Evaluating the choices

IFRS 1 will help in IFRS adoption, but it will also require evaluation of a number of accounting policy choices

Canadian publicly accountable entities should now have commenced their evaluation of the effects on their organization of adopting international financial reporting standards (IFRS). A key step in that evaluation is to study IFRS i, First-time Adoption of International Financial Reporting Standards. Application of IFRS ? will greatly assist IFRS adoption, but it also requires evaluation of a number of accounting policy choices. There are a number of considerations Canadian entities should take into account in applying IFRS i. Transitional relief provided by IFRS i: Without applying IFRS i, entities would be required to adopt IFRS as if they had always applied those standards. Thus, they would be required to restate their financial statements as if all past transactions and events had been accounted for in accor- dance with IFRS. For example, an entity that undertook a business combination transaction many years ago might have accounted for that transaction as a merger in accor- dance with Canadian accounting standards at that time. Restatement would require the entity to restate assets and liabilities remaining from that business combination in accordance with the carrying amounts that would have resulted had the entity applied the acquisition method in accordance with the current IFRS dealing with business combinations (IFRS 3). This could be extremely onerous and would probably result in little benefit to financial statement users.

To alleviate such problems, IFRS 1 provides a number of exemptions from and exceptions to the need to restate financial results as if IFRS had always been followed. The exceptions prohibit specified restatements. They provide options for entities to choose whether to make specified restatements - this is where the choices of accounting policies, referred to previously, come in.

However, before considering some of those exemptions and exceptions it is important to understand two additional principles in IFRS i. First, IFRS 1 requires an entity to use the same accounting policies for its financial statements in both the first year of adoption of IFRS and the comparative period. Those accounting policies are to be in compliance with IFRS applicable to the first year of adoption. This has two consequences. An entity cannot have a change in accounting policy between the comparative period and the first year of adoption - the accounting policies for the first year of adoption must also be applied to the comparative period. Also, an entity has to consider what accounting policies will be in compliance with IFRS in its first year of adoption as it prepares its comparative information - thus, it needs to look ahead to take into account IFRS that will change in the first year of adoption compared with those effective in the comparative period. Second, IFRS 1 overrides the transitional provisions of individual IFRS, except where specified otherwise. So, those transitional provisions are not available in the first year of adoption.

Exceptions: The exceptions in IFRS ? prohibit an entity from retrospectively applying IFRS, mainly where such application would enable the entity to benefit from hindsight. Therefore, for example, an entity is precluded from retrospectively designating hedge relationships or from adjusting previous accounting estimates to take account of information not available at the time the original estimate was made.

Exemptions: The optional exemptions are, perhaps, the most important aspect of IFRS ? for first-time adopters. An entity may choose to adopt some, all or none of the optional exemptions. Therefore, the entity needs to carefully evaluate its accounting policy in respect of each possibility and consider the most suitable approach in its circumstances. In some cases the correct choice will be obvious. For example, an entity that has undertaken multiple business combinations going back many years may find the costs of restating its assets and liabilities to reflect current business combinations standards unduly costly and will elect not to do so. However, even in this case, the election permits an entity to choose a date from which it might follow the new business combinations standards going forward. An entity might, therefore, wish to con- sider accounting for, say, very recent busi- ness combinations in accordance with the new standard, but not older ones. This option is available to the entity. Also of note regarding business combinations is the Accounting Standards Board's (AcSB) intent to put the IFRS standards on business combinations into the Handbook before the date of mandatory IFRS changeover, so that a Canadian entity undertaking a business combination in 2010 can choose to adopt the standard early and thus not have to restate its accounting when it adopts IFRS in 201 1.

Another example of an exemption where an entity needs to make careful choices is in choosing whether to elect to measure property, plant and equipment or intangible assets at fair value or revalued amounts, rather than at historic cost, at the date of transition to IFRS. This election is available on an asset-by-asset basis and does not require that fair value or revaluation accounting be continued subsequent to IFRS adoption - the fair value or revalued amount becomes the deemed cost of the asset going forward. This election might seem attractive to bring assets to up-to-date values on the balance sheet. However, this needs to be weighed against factors such as the increased future depreciation charges on an asset for which the deemed cost has been increased at the date of transition. IFRS 1 also permits redesignation of previously recognized financial instruments as at "fair value through profit or loss" or "available for sale" on first-time adoption and allows a subsidiary that becomes a first-time adopter later than its parent to elect to use the carrying amounts that would be included in the parent's consolidated financial statements based on the parent's transition to IFRS date.

Other exemptions are also available. The table on page 52 summarizes the extent to which a sample of European firms used exemptions available in accordance with IFRS 1. Canadian firms might consider their experience in assessing their choices. Future changes to IFRS 1: The AcSB has paid particular atten- tion to the issues that Canadian entities are likely to face on adopting IFRS. During late 2007 and early 2008 it consulted with the Canadian financial reporting community to ascertain whether additional exceptions or exemptions seemed necessary to help the Canadian transition. Two circumstances stood out as candidates for relief - the considerable difficulty of retro- spectively restating oil and gas assets previously accounted for using full-cost accounting and the difficulty of restating assets and liabilities of operations subject to rate regulation, which include amounts that do not qualify for capitalization in accor- dance with IFRS. In each case, the potential costs of retrospec- tive restatement were considered to significantly exceed any benefit. The AcSB approached the IASB on these issues and has worked with the IASB to develop an exposure draft, issued in September 2008, to provide relief in these circumstances. This exposure draft also proposes providing relief regarding specified aspects of lease classification. Entities with these circumstances should pay special attention to the proposals in that IASB expo- sure draft. The AcSB expects that final amendments to IFRS 1 resulting from this exposure draft will be issued in mid-2009 and will be applicable for the Canadian changeover.

Information for financial statement users: Other key aspects of IFRS 1 are its disclosure of information requirements for financial statement users to understand accounting policy choices and financial reporting changes made by entities in adopting IFRS and to provide a connection between prior financial statements and those in accordance with IFRS. Accordingly, IFRS 1 requires reconciliations between previous financial statements and IFRS as well as accounting policy disclosures. These will be required in the first IFRS reporting period, which for many entities will be its first interim financial statements in accordance with IFRS. Coupled with management discussion and analysis disclosures required by the Canadian Securities Administrators (see CSA Staff Notice 52-320 - Disclosure of Expected Changes in Accounting Policies Relating to Changeover to International Financial Reporting Standards) and additional guidance from the CICA's Canadian Performance Reporting Board, IFRS 1 will assist investors in understanding the effects on individual entities of the changeover to IFRS.

[Sidebar]

Exceptions in IFRS 1 prohibit an entity from retrospectively applying IFRS, mainly where such applications would enable the entity to benefit from hindsight

[Author Affiliation]

Ian Hague is a principal with the AcSB and is responsible for international activities.

Views are his own and do not represent official positions of the AcSB

Technical editor: Ron Salole, vice-president, Standards, Canadian Institute of Chartered Accountants