Overwhelming evidence of IFRS failure

A careful examination of the allegations, evidence and court decisions of Canadian corporate failures tells us all we need to know about financial causation. Clear patterns of financial trickery have arisen in the vast majority of these collapses. The evidence about the behaviour of accountants, auditors, and boards of directors is also clear. But the consequences often have not been pursued in courts to the point of trying to prove fraud.

Nevertheless, abundant detail is provided in these cases to tell lawmakers and regulators where to focus their attention so as to reduce Canadian accounting trickery and needless investor losses. For example, uncollectible receivables are commonly approved in audits as qualifying as cash-equivalents. Reported profits and actual operating cash flows therefore become “worlds apart,” which is dangerous.

Also glaring in any review of financial failures is that, over time, the situation in Canada has become much worse. Court cases are not being pursued today because of unwarranted protections for auditors that have been proclaimed by the Supreme Court of Canada. A current absence of communication is misleading investors into a false conclusion that “all is well.” Instead, a backlog of unchallenged failures is gradually building, and is increasingly conveying to global investors that Canadian financial reporting cannot be trusted. 

The economic consequences for Canada are immense. Fundamentally, minor tinkering by lawmakers with the concept of a national securities commission cure is massively misdirected. Applying the same philosophies of regulation nationwide that have long been ineffective provincially are pointless because inaction is widespread. 

In my opinion, permissive attitudes by self-regulators lie at the heart of most financial failures and must be abandoned. Minor wording changes in regulations are not a cure for reporting that encourages or permits material faked profits and bloated cash flows. 

Typical Canadian accounting manipulations

The most common major financial manipulations that have frequently been utilized in Canada include:

1. Unwarranted or premature revenue recognition leading to overstated receivables and profits (applied widely, such as with Nortel, Poseidon Concepts, and numerous financial institutions).
2. Exaggerated cash flows from operating activities, often by manipulating transfers from financing or investing transactions (chosen by many enterprises, including Sino-Forest, Livent, Confederation Life, and mortgage companies).
3. Overstated asset values, such as inventories, loans, pension assets, intangibles, and financial instruments (widely utilized in Philip Services, Hercules Managements, Standard Trust, Crocus Investment, and credit unions).
4. Understated liabilities (seen frequently in pension funds and utilized in Northland Bank, Canadian Commercial Bank, Victoria Mortgage, and much more).
5. Expenses capitalized to the balance sheet, so as to convert cash expenses to non-cash amortizations, including to distort the cash flow statement (widely used in Castor Holdings and various communications and high-tech entities).
6. A range of financial instruments or “investments” that have been “valued,” based on extensive speculation, because credible market values may not exist in Canada (seen in real estate and investment enterprises, including banks and trading companies).

What do the above manipulations have in common? All are situations in which the adoption of IFRS has made financial trickery much easier to exploit. A significant number of failed companies chose several of my cited methods to cover up unwise business decisions or frauds. 

Until 2010, the year of IFRS adoption, the broad signs of probable trickery could be detected, frequently years in advance. Today, standard-form “clean” audit reports are being signed by self-regulating external auditors for misleading statements. 

Financial statements using IFRS are not reporting “what actually happened” but what corporate management chooses to distort. Cash results are too often ignored because they contradict exaggerated reported profits. IFRS is based on extreme accrual accounting, with necessary third-party evidence being absent. 

Oncoming Dangers

The current sad reality must not be dismissed. Auditor-adopted IFRS did the opposite of curtailing dirty tricks. Because of IFRS, cover-ups of impending corporate failure are much easier to carry out now, due to:

• Weak rules and requirements.
• Greater power granted to corporate management to choose flattering numbers (e.g., marijuana companies).
• The allowance of a much-widened time gap between the reporting of profits and the “possible” eventual cash collection of receivables.
• The lack of oversight of financial reporting in Canada combined with the Supreme Court of Canada’s unfathomable 1997 and 2017 decisions. 

Clinging to IFRS is irresponsible for many reasons. It cannot be repaired because “current values” (anchored to credible discounted cash flows) are too often not available in Canada. Flattering IFRS estimates by management are frequently embedded within material conflicts of interest. And IFRS allows for too many pretences that are deeply inherent in IFRS’ illogical, minimal-cash-based foundations. 

The shocking audited financial statements for many of Canada’s marijuana companies currently provide all the evidence that is needed to discard failed self-regulation and add effective prohibitions. It’s time for Canadian regulators to seriously consider breaking from IFRS and adopting U.S. GAAP for public companies. 

Dr. Al Rosen, FCA, FCMA, FCPA, CFE, CIP and Mark Rosen, MBA, CFA, CFE, provide independent, forensic accounting investment research. They are the co-authors of Easy Prey Investors: Why Broken Safety Nets Threaten Your Wealth. Learn more at Accountability Research Corporation and Rosen & Associates Limited.