Canadian biotech companies get set to learn a new language of financial reporting

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Compiled by Shawn Lawrence

By Jan. 1, 2011, small and medium Canadian biotechnology private companies will need to decide what standard to use in reporting their financial statements, choosing whether to adopt Canadian
Generally Accepted Accounting Principles (GAAP) for Private Enterprises or adopt International Financial Reporting Standard (IFRS). While private companies will have a choice, publicly traded companies will not have this option, they must use IFRS.

As such, IFRS continues to be a popular subject not just for biotech’s but for companies in all industries. To date more than 110 countries have adopted or have taken steps to adopt IFRS. Even though the official starting point for IFRS in Canada is 2011, the work required to complete this transformation needs to be started now.

This month Biotechnology Focus goes one on one with Lisa Simeoni, a Partner and IFRS Leader for the Pharmaceutical and Life Sciences practice at PricewaterhouseCoopers (PwC) in Canada, to discuss one of the biggest changes to financial statements in a very long time and how it will affect the way biotechnology companies do their financial reporting.

Q: Europe adopted IFRS in 2005. What is the idea behind it and when did Canada make the choice to follow IFRS standards?

Lisa Simeoni: The globalization of business has led to the need for a set of common, high-quality accounting standards.

In comes IFRS which represents a fundamental change affecting not only the numbers, but systems, processes and data supporting financial reporting.

The Canadian Accounting Standards Board (AcSB) has decided that Canada will adopt IFRS by 2011 joining over 100 countries that already have adopted IFRS.

The AcSB also acknowledged that IFRS wasn’t necessarily a solution for private companies in Canada, so they made a distinction between what’s required for public companies and what’s required for private companies. As such private companies can choose to convert to IFRS or use the soon to be released standards for private company GAAP in Canada.

Q: What needs to happen between now and January 2011 to make the transition smooth?

A: It’s tempting for companies contemplating the adoption of IFRS to view the change simply as an accounting exercise. But the change to IFRS will require that many others within the organization learn a new reporting language.

For many companies, this will mean fundamental changes – changes that can ripple right across their business operations from customer facing functions, everyday procedures to investor relations.

It is likely to take considerable time to plan and make the necessary changes and to integrate them fully while continuing business operations as usual. It’s recommended to view the transition as a three phase approach.

The first is the significant task of collecting, collating and understanding IFRS numbers and disclosures. This enables the production of IFRS financial statements that compare to and eventually replace current financial reporting.

Secondly, companies need to anticipate and plan for changes to reporting procedures, financial and management information systems, and the skills and knowledge of staff. A company must prepare to manage the changes through the transition to ensure they are executed efficiently and, that at each stage of the transition, the business is running well.

Finally, embedding IFRS across the organization enables the business to implement change in a smooth transition to a new way of operating, using the new IFRS language comfortably and authoritatively.
Underestimating what is at stake or not implementing the change across an organization can have unintended negative consequences.

Q: What stage are companies at in making the transition?

A: You have a range of life science companies that have come to us as part of their IFRS strategy and planning process already. However, a survey by the Canadian Financial Executives Research Foundation (CFERF), the research institute of FEI Canada, and sponsored by PricewaterhouseCoopers (PwC) indicated that many companies will have a race to the finish line.

All respondents in the research indicated that they would be adopting IFRS although not necessarily on January 1, 2011.

Despite the fast-approaching conversion deadline, more than 12% of the 147 public companies surveyed and one in five of private companies had not yet taken the first step of starting their initial diagnostic assessments.

Several reasons for their delay were provided, with about 41% of public companies and 54% of private companies stating they had other higher priorities.

About 80% of public companies remain short of the half way mark in their overall conversion process. Private companies surveyed were lagging behind public companies, with 51% between only 0 - 20% complete.

A number of the small to mid sized public companies in the biotechnology industry are cash constrained and therefore have opted to complete the conversion process internally. This approach is doable as long as adequate time and resources are dedicated to keeping the conversion moving forward and that learning and communication strategies are in place.

This conversion can not be viewed as someone’s night job. Planning and ongoing monitoring are the keys to success.

Q: In terms of making this transition, are there any concerns with the progress being made?

A: One of my concerns would be is that it’s a bigger project then many companies anticipated initially. There may not be a lot of Canadian GAAP and IFRS differences on the surface, but when you get into the details, there’s a lot of data that may be necessary to be made available to companies and if they delay the planning and execution of the process they run the risk that they are not going to have the information that they need at the time of transition.

Additionally, disclosures are generally more expensive under the new standards. In our publication Putting IFRS in motion: The Impact of International Financial Reporting Standards on the Canadian Pharmaceutical and Life Sciences Sector, we talked about the fact that the average number of pages of disclosure in Europe went from 130 to180 pages upon conversion to IFRS. Many companies feel as though they have too much information in their financial statements already, but disclosures are not going to become less onerous under IFRS.

With IFRS, company management will be tasked with explaining the changes to stakeholders. On the people side, training initiatives are required to prepare for the transition. Contractual arrangements, such as debt agreements and other contracts which rely on accounting results need to be revisited. IT systems may need re-tooling, upgrading or a complete overhaul. Marketing, public and investor relations should educate stakeholders and manage perceptions.

But it’s not just corporate. Employees participating in profit sharing arrangements, or who are expecting bonuses or commissions based on revenue, will find themselves very interested in the financial statements produced under IFRS.

Furthermore, investors may find that IFRS will have a real impact on the way that they perceive companies and consequently the investment decisions that they make.

The scale of the transition means there are decisions to be made today. By planning ahead companies can not only ensure a smooth transition but also a more efficient business structure going forward.

Q: What are the benefits and drawbacks to IFRS?

A: As previously noted, the globalization of business has led to the need for a set of common of accounting standards. With IFRS companies will be comparable around the world – in the same language and on the same terms. This is a major benefit.

It is important for companies to recognize that there can be significant accounting differences between IFRS and Canadian GAAP which often reside in the details, causing recognition, measurement and/or presentation differences. Careful planning and proper use of certain options available under IFRS, however, can eliminate certain of these GAAP differences. Some of the accounting areas where the more significant differences arise between Canadian GAAP and IFRS include:

•     Business combinations (definition of business and treatment of contingent consideration)
•     Impairment of non-financial assets;
•     Financial instruments (de-recognition of assets and liabilities); and
•     Fair value of biological assets (such as plants used to produce drugs)

On the positive side IFRS permits a fresh start approach to accounting policy determinations.

Furthermore, IFRS compliance may require the realignment of reporting systems for new and additional data. PwC experience has shown that many of those who implement IFRS underestimate the time and resources needed for realigning systems and processes. This is particularly true for companies with existing management systems or legacy systems from historical acquisitions that have not been integrated and are not geared to provide sufficient or appropriate data for the new and increased disclosure requirements. For example:

•     Expanding existing reporting templates and other checklists to incorporate supplementary data required for additional disclosures under IFRS;
•     Rationalizing or expanding the chart of accounts to post additional measurement changes and/or collect additional disclosures under IFRS;
•     Reviewing period-end close procedures to achieve efficient close times;
•     Reviewing outsourced operations’ controls and capability in producing IFRS compliant information; and
•     Obtaining IFRS information from significantly influenced investees and/or variable interest entities.

This also represents an opportunity to accelerate modifications to existing IT systems to accommodate the additional information required by IFRS and in the process make the IFRS transition smoother.

More specifically for life sciences, a number of life science companies enter into strategic arrangements with Big Pharma and these agreements are complex.

Currently, there is no specific IFRS revenue recognition model for this industry, so you have to apply the broader principles under IFRS. As we talk about in our publication, there is a new revenue recognition standard coming out which is expected to be in place by 2011. So not only do you need to become familiar with IFRS, IFRS is itself changing. The International Accounting Standards Board calls for changes to over 20 standards between now and 2011.

Q: Why would a private company choose IFRS
or the proposed GAAP for Private Enterprises?

A: In April 2009 the AcSB released its long awaited Exposure Draft on GAAP for Private Enterprises. The AcSB have recently announced that the new standard has been finalized and will be issued by the end of the year. These new standards provide a choice for private enterprises to adopt a simpler, less time consuming and cost effective accounting approach or IFRS.

The standards are effective for annual financial statements relating to fiscal years beginning on or after January 1, 2011 with early adoption permitted. Private companies in Canada are going to have to make an important decision between adopting IFRS or GAAP for Private Enterprises.

Businesses are going to have to examine their options and choose a solution that best serves their purposes. We expect most will adopt the proposed GAAP but some companies might choose IFRS depending on their situation.

Some of the reasons a private enterprise might choose IFRS include:

•     They have an exit strategy that could involve acquisition by an IFRS reporting issuer or private equity interest
•     They are considering taking the company public
•     Have suppliers or customers across jurisdictions
•     Are a subsidiary of an IFRS parent
•     Have international operations and multiple sources of financing
•     Have competitors that use IFRS

Regardless of the path chosen by private companies’ changes to their current financial reporting will be required. The status quo is not an option.

Q: What else should our readers know?

A: Our research has shown that while the majority of Canadian public companies are well on their way to completing the initial diagnostic phase of their conversion to IFRS, much work remains to be done on the road to 2011.

Although most executives believe that they are on schedule, the amount of work remaining isn’t clearly understood until they complete a detailed diagnostic assessment of the differences between the two GAAPs.

Larger companies are further down the conversion path than smaller ones, and this is mainly due to resource availability. Companies that have not progressed as far as expected cite competing priorities as the reason for delay. In addition, human resource constraints are another factor impeding the progress of conversion, as people are often pulled in too many directions in order to give the project due attention.

Private companies are less likely to be in step with their public company counterparts. Much of this is explained by the fact that private companies are not required to report under IFRS by 2011, rather for them, conversion is voluntary and more likely to be done when resources permit.

With respect to understanding the impacts of adopting IFRS on the company as a whole, not enough attention is being paid to systems issues, given the need to run parallel accounting systems in 2010.

Similarly, CFOs who are ultimately accountable for the smooth transition to IFRS within their companies, have not yet made significant inroads into informing their boards, others on the senior management team, or external stakeholders on the potential impacts of IFRS on the bottom line. This is expected to be resolved by most companies by the end of 2009/early 2010, when they have a more concrete picture of what the financial impacts will be to the organization.

Training is an ongoing issue, and many CFOs are turning to external advisors/consultants for their expertise in IFRS implementation.

Another thing which your readers should know is that they are required to designate the company’s financial instruments as available for sale or at fair value through profit and loss. These designations and related documentation need to be in place by January 1, 2010.

Enhanced disclosures are also required in the annual MD&A under IFRS. In addition to a discussion of the status of the changeover plan, the 2009 annual MD&A should include a qualitative discussion of major identified differences between current accounting policies and those expected to be applied under IFRS. In 2010, interim and annual MD&A’s should be supplemented by the discussion of decisions about accounting policy choices and, if available, quantitative information about the impact of FIRS on the key line items in the financial statements.

The bottom line is that all key drivers to conversion must be aligned from systems and data, to training and education. Getting all of these pillars working effectively together is critical to a successful conversion.

How Can PwC help?

Our firm is actively engaged in helping clients navigate and prepare for IFRS. We have built industry focused, dedicated teams across all our lines of business to help our clients solve the accounting, tax, systems and process issues surrounding complex IFRS conversions.

For more information, please visit www.pwcifrs.ca