IFRS - Basics

International Financial Reporting Standards (IFRS) was issued by International Accounting Standards Board (IASB).  The International Standard setting process began long ago as an effort to Standardize and make easier to adopt by the developing and smaller nations which feel difficult to set and establish their own standards on Accounting and Reporting.The importance of having ONE standard was felt by the regulators, investors, large entities and audit firms as the business becomes more global.

Convergence with IFRS issued by IASB has recently gained momentum all over the world.  So far 109 countries presently require or permit use of IFRS in preparation of financial statements in their countries.  By 2011, the number is expected to reach 150.  Due to the complex nature of IFRS, Institute of Chartered Accountants of India (ICAI) in its 2006 concept paper expressed its view that IFRS should be adopted from 01.04.2011.  Implementation will be done in a phased manner.  Adoption of IFRS is mandatory for the following entities:

1.      Public and Private companies listed and in the process of listing.

2.      Private companies who have issued debt instruments in a public market and

3.      Private companies which hold assets in fiduciary capacity (ex: Banks and Insurance companies)

FIRST TIME ADOPTION OF IFRS

The Standards apply when the entity adopts IFRS for the first time by explicit and unreserved statements of compliance with IFRS.

These International Accounting Standards specifically covers:

1.      Comparable information with the earlier years

2.      Identification of the basis of reporting

3.      Retrospective application of IFRS information

4.      Formal identification of reporting date¹ and the transition date²

IFRS requires an entity to comply with each standard which are effective at the reporting date for its first financial statements complying IFRS pattern.  IFRS should be applied retrospectively subject to certain exceptions and exemptions.  Thereby, comparative amounts, including opening balance sheet for the comparative period, should be restated from Indian GAAP to IFRS.

An entity moving from National GAAP to IFRS should apply these requirements.  The basic requirement is full retrospective application of all IFRSs effective at the reporting date for the entitys first IFRS financial statements.

NOTE 1.  REPORTING DATE Reporting date is the balance sheet date of the first financial statements that explicitly state that they comply with IFRS (for example 31^st March 2012)       

NOTE 2. TRANSITION DATE Transition date is the date of opening balance sheet for the prior year comparative financial statements (for example 1^st April 2010 if the reporting date is 31^st March 2012)

However there are number of exemptions and 4 exceptions to the requirement for retrospective application.  The exemption covers standards for which the IASB considers that retrospective application could prove to be too difficult or could result in cost likely to exceed any benefits to users. The exemptions are optional. 

The following are the exemptions:

• Business combinations

• Share based payment transactions

• Insurance contracts

• Fair value or revaluation as deemed cost for the property, plant and equipment and other assets

• Leases

• Employee benefits

• Cumulative translation difference

• Investments in subsidiaries, jointly controlled entities and associates

• Assets and liabilities of subsidiaries, associates and joint ventures

• Compound financial instruments

• Assets and liabilities of subsidiaries

• Designation of previously recognized financial instruments

• Fair value measurement of financial assets or financial liabilities at initial recognition

• Decommissioning liabilities included in the cost of property, plant and equipment

• Service concession arrangements

• Borrowing cost

EXCEPTIONS:

The exceptions cover areas in which retrospective applications of the IFRS requirements is considered inappropriate.  The exceptions are not optional and mandatory. The 4 exceptions are:

1.      Estimates

2.      Derecognition of financial assets and liabilities

3.      Hedge accounting

4.      Some aspects of accounting for non-controlling assets

OPENING BALANCE SHEET:

The opening IFRS balance sheet as at the transition date should

°  Recognize all assets and liabilities whose recognition is required by IFRS, but

°  Not recognize items as assets and liabilities whose recognition is not permitted by IFRS

When preparing opening balance sheet:

°  Recognize all assets and liabilities whose recognition is required by IFRS. Examples of changes from national GAAP are derivates, leases, pension liabilities and assets, and deferred tax on revalued assets.  Adjustments required are either debited or credited to equity

°  Remove assets and liabilities whose recognition is not allowed by IFRS.  Examples of changes from national GAAP are deferred hedging gains and losses. Other deferred costs, some internally generated intangible assets and provisions.  Adjustments are either debited or credited to equity.

°  Reclassify the items that should be classified differently under IFRS

°  Apply IFRS in measuring assets and liabilities by using estimates which are consistent with the national GAAP estimates and condition at the transition date.

FAIR VALUE ACCOUNTING:

IFRS has a special focus on Fair Value accounting. The IASB defines Fair Value as the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arms length transaction.  It has been proposed that there is a four level measurement hierarchy in establishing fair value.

Level 1 is determinable by direct reference to an observable market price failing that, Level 2 requires an accepted model for estimating market price.  Level 3 has regard to the price actually paid (assuming no persuasive evidence that it was unrepresentative).  Level 4 allows techniques using entity specific data that can be estimated reliably and which is not inconsistent with market estimations.  

There are many advantages when Indian entities converge with IFRS:

a)      The use of common standards in the preparation of public company financial statements will make it easier to compare the financial results of reporting entities from different countries.

b)      It helps investors understand opportunities better.

c)      Large public company with subsidiaries in multiple jurisdictions would be able to use one accounting language company wide and present their financial statements in same language as their competitors.

d)      Finance professionals will be more mobile and company will more easily able to respond the human capital need of their subsidiaries around the world.

e)      Easy access to foreign capital markets.

f)       Helps reduced cost; at present when Indian entities list their securities abroad they have to make another set of accounts which are acceptable in that country.  Convergence with IFRS will eliminate this need for preparation of dual financial statements and thereby reduce the cost of raising capital from foreign markets.

g)      Greater disclosure requirement provides more transparency in the financial statements.

h)      It provides way for interpretation. International Financial Reporting Interpretations Committee (IFRIC) will reassess the standard.

Since convergence with IFRS has some complex process and techniques, it involves much cost and time.  The costs also extend to train the professionals under IFRS.  It is a tedious process when it comes to non-routine items like business restructuring, mergers and acquisitions and demergers.  The data has to be dug out and then do it on fair value basis which will be time consuming. Small and medium scale enterprises (SME) find it difficult to converge with IFRS.   It is a challenge for auditors since they have to give their opinion on the financial statements prepared under IFRS. So, they have to be trained well in advance. Companies will have an added task to educate the investors, lenders, business vendors, directors, employees, etc.  Companies and lending institutions will have to analyze the potential impact early on to avoid last minute surprises.  And for the students community it is yet another challenge they will be facing shortly by the change in syllabus. We are ready!