparability between companies around the world, which ultimately reduces the cost of capital. “If you want to operate in a global economy, then having unique standards will not find favour,” he says.

Or so the argument goes. “This is a matter of tight rules versus shitty rules,” argues Toronto-based forensic accountant Al Rosen. IFRS is a major step back from Canadian GAAP, he says, and will permit unethical managers to hide, massage and choose numbers to make their companies look good. “This is a Ponzi scheme in progress,” he says. Investors, who are supposed to benefit through increased comparability, could end up the victims of unfair accounting.

A key difference under IFRS is that managers have more choice in how they report certain information. Take revenue recognition. Canadian accounting standards had stringent criteria around when and how a company could record revenue on goods and services. Under IFRS, the guidelines are more vague, potentially permitting unscrupulous managers to pump up revenue or mask bad debt. A company issuing loans, such as mortgages, could record cash coming in on loans that are going unpaid.

Rosen is also fuming about related-party transactions. IFRS does away with fair market valuation of self-dealings — for instance, if a private company owned by a couple of executives sells an asset to the public company employing them — meaning investors have little to no assurance the goods and services are transacted at legitimate prices.

Along with his son Mark, Rosen claims to have identified a litany of such problems with IFRS, and the two have given numerous presentations to banks and institutional investors. “The level of knowledge in Canada of all the dirty tricks is near zero,” says the elder Rosen.

Supporters of IFRS will agree there is more leeway in reporting in some areas, but trust auditors to exercise their professional judgment to prevent accounting shenanigans from occurring. “The missing element is whether we are going to have enough educated people with sufficient backbone to apply their judgment in the face of client pressure,” says Barry Epstein, a financial reporting author and litigation consultant in Chicago. “The auditors are the frontline troops, so that’s where the action will be.”

Salole argues no standards, however stringent, will stop unethical executives from manipulating financial statements. The areas in which IFRS allow for greater choice reflect a more complex business world in which no two transactions are exactly alike. “Bringing in your professional judgment still doesn’t mean you can cherry-pick accounting,” he says. Managers will have to justify their accounting decisions in financial statements under IFRS, as well, giving investors more information to chew over. In some cases, these disclosures are more rigorous than what existed under Canadian GAAP.

In any event, there is no turning back, and Rosen is not looking forward to it. “This is just going to dwarf the fiasco of Nortel,” he says. “There’s no doubt in my mind.”