The Effects of IFRS on Financial Ratios: Early Evidence in Canada

This paper provides preliminary evidence of the impact on financial ratios caused by the transition to International Financial Reporting Standards (IFRS) in Canada. The main features of IFRS are explained in the context of a shift from Canadian Generally Accepted Accounting Principles (GAAP) while the main differences between the two sets of rules are underscored – heavier reliance of IFRS on fair value accounting and comprehensive income, and the use of the entity theory for consolidation. The effects of IFRS on financial ratios in the areas of liquidity, leverage, coverage and profitability are discussed and verified using a sample cohort of early adopters in Canada. The preliminary evidence reveals significantly higher volatility to most of the ratios under IFRS when compared to those derived under pre-changeover Canadian GAAP. While the means and medians of IFRS ratios differ from the means and medians of the same ratios under pre-changeover Canadian GAAP, the differences are not statistically significant overall. However, important individual discrepancies are in some cases observed. Naturally, analysts using ratios for analytical purposes during the transition period need to be vigilant as ratios computed under IFRS are not directly comparable with those derived under pre-changeover Canadian GAAP. It is recommended that heightened attention be directed to the new feature – comprehensive income – which incorporates unrealized gains and losses that bypass the income statement. The suggested analytical tools best suited to mitigate the contributing effect include reliance on comprehensive-Return on Assets (ROA) and comprehensive-Return on Equity (ROE).