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This article was first published in the June 2009 edition of Accounting and Business magazine.
In 2007, the UK Government made a commitment that the UK public sector would move towards adopting the International Financial Reporting Standards (IFRS). This was to bring about greater consistency and comparability across the global economy and to follow private sector best practice in the UK public sector.
However, experience has shown that the transition is both lengthy and complex and has wide-reaching implications, as it involves not only finance and the Treasury, but human resources, estates, procurement, IT and a range of other stakeholders.
IFRS 1 has great practical significance for sectors and countries that are expected to adopt the standards in the near future. It applies to an entity that presents its first IFRS financial statements and sets out ground rules an entity needs to follow when it adopts the standards for the first time.
An entity's first IFRS financial statements are those that are the first annual financial statements in which the entity adopts IFRS by an explicit and unreserved statement of compliance. The standards give examples of situations where financial statements do and do not qualify as 'first IFRS financial statements'.
An entity adopting the standards for the first time prepares an opening balance sheet on the date of transition. This balance sheet serves as the starting point for the entity's accounting under IFRS. The revised IFRS 1 issued at 1 January 2009 requires an entity to prepare and present an opening IFRS statement of financial position at the date of transition to IFRS.
However, disclosure of a reconciliation of equity reported under previous Generally Accepted Accounting Principles (GAAP) to equity under IFRS is required, as is a reconciliation of profit or loss for the last annual period reported under the previous GAAP, to profit or loss under IFRS for the same period.
In preparing the opening FRS balance sheet, the following rules should be followed, except in cases where IFRS 1 grants targeted exemptions and prohibits retrospective application:
- assets and liabilities should be recognised where required under IFRS
- assets and liabilities should be derecognised where required under IFRS
- items that were 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 should be reclassified, and
- all recognised assets and liabilities should be measured according to principles outlined in IFRS.
A first-time adopter should consistently apply the same accounting policies throughout the periods presented in its first IFRS financial statements, and these accounting policies should be based on the latest version of the IFRS effective at the reporting date. IFRS 1 states that the transitional provisions in other IFRSs do not apply to first-time adopters.
It does, however, allow a first-time adopter to elect to use one or more exemptions from the general measurement and restatement principles, as follows:
- An entity may keep the original GAAP accounting for business combinations that occurred before or prior to the date of opening balance sheet date.
- For assets (property, plant and equipment; intangible assets; and investment property) measured at fair value or revalued under previous GAAP, fair value becomes the 'deemed cost' under the IFRS cost model. Deemed cost is an amount used as a surrogate for cost or depreciated cost at a given date.
- An entity may elect to recognise all cumulative actuarial gains and losses for all defined employee benefit plans at the opening IFRS balance sheet date.
- An entity may elect to recognise all cumulative translation differences arising on the translation of the financial statements of foreign entities in accumulated profits or losses at the opening IFRS balance sheet date. This effectively means resetting the translation reserve included in equity under previous GAAP to zero.
There are also mandatory exceptions to the general restatement and measurement principles:
- A first-time adopter is not permitted to recognise financial assets or financial liabilities that had been derecognised under its previous GAAP in a financial year beginning before 1 January 2001. However, a first-time adopter should recognise all derivatives and other interests retained after derecognition and still existing, and consolidate all special-purpose entities (SPEs) that it controls at the date of transition to IFRS.
- The conditions in IAS 39 for a hedging relationship that qualifies for hedge accounting are applied at the opening IFRS balance sheet date, not retrospectively. The hedge accounting practices that were used in periods prior to the opening IFRS balance sheet may not be retrospectively changed. An entity's estimates under IFRS at the date of transition to IFRS should be consistent with estimates made for the same date under its previous GAAP, unless there is objective evidence that those estimates were wrong. Any information an entity receives after the date of transition to IFRS about estimates it made under previous GAAP should be treated by it as a 'non-adjusting' event after the balance sheet date.
Entity transition to IFRS 31 December 2009
The accounting policies selected will be based on IFRSs in force at 31 December 2009.
The entity should prepare 2009 and 2008 financial statements, and restate retrospectively the opening balance sheet (beginning of the first period for which full comparative financial statements are presented) by applying the IFRSs in force at 31 December 2009. Since IAS 1 requires that at least one year of comparative prior-period financial information be presented, the opening balance sheet will be 1 January 2008.
Case study: move to IFRS by public sector council in the UK
Councils will publish their first full set of IFRS-compliant accounts for the financial year of 2010/11. This means:
- restatement of the closing balance sheet for 2009 in accordance with IFRS
- preparation/restatement of the Government accounts for 2009/10 in accordance with IFRS
- restatement of the accounting policies of councils to be in line with IFRS, and
- preparation of IFRS financial statements at 31 March 2011.
There are several differences between IFRS and current practice within councils. Under IFRS, significant components of an asset that have different useful economic lives for depreciation purposes are required to be recorded, valued and depreciated separately within the accounts.
This is not a current accounting requirement for councils and thus professional valuers will be required in order to identify and value the significant components held. This change will have an impact on the council's fixed asset register by increasing the number of assets held within the system that are required to be administered each year.
IAS 17 requires leases of land and buildings to be accounted for and disclosed separately, and the classification criteria for finance leases are less rigid. Currently, many of the leases held by councils are classified as operating leases.
Under IFRS, some of the leases will be classified as finance leases and will need to be brought onto the balance sheet. Where changes in the treatment of any leases are identified, these are required to be accounted for retrospectively under IFRS 1 from the lease inception date.
Under IFRS, councils only require the power to influence another entity for it to be treated as a group entity, whereas at the moment a council has to actually exercise its power for the entity to be treated as part of the 'group'. This change under IFRS will lead to more entities being accounted for within the council's group accounts.
A council is required to accrue for the cost of accumulating short-term employee benefits. 'Accumulating benefits' are those that can be carried forward and used in future periods if the employee's entitlement is not utilised in full at the year end. Accruals will be required to made under IFRS for untaken annual leave and outstanding flexitime. Such details are unlikely to be recorded on the council's payroll system and will have to be determined.
Councils will also be required to prepare separate disclosures of the results and assets for its major operating segments. These new disclosures are considered to be significant, as the structure of the chart of accounts within councils' general ledger system will need to be modified. Separate subledgers will need to be set up to allow the required information to be held and extracted for each operating segment within a council.
Upon first-time adoption of the IFRS at the transition date of 1 April 2009, the accounts need to be restated as though a council had always accounted using IFRS. The council is required to review and restate the accounting records back to the start date of the transactions.
The adjustments that are identified are to be made to the opening balance sheet as at 1 April 2009. The introduction of the IFRS will be a significant challenge to a council, as seen in the implementation within the private sector where accounts have, on average, increased by 60% in content.
Many types of entity have not yet made the move to IFRS and, similarly, many countries have yet to fully adopt IFRS. A detailed knowledge of IFRS 1 is critical, as it gives entities the opportunity to clean up their balance sheets before being caught by IFRS.
Graham Holt, ACCA examiner and principal lecturer in accounting and finance, Manchester Metropolitan University Business School