Rules for the transition to IFRS

The International Accounting Standards Board (IASB) has issued IFRS 1, a new standard providing the rules on how companies adopting International Financial Reporting Standards (IFRS) for the first time should deal with the accounting issues raised. This is of particular importance to those in the EU, Australia and Russia who are making the changeover in 2005. The publication of its first standard also marks a coming of age of IASB.

The main principle in the standard is that there must be a full restatement of the accounts using IFRS. There are two important dates - the date of transition and the first reporting date. In the example of an EU-listed company with a 31 December year end and providing one year's comparative figures, then the transition date is 1 January 2004 and the first reporting date under IFRS would be 31 December 2005. The balance sheet at the start of 2004 must be restated in accordance with all international standards which apply at the end of 2005. This means that any existing assets and liabilities that do not meet the recognition tests in IFRS, for example some general provisions and deferred costs, must be eliminated. IFRS measurement rules will also apply, for example fair values for certain financial assets. It also means that companies will have to wait for the final platform of standards applicable to 2005 before completing the restatement of their 2004 figures.

Life would be too simple if there were not some exceptions to this general principle, and these are of two sorts - optional and mandatory. Companies will be allowed, for example:

• not to restate the effect of previous business combinations
• to use a revalued amount as a deemed cost for tangible fixed assets (property, plant and equipment)
• to choose between full recognition of pension scheme surplus or deficits at the beginning of 2004 and the 'corridor' approach of spreading actuarial gains and losses over future service of the employees.

On the other hand, restatement at the transition date is not allowed for:

• hedge accounting for financial instruments
• the effect of hindsight on estimates made properly in previous accounts.

These exceptions are meant to balance the need for comparability between different companies applying IFRS and the costs of restatements. So, for example, in 2005, the IFRS standard is expected to require that all business combinations must be accounted for as acquisitions and that goodwill must not be amortised, but subject to annual impairment tests. The exception under IFRS 1 will therefore mean that if a pre-transition combination has under national rules been treated as a merger, then a company need not in 2005 go back and treat it as an acquisition. In other words, it need not try to estimate fair values for assets and liabilities at the time of the combination. Nor need it establish a goodwill figure and reverse any amortisation for these past transactions or any immediate write-off direct to reserves (if that was permitted by national rules).

The restatement of past business combinations tends to be one of the most difficult and therefore costly for companies to carry out. On the other hand of course, the effect of the different possible accounting treatments in this area tends to be among the most significant. The result of these exceptions is that there will not be complete comparability between entities applying IFRS, but the comparability of one year to another of the same enterprise will be better.

If full comparability is not possible, then complete transparency is all the more important. IFRS 1 requires a full reconciliation of the differences in shareholders' funds and profits between those reported under national rules and those restated under IFRS.

The publication of IFRS 1 is important as a milestone for IASB. Though they adopted all of their predecessor's existing International Accounting Standards (IAS) when set up in 2001, two years later this is the first new standard they have produced. IFRS 1 also marks the first step in the development of the platform of standards that EU and other companies will use for their conversion in 2005. The rest are meant to follow before the end of March 2004 - the improvements to existing IAS, together with new standards on business combinations (as noted above), share-based payments and insurance.

Richard Martin is ACCA's head of financial reporting.