Application of IFRS - Case Study Example

 Evaluation of implementation of IFRS by larger companies Since January 2005 listed companies in EU are following standards and interpretations issued by IASB, but since then a number of issues have erupted on application of IFRS by larger companies that need proper appraisal. Various studies have been conducted on the subject matter of implementation of IFRS and results of these studies are mixed reactions from respondent companies. There are some opinions in favour and others against IFRS. An effort has been made in this write up to analyze various issues and opinions, both for and against IFRS and the resultant advantages and disadvantages of IFRS. Let us start with interpretation of Standards. Different companies have interpreted the standards in different ways; and it appears that this interpretation aspect is the major cause of inconsistency or lack of uniformity appearing the implementation of IFRS among companies. Uniformity and creditability are highly essential for financial reporting and its regulation ensures that directors and auditors provide reports that are credible by giving them guidance to point out instance relevant rules when certain policies are considered appropriate.(Barry Elliot and James Elliot, 2005)4 IFRS is considered a principal- based system. “The advantage of a principle based system is that it offers the accountant possibilities to adapt the reporting of transactions to their unique economic settings. A high portion or flexibility increases the possibility to provide a fair presentation of transactions”. (Wyatt, 2005)19. But this advantage is coupled with limitation of different interpretations in order to achieve fair presentation as far as possible, and thereby the inconsistency creeps in affecting the comparability. If a review is made of notes to financial statements of large companies, it will be revealed that most of these are either declaration of accounting principles and policies or other necessary disclosures required to be made under IFRS. Out of such detailed and long list of disclosures, very few are useful and important in practical sense. All other disclosures are required for experts and analysts of financial statements. It is not clear as exactly what purpose such large disclosures about already laid down policies in IFRS manual would serve? It would be sufficient if companies make only one line declaration that policies and procedures have been followed as laid down in IFRS manual, except for the principles and procedures detailed in the notes. In other words notes to financial statements of larger companies should contain disclosure of those policies and procedures that have not been followed by the company knowingly or otherwise. Matez Bosnak12, partner of Ernest & Young in Slovakia has, while assessing the first year implementation of IAS, rightly stated that “typically, IFRS financial statements include several pages explaining the company’s accounting policies. However, these are frequently no more than summaries of the requirements of the relevant accounting standards and do enable readers of the financial statements to understand the implications of policies applied; the summaries rarely provide any significant insights into the factors that are of particular relevance to the company concerned.” In fact IFRS has made financial statements to look like a bundle of papers wherein only laid down standards and policies in manual of IFRS are repeated by company after company. Financial reports could be regulated in a number of ways including legislation such as Companies Act (Alexander and Nobes, 2007)1. But those regulations needed to be implemented in a systematic way. There is great deal of objection from listed companies that FRSs are being replaced with IFRS in an unsystematic and speedy way. “In March 2004 the ASB issued plans for converging UK standards with IFRS. The phased approach set out in its discussion paper, intended to limit the burden of change in any one year, would see a new number of standards in 2005 and 2006 to enhance current UK standards. Also, a series of ‘step changes’ from 2007, replacing UK standards as their international equivalent completed. But by the end of 2005, we were already a significant way through the process, with ten new IFRS based standards in issue and the exposure drafts of three further standards issued for comments.” (Yvonne Land, Giles Murphy, and others)20. Eric Anstee7, chief Executive ICAEW commented that ‘If the ASB was to proceed with the current IFRS convergence programme, private companies could face the grim prospectus of switching from UK GAAP to full IFRS to simplified IFRS in short session.’ The idea is that let the change take place in a systematized manner leaving less chances of mistakes in implementation of standards. There are certain features of IFRS those have earned appreciation from different institutions. Like ICAEW10 has prepared a report ‘EU implementation of IFRS and the Fair value directive’ at the instance of EU; and according to this report it was “found that fair value accounting is much less expensive than is sometimes to be assumed in the case, and is in fact very limited overall. In particular where companies are given an option as whether to use cost or fair value, they typically choose a cost model.” At the same the time it is important to note that companies shied away from application of fair value rules. It was stated in the report that option of using fair value was used very selectively. The point to note is that in cases of financial assets and financial liabilities large number of companies measured those assets and liabilities on cost model basis. In a press release of Finland- Financial Supervision Authority (FIN-FSA) about IFRS performance in listed companies, it was reported that “Companies mainly engaged in investment property activities measured their property in balance sheet at fair value’(Tina Visakorpi, Sep 2006)16 Implementation of any accounting system or standard should not be costly enough to overtake the benefits derived from its application. Implementation of IFRS 3 has become a costly affair for larger companies’ engaging in mergers and takeovers, so much so that IFRS 3 has suffered direct criticism from intellectuals over viewing or assessing its implementation. Thayne Forbes14, joint managing director of ‘Intangible Business in London’ has assessed that “The implementation of International Accounting Standards and IFRS 3 in particular, has resulted in great deal of work for the accounting profession. The cost of this for business has been substantial: an estimate of fee paid by FTSE 100 companies to the accounting and valuation firm for implementing for implementing IFRS3 could be estimated at 0.2% of the deal value or about $80 million. In addition it has required significant resources from the companies themselves.” (Intellectual Assets Management, December/ January 2007) With such heavy cost for reporting business combinations, benefits from adherence of IFRS 3 look marginal. Certainly on account of such a state of affairs, the companies would seek reprisal again and again destroying the sanctity of the standard. It must be noted that ‘IFRS is a great opportunity to look at your systems, processes, and the very structure of the business’ (Virgina Stevens)17. It is believed that larger companies have exploited such opportunities and the result is the most of UK companies are showing increased profits since the applicability of IFRS in 2005. In fact Wayne Lonergan18 warned in 2005 that ‘the adoption of IFRS will have significant impacts on some companies’ reported profits and nets assets position. As per Anna Garvey2 of Haysmacintyre ‘a recent survey at Liverpool University showed that average overall impact of IFRS adoption was to inflate overall profits by 39%.’ The survey further states that this impact is due to the effects of small number of standards; but the standard that really impacted profits is IFRS 3, dealing with business combinations. The survey further conclude that impact is due to non- amortization of Goodwill, as instead those companies are now required to test Goodwill for impairment. The most important arguments that goes in favour of IFRS is that on completion of convergence of standards with large number of countries, there would be only one language that would reflect from financial statements world over. There is no doubt about accruing benefits like greater transparency, consistency, and comparability between companies across industries and countries. ‘By 2007, more than 100 countries across the world will permit or require the use of IFRS by public traded companies’.(Ian Dikis, 2008)11 Financial Reporting Standards are to develop high quality, understandable and enforceable global accounting standards.(Ball, 2006)3. But there was a major disqualification of existing GAAP of not recognizing the pension liabilities. IFRS has come up in a revolutionary way to plug in this incompleteness of the balance sheets. IAS 19 seeks recognition of pension liabilities and assets in full in the balance sheet. “Probably the most significant way in which IFRS enhances the completeness of balance sheet is the requirement for firms to recognize their pension liability or asset in the balance sheet (IAS 19 “Employee Benefits)” (Chris Higson, Mark Sproul 2005)5 An important factor favoring IFRS 19 is that ‘pension accounting under IFRS takes actuarial gains and losses to the income statement whereas they go the statement of total recognized gains and losses under UK rules’ (CIMA 2004)6 Though at initial recognition of pension liabilities or assets have been tremendous, but the presentation of changes s per fair value would really be revolutionary in the coming period to come. With regard to dealing with taxation it is pertinent to state that IAS 12 recognizes deferred taxes from temporary differences that arises from both timings as well permanent differences; whereas under UK GAAP only timing differences are considered for deferred taxes. This is really a commendable measure. At the same time, though deferred taxes has been dealt by IFRS leaving some positive impacts , but it has also made the situation so grim and tight on computation of deferred taxes that income statements now present now an altogether different picture with regard to profits available after deferred taxes. This is because ‘IFRS standard on tax can lead to potentially large deferred tax liabilities or assets that would not be required under present UK GAAP, and is a complex area to deal with. IAS 12 has some notable differences from FRS 19 and in conjunction IFRS 3 results in a significantly different approach. For example companies are required to recognize a deferred tax liability on the intangible assets recognized under IFRS 3.’ (MSI Global Alliance, 2005)13 The ultimate impact of taxes is on cash outflow of the entity. “The UK tax system has, since April 2002, allowed tax deductions based on accounts amortizations on intangible assets and goodwill acquired as part of trade and assets acquisitions. For companies claiming tax deductions on goodwill, the move to IFRS can have a negative impact. This is because goodwill is not amortized under IFRS.” (Gillian Wild, 2006)9 Another major failure or disadvantage which the experts and analyzers have declared is the operations of IFRS 3. This standard has proved as a failure on a number of grounds mainly because of its limitation while reporting intangibles and goodwill. Limitation have been viewed by observing the accounting treatments given to intangibles and goodwill on adoption IFRS by larger companies of EU. “Goodwill brought forward at the adoption of IFRS has been frozen at its brought forward value in all the reports and accounts looked at. This figure represent historical goodwill at the dates of pre-IFRS 3 acquisition less pre IFRS 3 amortization, plus post IFRS 3 goodwill at the dates of acquisition and less impairment charges. This is such a complicated combination of concepts that goodwill figures cannot be readily understood, yet the goodwill reported in the accounts is highly significant. There could be charges for impairment where carrying value of intangible assets is higher than their value. Impairment charges are a highly sensitive area. However, there have generally not been any significant impairment charges in the accounts reviewed and the impairment charges such as they are has ascribed to issues such as change in strategy. Some intangible assets have been stated at their historical valuation and some intangible assets values will be after charges for amortization and impairment. Values of goodwill and intangible assets are stated at historical amounts and have not been revalued. Goodwill and intangible assets that have been acquired will not be shown.” (Thayne Forbes, 2007)15 A Study conducted by Eva K. Jermakowicz and Sylwia Grornik-Tomaszewski8 on ‘Implementation of IFRS by EU companies’ has quantified the gross disadvantages of such implementation as per following reasoning: “A majority of respondents have adopted IFRS for more than just consolidation purposes. The process is costly, complex, and burdensome. Companies do not expect to lower their cost of capital by implementing IFRS. The more comprehensive is the approach to conversion, the more respondents tend to agree with the benefits and costs of the transitions. Companies expect extreme volatility in financial results. A majority of respondents would not adopt IFRS if not required by EU regulations.” The study reveals the actual story. Two things actually go against IFRS. One is that so far the companies are simply consolidating accounts and they are not implementing IFRS in right spirit; and second that companies are apprehensive of the volatility in financial results on implementing IFRS. It was expected that implication on implementation of IFRS in UK and elsewhere in EU would bring a lot of criticism and adverse comments. Like anything else implication of new standards are tested on its practical implementations. But the results of IFRS implementation on larger companies are not at all discouraging. In fact healthy criticisms provide an opportunity to remove whatever shortcomings that are noticed and argued upon. Future is very bright for IFRS, and in coming years there will be a common accounting language world over. Words count: 2275 Bibliography: 1Alexander and Nobes, Financial Accounting – An international Introduction (Harlow, Pearson Education, 2007), p.48. 2Anna Garvey, The impact of IFRS on UK companies, April 26, 2007, http://www.msiglobal.org/Content/ta/The_impact_of_IFRS_on_UK_companies.aspx 3Ball R. (2005) ‘IFRS: Pros and Cons for Investors’, P D Leake 2005, London: ICAEW, 8 September. 4Barry Elliot and James Elliot, Financial Accounting and Reporting (Prentice Hall, 2005) P. 103. 5Chris Higson, Mark Sproul, Coping with IFRS, 2005, http://www.london.edu/assets/documents/PDF/Chris_Higson_paper_IFRS.pdf 6CIMA Newsletter, March 2004, http://www1.cimaglobal.com/cps/rde/xchg/SID-0AE7C4D1-2B04B0A9/live/root.xsl/6383_6596.htm 7Eric Anstee, Chief Executive ICAEW, Smith and Williamson March 2006 newsletter, http://www.mondaq.com/article.asp?articleid=39026 8Eva K. Jermakowicz and Sylwia Grornik-Tomaszewski, Implementing IFRS from the perspective of EU publicly traded companies, Journal of International Accounting, Auditing, and Taxation, Vol. 15, Issue2, 2006, pages 170-196 9Gillian Wild, Tax Aim and IFRS, Tax Advisor, December 2006 issue, page 11 10ICAEW, EU Implementation of IFRS and the Fair Value Directive, A report for EU, Executive summary, Fair Value Accounting, page 12 11Ian Dikis, IFRS: the next stage, http://www.ifrs.co.uk/ifrs-ian-dilks-article2.html 12Matez Bosnak, partner of Ernest & Young in Slovakia, 2006: The year of IFRS Reporting, viewed on July 15, 2008, http://www.pwc.com/extweb/pwcpublications.nsf/docid/203a0572e87229f2802570f800783ec8/$file/SlovakSpectatorIKaAPonIFRS.pdf 13MSI Global Alliance, The Impact of IFRS on UK Companies, April 2005, http://www.msiglobal.org/Content/ta/The_impact_of_IFRS_on_UK_companies.aspx 14Thayne Forbes, IFRS 3: The cost/ benefit ratio, Failure of IFRS 3, Intellectual Assets management, December/ January 2007 issue, page 12 15Thayne Forbes, IFRS 3: The limitations of IFRS 3, Failure of IFRS 3, Intellectual Assets management, December/ January 2007 issue, page 11-12 16Tina Visakorpi, reporting on a press release of FIN-FSA, 11 September, 2006, http://www.rahoitustarkastus.fi/Eng/FIN-FSA_News/Press_releases/9_2006.htm 17Virgina Stevens, IFRS and AIM Companies, viewed on July 16, 2008, http://www.kpmg.co.uk/services/a/ifrs_uk/index.cfm 18Wayne Lonergan, The Implications of IFRS for Non- Accountants, Company Director Journal, August 2005, 19Wyatt, A., “Accounting recognition on intangible assets: Theory and Evidence on Economic determinants.” Accounting Review 80/3: 967-1003, 2005 20Yvonne Land, Giles Murphy, and others, United Kingdom- Financial Reporting, Smith and Williamson March 2006, http://www.mondaq.com/article.asp?articleid=39026 Read More