INTRODUCTION
IFRS 1 was issued to ensure that an entity’s first IFRS financial statements, and any interim financial reports for part of the period covered by those financial statements, contain high quality information that:
- Is transparent for users and comparable over all periods presented;
- Provides a suitable starting point for accounting under International Financial Reporting Standards; and
- Can be generated at a cost that does not exceed the benefits to users.
IFRS 1 applies to all entities adopting IFRS for the first time on or after 1st January 2004.
A first time adopter is an entity that presents its first IFRS financial statements. The entity must make an explicit or unreserved statement that the annual financial statements comply with all relevant IFRS’s.
The date of transition to IFRS’s is the beginning of the earliest period for which an entity presents full comparative information under IFRS’s in its first IFRS financial statements.
IFRS 1 states that the starting point for the adoption of IFRS’s for the year ended 31st December 2005 is to prepare an opening IFRS balance sheet at 1st January 2004 (or the beginning of the earliest comparative period).
The general rule is that this balance sheet will need to comply with each IFRS effective at 31st December 2005 (the reporting date).
As a result, the opening balance sheet should:
- Recognise all assets and liabilities whose recognition is required by IFRS’s
- Not recognise items as assets or liabilities if the IFRS’s do not permit such recognition
- Reclassify items that the entity recognised under previous GAAP as one type of asset, liability or component of equity but are a different type of asset, liability or component of equity under IFRS’s
- Apply IFRS’s in measuring all recognised assets and liabilities
The opening balance sheet need not be published. Its main function is to provide opening balances in order that future financial statements can be prepared in accordance with IFRS.
ACCOUNTING POLICIES
The entity must use the same accounting policies in its opening IFRS balance sheet and throughout all periods presented in its IFRS financial statements.
Those accounting policies must comply with each IFRS effective at the reporting date for its first IFRS financial statements (except with exemptions apply).
This requirement can cause a number of practical difficulties:
- At the effective date of transition, it is not totally clear which IFRS’s will be in force two years later. Thus, the originally prepared balance sheet may have to be amended several times prior to the publication of the first IFRS financial statements.
The entity cannot apply different versions of IFRS’s that were effective at earlier dates. However, an entity may apply a new IFRS that is not yet mandatory if it permits early application.
- The costs of retrospectively applying the recognition and measurement principles of IFRS’s might be considerable. IFRS 1 grants a limited number of exemptions from the general requirements where the cost of complying with them would be likely to exceed the benefits to users.
- The accounting policies used in the opening IFRS Statement of Financial Position may differ from those that it used for the same date using previous GAAP. The resulting adjustments arise from events and transactions before the date of transition to IFRS’s.
The entity must recognise those adjustments in retained earnings (or, if appropriate, another category of equity) at the date of transition to IFRS’s.
The entity must explain how the transition from previous GAAP to IFRS’s affected its reported financial position, financial performance and cash flows.
Thus, the entity’s first IFRS financial statements should include:
- Reconciliations of its equity reported under previous GAAP to its equity under IFRS’s for both of the following dates:
- The date of transition to IFRS’s; and
- The end of the latest period presented in the equity’s most recent annual financial statements under previous GAAP.
- A reconciliation of the profit or loss reported under previous GAAP for the latest period in the entity’s most recent annual financial statements to its profit or loss under IFRS’s for the same period.
- If the entity recognised or reversed any impairment losses for the first time in preparing its opening IFRS Statement of Financial Position, the disclosures that IAS 36 Impairment of Assets would have required if the entity had recognised those impairment losses or reversals in the period beginning with the date of transition to IFRS’s.
EXEMPTIONS AND EXCEPTIONS
In general, the transitional provisions in other IFRS’s do not apply to first time adoption. However, IFRS 1 does not allow full retrospective application of IFRS’s in the following areas:
- Assets classified as held for sale and discontinued operations
- Derecognition of financial assets and financial liabilities (c) Estimates
Hedge accounting
In addition, the following exemptions may be elected:
- Previous business combinations do not have to be restated
- Past currency translation gains/losses included in revenue reserves need not be separated out into the currency translation reserve
- An entity may elect to measure an item of property, plant and equipment at the date of transition to IFRS’s at its fair value and use that fair value as its deemed cost at that date.
- Under IAS 32 part of the proceeds of convertible debt is classified as equity. If the debt component is no longer outstanding at the date of transition, there is no need to separate the liability and equity components.
If a subsidiary adopts IFRS’s later than the parent, the subsidiary may value its assets/liabilities either:
At its own transition date; or
Its parents.
COMPARATIVE INFORMATION
To comply with IAS 1 Presentation of Financial Statements, an entity’s first IFRS financial statements must include at least one year of comparative information under IFRS’s.
Question
“One issue that will involve significant changes in accounting policy and have corresponding disclosure issues is the rules on first-time adoption of IFRS. Many companies are starting to transfer their financial statements from a previous GAAP into IFRS and are therefore having to restate those accounts”
IRS 1 First time adoption of International Financial Reporting Standards addresses the issues in completing this conversion.
Requirement
Draft a memo to the finance director of a client company explaining how IFRS 1 details the manner in which his company should implement a change from local accounting standards to international standards, making specific reference to the following:
- Selection of accounting policies that comply with IFRS
- Preparation of an opening Statement of Financial Position at the date of transition to IFRS
- Making estimates under IFRS for both the opening IFRS Statement of Financial Position and other periods presented
- Disclosures in the first IFRS financial statements
Tutorial Comment
This question focuses the candidate on the transition guidance from accounting under local GAAP to accounting under international standards.
The candidate is specifically asked to explain the guidance relating to four key areas:
- Selection of accounting policies that comply with IFRS
- Preparation of an opening Statement of Financial Position at the date of transition to IFRS
- Making estimates under IFRS for both the opening IFRS Statement of Financial Position and other periods presented
- Disclosures in the first IFRS financial statements
The candidate should be aware of the steps which must be taken when implementing IFRS for the first time and should also be familiar with the additional disclosures that are required in the initial reporting period.
IFRS 1 was introduced to help ensure that an entity’s first IFRS financial statements will contain high quality financial information that allows transparency and comparability for all periods presented and that these financial statements can be generated in a cost efficient manner.
- Selection of accounting policies that comply with IFRS
An entity must select accounting policies that comply with IFRS at the reporting date. These accounting policies must then be used to prepare the financial statements as at Statement of Financial Position date and the comparative financial statements. This also means that the selected accounting policies will have to be applied to the entity’s opening Statement of Financial Position date of the comparative figures i.e. full retrospective application to comparatives.
In the case of excessive cost of restatement, certain exemptions are permitted under the standard. These exemptions are independent of each other and are optional. They include the following:
- Property, Plant and Equipment
In cases where it is difficult to measure the historic cost of previously revalued assets, a first-time adopter may measure such an item at its fair value at the transition date and use the fair value as the deemed cost. An entity may also use a previous GAAP valuation as the deemed cost at transition date so long as the revaluation is broadly comparable to the fair value or depreciated replacement cost at the date of valuation.
In certain instances, these valuation methods may also apply to investment properties (under the cost model in IAS 40 Investment Property) and to intangible assets that meet the recognition criteria and the criteria for revaluation in IAS 38 Intangible assets.
- Business Combinations
An entity need not apply IFRS 3 Business Combinations retrospectively to business combinations recognised under previous GAAP. However, if an entity wishes to avail of this exemption, it must ensure that all combinations keep the same classification as in previous GAAP financial statements; if an entity restates any business combinations to comply with IFRS 3, it must also restate all later business combinations. For example, if a first-time adopter elects to restate a business combination that occurred on 1st January 2004, it must restate all business combinations that occurred on or after that date.
Some adjustments will still be required for business combinations which are not restated, predominantly regarding goodwill. Any positive goodwill on the Statement of Financial Position at the transition date should, from the start of the earliest comparative period, be subject to annual impairment reviews; if negative, it should be written back to retained earnings.
Otherwise, all acquired assets and liabilities must be recognised insofar as is permitted under IFRS. Items which do not qualify for recognition must be excluded from the opening IFRS Statement of Financial Position but reclassified into relevant line items if appropriate.
- Defined Benefit Fund Schemes
At variance to IAS 19 Employee Benefits, a first-time adopter may elect to recognise all cumulative actuarial gains or losses at the transition date and spread those that arise after this date. If a first-time adopter elects to do so, it must apply to all such pension schemes.
- Cumulative Translation Differences
Cumulative exchange differences arising on foreign entities should be presented as a separate reserve under IAS 21 The Effects of Changes in Foreign Exchange Rates and on disposal of the foreign entity to offset this reserve against the disposal proceeds.
However, on transition to IFRS, it is acceptable now to separate exchange differences arising before transition date and the subsequent gain/loss on disposal of that foreign entity would include only those exchange differences arising after transition date.
- Financial Instruments
IAS 32 Financial Instruments: Disclosure and Presentation requires an entity to split a compound financial instrument at inception in to separate liability and equity components. Under IFRS 1, a first-time adopter is not required to separate these two portions as the liability component is no longer outstanding at the date of transition.
- Designation of Previously Recognised Financial Instruments
IAS 39 Financial Instruments: Recognition and Measurement permits a financial instrument to be designated on initial recognition as a financial asset or financial liability at fair value through “profit or loss” or as “available for sale”. A first-time adopter may make such a designation at date of transition.
(Other exemptions also apply re share-based payment transactions, insurance contracts, and assets and liabilities of subsidiaries, associates and joint ventures also acceptable)
- Preparation of an opening Statement of Financial Position at the date of transition to IFRS
This should be restated using recognition and measurement criteria in IFRS. This involves restating the Statement of Financial Position prepared under the previous GAAP to ensure compliance with the IFRS i.e. an entity will have to restate its Statement of Financial Position as at 1st January 2004 if it is a first time adopter as at 31st December 2005.
This means that an entity must:
- Recognise all assets and liabilities whose recognition is required by IFRS
- Cease to recognise some assets and liabilities that cannot be recognised under IFRS
- Reclassify items as different types of assets, liability and equity under IFRS
- Apply IFRS in measuring recognised assets and liabilities
The accounting policies that an entity uses in its opening IFRS Statement of Financial Position may differ from those it used for reporting under the previous GAAP. Any adjustment to the opening net assets should be recognised against retained earnings.
- Making estimates under IFRS for both the opening IFRS Statement of Financial Position and other periods presented
Estimates on transition should be consistent with estimates made at the same date under previous GAAP (after any adjustments to reflect differences in accounting policies) unless there is objective evidence that those estimates were in error.
An entity may also need to make new estimates under IFRS at the date of transition if no such amount was recognised by previous GAAP.
- Disclosures in the first IFRS accounts
An entity must include at least one year of comparative financial information. There are however certain exemptions regarding the provision of comparative for financial instruments. If an entity avails of such an exemption it may apply its previous GAAP and disclose this fact, together with the nature of the main adjustments what would make the information comply with the IFRS guidance on financial instruments.
An entity must also explain the effect of the transition from previous GAAP to IFRS on financial performance, financial position and cashflows.
It must do so by providing reconciliations of (i) equity at date of transition and at Statement of Financial Position date and (ii) reported profit and loss highlighting values under previous GAAP to those under IFRS. These reconciliations must provide the readers with sufficient detail to understand the material adjustments to the Statement of Financial Position, the Statement of Comprehensive Income and to the cashflow statement, if prepared under previous GAAP.
If an entity recognised or reversed any impairment losses for the first time in preparing its opening IFRS Statement of Financial Position, the first IFRS Financial Statements must include the disclosures that IAS 36 Impairment of Assets would have required if the entity had recognised those impairment losses or reversals in the period beginning with the date of transition to IFRS.
If an entity corrects any errors made under previous GAAP the reconciliations must distinguish the correction of errors from changes in accounting policies.
Where fair value has been used as deemed cost, the entity’s first IFRS financial statements shall disclose for each line item in the opening IFRS Statement of Financial Position the aggregate of those fair values and the aggregate adjustment to the carrying amounts reported under previous GAAP.
I trust that my response will clarify the issues raised if you have any further queries please contact me.
