Conversion to International Financial Reporting Standards: The Philippine experience

(First of three parts) Why IFRS

A lot has been said and written about the international accounting standards which have been gradually phased into our financial reporting system since the late 1990s and which were fully adopted in 2005, with certain transitional relief, as Philippine Financial Reporting Standards (PFRS) based on equivalent International Financial Reporting Standards (IFRS). The adoption of these "harmonized" standards was meant to offer greater reliability, transparency and comparability of financial information for the benefit of investors.

Companies, especially those dealing with the investing public, now face greater scrutiny resulting from stricter regulatory and IFRS requirements. IFRS requires a lot more disclosures to be presented in financial reports. The modern CFO has to ensure that adequate technical knowledge resides in his people for the proper implementation of these standards. Going forward, he needs to ensure that such knowledge will be updated as IFRS is dynamic. The Code of Corporate Governance applicable to public companies now requires the CFO and auditors to have a lot more interaction with the audit committee and the Board of Directors as these bodies now assume a greater degree of responsibility over financial reporting. And since the Chairman and CEO are required by the Securities and Exchange Commission (SEC) to issue a statement assuming management responsibility for the financial statements, it is but natural for them to ask more questions before they sign the certification.

Ifrs implementation issues in the Philippines Fair value determination

Since IFRS gives more importance to the balance sheet, fair values rather than historical costs are now used for many assets and liabilities. The biggest problem in implementing IFRS in the Philippines, as in other developing countries, is determining fair values where there is no active market or where market data is unreliable. Of course, assets such as listed stocks and bonds where price discovery is easy are marked-to-market. Other assets whose price discovery is difficult are marked to a model. Determining the proper financial model as well as the assumptions/factors to be used is not easy. Under IFRS, the basis of estimates and assumptions must be disclosed. The users of the financial statements (FS) will see the reasonableness of those assumptions and estimates. If they are unrealistic, the users will be able to see through the FS figures. The external auditors who have to sign off on the FS, have to be convinced about the reasonableness of the factors and assumptions used in the model as their reputation is on the line.

Segment reporting disclosures

There is also an issue on segment reporting which is required for public companies. Some listed companies have complained that their competitors are not public companies and therefore are not required to do segment reporting. Their competitors will therefore gain undue advantage as they can access the segment disclosures of the listed company which includes the profitability of its major business units. Being a listed company, its FS and other regulatory filings are considered public records. Unfortunately, the corporate regulator had to insist that the segment disclosures stay as this is the price to pay for being a public company. It was agreed however, to liberalize on the segment disclosure by allowing the listed company to make more general categorization of the various Profit and Loss items and groupings of business units. This treatment ensured that the spirit of the segment standard was still followed.

Volatility of pension benefit liability

Recently, questions have been raised relating to the reasonableness of the basis used in discounting pension benefit obligations. In 2005, the first year implementation of PAS 19, Employee Benefits, companies generally used the rate of return on Philippine government issued bonds in discounting pension benefit obligations. However, in 2006, the rate of return on these bonds significantly declined.

PAS 19 prescribes that the rate for discounting pension benefit obligations should be based on current market conditions. The discount rate should reflect the market yields (at the balance sheet date) on bonds with an expected term consistent with the term of the obligations. Given the extent of the fluctuation of the rate of return on the Philippine government issued bonds from year to year, the corresponding fluctuation in the discount rate will likely cause volatility in the related financial statement accounts of the companies. For example, a one percent change in the discount rate could cause a fluctuation in the pension benefit obligations by as much as 20 percent. (To be continued)

(Roberto G. Manabat is the chairman and CEO of Manabat Sanagustin & Co., CPAs, a member firm of KPMG International, a Swiss cooperative. Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG international or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm. For comments and inquiries, please email [email protected] or [email protected])