IFRS - A FIRST TIME ADOPTER'S VIEW

(An updated version of a previous blog on adopting IFRS based reporting for the first time. Originally published on July 12, 2010)

Beginning January 1, 2011, Canadian publicly accountable companies are required to use International Financial Reporting Standards (IFRS), and private companies, Accounting Standards for Private Enterprises (ASPE).  For some public companies, the conversion journey has not seen significant changes in fundamental accounting principles.  In certain industries, the conversion process was complex because of significant changes to accounting policies and the difficulty in getting historic information necessary for the transition.  Other factors that contribute to the complexity are modifications to accounting processes and systems that are necessary to move forward with IFRS based reporting.

ASPE differs from IFRS (and pre January 1, 2011 Canadian GAAP) in many respects and is a simpler set of standards to implement.  So why are some Canadian private companies with North American and global operations, adopting IFRS?

With over 100 countries deciding to adopt IFRS, it is becoming the de facto set of global accounting standards (except perhaps in the US, where the topic is still under debate).  Using a global set of standards enables better comparison of financial statements across national borders, improves access to debt markets, and avoids the burden of converting to IFRS in the future when circumstances demand it (e.g. a parent company uses IFRS, to issue an IPO).

In our experience, an IFRS transition is a unique activity requiring a unique approach. Key ingredients for a trouble-free transition include a good grasp of the company and its operations (‘big picture’), excellent project governance, optimal disclosures, ability to anticipate auditor needs, and a depth of experience in financial close-to-disclose processes and accounting systems.

A logical place to start the IFRS transition journey would be to review specific rules and procedures your company needs to comply with; this allows you to disclose that you have ‘unreservedly complied with all IFRSs’. Enter IFRS 1.  This standard is a guidepost for navigating through all other IFRS standards; it recommends special transitional disclosures for inclusion in your first set of IFRS financial statements.  This blog is intended as a brief overview of IFRS 1:

What is IFRS 1?

IFRS 1 is essentially a road map for preparers of first year financial statements under IFRSs – it provides users of financial statements a clear distinction between changes in reported earnings arising from a) the changes in accounting recognition and measurement criteria, and b) the underlying economic activity of the company.  IFRS 1 also ensures that all first-time adopters have a consistent starting point.

A definition to help get started: The opening balance sheet is the earliest date (i.e. transition date) of the most recent period of comparative financial statements produced in accordance with local GAAP. The fundamental requirement is that companies must produce their financial statements retrospectively, i.e. as though IFRSs always applied – consider the consequences of traveling back in time to restate their statements to conform to the new standards. This is where IFRS 1 plays an important part: it provides exemptive relief and guidelines that a company adopting IFRS for the first time, must follow in preparing financial statements in accordance with IFRSs.

What are the primary requirements of IFRS 1?

IFRS 1 is a mandatory standard requiring first time adopters of IFRSs to:

• Select global accounting policies that comply with IFRS and apply them retrospectively to all periods presented in the first IFRS financial statements (including beginning retained earnings of the comparative period),

• Apply any of the optional exemptions from retrospective application, to facilitate a more efficient IFRS conversion process,

• Apply the mandatory exceptions from retrospective application,

• Prepare an opening balance sheet in accordance with IFRSs at the transition date,

• Prepare the first IFRS financial statements and comparatives,

• Explain the impact of the transition to IFRSs in its disclosures,

• Include an explicit and unreserved statement of compliance with IFRSs.

IASB’s intent with this important standard is to ensure that IFRS financial statements are transparent and comparable for all periods presented in the financial statements, while ensuring the costs of producing IFRS compliant statements don’t outweigh the benefits.

General Principles

The overriding principles of IFRS 1 require a company to apply all IFRSs to its financial statements as though it had always followed international standards. The opening IFRS balance sheet is the starting point for all subsequent accounting under IFRS; the opening balance sheet is prepared at the ‘date of transition’ (which is the beginning of the earliest period for which full comparative IFRS based financial statements are presented).

The opening balance sheet should:

• Include (i.e. recognize) all assets and liabilities that IFRS requires

• Exclude (i.e. derecognize) assets and liabilities that IFRS does not permit

• Classify all assets, liabilities and equity in accordance with IFRS

• Measure all items in accordance with IFRS

Adjustments as a result of applying IFRSs for the first time are recorded in retained earnings or another equity category in the opening balance sheet.  Exceptions to these general principles exist where one of the optional exemptions or mandatory exceptions does not require or permit recognition, classification, and measurement in accordance with IFRSs.

IFRS 1 grants limited exemptions from the requirements of IFRSs when a company adopts IFRSs for the first time, in specified areas where the cost of complying with them would be likely to exceed the benefits to the users of financial statements. Some exemptions need to be applied to classes of items or transactions; and others may be elected on an item-by-item basis. Voluntary exemptions are specific and cannot be applied to other items by analogy.

The selection of accounting policies can affect the conversion effort required and the opening equity balances and IFRS reported results. Remember IFRS 1 is a living document – additional exemptions are likely to be developed as the IASB completes various projects.  Effective January 1, 2010, there were five exceptions to the general principle of retrospective application.

Disclosures

IFRS 1 requires financial statement disclosures that explain how the transition from previous GAAP to IFRS affected the Company’s reported balance sheet, income statement and cash flows. Specifically, IFRS disclosures should include:

• Reconciliations of equity reported under previous GAAP to equity under IFRS, a) at the date of the opening IFRS balance sheet and, b) the end of the last annual period reported under the previous GAAP,

• Reconciliations of total comprehensive income for the last annual period reported under the previous GAAP to total comprehensive income under IFRSs for the same period,

• Explanation of material adjustments that were made, when adopting IFRSs for the first time,

• Errors in previous GAAP financial statements discovered in the course of transition to IFRSs,

• Disclosure of any impairment losses recognized or reversed in preparing the opening IFRS balance sheet,

• Appropriate explanations of specific recognition and measurement exemptions adopted under IFRS 1,

• To comply with IAS 1 Presentation of Financial Statements, disclose at least one year of comparative information, and,

• Inclusion of an explicit and unreserved statement of compliance with IFRSs within the IFRS financial statements.

IFRS adoption from a Canadian perspective involves minor differences as IFRS and Canadian GAAP are for the most part principle based, unlike US GAAP, which is primarily rule based. These minor differences may however translate to considerable effort during transition.  The differences between ASPE and IFRS will be can be significant depending on the company and its activities.  The company’s auditors will also require adequate documentation of accounting policy choices and rationale. Even with minor or moderate  differences, Canadian private companies should expect an increased level of disclosures that are required under IFRS (e.g. compensation of key management).

Ultimately, the financial statement users will be the final judge if you used IFRS 1 to the fullest extent possible.  Are users able to differentiate changes in opening equity and earnings reported under IFRS as those purely due to accounting changes and those due to company performance? Did the company provide sufficient disclosures to help with this understanding? Careful consideration of industry specific reporting issues, interpretation and management judgment in the application of IFRSs and clear transitional disclosures will help set a high benchmark for your first set of financial reporting using a set of global accounting rules.

Reference: “IFRS 1 – First Time Adoption of International Financial Reporting Standards”, International Accounting Standards Board (IASB)

Pradeep Shakespeare is a financial reporting and systems change agent with over 15 years of achievements in financial accounting, reporting, technology introduction and managing organizational change. As Corporate Controller, Director Treasury and in various consulting roles within public and private company settings, he helped deliver IFRS and SOx compliance, enterprise resource planning (ERP) systems and improved key operational processes. Through effective collaboration among various stakeholders, he negotiated significant SG&A expense reductions and contributed to profit improvement. Pradeep is a Chartered Management Accountant (England), Chartered Global Management Accountant and an executive MBA. If you are embarking on an IFRS adoption or updating for recently issued IFRS and would like to have a meaningful discussion please contact Pradeep at +1.905.609.4105 or via email: pshakespeare@solutionsthink.com. 

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