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Table of Contents 04
International GAAP® 2012 Ernst & Young Extract: Chapter 1 - International GAAP®
37 Wiley IFRS 2012 Bruce Mackenzie, Danie Coetsee, Tapiwa Njikizana, Raymond Chamboko Extract: Chapter 1 - Introduction to International Financial Reporting Standards
53 Wiley IFRS Practical Implementation Guide and Workbook Abbas A. Mirza, Graham Holt, Liesel Knorr Extract: Chapter 1 - Introduction to International Financial Reporting Standards
International GAAP® 2012
International GAAP® 2012 Generally Accepted Accounting Practice under International Financial Reporting Standards Ernst & Young 9781119962458 • Paper • 3806 pages 12/30/2011 • £135 / €162 / $220
Chapter 1 International GAAP® 1. WHY INTERNATIONAL FINANCIAL REPORTING STANDARDS MATTER With globalisation has come the increasing integration of world markets for goods, services and capital – with the result that companies that traditionally were reliant on their domestic capital markets for financing now have substantially increased access to debt and equity capital both inside and outside their national borders. Yet – perhaps not entirely surprisingly – the world of financial reporting has historically been slow to respond reflecting, no doubt, a widespread nationalism in respect of countries’ own standards. Undoubtedly, one of the main advantages of a single set of global accounting standards is that it would enable the international capital markets to assess and compare intercompany performance in a much more meani ngful, effective and efficient way than is presently possible. This should increase companies’ access to global capital and ultimately reduce the cost thereof. Thus the request for global standards came both from regulatory bodies and from preparers of financial statements. As early as 1989 the International Organisation of Securities Commissions (IOSCO), the world’s primary forum for co-operation among securities regulators, prepared a paper noting that cross border security offerings would be facilitated by the development of internationally accepted standards. For preparers, greater comparability in financial reporting with their global peers had obvious attractions. Notwithstanding these anticipated benefits it is only since 2000 that there has been a realistic prospect of such global standards and that has come about largely as a result of bold action by the European Commission. The European Commission announced in June 2000 that it would present proposals to introduce the requirement that all listed European Union (EU) companies report in accordance with International Accounting Standards by 2005. This requirement – which was adopted in an EU Regulation in 2002 – has changed fundamentally not only the face of European financial reporting, but global reporting as well. 4
Ernst & Young Although the EU is almost certainly the International Accounting Standards Board’s (IASB’s) most significant single constituency for the time being, there are also a number of other economically developed countries that either have already adopted – or will be adopting – International Financial Reporting Standards (IFRS) as their primary system of GAAP®. Notable examples are Australia, which adopted IFRS effective 2005, Canada, which replaced Canadian GAAP® with IFRS from 1 January 2011 onwards for ‘publicly accountable enterprises’, and Japan where, in June 2009 the Business Accounting Council (a key advisory body for the Financial Services Agency) approved a roadmap for the adoption of IFRS in Japan, subject to a final decision in 2012. Significantly also, countries such as Brazil, China, India and Russia have made significant progress towards the adoption of IFRS, whilst countries such as South Africa have already aligned their national standards with IFRS. The European Commission’s decision to adopt IFRS as the basis of financial reporting for all listed EU companies coincided also with the restructuring of the former International Accounting Standards Committee and the formation on 1 April 2001 of the present day IASB. Since then, the IASB and the US Financial Accounting Standards Board (FASB) have become increasingly committed to the convergence of IFRS and US GAAP®. This is evidenced by the October 2002 Norwalk Agreement and the February 2006 Memorandum of Understanding between the FASB and the IASB, both of which are discussed in section 3 below. Beyond convergence between IFRS and US GAAP® there is the prospect of adoption of IFRS in the US. In November 2007 the SEC voted unanimously to remove the requirement for a reconciliation to US GAAP® from financial statements prepared in accordance with IFRS issued by the IASB. In August 2008 the SEC approved for public comment its ‘roadmap’ relating to the eventual use of IFRS by US companies. The proposed ‘roadmap’ anticipates mandatory reporting under IFRS beginning in 2014, 2015 or 2016 depending on the size of the company. The SEC’s proposed roadmap is discussed more fully at 3.2.4 below. In May 2011, the SEC staff issued a paper to describe one possible approach for incorporation of IFRS into the US financial reporting system, assuming that the SEC decides it is in the best interest of US investors. The approach would establish an endorsement protocol for the FASB to incorporate newly issued or amended IFRS into US GAAP®. During a defined transition period (e.g. five to seven years), differences between IFRS and US GAAP® would be eliminated through ongoing FASB standard setting. This approach is one of several possible ways to incorporate IFRS into the US financial reporting system and the SEC has not yet decided whether to move ahead with incorporation. Although we believe that investors and the capital markets, as well as companies themselves, would benefit from a single set of high quality global accounting standards, the SEC staff’s approach recognises the challenges in making a wholesale US shift to IFRS. The staff’s proposals would move the US forward towards closer convergence with IFRS and, significantly, a commitment to not create further differences.
International GAAP® 2012 The fall-out from the 2007 – 2010 financial crisis created a strong underlying political pressure towards convergence of global accounting standards. Comments on the need to achieve this are a regular feature of communications from the G20. Thus global financial reporting has ceased to be characterised by numerous disparate national systems to the point at which there are today essentially only two – IFRS and US GAAP®. Furthermore, there is a strong possibility that IFRS eventually will become the global financial reporting standards. This chapter discusses the way IFRS is set, the status of convergence with US GAAP®, the current agenda of the IASB and adoption of IFRS around the world.
2. THE IFRS FOUNDATION AND THE IASB 2.1 The standard setting structure The diagram below illustrates the current structure within which standards are set by the IASB. The various elements of the structure are discussed further below.
Unless indicated otherwise, references to IFRS include the following: • International Financial Reporting Standards – standards developed by the IASB • International Accounting Standards (IAS) – standards developed by the International Accounting Standards Committee (IASC), the predecessor to the IASB • Interpretations developed by the IFRS Interpretations Committee or its predecessor, the Standing Interpretations Committee (SIC) • International Financial Reporting Standards for Small and Medium-sized Entities (IFRS for SMEs) – a stand-alone standard for general purpose financial statements of small and medium-sized entities (as defined).
Ernst & Young
2.1.1 The IFRS Foundation The governance of the organisation primarily rests with the Trustees of the IFRS Foundation (Trustees) who, in turn, act under the terms of the IFRS Foundation Constitution (the Constitution). It is a requirement of the Constitution that, in order to ensure a broad international basis, there must be: • six Trustees appointed from the Asia/Oceania region; • six Trustees appointed from Europe; • six Trustees appointed from North America; • one Trustee appointed from Africa; • one Trustee appointed from South America; and • two Trustees appointed from any area, subject to maintaining overall geographical balance. The appointment of Trustees to fill vacancies caused by routine retirement or other reasons is the responsibility of the remaining Trustees but subject to the approval of the Monitoring Board as discussed in 2.1.2 below. The appointment of the Trustees is normally for a term of three years, renewable once. The Constitution requires that the Trustees should comprise individuals that, as a group, provide an appropriate balance of professional backgrounds, including auditors, preparers, users, academics, and officials serving the public interest. Two of the Trustees will normally be senior partners of prominent international accounting firms. To achieve such a balance, Trustees are selected after consultation with national and international organisations of auditors (including the International Federation of Accountants), preparers, users and academics. The Trustees are required to establish procedures for inviting suggestions for appointments from these relevant organisations and for allowing individuals to put forward their own names, including advertising vacant positions. The Constitution provides that ‘all Trustees shall be required to show a firm commitment to the IFRS Foundation and the IASB as a high quality global standardsetter, to be financially knowledgeable, and to have an ability to meet the time commitment. Each Trustee shall have an understanding of, and be sensitive to the challenges associated with the adoption and application of high quality global accounting standards developed for use in the world’s capital markets and by other users.’ The Trustees are responsible also for appointing the members of the IASB, IFRS Interpretations Committee (the Interpretations Committee) and IFRS Advisory Council (the Advisory Council). In addition, their duties include the following: • assuming responsibility for establishing and maintaining appropriate financing arrangements; • reviewing annually the strategy of the IFRS Foundation and the IASB and their effectiveness, including consideration, but not determination, of the IASB’s agenda; 7
International GAAP® 2012 • approving annually the budget of the IFRS Foundation and determining the basis for funding; • reviewing broad strategic issues affecting financial reporting standards, promoting the IFRS Foundation and its work and promoting the objective of rigorous application of IFRS (the Trustees are, however, excluded from involvement in technical matters relating to accounting standards); • establishing and amending operating procedures, consultative arrangements and due process for the IASB, the Interpretations Committee and the Advisory Council; • approving amendments to the Constitution after following a due process, including consultation with the Advisory Council and publication of an exposure draft for public comment; • exercising all powers of the IFRS Foundation except for those expressly reserved to the IASB, the Interpretations Committee and the Advisory Council; and • publishing an annual report on the IFRS Foundation’s activities, including audited financial statements and priorities for the coming year. The IFRS Foundation has developed four principles for a funding system. Those principles are that it should be: • Broad based; • Compelling; • Open ended; and • Country specific. The Trustees have sought to establish national funding regimes consistent with these principles in a number of countries. In 2010, the major funders of the IFRS Foundation were the international accounting firms, the US, Japan and Germany.
2.1.2 The Monitoring Board A frequent criticism of the IASB and of the IFRS Foundation has been of its lack of ‘accountability’ and apparent lack of responsiveness to the concerns of its constituents. This criticism has increased as the level of international acceptance of IFRS has grown. The Trustees have recognised this concern. In a 2008 consultation paper on the Constitution they noted that they understood that the IFRS Foundation’s unique structure makes demonstrating public accountability more challenging than it would be for a national standard setter, which normally reports to national regulators, governments or parliaments. The response to these concerns was the creation of a Monitoring Board to provide a formal link between the Trustees and public authorities. This relationship seeks to replicate, on an international basis, the link between accounting standard-setters and those public authorities that have generally overseen accounting standard-setters. The responsibilities of the Monitoring Board are to: • Participate in the process for appointing Trustees and approve the appointment 8
Ernst & Young of Trustees; • Review and provide advice to the Trustees on the fulfilment of their responsibilities – there is an obligation on the Trustees to report annually to the Monitoring Board; • Meet with the Trustees or a sub-group thereof at least annually. The Monitoring Board has the authority to request meetings with the Trustees or separately with the chair of the Trustees and with the chair of the IASB to discuss any area of the work of the Trustees or the IASB. At the time of writing, the Monitoring Board comprises: (a) a member of the European Commission; (b) the chair of the IOSCO Emerging Markets Committee; (c) the chair of the IOSCO Technical Committee; (d) the commissioner of the Japan Financial Services Agency; (e) the chair of the US SEC; and (g) as an observer, the chair of the Basel Committee on Banking Supervision. The Charter of the Monitoring Board notes that the Monitoring Board’s mission is: • To cooperate to promote the continued development of IFRS as a high quality set of global accounting standards; • To monitor and reinforce the public interest oversight function of the IFRS Foundation, while preserving the independence of the IASB. In that regard;
• To participate in the selection and approval of the Trustee appointments;
• To advise the Trustees with respect to the fulfilment of their responsibilities, in particular with respect to regulatory, legal and policy developments that are pertinent to the IFRS Foundation’s oversight of the IASB and appropriate sources of IFRS Foundation funding; and
• To discuss issues and share views relating to IFRS, as well as regulatory and market developments affecting the development and functioning of these standards. To support the effective operation of the Monitoring Board, in April 2009 a Memorandum of Understanding was agreed between the Monitoring Board and the Trustees. The Memorandum of Understanding sets out how the oversight process will work in practice. When the Trustees originally proposed the Monitoring Board, a number of commentators expressed concerns that it could threaten the independence of the IASB and lead to greater ‘political interference’ if the Monitoring Board began to influence specific decisions. More recently, concerns about political interference in standard setting have increased because of the way that both the FASB and IASB were seen to react to political pressure during the 2007 – 2010 financial crisis. This goes to the heart of a very difficult balancing exercise. Most observers want the Trustees and the IASB to be responsive to constituents’ concerns but they also support the principle of 9
International GAAP® 2012 ‘independent standard setting’ – how does one achieve both? Regarding the role and influence of the Monitoring Board, the Trustees were satisfied that because its role was restricted to oversight of the Trustees’ fulfilment of their responsibilities there was no risk to the independence of the IASB. Furthermore the preservation of the independence of the IASB is, as noted above, part of the mission of the Monitoring Board. However, the Memorandum of Understanding provides a wide remit for the Monitoring Board, including the following statement: ‘The IASCF [now the IFRS Foundation] Monitoring Board may refer accounting issues to, and will confer regarding these issues with, the Trustees and the IASB Chair. i. The Trustees will work with the IASB to ensure these issues are addressed in a timely manner. ii. If the IASB determines that consideration of the issue(s) identified by the IASCF Monitoring Board is not advisable or that the issue(s) cannot be resolved within the time frame suggested by the Monitoring Board, the Trustees should: 1. call on the IASB to undertake all reasonable efforts to consider issues(s) in a manner that is consistent with the public interest, taking account the protection of investors; 2. call on the IASB to explain its position through the Trustees regarding the IASB’s position on the issue(s); and
3. promptly notify the IASCF Monitoring Board of the IASB’s position.’
To assess whether the three-tier structure of the IFRS Foundation is best achieving its goal of increasing accountability whilst maintaining independence, the Monitoring Board initiated a review of the governance structure supporting the development of IFRS in April 2010. As part of this review, the Monitoring Board issued the Consultative Report on the Review of the IFRS Foundation’s Governance in February 2011 requesting views on the following key areas: • Composition and structure of the IASB, Trustees and Monitoring Board • Oversight, roles and responsibilities of the Trustees and Monitoring Board However, the fundamental question of the review continues to be whether the current governance structure effectively promotes the standard-setter’s primary mission of setting high quality, globally accepted standards. A package of recommendations resulting from the governance review is expected to be issued in the second half of 2011. In addition, in April 2011 the Trustees issued their Report of the Trustees’ Strategy Review (Strategy Review). The Strategy Review sets out recommendations in the following areas: • The IFRS Foundation’s mission • Governance • The standard-setting process • Financing the IFRS Foundation. 10
Ernst & Young The review of the Monitoring Board focuses primarily on the institutional aspects of governance such as composition and roles of the Monitoring Board, the IASB and the Trustees. The Strategy Review places more emphasis on the operational aspects of governance, such as due process. Both reviews are aimed at ensuring the IFRS Foundationâ€™s governance balances independence and accountability appropriately to facilitate the development of high quality and truly global standards.
2.1.3 The International Accounting Standards Board (IASB) At the time of writing the IASB comprises 15 members, however the Constitution requires that this should be increased to 16 by no later than 1 July 2012. Up to three members may be part time and the remainder full time. The members of the IASB are appointed by the Trustees. The main qualifications for membership of the IASB are professional competence and practical experience. The Trustees are required to select IASB members so that the IASB as a group provides an appropriate mix of recent practical experience among auditors, preparers, users and academics. Furthermore, the IASB is, in consultation with the Trustees, expected to establish and maintain liaison with national standard-setters and other official bodies concerned with standard-setting in order to assist in the development of IFRS and to promote the convergence of national accounting standards and IFRS. By July 2012 the IASB will normally be required to comprise: (a) four members from Asia/Oceania; (b) four members form Europe; (c) four members from North America; (d) one member from Africa; (e) one member from South America; and (f) two members appointed from any area, subject to maintaining overall geographical balance. The responsibilities of the IASB are listed in Article 37 of the Constitution. Its primary role is to have complete responsibility for all IASB technical matters including preparing and issuing IFRSs (other than interpretations) and exposure drafts, each of which is required to include any dissenting opinions; and final approval of and issuing interpretations developed by the Interpretations Committee. Approval by at least nine members of the IASB is required for the publication of an exposure draft, and IFRS (which includes an IAS or final interpretation of the Interpretations Committee), if there are fewer than 16 members of the IASB. If there are 16 members that approval is required by at least 10 members. Other decisions of the IASB, including the publication of a discussion paper, require a simple majority of the members of the IASB present at a meeting that is attended by at least 60% of the members. The IASB has full discretion over its technical agenda and over project assignments on technical matters. It must, however, consult the Trustees on its agenda, and the Advisory Council on major projects, agenda decisions and work priorities. In addition, the IASB is required to carry out public consultation every three years in developing its technical agenda. 11
International GAAP® 2012
2.1.4 The IASB’s Due Process Handbook The Trustees set up a committee – the Trustees’ Due Process Oversight Committee (the Committee) – with the task of regularly reviewing and, if necessary, amending the procedures of due process in the light of experience and comments from the IASB and constituents. The Committee reviews proposed procedures for the IASB’s due process on new projects and the composition of working groups and ensures that their membership reflects a diversity of views and expertise. The ‘Due Process Handbook’ (the Handbook) for the IASB describes the consultative arrangements of the IASB. The Trustees approved the Handbook in October 2008, and it was updated in December 2010. The procedures described in the Handbook address the following requirements: • transparency and accessibility; • extensive consultation and responsiveness; and • accountability. In order to gain a wide range of views from interested parties throughout all stages of a project’s development, the Trustees and the IASB have established consultative procedures to govern the standard-setting process. The IASB’s standard-setting process comprises the following stages, with the Trustees having the opportunity to ensure compliance at various points throughout the process: • Stage 1: Setting the agenda; • Stage 2: Project planning; • Stage 3: Development and publication of a discussion paper; • Stage 4: Development and publication of an exposure draft; • Stage 5: Development and publication of an IFRS; and • Stage 6: Procedures after an IFRS is issued. It is important to note that the IASB’s due process requirements are separated into mandatory and non-mandatory steps. ‘The following due process steps are mandatory: • developing and pursuing the IASB’s technical agenda; • preparing and issuing IFRSs and exposure drafts, each of which is to include any dissenting opinions; • establishing procedures for reviewing comments made within a reasonable period on documents published for comment; • consulting the Advisory Council on major projects, agenda decisions and work priorities; and • publishing bases for conclusions with IFRSs and exposure drafts.’ The steps specified in the Constitution that are ‘non-mandatory’ include: • publishing a discussion document (e.g. a discussion paper); 12
Ernst & Young • establishing working groups or other types of specialist advisory groups; • holding public hearings; and • undertaking field tests (both in developed countries and in emerging markets). If the IASB decides not to undertake any of the non-mandatory steps defined by the Constitution, it is required by the Constitution to state its reasons (known as the ‘comply or explain’ approach). Explanations are normally made at IASB meetings, and are published in the decision summaries and in the basis for conclusions with the exposure draft or IFRS in question. Although not mandatory, the IASB conducts public meetings and roundtables to ensure that it has appropriate input from its constituents. There was criticism of the IASB during its attempts to respond to the 2007 – 2010 financial crisis for its failure to follow due process. This criticism relates to a failure to issue an exposure draft (in the case of the October 2008 amendment to IAS 39 – Financial Instruments: Recognition and Measurement (IAS 39) dealing with reclassification of financial assets) and more generally for only providing a short period for constituents to respond to proposals rather than the more normal three months. As a consequence a ‘fast track’ process was developed. Under this process, if the matter is exceptionally urgent, the exposure draft is short, ‘and the IASB believes that there is likely to be a broad consensus on the topic, the IASB may consider a comment period of no less than 30 days, but it will set such a short period only after formally requesting and obtaining prior approval from 75 per cent of the Trustees’.
2.1.5 The IFRS Advisory Council (the Advisory Council) The Advisory Council (whose members are appointed by the Trustees) provides a forum for geographically and functionally diverse organisations and individuals with an interest in international financial reporting to: • Give advice to the IASB on agenda decisions and priorities in the IASB’s work; • Inform the IASB on the views of the organisations and individuals on the council on major standard-setting projects; and • Give other advice to the IASB or the Trustees. The Advisory Council comprises ‘thirty or more members, having a diversity of geographical and professional backgrounds, appointed for renewable terms of three years’. The chair of the Council is appointed by the Trustees, and may not be a member of the IASB or a member of its staff. The Advisory Council normally meets at least three times a year, and its meetings are open to the public. It is required to be consulted by the IASB in advance of IASB decisions on major projects and by the Trustees in advance of any proposed changes to the Constitution. In June 2011, the Trustees announced the following changes to Advisory Council membership: • Inviting regional standard-setting bodies to join, instead of national standardsetters currently serving • Seeking further participation from the academic community, other 13
International GAAP® 2012 internationally recognised professional bodies with an interest in financial reporting not currently represented, and the small and medium sized entity community • Adding greater participating from developing markets and other economies committed to IFRS adoption In addition, in future years, membership will be for one, two or three years, to achieve an orderly rotation of membership.
2.1.6 The IFRS Interpretations Committee (the Interpretations Committee) For IFRS to be truly global standards consistent application and interpretation is required. ‘The mandate of the Interpretations Committee is to review on a timely basis widespread accounting issues that have arisen within the context of current IFRSs and to provide authoritative guidance (IFRICs) on those issues.’ The Interpretations Committee assists the IASB in improving financial reporting through timely identification, discussion and resolution of financial reporting issues within the framework of IFRS. It has 14 voting members. The chair, who is appointed by the Trustees, is a member of the IASB, the Director of Technical Activities or other appropriately qualified individual. The chair does not have the right to vote. The Trustees may appoint representatives of regulatory organisations, who have the right to attend and speak at meetings but not the right to vote. Currently, the European Commission and IOSCO have observer status. The quorum for a meeting is ten members, and approval of draft or final interpretations requires that not more than four voting members vote against the draft or final interpretation. The Interpretations Committee meets six times a year. All technical decisions are taken at sessions that are open to public observation. It reviews newly identified financial reporting issues not specifically addressed in IFRS or issues where unsatisfactory or conflicting interpretations have developed, or seem likely to develop in the absence of authoritative guidance, with a view to reaching a consensus on the appropriate treatment. The IASB approves and issues interpretations. Entities that prepare their financial statements in accordance with IFRS are required to comply with issued interpretations.
2.1.7 The IASB’s ‘Annual Improvements Process’ During 2007, the IASB adopted an annual process to deal with ‘non-urgent, minor amendments to IFRSs’ (the ‘Annual Improvements Process’). Issues dealt with in this process arise from matters raised by the Interpretations Committee and suggestions from IASB staff or practitioners, and focus on areas of inconsistency in IFRS or where clarification of wording is required. The premise behind the Annual Improvements Process is to streamline the IASB’s standard-setting process. If a number of minor amendments are processed together, there will be benefits both to constituents and the IASB. The Interpretations Committee assists the IASB by reviewing and recommending potential amendments to IFRS. ‘Annual Improvements’ is on the IASB’s work plan like its other projects and 14
Ernst & Young is subject to the same due process. In February 2011, the Trustees approved amendments to the Handbook to create enhanced criteria to assess whether a matter should be amended through the Annual Improvements Process. Although the Handbook has not been updated at the time of writing, the IASB is following these enhanced criteria for Annual Improvements 2009-2011.
3 THE IASB’S TECHNICAL AGENDA AND GLOBAL CONVERGENCE 3.1 The IASB’s current priorities and future agenda At the time of writing, the IASB could be described as being at a crossroads. The convergence projects with the FASB, which have consumed a significant effort throughout much of the Board’s history, are expected to be completed in 2012. All of the founding Board members have completed their terms and on 1 July 2011, the Board has a new chair, Hans Hoogervorst, and vice-chair, Ian Mackintosh. In addition, the SEC is expected to make a decision later in 2011 on whether and how IFRS should be incorporated into the US financial reporting system. All of these factors will influence the Board’s future agenda and are discussed in more detail below.
3.1.1 The IASB’s current priorities The majority of the projects on the IASB’s current work plan stem from a Memorandum of Understanding between the IASB and the FASB, which is discussed in more detail in 3.2.2. In a joint progress report on IASB and FASB convergence work issued in April 2011, the IASB indicated that its work plan for the remainder of 2011 would focus on the revenue recognition, leases, financial instruments and insurance contracts projects. Both boards consider the need for improvements in these areas to be the most urgent and as of July 2011 are targeting them for completion in 2011 and 2012. Annual improvements and the Agenda Consultation 2011 (which is discussed in more detail in 3.1.2) are also active projects on the IASB’s agenda. The IASB has deferred projects on financial statement presentation, financial instruments with characteristics of equity, emissions trading schemes, liabilities, income taxes and the conceptual framework until late 2011. It will review these projects as part of its agenda consultation process. The IASB’s current work plan is available on its website under the ‘Standards development’ tab, ‘Workplan for IFRSs’.
3.1.2 Agenda consultation 2011 As discussed in 2.1.3, the Constitution requires that that the IASB carry out public consultation every three years in developing its technical agenda. This process commenced on 26 July 2011 when the IASB issued a Request for Views on the 15
International GAAP® 2012 strategic direction and overall balance of its future agenda. The IASB proposed the following strategic foundation for setting its future agenda: • A more diverse IFRS community will potentially lead to new issues • A more complex market environment will create new challenges in financial reporting • The new and amended IFRS that have been issued in 2011 or are expected to be issued in 2012 will place pressure on preparers to implement the changes and users to understand the key differences; preparers and users may want a period of calm before additional significant projects are added to the agenda. The Request for Views also highlights that the strategy of the future agenda should not only focus on the development of new IFRS, but should also emphasise the need to perform post-implementation reviews of issued IFRS and targeted narrow scope improvements to existing IFRS. The post 2011 agenda will be heavily influenced by the progress actually made on existing projects in 2011. Furthermore any decision the SEC makes in 2011 on the role of IFRS in the US can also be expected to have an influence on the post 2011 agenda. The background and status of US adoption of IFRS is discussed in more detail in 3.2.4.
3.1.3 New IASB leadership 2011 marked the retirement of Sir David Tweedie from the IASB. David Tweedie led the IASB since its inception in 2001 and was hugely influential in its development. Effective 1 July 2011, Hans Hoogervorst became the chair of the IASB. Mr. Hoogervorst brings a regulatory background to the Board having served most recently as chair of the executive board of the Netherlands Authority for the Financial Markets and the IOSCO technical committee. He was also co-chair of the Financial Crisis Advisory Group (FCAG) to the IASB and chair of the IFRS Foundation Monitoring Board. Also effective 1 July 2011, Ian Mackintosh became vice-chair of the IASB. He has played an active role in standard setting since 1983 serving as chair of the UK Accounting Standards Board, deputy chair of the Australian Accounting Standards Board and chair of its Urgent Issues Group. Among other roles, Mr. Mackintosh also served as manager, financial management, South Asia at the World Bank. The effect the new chair and vice-chair will have on the IASB’s agenda is yet to be known, however, upon issuance of the Agenda Consultation 2011 Hans Hoogervorst commented: ‘Up until now, the agenda of the IASB has largely been determined by the need to support a first wave of jurisdictions adopting IFRSs and the completion of our programme to improve IFRSs and align them with US GAAP®. With this work largely completed, our attention can now turn to new issues that may require our attention.’ With exposure or re-exposure on several projects or phases of projects, the comment period on the agenda consultation and a decision from the SEC all 16
Ernst & Young occurring in the second half of 2011, as well as a new IASB chair and vice-chair, it is difficult to foresee what the priorities of the IASB will be for 2012.
3.2 IFRS/US GAAP® convergence ‘Convergence’ is a term used to describe the coming together of national systems of financial reporting and IFRS. Since its formation in 2001, the IASB has made great strides toward achieving global accounting convergence, with the result that the global acceptance of IFRS is rapidly becoming a reality. All listed EU companies are already required to prepare their consolidated financial statements in accordance with adopted IFRSs. Elsewhere, scores of non-EU countries have either adopted or are in the process of adopting or are aligning their national standards with IFRS. For a company to assert compliance with IFRS it is required to apply IFRS 1 – First-time Adoption of International Financial Reporting Standards (IFRS 1). The IASB has therefore established unambiguously the principle that full application of its standards and related interpretations is necessary for a company to be able to assert that its financial statements comply with IFRS (as issued by the IASB). Consequently, it is necessary for countries that align their national standards with IFRS to require the application of IFRS 1 so that companies reporting under those standards can assert compliance with IFRS. In addition, a company that applies IFRS as amended by a local authority cannot assert compliance with IFRS.
3.2.1 Convergence with US GAAP®: The Norwalk Agreement For many years, the co-operation between the IASC/IASB and national standard setters had happened – mostly at an informal level – through a variety of bodies such as the G4+1 and the Joint Working Group of Standard Setters.46 In the US, support for convergence grew steadily, and in October 2002 the IASB and FASB issued a memorandum of understanding that marked a significant step towards the two boards formalising their commitment to the convergence of IFRS and US GAAP®. This agreement, referred to as the Norwalk Agreement, was reached at a joint meeting in September 2002, where the Boards each acknowledged their commitment to the development of high-quality, compatible accounting standards that could be used for both domestic and cross-border financial reporting. At that meeting, the Boards pledged to use their best efforts to (a) make their existing financial reporting standards fully compatible as soon as is practicable and (b) to coordinate their future work programmes to ensure that once achieved, compatibility is maintained. To achieve compatibility, the Boards agreed, as a matter of high priority, to: • undertake a short-term project aimed at removing a variety of individual differences between US GAAP® and IFRS; • remove other differences between IFRS and US GAAP® that would remain at 1 January 2005, through coordination of their future work programmes; that is, through the mutual undertaking of discrete, substantial projects that both Boards would address concurrently; • c ontinue progress on the joint projects that they were currently undertaking; and 17
International GAAP® 2012 •e ncourage their respective interpretative bodies to coordinate their activities. The Boards agreed to commit the necessary resources to complete such a major undertaking and to start deliberating differences identified for resolution in the short-term project with the objective of achieving compatibility by identifying common, high-quality solutions. The Boards agreed also to use their best efforts to propose changes to US GAAP® or IFRS that reflected common solutions to some, and perhaps all, of the differences identified for inclusion in the short-term project during 2003.
3.2.2 Memorandum of Understanding between the FASB and the IASB On 27 February 2006, the FASB and the IASB published a Memorandum of Understanding (MOU) that reaffirmed the Boards’ shared objective of developing high quality, common accounting standards for use in the world’s capital markets. The MOU was a further elaboration of the objectives and principles first described in the Boards’ Norwalk Agreement (see 3.2.1 above). The Boards agreed that trying to eliminate differences between their respective standards when both were in need of significant improvement was not the best use of resources – instead, new common standards should be developed. Consistent with that principle, convergence work would continue to proceed on the following two tracks: • f irst, the Boards would reach a conclusion about whether major differences in focused areas should be eliminated through one or more short-term standardsetting projects, and, if so, would aim to complete or substantially complete work in those areas by 2008; and • s econd, the FASB and the IASB would seek to make continued progress on joint projects in other areas they identified where current accounting practices under US GAAP® and IFRS were regarded as candidates for improvement (eleven areas were identified in the MOU). The Boards pointed out that their work programmes were not limited to the items listed in the MOU. The FASB and the IASB would follow their normal due process when adding items to their agendas. Topics for short-term convergence included the following:
Ernst & Young Topics that were on the active and research agendas of the IASB and/or the FASB that would be worked on jointly (i.e. the MOU projects) included the following:
Subsequent to entering into the MOU, the Boards added a joint project on insurance. Progress on the various projects can perhaps be described as mixed. Certainly progress has been slower than was anticipated and a number of the areas that were to be addressed have proved intractable for the Boards. Nevertheless, the Boards concluded during 2008 that most of the milestones had been reached or were due to be reached during 2008, and as a result there was little guidance on prioritisation of projects on the Board’s active agenda.Given the number of jurisdictions that announced their intention to adopt or converge with IFRS in 2011 and 2012, the chairs of each board agreed to extend the timetable of the existing MOU through to 2011, to better direct their work plans during that period. These developments took place in the expectation that the SEC would be announcing plans for the adoption of IFRS in the US. In August 2008 the SEC approved for public comment its proposed ‘roadmap’ relating to the eventual use of IFRS by US companies (see 3.2.4 below). It was clear that the SEC saw the continued progress of the IASB and FASB on convergence as being an important condition for progress on the roadmap. In September 2008 the Boards published a short memorandum Completing the February 2006 Memorandum of Understanding: A progress report and timetable for completion. However, progress against the expectations set out in that memorandum was adversely affected by the time the Boards had to spend from 2008 through 2010 dealing with the implications of the 2007 – 2010 financial crisis. Since then, the Boards have issued three other progress reports, most recently in April 2011. In April 2011, the Boards reported that they are nearing completion of the MOU programme. The shortterm convergence projects ‘have been completed or are close to completion’ and of the other MOU projects, ‘only three ... remain for which the boards have yet to finalise the technical decisions – financial instruments, revenue recognition and leasing.’
International GAAP® 2012
3.2.3 SEC Concept Release on allowing US issuers to prepare financial statements in accordance with IFRS In July 2007 the SEC issued a proposal to accept IFRS financial statements from foreign private issuers (FPIs) without reconciliation to US GAAP®, which in turn raised the question as to whether it also should accept financial statements prepared in accordance with IFRS from US issuers. Consequently, in August 2007, the SEC published a Concept Release to obtain information about the extent and nature of the public’s interest in allowing US issuers to prepare financial statements in accordance with IFRS for purposes of complying with the rules and regulations of the SEC. According to the SEC, it had identified at least two market forces that might provide incentives for some market participants to request in the future that the SEC accepts from US issuers financial statements prepared in accordance with IFRS. First, as a growing number of jurisdictions move to IFRS, more non-US companies will report their financial results in accordance with IFRS. If a critical mass of non-US companies in a certain industry sector or market reports in accordance with IFRS, then there might be pressure for US issuers in that industry sector or market to likewise report in accordance with IFRS to enable investors to compare US issuers’ financial results more efficiently with those of their competitors. Second, as more jurisdictions accept financial statements prepared in accordance with IFRS for local regulatory or statutory filing purposes, US issuers’ subsidiaries based in these jurisdictions might be preparing and filing their local financial statements using IFRS as their basis of accounting. If US issuers have a large number of subsidiaries reporting in this manner, then these US issuers – most likely large, multinational corporations – might incur lower costs in preparing their consolidated financial statements using IFRS rather than US GAAP®. The SEC anticipated that not all US issuers would have incentives to use IFRS. For example, US issuers without significant customers or operations outside the US – which might tend to be smaller public companies – might not have the market incentives to prepare IFRS financial statements for the foreseeable future. Additionally, the SEC recognised that there might be significant consequences to allowing US issuers to prepare their financial statements in accordance with IFRS. If the SEC were to accept financial statements prepared in accordance with IFRS from US issuers, then investors and market participants would have to be able to understand and work with both IFRS and US GAAP® when comparing among US issuers, because not all US issuers would be likely to elect to prepare IFRS financial statements. On a more practical level, a US issuer might have contracts such as loan agreements that include covenants based on US GAAP® financial measures or leases for which rental payments are a function of revenue as determined under US GAAP®. Similarly, US issuers might use their financial statements as the basis for filings with other regulators and authorities (for example, local and federal tax authorities, supervisory regulators) that might require US GAAP® financial information. Consequently, the SEC consultation around the Concept Release focused on such matters as: 20
Ernst & Young • Whether market participants believe that the SEC should allow US issuers to prepare financial statements in accordance with IFRS; • What the effect would be on the US capital markets of some US issuers reporting in accordance with IFRS and others in accordance with US GAAP®; •W hat effect the change would have on cost of capital; •W hether comparative advantages would be conferred on those US issuers who move to IFRS versus those that do not; •W hat the effect would be on the US capital markets of not affording the opportunity for US issuers to report in accordance with either IFRS or US GAAP®; and • What immediate, short-term or long-term incentives would a US issuer have to prepare IFRS financial statements and what immediate, short-term or longterm barriers would a US issuer encounter in seeking to prepare IFRS financial statements. In December 2007, the SEC held two roundtables; one on IFRS in the US markets and one on the practical issues surrounding the use of IFRS in the US. The roundtables indicated strong support for a single set of high quality globally accepted accounting standards, and a recognition that the rest of the world was already heading in this direction and that the end point would be IFRS not US GAAP®.
3.2.4 The proposed Roadmap In August 2008, the SEC approved for public comment, a proposed roadmap outlining the milestones and conditions that, if met, could lead to the use of IFRS in the US (Roadmap). In the Roadmap, the SEC stated that it expected to make its final decision regarding the mandatory use of IFRS in 2011 based on whether, in the SEC’s view, adoption of IFRS is in the public interest and would benefit investors. However, during her confirmation hearings in 2009, SEC Chair Mary Shapiro made it clear that whilst she supported the goal of a single set of global accounting standards she did not feel bound by the proposed Roadmap. The Roadmap anticipated that IFRS reporting would be phased-in between 2014 and 2016 depending on the size and status of the company. However, at the annual AICPA National Conference on SEC and PCAOB Developments held in December 2010, Mary Shapiro indicated that if a decision is made to move to IFRS, adoption likely would not be required before 2015. The Roadmap also included the following milestones and conditions: • Improvements in accounting standards: The SEC expects the FASB and the IASB to continue to work together and progress towards convergence of IFRS and US GAAP®. • Accountability and funding of the IFRS Foundation: To date, the IFRS Foundation has financed IASB operations largely through voluntary contributions from companies, accounting firms, international organisations and central banks. The Roadmap would require the IFRS Foundation to develop a funding mechanism 21
International GAAP® 2012 that will enable it to remain a stand-alone, private-sector organization with the necessary resources to conduct its work in a timely fashion. • Improvement in the use of interactive data (XBRL) for IFRS: The SEC has invested heavily in XBRL and expects that IFRS information will be capable of being provided to the SEC in interactive data format. The IFRS Foundation has issued a version of an IFRS taxonomy, which the SEC will consider in evaluating the status of this milestone. • Improvements in IFRS education and training: Before making a final decision to move towards IFRS, the SEC will consider the state of preparedness of US issuers, auditors and users, including the extent and availability of IFRS education and training. The SEC received approximately 200 comment letters, which were submitted by a wide range of constituents including preparers, investors, auditors and academics. Comments varied widely so it is difficult to identify a common thread or whether there is a preference for mandating IFRS in the US. Perhaps inevitably there was general support for the goal of a single set of high quality accounting standards. However many respondents expressed concern at the SEC’s approach and felt that the Roadmap did not adequately address the complexity and cost of any transition. A number of respondents argued that the goal might best be achieved through further convergence of US GAAP® and IFRS over a ‘reasonable’ timescale. Many respondents challenged whether the timetable for the completion of the current phase of convergence was achievable without compromising the quality of the resultant standards. Concerns were also expressed about the funding and independence of the IASB and how IFRS standards with less interpretive guidance would operate in the US regulatory environment. The Financial Accounting Foundation (the body which has oversight of the FASB) submitted a response calling on the SEC to conduct a thorough analysis of the issues raised by the Roadmap, including an analysis of possible conversion approaches such as convergence through continued convergence of standards over a longer period. In February 2010, the SEC reaffirmed its longstanding commitment to the goal of a single set of high-quality global accounting standards and expressed its continued support for the convergence of US GAAP® and IFRS. To aid the SEC’s evaluation of IFRS use in the US, the staff of the Office of the Chief Accountant is carrying out a comprehensive work plan to address specific factors and areas of concern before the SEC makes its decision on whether, when and how it will further incorporate IFRS into the US financial reporting system for US issuers (the Work Plan). In October 2010, the SEC issued its first progress report on the Work Plan. In connection with its issuance, SEC Chief Accountant James Kroeker commented that the ‘staff has invested significant time and effort in executing the Work Plan, and we’ve made great progress to date’. Issuance of the progress report is an important step in helping the public to understand the magnitude of the project and the SEC staff’s progress to date. In May 2011, the SEC staff issued a paper to describe one possible approach for incorporation of IFRS into the US financial reporting system, assuming that the SEC decides it is in the best interest of US investors. The approach would establish an 22
Ernst & Young endorsement protocol for the FASB to incorporate newly issued or amended IFRS into US GAAP®. During a defined transition period (e.g. five to seven years), differences between IFRS and US GAAP® would be eliminated through ongoing FASB standard setting. In July 2011, the SEC staff sponsored a roundtable to discuss topics such as investor understanding of IFRS, the impact on smaller public companies, and on the benefits and challenges in potentially incorporating IFRS into the financial reporting system for US issuers. The feedback on the roundtable was mixed. Investors generally supported the goal of a single set of high-quality global accounting standards, but expressed concerns about consistent application, interpretation, regulation and enforcement on a global basis. Participants representing smaller public companies were less supportive, largely on the basis of cost. Many participants, including regulators, expressed some support for the approach outlined in the SEC staff paper discussed above. These developments have led to a doubt amongst observers that the Roadmap will proceed as originally envisaged. Although the SEC has subsequently indicated continuing commitment to IFRS it remains unclear what decision it will reach in 2011. We believe the approach described in the SEC staff paper could be a practical alternative to full adoption of IFRS as of a specified date and could help bring US GAAP® and IFRS closer together. We would support allowing US companies the option to adopt IFRS as issued by the IASB.
3.2.5 The future for convergence Although one of the ways forward suggested in the US is further convergence of standards over a longer timescale we doubt whether that is a realistic prospect. In July 2009 the Federation of European Accountants (FEE) issued a call for a new approach to setting global financial reporting standards. FEE argued that convergence had delivered many benefits including the elimination of the SEC’s reconciliation requirement. However, it believed that there are diminishing returns from convergence due to the rapid increase in complexity with little benefit to users that arise from seeking to eliminate increasingly smaller differences. FEE therefore believed that the IASB should change its strategy to focus on major improvements and simplifications to IFRS and that it should work with standard setters from around the world in doing so. Such a change would lead to a significant reduction in the number of IASB projects. We suspect that FEE’s comments had some resonance amongst the IASB’s constituents. For example there was very little enthusiasm for a proposed amendment to IAS 33 – Earnings per Share, which was part of the convergence agenda but is no longer on it. There was a similar lack of enthusiasm for a convergence-based proposed amendment to IAS 12 – Income Taxes, particularly once the FASB effectively dropped its corresponding project. It would appear that this issue has been recognised by the Board. Speaking at the American Accounting Association’s 2009 annual meeting David Tweedie made the following observations; ‘The European Federation of Accountancy Bodies has just talked about how the 23
International GAAP® 2012 point has been reached where there have been diminishing returns from convergence with US GAAP®, particularly as more and more countries, including major economies such as Japan and India move towards direct adoption of full IFRS, and the IASB should change its strategy and concentrate exclusively on major improvements and simplifications of IFRS for the short term. We think that’s wrong. If you’re going to have global standards we need the US, but it cannot go on indefinitely ... My view is we must keep going. But to be blunt if the US turns down IFRS or does not even put a date certain – it does not matter when it is to be, 2017 who cares, if they don’t commit, I think it will be impossible to continue this after 2011.’ More recently, Ian Mackintosh suggested that future work between the IASB and FASB will depend on the SEC’s decision on IFRS. Mr. Mackintosh was quoted as saying ‘My personal opinion is that there would be less joint work with the FASB going forward.’ We are therefore at an important point in the search for a single set of high quality international financial reporting standards. All interested parties express their desire for such an outcome, it is to be hoped that continued progress can be achieved.
3.3 The impact of the 2007 – 2010 financial crisis The 2007 – 2010 financial crisis had a significant impact on the IASB and on the development of IFRS from 2008 onwards. At a basic level the time the Board had to spend discussing issues arising from the crisis caused delays in other projects, but more fundamentally it put pressure on the Board’s working relationship with the FASB, it raised again questions about the quality of some of the Board’s standards and probably had an impact on the credibility of the Board itself. There is a detailed description of the chronology of the Board’s responses to the 2007 – 2010 financial crisis in Chapter 42 at 5. Rather than repeat that here it is perhaps more useful to consider, at a high level, some of the key events and try to draw out their implications. The Financial Stability Forum (now the Financial Stability Board) was established to enhance cooperation amongst the various national and international regulatory bodies. In 2008 it raised concerns about the difficulty of valuing financial instruments in markets that had become illiquid. The IASB responded by the appointment of an Expert Advisory Panel, which proceeded to produce valuation guidance. Subsequently the IASB and FASB worked hard to ensure that there was consistency of guidance between IFRS and US GAAP®. Later in 2008 the EU expressed considerable concern that European financial institutions should not be at a disadvantage compared to their US peer group. Eventually, under pressure from the EU, this led to the publication of the reclassification amendment to IAS 39. Differences in guidance between US GAAP® and IFRS remained even after those changes. In October 2008 the FASB and IASB announced the creation of the FCAG. The remit of this group was to consider how improvements in financial reporting could enhance investor confidence in financial markets and to identify significant accounting issues that require the urgent attention of the Boards as well as issues for longer term 24
Ernst & Young consideration. Although the 2007 – 2010 financial crisis has largely passed, at the time of writing, a sovereign debt crisis has emerged in several countries. To date, the FCAG has not taken steps to address this matter. However, in August 2011, Hans Hoogervorst issued a letter to the chair of the European Securities and Markets Authority commenting on the IASB’s observations on European companies’ accounting for distressed sovereign debt. In his letter, Mr. Hoogervorst observes inconsistencies among companies in Europe in the application of IAS 39 with respect to the accounting requirements for fair value measurement and impairment losses.57 While Mr. Hoogervorst’s letter provides clarity around the requirements of IAS 39 for measuring fair value and recognising impairment losses, financial statement preparers and their auditors could have benefitted from the IASB’s comments on the issue earlier. Various themes arise from this brief summary. Firstly, standard setting remains susceptible to political pressure and the application of due process together with appropriate governance structures for the standard setters are a key defence against that. Secondly, although the IASB’s stated role is not to ensure compliance with IFRS, in the absence of a global body with such responsibility the IASB’s public comments on urgent reporting matters of global significance could go a long way to doing just that. Thirdly, whilst US GAAP® and IFRS remain as separate bodies of standards there remains the risk that at times of stress there will be pressure to converge to the ‘weaker’ standard, what some have called a ‘race to the bottom’. Fourthly, it is important to recognise the limitations of financial reporting as expressed by FCAG in 2009 that financial reporting can only provide a snapshot of performance not perfect insight into the effects of macro-economic developments, Financial reporting is important, there was and is scope for improving standards on financial instruments. However, weaknesses in those standards did not cause the 2007 – 2010 financial crisis as some have claimed and any search for perfection in standard setting is ultimately doomed because of the inherent limitations the FCAG explains. Finally, however it is worth noting that there appears still to be common ground that a single set of high quality financial reporting standards is a desirable goal. It is to be hoped that the IASB is able to deliver that. In that context it is perhaps unfortunate that there are appreciable differences between the FASB’s proposals for financial instruments and those being developed in IFRS 9 – Financial Instruments – by the IASB.
4 THE ADOPTION OF IFRS AROUND THE WORLD 4.1 Worldwide adoption Since 2001, there has been a tremendous increase in the adoption of IFRS around the world. The precise way in which this has happened has varied among jurisdictions. This section sets out a brief description of how a number of key jurisdictions in each continent have approached the adoption.
4.2.1 EU On 13 February 2001, the European Commission published a draft EU Regulation that would require publicly traded EU incorporated companies to prepare, by 2005 at 25
International GAAP® 2012 the latest, their consolidated financial statements under IFRS ‘adopted’ (as discussed further below) for application within the EU. On 12 March 2002, the European Parliament endorsed this proposal, which was adopted as Regulation No. 1606/2002 of the European Parliament and of the Council of the EU on 19 July 2002 (the Regulation). An EU regulation has direct effect on companies, without the need for national legislation. However, the Regulation also provides an option for EU member states to permit or require the application of adopted IFRS in the preparation of annual (unconsolidated) financial statements and to permit or require the application of adopted IFRS by unlisted companies. This means that EU member states can require the uniform application of adopted IFRS by important sectors, such as banking or insurance, regardless of whether or not companies are listed. The Regulation established also the basic rules for the creation of an endorsement mechanism for the adoption of IFRS, the timetable for implementation and a review clause to permit an assessment of the overall approach proposed. The European Commission took the view that an endorsement mechanism was needed to provide the necessary public oversight. The European Commission considered also that it was not appropriate, politically or legally, to delegate accounting standard setting unconditionally and irrevocably to a private organisation over which the European Commission had no influence. In addition, the endorsement mechanism is responsible for examining whether the standards adopted by the IASB satisfy relevant EU public policy criteria. The role of the endorsement mechanism is not to reformulate or replace IFRS, but to oversee the adoption of new standards and interpretations, intervening only when these contain material deficiencies or have failed to cater for features specific to the EU economic or legal environments. The central task of this mechanism is to confirm that IFRS provides a suitable basis for financial reporting by listed EU companies. The mechanism is based on a two-tier structure, combining a regulatory level with an expert level, to assist the European Commission in its endorsement role. The recitals to the Regulation state that the endorsement mechanism should act expeditiously in relation to proposed international accounting standards and also be a means to deliberate, reflect and exchange information on international accounting standards among the main parties concerned, in particular national accounting standard setters, supervisors in the fields of securities, banking and insurance, central banks including the European Central Bank (ECB), the accounting profession and users and preparers of accounts. The mechanism should be a means of fostering common understanding of adopted international accounting standards in the EU community. There are three criteria set out in the Regulation on the application of IAS in the EU with which any individual IAS must comply if it is to be adopted: • the standard should not be contrary to the principle of true and fair in conformity with accounting directives; • the standard should be conducive to the European public good; and • the standard should meet basic criteria as to the quality of information required for financial statements to be useful to users. 26
Ernst & Young These criteria, although wide, do not appear unreasonable or overly burdensome in the light of the substantial power the EU has effectively vested in the IASB. It is important to note that although a standard or interpretation can only be adopted if all three criteria are met, this does not mean that if all three criteria are met a standard or interpretation must necessarily be adopted. However, if a standard or interpretation is not adopted, EU companies are free to apply it, other than in those cases where such application would be in conflict with an accounting standard that has been adopted or with EU law. Concerns have been expressed on occasions about the speed of the EU endorsement process but to date, apart from the carve out from IAS 39 (refer to Chapter 42), all IASB standards to have gone through the process have ultimately been endorsed albeit a number of Interpretations Committee interpretations have had delayed application dates under the endorsement. However, the discussions in relation to IFRS 8 – Operating Segments (refer to Chapter 34) were particularly difficult and as a consequence the EU enacted Regulation 297/2008, which gives the EU Parliament a greater involvement in the endorsement process. Discussions about the adoption of IFRS 9 (the IASB’s revised standard on financial instruments) are also likely to be difficult in the future. At present, the process has not started pending finalisation of all aspects of the standard by the IASB. However many of those involved are likely to have strong views on this standard. The European Commission is advised on IFRS by the European Financial Reporting Advisory Group (EFRAG) and specifically by its Technical Expert Group (TEG). In addition to advising the European Commission on endorsement of IFRS, EFRAG is the mechanism by which Europe as a whole can participate in the global debate on accounting standards and it coordinates European responses to IASB proposals. Enforcement of compliance with IFRS within Europe is still, in the first instance, the responsibility of national regulators. However, the European Securities and Markets Authority (ESMA) – formerly Committee of European Securities Regulators (CESR) – has responsibility for reinforcing cooperation between those regulators. An ESMA database of regulatory decisions taken by EU National Enforcers participating in European Enforcers Co-Ordination Sessions (EECS) has been established, which should further promote consistency of application of IFRS within Europe.
4.2.2 Russia Since 2004, the Central Bank of the Russian Federation (CBR) has required credit institutions to file financial statements prepared in accordance with IFRS as issued by the IASB. For public reporting purposes, all Russian listed companies prepare their financial statements in accordance with Russian Accounting Principles (RAP), except for ‘A-listed’ companies, which are also required to prepare financial statements in accordance with IFRS or US GAAP®. Statutory financial statements also are required to be prepared in accordance with RAP. Since 1998, RAP has been gradually converging towards IFRS. Most of RAP is substantially based on IFRS, although some IFRSs have no comparable RAP standard and some RAP that are based on IFRS have not been updated for recent changes to the 27
International GAAP® 2012 comparable IFRS. On 27 July 2010, with the adoption of the Federal Law ‘On Consolidated Financial Statements’ (the Law), IFRS was introduced into the Russian legislation for the purposes of consolidated financial reporting by public companies. The Law requires that all credit and insurance institutions, as well as all listed entities, publish annual IFRS consolidated financial statements as described below. The Law and consequent Government Resolution 107 of 25 February 2011 establish the process of IFRS endorsement in Russia. Individual IFRSs (standards and interpretations) become mandatory starting from the beginning of the calendar year following the year of their endorsement, or from the effective date specified in the IFRS, if it is later. IFRSs can be voluntarily applied after they are endorsed but before their effective date. The Law allows the following companies to defer the adoption of IFRS until 2015 at the latest: • Listed companies that prepare consolidated financial statements under internationally recognised accounting principles other than IFRS (e.g. US GAAP®); • Companies with only listed debt securities. The IFRS endorsement process will begin with an analysis of the Russian language text of an IFRS provided by the IFRS Foundation by an independent expert body. On 7 July 2011, the National Organization for Financial Accounting and Reporting Standards Foundation (NOFA Foundation), a non-commercial organisation, was identified by the Ministry of Finance of the Russian Federation (Ministry of Finance) as the independent body for performing analysis of individual IFRSs’ suitability for the Russian financial reporting system. NOFA will advise the Ministry of Finance whether an IFRS should be endorsed as issued by the IASB or whether certain requirements should be ‘carved out’ to meet the needs of the financial reporting system in Russia. The Ministry of Finance, after consultation with the CBR and the Federal Service for Securities Market, makes the final decision on endorsement and publication of an IFRS. It is currently expected that the endorsement process for IFRS issued as of 1 January 2011 will be completed by the end of 2011, which would mean that most listed companies will have to file consolidated IFRS financial statements for fiscal years ending 31 December 2012. The endorsement process will continue into 2012 and beyond for all IFRSs issued after 1 January 2011.
4.3.1 US See 3.2 for a discussion of the status of US adoption of IFRS.
4.3.2 Canada In Canada, the Accounting Standards Board (AcSB) is charged with the responsibility for establishing standards of accounting and reporting for Canadian companies and not-for-profit organisations. The AcSB derives its authority from the 28
Ernst & Young Canadian Institute of Chartered Accountants (CICA). The AcSB is supported in its standard setting role by the Accounting Standards Oversight Committee (AcSOC). In January 2006 the AcSB ratified a new Strategic Plan outlining its direction for financial reporting in Canada. Under this plan the AcSB developed three separate categories of reporting entities in Canada, which are: • publicly accountable enterprises; • non-publicly accountable enterprises; and • not-for-profit organisations. For publicly accountable enterprises, the AcSB has adopted IFRS as Canadian GAAP® for fiscal years beginning on or after 1 January 2011. From that date forward, Canadian GAAP® for publicly accountable enterprises is IFRS as issued by the IASB, with the following exceptions: • Entities with rate-regulated activities have the option to defer their changeover to IFRS by one year to 1 January 2012. • Investment companies and segregated accounts of life insurance enterprises have the option to defer their changeover by two years to 1 January 2013 to correspond with the anticipated completion date for the IASBs Investment Entities project. • Pension plans, and benefit plans that have characteristics similar to pension plans, will follow the accounting standards for pension plans issued by the AcSB as of 1 January 2011, rather than IAS 26 – Accounting and Reporting by Retirement Benefit Plans. The term ‘publicly accountable enterprises’ encompasses public companies and some other classes of enterprise that have relatively large or diverse classes of financial statement users. Canadian publicly accountable enterprises that are registered with the US SEC continue to be permitted to apply US accounting standards rather than IFRS. SEC registered Canadian entities operating in industries dominated by US entities tend to favour US accounting standards over IFRS. Recently, securities regulators have indicated that they will consider permitting the use of US standards by Canadian entities that are not SEC registered. This possibility may prove attractive to rate-regulated entities in particular. For non-publicly accountable enterprises and not-for-profit organizations the AcSB has developed new bases of accounting that are derived from Canadian rather than International Standards, although IFRS is also available for use by those entities on a voluntary basis. The adoption of IFRS in Canada for publicly accountable enterprises means that the AcSB has effectively ceased to make final decisions on most matters affecting the technical content and timing of implementation of standards applied to publicly accountable enterprises in Canada. The AcSB’s plans for incorporating new or amended IFRS into Canadian standards include reviewing all IASB documents issued for comment. As part of this process, the AcSB will seek the input of Canadian stakeholders by issuing its own exposure draft of the IASB proposals, together with 29
International GAAP® 2012 a document highlighting the key elements of the IASB proposals that are particularly relevant to Canadian stakeholders. In addition, the AcSB may perform outreach activities such as public roundtables. Any changes to IFRS must be approved by the AcSB before becoming part of Canadian GAAP®. While the AcSB retains the power to modify or add to the requirements of IFRS, it intends to avoid changing IFRS when adopting them as Canadian GAAP®. Accordingly, the AcSB does not expect to eliminate any options within existing IFRS. As issues relevant to Canadian users of financial information arise in the future, the AcSB will work to resolve them through the Interpretations Committee or the IASB. In the event that a resolution by the Interpretations Committee or IASB is not possible the AcSB will stand ready to develop additional temporary guidance. In late 2009, AcSB formed its IFRS Discussion Group to provide a public forum to discuss the application of IFRS in Canada and to identify matters that should be forwarded to the Interpretations Committee for further consideration. The Group does not interpret IFRS or seek consensus on its application in Canada. It meets in public four times per year and has generated several suggestions for the Interpretations Committee’s agenda.
4.3.3 Brazil Local accounting standards in Brazil (CPCs) have been converged with IFRS since 2010 and public companies regulated by the ‘Comissão de Valores Mobiliários’ (CVM) are now also required to make a formal statement of compliance with IFRS as issued by the IASB in their financial statements. The only exception is for homebuilding companies, which are temporarily permitted to continue to apply IAS 11 – Construction Contracts – rather than IAS 18 – Revenue – under IFRIC 15 – Agreements for the Construction of Real Estate. Banks are regulated by the Brazilian Central Bank, which continues to require preparation of financial statements under its pre-existing rules. However, larger banks have also been required to prepare financial statements in accordance with IFRS since 2010, which must be made publicly available. Insurance companies are required to adopt the local CPCs, and hence IFRS, in 2011. Non-public companies outside financial services are required to apply the CPCs. Smaller non public companies are permitted to apply an equivalent of IFRS for SMEs.
4.4.1 China 4.4.1.A Mainland China The developments in IFRS have been playing an important role in the development of accounting standards and practices in China. The Ministry of Finance (the MOF) – through its Accounting Regulatory Department – is responsible for the promulgation of accounting standards. In 1993, the MOF started a work programme to develop a set of Accounting Standards for Business Enterprises. Before 2006, China had promulgated and implemented Accounting Standards for Business Enterprises – Basic Standard, with 16 specific standards, as well as Accounting System for Business Enterprises, Accounting System for Financial Institutions and Accounting 30
Ernst & Young System for Small Business Enterprises which are applicable to various business enterprises. Representatives of the China Accounting Standards Committee (CASC) – which falls under the Accounting Regulatory Department of the MOF – and the IASB met in Beijing in November 2005 to discuss a range of issues relating to the convergence of Chinese accounting standards with IFRS. At the conclusion of the meeting, the two delegations released a joint statement setting out key points of agreement, including the following: • The CASC stated that convergence is one of the fundamental goals of its standard-setting programme, with the intention that an enterprise applying Chinese accounting standards should produce financial statements that are the same as those of an enterprise that applies IFRS; and • The delegation acknowledged that convergence with IFRS will take time and how to converge with IFRS is a matter for China to determine. In February 2006, the MOF issued a series of new and revised Accounting Standards for Business Enterprises (ASBE), which included the revised Basic Standard, 22 newly-promulgated accounting standards and 16 revised accounting standards. The new and revised ASBE was effective from 1 January 2007 for listed companies. Other companies are also encouraged to adopt it. In April 2010, the MOF issued the Road Map for Continual Convergence of the ASBE with IFRS (the Road Map), which requires the application of ASBE by all listed companies, some non-listed financial enterprises and central state-owned enterprises, and most large and medium-sized enterprises. The Road Map also states that ASBE will continue to maintain convergence with IFRS. ASBE, to a large extent, represents convergence with IFRS, with due consideration being given to specific situations in China. ASBE covers the recognition, measurement, presentation and disclosure of most transactions and events, financial reporting, and nearly all the topics covered by current IFRS. Most of ASBE is substantially in line with the corresponding IFRS, with a more simplified form of disclosures. However, there are ASBE that do not have an IFRS equivalent, such as that on non-monetary transactions and common control business combinations, and there are certain standards that restrict or eliminate measurement alternatives thatexist in IFRS. For example, the ASBE on investment property permits the use of the fair value model only when certain strict criteria are met. Whilst ASBE is not identical to IFRS, the substantive difference from IFRS is that the ASBE on impairment of assets prohibits the reversal of an impairment loss for long-lived assets in all situations.
4.4.1.B Hong Kong The Hong Kong Institute of Certified Public Accountants (HKICPA) is the principal source of accounting principles in Hong Kong. These include a series of Hong Kong Financial Reporting Standards, accounting standards referred to as Hong Kong Accounting Standards (HKAS) and Interpretations issued by the HKICPA. The term ‘Hong Kong Financial Reporting Standards’ (HKFRS) is deemed to include all of the foregoing. While HKFRS has no direct legal force, it derives its authority from the HKICPA, which may take disciplinary action against any of its members responsible, as 31
International GAAP® 2012 preparer or as auditor, for financial statements that do not follow the requirements of the pronouncements. In 2001, the HKICPA Council mandated a strategy of achieving convergence between its accounting standards and IFRS issued by the IASB. HKFRS was fully converged with IFRS with effect from 1 January 2005. The HKICPA Council supports the integration of its standard setting process with that of the IASB. Although the HKICPA Council has a policy of maintaining convergence of HKFRS with IFRS, the HKICPA Council may consider it appropriate to include additional disclosure requirements in an HKFRS or, in some exceptional cases, to deviate from an IFRS. Each HKFRS contains information about the extent of compliance with the equivalent IFRS. Where the requirements of an HKFRS and an IFRS differ, the HKFRS is required to be followed by entities reporting within the area of application of HKFRS. However in practice, exceptions to IFRS are few and relate to certain transitional provisions.
4.4.2 Japan In 2007, an agreement between the Accounting Standards Board of Japan (ASBJ), and the IASB, known as ‘The Tokyo Agreement’, was announced. The Tokyo Agreement advanced the gradual convergence of Japanese GAAP® and IFRS, which had been taking place for a number of years. Following the initial convergence projects under this agreement, in 2008 the European Commission accepted Japanese GAAP® in its markets as part of its process to accept certain GAAP® as equivalent to IFRS for listing non-EU companies in a European ‘regulated market’ (as defined by the European Commission). Further convergence of Japanese GAAP® has continued as new standards are issued or expected to be issued. Since adoption of IFRS is being considered for consolidated financial statements only, this convergence process is expected to continue as Japanese GAAP® is used by Japanese companies in their standalone financial statements. In June 2009, the Business Advisory Council (BAC) a key advisory body to the Financial Services Agency approved a roadmap for the adoption of IFRS in Japan and the relevant related matters have subsequently been incorporated into the regulation for consolidated financial statements. The key points of this roadmap are: • Option of voluntary adoption of IFRS from fiscal years ended after 31 March 2010 for companies with global financial or operating activities; and •D ecision on the mandatory adoption of IFRS to be made in 2012. In June 2011, the BAC announced that if mandatory application of IFRS were to be decided, a period of five to seven years would be given for preparing for adoption. This is a longer period than proposed in the roadmap. A number of Japanese companies have already taken, or are planning to take, the option to apply IFRS voluntarily.
4.4.3 India Accounting standards in India are issued by the Institute of Chartered Accountants of India (ICAI) and are ‘notified’ by the Ministry of Corporate Affairs (MCA) under the Companies Act, 1956 (Companies Act). The MCA had originally issued an IFRS conversion roadmap in which it had proposed a date for IFRS conversion in a phased 32
Ernst & Young manner from 2011. The phasing was done based on certain criteria, such as the listing status, net worth and nature of the industry. The MCA had also clarified that companies subject to the IFRS conversion roadmap would not have the option of using ‘full IFRS’; rather, they would need to comply with IFRS converged standards that would be issued by the ICAI. This effectively created a separate body of accounting standards known as ‘Indian Accounting Standards’ (Ind-AS) to be followed by all companies registered under the Companies Act, other than non-listed companies with net worth less than approximately US$110 million. At the time of writing, the MCA has notified 35 Ind-AS standards. Further, the MCA has stated that these standards will be applied in a phased manner, after resolving various issues, including tax-related ones. Therefore, Ind-AS may not apply from the dates announced in the original roadmap. At the time of writing, these dates of application are not fixed. Notified Ind-AS contains numerous departures from IFRS. The MCA felt that these departures were necessary to reflect the accounting principles, practices and economic conditions prevailing in India. The departures from IFRS may be segregated into five broad categories. These categories and some examples in each category are given below: • Departures from IFRS that result in Ind-AS financial statements not being compliant with IFRS, when the issues addressed in those IFRS apply to an entity. For example, under IFRS, a foreign currency convertible bond is treated as a hybrid financial instrument having liability and derivative components. Under Ind-AS, the derivative component is treated as fixed equity, if the exercise price is fixed in any currency. • Removal of options available under IFRS. For example, IAS 40 – Investment Property – permits both the cost model and fair value model for subsequent measurement of investment properties. Ind-AS 40 – Investment Property – does not permit the use of the fair value model. • Additional options provided in Ind-AS that, if selected, would result in Ind-AS financial statements not being compliant with IFRS when those additional options under Ind-AS are used by an entity. For example, in addition to the exemption given in IFRS 1, Ind-AS 101 – First-time adoption of Indian Accounting Standards, also allows a first time adopter to continue with the previous GAAP® carrying value for all its property, plant and equipment at the transition date. This previous GAAP® carrying value is used as the deemed cost at the date of transition, after making necessary adjustments for decommissioning liabilities, etc. A similar exemption is also available for intangible assets and investment property. •D eferment or non-adoption of certain IFRS. For example, the notification of IFRS 4 – Insurance Contracts, IFRIC 4 – Determining whether an Arrangement contains a Lease, IFRIC 12 – Service Concession Arrangements – and SIC-29 – Service Concession Arrangements: Disclosures – have been deferred under Ind- AS. The implementation dates for these standards/interpretations have not been announced by the MCA. Further, there is no certainty that these standards/ interpretations will be issued without modifications to the IASB version. 33
International GAAP® 2012 • Additional differences may arise between Ind-AS and IFRS if the Companies Act is not amended. For example, the Companies Act permits a company to charge the debenture redemption premium to the securities premium reserve account instead of to the profit or loss account. An amendment to the Companies Act is required to prevent such departures from IFRS being created.
4.5 Australia/Oceania – Australia The Australian Financial Reporting Council (FRC) is a statutory body established under the Australian Securities and Investments Commission Act 2001, as amended by the Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) Act 2004. The FRC is responsible for providing broad oversight of the process for setting accounting and auditing standards as well as monitoring the effectiveness of auditor independence requirements in Australia and providing the Australian Government with reports and advice on these matters. It comprises key stakeholders from the business community, the professional accounting bodies, governments and regulatory agencies. In July 2002, the chair of the FRC announced that the FRC had formalised its support for the adoption by Australia of international accounting standards by 1 January 2005. In accordance with this strategic directive, the Australian Accounting Standards Board (AASB) issued Australian equivalents to IFRS (AIFRS) on 15 July 2004. Australian Accounting Standards have the force of law for Australian corporations, and therefore the standards issued by the IASB are required to be issued as Australian standards by the AASB. The implementation of AIFRS has achieved the FRC’s strategic directive of ensuring that the financial statements of for-profit entities applying AASB standards are also in compliance with IFRS. In adopting the IASB’s standards, the AASB’s initial approach was to ensure that compliance with Australian Accounting Standards would permit a company to be in compliance with IFRS At the time of initial adoption in 2005, in certain AIFRS the AASB permitted only one of certain optional treatments available in the equivalent IASB standards, and retained a number of specific disclosures from domestic GAAP® in addition to the disclosure requirements of IFRS. On 30 April 2007, the AASB issued AASB 2007-4 – Amendments to Australian Accounting Standards arising from ED 151 and Other Amendments. This Standard was a result of an AASB decision that, in principle, AIFRS should reflect the exact requirements and wording of IFRS. AASB 2007-4 was effective for reporting periods beginning on or after 1 July 2007, and had the effect of incorporating all remaining IFRS accounting policy options into AIFRS and removing almost all Australian-specific disclosure requirements from AIFRS. In some cases, existing AASB standards contained commentary that was not included in the equivalent IASB standards. The AASB has removed all this guidance that was not part of the standards, except where the guidance deals with situations that are commonly encountered in the Australian environment but are not catered for in the IASB standards. In 2007, the Australian Auditing and Assurance Standards Board (AUASB) issued a revised auditing standard requiring the auditor to opine on the entity’s compliance with 34
Ernst & Young IFRS where it has made the statement under the Australian equivalent of paragraph 16 of IAS 1 – Presentation of Financial Statements. This is in addition to the auditor’s opinion on compliance with Australian Accounting Standards. In effect, both the reporting entity and the auditor make a statement of dual compliance with IFRS and Australian Accounting Standards. The AASB plans to continue to work to maintain consistency with the IASB’s standards in order that the FRC’s strategic directive continues to be met. IFRS also forms the basis for Australian Accounting Standards that apply to not-for-profit private and public sector organisations. In 2010, the AASB introduced a differential reporting system based on the IASB’s definition of publicly accountable entities. Non-publicly accountable entities can now adopt Australian Accounting Standards – Reduced Disclosure Regime. These Standards contain the recognition and measurement requirements of IFRS, but have reduced disclosures determined on the principles adopted by the IASB in its development of IFRS for SMEs.
4.6 Africa – South Africa In 2004, South Africa completed a convergence project and all IFRS in issue at that time were fully adopted, thus removing all differences, except one, between the standards that made up South African GAAP® (SA GAAP®) and IFRS. After this convergence project, the only remaining difference between companies reporting under SA GAAP® and an IFRS reporter would be the legacy effect of different effective dates (between the equivalent IFRS and SA GAAP® standards) and the non application of IFRS 1. Since 2004, until early 2011, all standards and interpretations that have been issued by the IASB have been adopted into SA GAAP® without change by the South African standard setting body, the Accounting Practices Board (APB). With effect from periods beginning on or after 1 January 2005 the South African securities exchange, JSE Limited (JSE), required all listed companies to prepare financial statements under IFRS. All listed entities that were not already reporting under IFRS transitioned to IFRS by applying IFRS 1. Non-listed companies in South Africa continued to use either IFRS, IFRS for SMEs or SA GAAP® as the framework for preparing their financial statements. In addition to the disclosure requirements of IFRS, IFRS for SMEs and SA GAAP®, the South African Companies Act and the JSE imposed certain additional disclosure requirements. For example, the JSE requires the calculation of headline earnings per share and the disclosure of a detailed reconciliation of headline earnings to the earnings numbers used in the calculation of basic earnings per share in accordance with the requirements of IAS 33. Further to these additional disclosure requirements, the APB has also issued its own interpretations on four issues, as a result of the Interpretations Committee deciding not to issue interpretations on what were considered issues specific to the South African environment. These interpretations deal with an additional tax payable when dividends are declared, the meaning of substantively enacted tax rates and tax laws in a South African context, accounting for black economic empowerment transactions (which are not specifically dealt with in IFRS 2 – Share-based 35
International GAAP® 2012 Payment) and the application of IFRIC 14 – IAS 19 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction – in a South African environment. While these interpretations are specific to SA GAAP®, IFRS reporters in South Africa make use of them as they are based on a framework equivalent to that used for IFRS. Effective 1 May 2011, different accounting frameworks now apply to different categories of companies. For example, while listed companies are required to use IFRS, other larger companies in South Africa are required to either apply IFRS or IFRS for SMEs. The concept of SA GAAP® still remains, but is only permitted to be used by certain categories of companies. In addition, the APB was replaced with the Financial Reporting Standards Council (FRSC) as the new standard setting body in South Africa in the second half of 2011. In light of these changes, the APB made a decision earlier in 2011 to defer approving some of the latest IFRS as part of SA GAAP®, pending a final decision on whether to continue to issue SA GAAP® standards and interpretations in the future. For categories that generally encompass the smallest companies, these entities are permitted to use IFRS, IFRS for SMEs, SA GAAP®, or in certain situations entity specific accounting policies as determined by themselves.
5 SUMMARY IFRS is now, together with US GAAP®, one of the two globally recognised financial reporting frameworks. Although there remains some uncertainty as to what view the SEC will take on the role of IFRS in the US there is strong demand among policy makers and regulators for there to be just one set of high quality accounting standards recognised globally. It therefore continues to seem likely that IFRS will fill that role and truly become ‘International GAAP®’. However for there to be a truly International GAAP® it is necessary that there is consistent application, interpretation and regulation of those standards to mirror the processes that have traditionally supported national GAAP®s. Whilst complete consistency does not exist today, many mechanisms to achieve it are in place. The Interpretations Committee plays a key role not just through its interpretations but also through its agenda decisions. In the Strategy Review, the Trustees propose a number of ways to help ensure consistent application of IFRS, including working with a network of securities regulators, audit regulators, standard setters and other stakeholders to identify areas of divergence.63 We agree that the IFRS Foundation needs to focus on discouraging local interpretations of IFRS and support the proposals to involve regulators in the process. To continue...
Mackenzie, Coetsee, Njikizana, Chamboko
Wiley IFRS 2012 Interpretation and Application of International Financial Reporting Standards Bruce Mackenzie, Danie Coetsee, Tapiwa Njikizana, Raymond Chamboko 9780470923993 • Paper • 1080 pages Feb 2012 • £90 / €104 / $130
INTRODUCTION The stated goal of the IFRS Foundation and the International Accounting Standards Board (IASB) is to develop, in the public interest, a single set of high-quality, understandable, enforceable and globally accepted financial reporting standards based upon clearly articulated principles. There were once scores of unique sets of financial reporting standards among the more developed nations (“national GAAP”). The year 2005 marked the beginning of a new era in global conduct of business, and the fulfillment of a thirty-year effort to create the financial reporting rules for a worldwide capital market. For during that year’s financial reporting cycle, the 27 European Union (EU) member states, plus many others in countries such as Australia, New Zealand, Russia, and South Africa adopted International Financial Reporting Standards (IFRS). Since then, many countries, such as Argentina, Brazil, and Canada, have adopted IFRS. Mexico is adopting IFRS in 2012. China has substantially converted their national standards in line with IFRS. All other major economies, such as Japan and United States have established time lines to converge with or adopt IFRS in the near future. 2007 and 2008 proved to be watershed years for the growing acceptability of IFRS. In 2007, one of the most important developments was that the SEC dropped the reconciliation (to US GAAP®) requirement that had formerly applied to foreign private registrants; thereafter, those reporting in a manner fully compliant with IFRS (i.e., without any exceptions to the complete set of standards imposed by IASB) do not have to reconcile net income and shareholders’ equity to that which would have been presented under US GAAP®. In effect, the US SEC was acknowledging that IFRS was fully acceptable as a basis for accurate, transparent, meaningful financial reporting. This easing of US registration requirements for foreign companies seeking to enjoy the benefits of listing their equity or debt securities in the US led, quite naturally, to a call by domestic companies to permit them to also freely choose between financial reporting under US GAAP® and IFRS. By late 2008 the SEC had begun the process of acquiescence, first for the largest companies in those industries having (worldwide) the preponderance of IFRS adopters, and later for all publicly held companies. A new SEC chair took office in 2009, expressing a concern that the move to IFRS, if it were to occur, should perhaps move more slowly than had previously been indicated. In the 37
Wiley IFRS 2012 authors’ view, however, any revisiting of the earlier decision to move decisively toward mandatory use of IFRS for public company financial reporting in the US will create only a minor delay, if any. Simply put, the worldwide trend to uniform financial reporting standards (for which role the only candidate is IFRS) is inexorable and will benefit all those seeking to raise capital and all those seeking to invest. It had been highly probable that nonpublicly held US entities would have remained bound to only US GAAP® for the foreseeable future, both from habit and because no other set of standards would be viewed as being acceptable. However, the body that oversees the private-sector auditing profession’s standards in the US amended its rules in 2008 to fully recognize IASB as an accounting standard-setting body (giving it equal status with the FASB), meaning that auditors and other service providers in the US may now opine (or provide other levels of assurance, as specified under pertinent guidelines) on IFRS-based financial statements. This change, coupled with the promulgation by IASB of a long-sought standard providing simplified financial reporting rules for privately held entities (described later in this chapter), has probably increased the likelihood that a broad-based move to IFRS will occur in the US within the next several years. The SEC commissioner and chair recently confirmed that they are committed to a single set of global standards and are on schedule for the 2011 determination whether to incorporate IFRS in the US for US issuers. The impetus for the convergence of historically disparate financial reporting standards has been, in the main, to facilitate the free flow of capital so that, for example, investors in the United States will become more willing to finance business in, say, China or the Czech Republic. Having access to financial statements that are written in the same “language” would eliminate what has historically been a major impediment to engendering investor confidence, which is sometimes referred to as “accounting risk,” which adds to the already existing risks of making such crossborder investments. Additionally, the permission to list a company’s equity or debt securities on an exchange has generally been conditioned on making filings with national regulatory authorities, which have historically insisted either on conformity with local GAAP® or on a formal reconciliation to local GAAP®. Since either of these procedures was tedious and time-consuming, and the human resources and technical knowledge to do so were not always widely available, many otherwise anxious wouldbe registrants forwent the opportunity to broaden their investor bases and potentially lower their costs of capital. The historic 2002 Norwalk Agreement—between the US standard setter, FASB, and the IASB—called for “convergence” of the respective sets of standards, and indeed a number of revisions of either US GAAP® or IFRS have already taken place to implement this commitment, with more changes expected in the immediate future. The aim of the Boards was to complete the milestone projects of the Memorandum of Understanding (MOU) by the end of June 2011. These milestone projects include • Financial instruments • Consolidations • Derecognition • Fair value measurement 38
Mackenzie, Coetsee, Njikizana, Chamboko • Revenue recognition • Leases • Financial instruments with characteristics of equity • Financial statement presentation • Other MOU projects • Other joint projects Details of these and other projects of the standard setters are included in a separate section in each relevant chapter of this book. Although the Boards were committed to complete the milestone projects by June 2011, certain projects such as financial instruments (impairment and hedge accounting), revenue recognition and leases have been deferred due to the complexity of the projects and obtaining consensus views. Only after these projects are completed will the US make a final decision on the adoption of IFRS in the US. Although the target date to make the decision was for 2011, at date of completion of this book no decision was made. Until this issue is resolved, IFRS and US GAAP® will remain the two comprehensive financial reporting frameworks in the world, with IFRS gaining more and more momentum.
ORIGINS AND EARLY HISTORY OF THE IASB Financial reporting in the developed world evolved from two broad models, whose objectives were somewhat different. The earliest systematized form of accounting regulation developed in continental Europe in 1673. Here a requirement for an annual fair value statement of financial position was introduced by the government as a means of protecting the economy from bankruptcies. This form of accounting at the initiative of the state to control economic actors was copied by other states and later incorporated in the 1807 Napoleonic Commercial Code. This method of regulating the economy expanded rapidly throughout continental Europe, partly through Napoleon’s efforts and partly through a willingness on the part of European regulators to borrow ideas from each other. This “code law” family of reporting practices was much developed by Germany after its 1870 unification, with the emphasis moving away from market values to historical cost and systematic depreciation. It was used later by governments as the basis of tax assessment when taxes on business profits started to be introduced, mostly in the early twentieth century. This model of accounting serves primarily as a means of moderating relationships between the individual company and the state. It serves for tax assessment, and to limit dividend payments, and it is also a means of protecting the running of the economy by sanctioning individual businesses that are not financially sound or were run imprudently. While the model has been adapted for stock market reporting and group (consolidated) structures, this is not its main focus. The other model did not appear until the nineteenth century and arose as a consequence of the industrial revolution. Industrialization created the need for large concentrations of capital to undertake industrial projects (initially, canals and railways) and to spread risks between many investors. In this model the financial report provided 39
Wiley IFRS 2012 a means of monitoring the activities of large businesses in order to inform their (nonmanagement) shareholders. Financial reporting for capital markets purposes developed initially in the UK, in a commonlaw environment where the state legislated as little as possible and left a large degree of interpretation to practice and for the sanction of the courts. This approach was rapidly adopted by the US as it, too, became industrialized. As the US developed the idea of groups of companies controlled from a single head office (towards the end of the nineteenth century), this philosophy of financial reporting began to become focused on consolidated accounts and the group, rather than the individual company. For different reasons, neither the UK nor the US governments saw this reporting framework as appropriate for income tax purposes, and in this tradition, while the financial reports inform the assessment process, taxation retains a separate stream of law, which has had little influence on financial reporting. The second model of financial reporting, generally regarded as the Anglo-Saxon financial reporting approach, can be characterized as focusing on the relationship between the business and the investor, and on the flow of information to the capital markets. Government still uses reporting as a means of regulating economic activity (e.g., the SECâ€™s mission is to protect the investor and ensure that the securities markets run efficiently), but the financial report is aimed at the investor, not the government. Neither of the two above-described approaches to financial reporting is particularly useful in an agricultural economy, or to one that consists entirely of microbusinesses, in the opinion of many observers. Nonetheless, as countries have developed economically (or as they were colonized by industrialized nations) they have adopted variants of one or the other of these two models. IFRS are an example of the second, capital market-oriented, systems of financial reporting rules. The original international standard setter, the International Accounting Standards Committee (IASC) was formed in 1973, during a period of considerable change in accounting regulation. In the US the Financial Accounting Standards Board (FASB) had just been created, in the UK the first national standard setter had recently been organized, the EU was working on the main plank of its own accounting harmonization plan (the Fourth Directive), and both the UN and the OECD were shortly to create their own accounting committees. The IASC was launched in the wake of the 1972 World Accounting Congress (a five-yearly get-together of the international profession) after an informal meeting between representatives of the British profession (Institute of Chartered Accountants in England and Walesâ€”ICAEW) and the American profession (American Institute of Certified Public Accountants). A rapid set of negotiations resulted in the professional bodies of Canada, Australia, Mexico, Japan, France, Germany, the Netherlands, and New Zealand being invited to join with the US and UK to form the international body. Due to pressure (coupled with a financial subsidy) from the UK, the IASC was established in London, where its successor, the IASB, remains today. The actual reasons for the IASCâ€™s creation are unclear. A need for a common language of business was felt, to deal with a growing volume of international business, but other more political motives abounded also. For example, some believe that the 40
Mackenzie, Coetsee, Njikizana, Chamboko major motivation was that the British wanted to create an international standard setter to trump the regional initiatives within the EU, which leaned heavily to the Code model of reporting, in contrast to what was the norm in the UK and almost all Englishspeaking nations. In the first phase of its existence, the IASC had mixed fortunes. Once the International Federation of Accountants (IFAC) was formed in 1977 (at the next World Congress of Accountants), the IASC had to fight off attempts to become a part of IFAC. It managed to resist, coming to a compromise where IASC remained independent but all IFAC members were automatically members of IASC, and IFAC was able to nominate the membership of the standard-setting Board. Both the UN and OECD were active in international rule making in the 1970s, but the IASC was successful in persuading them to leave establishment of recognition and measurement rules to the IASC. However, having established itself as the unique international rule maker, IASC encountered difficulty in persuading any jurisdiction or enforcement agency to use its rules. Although member professional bodies were theoretically committed to pushing for the use of IFRS at the national level, in practice few national bodies were influential in standard setting in their respective countries (because standards were set by taxation or other governmental bodies), and others (including the US and UK) preferred their national standards to whatever IASC might propose. In Europe, IFRS were used by some reporting entities in Italy and Switzerland, and national standard setters in some countries such as Malaysia began to use IFRS as an input to their national rules, while not necessarily adopting them as written by the IASC or giving explicit recognition to the fact that IFRS were being adopted in part as national GAAP®. IASC’s efforts entered a new phase in 1987, which led directly to its 2001 reorganization, when the then-Secretary General, David Cairns, encouraged by the US SEC, negotiated an agreement with the International Organization of Securities Commissions (IOSCO). IOSCO was interested in identifying a common international “passport” whereby companies could be accepted for secondary listing in the jurisdiction of any IOSCO member. The concept was that, whatever the listing rules in a company’s primary stock exchange, there would be a common minimum package which all stock exchanges would accept from foreign companies seeking a secondary listing. IOSCO was prepared to endorse IFRS as the financial reporting basis for this passport, provided that the international standards could be brought up to a quality and comprehensiveness level that IOSCO stipulated. Historically, a major criticism of IFRS had been that it essentially endorsed all the accounting methods then in wide use, effectively becoming a “lowest common denominator” set of standards. The trend in national GAAP® had been to narrow the range of acceptable alternatives, although uniformity in accounting had not been anticipated as a near-term result. The IOSCO agreement energized IASC to improve the existing standards by removing the many alternative treatments that were then permitted under the standards, thereby improving comparability across reporting entities. The IASC launched its Comparability and Improvements Project with the goal of developing a “core set of standards” that would satisfy IOSCO. These were complete by 1993, not without difficulties and spirited disagreements among the 41
Wiley IFRS 2012 members, but then—to the great frustration of the IASC—these were not accepted by IOSCO. Rather than endorsing the standard-setting process of IASC, as was hoped for, IOSCO seemingly wanted to cherry-pick individual standards. Such a process could not realistically result in near-term endorsement of IFRS for cross-border securities registrations. Ultimately, the collaboration was relaunched in 1995, with IASC under new leadership, and this began a further period of frenetic activities, where existing standards were again reviewed and revised, and new standards were created to fill perceived gaps in IFRS. This time the set of standards included, among others, IAS 39, on recognition and measurement of financial instruments, which was endorsed, at the very last moment and with great difficulty, as a compromise, purportedly interim standard. At the same time, the IASC had undertaken an effort to consider its future structure. In part, this was the result of pressure exerted by the US SEC and also by the US private sector standard setter, the FASB, which were seemingly concerned that IFRS were not being developed by “due process.” While the various parties may have had their own agendas, in fact the IFRS were in need of strengthening, particularly as to reducing the range of diverse but accepted alternatives for similar transactions and events. The challenges presented to IASB ultimately would serve to make IFRS stronger. If IASC was to be the standard setter endorsed by the world’s stock exchange regulators, it would need a structure that reflected that level of responsibility. The historical Anglo- Saxon standard-setting model—where professional accountants set the rules for themselves— had largely been abandoned in the twenty-five years since the IASC was formed, and standards were mostly being set by dedicated and independent national boards such as the FASB, and not by profession-dominated bodies like the AICPA. The choice, as restructuring became inevitable, was between a large, representative approach—much like the existing IASC structure, but possibly where national standard setters appointed representatives—or a small, professional body of experienced standard setters which worked independently of national interests. The end of this phase of the international standard setting, and the resolution of these issues, came about within a short period in 2000. In May of that year, IOSCO members voted to endorse IASC standards, albeit subject to a number of reservations (see discussion later in this chapter). This was a considerable step forward for the IASC, which itself was quickly exceeded by an announcement in June 2000 that the European Commission intended to adopt IFRS as the requirement for primary listings in all member states. This planned full endorsement by the EU eclipsed the lukewarm IOSCO approval, and since then the EU has appeared to be the more influential body insofar as gaining acceptance for IFRS has been concerned. Indeed, the once-important IOSCO endorsement has become of little importance given subsequent developments, including the EU mandate and convergence efforts among several standard-setting bodies. In July 2000, IASC members voted to abandon the organization’s former structure, which was based on professional bodies, and adopt a new structure: beginning in 2001, 42
Mackenzie, Coetsee, Njikizana, Chamboko standards would be set by a professional board, financed by voluntary contributions raised by a new oversight body.
THE CURRENT STRUCTURE The formal structure put in place in 2000 has the IFRS Foundation, a Delaware corporation, as its keystone (this was previously known as the IASC Foundation). The Trustees of the IFRS Foundation have both the responsibility to raise funds needed to finance standard setting, and the responsibility of appointing members to the International Accounting Standards Board (IASB), the International Financial Reporting Interpretations Committee (IFRIC) and the Standards Advisory Council (SAC). The structure changed by incorporating the Monitoring Board in 2009, renaming and incorporating the SME Implementation Group in 2010 as follows:
The Monitoring Board is responsible to ensure that the Trustees of the IFRS Foundation discharge their duties as defined by the IFRS Foundation Constitution and to approve the appointment or reappointment of Trustees. The Monitoring Board consists of the Emerging Markets and Technical Committees of the International Organization of Securities Commissions (IOSCO), the European Commission, the Financial Services Agency of Japan (JFSA), and US Securities and Exchange Commission (SEC). The Basel Committee on Banking Supervision currently only participates as an observer. The IFRS Foundation is governed by trustees and reports to the Monitoring Board. The IFRS Foundation has fundraising responsibilities and oversees the standardsetting work, the IFRS structure and strategy. It is also responsible for the review of the Constitution. The IFRS Advisory Council (formerly the SAC) is the formal advisory body to the IASB and the Trustees of the IFRS Foundation. Members consist of user groups, preparers, financial analysts, academics, auditors, regulators, professional accounting bodies and investor groups. The IASB is an independent body that is solely responsible for establishing International Financial Reporting Standards (IFRS), including IFRS for SMEs. The IASB also approves new interpretations. 43
Wiley IFRS 2012 The IFRS Interpretations Committee (IFRIC) is a committee comprised mostly of technical partners in audit firms but also includes preparers and users. IFRIC’s function is to answer technical queries from constituents about how to interpret IFRS—in effect, filling in the cracks between different rules. In recent times it has also proposed modifications to standards to the IASB, in response to perceived operational difficulties or need to improve consistency. IFRIC liaises with the US Emerging Issues Task Force and similar bodies and standard setters, to try to preserve convergence at the level of interpretation. Working relationships are set up with local standard setters who have adopted or converged with International Financial Reporting Standards (IFRS), or are in the process of adopting or converging with IFRS. The statement of working relationship sets out a range of activities that should be undertaken to facilitate the adoption and use of IFRS.
PROCESS OF IFRS STANDARD SETTING The IASB has a formal due process which is set out in the Preface to IFRS, and The Due Process Handbook of the IASB. At a minimum, a proposed standard should be exposed for comment, and these comments should be reviewed before issuance of a final standard, with debates open to the public. However, this formal process is rounded out in practice, with wider consultation taking place on an informal basis. The IASB’s agenda is determined in various ways. Suggestions are made by the Trustees, the IFRS Advisory Council, liaison standard setters, the international audit firms, and others. These are debated by IASB and tentative conclusions are discussed with the various consultative bodies. The IASB also has a joint agenda committee with the FASB. Longrange projects are first put on the research agenda, which means that preliminary work is being done on collecting information about the problem and potential solutions. Projects can also arrive on the current agenda outside that route. The agenda was largely driven in the years immediately after 2001 by the need to round out the legacy standards, to ensure that there would be a full range of standards for European companies moving to IFRS in 2005. Also, it was recognized that there was an urgent need to effect modifications to many standards in the name of convergence (e.g., acquisition accounting and goodwill) and to make needed improvements to other existing standards. These needs were largely met by mid-2004. Once a project reaches the current agenda, the formal process is that the staff (a group of about 20 technical staff permanently employed by the IASB) drafts papers which are then discussed by IASB in open meetings. Following that debate, the staff rewrites the paper, or writes a new paper which is then debated at a subsequent meeting. In theory there is an internal process where the staff proposes solutions, and IASB either accepts or rejects them. In practice the process is more involved: sometimes (especially for projects such as financial instruments) individual Board members are delegated special responsibility for the project, and they discuss the problems regularly with the relevant staff, helping to build the papers that come to the Board. Equally, Board members may write or speak directly to the staff outside of the formal meeting process to indicate concerns about one thing or another. 44
Mackenzie, Coetsee, Njikizana, Chamboko The due process comprises six stages: (1) setting the agenda; (2) planning the project; (3) developing and publishing the discussion paper; (4) developing and publishing the Exposure Draft; (5) developing and publishing the standard and (6) the stages after the standard is issued. The process also includes discussion of Staff Papers outlining the principal issues and analysis of comments received on Discussion Papers and Exposure Drafts. Final draft standards are sometimes provided to certain individuals or entities for final comments before the final ballot. Final ballots on the standard are carried out in secret, but otherwise the process is quite open, with outsiders able to consult project summaries on the IASB Web site and attend Board meetings if they wish. Of course, the informal exchanges between staff and Board on a day-to-day basis are not visible to the public, nor are the meetings where IASB takes strategic and administrative decisions. The basic due process can be modified in different circumstances. The Board may decide not to issue Discussion Papers or to reissue Discussion Papers and Exposure Drafts. The IASB also has regular public meetings with the Analyst Representative Group (ARG) and the Global Preparers Forum (GPF), among others. Special groups such as the Financial Crisis Advisory Group are set up from time to time. Formal working groups are established for certain major projects to provide additional practical input and expertise. Apart from these formal consultative processes, IASB also carries out field trials of some standards (as it recently did on performance reporting and insurance), where volunteer preparers apply the proposed new standards. The IASB may also hold some form of public consultation during the process, such as roundtable discussions. The IASB engages closely with stakeholders around the world such as investors, analysts, regulators, business leaders, accounting standard setters, and the accountancy profession.
CONVERGENCE: THE IASB AND FINANCIAL REPORTING IN THE US Although IASC and FASB were created almost contemporaneously, FASB largely ignored IASB until the 1990s. It was only then that FASB became interested in IASC, when IASC was beginning to work with IOSCO, a body in which the SEC has always had a powerful voice. In effect, both the SEC and FASB were starting to consider the international financial reporting area, and IASC was also starting to take initiatives to encourage standard setters to meet together occasionally to debate technical issues of common interest. IOSCO’s efforts to create a single passport for secondary listings, and IASC’s role as its standard setter, while intended to operate worldwide, would have the greatest practical significance for foreign issuers in terms of the US market. It was understood that if the SEC were to accept IFRS in place of US GAAP®, there would be no need for a Form 20-F reconciliation, and access to the US capital markets by foreign registrants would be greatly facilitated. The SEC has therefore been a key factor in the later evolution of IASC. It encouraged IASC to build a relationship with IOSCO in 1987, and also observed that too many options for diverse accounting were available under IAS. 45
Wiley IFRS 2012 SEC suggested that it would be more favorably inclined to consider acceptance of IAS (now IFRS) if some or all of these alternatives were reduced. Shortly after IASC restarted its IOSCO work in 1995, the SEC issued a statement (April 1996) to the effect that, to be acceptable, IFRS would need to satisfy the following three criteria: 1. It would need to establish a core set of standards that constituted a comprehensive basis of accounting; 2. The standards would need to be of high quality, and would enable investors to analyze performance meaningfully both across time periods and among different companies; and 3. The standards would have to be rigorously interpreted and applied, as otherwise comparability and transparency could not be achieved. IASC’s plan was predicated on its completion of a core set of standards, which would then be handed over to IOSCO, which in turn would ask its members for an evaluation, after which IOSCO would issue its verdict as to acceptability. It was against this backdrop that the SEC issued a “concept release” in 2000, that solicited comments regarding the acceptability of the core set of standards, and whether there appeared to be a sufficiently robust compliance and enforcement mechanism to ensure that standards were consistently and rigorously applied by preparers, whether auditors would ensure this, and whether stock exchange regulators would verify such compliance. This last-named element remains beyond the control of IASB, and is within the domain of national compliance bodies or professional organizations in each jurisdiction. The IASC’s Standards Interpretations Committee (SIC, which was later succeeded by IFRIC) was formed to help ensure uniform interpretation, and IFRIC has taken a number of initiatives to establish liaison channels with stock exchange regulators and national interpretations bodies—but the predominant responsibilities remain in the hands of the auditors, the audit oversight bodies, and the stock exchange oversight bodies. The SEC’s stance at the time was that it genuinely wanted to see IFRS used by foreign registrants, but that it preferred convergence (so that no reconciliation would be necessary) over the acceptance of IFRS as they were in 2000 without reconciliation. In the years since, the SEC has in many public pronouncements supported convergence and, as promised, waived reconciliations in 2008 for registrants fully complying with IFRS. Thus, for example, the SEC welcomed various proposed changes to US GAAP® to converge with IFRS. Relations between FASB and IASB have grown warmer since IASB was restructured, perhaps influenced by the growing awareness that IASB would assume a commanding position in the financial reporting standard-setting domain. The FASB had joined the IASB for informal meetings as long ago as the early 1990s, culminating in the creation of the G4+1 group of Anglophone standard setters (US, UK, Canada, Australia and New Zealand, with the IASC as an observer), in which FASB was an active participant. Perhaps the most significant event was when IASB and FASB signed the Norwalk Agreement in October 2002, which set out a program for the convergence of their respective sets of financial reporting standards. The organizations’ staffs have 46
Mackenzie, Coetsee, Njikizana, Chamboko worked together on a number of vital projects, including business combinations and revenue recognition, since the Agreement was signed and, later, supplemented by the 2006 and 2008 Memorandum of Understandings (MOU) between these bodies. The two boards have a joint agenda committee whose aim is to harmonize the timing with which the boards discuss the same subjects. The boards are also committed to meeting twice a year in joint session. In June 2010 the Boards announced a modification to their convergence strategy, responding to concerns from some stakeholders regarding the volume of draft standards due for publication in close proximity. The strategy retained the June 2011 target date to complete those projects for which the need for improvement was the most urgent. In line with this strategy, the Boards completed the consolidation (including joint arrangements) and fair value measurement project before the June 2011 target date. The derecognition project was cancelled and only disclosure amendments were incorporated in the standard. Projects on financial instruments (impairment, hedging and offsetting), leases and revenue were extended to create significant time for reconsultation after comments were received. Standards on most of these are only expected in 2012. The Boards also decided to amend the timetable for projects that are important but less urgent. The projects affected are Financial Statement Presentation (the replacement of IAS 1 and IAS 7), Financial Instruments with Characteristics of Equity, Emissions Trading Schemes, Liabilities (IAS 37 amendments) and Income Taxes. The Boards do not expect to return to these topics until the June 2011 targeted projects are completed. However, certain convergence problems remain, largely of the structural variety. FASB operates within a specific national legal framework, while IASB does not. Equally, both have what they term “inherited” GAAP® (i.e., differences in approach that have a long history and are not easily resolved). FASB also has a tradition of issuing very detailed, prescriptive (“rules-based) standards that give bright-line accounting (and, consequently, audit) guidance, which are intended to make compliance control easier and remove uncertainties. Notwithstanding that detailed rules had been ardently sought by preparers and auditors alike for many decades, in the post-Enron world, after it became clear that some of these highly prescriptive rules had been abused, interest turned toward developing standards that would rely more on the expression of broad financial reporting objectives, with far less detailed instruction on how to achieve them (“principles-based” standards). This was seen as being superior to the US GAAP® approach, which mandated an inevitably doomed effort to prescribe responses to every conceivable fact pattern to be confronted by preparers and auditors. This exaggerated rules-based vs. principles-based dichotomy was invoked particularly following the frauds at US-based companies WorldCom and Enron, but before some of the more prominent European frauds, such as Parmalat (Italy) and Royal Ahold (the Netherlands) came to light, which would suggest that neither the use of US GAAP® nor IFRS could protect against the perpetration of financial reporting frauds if auditors were derelict in the performance of their duties or even, on rare occasions, complicit in managements frauds. As an SEC study (which had been mandated by the Sarbanes-Oxley Act of 2002) into principles-based standards later observed, use of principles alone, without detailed guidance, reduces comparability. 47
Wiley IFRS 2012 The litigious environment in the US also makes companies and auditors reluctant to step into areas where judgments have to be taken in uncertain conditions. The SEC’s solution: “objectives-based” standards that are both soundly based on principles and inclusive of practical guidance. Events in the mid- to late-2000s have served to accelerate the pressure for full convergence between US GAAP® and IFRS. In fact, the US SEC’s decision in late 2007 to waive reconciliation requirements for foreign registrants complying with “full IFRS” was a clear indicator that the outright adoption of IFRS in the US is on the horizon, and that the convergence process may be made essentially redundant if not actually irrelevant. The SEC has since granted qualifying US registrants (major players in industry segments, the majority of whose worldwide participants already report under IFRS) the limited right to begin reporting under IFRS in 2009, after which (in 2011) it has indicated it will determine the future path toward the supercession of US GAAP® by IFRS. In late 2008, the SEC proposed its so-called “roadmap” for a phased-in IFRS adoption, setting forth four milestones that, if met, could lead to wide-scale adoption beginning in 2014. Under the new leadership, which assumed office in 2009, the SEC may act with less urgency on this issue, and achievement of the “milestones”—which include a number of subjective measures such as improvement in standards and level of IFRS training and awareness among US accountants and auditors—leaves room for later balking at making the final commitment to IFRS. Notwithstanding these possible impediments to progress, the authors believe that there is an inexorable move toward universal adoption of IFRS, and that the leading academic and public accounting (auditing) organizations must, and will, take the necessary steps to ensure that this can move forward. For example, in the US the principal organization of academicians is actively working on standards for IFRS-based accounting curricula, and the main organization representing independent accountants is producing Web-based materials and live conferences to educate practitioners about IFRS matters. While the anticipated further actions by the US SEC will only directly promote or require IFRS adoption by multinational and other larger, publicly held business entities, and later by even small, publicly held companies, in the longer run, even medium- and smallersized entities will probably opt for IFRS-based financial reporting. There are several reasons to predict this “trickle down” effect. First, because some involvement in international trade is increasingly a characteristic of all business operations, the need to communicate with customers, creditors, and potential partners or investors will serve to motivate “one language” financial reporting. Second, the notion of reporting under “second-class GAAP®” rather than under the standards employed by larger competitors will eventually prove to be unappealing. And thirdly, IASB’s issuance of a one-document comprehensive standard on financial reporting by entities having no public reporting responsibilities (IFRS for SMEs, discussed later in this chapter), coupled with formal recognition under US auditing standards that financial reporting rules established by IASB are a basis for an expression of an auditor’s professional opinion may actually find enthusiastic support among smaller US reporting entities and their professional services providers, even absent immediate adoptions among publicly held companies. In a March 2010 statement, the SEC stated that staff has been directed to 48
Mackenzie, Coetsee, Njikizana, Chamboko develop a work plan to enhance both the understanding of the SECâ€™s purpose and public transparency regarding the incorporation of IFRS in the US. The execution of this work plan and the completion of the projects in the MOU by 2011 will position the SEC to make a decision regarding such an incorporation of IFRS. However, if the SEC determines late 2011 or early 2012 to incorporate IFRS in the US, the first time that US issuers will report under IFRS is foreseen to be only in 2015 or 2016, thus extending the initial proposal to implement IFRS by 2014.
THE IASB AND EUROPE Although France, Germany, the Netherlands and the UK were founding members of predecessor organization IASC and have remained heavily involved with IASB, the European Commission as such has generally had a fitful relationship with the international standard setter. The EC did not participate in any way until 1990, when it finally became an observer at Board meetings. It had had its own regional program of harmonization since the 1960s and in effect only officially abandoned this in 1995, when, in a policy paper, it recommended to member states that they seek to align their rules for consolidated financial statements on IFRS. Notwithstanding this, the Commission gave IASB a great boost when it announced in June 2000 that it wanted to require all listed companies throughout the EU to use IFRS beginning in 2005 as part of its initiative to build a single European financial market. This intention was made concrete with the approval of the IFRS Regulation in June 2002 by the European Council of Ministers (the supreme EU decision-making authority). The EU decision was all the more welcome given that, to be effective in legal terms, IFRS have to be enshrined in EU statute law, creating a situation where the EU is in effect ratifying as laws the set of rules created by a small, self-appointed, privatesector body. This proved to be a delicate situation, which was revealed within a very short time to contain the seeds of unending disagreements, as politicians were being asked in effect to endorse something over which they had no control. They were soon being lobbied by corporate interests that had failed to effectively influence IASB directly, in order to achieve their objectives, which in some cases involved continued lack of transparency regarding certain types of transactions or economic effects, such as fair value changes affecting holding of financial instruments. The process of obtaining EU endorsement of IFRS was at the cost of exposing IASB to political pressures in much the same way that the US FASB has at times been the target of congressional manipulations (e.g., over stock-based compensation accounting rules in the mid1990s, the derailing of which arguably contributed to the practices that led to various backdating abuse allegations made in more recent years). The EU created an elaborate machinery to mediate its relations with IASB. It preferred to work with another private-sector body, created for the purpose, the European Financial Reporting Advisory Group (EFRAG), as the formal conduit for EU inputs to IASB. EFRAG was formed in 2001 by a collection of European representative organizations (for details see www.efrag.org), including the European Accounting Federation (FEE) and a European employer organization (UNICE). EFRAG in turn formed the small Technical Expert Group (TEG) that does the detailed work on IASB proposals. EFRAG consults widely within the EU, and particularly with national 49
Wiley IFRS 2012 standard setters and the European Commission to canvass views on IASB proposals, and provides input to IASB. It responds formally to all discussion papers and Exposure Drafts. At a second stage, when a final standard is issued, EFRAG is asked by the Commission to provide a report on the standard. This report is to state whether the standard has the requisite quality and is in conformity with European company law directives. The European Commission then asks another entity, the Accounting Regulation Committee (ARC), whether it wishes to endorse the standard. ARC consists of permanent representatives of the EU member state governments. It should normally only fail to endorse IFRS if it believes they are not in conformity with the overall framework of EU law, and should not take a strategic or policy view. However, the European Parliament also has the right to independently comment, if it so wishes. If ARC fails to endorse a standard, the European Commission may still ask the Council of Ministers to override that decision. Experience has shown that the system suffers from a number of problems. First, although EFRAG is intended to enhance EU inputs to IASB, it may in fact isolate people from IASB, or at least increase the costs of making representations. For example, when IASB revealed its intention to issue a standard on stock options, it received nearly a hundred comment letters from US companies (who report under US GAAP®, not IFRS), but only one from EFRAG, which in the early 2000s effectively represented about 90% of IASB’s constituents. It is possible, however, that EFRAG is seen at IASB as being only a single respondent, and if so, that people who have made the effort to work through EFRAG feel underrepresented. In addition, EFRAG inevitably will present a distillation of views, so it is already filtering respondents’ views before they even reach IASB. The only recourse is for respondents to make representations not only to EFRAG but also directly to IASB. However, resistance to the financial instruments standards, IAS 32 and IAS 39, put the system under specific strain. These standards were already in existence when the European Commission announced its decision to adopt IFRS for European listed companies, and they had each been exhaustively debated before enactment. European adoption again exposed these particular standards to strenuous debate. The first task of EFRAG and ARC was to endorse the existing standards of IASB. They did this—but excluded IAS 32 and 39 on the grounds that they were being extensively revised as part of IASB’s then-ongoing Improvements Project. During the exposure period of the improvements proposals—which exceptionally included roundtable meetings with constituents—the European Banking Federation, under particular pressure from French banks, lobbied IASB to modify the standard to permit special accounting for macrohedging. The IASB agreed to do this, even though that meant the issuance of another Exposure Draft and a further amendment to IAS 39 (which was finally issued in March 2004). The bankers did not like the terms of the amendment, and even as it was still under discussion, they appealed to the French president and persuaded him to intervene. He wrote to the European Commission in July 2003, saying that the financial instruments standards were likely to cause banks’ reported earnings to be more volatile and would destabilize the European economy, 50
Mackenzie, Coetsee, Njikizana, Chamboko and thus that the proposed standard should not be approved. He also argued that the Commission did not have sufficient input to the standardsetting process. This drive to alter the requirements of IAS 39 was intensified when the European Central Bank complained in February 2004 that the “fair value option,” introduced to IAS 39 as an improvement in final form in December 2003, could be used by banks to manipulate their prudential ratios (the capital to assets ratios used to evaluate bank safety), and asked IASB to limit the circumstances in which the option could be used. IASB agreed to do this, although this meant issuing another Exposure Draft and a further amendment to IAS 39 which was not finalized until mid-2005. When IASB debated the issue, it took a pragmatic line that no compromise of principle was involved, and that it was reasonable that the principal bank regulator of the Board’s largest constituent by far should be accommodated. The fact that the European Central Bank had not raised these issues at the original Exposure Draft stage was not discussed, nor was the legitimacy of a constituent deciding unilaterally it wanted to change a rule that had just been approved. The Accounting Standards Board of Japan lodged a formal protest, and many other constituents were not pleased at this development. Ultimately, ARC approved IAS 32 and IAS 39, but a “carve out” from IAS 39 was prescribed. Clearly the EU’s involvement with IFRS is proving to be a mixed blessing for IASB, both exposing it to political pressures that are properly an issue for the Commission, not IASB, and putting its due process under stress. Some commentators speculated that the EU might even abandon IFRS, but this is not a realistic possibility, given the worldwide movement toward IFRS and the fact that the EU had already tried and rejected the regional standard-setting route. A better observation is that this is merely part of a period of adjustment, with regulators and lobbyists both being uncertain as to how exactly the system does and should work, and both testing its limits, but with some modus vivendi evolving over time. However, it is severe distraction for IASB that financial instruments, arguably the area of greatest accounting controversy in the 1990s, is one that is still causing concern to the present date, in part exacerbated by the worldwide financial crisis of 2007-2009. Some believe that financial instruments accounting issues should have been fully resolved years ago, so that IASB could give its undivided attention to such crucial topics as revenue recognition, performance reporting and insurance contracts. The EC decision to impose “carve-outs” has most recently had the result that the US SEC’s historic decision to eliminate reconciliation to US GAAP® for foreign private issuers has been restricted to those registrants that file financial statements that comply with “full IFRS” (which implies that those using “Euro-IFRS” and other national modifications of IFRS promulgated by the IASB will not be eligible for this benefit). Registrants using any deviation from pure IFRS, and those using any other national GAAP®, will continue to be required to present a reconciliation to US GAAP®. Over time, it can be assumed that this will add to the pressure to report under “full IFRS,” and that even the EU may line up behind full and complete adherence to officially promulgated IFRS. In November 2009 the EFRAG decided to defer the endorsement of IFRS 9, although in principle they agree with the management approach adopted in IFRS 9. They believe that more time should be taken to consider the outcome of other 51
Wiley IFRS 2012 sections of the financial instrument project and that the sections should be endorsed as a package. In June 2010 the EFRAG issued a new Strategy for European Proactive Financial Reporting Activities. This strategy of proactive activities enhances EFRAG’s role in influencing standard setting by early engagement with European constituents to provide effective and timely input to the IASB’s work. This demonstrates that EFRAG is positively committed to the standard-setting process.
IFRS FOR SMES The IFRS for SMEs was issued by the IASB in July 2009 to reduce the financial reporting burden of small and medium-sized entities. In the process, many of the recognition and measurement principles in full IFRS have been simplified, disclosures significantly reduced and topics not relevant to SMEs omitted. Appendix B attached to this chapter provides discussion of these differences. The standard is a stand-alone document with only one optional cross-reference to full IFRS for financial instruments, which provides a choice regarding the treatment of financial instruments. The standard is appropriate for general-purpose financial statements. Generalpurpose financial statements are directed towards the common information needs of a wide range of users, for example, shareholders, creditors, employees, and the public at large. IFRS for SMEs is intended for entities that do not have public accountability. An entity has public accountability—and therefore would not be permitted to use the full IFRS—if it meets either of the following conditions: (1) it has issued debt or equity securities in a public market; or (2) it holds assets in a fiduciary capacity, as its primary purpose of business, for a broad group of outsiders. The latter category of entity would include banks, insurance companies, securities broker/dealers, pension funds, mutual funds, and investment banks. The responsibility lies with each jurisdiction to determine which entities should apply the IFRS for SMEs. Comprehensive training material is in the process of being developed for SMEs by the IFRS Foundation and a SME Implementation Group is set up to deal with financial reporting issues regarding SMEs. However, the IASB has indicated that the IFRS for SMEs will only be updated every three years. The application of the IFRS for SMEs standard has not been covered in this publication. However, there is a detailed accounting manual available that addresses the requirements, application, and interpretation of this standard—Applying IFRS for SMEs (available from Wiley). To continue...
Mirza, Holt, Knorr
Wiley IFRS: Practical Implementation Guide and Workbook 3rd Edition Abbas A. Mirza, Graham Holt, Liesel Knorr 9780470647912 • Paper • 584 pages Dec 2010 • £65 / €76 / $95
Chapter 1- INTRODUCTION TO INTERNATIONAL FINANCIAL REPORTING STANDARDS Need for a Common Set of Accounting and Financial Reporting Standards As the oft quoted verse from the world-renowned works of Shakespeare (Romeo and Juliet) goes: “What’s in a name? That which we call a rose by any other name would smell as sweet.” One wonders if the same can be said of financial statements prepared in different jurisdictions of the world. Not too far in the distant past, countries and economic regional blocs, such as Europe, would not be swayed by the thought of converging to a single set of global accounting standards and, due to nationalistic approaches to accounting standard setting, a financial statement issued in Japan (under the Japanese accounting standards) was vastly different in terms of accounting treatments and disclosures compared to a financial statement issued in other major parts of the world, say, in Germany where German accounting standards were used. In other words, the “name” that was given to the set of accounting standards used in the preparation of financial statements did matter for several countries since their national standard setters strongly believed that their own (national) accounting standards were suitable for their needs and were compatible to other globally preferred accounting standards. However, due to the advent of globalization, the falling of the erstwhile insurmountable trade barriers between nations, and more recently the much-awaited response to the global financial crisis, together with calls by world leaders, things have changed dramatically in terms of the preferred set of standards of accounting globally. The accounting and financial world is now seriously considering the notion of using a single set of accounting and financial reporting standards that would be used by most, if not all, the nations around the globe, it appears that in all likelihood the name of that set of global accounting standards may be the International Financial Reporting Standards (IFRS®). With this transformation of our world into a “flat world” (as some claim) the magical phenomenon of globalization has led to the emergence of a “global village” that we all live in now. The robust waves of globalization surging through the world 53
Wiley IFRS: Practical Implementation Guide and Workbook seem to have transformed businesses across the globe as well as the manner in which they deal with each other across boundaries. If therefore, as the old adage goes, “accounting is the language of business,” then businesses around the world cannot afford to be speaking in different languages to each other while exchanging and sharing financial results of their international business activities with each other, and also while reporting the results of business and trade to their international stakeholders. As one school of thought believes, since business enterprises around the world are so highly globalized now and need to speak to each other in a common language of business, there is a real need for adopting a single set of accounting standards to unify the accounting world under one canvas and more importantly, solve the problem of diversity of accounting practices across borders. Historically, countries around the world have had their own national accounting standards (which some countries have treasured for whatever reason, most likely due to the pride of national sovereignty). However, with such a compulsion to be part of the globalization movement, wherein businesses across national boundaries are realizing that it is an astute business strategy to embrace the world as their workplace and marketplace, having different rules (standards) of accounting for the purposes of reporting financial results would not help them at all (rather, it would serve as an impediment to smooth flows of information), and therefore, businesses have realized that they need to talk to each other in a common language. Thus, there is an urgent need for a common set of global, or even universal, accounting and financial reporting standards that are understood, used, and interpreted by different people around the world in the same manner. The adoption of accounting standards that require high-quality, transparent, and comparable information is welcomed by investors, creditors, financial analysts, and other users of financial statements. Without a common set of accounting and financial reporting standards, it is difficult to compare financial information prepared by entities located in different parts of the world. In an increasingly global economy, the use of a single set of high-quality accounting standards facilitates investment and other economic decisions across borders, increases market efficiency, and reduces the cost of raising capital. International Financial Reporting Standards (IFRS) are increasingly becoming the set of globally accepted accounting standards that meet the needs of the world’s increasingly integrated global capital markets.
What Are IFRS? IFRS is a set of standards promulgated by the International Accounting Standards Board (IASB), an international standard-setting body based in London, United Kingdom. The IASB places emphasis on developing standards based on sound, clearly-stated principles, on which interpretations may be required (sometimes referred to as principles-based standards). This contrasts with sets of standards, like US GAAP®, the national accounting standards of the United States, which contain significantly more application guidance. These standards are sometimes referred to as rulesbased standards, but that is really a misnomer as US standards also are based on principles— they just contain more application guidance (or “rules”). IFRS also generally do not provide “bright lines” in distinguishing between circumstances in 54
Mirza, Holt, Knorr which different accounting requirements are specified. This reduces the chances of ‘structuring’ transactions to achieve particular accounting effects. According to one school of thought, since IFRS are primarily “principles-based” standards, the IFRS-approach to standard setting focuses more on the business or the economic purpose of a transaction and the underlying rights and obligations and therefore, instead of providing prescriptive rules (or guidance), IFRS promulgates Standards that lay down guidance in the form of “principles.” This significant difference in approach to standard setting between IFRS and US GAAP® is responsible for the limited number of pages that the IFRS Standards are spread over compared to US GAAP® (US GAAP® extends to over 20,000 pages of accounting literature as opposed to IFRS which presently is covered in approximately 2,000 to 3,000 pages).
WORLDWIDE ADOPTION OF IFRS International Financial Reporting Standards (IFRS), which were initially called International Accounting Standards (IAS), are gaining acceptance worldwide. This section discusses the extent to which IFRS are recognized around the world and includes a brief overview of the history and key elements of the international standardsetting process. In the last few years, the international accounting standard-setting process has been able to claim a number of successes in achieving greater recognition and use of IFRS. A major breakthrough came in 2002 when the European Union (EU) adopted legislation that required listed companies in Europe to apply IFRS in their consolidated financial statements. The legislation came into effect in 2005 and applies to more than 8,000 companies in 30 countries, including France, Germany, Italy, Spain, and the United Kingdom. The adoption of IFRS in Europe means that IFRS have replaced national accounting standards and requirements as the basis for preparing and presenting group financial statements for listed companies in Europe. Outside Europe, many other countries also have been moving to IFRS. By 2005, IFRS had become mandatory in many countries in Africa, Asia, and Latin America. In addition, countries such as Australia, Hong Kong, New Zealand, Philippines, and Singapore have adopted national accounting standards that mirror IFRS. According to estimates, currently more than 100 countries require or permit IFRS in preparing and presenting financial statements, and many other countries are expected to adopt or apply IFRS in the coming years. In the period 2011–2012 several major players such as Canada and India are expected to adopt IFRS. The adoption of standards that require high-quality, transparent, and comparable information is welcomed by investors, creditors, financial analysts, and other users of financial statements. Without common standards, it is difficult to compare financial information prepared by entities located in different parts of the world. In an increasingly global economy, the use of a single set of highquality accounting standards facilitates investment and other economic decisions across borders, increases market efficiency, and reduces the cost of raising capital. IFRS are increasingly becoming the set of globally accepted accounting standards that meet the needs of the world’s 55
Wiley IFRS: Practical Implementation Guide and Workbook increasingly integrated global capital markets.
REMAINING EXCEPTIONS Measured in terms of the size of the capital markets, the most significant remaining exception to the global recognition of IFRS is the United States. In the US domestic entities continue to follow US GAAP® (Generally Accepted Accounting Principles). However, IFRS are being considered for adoption in the United States as well. The International Accounting Standards Board (IASB), the body responsible for setting IFRS, works closely with the national accounting standard-setting body in the US Financial Accounting Standards Board (FASB), to converge (that is, narrow the differences between) US GAAP® and IFRS. In the United States, the domestic securities regulator (Securities and Exchange Commission, SEC) has dropped its prior requirement for non-US companies that raise capital in US markets to prepare a reconciliation of their IFRS financial statements to US GAAP®. This means that non-US companies (foreign private issuers, FPIs) raising capital in US markets no longer are required to reconcile their IFRS financial statement to US GAAP® beginning with financial years ending after November 15, 2007. With this important SEC initiative IFRS have already made major inroads into the US capital markets. The SEC is currently considering whether to permit US companies to use IFRS instead of US GAAP® in preparing their financial statements. This is in response to the recognition that the world’s rapidly integrating capital markets would benefit from having a set of globally accepted accounting and financial reporting standards and that IFRS have become the primary contender for that title. Additionally, many question why US companies should continue to be required to use US GAAP® when non-US companies are permitted to raise capital in US markets without reconciling their IFRS financial statements to US GAAP®. The SEC has announced a Work Plan whereby it will assess and confirm by 2011 whether or not it would recommend that the United States should abandon US GAAP® and adopt IFRS, and if they do decide to adopt IFRS, when that would finally happen. The possible timescale for adoption of IFRS according to the initial SEC announcement through a SEC Roadmap (which approach was later modified and replaced with the SEC Work Plan) has been extended and is now expected to be around 2014. On June 2, 2010, the IASB and the US Financial Accounting Standards Board (FASB), jointly referred to as the Boards, announced a modified strategy for the convergence of IFRS and US GAAP®. The Boards first entered into a Memorandum of Understanding (MOU), which was updated in 2008, and a very aggressive work plan was agreed upon in order to complete the MOU projects by 2011. On June 24, 2010, the IASB issued a revised work plan for those MOU and non-MOU projects affected by the joint modified strategy announcement by the Boards, confirming their goal to complete several of these projects by June 2011 while extending the timeline for other nonurgent projects.
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THE INTERNATIONAL ACCOUNTING STANDARDS COMMITTEE From 1973 until 2001, the body in charge of setting the international standards was the International Accounting Standards Committee (IASC). The principal significance of IASC was to encourage national accounting standard setters around the world to improve and harmonize national accounting standards. Its objectives, as stated in its Constitution, were to â€˘ Formulate and publish in the public interest accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance â€˘ Work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements
IASC and the Accounting Profession IASC always had a special relationship with the international accounting profession. IASC was created in 1973 by agreement between the professional accountancy bodies in nine countries, and, from 1982, its membership consisted of all those professional accountancy bodies that were members of the International Federation of Accountants (IFAC), that is, professional accountancy bodies in more than 100 countries. As part of their membership in IASC, professional accountancy bodies worldwide committed themselves to use their best endeavors to persuade governments, standard-setting bodies, securities regulators, and the business community that published financial statements should comply with IAS.
IASC Board The members of IASC (i.e., professional accountancy bodies around the world) delegated the responsibility for all IASC activities, including all standardsetting activities, to the IASC Board. The Board consisted of 13 country delegations representing members of IASC and up to four other organizations appointed by the Board. The Board, which usually met four times per year, was supported by a small secretariat located in London, United Kingdom.
The Initial Set of Standards Issued by IASC In its early years, IASC focused its efforts on developing a set of basic accounting standards. These standards usually were worded broadly and contained several alternative treatments to accommodate the existence of different accounting practices around the world. Later these standards came to be criticized for being too broad and having too many options.
Improvements and Comparability Project Beginning in 1987, IASC initiated work to improve its standards, reduce the number of choices, and specify preferred accounting treatments in order to allow greater comparability in financial statements. This work took on further importance as securities regulators worldwide started to take an active interest in the international 57
Wiley IFRS: Practical Implementation Guide and Workbook accounting standard-setting process.
Core Standards Work Program During the 1990s, IASC worked increasingly closely with the International Organization of Securities Commissions (IOSCO) on defining its agenda. In 1993, the Technical Committee of IOSCO held out on the possibility of IOSCO endorsement of IASC Standards for cross-border listing and capital-raising purposes around the world and identified a list of core standards that IASC would need to complete in order to gain such an endorsement. In response, IASC in 1995 announced that it had agreed on a work plan to develop the comprehensive set of core standards sought after by IOSCO. This effort became known as the Core Standards Work Program. After three years of intense work to develop and publish standards that met IOSCOâ€™s criteria, IASC completed the Core Standards Work Program in 1998. In 2000, the Technical Committee of IOSCO recommended that securities regulators worldwide permit foreign issuers to use IASC Standards for cross-border offering and listing purposes, subject to certain supplemental treatments.
International Accounting Standards and SIC Interpretations During its existence, IASC issued 41 numbered Standards, known as International Accounting Standards (IAS), as well as a Framework for the Preparation and Presentation of Financial Statements. While some of the Standards issued by the IASC have been withdrawn, many are still in force. In addition, some of the Interpretations issued by the IASCâ€™s interpretive body, the Standing Interpretations Committee (SIC), are still in force.
List of IAS Still in Force for 2009 Financial Statements IAS 1, Presentation of Financial Statements IAS 2, Inventories IAS 7, Statement of Cash Flows IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors IAS 10, Events After the Reporting Period IAS 11, Construction Contracts IAS 12, Income Taxes IAS 16, Property, Plant, and Equipment IAS 17, Leases IAS 18, Revenue IAS 19, Employee Benefits IAS 20, Accounting for Government Grants and Disclosure of Government Assistance IAS 21, The Effects of Changes in Foreign Exchange Rates IAS 23, Borrowing Costs 58
Mirza, Holt, Knorr IAS 24, Related-Party Disclosures IAS 26, Accounting and Reporting by Retirement Benefit Plans IAS 27, Consolidated and Separate Financial Statements IAS 28, Investments in Associates IAS 29, Financial Reporting in Hyperinflationary Economies IAS 31, Interests in Joint Ventures IAS 32, Financial Instruments: Presentation IAS 33, Earnings Per Share IAS 34, Interim Financial Reporting IAS 36, Impairment of Assets IAS 37, Provisions, Contingent Liabilities, and Contingent Assets IAS 38, Intangible Assets IAS 39, Financial Instruments: Recognition and Measurement IAS 40, Investment Property IAS 41, Agriculture
List of SIC Interpretations Still in Force for 2009 Financial Statements SIC 7, Introduction of the Euro SIC 10, Government Assistance—No Specific Relation to Operating Activities SIC 12, Consolidation—Special-Purpose Entities SIC 13, Jointly Controlled Entities—Nonmonetary Contributions by Venturers SIC 15, Operating Leases—Incentives SIC 21, Income Taxes—Recovery of Revalued Nondepreciable Assets SIC 25, Income Taxes—Changes in the Tax Status of an Entity or Its Shareholders SIC 27, Evaluating the Substance of Transactions Involving the Legal Form of a Lease SIC 29, Service Concession Arrangements: Disclosures SIC 31, Revenue—Barter Transactions Involving Advertising Services SIC 32, Intangible Assets—Web Site Costs
THE INTERNATIONAL ACCOUNTING STANDARDS BOARD In 2001, fundamental changes were made to strengthen the independence, legitimacy, and quality of the international accounting standard-setting process. In particular, the IASC Board was replaced by the International Accounting Standards Board (IASB) as the body in charge of setting the international standards.
Key Differences between IASC and IASB 59
Wiley IFRS: Practical Implementation Guide and Workbook The IASB differs from the IASC Board, its predecessor body, in several key areas: • Unlike the IASC Board, the IASB does not have a special relationship with the international accounting profession. Instead, IASB is governed by a group of Trustees of diverse geographic and functional backgrounds who are independent of the accounting profession. • Unlike the members of the IASC Board, members of the IASB are individuals who are appointed based on technical skill and background experience rather than as representatives of specific national accountancy bodies or other organizations. • Unlike the IASC Board, which only met about four times a year, the IASB Board usually meets each month. Moreover, the number of technical and commercial staff working for IASB has increased significantly as compared with IASC. (Similar to IASC, the headquarters of the IASB is located in London, United Kingdom.) The interpretive body of the IASC (SIC) was replaced in 2002 by the International Financial Reporting Interpretations Committee (IFRIC). The latest name of this interpretive arm of the IASB is IFRS Interpretations Committee (which until March 31, 2010 was named International Financial Reporting Interpretations Committee (IFRIC)). The name of the organization that comprises both the IASB and its Trustees is the IFRS Foundation (which until March 31, 2010, was named International Accounting Standards Committee Foundation). The objectives of the IFRS Foundation, as stated in its Constitution, are 1. To develop, in the public interest, a single set of high-quality, understandable, and enforceable global accepted financial reporting standards based on clearly articulated principles that require high-quality, transparent, and comparable information in financial statements and other financial reporting to help investors and other participants in the various capital markets of the world and other users of the information to make economic decisions. 2. To promote the use and rigorous application of those standards. 3. In fulfilling the objectives associated with 1. and 2., to take account of, as appropriate, the needs of a range of sizes and types of entities in diverse economic settings. 4. To promote and facilitate adoption of IFRS through convergence of national accounting standards and IFRS. At its first meeting in 2001, IASB adopted all outstanding IAS issued by the IASC as its own Standards. Those IAS continue to be in force to the extent that they are not amended or withdrawn by the IASB. New Standards issued by IASB are known as IFRS. When referring collectively to IFRS, that term includes both IAS and IFRS.
List of IFRS Issued by the IASB to December 31, 2009 IFRS 1, First-Time Adoption of International Financial Reporting Standards IFRS 2, Share-Based Payment 60
Mirza, Holt, Knorr IFRS 3, Business Combinations IFRS 4, Insurance Contracts IFRS 5, Noncurrent Assets Held for Sale and Discontinued Operations IFRS 6, Exploration for and Evaluation of Mineral Resources IFRS 7, Financial Instruments: Disclosures IFRS 8, Operating Segments IFRS 9, Financial Instruments IFRS for SMEs* * NOTE: In July 2009 the IASB promulgated the much-awaited “IFRS for Small and Medium-Sized Enterprises (SMEs).” It provides standards applicable to private entities (that are not publicly accountable as defined in this standard). One of the initial projects undertaken by IASB was to identify opportunities to improve the existing set of Standards by adding guidance and eliminating inconsistencies and choices. The improved Standards, adopted in 2003, formed part of IASB’s stable platform of Standards for use in 2005 when a significant number of countries around the world moved from national accounting requirements to IFRS, such as all the countries in the European Union.
STRUCTURE AND GOVERNANCE Diagram of the Current IASB Structure
Wiley IFRS: Practical Implementation Guide and Workbook
IFRS Foundation and the Trustees: The governance of the IFRS Foundation rests on the shoulders of the Trustees of the IFRS Foundation (the “IFRS Foundation Trustees” or, simply, the “Trustees”). The Trustees comprise 22 individuals that are chosen from around the world. In order to ensure a broad international representation it is required that • Six Trustees are appointed from North America • Six from Europe • Six from Asia/Oceanic region • One from Africa • One from South America • Two from any part of the world, subject to maintaining overall geographical balance The Trustees are independent of the standard-setting activities (which is the primary responsibility of the Board members of the IASB). The Trustees, on the other hand, are responsible for broad strategic issues, such as • Appointing the members of IASB, the IFRS Interpretations Committee, and the IFRS Advisory Council • Approving the budget of the IFRS Foundation and determining the basis of funding it • Reviewing the strategy of the IFRS Foundation and the IASB and its effectiveness, including consideration, but not determination, of the IASB’s agenda (which if allowed may impair the Trustees’ independence of the standard-setting process) • Establishing and amending operating procedures, consultative arrangements, and “due process” for the IASB, the IFRS Interpretations Committee, and the IFRS Advisory Council • Approving amendments to the Constitution after consulting the IFRS Advisory Council and following the required “due process” • Fostering and reviewing the development of the educational programs and materials that are consistent with the objectives of the IFRS Foundation • Generally, exercising all powers of the IFRS Foundation except those expressly reserved for IASB, the IFRS Interpretations Committee, and the IFRS Advisory
Council Monitoring Board In order to enhance public accountability of the IFRS Foundation, while maintaining the operational independence of the IFRS Foundation and the IASB, the Monitoring Board, a new body, was created in 2009. The Monitoring Board comprises capital market authorities (e.g. representatives of institutions such as the IOSCO, the US SEC, and the European Commission) and its responsibilities include participating in the appointment of the Trustees of the IFRS Foundation, advising the Trustees in the fulfillment of their responsibilities, and holding meetings with the Trustees to discuss matters referred by the Monitoring Board to the IFRS Foundation or the IASB. 62
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The Board The Board is responsible for all standard-setting activities, including the development and adoption of IFRS. The Board members are from around the world and are selected by the Trustees based on technical skills and relevant business and market experience. The Board, which usually meets once a month, has currently 15 full-time members. The Board members are from a mix of backgrounds, including auditors, preparers of financial statements, users of financial statements, and academics. According to the IFRS Constitution, the Board shall comprise 14 members, increasing to 16 members at a date no later than July 1, 2012.
IFRS Advisory Council The Trustees appoint the members of the IFRS Advisory Council (which until March 2010 was named the Standards Advisory Council, SAC). The primary responsibility of the IFRS Advisory Council is to provide advice to the IASB on agenda decisions and priorities in the IASB’s work. The IFRS Advisory Council provides a forum for organizations and individuals with an interest in international financial reporting. It encompasses diverse geographical and professional backgrounds. The IFRS Advisory Council shall comprise 40 members approximately. Members are appointed for a three-year renewable term. Currently the membership of the IFRS Advisory Council includes chief financial and accounting officers from some of the world’s largest corporations and international organizations, leading financial analysts and academics, regulators, accounting standard setters, and partners from leading accounting firms.
IFRS Interpretations Committee IASB’s interpretive body, IFRS Interpretations Committee (which until March 2010 was named International Financial Reporting Interpretations Committee, IFRIC), is the IASB’s interpretive body and is in charge of developing interpretive guidance on accounting issues that are not specifically dealt with in IFRS or that are likely to receive divergent or unacceptable interpretations in the absence of authoritative guidance. The Trustees select members of the IFRS Interpretations Committee keeping in mind personal attributes such as technical expertise and diversity of international business and market experience in the practical application of IFRS and analysis of financial statements prepared in accordance with IFRS. The IFRS Interpretations Committee is comprised of 14 voting members. The Trustees, if they deem fit, may also appoint nonvoting observers representing regulatory bodies, who shall have the right to attend and speak at the meetings of the IFRS Interpretations Committee. A member of the IASB, the Director of Technical Activities, or another senior member of the IASB staff, or another appropriately qualified individual, is appointed by the Trustees to chair the IFRS Interpretations Committee. The IFRS Interpretations Committee meets as and when required, and ten voting members present in person or by telecommunication constitute a quorum. Meetings of the IFRS Interpretations Committee (and the IASB) are open to the public but certain discussions may be held in private at the discretion of the 63
Wiley IFRS: Practical Implementation Guide and Workbook IFRS Interpretations Committee. It is important to note that an IFRS Interpretations Committee interpretation requires the IASB’s approval before its final issuance.
List of IFRIC Interpretations issued up to December 31, 2009 IFRIC 1, Changes in Existing Decommissioning, Restoration, and Similar Liabilities IFRIC 2, Members’ Shares in Cooperative Entities and Similar Instruments IFRIC 3, Emission Rights (withdrawn) IFRIC 4, Determining Whether an Arrangement Contains a Lease IFRIC 5, Rights to Interests Arising from Decommissioning, Restoration, and Environmental Rehabilitation Funds IFRIC 6, Liabilities Arising from Participating in a Specific Market—Waste Electrical and Electronic Equipment IFRIC 7, Applying the Restatement Approach under IAS 29, “Financial Reporting in Hyperinflationary Economies” IFRIC 8, Scope of IFRS 2 (withdrawn) IFRIC 9, Reassessment of Embedded Derivatives IFRIC 10, Interim Financial Reporting and Impairment IFRIC 11, IFRS 2—Group and Treasury Share Transactions (withdrawn) IFRIC 12, Service Concession Arrangements IFRIC 13, Customer Loyalty Programs IFRIC 14, IAS 19—The Limit on a Defined Benefit Asset, Minimum Funding Requirements, and Their Interaction IFRIC 15, Agreements for the Construction of Real Estate IFRIC 16, Hedges of a Net Investment in a Foreign Operation IFRIC 17, Distribution of Noncash Assets to Owners IFRIC 18, Transfer of Assets from Customers IFRIC 19, Extinguishing Financial Liabilities with Equity Instruments
Standard-Setting Due Process As part of its due process in developing new or revised Standards, the Board publishes an Exposure Draft of the proposed Standard for public comment in order to obtain the views of all interested parties. It also publishes a “Basis for Conclusions” to its Exposure Drafts and Standards to explain how it reached its conclusions and to give background information. When one or more Board members disagree with a Standard, the Board publishes those dissenting opinions with the Standard. To obtain advice on major projects, the Board often forms advisory committees or other specialist groups and may also hold public hearings and conduct field tests on proposed Standards.
THE WAY FORWARD IFRS are clearly emerging as a global financial reporting benchmark and most countries have already started using them as their benchmark standards for listed companies. With the recent issuance of “IFRS for SMEs,” a stand-alone set of standards for private entities that do not have public accountability, the global reach of the IASB is further enhanced. However, if these international standards are not applied uniformly across the world due to interpretational differences, then their effectiveness 64
Mirza, Holt, Knorr as a common medium of international financial reporting will be in question; especially if different entities within the region apply them differently based on their interpretation of the standards, it would make global comparison of published financial statements of entities using IFRS difficult. Debate still rages amongst accountants and auditors globally on many burning and contentious accounting issues that need a common stand based on proper interpretation of these standards. According to one school of thought, IFRS are fast emerging as the muchawaited answer to the “billion dollar question” on the minds of accountants, financial professionals, financial institutions, and regulators, that is: Which set of accounting standards would solve the conundrum of diversity in accounting practices worldwide by qualifying as a single or a common set of standards for the world of accounting to follow and rely upon? Undoubtedly, for years US GAAP® was leading this much-talked-about international race to qualify as the most acceptable set of accounting standards worldwide. However, due to several reasons, including the highly publicized corporate debacles such as that at Enron in the United States, the global preference (or choice) of most countries internationally has now clearly tilted in favor of IFRS as the most acceptable set of international accounting and financial reporting standards worldwide. With the current acceptance of IFRS in over 100 countries (and with several more expected to adopt IFRS in the coming years) one can probably argue that IFRS could possibly qualify as an “Esperanto of international accounting” (“Esperanto” referring to the well-known “universal language”). However, some still believe that the race for global acceptance of IFRS is not over yet. While more than 100 countries have adopted IFRS as their national accounting standards, there are some very important jurisdictions in the financial world (such as the United States) which have not yet fully accepted IFRS for financial reporting of their domestic companies. Therefore, unless the United States, the largest economic superpower of the world for years now, accepts IFRS as their national GAAP® (replacing US GAAP®) it may be difficult to call IFRS the world’s standards. There is however a good possibility of the US SEC’s accepting IFRS ultimately. Judging from the amazing turnaround in the attitude of the US Securities and Exchange Commission, which has already allowed use of IFRS by foreign private issuers for filings on US stock exchanges, one may expect, that is if the SEC’s Work Plan to convergence with IFRS goes through successfully without any glitches, that by the year 2014 (unless the date of convergence is extended further for whatever reason), the world of accounting may be rejoicing and celebrating under a strong common banner of a global set of accounting and financial reporting standards, namely, the IFRS. However, some may believe that the idea of a single set of standards for the world may be wishful thinking, especially since the US SEC’s Road Map was amended and was replaced with the SEC’s Work Plan. But as things stand presently it may be expected that there is a strong possibility of allowing the use of IFRS in the United States in some form or another. To continue...
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