Latest IAS/IFRS standard principles in financial statement preparation

Introduction

It is been so long since IOSCO (International Organization of Securities Commissions) asked securities commissions from all over the world to accept financial statements compliant to international standards. It was 2000. The idea was to encourage freedom of capital movements beyond national borders. Today, we are witnessing a more and more pronounced convergence, nevertheless with not a few issues. Here, latest international standard principles in the financial statement preparation have been enlightened and main lists of IFRS/IAS/IFRIC/SIC principles appendix are kept up-to-date.

Table of Contents

  1. Introduction
  2. International Accounting Standards
    1. IFRS vs US GAAP: similarities and differences
  3. IAS/IFRS adoption between accounting quality and costs
  4. The financial statement according to IAS/IFRS
    1. The statement of financial position
    2. The statement of comprehensive income
    3. The statement of cash flows for the period
    4. The Explanatory notes to the financial statements
  5. Relevant IFRS principles list
  6. Relevant IAS principles list
  7. Relevant IFRIC principles list
  8. Relevant SIC principles list
  9. References

International Accounting Standards

High quality, enforceable and globalized financial information. This is the mantra of IASB (International Accounting Standards Board), international accepted leader as accounting standards setter. Nowadays, their standards are being used in some form by more than 115 countries around the world (Kieso, Weygandt & Warfield, 2020). This commits to the primary goal of the financial statement: help stakeholders to better understand financial position and related performance.

Actually, each jurisdiction has its own accounting standards: in Germany there are GAS, in Italy there are OIC and so on. In U.S., the standard-setting body is GAAP. Regardless the country, we can find a convergence path towards IFRS, because IASB can prove autonomy, high-skilled membership, independence and majority voting in issuing new principles.

IFRS vs US GAAP: similarities and differences

Special mention is deserved by the everlasting struggle between IFRS and US GAAP.

Well, luckily it is not really a struggle, because there is a convergence in US too and most GAAP rules follow IFRS schema. However, since market capitalization leaders are Americans (NYSE with 21,5% foreign listings and 14,4 in Nasdaq), it is crucial to compare IFRS to GAAP accounting.

Bearing in mind US GAAP differs among countries too, the main difference between US GAAP and IFRS is essentially conceptual: US GAAP are based primarily on accounting rules with specific guidance in applying them, whereas IFRS are based more on principles requiring professional judgment by accountants, and specific guidance in application is limited.

Hereafter, further differences.
The first dilemma is about L.I.F.O.: the Last In First Out method of valuing inventory is allowed to US companies, whereas international companies are basically not encouraged (IAS 2). This could lead to a distortion because LIFO often means a reduced taxable income.

Under US GAAP, research and development costs, for example, are generally expensed when they occur. Under the international standards, once a project gets to the development stage, costs are spread out over time. The upshot is that a company could show different operating income and net profit depending on which system they use […]

Scannell K. & Reilly D. (2007, 21th June). Is end near for “U.S. only” accounting?. The Wall Street Journal, pp. A7, A8

Moreover, US GAAP generally prohibit the upward revaluation of non-financial assets, whereas IFRS allow the revaluation of some such assets to fair value.

That said, modifications to both IFRS and US GAAP have brought the two closer together, with the key remaining differences in the areas of impairment charges, leasing, insurance and the treatment of financial instruments (Berk, DeMarzo, 2017)

Regardless these points, US GAAP and IFRS are similar, thus the main remaining difference is that US GAAP are rule-driven, while IFRS are principle-driven. A question mark remains about donations (in particular from US companies to IFRS foundation), that could be seen as an attempt – by rule-based jurisdictions – to move towards a more flexible accounting approach (i.e. IFRS), based on interpretation. In this sense, over-regulation is the child of scandals and so SEC wants to ensure an adequate market protection.

IAS/IFRS adoption between accounting quality and costs

Nowadays, according to IFRS foundation, more than half of Global Fortune 500 companies report using IFRS Standards. In the world, they have complete profiles for 166 jurisdictions.

But, who uses IFRS standards? Who does it apply? According to the Regulation (EC) No 1606/2002 (the progenitor law about IFRSs), and successive amendments, we have to distinguish:

  • Mandatory IAS adopters: public listed companies, banks and insurance, companies with consolidated statement etc;
  • Optional IAS adopters: companies included in the preparation of a consolidated statement.

We can think about accounting quality as a decision-usefulness index, hence the accounting willingness to provide useful information to decision makers.

IFRS can improve accounting quality due to the two main pillars on which is based (Soderstrom, Naomi & Sun, Kevin., 2007):

  • Relevance, in particular:
    • Predictive value
    • Confirmatory value
    • Materiality
  • Faithful representation, in particular:
    • Completeness
    • Neutrality
    • Free from error

These two pillars, in turn, has to involve comparability, verifiability, timeliness and understandability.

It is common knowledge that the IAS/IFRS adoption can have wide-ranging benefits:

IFRS was successful in creating a common accounting language for capital markets (European Commission, 2015).

Evidence suggests that IFRS adoption was largely positive for listed companies in Australia (Australian Accounting Standards Board, 2016).

IFRS adoption helped to reduce investment risk in domestic firms, mitigate the “Korea discount,” and attract foreign capital via overseas shares listing, bond issuance, or mergers and acquisitions (Korean Accounting Standards Board, 2016).

Authorities about ias/ifrs adoption

Some companies also report benefits from being able to use IFRS in their internal reporting (Kieso, Weygandt & Warfield, 2020). This improves their ability to compare operating units in different jurisdictions by reducing the number of different reporting systems. In Japan, where use of IFRS has been voluntary since 2010, business efficiency, enhanced comparability, and better communications with international investors have been identified as the main reasons why many Japanese companies made the choice to adopt IFRS (Japanese Financial Services Agency).

Nevertheless, the adoption is certainly not free-of-cost, rather, it has to be treated as a complex migration process. The involvement of a change manager could be thoughtful. The same for external consultancies in order to support IT, especially if the accounting software is integrated to ERP platform as SAP, Oracle and so on.

From a technically standpoint, in the first time adoption, it is necessary to recast prior financial statements according to IFRS and, once identified the right time to transition, proceed to design an opening statement of financial position, establish new IFRS accounting policies (and apply them retrospectively), evaluate optional exemptions’ and apply those mandatory and finally prepare an explanation about the transition. The idea is to act as if the company had always implemented IFRS.

The financial statement according to IAS/IFRS

In order to be compliant with IAS/IFRS principles, the preparation of financial statement has to be based on the so called framework for the preparation of financial statement, directly drafted by IASB authority. The financial statement consists of four main mandatory documents:

  • The statement of financial position as at the end of the period;
  • The statement of comprehensive income;
  • The statement of cash flows for the period;
  • The explanatory notes to the financial statements;

The statement of financial position

IASB defines balance sheet’s assets as all kind of resources controlled by the firm, related to past affairs and expected to give future measurable benefits, regardless of the ownership (e.g. financial lease of instrumental goods or industrial secrets). Similarly, liabilities are considered as current obligations, related to past affairs and expected to give future measurable outflows (Quagli, 2017).

According to IAS 1, the balance sheet must include a minimum content to be compliant (Di Pietra, Allegrini, 2011):

ASSETLIABILITIES
Non-current assetsEquity
Current assetsNon-current liabilities
Non-current assets for salesCurrent liabilities
Non-current liabilities for sales
IASB balance sheet: asset and liabilities

The statement of Comprehensive Income

How an income is defined? What does the law say? Incomes are often defined according to the jurisdiction traditional approach. As we know, IAS/IFRS received across-the-board approval and its approach is basically patrimonialist. Thus, IASB defines an income (cost) as increases (decreases) in assets, or decreases (increases) in liabilities, that result in increases (decreases) in equity, other than those relating to contributions from holders of equity claims.

Moreover, IAS 1 does not establish a standard cost criteria, even if it is more advisable the nature classification, bearing in mind the fundamental role of the fair value accounting approach, piece de resistance of IAS/IFRS.

In light of the fact that the income has to be considered in a broad sense, IAS 1 moved from the traditional profit and loss changing its name to Statement of comprehensive income. The comprehensive income calculation can result of an unique document or two sections (the traditional profit and loss with the new Other comprehensive income section enclosed). The minimum requirements of the new profit and loss section is represented by:

STATEMENT OF COMPREHENSIVE INCOME (PROFIT AND LOSS SECTION)
Revenue
Finance costs
Capital gain & losses from goods or company branches’ alienations
Tax expense
Profit (loss) of the year
Traditional section of the new IASB “Statement of comprehensive income” (profit and loss section)

If divided, the other section – the Other comprehensive income – has to start with the last item of the (ex) profit and loss statement, namely the profit or the loss result and then:

STATEMENT OF COMPREHENSIVE INCOME (OTHER COMPREHENSIVE SECTION)
(Profit or loss)
Gain & losses matured but not realized related to asset or liabilities
Total comprehensive income for the year
Other income section of the new IASB “Statement of comprehensive income”

Gain and losses are often not yet realized: for instance, material and immaterial immobilizations adjusted according to the fair value based revaluation model (IAS 16 and 38); or financial activities classified into the Available for sale section, even these fair valued adjusted.

The statement of cash flows for the period

Preparing the financial report means relying on the IAS 7 definition of financial resources: cash, bank and deposit accounts, namely financial means. Moreover, three areas are expected to be pointed out by IAS 7:

  • ± Operating activities: customers inflows, suppliers and employees outflows, payable interests, taxes, extraordinary operations etc.;
  • ± Investing activities: interests income and dividends collected, investments outflows, divestments inflows etc.;
  • ± Financing activities: inflows from new shares issuance, inflows from long term debts, outflows from financial leasing, payed dividends, etc..

Their summation shows the yearly financial means’ delta (±).

The Explanatory Notes to the Financial Statements

IAS 1 establishes minimum requirements for notes: in particular it is mandatory to discuss unusual evaluation criteria adopted and insert information not included in other statements or related to the consolidated statement (if any). Moreover, notes are expected to contain IASB compliance declaration, general company data and main performance metrics. In addition, IFRS 8 establishes the segment reporting, hence to include information about relevant business segments where the company is able to generate income (if diversified) and IAS 24 that set off the crucial role of related party disclosures (if held).

Relevant IFRS principles list

Hereafter, the main IFRS list updated:

  • IFRS 1 First-Time Adoption of IFRS
  • IFRS 2 Share-Based Payment
  • IFRS 3 Business Combinations
  • IFRS 4 Insurance Contracts
  • IFRS 5 Non-current Assets Held for Sale and Discontinued Operations
  • IFRS 6 Exploration for and Evaluation of Mineral Resources
  • IFRS 7 Financial Instruments: Disclosures
  • IFRS 8 Operating Segments
  • IFRS 9 Financial Instruments (effective for accounting periods commencing on or after January 1, 2018 and will supersede IAS 39 and IFRIC 9)
  • IFRS 10 Consolidated Financial Statements
  • IFRS 11 Joint Arrangements
  • IFRS 12 Disclosure of Interest in Other Entities
  • IFRS 13 Fair Value Measurement
  • IFRS 14 Regulatory Deferral Accounts
  • IFRS 15 Revenue from Contracts with Customers (effective for accounting periods commencing on or after January 1, 2018 and will supersede IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18 and SIC 31)
  • IFRS 16 Leases (effective for accounting periods commencing on or after January 1, 2019 and will supersede IAS 17, IFRIC 4, SIC 15 and SIC 27)
  • IFRS 17 Insurance Contracts (effective for accounting periods commencing on or after January 1, 2022 and will supersede IFRS 4, IFRIC 4 and SIC 15)

Relevant IAS principles list

Hereafter, the main IAS list updated:

  • IAS 1 Presentation of Financial Statements
  • IAS 2 Inventories
  • IAS 7 Statement of Cash Flows
  • IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
  • IAS 10 Events after the Reporting Period
  • IAS 11 Construction Contracts (replaced by IFRS 15)
  • IAS 12 Income Taxes
  • IAS 16 Property, Plant and Equipment
  • IAS 17 Leases
  • IAS 18 Revenue (replaced by IFRS 15)
  • IAS 19 Employee Benefits
  • IAS 20 Accounting for Government Grants and Disclosure of Government Assistance
  • IAS 21 The Effects of Changes in Foreign Exchange Rates
  • IAS 23 Borrowing Costs
  • IAS 24 Related-Party Disclosure
  • IAS 26 Accounting and Reporting by Retirement Benefit Plans
  • IAS 27 Separate Financial Statements
  • IAS 28 Investments in Associates and Joint Ventures
  • IAS 29 Financial Reporting in Hyperinflationary Economies
  • IAS 32 Financial Instruments: Presentation
  • IAS 33 Earnings per Share
  • IAS 34 Interim Financial Reporting
  • IAS 36 Impairment of Assets
  • IAS 37 Provisions, Contingent Liabilities and Contingent Assets
  • IAS 38 Intangible Assets
  • IAS 39 Financial Instruments: Recognition and Measurement (replaced by IFRS 9)
  • IAS 40 Investment Property
  • IAS 41 Agriculture

Relevant IFRIC principles list

The ex SIC (Standard Interpretations Committee) is currently known as IFRS Interpretations Committee (IFRIC): they provide authoritative and supportive explanations to not completely addressed topics by IAS/IFRS (PKF international ltd., 2020). Hereafter, the main IFRIC list updated:

  • IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities
  • IFRIC 2 Members’ Shares in Co-operative Entities and Similar Instruments
  • IFRIC 4 Determining Whether an Arrangement Contains a Lease
  • IFRIC 5 Rights to Interests Arising from Decommissioning, Restoration and Environmental Rehabilitation Funds
  • IFRIC 6 Liabilities Arising from Participating in a Specific Market—Waste Electrical and Electronic Equipment
  • IFRIC 7 Applying the Restatement Approach under IAS 29, Financial Reporting in Hyperinflationary Economies
  • IFRIC 9 Reassessment of Embedded Derivatives (replaced by IFRS 9)
  • IFRIC 10 Interim Financial Reporting and Impairment
  • IFRIC 12 Service Concession Arrangements
  • IFRIC 13 Customer Loyalty Programmes (replaced by IFRS 15)
  • IFRIC 14 IAS 19—The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction
  • IFRIC 15 Agreements for the Construction of Real Estate (replaced by IFRS 15)
  • IFRIC 16 Hedges of a Net Investment in a Foreign Operation
  • IFRIC 17 Distributions of Non-cash Assets to Owners
  • IFRIC 18 Transfer of Assets from Customers (replaced by IFRS 15)
  • IFRIC 19 Extinguishing Financial Liabilities with Equity Instruments
  • IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine
  • IFRIC 21 Levies
  • IFRIC 22 Foreign Currency Transactions and Advance Consideration
  • IFRIC 23 Uncertainty over Income Tax Treatments

Relevant SIC principles list

SIC stands for Standards Interpretation Committee: their principles act as “clarifiers” for doubts about IAS/IFRS or not fully covered areas. Hereafter, the main SIC list updated:

  • SIC 7 Introduction of the Euro
  • SIC 10 Government Assistance—No Specific Relation to Operating Activities
  • SIC 15 Operating Leases—Incentives
  • SIC 25 Income Taxes—Changes in the Tax Status of an Enterprise or its Shareholders
  • SIC 27 Evaluating the Substance of Transactions involving the Legal Form of a Lease
  • SIC 29 Disclosure—Service Concession Arrangements
  • SIC 31 Revenue—Barter Transactions involving Advertising Services (replaced by IFRS 15)
  • SIC 32 Intangible Assets—Web Site Costs

References

BERK, J. & DEMARZO, P. (2017). Corporate Finance. Harlow, EN: Pearson.

DI PIETRA R., ALLEGRINI M. (2011). Bilancio IFRS. Best practice e casi operativi. Arezzo, IT: Knowità.

KIESO, D. E., WEYGANDT J. J. & WARFIELD T. D. (2020). Intermediate accounting: IFRS edition. River Street, Hoboken, NJ: John Wiley & Sons, Inc..

PKF INTERNATIONAL LTD. (2020). Interpretation and Application of IFRS Standards 2020. Cornwall, UK: John Wiley & Sons, Inc..

QUAGLI A. (2017). Bilancio di esercizio e principi contabili. Torino, IT: G. Giappichelli Editore.

SCANNELL K. & REILLY D. (2007, 21th June). Is end near for “U.S. only” accounting?. The Wall Street Journal, pp. A7, A8

SODERSTROM, NAOMI & SUN, KEVIN (2007). IFRS Adoption and Accounting Quality. European Accounting Review. 16. 675-702. 10.1080/09638180701706732.

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