Differences between IFRS and AAIOFI Standards - Term Paper Example

? Differences between IFRS and AAIOFI standards Introduction For the economic well being effective capital market functioning is necessary and hence the need of financial standards. A consistent and comprehensive standard are necessary which will be based on clear principles. The execution and implementation of the accounting standards are needed which should be done by effective corporate governance and strong internal control. Due to the integration of the world’s capital market, a single set of accounting sets are logical and need of the hour which will help in comparing the information related to finance and thereby would enhance the efficiency of the allocation of resources across the border. The development of the international accounting standards and its acceptance would help in reducing the compliance costs and in the process would develop consistency in the quality of the audit. (IFRS in your pocket 2005, p. 2) What are IFRS standards? The International Financial Reporting Standards (IFRS) have been enforced by International Accounting Standards Committee for the better understanding by the equity investors, the lenders and anyone else who uses the information. The world securities regulators have been recommended by the International Organization of Securities Commission to allow the foreign users to use IFRS in making financial statements for the cross border offerings and listings. The uses of IFRSs have been made obligatory in the consolidated statements of the listed Europe companies from the year 2005. It has also been reported that many countries have started replacing their national GAAP by IFRSs in their domestic companies in comparison with the other nations which are adopting policies to approve IFRSs either verbatim or in the exact manner as their national standards. The IASB and the US counterpart of it, the Financial Accounting Standard Boards, have taken up a comprehensive agenda to converge the IFRSs and the US GAAP as much as possible over the next several years. A convergence project has also been initiated with Japan. The pre-requisites of the global business is a global capital market which is ensured by superior governance, better-quality laws and a set of internationally accepted accounting standards. The IFRSs standards have been largely accepted around the world. The Standards of IFRS 1. The initial acceptance of the International Financial Reporting standards. The objective of the standard was to lay down the process when the IFRSs are being newly adopted by any organization while drafting its financial statements for common purpose. The statement includes an overview of the financial statements for the first time entities and they should draft their accounting policies according to the IFRSs which have been enforced from 31st December, 2005. The organization is needed to frame its financial statements at least for the years 2005 and 2004 and also should reaffirm the opening balance sheet. As IAS 1 requires the comparative financial data of the previous one year minimum the opening balance sheet that will be produced should be of January 1, 2004 if not earlier than that. If the entity adopts the standards on 31st December 2005 and produce selected portion of the financial data on an IFRS basis for the period before 2004 along with its financial statements for the year 2004 and 2005, that would not change the fact that the opening balance sheet according to the IFRSs standards will be of 1st January 2004. (p. 57) 2. Share Based Statement The objective of the standard is to lay down for the transaction which involves the receiving or acquiring of goods or services by the entity either as a “consideration for its equity instruments or by incurring liabilities for amount based on the price of the entity’s shares or other equity instruments of the entity”. (p. 58) The Standard specifies the mandatory recognition of the entire share based payments in the financial statements on the basis of a fair value measurement. It also specifies the recognition of any goods and services which has been consumed. These recognized standards and measurements are applicable for both the public and the non public companies. The “transaction in which goods or services are received as consideration for equity instruments of the entity should be measured at the fair value of the goods or services received.”(p. 58) Under the circumstances when it is not possible to calculate the reasonable worth of the goods and services reliably then only the granted value of the equity instruments can be used. As it is not feasible to estimate properly the fair value of the services of the employee which has been acknowledged, the entity must calculate the just value of the equity instruments approved for the transaction that takes place with the employee and others who also provides similar services. The fair value must be estimated at the grant date for the transaction that has been calculated at the fair value of the equity statements granted (like transaction with employees). “For transaction measured at the fair value of the goods or services received, fair value should be estimated at the date of receipt of those goods and services”. (p. 59) The goods or services which has been calculated by referencing the fair value of the granted equity instruments, it has been specified by the IFRSs 2 that generally vesting conditions are not considered except for the market conditions while predicting the fair value of the shares or options at the appropriate calculating date. On the contrary the vesting conditions are considered by making adjustments in the number of equity instruments which are involved in measuring the transaction amount so that the amount that is recognized for goods and services received “as a consideration for the equity instruments granted is based on the number of equity instruments that eventually vents”. (IFRS in your pocket, 2005, p. 59) The Standard has mandated that the fair value of the equity which has been granted must be calculated on the basis of the market prices when it is available and also to consider the terms and conditions of the basis of which the equity instruments are granted. When the market prices are not available in that case a valuation model is used to calculate approximately the fair value. The valuation model is used to predict the equity instruments price on the date of measurement “in an arm’s length transaction between knowledgeable, willing parties.”(IFRS in your pocket, 2005, p. 59) There is no specification in the IFRS 2 about the use of any particular valuation model. The disclosures should include “the nature and the extent of share based payment arrangements that existed during the period and how the fair value of the goods or services received or the fair value of the equity instruments granted, during the period was determined and the effect of share- based payment transaction on the entity’s profit or loss for the period and on its financial position.” (IFRS in your pocket, 2005, pp. 59-60) 3. Business combination The objective of the standard is to lay down the financial reporting by an entity while a business combination is undertaken by it. Under certain circumstances the IAS 22 allowed the uniting of the interest method, but the IFRS 3 totally prevents that. The impairment test for insubstantial assets like goodwill which have indefinite life must be done annually. The goodwill is considered as impaired when it carries amount that exceeding its implied value. “The implied value is the recoverable amount of the cash generating unit (CGU) to which the goodwill has been allocated and the current fair value of the CGU’s identifiable net assets.” (IFRS in your pocket, 2005, p. 60) The excess of the “acquirer’s interest in the net fair value of the acquiree’s identifiable assets, liabilities and contingent liabilities over the cost is recognized as an immediate gain.” (IFRS in your pocket, 2005, p. 60). The share of the minority in the acquired assets is calculated at the fair value. The interest of the minority is listed in the balance sheet within the equity. (IFRS in your pocket, 2005, p. 60) 4. Insurance Contracts The objective behind this was to lay down the financial reporting for the insurance contracts till the second phase of the project is not completed by the IASB. According to the standard there are certain IFRSs and the IASB framework which the insurers are absolved from applying. It also prevents the catastrophe reserves and equalisation. Test for the already recognized insurance liabilities and an impairment test for the reinsurance assets were also a requisite and the insurance liabilities cannot be offset against the related reinsurance assets. There is restriction imposed on any changes in the accounting policies. The Standards also necessitates new disclosures. (IFRS in your pocket, 2005, p. 61) 5. ‘Non Current Assets held for sale and discontinued operations’: The objective is to lay down the accounting standards for assets that are detained for transaction and also prescribe regarding the discontinued operations in its presentation and disclosure. The standard inculcates the classification between the ‘held for sale’ and the concept of the disposal group. The ‘disposal group’ includes the collection of assets which are to be ‘disposed’ after a single transaction which may also include transferred related liabilities. The assets or the disposal groups which are held for sale are to be calculated at the ‘minor carrying amount’ and the fair value excluding the costs of sale. These kinds of asset or disposal groups are not depreciated. “An asset classified a held for sale and the assets and liabilities in disposal group classified as held for sale are presented separately on the face of the balance sheet.” When the assets are distinguished as ‘held for sale’, the main area of business must be halted. (IFRS in your pocket, 2005, pp. 61-62) 6. ‘Exploration for and evaluation of mineral resources’ The standard aims at prescribing the financial report for the examination and assessment of the mineral wealth. The body which accepts the IFRS 6 standards may carry on with the use of its already existing accounting policies. The entity is required to undertake an impairment test when it is identified or indicated that “the carrying amount of exploration and evaluation assets exceeds recoverable amount”. (IFRS in your pocket, 2005, p. 62) The standard allows the assessment of impairment at a higher level than the CGU. But it calculates the impairment on the basis of the IAS 36 after its assessment. (IFRS in your pocket, 2005, p. 62) What are The AAIOFI standards? The Islamic Banking and Finance industry decided to come up with new accounting standards as the existing international standards had become inadequate according to them. The Accounting and Auditing Organization for Islamic Financial Institutions (AAOIFI) have issued more than seventy accounting principles on auditing and corporate control. Besides this they have also issued the codes of ethics and Shari’a (Islamic Law) Standards. Over the past years AAOIFI has taken momentous steps in encouraging the financial institutions to adopt the standards prescribed by them. The standards have been widely accepted by the Islamic financial institutions throughout the world. Apart from working on new standards as according to the need and developing them, the AAOIFI also organizes Conferences in regulatory and Shari’s issues which has become a necessity for the practitioners and scholars to initiate the process of discussion and debate on important topics related to the future of the industry. (Accounting and Auditing Organization for Islamic Financial Institutions, n. d) The AAIOFI standards 1. Overall Presentation and revelation in the Financial Statements of Islamic Banks and the financial organizations. The Islamic banks which would publish the complete set of the financial statements should consist of the “balance sheet or the statement of the financial position, the income statement, the statement of cash flows, a statement of the changes in the owner’s equity or a statement of retained earnings, a statement of changes in restricted investment, a statement of sources and use of funds in the Zakah (Charity) and charity fund when the bank assumes the responsibility for the collection and distribution of Zakah, a statement of sources and uses of funds in the Qards fund, notes to the financial statements, and statement or reports and other data which assists in providing information required by users of financial statements as specified in the Statement of objectives.” It has been specified in the standards to publish the comparative financial statements including the financial statements of the comparable period. (General Presentation and Disclosure in the Financial Statements of Islamic banks and Financial Institutions, n. d, p. 67) 2. Disclosures There should be disclosure of all the material information in the financial statements which are applicable and dependable to the users. The revelation should include the name of the Islamic Bank, the name of the country of incorporation and the formation date and legal form. The standard mentions the “disclosure of the currency used for the accounting standards”, “disclosure of significant accounting policies”, “disclosure of unusual supervisory restrictions”, “disclosure of earnings or expenditures prohibited Shari’a”, “disclosure of concentration of assets risk”, “disclosure of concentration of sources of unrestricted investment account and their equivalent and other accounts”, “disclosure of the distribution of unrestricted investments accounts and their equivalent and other accounts in accordance with their respective periods to maturity”. It also lists down the necessity of the “disclosure of the distribution of assets in accordance with their respective periods to maturity or expected periods to cash conversion”, “disclosure of compensation balances”, “disclosure of risk associated with assets and liabilities which are denominated in foreign currency”, “disclosure of contingencies”, “disclosures of outstanding financial commitments as of the Statement of Financial Position date”, “disclosure of significant subsequent events” , “disclosure of restricted assets or assets pledged as security”, “disclosure of accounting changes”, “disclosure of the method used by the Islamic bank to allocate investment profits(losses) between unrestricted investment account holders or their equivalent and the Islamic bank as a Mudarib or as an investments with its own funds”, “disclosure of related party transactions” (General Presentation and Disclosure in the Financial Statements of Islamic banks and Financial Institutions, n. d, pp. 68-74) 3. Provisions and Reserves The standard aims at listing down rules of accounting for recognitions of the provisions made by the Islamic bank and the financial institutions. This rule also aims at measuring the provisions and presenting and disclosing it. The standard is applicable to the Islamic banks which will be used to revalue its receivables, and assets for financing and venture. The standard is not applicable to the reserves of the owner’s equity which has been set aside by the Islamic banks from its earnings to abide by the legal requirements like the statutory requirements. (Provisions and Reserves, p. 341) 4. ‘General Presentation and Disclosure in the Financial Statements of the Islamic Insurance Companies’. The standard applies for the financial statements prepared by the companies to meet the needs of the common information of the main users of these statements. This is applicable to all companies irrespective of the fact about their legal form, incorporated country or the size of the company. If requirements prescribed by the standard contradicts with the charter of the company or any law or regulation of the country, in case of it a disclosure regarding the impact must be made. The standard mandates the necessity of a total set of financial statements consisting of the balance sheet of the company. The financial statements should also comprise the statement revenues and expenses of the policy holders, the income statement of the company, the cash flow statements, and the statement revealing the changes in the shareholders, a statement showing the deficit, the notes to the financial statements. The financial statement should also include any relevant reports or data which would help the users of financial statements to acquire information. (General Presentation and Disclosure in the Financial Statements of Islamic Insurance Companies, n. d, p. 362) 5. Foreign Currency Transaction and Foreign Operations. This standard lists down the accounting rules for recognizing, measuring, presentation and disclosing of transaction which are done in various currencies other than the reporting currency of the Islamic bank, whether or not such “currencies relate to assets, liabilities, off-balance sheet items, revenues, expenses, gains or losses in the financial statements.”(Foreign Currency Transaction and Foreign Operations, n. d, p. 465) The Standard is also applicable for the foreign operations of the Islamic bank which has drafted its financial statements in a different currency other than the reporting currency of the Islamic banks. .”(Foreign Currency Transaction and Foreign Operations, n. d, p. 465) 6. Segment Reporting The standard applies to a set of financial statements that includes balance sheet and income statement which are prepared and published by the Islamic institutions (IFIs) irrespective of the fact about their legal form, country and size. The information regarding the segments has to be provided to the parent unit, the branches or the associate separate’s financial statements. In case when both the “consolidated financial statements of an IFI or its subsidiary or associate and the separate financial statements of the parent institutions are presented together, segment information need only to be presented on the basis of the consolidated financial statements.” The institute should apply this standard even if their securities are publicly traded or privately held, or if the institute is in the process of issuing securities in the market. (Segment Reporting, n. d, p. 556) Comparison Comparing the two standards, the IFRS standard1 which lays down the accounting standard for the first time entity that adopts the IFRS rules mandates the preparation of the financial statements of the comparable period and mentions it to be at least two years prior, whereas, the AAIOFI in its Financial Accounting Standard no 1, the General disposition and Disclosure in the financial statements of the Islamic and Financial Institutions mentions the submission of the comparable financial statements but no period has been mentioned. Secondly, the IFRS Standard 2 mandates the recognition of all the share based business, but there is no mention of the share-based payment in the AAIOFI standards. Thirdly, the IFRS in its standard no 2, the share based payment, makes the provisions of the disclosures of the share based payments of the employee, but nowhere in the AAIOFI does not mentions about the provisions the share based payment of the employee. Fourthly, the accounting standard 4 of IFRS which is about the Insurance Contracts does not prescribe anything for the insurance contracts till the second phase of the project on the insurance contracts taken up by the IASB is completed but they mandates a test of adequacy for the ‘recognized insurance liabilities’ and also an impairment test whereas the AAOIFI standard numbered 12 mentions for the Insurance companies but there are no restrictions or tests for recognizing the adequacy of the insurance liabilities and impairment test for reinsurance assets though it mandates the disclosures of the assets and liabilities in the financial statements. Fourthly, the AAOIFI standard 1 makes it compulsory for the financial institutions to provide useful information to its users as they will be able to take decisions in their deals with the Islamic financial institutions, whereas such provisions are not provided in the IFRS standards. Finally, the most important difference is that the AAOIFI standards are industry specific standards that is in the banking institutions where as the IFRS are not industry specific. The AAOIFI standards numbered 16 and 22 provides for the transaction in foreign currency and segment reporting which is absent in the IFRS standards. (IFRS in your pocket 2005; Accounting and Auditing Organization for Islamic Financial Institutions.) Conclusion The IFRS is much more rigid and strict than the AAOIFI. There is no granting of any exception, either the standards are abided by or it is not. The IFRSs are based on the conventional accounting process, which focuses on the decision usefulness framework; the AAOIFI is more based on Shari’a (the Islamic law) compliance framework, which makes an effort to know the rights of all. The AAOIFI enable the users of the financial information to take proper decisions in dealing with the Islamic banks. The Institutions cannot adopt both the AAOIFI and the IFRS standards, as there exist differences in the set of standards due to the different structural objectives. The AAOIFI’s objective is to develop standards for the Islamic banks and financial institutions whereas the IFRS standards do not meet the need of the Islamic banks. The economic, legal and social differences between the Islamic banking systems and the conventional banking system results in the formation and development to two different standards catering to two different needs. References: 1. IFRS in your pocket 2005, Deloite, 2. General Presentation and Disclosure in the Financial Statements of Islamic banks and Financial Institutions, n.d, Financial Accounting standard 1 3. Foreign Currency Transaction and Foreign Operations,(n. d) Financial Accounting Standard No. 16. 4. Segment Reporting, (n. d), Financial Accounting Standard No. 22. 5. General Presentation and Disclosure in the Financial Statements of Islamic Insurance Companies, (n. d), Financial Accounting Standard No. 12. 6. Provisions and Reserves, (n. d), Financial Accounting Standards No. 11. 7. Accounting and Auditing Organization for Islamic Financial Institutions, (n. d), available at: http://www.aaoifi.com/SGword.html (accessed on May 23,2011) 8. The Financial Standards, (n. d), Accounting and Auditing Organization for Islamic Financial Institutions. . Read More