Wrestling with the First-Time Adoption of IFRS PwC
First time adoption Session outline Exemptions and
Preparation of the first IFRS financial statements IFRS 1 General principles Replaces SIC-8 Application Requires To the first IFRS financial statements if these statements are for a period beginning on or after 1 January 2004. Earlier application is encouraged. If an entity s first financial statements are for a period beginning before 1 January 2004 and the entity applies this IFRS instead of SIC-8, its shall disclose that fact Each interim report under IFRS in the first period Selection of accounting policies that comply with IFRS Preparation of an opening IFRS balance sheet
IFRS 1 General principles Similar to SIC-8 in many respects IFRS 1 requires retrospective adoption of most IFRS, BUT The guidance is more comprehensive There are specific exemptions The latest version of each IFRS will be applied There is guidance on the use of previous estimates The disclosure requirements are more extensive
IFRS 1 General principles The Board will consider case by case when it issues a new IFRS whether a firsttime adopter should apply that IFRS retrospectively or prospectively. The Board expects that retrospective application will be appropriate in most cases, given its primary objective of comparability over time within a first-time adopter s first IFRS financial statements. However, if the Board concludes in a particular case that prospective application by a first-time adopter is justified, it will AMEND the IFRS on first-time adoption of IFRS. As a result, IFRS 1 will contain ALL material on first-time adoption of IFRS s and other IFRS s will not refer to first-time adopters. Stay tuned.
IFRS 1 General principles The Board used a balanced approach - between costs and benefits - when setting the accounting requirements of the IFRS 1 Fair value as deemed cost of assets is allowed but restricted to those assets for which reconstructing historical costs is likely to be of limited benefit to the users and particularly onerous: plant and equipment, investment property (when electing for the cost method) and intangibles that meet restrictive criteria Business combinations before the transition date should not be fully restated grand fathering of previously recorded goodwill is allowed. IFRS 1 deals with specific requirements when applying this exception. Subsidiaries already reporting under IAS for internal reporting purposes when and subsequent to the transition date of the parent, these subsidiaries also start to present their financial statements under IFRS, these subsidiaries are allowed to use the financial data included in the parent s consolidation (thus referring to their data previously reported internally)
IFRS 1 General principles Use of hindsight is prohibited: supplementary information that became available, for example at the beginning of 2005, would not be used even if it confirms a position in existence at January 1, 2004.
IFRS 1 First IFRS Financial statements The first IFRS financial statements are: The first financial statements to contain an explicit and unreserved statement of compliance with IFRS Financial statements are NOT IFRS financial statements when There is no explicit statement of compliance with IFRS They do not comply with all aspects of IFRS IFRS are used to fill gaps in local guidance
IFRS 1 Key dates 1 Jan 2003 1 Jan 2004 31 Dec 2005 Opening IFRS balance sheet for SEC registrants Any other entity requiring three years of income statements Not published Opening IFRS balance sheet for Most companies Recognise and measure all items using IFRS Not published First IFRS reporting date Select policies Use standards in force at this date First IFRS financial statements Use the same accounting policies for all periods presented in first IFRS financial statements
IFRS 1 Selection of accounting policies Accounting policies based on Standards in force at the reporting date When the effective date of a standard is between the date of the opening IFRS balance sheet and the reporting date, the NEW version of the standard is applied to the opening balance sheet, unless specific provisions override it When the effective date is after the reporting date: the new version of the standard MAY be applied to the opening balance sheet when the new version allows early application and IFRS 1 contains no contrary provision
IFRS 1 Selection of accounting policies Retrospective application to opening IFRS balance sheet and all periods, subject to eight optional exemptions; and three mandatory Earlier versions of the same IFRS are not used Transitional guidance in IFRS not used by first time adopters
IFRS 1 Opening IFRS Balance Sheet IFRS 1 requires an entity in its opening IFRS balance sheet to: Include all assets and liabilities required by IFRS Exclude assets and liabilities not permitted by IFRS; and Classify all assets, liabilities and equity as required by IFRS Measure all items in accordance with IFRS EXCEPT where an exemption or exception allows or requires otherwise Resulting adjustments recorded directly in the opening equity (not in P/L) apart from intangible assets that have been recognized in or eliminated from goodwill related to business combinations
IFRS 1 Comparative Information IFRS 1 requires only one comparative period. However, if the first IFRS financial statements contain more than one comparative period, any information not restated under IFRS must be clearly identified and accompanied by a description of the adjustment needed to bring them in conformity with IFRSs being the version of IFRSs also used for the IFRS opening balance sheet Watch carefully the requirements of the SEC: a full presentation of all information under IFRS is likely to be required Specific exemption is granted for the IAS 32-39. Comparatives (e.g. of 2004) need not to be restated for IAS 32 39 matters. However, a reconciliation between amounts at the end of the comparable period (e.g. Dec. 31, 2004) and those recognized at the beginning of the next period (e.g. January 1, 2005) after the application of IAS 39, should be disclosed
IFRS 1 Comparative Information IFRS 1 states that historical summaries for periods before the date of transition (1 January 2004 e.g.) need not be restated. When such a summary is included in the financial statements, the nature of the main adjustments that would be required to restate the information in accordance with IFRS should be disclosed. The information should be labeled prominently and described clearly as being prepared in accordance with previous GAAP.
Exemptions and Exemptions and
IFRS 1 Exemptions/ Exemptions Eight optional exemptions Three mandatory Business combinations Property, plant and equipment, investment properties, intangibles Employee benefits Compound instruments Cumulative translation differences Transition date for subsidiaries, associates and joint ventures Designation of previously recognised financial instruments Equity-settled share-based payment transactions Standards in force at reporting date Derecognition of financial assets and liabilities Estimates Hedge accounting
IFRS 1 Exemptions Exemptions Exemption Impact Apply to all? Business combinations Previous business combinations before the date of transition need not be restated NO Property, plant and equipment, Fair value or revaluation as deemed cost investment properties, intangibles of individual items (the application of an entire class is not required) NO Employee benefits Unrecognised actuarial gains and losses at the date of transition need not be recognised YES Cumulative translation differences May be set at zero for all items considered as net investment in a foreign entity YES Compound financial instruments Circumstances at inception, but equity element not to be identified if liability not outstanding at transition date NO Date of transition for some Balances already reported by subsidiary entities to parent need not be restated NO Designation of previously Designation of a financial asset or financial recognised financial instruments liability at fair value through P/L at the date of transition is permitted NO Equity-settled share-based Transactions whose grant date is before payment transactions 7/11/2002 need not be restated YES
IFRS 1 - Business combinations exemption Exemptions IFRS 3 need not be applied to business combinations before date of transition BUT, if one combination is restated, ALL subsequent combinations are restated When the exemption is used No change in classification (pooling versus purchase method) Assets and liabilities acquired are recognized in the acquirer s opening balance sheet unless IFRS does not permit recognition The deemed cost of assets and liabilities acquired is the carrying value immediately after the business combination Assets and liabilities measured at fair value subsequently are restated at date of transition - adjust retained earnings
IFRS 1 - Business combinations exemption Exemptions Assets and liabilities NOT recognized at the time of a business combination under previous GAAP are: Only recognized in the opening balance sheet of the acquirer if these assets and liabilities would be recognized in the ACQUIRED entity s separate IFRS balance Subsidiaries not consolidated under previous GAAP are: Consolidated as if subsidiary adopted IFRS at the same date as the parent Goodwill is the difference between cost of investment and net assets recognized at date of transition
IFRS 1 - Business combinations exemption Exemptions Goodwill is : Recognized at the carrying amount under previous GAAP and adjusted for: Intangibles that are not recognized under IFRS (goodwill is increased by the net amount taking into account deferred taxes and minority interest adjustments) Intangibles that must be recognized under IFRS and which were subsumed within goodwill (goodwill is decreased by the net amount taking into account deferred taxes and minority interests) Contingent consideration not recognized or previously recognized contingent consideration requiring an adjustment
IFRS 1 - Business combinations exemption Exemptions Goodwill is : Not adjusted: To exclude in-process research and development acquired unless the related intangible asset would qualify for recognition under IAS 38 in the separate balance sheet of the acquiree For previous amortization To reverse adjustments to goodwill that IFRS 3 would not permit, but were made under previous GAAP because of adjustments to assets and liabilities between the date of the business combination and the date of the transition to IFRS
IFRS 1 - Business combinations exemption Exemptions Impairment test on goodwill : Goodwill is tested for impairment at the date of transition regardless of whether there is any indication that the goodwill may be impaired The impairment is recognized in retained earnings (or, if so required by IAS 36 in the revaluation surplus) in the opening balance sheet This does not prevent the implicit recognition of internally generated goodwill that arose after the date of the business combination This mandatory impairment test is required in order to minimize the possibility of double counting an item that was included in goodwill under previous GAAP and is included under IFRS s either within the measurement of another asset or as a deduction of a liability
IFRS 1 - Business combinations exemption Exemptions When goodwill has been written off to equity immediately at the time of the business combination: Goodwill remains in equity Subsequent resolution of a contingency affecting the purchase price consideration shall be recognized in retained earnings Subsequent disposal of the investment does not require a recycling of the goodwill from the equity to the income statement
IFRS 1 - Business combinations exemption Exemptions Business combinations that arose as from the transition date, i.e. during the periods of the first IFRS statements (e.g. 2004 and 2005 for reporting date of Dec. 31, 2005), need to be fully restated in accordance with IFRS 3 However, as IFRS 3 is mandatory at the end of December 2004, all business combinations which need to be fully restated within IFRS 1 (e.g. for all periods covered by 2004 consolidated financial statements) should be done on the basis of the new standard in respect of business combinations
An event driven revaluation (IPO, privatization) made under previous GAAP if the revalued amount approximated fair value IFRS 1 PPE and intangibles exemption Exemptions Assets made up of components that have a different useful life or provide benefits to the entity in different patterns should be treated as separate assets under IAS 16 Possible to use fair value as deemed cost at the date of transition A revaluation may also be used as deemed cost at the date of revaluation A one-time revaluation made under previous GAAP if the revalued amount approximated fair value Cost or depreciated cost adjusted to reflect, e.g. changes in a general or specific price index
IFRS 1 PPE and intangibles exemption Exemptions These values represent the deemed cost at these dates of measurement. This basis should be adjusted to the required value as per transition date (additional cost re dismantling or restoration IAS 37 and depreciations) This exemption does not restrict the use of fair value as deemed cost to the entire classes of assets. The entity should also not demonstrate the undue cost or effort to reconstruct the historical cost data The flexibility in this area permits a cost-effective solution for the unique problem of transition to IFRSs. It allows a first-time adopter to establish a deemed cost using a measurement that is already available and is a reasonable starting point for a cost-based measurement.
IFRS 1 PPE and intangibles exemption Exemptions For intangibles following additional criteria should be met in order to be able to apply fair values as deemed cost basis The recognition criteria of IAS 38 including the reliable measurement of the original cost The criteria for revaluation in IAS 38 including the existence of an active market
IFRS 1 PPE and intangibles exemption Exemptions Depreciations should be accounted for in accordance with IFRS When the methods and rates under previous GAAP differ from the methods and rates applicable under IFRS, the entity adjusts the accumulated depreciation in its opening balance sheet retrospectively If the entity s depreciation methods and rates under previous GAAP are acceptable under IFRS, it accounts for any change in estimated useful life or depreciation pattern prospectively from when it makes that change in estimate
IFRS 1 PPE and intangibles exemption Exemptions When the entity adopts the allowed alternative treatment of IAS 16 (revaluation) for some or all classes of PPE, it presents the cumulative revaluation surplus as a separate component of equity. The revaluation surplus at transition date is based on a comparison of the carrying amount of that asset at that date with its cost or deemed cost. If the deemed cost is the fair value, the fair value and the previously reported value under previous GAAP is disclosed
IFRS 1 - IFRS Subsidiaries exemption Exemptions When a subsidiary adopts IFRS later than its parent, it can measure its assets and liabilities either at the carrying amount included in the parent s consolidated financial statements or by applying IFRS 1 at its transition date. The carrying amounts included in the parent s consolidation are adjusted to exclude consolidation and acquisition adjustments When a parent adopts IFRS later than its subsidiary, it MUST use the subsidiary s carrying amounts after consolidation and acquisition accounting adjustments These exemptions do not override the requirements in respect of the assets acquired and liabilities assumed in business combinations (exemption rules). However, the above rules are applicable to new assets and new liabilities acquired/assumed by the acquiree after the business combination and still held at the acquirer s date of transition to IFRS
IFRS 1 - IFRS Subsidiaries exemption Exemptions These exemptions do not override the requirements in respect of the application of the other paragraphs of the IFRS 1 related to the measurement of all assets and liabilities
IFRS 1 IAS 39 derecognition exception Exemptions A first-time adopter that had derecognised financial assets or financial liabilities under its previous GAAP before 1 January 2004 should keep those assets and liabilities unrecognised. It is however allowed to apply the derecognition rules retrospectively to the extent that the information needed to apply IAS 39 (revised 2003) to financial assets and liabilities derecognised as a result of past transactions was obtained at the time of initially accounting for those transactions. But: Recognise all derivatives and other interests retained from 1 January 2005 onwards. Consolidate all SPE controlled at transition date (SIC-12).
IFRS 1 IAS 39 hedging exception Exemptions Retrospective application of IAS 39 is PROHIBITED for hedge accounting. Prospective application of hedge accounting as from the transition date is permitted provided: The transaction qualified for hedge accounting under previous GAAP The designation, effectiveness and documentation IFRS requirements are met
IFRS 1 IAS 32/39 2004 comparatives Exemptions Reminder: entities adopting IFRSs for the first time in 2005 would not be required to restate comparative financial statements to incorporate the requirements of IAS 32 and 39. However, such entities would be required to provide a reconciliation between amounts recognised at the end of the comparative period (for an entity with a December year-end, 31 December 2004) and those recognised at the beginning of the next period (for an entity with a December year-end, 1 January 2005)
IFRS 1 Estimates exception Exemptions Estimate required by previous GAAP? YES Evidence of error? NO Calculation consistent with IFRS? NO YES YES NO Make estimate reflecting conditions at relevant date Use previous estimate Use previous estimate and adjust to reflect IFRS
IFRS 1 Reconciliation of equity from previous GAAP to IFRS at transition and last year end (e.g. 1 Jan 2004 and 31 Dec 2004) Reconciliation of last year s net profit under previous GAAP to IFRS (e.g. year to 31 Dec 2004) Sufficient detail to understand adjustments to each line item Errors made under previous GAAP and identified during transition Fair value as deemed cost and the amount of the adjustment IAS 36 disclosures for impairment identified during transition
IFRS 1 Interim financial information Reconciliation of equity/net profit as above for previous full year Reconciliation of equity and net profit for comparative interim period (e.g. 6 months to 30 June 2004 ) Further information to comply with IAS 34
IFRS 1 Reconciliations Equity Equity and net income Equity and net income 01.01.04 30.06.04 31.12.04 30.06.05 31.12.05 Transition date Interim comparative Year end comparative Interim date Reporting date
Conclusion The guidance in IFRS 1 is complex First time adoption is likely to be challenging for many companies The key is early and comprehensive planning
Introduction to the quizz One of your Belgian listed client (Wayne Holdings) (holding + industrial activities) is planning its conversion to IFRS. Wayne Holding will publish its first IFRS consolidated financial statements by 31 December 2005. Wayne Holdings CFO asks you 10 questions in relation to the first-time adoption of IFRS for its company. Work for 15 minutes in your table groups, go through the 10 questions, discuss your suggested solution and appoint a spokesman to present your conclusions.
Q1: Waynes Holdings annual report usually contains a summary of selected data that includes financial information for at least five years. Does all of this information have to be restated in accordance with IFRS?
Q2: The CFO has noticed in the IASB s timetable that the IFRS dealing with business combinations (phase II) will probably be published in 2005 only, thus not in time to be mandatory at 31 December 2005. Can Wayne Holdings apply the guidance in the standard if it has been published by 31 December 2005, but is not mandatory?
Q3: For the German subsidiary, which was acquired in 2000, the CFO is aware that no adjustment has been made to local tax depreciation that has resulted in certain assets being fully depreciated several years before they are retired from service. Should there by any adjustment on transition to IFRS?
Q4: The business in South Africa is specific to the group. Most of the industrial equipments consist of a number of individual assets which have different useful lives. These assets are depreciated over the average life of the entire equipment and any renewals are charged as repairs and maintenance. Applying the component approach required by IAS 16 to determine net book value on transition to IFRSs would be burdensome. Should it be applied? What do you suggest?
Q5: Wayne Holdings revalued its head office building in 1995 in its local books. The revalued amount was based on the current market price determined by an independent expert. The other office buildings in the group were not revalued. Under IFRS, the CFO does not want to adopt as an accounting policy the allowed alternative treatment under IAS 16 that permits an entity to measure its items of PPE at a revalued amount. At transition date, should the revaluation be reversed?
Q6: Wayne Holdings undertakes R&D activities and charged all R&D costs to P/L under its previous GAAP accounting policies. The company has 4 major projects. For one of the projects (for which which there is a possibility to obtain subsidies), Wayne Holdings has accumulated cost information relating to the different phases and carried out assessments of the future economic benefits. No such information exists for the other projects. Should there be any adjustments at transition date? Should the company go backwards to determine the costs that would have been capitalised, had IAS 38 been applied from the beginning?
Q7: Wayne Holdings merged with Joker as a result of a share exchange at the end of 2001. Wayne Holdings (by far the biggest company) recorded this transaction using the pooling of interests method under previous GAAP, so the assets and liabilities of Joker were recorded in the consolidated financial statements using the book values in Joker s financial statements. Joker entered into a lease with a bank for its administrative building. The transaction was accounted for as an operating lease under previous GAAP (but should have been considered as a finance lease had IAS 17 been applied at that time). Should the merger be restated using the IFRS business combinations guidance, and the assets and liabilities of Joker restated to fair value at the date of acquisition? Should there be any adjustment in relation to the leased building?
Q8: Wayne Holdings has adopted some aspects of IAS 39, but only to the extent permitted by previous GAAP. The CFO has discussed the Group s hedging strategy with the treasurer and has noted that IFRS 1 proposes that the requirements of IAS 39 for hedge accounting should be applied prospectively. He has not reviewed the documentation prepared in connection with the group s interest rate hedges, but he is aware that group treasury only uses hedging instruments that are identified with specific borrowings. He intends to review this documentation in detail in Q2 2005 after the 2004 closing for adoption of hedge accounting as from 1 January 2005. Is the proposal above appropriate?
Q9: The CFO has noted that some of the group s investments in equity or debt securities will be presented as available-for-sale assets under IFRS and remeasured to fair value. Such investments are often used when the group has surplus cash, so the portfolio changes frequently. If the investments have been sold by 31 December 2005, can the fair value at the date of transition to IFRS be assumed to be the actual selling price?
Q10: When Wayne Holdings acquired Riddler SA in 2000, the acquisition included O Hara Enterprises, a 100%-owned subsidiary of Riddler SA. Wayne Holdings considered the business of O Hara Enterprises SA to be outside the main business of Riddler SA. O Hara Enterprises has never been consolidated. Can O Hara Enterprises SA be excluded from the first IFRS financial statements?
Question time QUESTION TIME Contact: E-mail: patrice.schumesch@pwc.be Tel. 02/710.40.28 E-mail: herwig.opsomer@pwc.be Tel. 09/268.82.23 Site web: www.pwc.be