Undertaking the Transition to IFRS

Undertaking the Transition to IFRS Ann Clarke considers the key points in IFRS 1 for first-time adopters of IFRSs Summary of IFRS1 Introduction International Financial Reporting Standard 1 Firsttime Adoption of International Financial Reporting Standards (IFRS1) sets out the requirements that a first-time adopter of IFRS must meet when preparing its annual financial statements. A first-time adopter is an entity that is formally adopting all the IAS/IFRSs for the first time, and does so by making an explicit and unreserved statement of compliance with IFRS in its financial statements. Therefore, the requirements of IFRS1 apply to entities adopting IFRS for the first time as a result of its mandatory introduction across the EU from 2005. General principle In general, IFRS1 requires an entity: * To comply with each IFRS effective at the reporting date (balance sheet date) for its first IFRS financial statements. For example, entities with a 31 December year-end that are performing the change-over to IFRS in 2005 must comply with all IAS/IFRSs effective at 31 December 2005. * To apply each IFRS retrospectively Thus, an entity s first IFRS financial statements are presented as if the entity had always presented its financial statements in accordance with IFRS. While the retrospective application of IFRS will be onerous for entities, there may also be some benefits to it. For example the retrospective application of IFRS 3, Business Combinations, will provide brand- driven companies with a one-off opportunity to put previously acquired brands on the balance sheet. The general principle of retrospective application is applied to all items except mandatory exceptions available and optional exemptions specified in IFRS1 (see below). The ability of first-time adopters to take advantage of the exemptions laid down in IFRS1 is critical to efficient transition from current standards to IFRS. Ability to use IFRS1 requires an explicit and unreserved statement of compliance with IFRS. Effective Date Objective Summary First IFRS financial statements for an accounting period beginning on or after 1 January 2004. To set out the procedures to be followed when an entity adopts IFRS for the first time. For an entity with a 31 December year-end that adopts IFRS for the first time in 2005 in its annual financial statements: Select its accounting policies based on IFRSs effective at 31 December 2005. Prepare at least 2004 and 2005 financial statements in accordance with IFRSs effective at 31 December 2005. Prepare opening balance sheet (at beginning of first period for which comparative financial statements are presented) in accordance with IFRSs effective at 31 December 2005. IAS1 requires at least one years comparative information thus the opening balance sheet will be at 1 January 2004. Starting Point Opening IFRS balance sheet As a starting point the entity must prepare an opening IFRS balance sheet at the date of transition. The date of transition is defined as the beginning of the earliest period for which an entity presents full comparative information under IFRS in its first IFRS financial statements. For an entity preparing 2005 financial statements with a 31 December year-end the date of transition is 1 January 2004. The accounting policies to be applied to the opening balance sheet are those effective as at the reporting date. In the aforementioned example this means standards effective at 31 December 2005. The opening IFRS balance sheet is used as a basis for the preparation of the first IFRS financial statements, but is not required to be published in any financial statements. In its opening balance sheet and all periods presented in the first IFRS financial statements the entity applies the same accounting policies. 19

Recognition of assets and liabilities required by IFRS Following are some examples of assets and liabilities, which are required to be recognised under IFRS: * Development costs should be capitalised as an intangible asset where particular criteria are met. This contrasts with Irish/UK GAAP, where an entity may choose to capitalise development costs, if certain criteria are met. * Acquired intangible assets should be recognized if they meet certain criteria. * All derivative financial instruments, including embedded derivatives, must be recognized and measured at fair value, whereas under Irish/UK GAAP derivatives hedging future cash flows are not required to be recognized. * Provisions should be recognized as liabilities. This could include onerous contracts, decommissioning, restructuring obligations, litigation and warranties. * Deferred tax assets and liabilities should be recognized in accordance with IAS 12. Derecognition of assets and liabilities not in compliance with IFRS If previous GAAP assets and liabilities do not qualify for recognition under IFRS they should be derecognised. Examples of assets and liabilities, which are not allowed recognition under IFRS include: * Provisions, if there is no present obligation. * General reserves as liabilities. * Expenditure on research, start-up costs, preoperating and pre-opening costs, training, advertising and promotion, moving and relocation may not be recognized as an intangible asset. Application of IFRS in measuring all recognised assets and liabilities. The general measurement principle is to apply IFRS in measuring all recognised assets and liabilities. This means that if an entity adopts IFRS for the first time in the financial statements for the year ended 31 December 2005, in general it would use the measurement principles in effect at 31 December 2005. There are some exemptions and exceptions to the general measurement principle, as noted below. Examples of measurement requirements under IFRS include the following: * Financial instruments are measured at fair value or amortised cost (IAS 39) * Provisions are measured at best estimate (IAS 37) * Intangible assets are measured at cost (IAS 38) * Investment property is measured at either fair value or depreciated cost (IAS 40). * Requirements for impairment of assets (IAS36) and measurement of pension liabilities (IAS 19) are detailed and complex. The change-over to IFRS will more than likely result in the entity having to change its accounting policies with respect to recognition and measurement. The effect of changes in accounting policies as a result of transition to IFRS should be recognised directly in equity in the opening balance sheet (except for reclassifications between goodwill and intangible assets, arising from accounting for business combinations in accordance with Appendix B to IFRS1 or IFRS3). Significant disclosures are required with respect to changes in accounting policies on transition to IFRS. Such disclosures are essential in the first IFRS financial statements because they help users understand the effect and implications of the transition to IFRS and how they need to change their analytical models to make the best use of information presented using IFRS. Reclassifications Reclassify items recognised under Irish GAAP to comply with IFRS classification. The entity should reclassify Irish GAAP opening balance sheet items into the appropriate IFRS classification. Examples of classifications required under IFRS include the following: * Dividends to shareholders proposed or declared after the balance sheet date are not recognized as a liability at the balance sheet date. In the opening IFRS balance sheet they are required to be classified as a component of retained earnings. * Separate presentation of non-current and current assets and liabilities under IAS 1 * Classification of financial assets into four categories under IAS 39 * No offsetting of assets and liabilities unless permitted by specific IAS/IFRS. Presentations and disclosures required under IFRS. All IFRS presentation and disclosure requirements must be fulfilled in the first IFRS financial statements. IFRS1 does not provide any exemptions from the presentation and disclosure requirements of the separate IFRSs. Some standards may have a significant impact on an entity s presentation and disclosure requirements. For most first-time adopters, meeting these disclosure requirements will require costly and time consuming changes to reporting and information systems. The following are examples of IAS/IFRS with significant disclosure requirements: * Segmental reporting: SSAP 25 contains an exemption from the disclosure requirements where disclosure would be seriously prejudicial to the entity s interests. There is no such exemption in IAS 14. The disclosure requirements of IAS 14 are more extensive than in SSAP 25. 20

* Reconciliations of equity reported under Irish GAAP to equity reported under IFRS for a) the date of transition to IFRS and b) the end of the latest period presented in the entity s most recent annual statements under previous GAAP. For an entity preparing 2005 financial statements with a 31 December year-end this means that equity reconciliations are required for a) 1 January 2004 and b) 31 December 2004. * Reconciliation of profit/loss reported under previous GAAP for the latest period to profit/loss under IFRS for the same period. For an entity preparing 2005 financial statements with a 31 December year-end this means that a profit reconciliation for year-ended 31 December 2004 is required. These reconciliations should be in sufficient detail for users to understand the material adjustments to the balance sheet and income statement as well as to the cash flow statement. The required disclosures relate to both: * Financial Instruments: IAS 32 disclosure requirements are much more voluminous than those required by FRS 4, FRS 13 and the Companies Acts. The IAS 32 disclosure requirements focus on risk management policies and hedging activities, terms, conditions and accounting policies, interest rate risk, credit risk, fair values, derecognition, collateral, compound financial instruments with multiple embedded derivatives, reclassifications, material items affecting the income statement or equity, impairment and defaults and breaches. * IAS 36 requires extensive disclosure of impairments by segment and, where material, by cash-generating unit. In addition there is extensive narrative disclosure required on the impairment testing process and, in certain circumstances, disclosure of the key assumptions made in impairment tests and sensitivity analysis. Comparative Information Prepare comparative information for the previous period. IFRS1 allows three exemptions from this requirement. An entity that adopts IFRS before 1 January 2006 is not required to present comparative information that complies with IAS 31, IAS 39 and IFRS 4. Reconciliations An entity must explain how the transition from Irish GAAP to IFRS affected the performance, position and cash flows of the entity. In order to comply with this requirement the financial statements must include: a) the most recent information published under UK/Irish GAAP, so that users have the most up-to-date information; and b) the date of transition to IFRS. This is important as the opening IFRS balance sheet is the starting point for accounting under IFRS. Correction of errors must be distinguished from changes in accounting policy. Optional exemptions and mandatory exceptions to the general principle of retrospective application. It is important to be aware of the above. IFRS1 describes some exemptions and exceptions to retrospective application of IFRS. The IFRS groups the exceptions to retrospective application into two categories: 1. Optional exemptions: IFRS1 describes ten optional exemptions, where entities can opt not to apply IFRS retrospectively. These optional exemptions are available due to the fact that the costs of applying IFRS retrospectively in certain situations may exceed the benefits. The following exemptions are individually optional, and a first-time adopter may opt to apply all, none, or some of these exemptions: a) Business combinations that occurred before the opening balance sheet date * An entity may retain the original UK/Irish GAAP accounting, and not restate: - Previous mergers or goodwill written-off from reserves - The carrying amount of items recognised at the date of acquisition or merger - How goodwill was initially determined 21

* IFRS1 contains an appendix, which details how a first-time adopter should account for business combinations prior to transition to IFRS. * An entity may restate all business combinations from a date it selects before the opening balance sheet date. b) Fair value or revaluation as deemed cost A first-time adopter may measure property, plant and equipment, intangible assets, and investment property carried under the cost model at their fair value or revalued amount. c) Employee benefits A first-time adopter may choose to recognise all cumulative actuarial gains and losses for all defined benefit plans at the opening IFRS balance sheet date, and set any corridor recognised previously to zero. If a first-time adopter avails of this exemption it may still elect to use the IAS 19 corridor approach for actuarial gains and losses that arise after first-time adoption of IFRS. If the first-time adopter does not avail of this exemption it must restate all defined benefit plans under IAS 19 since the start of those plans. d) Cumulative translation differences An entity may avail of the exemption to recognise all translation adjustments arising on the translation of the financial statements of foreign entities in accumulated profits or losses at the opening IFRS balance sheet date, that is, reset the translation reserve to zero. e) Compound financial instruments f) Assets and liabilities of subsidiaries, associates, and joint ventures g) Designation of previously recognised financial instruments h) Share based payments i) Insurance contracts 2. Exceptions that prohibit retrospective application of IFRS to some aspects of derecognition of financial instruments, hedge accounting and estimates. Conclusion The purpose if IFRS1 is to ease the transition to IFRS globally, and also specifically for the many listed companies in the EU, which have to present consolidated accounts in accordance with IFRS from 2005 onwards. It aims to ensure that an entity s first IFRS statements contain high quality information that is comparable over time in an individual entity, and also between different entities adopting IFRS for the first time at a given date. It aims to ensure that the first IFRS statements provide a suitable starting point for accounting under IFRS, and also that the information contained in the financial statements can be generated at a cost that does not exceed the benefits to users. Ann Clarke is Members Services Executive with the Institute of Certified Public Accountants in Ireland. She is responsible for the provision of technical information and support to CPA members. She can be contacted at aclarke@cpaireland.ie. Timetable for first time adopter with 31 December year-end, presenting IFRS financial statements for first time in 2005. i ii The specific transitional provisions of the individual standards do not apply to a first-time adopter of IFRS. Instead a first-time adopter prepares the opening balance sheet in accordance with the provisions of IFRS1. IAS 8 does not deal with changes in accounting policies that occur when an entity first adopts IFRS. Therefore, IAS 8 s requirements for disclosures about changes in accounting policies do not apply in an entity s first IFRS financial statements. A first-time adopter applies the requirements of IFRS1 when dealing with changes in accounting policies. As at 31 December 2003 (Date of transition) Year-end 31 December 2004 (Previous GAAP reporting) Year-end December 2005 (Reporting date) 1. Prepare opening IFRS balance sheet. 2. Reconcile opening IFRS balance sheet to Irish/UK GAAP balance sheet. 3. Publish Irish/UK GAAP accounts for 2003 1. Prepare IFRS accounts for the year for use as comparatives in 2005. 2. Publish Irish/UK GAAP accounts for 2004. 1. Publish IFRS accounts for 2005 with IFRS comparatives for 2004. 2. Publish the reconciliation of the 31 December 2003 Irish/UK GAAP and IFRS balance sheets. 3. Publish the reconciliation of all 2004 primary statements. 22

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