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IAS 1, Presentation of Financial Statements, requires that an entity whose financial statements comply with International Financial Reporting Standards (IFRS) has to make an explicit and unreserved statement of such compliance in the notes. Financial statements cannot be described as complying with IFRS unless they comply with all the requirements of IFRS, including International Financial Reporting Interpretations Committee interpretations (IFRICs). Inappropriate accounting policies cannot be rectified either by disclosure of the accounting policies used or by notes or explanatory material. On the basis of the above statements, it could be assumed that the comparability of financial statements could be assured, as the language used in IAS 1 is clear and concise.
Recently staff at the US Securities and Exchange Commission (SEC) analysed the annual consolidated financial statements of 183 companies, including both SEC registrants and companies that are not SEC registrants, which prepare financial statements in accordance with IFRS. The 183 companies were domiciled in 22 countries and approximately 80% were domiciled in the European Union (EU), with companies from Germany, France and the UK representing just over half. The companies in the analysis represented 36 industries and were selected from the Fortune Global 500, a listing of the world's largest companies by revenue. The standards reviewed were those in effect at 31 December 2009.
It was found that company financial statements generally appeared to comply with IFRS requirements. However, it was felt that the transparency and clarity of the financial statements in the sample could be enhanced. Many companies did not appear to provide sufficient detail or clarity in their accounting policy disclosures to support an investor's understanding of the financial statements, and some also used terms that were inconsistent with the terminology in the applicable IFRS. Further, some companies referred to local guidance, the specific requirements of which were not clear.
Differences in the application of IFRS affect the comparability of financial statements across countries and industries. In the sample, any lack of comparability seemed to be caused through application of IFRS, or due to options permitted by IFRS or the absence of IFRS guidance in certain areas. In other cases, differences resulted from what appeared to be non-compliance with IFRS.
Differences arising from the standards themselves were affected by guidance from local standard setters or regulatory bodies that narrowed the range of acceptable alternatives permitted by IFRS or provided additional guidance or interpretation. There was also a tendency by some companies to carry over their previous national practices in their IFRS financial statements.
In the absence of a specific applicable IFRS, an entity is required first to consider guidance in an IFRS standard that relates to similar issues, and then to consider the IFRS Framework. The entity may also consider recent pronouncements of other standard-setting bodies that use a similar conceptual framework, other accounting literature and industry practices, if they do not conflict with IFRS. Approximately 20% of companies in the analysis referred to local guidance for a specific transaction as part of their accounting policy disclosures. An interesting case arose where a company elected to rely on the pronouncements of another standard setter as regards their revenue recognition accounting policy. Subsequently the standard setter changed its guidance but the company did not incorporate the changes that the standard setter had made. IFRS is silent on this matter.
IFRS requires compliance with IFRICs. However, like new IFRSs, IFRICs are not mandatory immediately. For example, in the EU, IFRICs are not implemented until after the European Commission adopts them. As a result, some companies in the EU adopted IFRICs at dates later than companies outside the EU. This practice can cause differences in accounting practices that the IFRICs are issued to address, due to a timing difference.
IFRS permits a departure from specific requirements of IFRS if an entity determines that the application of that requirement would result in the financial statements being so misleading that they no longer meet the objectives of the Framework. This is often referred to as a 'true and fair override'. There were no examples of the true and fair override in the sample.
There were significant differences in the presentation of the statement of cash flows. IAS 7, Statement of Cash Flows, permits the use of the direct or indirect method of presentation. The vast majority of companies used the indirect method, with companies in two countries primarily using the direct method. This was due to the use of the indirect method being prohibited at the time of initial adoption of IFRS. Further, there were many variations relating to the profit or loss measure used as the starting point to determine operating cash flows. Additionally, there were differences in the classification of items within the operating, investing and financing categories.
For example, most companies in the insurance industry classified their investment activities within cash flows from investing activities but some presented investing activities within cash flows from operating activities, either on a gross basis or net of payments of related benefits and claims. IFRS defines cash equivalents as 'short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk of changes in value'. Differences were seen in the items classified as cash equivalents; these ranged from balances at central banks to investments with a maturity exceeding three months.
IAS 38, Intangible Assets, defines an intangible asset as 'an identifiable, non-monetary asset without physical substance' and requires each entity to 'assess whether the useful life of an intangible asset is finite or indefinite'. Some companies determined that certain types of intangible assets – for example, brand names – had a finite life, while others determined that the same type of intangible assets had an indefinite life. The brand names included some of the world's most recognised brands. Additionally some companies disclosed useful lives that appeared to be capped at a maximum length rather than using an assessment of the useful life of the asset. Companies can select either the cost model or the revaluation model as their accounting policy and must apply that policy to an entire class of intangible assets. All of the companies elected to use the cost model to account for intangible assets.
IAS 36, Impairment of Assets, requires assets to be evaluated for impairment individually, or, if the recoverable amount of an individual asset cannot be determined, by cash-generating unit. A cash-generating unit is 'the smallest identifiable group of assets that generates cash inflows that are largely independent of the cash inflows from other assets or groups of assets'. It was seen that there were several levels defined as cash-generating units, including: the operating segment; below the operating segment but not defined; one level below the operating segment; two levels below the operating segment; and the individual store or outlet. This is obviously a cause for concern in terms of the nature and accuracy of the impairment charge.
One-third of companies disclosed that they entered into transactions within the scope of IAS 40, Investment Property. IAS 40 permits companies to elect to use either the fair value model or the cost model. Most companies applied the cost method, with those that used the fair value model mainly in the banking sector. There were problems with those companies who used the fair value model; several did not disclose the methods and significant assumptions used to determine the fair value of the investment properties, as required by IFRS. Also, there were variations by country in the determination of fair value for investment properties. The determination of fair value of investment property was regulated in one country, while in another it was measured for fair value in accordance with guidance published by a national organisation. Fair value should reflect market conditions at the end of the reporting period.
In IAS 37, Provisions, Contingent Liabilities and Contingent Assets, IFRS requires a provision to be recognised when an entity has a present obligation whether legal or constructive as a result of a past event; it is probable that an outflow of resources embodying economic benefits will be required to settle that obligation, and a reliable estimate can be made of the amount of obligation. Most companies stated these recognition criteria in their accounting policy, but did not provide any additional explanation as to how the criteria were applied. Some disclosed that one of the criteria applied to recognise a provision would be that no inflow of resources of an equivalent amount was expected. IFRS does not allow offsetting in the statement of financial position of amounts recoverable from third parties. In addition, some entities did not discuss the recognition criteria in IAS 37 but indicated that they looked to legal experts to determine whether a provision should be recorded.
There were several instances in which local laws or accounting regulations required the use of a separate account within shareholders' equity to provide for specifically mandated reserves. IFRS gives no guidance regarding the presentation of these separate accounts. A group of companies in a particular country disclosed that 10% of profit was transferred to a non-distributable statutory surplus reserve in shareholders' equity in accordance with national accounting standards. Similarly, an entity disclosed that national law required it to maintain a general reserve within shareholders' equity for the risk of impairments equal to 1% of risk assets, which are defined by law.
Graham Holt is an examiner for ACCA and executive head of the accounting and finance division at Manchester Metropolitan University Business School