Background
In the coming years, entities in many jurisdictions will adopt international financial reporting standards for the first time. The problems faced by an entity that adopts an entire accounting regime for the first time are somewhat different from those faced by an entity that adopts an individual change in an existing body of accounting standards. Some IASB constituents, including public accounting firms and entities in Europe, have expressed concerns about the complexity of this task and the existing guidance on first-time Adoption (FTA). The Board plans to review the existing guidance with an eye to developing an approach that is both workable and conceptually sound.
In SIC 8, First-time Application of IASs as the Primary Basis of Accounting, the Standing Interpretations Committee concluded:
In the period when IASs are applied in full for the first time as the primary accounting basis, the financial statements of an enterprise should be prepared and presented as if the financial statements had always been prepared in accordance with the Standards and Interpretations effective for the period of first-time application. Therefore, the Standards and Interpretations effective for the period of first-time application should be applied retrospectively, except when:
(a) individual Standards or Interpretations require or permit a different transitional treatment; or
(b) the amount of the adjustment relating to prior periods cannot be reasonably determined.
In theory, SIC 8 achieves complete comparability between enterprises, both between first time adopters of IAS and those entities already applying IAS, and across all entities using IAS. However, the degree of comparability is subject, in part, to the availability of alternatives in some Standards and to determinations made about exemptions written into individual Standards (for example, IAS 8.49 notes that "comparative information should be restated unless it is impracticable to do so") and the overall exemption in SIC 8.3(b) that retrospective application is not required when "the amount of the adjustment relating to prior periods cannot be reasonably determined." In the context of some of the practical application problems raised in the May Board paper, different enterprises converting to IAS might make very different interpretations of what is practicable or reasonably determinable, especially where the costs of compliance are very high.
IASB is addressing these concerns in its project on first-time Adoption of IFRS.
Deloitte Touche Tohmatsu Letter of Comment on ED 1
Click to Download our Letter of Comment (PDF 63k, 31 October 2002).
Summary of the Key Proposals in ED 1
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Summary of the Key Proposals in Exposure Draft ED 1 First-time Application of International Financial Reporting Standards
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On 31 July 2002, the IASB issued exposure draft ED 1 First-time Application of
International Financial Reporting Standards. Comments requested by 31
October 2002.
The purpose of the Standard is to ensure that all entities adopting IFRSs for the first
time present comparative information in their financial statements that is as close
as possible to the information provided by existing IFRS preparers, but within
cost/benefit constraints. The proposals would allow an entity to restate information
either by applying either:
- the SIC 8 approach (that is, retrospective restatement using the Standards
applicable at the date of transactions and their subsequent revisions and
transitional provisions if applicable), except that the exception to restatement
because 'the amount cannot be reasonably determined' will not be available; or
- all the other proposed requirements of the Standard on the First -Time
Application of IFRS if the SIC 8 approach is not used. Under this approach, an
entity is required to use every IFRS current at the end of the reporting period in
which it first adopts IFRS. At least one year of comparative information
prepared using those same IFRSs is required.
First-time adopters of IFRSs must disclose how the transition to IFRS affected the
entity's financial position, performance, and cash flows.
The following is a summary of the provisions of ED 1 if an enterprise chooses to
apply the specific transitional provisions in the proposed Standard and decides to
adopt IFRS in 2005 for its 31 December year-end.
1. Select accounting policies based on IFRS in force at 31 December 2005.
2. Prepare 2005 and 2004 information and restate the opening balance sheet
(beginning of the first period presented) using those Standards retrospectively:
a. Reclassify local GAAP opening balance sheet items into the appropriate
IFRS classification.
b. Eliminate local GAAP assets and liabilities from the opening balance sheet,
if they do not qualify for recognition under IFRS.
c. Recognise and measure under IFRS all required assets and liabilities
d. In preparing IFRS estimates retrospectively, use inputs and assumptions
used to determine local GAAP estimates in previous periods if those inputs
and assumptions are consistent IFRS.
3. Exceptions to the general restatement principle:
a. Business combinations that occurred before opening balance sheet date:
i. Keep local GAAP accounting, that is, do not restate:
- previous mergers or goodwill written-off from reserves
- the carrying amounts of assets and liabilities recognised at the date of
acquisition/merger
- how goodwill was initially determined
ii. Must make IAS 36 impairment test of any remaining goodwill in the
opening balance sheet (including potential reclassifications of local
GAAP intangibles reclassified to goodwill).
iii. Eliminate any negative goodwill
b. Property, plant and equipment and investment property carried under the
cost model:
i. If restatement requires undue cost and effort, measure the item at its fair
value at the opening balance sheet date (fair value becomes the 'deemed
cost' under IFRS).
ii. Do not restate certain previous revaluations (local GAAP carrying
amount becomes the 'deemed cost' under IFRS).
c. Do not restate fair value adjustments that occurred during privatisations or
initial public offerings.
d. Employee benefits - actuarial gains and losses: reset any corridor
recognised under local GAAP to zero at the opening balance sheet date.
e. Accumulated translation reserves: do not restate local GAAP translation
amounts that may have not been distinguished in accumulated reserves.
f. Hedging: conditions to qualify for hedge accounting apply as from the
opening balance sheet date.
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Consideration of the Comments on ED 1
November 2002
The Board received 81 comment letters on ED 1 First-time application of International Financial Reporting Standards. The Board discussed the comment letters received with specific reference to the following:
- Scope
- Recognition and measurement (other than financial instruments)
- Disclosure and effective date
Scope
The Board noted that current IAS requires a statement by management for full compliance with IAS. The Board decided to clarify in the final standard that the auditors' report should not be used as a primary determinant of whether an entity is a first time adopter. The final standard will provide clarification that the audit report may be one factor to look at in addition to management's statement of compliance.
Recognition and measurement
The Board decided to retain the option in ED 1 of a SIC 8 approach (without the impracticability exception) and the approach in the standard with exceptions. The Board confirmed that the modified SIC 8 approach would require reference to historical versions of a standard when the transition requirements of the amendments are prospective.
The Board discussed the following issues related to the exceptions in the ED.
Business Combinations
- An entity should have the choice of restating business combinations under current IFRS or following the exception in the exposure draft. However, if an entity restates a business combination, all combinations after the earliest business combination restated shall also be restated.
- No change to intangible assets
- All finance leases shall be restated. That is, there is no exception for finance leases that are acquired in a business combination. The Board requested that the ED be made clear that an entity would first look to the requirements for recognised assets and liabilities and then determine whether unrecognised assets and liabilities should remain unrecognised as a result of this exception.
- There will be no specific exemption for negative goodwill.
- The entity should perform an impairment test of its goodwill at the date of transition to IFRS. Therefore, the fair value for all assets and liabilities for cash generating units that have goodwill shall be measured at the date of transition. The Board will not require these assets and liabilities be recorded at fair value. The Board acknowledged that the determination of the fair value of goodwill under the final standard may need to be performed prior to the issuance of the business combinations standard (and amendments to IAS 38). The Board did not discuss providing any guidance on performing this impairment test in the mean time.
- There shall be no difference in the accounting for equity method goodwill recorded in a joint venture or an associate.
- Subsequent remeasurement of contingent consideration should not be an adjustment to goodwill, but presumably to income.
- The Board discussed several drafting issues related to IPR&D, minority interest, taxes, etc.
Other Issues
- There will be no changes to the event driven revaluation as deemed cost exception. The Board clarified that the use of the revalued amount is a requirement of the standard, and not an option.
- The Board decided that the corridor amount should be reset to zero for all entities that are not using the modified SIC 8 approach.
- There were no changes to exception for fixed assets
- The Board decided that the cumulative translation amount resulting from the translation of financial statements should be reset to zero at the date of transition if the IFRS amount can not be determined.
- A subsidiary that reports under IFRS to a parent shall use the parent's date of transition when developing its first set of full financial statements. The Board will discuss this issue further at a future Board meeting.
- There were not changes to the components approach for property.
Disclosure and effective date
The Board reaffirmed its decision that the disclosure requirements in the final standard should cover all comparative information prepared under IFRS. There was concern expressed by certain regulators that will require a second year of comparative information prepared under local GAAP. The Board decided to avoid creating obstacles that may prevent such a presentation for regulatory purposes.
The Board reaffirmed its conclusions on the reconciliations required by paragraph 31 in the ED. The Board agreed to provide illustrative examples of reconciliations in the final standard.
The Board also agreed that an error in the local GAAP financial statements should be accounted for as such and correction in the movement to IFRS should not be allowed.
The Board decided not to change the requirements related to presentation of the cash flow statement or interim financial reports and historical summaries. The board decided to remove the requirement to disclose the denominator of the EPS calculation as part of the first time Adoption of IFRS
The effective dated was moved from 1 January 2003 to 1 January 2004. Early application will be encouraged.
January 2003
Derecognition
Under the general principles in ED 1 First-time Application of International Financial Reporting Standards, a first-time adopter would apply the transition provisions of IAS 39 (except for the provision for hedge accounting in paragraph 24 and appendix C of ED 1). Some Board members are concerned that the wording in IAS 39.172(a) prohibits derivatives that are part of derecognition transactions from being recorded in the transition to IAS 39. That is, these derivatives would remain off balance sheet. This was clearly not the intention of the Standard and several members expressed concern over this interpretation.
Nevertheless, the IASB decided to amend the transition provisions of IAS 39 to make it 'crystal clear' that these derivatives should be put on the balance sheet at the date of implementation of IAS 39. The Board noted that this consequential amendment to IAS 39 may be amended during the IAS 32/39 improvements project to require a full retrospective approach.
Special Purpose Entities
The staff noted that the comment letters did not provide any new arguments for changing the current inclusion (or lack of scope exception) of SPEs in the general requirements of ED 1. Therefore, the provisions of SIC 12 for retrospective application (by reference to IAS 8.46) shall be applied.
Transaction Costs
The staff believes that no exception should be made for transaction costs as these amounts are either immaterial or entities should be able to make a reasonable estimation.
Compound Instrument
The staff addressed a concern related to a compound instrument where at the date of transition the liability component was gone. ED 1 would currently require a retrospective split of that amount between retained earnings and equity. The staff noted that such a split was not required in this limited fact pattern. Therefore, the entire fair value should be charged to equity.
Embedded Derivatives
No changes to the current requirements and exceptions are proposed. The Board reiterated the IAS 39 requirement that if an embedded exists, but it cannot be individually measured, then the entire contract should be recorded at fair value.
Available-for-Sale Financial Assets
No changes to the existing requirements were proposed.
Debt/Equity Classification
No changes to the existing requirements were proposed.
Measurement
No changes to the existing requirements were proposed.
Disclosure
No changes to the existing requirements were proposed.
Date of Transition to IFRSs for Some Subsidiaries
The Board discussed the current exception from the scope of ED 1 related to subsidiaries that report IFRS numbers to a parent, but then subsequently issue IFRS statements to the public for the first time with an unreserved statement of compliance (paragraph 5). The concern is that the IASB does not want to create a requirement for an entity to keep two separate sets of IFRS financial statements.
The staff proposed keeping the scope exception, but rewording it so that the subsidiary would adopt the parent's date of transition as its own. The Board also decided to make this scope exception optional. The Board decided to drop the requirement for agreement from all minority shareholders to use the parent's date of transition as its own from the final standard (paragraph 5(b)).
Other FTA Issues
The Board stated that it plans to readdress the necessity of having the requirement that if an entity chooses one exception, it must choose them all (paragraph 14).
The Board decided to provide an exception for intangible assets similar to paragraph 17 for tangible fixed assets. Therefore, if cost can be established (and therefore outside of the measurement exception) and the mark-to-market requirements in IAS 38 have been met, the revalued amount of this intangible may be carried forward as deemed cost.
February 2003
Hedging
The Board discussed issues surrounding the recognition of hedging instruments and the hedged item in the first IFRS financial statements of an entity. The Board confirmed its decision that the hedging instrument should be recognised at fair value with the offset to retained earnings at the date of transition. The Board considered two options for accounting for the hedged item – fair value or deemed cost. Several members expressed concern that if fair value is not required the hedging relationship would no longer exist, even if there is an effective relationship at the date of transition. However, the Board tentatively agreed to require the hedged item be accounted for similarly to other similar items, which will most likely be deemed cost. There was strong opposition to this approach by some members and therefore, the decision may be re-addressed at a future meeting.
The Board discussed how first-time adopters should treat hedge accounting in their opening IFRS balance sheet. The Board concluded by supporting prospective application of hedge accounting under IAS 39 to hedges designated under
previous GAAP.
Elimination of Proposed Choice to Use 'SIC 8' Method
The Board discussed whether final first time Adoption standard should include two approaches – (1) use of current IFRS, with limited exceptions, and (2) IFRSs applicable to each period, with no exceptions (the SIC-8 approach). The Board agreed that using the current IFRSs is a superior solution and should be required.
March 2003
The Board discussed certain issues that have arisen from drafting the pre-ballot draft for a final IFRS on first-time Adoption of IFRSs. The Board expects a final IFRS in the second quarter of 2003. In addition to miscellaneous drafting issues, the Board discussed the delineation in the Exposure Draft of choices between those made on the basis of cost versus benefit and other choices freely provided in the standard. The Board has decided that all choices in the final IFRS shall be free choices, except for hedge accounting, derecognition and estimates.
April 2003
The Board discussed whether an entity should be allowed to use the exemptions on first-time adoption set out in the revised draft of the Standard for its individual entity-only financial statements (i.e. in the parent-only financial statements or subsidiary-only financial statements) when that entity has in fact already prepared IFRS-compliant information for the purposes of group reporting in the consolidated financial statements.
This issue arises because some exemptions in the latest draft Standard on first-time adoption result in measurements that depend on the date of transition to IFRSs. If an entity is a member of a group, the use of those exemptions could lead to some assets or liabilities being measured at two different amounts if the group adopts IFRSs for the first time in one period, but the entity adopts IFRSs in its separate financial statements for the first time in a different period.
The Board discussed whether, to avoid those differences in amounts, if a first-time adopter has an asset or liability that was already included in the opening IFRS balance sheet of its group (or another member of its group) at an earlier date, it should be able to elect to apply the exemptions in the Standard to that asset or liability in the same way as the group (or the other member of the group) and based on the same date of transition to IFRSs. This would mean that both entities could use the same measurements for that asset or liability.
The Board first discussed this issue for first-time adoption in the separate financial statements of the parent and the subsidiary, and then for those of associates, joint ventures, and venturers.
The Board decided as follows:
- If the subsidiary has adopted IFRS in its entity-only financial statements before the group to which it belongs adopts IFRS for the consolidated financial statements, then the subsidiary's first-time adoption date is still the date at which it adopted IFRS for the first-time, not that of the group.
- If the group adopts IFRS before the subsidiary adopts IFRS in its entity-only financial statements, then the subsidiary should have the option to elect that either the group date of IFRS adoption is its transition date or to first-time adopt in its entity-only financial statements.
- If the parent has adopted IFRS in its entity-only financial statements before the group adopts IFRS for the consolidated financial statements, then the parent's first-time adoption date is still the date at which the group adopted IFRS for the first time.
- If the group adopts IFRS before the parent adopts IFRS in its entity-only financial statements, then the parent's first-time adoption date is still the date at which the group adopted IFRS for the first time.
- If the group adopts IFRS before its associate or joint venture adopts IFRS in its entity-only financial statements, then the associate or joint venture should have the option to elect that either the group date of IFRS adoption is its transition date or to first-time adopt in its entity-only financial statements.
The Board also discussed two issues arising from the fatal flaw review of the revised draft first-time adoption Standard by IFRIC and concluded as follows:
- Previously recognised intangibles from past business combinations should be measured at the amount measured in the acquiree's separate financial statements on acquisition. The purchase price allocation on acquisition should not be revisited.
- Additional explanatory information will be needed in the interim financial statements that precede the first set of IFRS annual financial statements, most notably information about expected changes in accounting policies, so that financial statement users will be aware of the changes ahead. The Board discussed whether to add these additional disclosure into the first-time adoption Standard. The Board decided to add a cross-reference in the first-time adoption Standard to IAS 1 (paragraph 12 in the exposure draft of revised IAS 1), which states that additional disclosure should be provided when the requirements in IFRS and Interpretations of IFRS are insufficient to enable users to understand the impact of particular transactions or other events on the entity's financial position and financial performance.
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