Part I on the IFRS, GAAP and SAP – Part I.
The transitionary provisions are predominantly presented in IFRS 1 which we would be looking at in this post. Prior to understanding the nuances of the IFRS, let us understand what an accounting policy is. An accounting policy is a statement by the entity on any aspect of the recording, preparation, presentation of the financial statements or accounting records which requires a level of judgement and there is more than one way of doing it correctly. For eg.: Most entities disclose the accounting policy for depreciation, because there are multiple ways of calculating it. Accounting standards provide guidelines to prepare accounting policies in most cases.
IFRS 1 requires that for the initial year in which the IFRS is being adopted, the entity prepare comparitives in compliance with the IFRS as well. According to the IFRS 1, there requires a retrospective application of all IFRS standards in effect as on the date on which the closing IFRS financial statements are prepared.
This means that if an entity seeks to prepare its first IFRS compliant financial statements for the year ended 2008, then the opening balance sheet/financial statements should be prepared for 31st December 2007 in order to have comparitive data which is IFRS compliant. And the accounting policies would have to be selected after carefully considering their usage and compliance with the IFRS. Adjustments which occur as a result of applying IFRS for the first time are to be transacted against the retained earnings in the opening balance sheet.
Let us consider a few places where IFRS would require a change as compared to the US GAAP.
- Additional assets and liabilities would have to be disclosed as per the requirements of the IFRS. For eg.: development assets as per IAS 38 on intangible assets. Provisions which are “probable”
- Assets and liabilities which are not compatible with IFRS. such as regulatory assets which could be allowed under the US GAAP.
- Classify all assets and liabilities in accordance with the requirements of IFRS. Investments, hedged assets etc.
- Measure all assets and liabilities as required by the IFRS. Such as valuation of inventory – use of LIFO method of accounting for inventory is prohibited.
Unlike the US GAAP which are numerous and comparatively stricter in terms of their requirements, the IFRS contain texts which are more in the form of principles which require to be interpreted and might be adopted to suit circumstances of each case. In such a case it is an usual error to shift back to adopting an accounting policy in line with the US GAAP considering that the text of the IFRS does not give a clear and detail guidance on a certain aspect. However, IFRS requires that the entity first apply its judgement and refer to IFRS interpretations before defaulting back to the US GAAP requirements.
IFRS 1 also details mandatory and discretionary exemptions which the entity needs to utilize while preparing its first IFRS financials.
This post has been written with a primary focus on US GAAP since many other countries have shifted to IFRS or have their existing accounting standards in line with or heavily borrowed from the IFRS.