Displeasure with the International Financial Reporting Standards (IFRS) is on the rise, and will likely gain steam as annual results are issued in the first quarter of 2012. As investors begin to digest some of the quarterly numbers from last year, more have started expressing unease with the new accounting rules.

Tracking this trend is the expanding list of executives and companies that are addressing—through actions or words—the shortcomings of IFRS. The discontent started brewing a few years ago among executives from the insurance companies and banks, and is now creeping into energy, pipelines and other sectors as well.

Expressions of disapproval range from relatively unpublicized corporate announcements to point-blank criticisms from executives. Pieced together, they don’t form the kind of picture that inspires confidence in the new accounting numbers among investors.

In a recent U.S.-based investment newsletter, the CFO of Canadian Energy Services, a midcap TSX-listed firm, remarked it is neither easier to understand companies any better under IFRS, nor to raise money.

He added the new accounting rules impair consistency between companies, and probably make the situation worse. With this assessment, it’s not surprising to see more Canadian companies turning their backs on IFRS.

Canadian companies turn away

TransCanada, Enbridge and Fortis have all announced their conversion to U.S. Generally Accepted Accounting Principles (GAAP), effective January 1, 2012.

IFRS adoption around the world

  • Australia—Required for all private-sector reporting entities and as the basis for public-sector reporting since 2005
  • Brazil—Required for consolidated financial statements of banks and listed companies from December 31, 2010 and for individual company accounts progressively since January 2008
  • Canada—Required from January 1, 2011 for all listed entities and permitted for private-sector entities, including not-for-profits
  • China—Substantially converged national standards European Union All members required to use for listed companies since 2005
  • Japan—Permitted from 2010 for some international companies; decision about mandatory adoption by 2016 expected this year
  • Russia—Required from 2011

    • Source: IFRS Foundation. As of April 2010.

Utilities were granted a delay in adopting IFRS since the rules for rate-regulated entities had not been established in time. The reprieve, however, has given the Canadian companies time enough to realize the intended form of IFRS for utilities will be unwieldy and deficient for their purposes.

Magna already switched to U.S. GAAP in January 2011, when it otherwise would have been required to adopt IFRS. Part of the appeal was the realization that to be comparable to its closest peers such as BorgWarner and Visteon, the company would have to use the same accounting rules.

The move by Magna is significant because the general belief is that the primary beneficiaries of IFRS are multinational firms that can save money by using one set of accounting practices across multiple countries.

However, Magna was likely not prompted by the quest for comparability to peers, since it contended with incomparability while using Canadian GAAP for years. There was most likely something that Magna did not like about IFRS, something that even outweighed the advantage of consolidating its global operations onto one accounting platform.

It’s impossible to know what tipped the scale, but it is difficult to discount the sheer amount of volatility that IFRS can create in a company’s financial results.

Dumped after one year

In the energy sector, Encana has also made an interesting choice by deciding to dump IFRS after just one year of use. In a December news release, the company noted the move was ostensibly to make it more comparable to peers based mostly in the United States.

While it is true Encana is often compared to the likes of Chesapeake and Devon in the U.S., the company is also consistently valued against Canadian peers.

Similar to Magna, Encana might have found something it did not particularly like about IFRS, since it would have known about the comparability issue well in advance, and could have avoided the very expensive flip-flop of changing accounting standards twice in two years.

Interestingly, when faced with choosing between IFRS or U.S. GAAP, these companies came down clearly on the side of U.S. GAAP, despite long and aggressive marketing around the advantages of IFRS.

Companies seem to be soberly considering their choices now that the hype from their auditing firms has died down, and management is better able to assess the overall impact of IFRS.

Another shift: companies like Magna and Encana have started voting with their feet. Previously, the uproar against IFRS was limited to executives voicing concern with the new accounting rules.

Manulife CEO Don Guloien told the Globe and Mail in 2010: “One direction IFRS could take is to disassociate assets from liabilities, and we think that would be a dreadful mistake.”

Similar concerns were echoed by recently retired Sun Life CEO Don Stewart, and Industrial Alliance CEO Yvon Charest, who saw little advantage in switching to IFRS, and estimated the net income would be seven times more volatile for his company under the new rules.

Indecent proposals

Much of the concern among insurance ranks is centred on proposed changes to IFRS that have yet to be implemented. Insurance executives haven’t yet had to decide whether they might switch to using U.S. GAAP instead of IFRS.

Combined with other proposed changes, including those we mentioned last month (see “Challenging years ahead for life insurers,”), that decision might be coming soon.

With recent U.S. GAAP-converts Magna, Encana, Enbridge, TransCanada and Fortis, joining Agnico-Eagle, Imperial Oil, Research In Motion, Valeant Pharmaceuticals, Tim Hortons, Canadian National and Canadian Pacific, 20% of the S&P/TSX 60 is now following U.S. accounting standards instead of IFRS.

It is hard to ignore that statistic if you are an investor, especially as it speaks to the perceived quality of IFRS among Canadian companies and executives.Will 20% be a tipping point in the cascade of Canadian companies moving to U.S.GAAP, and away from IFRS? Or could it be a high-water mark that recedes as changes are made to international accounting rules?

We put our money firmly on the former, especially as junior and mid-cap Canadian companies get a good taste of the volatile results IFRS can create. Likewise, largecap insurance names will have to grapple with some pretty unwieldy changes needed to fill the extensive gaps in the current IFRS rules.

Given the recent switch by Encana, a quick about-face by the insurers cannot be ruled out. It would certainly cure some of the bad optics the major Canadian insurers have had to deal with recently, including their large Q3, 2011, losses that would not have existed under U.S. accounting rules. Expensive as it would be in the short term, switching to U.S. GAAP might be the best route to take for all stakeholders.

Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, MBA, CFA, CFE, run Accountability Research Corp., providing independent equity research to investment advisors across Canada.