In Part II of the blog we saw the list of IFRS that included IFRS statements and Accounting standard. In this blog we discuss some technical deep dive of IFRS. IFRS is a vast subject and its not possible to cover the same. The blog would cover some of the salient features of IFRS.
Fair Presentation and Compliance with IFRS
Financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the impacts of transactions, in accordance with the definitions (and recognition criteria) for assets, liabilities, income and expenses set out in the Framework. The application of IFRSs (with additional disclosure when necessary) is presumed to result in financial statements that achieve a fair presentation. Financial statements that comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. Financial statements shall not be described as complying with IFRSs, unless they comply with all the requirements of IFRSs.
Departure from standard
When an entity departs from a requirement of a Standard, it shall disclose:(i) that management has concluded that the financial statements present fairly the financial position, financial performance and cash flows;(ii) that it has complied with applicable Standards, except that it has departed from a particular requirement, to achieve a fair presentation; One example of departure from standard could that the requirements of a Standard as your legal system insists that specific procedures that do not comply with IFRS must be applied at all times. You provide the disclosures listed above.
Identification of Financial Statements
The financial statements shall be identified clearly, and distinguished from other information in the same document. Users must be able to distinguish information that is prepared using IFRSs, from other information that is not the subject of those requirements. Each component of the financial statements shall be identified clearly. In addition, the following information shall be displayed prominently (and repeated when it is necessary), for a proper understanding of the information presented:(i) the name of the reporting entity, and any change from the preceding balance sheet date;(ii) whether the financial statements cover the individual entity, or a group; (iii) the balance sheet date, or the period covered by the financial statements, whichever is appropriate to that component of the financial statements;(iv) the presentation currency, (v) the level of rounding used in presenting amounts in the financial statements.
In IFRS 1, the rules are laid out of how first time adapters should move into IFRS. The important aspect of IFRS 1 is there is an explicit and unreserved statement in those financial statements of compliance with IFRSs. The IFRS requires disclosures that explain how the transition from previous GAAP to IFRSs affected the entity’s reported financial position, financial performance and cash flows. This is an important aspect to ascertain the impact of change of standards vs. the actual business performance.
IFRS 2 covers share based payments. The reasons for granting shares are primarily for the entity to save cash, if the recipient can sell the shares in the market and the entity does not have to buy back the shares. Share options are given to staff to motivate them to improve the performance of the entity to lift the market price of its shares. It has been disputed whether there is a cost to the entity of these transactions. IFRS 2 says there is a cost to the entity and specifies its treatment. Estimates are now required of the number of options or other instruments expected to be exercised. Such estimates are complex to calculate where performance criteria, such as earnings targets, are involved. Specialist valuation skills are likely to be required in order to determine the amounts to be reported in the financial statements.
IFRS 3 deals with business combinations. This covers basically the treatment on account of an acquisition of another business. Cost of a combination is measured as the aggregate of: i. the fair values at the date of exchange of net assets given in exchange for control of the acquiree; plus ii. any costs directly attributable to the combination. The contractual obligation is recorded when a combination becomes probable and the liability can be measured reliably. The acquirer records an intangible asset and/or goodwill at the acquisition date.Intangible asset is separable, capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract e.g. patent rights. Goodwill represents a payment made by the acquirer, in anticipation of benefits from assets, that are not capable of being individually identified and separately recorded.
IFRS 4 covers insurance contracts. IFRS 4 focuses on any entity that issues an insurance contract as an insurer, whether (or not) the issuer is regarded as an insurer for legal, or supervisory purposes. An insurance contract is a contract under which one party (the insurer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.
IFRS 5 sets out requirements for the classification, measurement and presentation of non-current assets ‘held for sale’. IFRS 5 arises from the IASB’s consideration of the U.S. based FASB Statement No. 144 which addresses three areas: i. the classification, measurement and presentation of assets ‘held for sale’; ii. the classification and presentation of discontinued operations; and iii. the impairment of long-lived assets to be held and used.IFRS 5 achieves substantial convergence with the requirements of SFAS 144 relating to assets ‘held for sale’. IFRS 5 is one of several standards that apply to property.
IFRS 5 is used when the sale of property is not the main business, in which case it is treated as inventory.
Some examples of classification that would not come under the scope of IFRS 5
- Your board has decided to sell a division. Consultants have been hired to provide a sales plan. The division is not yet ‘held for sale’ as there is no plan to which management can be committed, nor is there any marketing.
- Your board has decided to sell a division. Markets are depressed and the division will only be sold when a minimum price is secured. The division is not yet ‘held for sale’ as no time commitment has been made. There are multiple use cases laid out on what should be classified vs. what should not be classified under this.
IFRS 6 is a industry specific standard. IFRS 6 covers treatment with respect to exploration for and evaluation of mineral resources. The scope mainly covers companies in the business of search for mineral resources, including minerals, oil, natural gas and similar non-regenerative resources, as well as the determination of the feasibility and commercial viability of extracting the mineral resource before the decision to develop the mineral resource. Since the nature of this business is unique, IFRS has laid out specific approach for this area.
IFRS 7 is a significant one in this economic and risk based times we are living in. This covers the disclosure of financial instruments and applies to all industries whether they are in the business of financial services or they are a pure manufacturing company. In case of a manufacturing company financial instruments would be accounts receivable or accounts payable, whereas in case of financial institution or bank every asset and liability could be financial instrument.
IFRS 8 is a very relevant one for large enterprise that have multiple business or companies that operate from different geographies. IFRS 8 specifies how organizations should do segment reporting.
As entities become larger, understanding how they operate:
- in different markets,
- with different products and services and
- providing to a growing range of clients becomes more difficult, unless additional detail is provided.
IFRS 8 specifies ways where financial statements have to be presented in more detail, by segments in order to allow for stakeholders to look at the numbers and make sense of the overall business. For example, if a company has invested in a country that has become politically unstable. Segment reporting explains how much (or little) performance depends on that country, and helps measure the risk that any loss of business could have on the group. Same is the case with a particular business line in the overall scheme of things. Segmentation or hierarchies based on which reporting should happen should be logically adapted by organization according to the relevance of business or geographies. For example, if a company is both in foods and bank business, these business have to be separated out in the segment reporting
Some examples
- Many international oil companies report their upstream activities (exploration and production) and their downstream activities (refining and marketing) as separate business segments, even if most of the upstream product (crude petroleum) is transferred internally to the entity’s refining operation.
- Particular enterprise is in food business. Part of the business is wholesale: low profit margins, and high volume. The other part is restaurants: higher margins, but lower volumes. Both should be separate segments.
- Pharma company provides pharmaceuticals to all areas of the world. Countries where tropical diseases will have different characteristics from those where colds and influenza dominate. The two groups should in different segments. IFRS 8 lays the following approach to identify the segments for reporting.An entity shall report separately information about an operating segment that meets any of the following quantitative thresholds: (1) Its reported revenue, including both sales to external clients and intersegment sales or transfers, is 10 per cent or more of the combined revenue, internal and external, of all operating segments. (2) The absolute amount of its reported profit or loss is 10 per cent or more of the greater, in absolute amount, of (i) the combined reported profit of all operating segments that did not report a loss and (ii) the combined reported loss of all operating segments that reported a loss. (3) Its assets are 10 per cent or more of the combined assets of all operating segments.
The above blog covered facets of the IFRS taking some deep dive into the various IFRS and explained some of them with examples. Please check out the Global convergence through IFRS - Part I and Global convergence through IFRS - Part II of the blog series.
