International Financial Reporting: International Financial Reporting Standards

International Financial Reporting Standards (IFRS) are standards and interpretations adopted by the International Accounting Standards Board (IASB).

Many of the standards forming part of IFRS are known by the older name of International Accounting Standards (IAS). IAS were issued between 1973 and 2001 by the board of the International Accounting Standards Committee (IASC). In April 2001 the IASB adopted all IAS and continued their development, calling the new standards IFRS.

Contents

1 Adoption of IFRS

2 IASB current projects

3 Structure of IFRS

4 Features of IFRS

5 Framework for the Preparation and Presentation of Financial Statements

Adoption of IFRS

IFRS are used in many parts of the world, including the European Union, Hong Kong, Australia, Russia, South Africa, Singapore and Pakistan. Nearly 100 countries currently require or permit the use of, or have a policy of convergence with, IFRSs. ^[1]

For a current overview see IAS PLUS's list of all countries that have adopted IFRS.

Australia

The Australian Accounting standards, previous to 1 January 2005, were based around accounting standards developed by the Australian Accounting Standards Board (AASB). As a result of pressure towards international harmonisation, the AASB had been working towards a convergence between the Australian Standards and the IFRS. From 1 January 2005, the Australian equivalent of IFRS have been fully implemented as AASB 101 - 141. It is a requirement that all reporting entities adopt the standards as they have replaced the previous Australian generally accepted accounting principles.

Due to the accounting standards operating halfway through the year, the requirements can be summarised as follows:

Year ended 30 June 2004—Prepare under pre IFRS standards and state in notes the expected effect of the adoption of IFRS
Year ended 30 June 2005—Prepare under pre IFRS standards and prepare a reconciliation to IFRS standards
Year ended 30 June 2006—Prepare under Australian Equivalents to IFRS standards

European Union

All publicly traded EU companies have been required to prepare their consolidated accounts using IFRS since 2005. Prior to 2005 there were around 350 publicly listed companies that used IFRS — since 2005 the figure has been around 7,000.

In order to be approved for use in the EU, standards must be endorsed by the Accounting Regulatory Committee (ARC), which includes representatives of member state governments and is advised by a group of accounting experts known as the European Financial Reporting Advisory Group. As a result IFRS as applied in the EU may differ from that used elsewhere.

Parts of the standard IAS 39: Financial Instruments: Recognition and Measurement were not originally approved by the ARC. IAS 39 was subsequently amended, removing the option to record financial liabilities at fair value, and the ARC approved the amended version. The IASB is working with the EU to find a way to an acceptable way to remove a remaining anomaly in respect of hedge accounting.

As the standards are part of European law the approved standards and approved subsequent changes must be published in the Official Journal of the European Union. On October 13th 2003 the first publication of the standards was included in PB L 261. Changes to the earlier published IAS and IFRS can be monitored using the webpage of the Directorate Internal Market of the European Union on the implementation of the IAS in the European Union.

From 2007 companies traded on the Alternative Investment Market in the UK will be required to prepare their accounts using IFRS.

Russia

The government of Russia has been implementing a program to harmonize its national accounting standards with IFRS since 1998. Since then twenty new accounting standards were issued by the Ministery of Finance of Russian Federation aiming to align accounting practices with IFRS. Despite of these efforts essential differences between national accounting standards and IFRS remain. From 2004 all commercial banks are obliged to prepare financial statements in accordance with both national accounting standards and IFRS. Full transition to IFRS is delayed and is expected to take place from 2010.

Turkey

Turkish Accounting Standards Board translated IFRS into Turkish in 2006. As of 31 December 2006 Turkish companies listed in Istanbul Stock Exchange are required to prepare IFRS reports.

Convergence with US GAAP

In 2002 at a meeting at Norwalk, Connecticut, the IASB and the US Financial Accounting Standards Board agreed to harmonise their agenda and work towards reducing differences between IFRS and US GAAP (the Norwalk Agreement). In February 2006 FASB and IASB issued a Memorandum of Understanding including a programme of topics on which the two bodies will seek to achieve convergence by 2008.

The United States Securities and Exchange Commission currently requires all overseas companies listed in the US to prepare their results either under US GAAP or according to their local requirements with a footnote reconciling their local GAAP to US GAAP. This imposes expense on companies which are listed on exchanges both in the US and another country. The SEC has proposed a change to its rules to remove the reconciliation requirement for foreign issuers which prepare accounts under IFRS, indicatively from 2009.^[2]. US registered companies will still be required to use US GAAP.

IASB current projects

^[3]

Convergence projects with FASB

Government grants
Joint ventures
Impairment
Income tax
Investment properties
Research and development
Subsequent events

Projects under research

Derecognition (Asset and/or liabilities)
Financial instruments (replacement of existing standards -> Merge all 3 standards)
Intangible assets
Liabilities and Equity

Structure of IFRS

IFRSs are considered a "principles-based" set of standards in that they establish broad rules as well as dictating specific treatments.

International Financial Reporting Standards comprise:

International Financial Reporting Standards (IFRS)—standards issued after 2001
International Accounting Standards (IAS)—standards issued before 2001
Interpretations originated from the International Financial Reporting Interpretations Committee (IFRIC)—issued after 2001
Standing Interpretations Committee (SIC)—issued before 2001

There is also a Framework for the Preparation and Presentation of Financial Statements which describes some of the principles underlying IFRS

List of IFRS Statements

The following IFRS statements are currently issued:

IFRS 1 First-time Adoption of International Financial Reporting Standards
IFRS 2 Share-based Payment
IFRS 3 Business Combinations
IFRS 4 Insurance Contracts
IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
IFRS 6 Exploration for and Evaluation of Mineral Resources
IFRS 7 Financial Instruments: Disclosures
IFRS 8 Operating Segments (effective Jan. 1st, 2008)

IAS 1: Presentation of Financial Statements
IAS 2: Inventories
IAS 7: Cash Flow Statements
IAS 8: Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Practices
IAS 10: Events After the Balance Sheet Date
IAS 11: Construction Contracts
IAS 12: Income Taxes
IAS 14: Segment Reporting
IAS 15: Information Reflecting the Effects of Changing Prices
IAS 16: Property, Plant and Equipment
IAS 17: Leases
IAS 18: Revenue
IAS 19: Employee Benefits
IAS 20: Accounting for Government Grants and Disclosure of Government Assistance
IAS 21: The Effects of Changes in Foreign Exchange Rates
IAS 22: Business Combinations
IAS 23: Borrowing Costs
IAS 24: Related Party Disclosures
IAS 26: Accounting and Reporting by Retirement Benefit Plans
IAS 27: Consolidated Financial Statements
IAS 28: Investments in Associates
IAS 29: Financial Reporting in Hyperinflationary Economies
IAS 30: Disclosures in the Financial Statements of Banks and Similar Financial Institutions
IAS 31: Financial Reporting of Interests in Joint Ventures
IAS 32: Financial Instruments: Disclosure and Presentation
IAS 33: Earnings Per Share
IAS 34: Interim Financial Reporting
IAS 35: Discontinuing Operations
IAS 36: Impairment of Assets
IAS 37: Provisions, Contingent Liabilities and Contingent Assets
IAS 38: Intangible Assets
IAS 39: Financial Instruments: Recognition and Measurement
IAS 40: Investment Property
IAS 41: Agriculture

Interpretations

Preface to International Financial Reporting Interpretations (Updated to January 2006)
IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities (Updated to January 2006)
IFRI Approach under IAS 29 Financial Reporting in Hyperinflationary Economies (Issued February 2006)
IFRIC 8 Scope of IFRS 2 (Issued February 2006)
IFRIC 9 Reassessment of Embedded Derivatives (Issued April 2006)
IFRIC 10 Interim Financial Reporting and Impairment (Issued November 2006)
IFRIC 11 IFRS 2—Group and Treasury Share Transactions (Issued November 2006)
IFRIC 12 Service Concession Arrangements (Issued November 2006)

SIC 7 Introduction of the Euro (Updated to January 2006)
SIC 10 Government Assistance—No Specific Relation to Operating Activities (Updated to January 2006)
SIC 12 Consolidation—Special Purpose Entities (Updated to January 2006)
SIC 13 Jointly Controlled Entities—Non-Monetary Contributions by Venturers (Updated to January 2006)
SIC 15 Operating Leases—Incentives (Updated to January 2006)
SIC 21 Income Taxes—Recovery of Revalued Non-Depreciable Assets (Updated to January 2006)
SIC 25 Income Taxes—Changes in the Tax Status of an Entity or its Shareholders (Updated to January 2006)
SIC 27 Evaluating the Substance of Transactions Involving the Legal Form of a Lease (Updated to January 2006)
SIC 29 Disclosure—Service Concession Arrangements (Updated to January 2006)
SIC 31 Revenue—Barter Transactions Involving Advertising Services (Updated to January 2006)
SIC 32 Intangible Assets—Web Site Costs (Updated to January 2006)

Features of IFRS

References

References to IFRS standards given in the standard convention, for example (IAS1.14) refers to paragraph 14 of IAS1, Presentation of Financial Statements

Content of financial statements

IFRS financial statements consist of (IAS1.8)

a balance sheet
income statement
either a statement of changes in equity or a statement of recognised income or expense (“SORIE”)
a cash flow statement
notes, including a summary of the significant accounting policies

Comparative information is provided for the previous reporting period (IAS 1.36). An entity preparing IFRS accounts for the first time must apply IFRS in full for the current and comparative period although there are transitional exemptions (IFRS1.7).

Consolidated financial statements

The ultimate parent company of a group must produce consolidated financial statements including all of its subsidiaries (IAS27.9). A subsidiary is an entity which is controlled by another entity; control is the power to govern the financial and operating policies (IAS27.4). In preparing consolidated financial statements, balances, transactions, income and expenses with other group members are eliminated (IAS27.24).

Acquisition accounting and goodwill

All business combinations are accounted for by applying the purchase method, requiring that one entity is identified as acquirer (IFRS3.17).

The acquiring entity assesses the fair value of the separate assets, liabilities and contingent liabilities in the business it has acquired; this can include identification of intangible assets, for example customer relationships, which are not commonly recognised except on acquisitions (IFRS3.36)

The difference between the cost of the business combination and the fair value of the assets and liabilities acquired represents goodwill (IFRS3.51). Goodwill is not subject to amortisation, but is assessed for impairment at least annually (IFRS3.54 and IAS36.10). Impairment is charged to the income statement. (IAS36. 60). Impairment provisions on goodwill are not subsequently reversed (IAS36.124).

Property, plant & equipment

Property, plant and equipment is measured initially at cost (IAS16.15). Cost can include borrowing costs directly attributable to the acquisition, construction or production if the entity opts to adopt such a policy consistently (IAS23.11).

Property, plant and equipment may be revalued to fair value if the entire class of assets to which it belongs is so treated (for example, the revaluation of all freehold properties) (IAS16.31 and 36). Surpluses on revaluation are recognised directly to equity, not in the income statement; deficits on revaluation are recognised as expenses in the income statement (IAS16.39 and 40).

Depreciation is charged to write off the cost or valuation of the asset over its estimated useful life to down to the recoverable amount (IAS16.50). The cost of depreciation is recognised as an expense in the income statement (IAS16.48). The depreciation method and recoverable amount is reviewed at least annually (IAS16.61). In most cases the method is “straight line”, with the same depreciation charge from the date when an asset is brought into use until it is expected to be sold or no further economic benefits obtained from it, but other patterns of depreciation are used if assets are used proportionately more in some periods than others (IAS16.56).

Joint ventures, associates and other investments

Joint ventures are investments other than subsidiaries where the investor has a contractual arrangement with one or more other parties to undertake an economic activity that is subject o joint control (IAS31.3).

Joint ventures may be accounted for using either

proportionate consolidation, accounting for the investor’s share of the assets, liabilities, income and expenses of the joint venture (IAS31.30).
equity method. The investment is stated initially at cost and adjusted thereafter for the investor’s share of post-acquisition changes in net assets. The income statement includes the investor’s share of profit or loss of the investment (IAS31.38).

Associates are investments, other than joint ventures and subsidiaries, in which the investor has a significant influence (the power to participate in financial and operating policy decisions) (IAS28.2). It is presumed that this will be the case if the investment is greater than 20% of the investee unless it can be clearly demonstrated not to be the case (IAS28. 6). Associates are accounted for using the equity method.

Investments other than subsidiaries, joint ventures and associates are accounted for at their fair values unless (IAS39.9 and 46):-

they have fixed or determinable maturity periods and are expected to be held to maturity, in which case they are stated at amortised cost (providing a constant rate of return until maturity;
there is no reliable market value, in which case they are measured at cost.

Inventory (stock)

Inventory is stated at the lower of cost and net realisable value (IAS2.9).

Cost comprises all costs of purchase, costs of conversion and other costs incurred in bringing items to their present location and condition (IAS2.100. Where individual items are not identifiable, the “first in first out” (FIFO) method is used, such that cost represents the most recent items acquired. “Last in first out” (LIFO) is not acceptable (IAS2.25).

Net realisable value is the estimated selling price less the costs to complete and costs to sell (IAS2.6).

Receivables (debtors) and payables (creditors)

Receivables and payables are recorded initially at fair value (IAS39.43). Subsequent measurement is stated at amortised cost (IAS39.46 and 47). In most cases, trade receivables and trade payables can be stated at the amount expected to be received or paid; however, it is necessary to discount a receivable or payable with a substantial credit period (see for example IAS18.11 for accounting for revenue).

If a receivable has been impaired its carrying amount is written down its recoverable amount (the higher of value in use and its fair value less costs to sell). Value in use is the present value of cash flows expected to be derived from the receivable (IAS36.9 and 59).

Borrowing

Borrowing is stated at amortised cost using the effective interest method. This requires that the costs of arranging the borrowing are deducted from the principal value of debt and are amortised over the period of the debt (IAS39.46).

Provisions

Provisions are liabilities of uncertain timing or amount (IAS37.10). Provisions are recognised when an entity has, at the balance sheet date, a present obligation as a result of a past event, when it is probable that there will be an outflow of resources (for example a future cash payment) and when a reliable estimate can be made of the obligation (IAS37.14). Restructuring provisions are recognised when an entity has a detailed plan for the restructuring and has raised an expectation amongst those affected that it will carry out the restructuring (IAS37.72).

Revenue

Revenue is measured at the fair value of consideration received or receivable (IAS18.9).

Revenue for the sale of goods cannot be recognised until the entity has transferred to the buyer the significant risks and rewards of ownership of the goods (IAS18.14).

Revenue for rendering of services is accounted for to the extent that the stage of completion of the transaction can be measured reliably (IAS18.20).

Employee costs

Employee costs are recognised when an employee has rendered service during an accounting policy (IAS19.10). This requires accruals for short-term compensated absences such as vacation (holiday) pay (IAS19.11). Profit sharing and bonus plans require accrual when an entity has an obligation to make such payments at the reporting date (IAS19.17).

Share-based payments

Where an entity receives goods or services in return for the issue of its own shares or equity instruments it accounts for the fair value of those goods or services as an expense or as an asset (IFRS2.7). Where it offers options and other share based incentives to its employees it is required to assess the market value of the instruments when they are are first granted and then to charge the cost over the period in which the benefit vests (IFRS2.10).

Income taxes

Taxes payable in respect of current and prior periods are recognised as a liability to the extent they are unpaid at the balance sheet date (IAS12.12).

Deferred tax liabilities are recognised for taxable temporary differences at the balance sheet date which will result in tax payable in future periods (for example, where tax deductions have been claimed for capital expenditure before the cost of depreciation has been charged in the income statement) (IAS12.39). Deferred tax assets are recognised for deductible temporary differences at the balance sheet date (for example, tax losses which can be used in future periods) to the extent that it is probable that these will reverse in future and that there will be taxable profits against which they can be offset (IAS 12.44).

Cash flow statements

IFRS cash flow statements show movements in cash and cash equivalents. This includes cash on hand and demand deposits, short term liquid investments readily convertible to cash and overdrawn bank balances where these readily fluctuate from positive to negative (IAS7.6 to 9). IFRS cashflow statements do not need to show movements in borrowings or net debt.

Cash flow statements may be presented using either a direct method, in which major classes of cash receipts and cash payments are disclosed, or using the indirect method, whereby the profit or loss is adjusted for the effect of non-cash adjustments (IAS7.18).

Items on the cash flow statement are classified as operating activities, investing activities and financing activities (IAS7.10).

Leasing (accounting by lessees)

Leases are classified:-

finance leases, being a lease which transfers substantially all the risks and rewards incidental to ownerships to the lessee. Finance leases are recognised on the balance sheet as an asset (the asset being leased) and as a liability (liability to the lessor) (IAS17.4, 20 and 25)
operating leases, a being lease other than a finance lease. The cost of an operating leases is recognised in the income statement as the asset is used (IAS17.4 and 33)

Fair value

Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction (IFRS1 App A).

Amortised cost

Amortised cost uses the effective interest method to provide a constant rate of return on an asset or liability until maturity (IAS39.9)

Framework for the Preparation and Presentation of Financial Statements

Introduction

The Framework for the Preparation and Presentation of Financial Statements states basic principles for IFRS.

The framework states that the objective of financial statements is to provide information about the financial position, performance and changes in the financial position of an entity that is useful to a wide range of users in making economic decisions.

The Framework can divide into the following sections:

Purpose and status
Scope
Objective
Underlying assumptions
Qualitative characteristics of financial statements
Elements of financial statements
Recognition of elements of financial statements
Measurement of the elements of financial statements

Underlying assumptions

The underlying assumptions used in IFRS are:

Accrual basis - the effect of transactions and other events are recognised when they occur, not as cash is received or paid
Going concern - the financial statements are prepared on the basis that an entity is a going concern and will continue in operation for the foreseeable future

Note that matching is not a fundamental assumption for IFRS. IFRS follows a balance sheet approach:-

Equity at year-end = calculation base on IFRS.
Net profit = Equity at year-end minus Equity at the beginning of the year

Qualitative characteristics of financial statements

The Framework describes the qualitative characteristics of financial statements as being

Understandability
Relevance
Reliability and
Comparability.

Elements of financial statements

The Framework sets out the statement of financial position (balance sheet) as comprising:-

Assets - resources controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity
Liabilities - a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits
Equity - the residual interest in the assets of the entity after deducting all its liabilities
Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or reductions in liabilities.
Expenses are decreases in such economic benefits.

Recognition of elements of financial statements

An item is recognised in the financial statements when:-

it is probable that a future economic benefit will flow to or from an entity and
when the item has a cost or value that can be measured with reliability.

Further reading

International Accounting Standards Board (2007): International Financial Reporting Standards 2007 (including International Accounting Standards (IASs™) and Interpretations as at 1st January 2007), LexisNexis, ISBN 1422418138

Original texts of IASs/IFRSs, SICs and IFRICs adopted by the Commission of the European Communities and published in Official Journal of the European Union http://ec.europa.eu/internal_market/accounting/ias_en.htm#adopted-commission

Reference