Your Essential Guide to IFRS Financial Reporting
Table of Contents1. Application of IFRS
2. Using the Conceptual Framework to improve reporting consistency
3. What's included in IFRS Financial Statements?
4. Understanding Fair value measurement
5. Using Fair Value in IFRS 9 Financial Instruments
6. Getting to grips with IFRS 15: Revenue from Contracts with Customers
7. What are the new IFRS standards that have been issued?
8. Keeping up to date with IFRS Workplan
9. How to Transition to IFRS
10. Is there an IFRS Template available?
11. What are the key benefits of using an IFRS template?
Application of IFRS
The first International Accounting Standard (IAS) was issued back in 1975 and, in the years since, the international financial reporting movement has gained momentum such that IAS and successors, International Financial Reporting Standards (IFRS), are now permitted or required to be used by companies in over 150 countries throughout the world. IFRS adopters benefit from increased opportunity for cross-border investment and financing and, as a result, many companies choose to adopt, even if they are not required to.
In the UK, the application of IFRS became mandatory for listed companies in 2005 thanks to the European Commission (EC) and its ‘IAS Regulation’. This regulation requires that all companies with securities traded on a regulated market within the European Union (EU) apply IFRS to prepare their consolidated financial statements. Other companies may choose to apply either IFRS or UK GAAP. Regardless of whether the application is mandatory or voluntary, UK companies should only apply IFRS that are endorsed by the EU.
The EU endorsement process begins when a new standard is issued, or an existing standard amended, by the International Accounting Standards Board (IASB). It is carried out by the European Financial Reporting Advisory Group (EFRAG), which ensures that the standard meets technical criteria and that its adoption would be for the public good in Europe. The endorsement process is usually complete by the time a standard becomes effective, however in some cases in the past this has not happened, and therefore the European effective date of some standards differs from that effective date stated in the IFRS. Although most IFRS may be adopted before the mandatory effective date, it’s worth remembering that this is only the case in the EU if the endorsement process is complete.
A conceptual framework is a statement of generally accepted principles that form a frame of reference for financial reporting. The IASB issued its first conceptual framework in 1989, and this was in place for over 20 years before it was updated in 2010. In recent years the International Accounting Standards Board (IASB) has been involved in an on-off project to improve the 2010 guidance. This was finally completed in March 2018, and an updated conceptual framework was issued, which updates the previous issue and fills gaps in guidance.
The intention is that the principles contained within the 2018 Conceptual Framework will be considered by the IASB as it develops new IFRS and improves existing international standards. As such, inconsistency of approach to accounting for different types of transactions will be minimised. The Conceptual Framework should also be applied by preparers to develop accounting policies for transactions where no standard exists.
Two fundamental principles feature in the new Conceptual Framework:
- Relevance, which in this context means that information should be capable of making a difference to decisions made by users; and
- Faithful representation, which here means that information should represent the substance of transactions and be complete, neutral and free from error.
These were both identified as fundamental characteristics of financial information in the 2010 Conceptual Framework, however their importance is now emphasised even more. Relevance and faithful representation are now key factors in the Conceptual Framework’s criteria for recognising assets and liabilities in the balance sheet. The IASB says they are also the main factors to consider when making a decision to measure those assets and liabilities using a cost or a fair value measure. Furthermore, they should be considered when making presentation decisions.
As new standards are issued and existing standards amended and revised, we can expect to see a lot more reference to relevance and faithful representation, so reinforcing IFRS’s status as principles-based rather than rules-based standards.
A full set of IFRS financial statements includes a statement of financial position, a statement of profit or loss and other comprehensive income, a statement of changes in equity and a statement of cash flows, together with related notes. Comparatives are required for each and, where there has been a retrospective adjustment, a third statement of financial position at the start of the comparative period is required. Although these financial statement titles are used in the standards themselves, companies can use alternative UK names, such as balance sheet, in their published accounts.
Items are recognised, measured and disclosed in the financial statements in accordance with the requirements of IFRS. Departure from these requirements is allowed but only in extremely rare circumstances and leads to additional disclosure.
Almost all IFRS financial statements include disclosure requirements, although there are some exceptions where the accounting treatment of a topic is included in one or more standards and the related disclosures in a separate standard. Notable examples are financial instruments and the consolidation. Other standards only relate to disclosure. These include:
- IFRS 8 Operating Segments, which requires listed companies to disaggregate their results and report them by business or geographical segment
- IAS 33 Earnings Per Share, which again relates only to listed companies and requires disclosure of basic and diluted earnings per share in the financial statements, and;
- IAS 24 Related Party Transactions, which relates to all companies and details disclosures that are necessary to alert the audience of the financial statements to any transactions and balances with parties that may influence or be influenced by the reporting entity.
The disclosure requirements of IFRS are extensive and detailed notes to the accounts represent the majority of any set of IFRS financial statements, both in terms of volume and time to prepare.
Numerous IFRS, including those on investment property, owner-occupied property and financial instruments either allow or require an item to be measured at fair value in the balance sheet. Until 2011, individual standards provided guidance on how to determine fair value. This guidance was often inconsistent, and different definitions of fair value applied to different items. As a result, the IASB developed IFRS 13 Fair Value Measurement which became effective in 2013, to be applied in almost all cases where another standard allows or requires measurement at fair value.
IFRS 13 defines fair value as an exit price, in other words the price that would be ‘received to sell an asset or paid to transfer a liability’. It also clarifies that fair value should be based on an orderly transaction, in other words, not a forced sale.
When a non-financial asset is being measured, fair value is based on its highest and best use, assuming that use is possible. Therefore, if land is used for industrial purposes but would be worth more if developed for residential purposes, then fair value is based on residential use. Fair value is also based on a sale within the principal or main market for an item, or if one doesn’t exist, in the most advantageous market.
The determination of fair value will vary depending on what is being measured. For example, the fair value of listed shares is easily determined by reference to quoted prices; whereas the fair value of an unlisted subsidiary is likely to require the use of a valuation technique such as discounted cash flows.
However fair value is determined, it will require inputs to the valuation. IFRS 13 classifies these as level 1, 2 or 3 within a ‘fair value hierarchy’. Level 1 inputs are quoted prices in active markets and are the most desirable inputs and result in the most reliable measurement of fair value – or to use the Conceptual Framework’s term, result in the most faithful representation.
One area in which fair value measurement is used extensively is financial instruments. In July 2014, the IASB finally issued the complete version of its new standard on financial instruments, IFRS 9. This standard, which replaced IAS 39 from 1 January 2018, had been a long time in the making, with more than five years between the issue of the first exposure draft and the final standard.
IFRS 9 was developed in response to the global financial crisis, with the aims of:
- reducing the widely-criticised complexity of IAS 39
- aligning reporting for financial instruments and hedging arrangements, with the way that companies actually manage their business and risks, and, most importantly of all;
- bringing forward the recognition of credit losses on loans and receivables to an earlier stage in the credit cycle.
The standard requires that financial assets are classified in accordance with their cash flow characteristics and the business model under which they are held. As a result, debt investments may be measured at amortised cost, fair value through other comprehensive income (FVTOCI) or fair value through profit or loss (FVTPL). In most cases, equity investments are measured at FVTPL; financial liabilities are measured at either amortised cost or FVTPL. In a further change from IAS 39, the IFRS 9 default model for all financial instruments is FVTPL, resulting in increased potential for volatility of earnings.
In terms the impairment of financial assets, IFRS 9 uses an expected credit loss model. Application of this model means that from day one, an entity must recognise an allowance for future losses based on expected future cash shortfalls under various default scenarios. This is a significant change from the widely-criticised ‘incurred loss model’ of IAS 39 under which an impairment loss was not recognised until the impairment had occurred.
IFRS 9 itself does not include any disclosure requirements for financial instruments; these disclosures are deemed so significant that they have their own disclosure standard: IFRS 7 Financial Instruments: Disclosure.
2018 has been a busy year for IFRS reporters – as well as IFRS 9, the new standard on revenue, IFRS 15, became effective from the start of the year.
IFRS 15 replaces an old and outdated standard, IAS 18 (on which UK GAAP is based). This was much criticised for its lack of detailed guidance on the timing of revenue recognition and its measurement. The new standard takes a five-step approach to the recognition of all revenue, be it from the sale of goods, provision of services or delivery of a long-term contract.
The crux of this process is that each contract with a customer must be analysed into the separate deliverables, or performance obligations within that contract, and the total transaction price allocated to each deliverable in relation to its standalone selling price. Revenue in respect of each is recognised on delivery.
Although there is unlikely to be any change in the timing or measurement of revenue in simple transactions, there may be significant changes in relation to more complex transactions, particularly in the telecoms, software development and real estate industries. For example, telecoms companies that provide network services plus a handset within a contract must now treat the provision of services and the handset as separate performance obligations. Revenue in relation to the handset must be recognised at the start of the contract. This is a marked change from the ‘old’ treatment, in which a handset was often recognised as a marketing cost giving rise to no revenue.
IFRS 15 goes into significant detail on determining the total transaction price within a contract. For example, it considers variable elements of the price such as a performance bonus or rebate and the existence of a significant financing component in the price. This may mean that some transactions are measured differently from before.
Be aware - these measurement and recognition changes are likely to result in significant changes in profit reporting patterns for some companies!
The new leases standard introduces extensive guidance as to what is a lease contract, accompanied by a number of illustrative examples to help with the application of this guidance. Having identified that they are party to a lease, in all but a few cases a lessee will be required to recognise an asset and lease liability in the balance sheet. This is a significant change from IAS 17, which required lessees to classify leases as either operating or finance and then applied different accounting models to each. Crucially, no asset or liability was recognised in respect of an operating lease. As a result of this new single model approach, companies with material off balance sheet leases will see significant changes in Key Performance Indicators (KPI) such as gearing and, in turn, bank and other covenants are likely to be affected.
The good news is that lessor accounting remains more or less the same as before and lessors will continue to classify leases as operating or finance in nature. This does, of course, result in asymmetrical accounting for lessee and lessor; however the IASB decided that the cost of changing the lessor accounting model far outweighed any benefit of doing so.
The most recent IFRS to have been issued are IFRS 16 Leases and IFRS 17 Insurance Contracts, rather fittingly in 2016 and 2017 respectively. Neither of these new IFRS must yet be applied on a mandatory basis, although the effective date of IFRS 16 is just around the corner on 1 January 2019. Therefore, now is the time to consider its impact and prepare.
IFRS 17 is a specialist standard that will only apply to those entities that issue insurance or reinsurance contracts or hold reinsurance contracts – as such it will have no impact on the majority of IFRS reporters.
IFRS 16 will therefore be the most significant of the new IFRS in a general sense. Given the popularity (and cash flow benefits) of obtaining the use of an asset by way of lease, a high proportion of larger organisations will be affected.
New IFRS and changes to existing IFRS are the output of the IASB’s IFRS workplan. This is effectively a continuous process to update and improve reporting standards in response to emerging issues and implementation problems. The IFRS workplan includes research projects, standard-setting projects and maintenance projects.
Currently, standard-setting projects include the revision of the IASB’s practice statement on management commentary and the development of a new IFRS for rate-regulated activities. This will be relevant to companies that are subject to regulations restricting how much customers can be charged. A standard on this topic is expected in 2019.
There are a number of on-going maintenance projects, two of which are part of the IASB’s major Disclosure Initiative project, through which it aims to:
- increase the amount of relevant information in disclosure notes
- decrease the amount of irrelevant information, and
- communicate information more effectively.
The intention is to achieve this through the development of new disclosure principles that are related to those in the Conceptual Framework.
In other maintenance projects within the IFRS workplan, the IASB is working on revised definitions of accounting policies and accounting estimates to improve clarity and distinction; improvements to IFRS 8 Operating Segments; and guidance on how to account for proceeds of goods sold whilst testing plant and machinery before it is ready for use.
The updating and revising process for IFRS is continuous and projects are added to the agenda frequently. The up-to-date IFRS workplan is available here at the IFRS Foundation website.
Any company transitioning to IFRS from another GAAP should apply IFRS 1 First-time Adoption of IFRS. This essentially provides guidance on the preparation of an opening balance sheet at the date of transition to IFRS. IFRS are then applied to these brought-forward balances.
As IFRS require that comparative financial statements are provided for the prior year, the date of transition to IFRS is the start of the period before that in which IFRS are to be applied for the first time.
At this date a balance sheet should be prepared that:
- reflects IFRS accounting policies, and
- recognises, measures and classifies assets, liabilities and equity in line with IFRS.
In other words, the general rule in the opening IFRS balance sheet is that IFRS are applied fully retrospectively. Of course, in practice that is difficult and time-consuming, and in order not to deter would-be adopters, IFRS 1 includes some exceptions and exemptions that are available on transition to IFRS. These are designed to ensure that the costs of first-time adoption don’t exceed the benefits. They allow relief from certain requirements of IFRS in a number of areas, including financial instruments, consolidation and share-based payment. In some cases exceptions are mandatory and in others exemptions are optional.
To ensure users of the financial statements can understand the impact of the adoption of IFRS, IFRS 1 also requires that a company presents old GAAP to new GAAP reconciliations of equity and total comprehensive income in its first IFRS financial statements.
The production of statutory accounts can be a time-intensive and onerous process. The thought of reporting under IFRS rather that UK GAAP may be even more daunting, particularly given the extensive disclosure requirements of the 41 standards that are currently effective.
Caseware’s IFRS template is designed to increase the efficiency of the finance team, reducing time spent on statutory accounts while generating fully compliant financial statements. The IFRS template offers the same level of automation that clients currently have for FRS 101 and 102, and also means that full EU-adopted IFRS templates can be generated as well as IFRS reports in consolidated or single entity formats for SMEs.
Statements within the IFRS template are populated using a ‘Wizard’ to automate data entry wherever possible. Where manual analysis is required, the face of the account can be easily edited after automated population.
Producing statements can be completed in a matter of minutes through the wizard. Once complete, the statement can be accessed by multiple team members, using the review tools to assist with analysis.
- Compliance & consistency
As well as staying updated with the latest accounting standards, the template eliminates the risk of incorrect disclosure by ensuring that accounts are in the same format as FRS 102 or FRS 101. It also comes with over 50 standard notes, expanding on the existing library of notes in the Notebuilder function. If accountants wish to add supplementary or non-statutory notes to their financial statements, custom notes can be easily created and stored within the library for future use.