IFRS 7 and the South African reporting environment

Disclosure of previously “confidential information”, expensive system upgrades, increased compliance costs, skills and competency shortages – these are just some of the perceptions and practical problems being experienced by South African companies as they implement International Financial Reporting Standards (IFRS) 7 Financial Instruments: Disclosures (IFRS 7), according to Laura Elliott (Senior manager at Ernst & Young Johannesburg).

IFRS 7, which is effective for financial periods beginning on or after 1 January 2007, deals with the disclosure requirements surrounding an entity’s financial instruments. The range of items regarded as financial instruments is wide, and includes for example, accounts receivable and payable, loans receivable and payable, cash and bank, equity investments in other companies, any other investment where there is a right to receive cash, lease arrangements, derivatives etc. The IFRS 7 disclosure requirements include, inter alia, enhanced balance sheet and income statement disclosures, as well as additional qualitative and quantitative disclosure on the risks arising from an entity’s exposure to financial instruments.

When IFRS 7 was released, the perception was that as it was a standard focusing on disclosure, its implementation would not present major difficulties. In reality, a number of information system changes are necessary to enable companies to comply with the disclosure requirements.

“It is only now that the standard has become effective, that entities appear to be coming to grips with just how daunting these disclosure requirements are. Initially a misconception existed that as IFRS 7 relates to disclosures only, it would be relatively simple to apply – after all, companies had made IAS 32 disclosures in the past,” Elliott adds.

IFRS 7 replaced IAS 30 Disclosures in the Financial Statements of Banks and Similar Institutions, and the disclosure requirements of IAS 32 Financial Instruments: Disclosure and Presentation.

“It is interesting to note that for those entities, particularly financial institutions, that have previously ensured a quality level of compliance with these predecessor standards, the shift to the requirements of IFRS 7 has not been as difficult, other than possibly in respect of the increased risk disclosures,” says Elliott.

Elliott says that all entities reporting in accordance with IFRS need to comply with IFRS 7, regardless of the extent of their use of financial instruments. “There is no doubt that where an entity manages its risks of financial instruments, the disclosures required prove valuable to all parties involved. The concern arises where this is not the case, and the resultant disclosures are not perceived to provide any real benefit to a user of the financial statements.”

The comprehensive disclosure requirements of IFRS 7, continues Elliott, create a complication because current financial reporting systems are not generally equipped to generate the required information.

“Even though IFRS 7 requires disclosures based on management’s perception of risk, systems were not created with detailed IFRS 7 requirements in mind. The more detailed quantitative disclosures are seldom recorded at a management level, if at all. Examples of such detailed disclosures include those financial assets which are past due but not impaired, and maintaining a record of those financial assets whose terms have been renegotiated. Financial institutions may have systems in place to facilitate a relatively easier gathering of the required information (although even this has proven challenging in certain circumstances), however this is usually not the case in other industries,” says Elliott.

Elliott believes that the requirements necessitate that the preparer and the auditor have an intimate knowledge of financial instruments. This is a cause for concern, Elliott says, as the environment is challenged by an ever-increasing skills shortage. Furthermore the users of financial statements, will need to have at least a sound understanding of financial instruments to be able to make sense of the complex additional disclosures that companies will have to include in their annual financial statements.

Elliott concludes, “Just as the conversion to IFRS has improved the level of disclosures provided within the South African reporting environment, IFRS 7 should continue to take South African corporate reporting to an even higher level.”