International Financial Reporting Standards
Introduction
“From 2005 UK listed companies must use IFRS for their consolidated statements” (Nobes and Parker, 2006, p.103). Therefore all companies listed in the UK, and whose financial statement date commences after this date, are required under European Union law to prepare consolidated financial statements upon the provisions of the international accounting standards. Among these standards is IFRS[1] 1, which will therefore also be applicable. IFRS determines that in the first year of reporting, a organisations complying with these regulations must include within their financial statements previous years figures compiled using the IFRS system for comparative purposes.
Following such major changes, it is important to understand the reasoning behind the EU’s adoption of these standards; the critical objectives of IFRS and to evaluate how their use has impacted upon the financial statements of a company in comparison with previous methods of reporting.
EU Adoption of international accounting standards
Historically, the member states of the European Union has been subjected to many different political and market structures, including those that prevailed in fledgling states that were formerly part of communist bloc of the Soviet Union. As Nobes and Parker’s (2006) earlier publications (1980 and 1998) have shown over the years, this has resulted in differing reporting classes of nations, between those who are driven by business or state and who have weak or strong equity markets.
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This diversity of national reporting standards has previously led to difficulties in terms of the international flow of capital because of the problems that arise in understanding the complexities of financial statements prepared under numerous national standards (Blake and Amat 1993). At this time, the EU was reluctant to accept IFRS, being concerned with the dominant of the US, and preferred to attempt harmonisation through raising its own legislation. However, when these failed to address the problem, the EU changed its stance and became a vigorous supporter for change (Nobel and Parker, 2005, p.105), within the single market.
There are several benefits to aligning reporting standards in EU member states with the IFRS, which has already been adopted internationally by a number of other countries, including the US. Primarily, within the EU itself, it will considerably reduce the problems of cross border trade between countries with differing standards, thereby making trade more secure. Secondly, it will facilitate increased free-flow of capital between nations (Armstrong et.al. 2002) and thirdly, it will make the Union as a trading bloc more competitive on the international stage.
Despite adopting most of the IFRS standards in 2002 (Mirza et.al. 2006, p.1), there were still some which it was reluctant to accept. Similarly, there were areas where reporting differences between member states still existed, as identified by Ann Tarca (2002) and, more recently, by Nobes and Parker (2006, p.19). However, the EU adopted the most controversial IFRS standard, which relates to fair value, subject to certain exemptions, in November 2004 (Press release 2005). There is little doubt that the current direction of international standards that they will lead to the end of individual nations reporting standards and influences (Nobes and Parker, 2006,p.103) and this makes sense from a regional and global trade position.
Executive summary of IFRS
Since IFRS initially came into force, IFRS 1 has been amended twice, with the latest amendment coming into force from the 1st January 2007. The standard itself has an overall objective and there are objectives for other aspects of the financial reporting statements outlined within the standards themselves.
Main IFRS objective
The overall objective for IFRS is to attempt to achieve a position where there is a single financial reporting standard, which will be globally accepted. It is envisaged that this will provide a position where there will be more equality in financial information where these are being used for comparison purposes. The anticipation is that the fact that more reliance can be placed on the financial reporting system, achievement of this goal will be made easier.
A further objective is to enable the reduction of existing international barriers to investment, which will partially be brought about by the increased reliance on the statements and also, because all statements will conform to a set standard, understanding of the results will be more universally available. This should also lead to an improvement of the performance of the various capital markets.
The IFRS standards are more objective in their purpose than previous reporting systems. Therefore, this should lead to a better understanding and more clarity in the statements. Furthermore, it will improve management information and improve the risk management and processes for reporting.
Other objectives
Within the standards themselves IAS 1:7 has been produced with the objective of providing financial information relating to corporations that will be useful to any who wish to use them, either for investment or any other economic purpose. Therefore, there is a concentration particularly on the reporting procedures for the balance sheet, as well as cash flow statements to enable the decision-making process to be based upon reliable information.
The focus of these statements is to present a fair representation of both the activities of the business during the period being reported, as well as fairly showing the value of all the assets, liabilities, equity and other aspects of the business. To bring the financial statements into line with current international trading situations, IFRS has moved financial statements away from the previously used “historical cost basis” to what is known as “fair value.” The reason for this is that interested parties will then know that the real and current market values are being represented.
To evidence that such objectives are being achieved, officers of the company are required to prepare and sign statements of compliance.
In general, the measurements of IFRS are noted throughout all of the standards, although there is a project to combine this into a single application[2]. For example, IFRS 2, relating to share based performance has the measurement guidelines set out, which relates specifically to this issue. Similarly, IFRS calls for the measurement of fixed assets, In this case the initial measurement on acquisition would be the price paid, but in subsequent years the fixed and intangible asset value must reflect the current market value at that times, unless for some reason this cannot be determined.
The overall measurements guidelines for all of the IFRS standards are, as previously indicated that all figures within the statements must be measured in relation to their “current fair value.”
The reporting standards also provide information relating to the presentation of the financial statements and the disclosures that must be included. IAS1.68 clearly outlines the minimum amount of information that is to be covered within the balance sheet, a total of sixteen lines, ranging from the fixed and current assets to the trade and current liabilities, and to include all aspects of the equity make-up of the business. There is similar provision for the presentation of the Income statement in IAS 1.81, which should present, amongst other items, the revenue, finance costs, tax expense, profit and loss and how that profit and loss is to be distributed.
There are a significant number of disclosure that are required by the IFRS standards, as can be seen by the checklist that has been prepared by the auditing firm Deloitte (2005). These include disclosure for all of the issues that have been previously examined within this summary as well as disclosures for other areas of the preparation of the financial statements, such as risk assessment and compliance with corporate governance regulations. The duty to comply with these various disclosures fall upon the management and all other appropriate officers of the business as well as external parties, such as the independent auditors. Additionally, if for some reason, items within the statements cannot be disclosed in the manner determined within the standards then it is necessary to provide a statement within the statements to explain this omission.
There is little doubt that the comprehensiveness of the IFRS standards will achieve the desired objectives, if or when they have been fully accepted on a truly international basis. Nevertheless, even at the current level of acceptance, they are making a difference.
IFRS impact on company results
Use of IFRS in preparing financial statements has resulted in some changes to company results. To assess this impact Telecom plus plc is being used as a case study. Under IFRS 1 rules, the company has elected to take advantage of three exceptions, these being: –
- Business combinations. This allows the company not to restate figures that relate to other operations within the group, save that referred to it point five below.
- The company has not applied IFRS to share options granted prior to 7 November 2004.
- Figures have not been restated to comply with IFRS 39, which relates to instrument recognition and measurement.
The major areas of change are indicated on page 51 of the company’s annual report. In summary these are as follows: –
- Goodwill. Under the old UK GAAP system provided goodwill was required to be amortised over a set number of years. The provisions of IFRS assets and other balance sheet figures to reflect their true value. Therefore, they need to be reviewed every year. The review process led to goodwill being valued at its original figure, therefore an amount of £456, 000 needed to be added back.
- The company’s billing system has been transferred from fixed assets to intangible assets. The reason for this is that it is not considered to be of a fixed nature in accordance with IAS 38. The cost of £283,000 was therefore transferred.
- Under the UK GAAP system, firma were allowed to account for divided provisions within the profit and loss account. IFRS standards state that this should not be the case, and that the dividends can only be included within the year that they are payable, therefore these has been excluded.
- Share options granted have no value until they are exercised. Therefore, under the IFRS standards this should not be shown within the profit and loss account.
- Telecom plus have an equity holding in a company called Oxford Power Holding Ltd. Due to the size of the holding, current IFRS standards consider that the provides Telecom with an influential position. Such a position needs to be identified within the statements by including the other business as an associate.
The net effect of all these changes is to have increased the retained earnings for both 2004 and 2005, by £3,137,000 and £4,150,000 respectively. Whilst this might give the impression of significantly improving the business equity situation, as all businesses within the industry are subjected to the same reporting requirements, there will be no resultant change to its market position.
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Footnotes
[1] International Financial Reporting Standards
[2] see http://www.iasb.org/Current+Projects/IASB+Projects/Fair+Value+Measurements/Fair+Value+Measurements.htm
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