IAS: Interpretation and Application of International Accounting Standards provides analytical explanations and copious illustrations of all current accounting principles promulgated by the IASB (and its predecessor, the IASC). The book integrates principles promulgated by the Board—international financial reporting standards (IFRS) and the earlier international accounting standards (IAS)—and by the Board's body for responding to more narrowly focused issues—the International Financial Reporting Interpretations Committee (IFRIC), which succeeded the Standing Interpretations Committee (SIC). These materials have been synthesized into a user-oriented topical format, eliminating the need for readers to first be knowledgeable about the names or numbers of the salient professional standards.
The focus of the book is the practitioner and the myriad practical problems faced in applying IAS. Accordingly, the paramount goal has been to incorporate meaningful, real-world-type examples in guiding users in the application of IAS to complex fact situations that must be dealt with in the actual practice of accounting. In addition to this emphasis, a major strength of the book is that it does explain the theory of IAS in sufficient detail to serve as a valuable adjunct to, or substitute for, accounting textbooks. Not merely a reiteration of currently promulgated IAS, it provides the user with the underlying conceptual basis for the rules, to enable the reasoning by analogy that is so necessary in dealing with a complex, fast-changing world of commercial arrangements and structures. It is based on the author's belief that proper application of IAS demands an understanding of the logical underpinnings of its technical requirements. This is perhaps more true of IAS than of various national GAAP sets of standards, since IAS is by design more "principles based" and hence less prescriptive, leaving practitioners with a proportionately greater challenge in actually applying the rules.
Each chapter of this book, or major section thereof, provides an overview discussion of the perspective and key issues associated with the topics covered; a listing of the professional pronouncements that guide practice; and a detailed discussion of the concepts and the accompanying examples. A comprehensive checklist following the main text offers practical guidance to preparing financial statements in accordance with IAS. New to the current edition is a detailed, tabular comparison between IAS and both US and UK national GAAP, keyed to the chapters of this book. Also new this year is a set of three comprehensive financial statements that illustrate application of financial reporting standards to different types of enterprises.
The authors' wish is that this book will serve practitioners, faculty, and students as a reliable reference tool, to facilitate their understanding of, and ability to apply, the complexities of the authoritative literature. Comments from readers, both as to errors and omissions and as to proposed improvements for future editions, should be addressed to Barry J. Epstein, c/o John Wiley & Sons, Inc., 155 N. 3rd Street, DeKalb, Illinois 60115, prior to May 15, 2003, for consideration for the 2004 edition.
Barry J. Epstein
Abbas Ali Mirza
Chapter 1: Introduction to International Accounting Standards
Need for Accounting Standards
Development of accounting and financial reporting.
Accounting was created as a means of measuring and reporting upon economic activity. Renaissance-era monk Fra Luca Pacioli is normally credited with the invention of double-entry bookkeeping, designed for use of traders operating in fourteenth and fifteenth century Italian city-states. From there, the use of double entry bookkeeping largely followed evolving trading patterns.
Thus, double entry bookkeeping has been traced to Germany and France, and then to Great Britain, where it became widely proliferated via the commercial activities in the seventeenth and eighteenth century of the British Empire. The industrialization of North America and the Commonwealth countries, partially in response to British investments in the insurance and railroad industries, led to the further spread of double entry bookkeeping. Contemporaneously, Dutch accounting followed the discoveries and settlements made in Indonesia and South Africa. Other patterns of influence can be traced from their European origins throughout the world, as from Spain to Latin American nations. Later, with its economic ascendancy, the United States became the prime developer of accounting theory and exported its favored financial reporting model around the globe.
Different practices and regulations tended to evolve to meet local needs and economic characteristics. Some of the factors affecting these variations include the degree of centralization in the economy, ranging from state control to unfettered free enterprise; the nature of economic activity, from simple agrarian societies to the most sophisticated and complex business enterprises; the stage of economic development, from emerging economies to fully matured postindustrial ones; the pattern and pace of economic growth, ranging from stagnation of the former Communist economies to the explosive growth of certain Asian economies in the 1990s; and the history of price stability or inflationary experience of the nation's economy. In addition, the nature of the nation's legal system has profoundly impacted its approach to accounting and financial reporting.
Accounting and reporting models.
To serve the needs of (primarily) business entities reporting on their economic activities, an accounting profession developed. This gained momentum when absentee ownership and professional management became the model for larger business enterprises. Once the era of laissez faire had passed into history, virtually every nation, having every variant of economic and legal systems, imposed some type of regulation over the accounting profession. This was done either by means of direct government regulation, or indirectly via professional self-regulation (often under implied threat of direct supervision should that prove unsatisfactory).
Accounting and reporting practices, despite real variations among the nations, have nonetheless been rather remarkably consistent. This is perhaps logical, given that all these practices were intended to accomplish the very same goals. Over time, even the diversity that once existed has become much diminished, as the systems of the more dominant economic powers (particularly the US and the UK) became the preferred sets of practices for enterprises hoping to one day engage in significant activity in those nations or those (e.g., Commonwealth members) aligned with them.
Historically, the major dichotomy of accounting standards was between those that evolved in nations adhering to a common law tradition and those that had code law. Those that had codified rules of behavior tended to formally prescribe accounting and financial reporting matters as well, and most often the role of financial reporting was made subservient to the nation's system of taxation. Under such systems, actions (e.g., financial reporting) can only be taken if specifically allowed under the law. The Napoleonic Code is the prototype of code law, and indeed most of the nations that were dominated by France during that era have subscribed to this approach. Before the very recent rise of IAS, both France and Germany had highly prescriptive financial reporting systems, for example.
Nations having a common law tradition, on the other hand, have more permissive systems, generally only setting rules governing those actions (e.g., fraudulent financial reporting) that cannot be taken. Financial reporting requirements tend to not be defined in national laws of common law countries; instead, rules have developed largely through the efforts of the private sector. These are often the product of the professional societies, assisted by the work of academicians. In common law countries, the goals of financial reporting are often at variance with those of national tax policy.
By the middle of the twentieth century, there were a relative handful of distinct accounting models in broad use. Thus, Latin American nations' systems tended to rely on regular adjustments for the effect of changing prices, made necessary by those nations' problems with persistent and often virulent inflation. Nations such as the UK and US having price stability (albeit with intermittent bouts of serious inflation, particularly in the 1970s) evolved very similar sets of accounting rules. Other countries, typically from the code law tradition, had tightly circumscribed financial reporting practices oriented to the twin goals of protecting the interests of creditors and ensuring the effectiveness of taxation.
More recently, international accounting standards (established by the International Accounting Standards Board, formerly the International Accounting Standards Committee) have been gaining many adherents. In the past few years, certain watershed events, such as the European Union's decision to mandate the use of international accounting standards (which will be referred to hereinafter as IAS) by 2005, have greatly enhanced the stature of this set of accounting standards and improved the likelihood of its becoming the global norm.
Setting accounting standards.
The accounting standard-setting process has proceeded somewhat differently in the major nations of the developed world. In the United States and the United Kingdom—having experienced similar traditions of common law, capitalism, highly educated and professional workforces, large and sophisticated companies that raise equity capital in the public markets, and a belief in the responsibility of managements to report on their stewardship to the owners of the respective businesses—independent accounting professions have largely controlled the setting of accounting standards. In both nations, the principle of full disclosure has been of central importance: financial statements are expected to be transparent, so that users, generally assumed to be investors and creditors, are able to understand fully the nature of the reporting enterprise's operations and finances. Tax reporting is a distinct and separate matter, which does not drive financial reporting.
In the US, reporting by publicly held enterprises has been subject to oversight by the Securities and Exchange Commission, which has the statutory right to set accounting principles, which it has virtually never exercised. In the UK, there is no equivalent to the US SEC, but the autonomous Financial Reporting Review Panel (FRRP) does examine financial statements in order to determine whether there has been a failure to provide a "true and fair view" as a result of a departure from an accounting standard, and has the authority to seek revisions, by court order if necessary, when failures are found to exist.
Despite the vast similarities, there are notable differences between the UK and US accounting systems. For example, there are many legal and institutional regulations that apply only to public companies in the UK, while in the United States the only accounting rules that are limited to public companies under current generally accepted accounting principles (GAAP) are those related to segment reporting and earnings per share disclosures.
In contrast to the United States and the United Kingdom, the nations of Europe and Japan, which also have capitalist economic systems, historically have relied far less on public equity markets and much more on bank financing—a distinction that is now fading as the move to global equity markets has gained momentum. When creditors held sway over corporate accounting, practices such as the use of "hidden reserves" that protected their interests at the possible expense of shareholders' interests were common. The acceptance of IAS in Japan and most recently in the EC effectively means that this bias will no longer be tolerated.
Even under the former regimes, financial reporting in the code law nations was similar to that in the common law ones. Thus, for example, basic underlying concepts such as accrual basis accounting and the going concern assumption were fundamental to both systems. However, in some important areas, there were substantial distinctions; for example, companies in France and Germany rarely displayed deferred income tax liabilities even though the concept was accepted, since most tax deductions were conditioned on the item being expensed currently for financial reporting purposes. Also, consistent with the conservative reporting bias of those reporting models, reserves were required to be set aside (e.g., as a set percentage of annual earnings, sometimes subject to a cap), which were not based on actual, estimated obligations of any sort—a practice that was long clearly banned under UK and US GAAP.
In the late 1990s there was a short-lived reaction in Europe against the growing dominance of UK, US, and IAS financial reporting standards. A plan was proposed to sponsor the development of a set of continental European or EU accounting standards, which presumably would have retained the creditor-oriented bias that previously had served to make European financial reporting more conservative than in Anglophone nations. However, this idea was quickly dropped, and the EU has now endorsed IAS, with a mandate that it be fully implemented by listed companies in preparing consolidated financial statements by January 1, 2005.
Arguably, these recent developments leave the real competition for the role of de facto world accounting standards between US GAAP and the IAS. While the US standard setter has certainly not conceded the fight, there have been important signs that momentum has shifted to the IAS.
US GAAP contains by far the largest number of specific rules, currently comprising several still-effective Accounting Research Bulletins, 31 APB Opinions, 146 FASB Statements, and scores of Interpretations and Technical Bulletins, and Statements of Position and Accounting Guides issued by the AICPA, as well as other relevant professional literature. Many of these were prescribed in reaction to attempts to evade the spirit of earlier standards—for example, the basic standard on lease accounting was supplemented by dozens of interpretations, amendments and lesser forms of guidance, as companies sought to avoid capitalization of obligations under finance leases. In many cases, efforts to block evasive maneuvers were frustrated, as the ever more specific rules suggested new opportunities to create further evasions. Over the decades, US GAAP has become largely "rules based," whereas it was once far more "principles based."
The International Accounting Standards Committee (the IASC), originally, and now its successor, the International Accounting Standards Board (the IASB), has made clear the intention to not duplicate this body of guidance, and to adhere to a philosophy of providing general guidance rather than detailed standards addressing every nuance of business practice. While this is undoubtedly sincerely based on a belief in such an approach, it is also true that (until the restructuring that created the IASB) the IASC lacked the financial resources to create a US GAAP-like set of detailed standards.
The distinction between these two philosophies may have become exaggerated in popular perception, in any event. Thus, in the aftermath of recent accounting debacles at companies such as Enron and WorldCom, claims were made that these scandals would not have occurred had IAS-type "principles-based" standards been in place. However, the malefactors in those cases had violated, not complied with, US GAAP, and thus it is not clear at all that violations would not have occurred equally under an IAS reporting regime. In fact, audit failure and management fraud were probably more important explanations than were choice of accounting standards. In any event, IAS have probably not yet been put to a similar test, so it is far from certain that Enronesque accounting catastrophes would not occur under that reporting system.
Notwithstanding the mixed evidence, the recently enacted Sarbanes-Oxley Act of 2002, which was rushed through Congress in reaction to these outrages, requires the US SEC "to conduct a study on the adoption by the United States financial reporting system of a principles-based accounting system." While the ultimate outcome is unknown at this early date, it would be very surprising indeed if US GAAP as currently codified were to be stripped of its detailed guidance to a significant degree. More likely, perhaps, would be for new standards, as they developed, to veer somewhat more toward the "principles-based" end of the spectrum than has been the case over most of the FASB's thirty-year history.
Need for International Accounting Standards
Although historically differing national traditions and circumstances such as price instability contributed to the development of varying sets of financial reporting standards, with the greatly magnified emphasis on international commerce and capital flows over the past thirty years, the need for global accounting standards has been increasingly recognized.
Multinational companies (MNC) have grown dramatically in both size and importance over this period, assuming dominant roles in many market segments and affecting almost every country, every government, and every person. From a financial reporting perspective, the complexity of conducting international business operations across national borders, each with a different set of business regulations and often different accounting methods, presents a daunting challenge for both individual accountants and for the professional bodies that establish accounting and auditing standards. A diversity of applicable accounting, auditing, and tax standards and regulations may negatively impact such enterprises' abilities to prepare reliable financial information necessary for both reporting to their stakeholders and for the careful analysis of investment opportunities vital to their further growth. As the number of countries of activity increases, so too do the potential complications.
As noted above, over recent years the disparities of accounting practices among nations have declined markedly. The European adoption of IAS beginning in 2005 will eliminate a large fraction of remaining variations, essentially leaving US GAAP, UK GAAP, and IAS as the "big three" comprehensive sets of standards—with UK-IAS convergence likely to occur as well. The hope is to eliminate the final set of disparities, between US GAAP and IAS, over the next ten years or so, and both standard setters are seriously committed to such convergence.
One very large impediment has been the US SEC's refusal to recognize the validity of IAS as a basis for filing registration statements and periodic reports under US securities laws, other than when accompanied by a reconciliation to US GAAP for major captions in the income statement and balance sheet. The SEC solicited comments on a possible rule relaxation, but has not indicated the nature of responses received or its inclination to actually move forward with changes to filing requirements. Conditional acceptance of IAS by the international body of national securities regulatory authorities was a positive development but did leave open the possibility that continued reconciliations could still be required, which would prevent the rapid move toward IAS as an "Esperanto" for worldwide financial reporting. These developments are discussed further below.
The International Accounting Standards Committee (predecessor of the current International Accounting Standards Board)
The International Accounting Standards Committee was founded in 1973 by representatives of professional bodies in Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom, Ireland, and the United States, and grew to include representatives from ninety-one countries. From 1983 until December 2000, the IASC's members had included all the professional accountancy bodies that are members of the International Federation of Accountants (IFAC); as of January 2000, these comprised 143 member bodies in 104 countries, representing over two million accountants.
From its formation, the IASC engaged in a standard-setting program that has now gained worldwide recognition. Prior to the transition to the new IASB (discussed below), the IASC had issued forty-one international accounting standards (IAS), of which, after a series of revisions, thirty-four remain in force. Also issued to date have been a number of Exposure Drafts (at least one of which preceded the final issuance of each standard). A number of Interpretations of these standards have also been issued by the former Standing Interpretations Committee (SIC). A listing of standards and SIC issued to date that remain currently operative appears in Appendix A to this chapter.
A conceptual release on the Framework for the Preparation and Presentation of Financial Statements (the Framework), which was issued in 1989, was intended to be the IASC's conceptual foundation upon which later accounting standards would be built, and it has largely served this purpose. This document identifies the expected beneficiaries of financial reporting, the objective of the reporting process, the key underlying assumptions (going concern and accrual basis), the qualitative characteristics of financial statements (the primary ones being understandability, relevance, reliability, and comparability; there are a number of secondary ones as well), and the elements of the financial statements (assets, liabilities, equity, income, and expenses). It also sets forth the twin criteria for recognition of an item in the financial statements (the probability that the economic benefits associated with it will flow to or from the entity, and the reliability of measurement of the item).
Objectives of standard setting under the Constitution of the IASC Foundation.
The objectives of IASC as set forth in its original constitution (approved in 1992) were twofold. The first was to formulate and publish, in the public interest, accounting standards to be observed in the presentation of financial statements and to promote their worldwide acceptance and observance and the second was to work generally for the improvement and harmonization of regulations, accounting standards, and procedures relating to the presentation of financial statements. The new Constitution of the International Accounting Standards Committee Foundation (IASC Foundation), that was approved by the members of IASC in May 2000 and was revised by the trustees of the IASC Foundation in March and July 2002, has expanded the objectives of the IASC Foundation, as set forth below.
To develop in the public interest a single set of high-quality, understandable, and enforceable global accounting standards that require high-quality, transparent, and comparable information in financial statements and other financial reporting to help participants in the world's capital markets and other users make economic decisions;
To promote the use and rigorous application of those standards; and
To bring about convergence of national accounting standards and International Accounting Standards to high-quality solutions.
It is significant that the emphasis has now shifted from mere "harmonization" to the actual "convergence" of the various national accounting standards and the International Accounting Standards (which are prospectively to be called International Financial Reporting Standards [IFRS]).
The significant achievements of the former IASC and the new IASB are explained in detail later in this chapter.
The international "due process."
In May 2002, the IASB issued the Preface to International Financial Reporting (the Preface). This addresses, in addition to a number of other matters, the steps set out in the "due process" of the IASB and the International Financial Reporting Interpretations Committee (IFRIC). These are summarized below.
IASB's due process.
International Financial Reporting Standards (IFRS) are to be developed through an international system of due process involving many interested parties around the globe, including accountants, financial analysts and other users of financial statements, regulators, stock exchanges, academics, and the business community at large. A Standards Advisory Board (SAC) advises the IASB about the projects it should add to its agenda. The standard-setting "due process" generally encompasses the following steps:
The IASB staff identify and review all issues related to the topic under consideration, and examine the application of the IASB's Framework to the issues.
The requirements of national accounting standards on the topic (including practices within various jurisdictions) are examined, and views are exchanged about related issues with national standard setters.
The SAC is consulted on the advisability of including the topic in the IASB's agenda.
An advisory group is formed to advise the IASB on the project.
A discussion document is published for public comment.
An Exposure Draft (ED), approved by at least eight votes of the IASB members and incorporating dissenting opinions and a basis for conclusions, is published for public comment.
All comments received on discussion documents and ED are considered.
The holding of public hearings and the conducting of field tests are considered and, if deemed desirable, are held and conducted.
The Standard is voted upon; if the approval of at least eight board members is obtained, it is published—incorporating dissenting opinions and a basis for conclusion, explaining, among other things, how the IASB dealt with public comments on the ED.
The IASB deliberates in meetings that are open to public observation.
International Financial Reporting Interpretations Committee's (IFRIC) due process.
The former Standard Interpretations Committee (SIC) was reconstituted in December 2001 as the IFRIC. This required that the IASC Foundation's constitution be revised, which it was by the IASC Foundation trustees following public consultation in March 2002.
Interpretations of IFRS will be developed by the IFRIC for approval by the IASB. The due process for interpretations of IFRS would normally include the following steps:
The IASB staff identify and review all issues related to the Interpretation and examine existing national standards and practices.
IFRIC studies national standards and practices.
A draft Interpretation is published for comment if no more than three IFRIC members have voted against the proposal.
The normal comment period is sixty days, but for urgent issues the trustees have agreed to shorten it to thirty days.
Comments received on the draft Interpretation are considered by IFRIC within a reasonable period of time.
If no more than three IFRIC members have voted against the proposal, IFRIC approves the final Interpretation and submits it to the IASB for approval.
The final Interpretation is voted upon and is considered approved if at least eight Board members vote affirmatively.
IFRIC deliberates in meetings open to public observation.
Historical Stages of Development in the International Accounting Standard-Setting Process (prior to the formation of the IASB)
Reviewing the history of the IASC, from its inception until the date of its transformation to the new IASB (addressed separately later in this chapter), it is possible to identify three stages through which it passed, each of which was characterized by rather different foci and objectives. These phases were, respectively, the early years during which it attempted to demonstrate attention to all the major accounting issues; the middle period of consolidation when allowable alternative treatments were reduced as part of the effort to improve comparability; and the final era when a core set of standards necessary to obtain the support of the international capital markets was completed. The important achievements of each of these eras are summarized in the following paragraphs.
In its earliest years, the IASC attempted to establish a common body of standards on major accounting topics, such as for inventory, for leases, and for long-lived assets. This consisted largely of inventorying and then endorsing virtually all the main-stream methods used in any of the major nations of the world. This "lowest common denominator" approach resulted in the promulgation of standards permitting diverse accounting methods for similar fact situations. The conceptual bases for allowing these alternative treatments generally were not addressed. Notwithstanding what might appear to be the limited achievement this phase of IASC activity represented, it did serve to establish its legitimacy as a transnational standard-setting body, albeit one bereft of any enforcement mechanism.
The highlight of the second phase in the IASC's evolution was the Comparability/Improvements Project that culminated with the promulgation of ten revised standards that took effect in 1995. The objective of this undertaking was to narrow the range of the acceptable accounting treatments that could be brought to bear upon given fact situations. It could be judged a qualified success as indeed the number of acceptable alternatives was reduced, but arguably too many alternatives still remained available.
The Comparability/Improvements Project experience revealed the very difficult task faced by the IASC as a body whose only power derived from moral suasion. For example, in attempting to narrow the then-available inventory costing options set forth in the original IAS 2, the IASC determined that the LIFO and base stock methods should be prohibited. However, in a number of countries, LIFO is a popular method that depends on conformity between financial reporting and tax reporting (i.e., tax advantages are available only if published financial statements conform to the method used in the tax returns). As a result, the IASC found it necessary to accept the continued existence of LIFO costing (which was, however, demoted to allowed alternative status, with FIFO and weighted-average cost flow assumptions becoming the benchmarks.
Notwithstanding the fact that the range of alternatives was not narrowed as much as might have been hoped, the Comparability/Improvements Project had its achievements. These accomplishments are summarized as follows:
IAS 2: Inventories
The base stock method was dropped and the LIFO method was relegated to allowed alternative status.
IAS 8: Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies
The original standard addressed the reporting of unusual items, prior period items, and changes in accounting policies and accounting estimates. In the revised standard, benchmark and allowed alternative treatments are prescribed for correction of what are called "fundamental" errors, with the benchmark involving adjustment of retained earnings and restatement of comparative prior periods, and the alternative being inclusion of the effect of the correction in current period income. The new standard also requires that extraordinary items be set forth separately on the face of the income statement, and the expanded disclosure of certain unusual items that are included in ordinary income (e.g., write-downs of inventories to net realizable values) and of discontinued operations. The effect of this revised standard was to bring the international accounting standard into closer conformity with the US standard and to streamline financial statement disclosures.
IAS 9: Research and Development Costs
The original standard required expensing research costs but permitted either capitalization or expensing of defined development costs. The revised IAS 9 continues to require expensing of all research costs but sets standards for capitalization of certain development costs. If certain conditions are met, the costs must be capitalized and amortized; if not, they must be expensed at once. Thus, this revision did fully achieve the goal of eliminating alternative treatments. As part of its core set of standards project, the IASC has promulgated IAS 38, Intangible Assets, which has superseded IAS 9 and substantially requires the same accounting treatment as the erstwhile IAS 9.
IAS 11: Construction Contracts
The original standard permitted a free choice between percentage-of-completion and completed-contract methods of accounting, while the revised standard allows percentage-of-completion only. Once again, the goal of narrowing alternatives was fully achieved.
IAS 16: Property, Plant, and Equipment
The original standard permitted either historical cost or revalued amounts as the basis for reporting property, plant, and equipment; these remain in the revised standard, but historical cost is now designated as the benchmark treatment, with revalued amounts being relegated to the allowed alternative category. A number of other changes were also made, including incorporating the formerly separate guidance of IAS 4, Depreciation Accounting, and requiring that any revaluations be to fair value and that these be updated regularly (e.g., every three years). Although this revised standard offers guidance superior to its predecessor, it nonetheless still permits diverse accounting methods.
IAS 18: Revenue Recognition
Whereas the original standard permitted either percentage-of-completion or completed-contract accounting for recognition of revenue related to the rendering of services, in the revision only the percentage-of-completion method is allowed, if specified conditions are met.
IAS 19: Retirement Benefit Costs
Accounting for retirement benefits by employers was, and remains, a very complicated topic. In the original standard, the guidance was very general, essentially only demanding that costs be rationally allocated to the periods of benefit. This revised standard, on the other hand, is far more detailed but nonetheless still permits a range of methods, most notably defining the accrued benefit valuation method as the benchmark and the projected benefit method as the allowed alternative (contrasted to the US standard, SFAS 87, which mandates exclusive use of the projected benefit method alone). The revised standard also requires that actuarial valuations regarding projected salaries, past service costs, experience adjustments, and the effects of changes in actuarial assumptions be allocated to income on a systematic basis. It should be noted that yet another revision to this standard was undertaken by the IASC as part of the core set of standards project, under which program the revised standard was made more comprehensive and now deals with accounting treatment of not just retirement costs but other employee benefits as well. (The requirements of the latest revised standard, which eliminates the allowed alternative treatment of benefit costs, are discussed in detail in a later chapter.)
IAS 21: Effects of Changes in Foreign Exchange Rates
The revisions to this standard were rather modest in scope; certain choices relative to the deferral and amortization of exchange differences on long-term monetary items, on translation of income statements of foreign entities at the closing rate, and on translation of financial statements of foreign entities that report in the currency of a hyperinflationary economy without prior restatement, all were narrowed. Additional disclosures were also mandated by the revised standard. The revised standard largely duplicates the corresponding US standard, SFAS 52.
IAS 22: Accounting for Business Combinations
The revision more clearly defined which combinations (known as acquisitions) are to be accounted for using the purchase method and which (unitings of interests) must be accounted for by the pooling of interests method. The criteria for unitings are quite restrictive but are simpler than those in the parallel US standard, APB 16 (the latter defines twelve criteria that must all be met, while the former sets forth only three). Furthermore, the revised IAS 22 prohibits the immediate write-off of goodwill against stockholders' equity that was allowed previously. On the other hand, the revised standard sets forth benchmark and allowed alternatives with regard to the measurement of minority interest and for the accounting for negative goodwill. Thus, alternative accounting for essentially identical events has not been eliminated completely.
IAS 23: Borrowing Costs
The original standard permitted either capitalization or expensing of borrowing costs incurred in connection with construction of assets, while the revision slightly alters this by defining expensing as the benchmark treatment and capitalization as the allowed alternative. This change is only a modest achievement, given that enterprises are under no real burden to conform to the benchmark treatment.
The IASC entered its third and final phase in 1995, when it embarked on a mission to complete what had been defined as the "comprehensive core set of standards." This was motivated by an historic agreement with IOSCO, which committed IASC to the completion of revisions of the standards that IOSCO deemed essential to its consideration of possible endorsement of the IAS for purposes of cross-border securities registrations. IOSCO had previously approved IAS 7, Cash Flow Statements, as being acceptable for use by companies registering securities in IOSCO's member nations, and was, in 1995, agreeing to accept most (but not all) of the other IAS if certain changes were made. IASC completed these changes and promulgation of required new standards at year-end 1998.
The actual agreement between the IASC and IOSCO had involved the formal acceptance of a work plan that set forth a number of projects to be completed on a targeted schedule. The standards that were addressed as part of this project and the results obtained included accounting for income taxes (revised IAS 12, issued in late 1996); financial instruments (divided into two projects: "disclosure and presentation," completed with the issuance of IAS 32 in 1995, and "recognition and measurement," completed with the promulgation of IAS 39 at the end of 1998); earnings per share reporting (IAS 33 in mid-1997); segment reporting (revised IAS 14, issued in mid-1997); financial statement presentation (revised IAS 1, replacing IAS 1, 5, and 13, issued in mid-1997); accounting for intangibles, research and development, and goodwill (IAS 38, issued mid-1998); employee benefits (revised IAS 19, issued in 1998); interim financial reporting (IAS 34, issued in 1998); reporting of discontinuing operations (IAS 37, issued in mid-1998); and impairment of assets (IAS 36, issued in mid-1998).
IOSCO's endorsement of the "IASC 2000 Standards."
The completion of this "core set of standards" was a major achievement, and IASC quite naturally expected that, having performed on its side of the bargain, IOSCO would likewise deliver on its explicit and implicit commitments. The accounting world waited for over four years for a favorable nod from IOSCO, signifying an endorsement of the IASC standards that would mark a major milestone in the globalization of financial reporting. The much-awaited report from the world's securities regulators was accepted and published in May 2000.
IOSCO's Working Group No. 1 on Multinational Accounting and Disclosure, after carefully assessing the IASC standards, submitted its report to the Technical Committee of IOSCO, which in turn recommended to IOSCO members the use of thirty selected IAS for cross-border listings and offerings by multinational enterprises. The endorsement was, alas, qualified, inasmuch as it contemplated augmentation of the IAS-compliant financial statements by means of reconciliations, supplemental disclosures and interpretations, and where deemed necessary, the addressing of outstanding substantive issues at a national or regional level.
The endorsement meant that it was recommended that IOSCO member organizations (national securities regulators) permit incoming multinational issuers to use the thirty IASC 2000 standards to prepare their financial statements for cross-border offerings and listing, as supplemented in the manner noted above. IASC 2000 standards included all IAS with the exception of three standards then extant; namely IAS 26 and 30, because they dealt with specialized industry reporting practices, and IAS 25, expected to be revised as part of the IASC's work on financial instruments (it was later superseded by IAS 40). It also included SIC Interpretations issued and in force on January 1, 2000. IOSCO could only recommend acceptance, since it has no authority to mandate the actions of the sovereign bodies of which it is comprised.
Supplemental treatments mandated by IOSCO's endorsement.
IOSCO's endorsement came with certain strings attached in the form of "supplemental treatments." As explained by IOSCO's Presidents' Committee resolution, these supplemental treatments are as follows:
Reconciliation— Requiring reconciliation of certain items to show the effect of applying a different accounting method, in contrast with the method applied under IASC standards;
Disclosure— Requiring additional disclosures, either in the presentation of the financial statements or in the footnotes; and
Interpretation— Specifying use of a particular alternative provided in an IASC standard, or a particular interpretation in cases where the IASC standard is unclear or silent.
The resolution also establishes the notion of "waivers." It states that, as part of national or regional specific requirements, waivers of particular aspects of an IASC standard may be envisaged, without requiring that the effect of the accounting method used be reconciled to the effect of applying the IASC method. The clear intention is that the use of waivers will be restricted to exceptional circumstances, such as issues identified by a domestic regulator when a specific IASC standard is contrary to domestic or regional regulation.
Although the IASC's outgoing chairman, Stig Enevoldsen, was quoted in the media to have said that IOSCO's endorsement was a dream come true for the IASC, some commentators have dubbed it as a qualified or a lukewarm endorsement, since it requires supplemental treatments. While the true implications of the supplemental treatments envisaged by IOSCO's endorsement are not yet fully understood, it is evident that it is not an unequivocal endorsement. What is obvious is that IOSCO endorsement allows the individual regulators to require certain supplemental treatments. However, as explained by the IASC's spokesman, even though it requires "reconciliation," it does not envision full reconciliation similar to the one currently mandated by the US SEC's listing requirements. Furthermore, it requires reconciliation of "certain items" in order to demonstrate the effect of applying a different accounting method. This, according to the IASC spokesman, softens the requirement to the status of "partial reconciliation" as opposed to "full reconciliation." The IASC thus hoped that by requiring reconciliation of certain items IOSCO's endorsement would, in practice, require reconciliation of relatively few items, for example, "not more than ten items." It expects that most companies would be able to avoid having to adjust more than a couple of items if the accounting policies are chosen carefully.
Outstanding substantive issues under IOSCO's endorsement.
There are a number of outstanding substantive issues relating to the IASC 2000 standards. Initially when IOSCO began its assessment of the IASC 2000 standards, it considered over 850 issues that had been raised over the course of the core set of standards project. After evaluating the IASC 2000 standards, the working party members concluded that the majority of their concerns had been addressed and the range of concerns had been narrowed significantly. According to the report of the Technical Committee, the outstanding substantive issues vis-a-vis the IASC 2000 standards could be summarized as follows:
In the case of six IAS, no outstanding substantive issues were identified;
In the case of six other IAS, each have only one outstanding substantive issue;
The remaining issues identified include approximately twenty issues where one or more jurisdictions expect to require reconciliation of a treatment specified by the IASC 2000 standards to another specified accounting treatment (which may be a host country accounting treatment);
Approximately fifty issues were also noted where one or more jurisdictions would expect to require supplemental disclosures;
Approximately fifty issues where one or more jurisdictions expect to require a specific application of an IASC 2000 standard were also identified; and
Four issues were also noted where one or more jurisdictions expect to waive compliance with a requirement of an IASC 2000 standard.
The recommendations regarding specific IAS are set forth in greater detail in Appendix B to this chapter.
IOSCO'S Vision of the Future and Latest Developments
IOSCO's report has a section entitled "suggestions for future projects with the IASC," which very aptly points out that this report is only a "point-in-time snapshot" with respect to the IASC standards and to the experience with the implementation of these standards.
Accordingly the Working Party recommends that it continue to be actively involved in the standard-setting and interpretive process and to follow and comment on IASC projects. This will allow the concerns of securities regulators to be raised and addressed early in the IASC's process.
At the time of the IOSCO's endorsement, it had envisioned a survey of its membership by the end of 2001 to determine the extent to which they had taken steps to permit incoming multinational issuers to report consistent with IAS 2000 standards, subject to those supplemental treatments described above adopted in the local jurisdictions. This survey was conducted, and the results were reported in the final communiqué of IOSCO's twenty-seventh annual conference, in May 2002, noting considerable progress towards acceptance of IAS by its members.
The results (of the survey) indicate that many jurisdictions permit incoming issuers to use IAS, and others are actively working towards this end. Moreover, since May 2000, there have been a number of developments promoting the use of IAS. These include: (i) the decision of the EU Council of Ministers (ECOFIN Council) requiring the use of IAS by 2005; (ii) the completion of the reconstitution of the IASB into a full-time independent standard-setter; and (iii) the formation of the Committee of European Securities Regulators with a special sub-group devoted to these issues. Looking ahead, to further these efforts, IOSCO encourages the IASB and national standard setters to work cooperatively and expeditiously to achieve convergence in order to facilitate cross-border offerings and listings and encourages regulators to address the broader issues of consistent interpretation, application and enforcement.
The EU's Acceptance of the IASC Standards
IASC's efforts received a boost in late 1995, when the European Commission's (EC) Single Market Commissioner announced that the European Union had abandoned its previously stated goal of developing unique European standards of accounting. By deferring to international accounting standards (IAS), the EC has removed the specter of yet another layer of national and supranational accounting standards and contributed to achieve true internationalization of financial reporting and harmonization of accounting principles.
The European Commission's mid-2000 policy document, EU Financial Reporting Strategy: The Way Forward, stated that companies within the EU seeking listings on EU stock markets should no longer have the choice of preparing their consolidated financial statements in accordance with either their national accounting standards or US GAAP. In June 2002 the Council of Ministers of the EU approved a Regulation, proposed in early 2001 by the European Commission, to require publicly traded companies to use IAS and IFRS in their consolidated financial statements by January 1, 2005. A temporary exemption will be granted for companies that are currently traded in the US and use US GAAP, and for companies that have issued debt instruments but not equity instruments; those companies will be required to comply with IAS by January 1, 2007.
In March 2001, in response to this proposal of the European Commission for an expert level in the EU IAS endorsement mechanism, a broad group of organizations representing the European accounting profession, preparers, users, and stock exchanges proposed to organize a private-sector body that would
Provide input to the IASB, and
Assess whether IAS and the SIC Interpretations are suitable for use in Europe.
In response to this proposal, the European Financial Reporting Advisory Group or EFRAG came into existence, creating a Technical Expert Group and a Supervisory Board. This group will provide support and expertise to the European Commission in the assessment of the international accounting standards, consistent with the proposal that led to the adoption of the 2005 mandate for compliance with IAS. EFRAG has since published several pronouncements, explaining its due process procedures and endorsing IAS.
With regard to its due process, EFRAG has clarified the distinction between its proactive work and its endorsement advice to the Commission. The former refers to EFRAG's response to IASB proposals made via comment letters to the Board; the latter involves EFRAG's advisory role to the Commission on whether to endorse an IFRS or IFRIC pronouncement. Also, while EFRAG's primary focus is on standards for listed companies, it is also concerned with financial reporting by private enterprises, since member states optionally may require or permit the application of IAS not just for consolidated accounts of listed companies but also for other accounts of a wide range of companies. It is expected that, in a number of countries, there will be an immediate impact for (certain classes of) unlisted companies including smaller and medium-sized enterprises ("SME").
EFRAG has indicated its concern for balancing timely response with careful deliberation, being mindful that "(t)oo late an announcement that EFRAG is minded to advise against adopting an IASB pronouncement will leave insufficient time for aggrieved parties to make their views known to EFRAG." EFRAG is committed to "transparent due process open to all parties" and, to that end, will publish its comment letters to the IASB, its endorsement advice to the Commission, and other EFRAG position papers as appropriate; will provide reasoned opinions for EFRAG positions; will publish Technical Expert Group agendas and summary minutes of its meetings; will invite comments on IASB proposals, EFRAG tentative positions, etc.; and will publish an annual report. Documents will be freely available via the Internet for all interested parties.
In June 2002 EFRAG announced its endorsement of existing IAS 1 through 41, and SIC 1 through 33. It had been requested by the EU Commission to confirm that there were no remaining discrepancies between IAS and related SIC, on the one hand, and the EU's Fourth and Seventh Directives (as modified under proposals still under discussion). EFRAG reviewed the standards and interpretations to the extent that they remained extant as of March 2002, and, based on that review, opined that the current standards met the requirements of the Regulation of the European Parliament and of the council on the application of IAS by EU listed companies from 2005 onwards.
EFRAG expressed its approval of the IAS standards and stated that they were not contrary to the "true and fair" principle set out in the EU Directives and also met the criteria of understandability, relevance, reliability and comparability required of the financial information needed for making economic decisions and assessing the stewardship of management. For those reasons, it concluded that it was in the European interest that the process of adoption of the current standards should be set in motion. Accordingly, they recommended endorsement of the current standards "en bloc."
More recently, EFRAG has responded in detail to the IASB's proposal to amend a number of existing standards, under its Improvements Project. The project and certain of EFRAG's responses thereto are noted later in this chapter.
Modernization of EU Accounting Directives
EU Accounting Directives were intended to establish a minimum level of harmonization for preparation of financial statements. Having not been significantly amended since their adoption in the period from 1978 to 1983, these had become somewhat obsolete or redundant due to significant changes to financial reporting practices and various subsequent developments from the accounting standard setters and in the broader business community. In May 2001, the EU's Council of Ministers and the European Parliament issued a Directive that modernized the EU accounting rules by introducing "fair value" rules for certain categories of financial instruments. This was intended to enable EU companies that use financial instruments to apply IAS 39 while meeting the requirements of the EU accounting law.
In May 2002, Commission of European Communities issued a proposed Directive of the European Parliament to amend certain Council Directives dealing with annual and consolidated accounts of certain types of companies. Noting the continuing importance of the Directives, which transcend the scope of the IAS Regulation (e.g., by establishing the requirement to obtain an audit and to prepare an annual report), there was a recognized need to revise the Directives rather than eliminate them. Incompatibilities with IAS would accordingly prove unacceptable for two reasons, according to the Commission.
First, if the Accounting Directives were to play an important role in the mechanism for adopting IAS under the proposed IAS Regulation, they would need to reflect current accounting developments. In this respect, the Directives should be structured so as to accommodate and to be consistent with future incremental developments within IAS. That is, it should not be necessary to consider amendments to the Directives each time a new IAS is proposed. Second, there would hopefully be a level playing field between companies that apply IAS and those that do not. Such a position is also necessary to enable a smooth transition when companies seek a public listing.
To deal with these perceived issues, the Commission's proposal was intended to
Remove all existing conflicts between the Accounting Directives and IAS.
Ensure that optional accounting treatments currently available under IAS are available to EU companies which continue to have the Accounting Directives as the basis of their accounting legislation (i.e., those companies which do not prepare their annual or consolidated accounts in accordance with adopted IAS further to the IAS Regulation).
Update the fundamental structure of the Accounting Directives so that they provide a framework for financial reporting that is both consistent with modern practice and flexible enough to allow for future developments in IAS.
Among the changes proposed, some of the more important were the following:
Explicit empowering of member states to require presentation of cash flow statements in accordance with IAS 7.
Explicit endorsement of the "substance over form" principle, which was found to be consistent with the "true and fair view" requirement of the Directives, and the right of member states to permit or require that, in determining within which format item an amount should be included, regard may be had to substance as well as form.
Amendment to Fourth Directive provision dealing with estimated liabilities, to require the recognition of amounts consistent with IAS 37, while allowing member states to continue to permit or require those additional amounts currently envisioned by the Directive.
Amendment to the Fourth Directive to permit revaluation of intangibles as well as the already permissible revaluation of tangible long-lived assets, to conform to IAS 38.
Further expansion of the already adopted revision to the Fourth Directive to permit fair value reporting for certain assets as set forth in IAS 40 (for investment property) and IAS 41 (for certain agricultural assets), as well as the already addressed IAS 39 (for financial instruments).
Changes to the Seventh Directive to eliminate certain exemptions from consolidation requirements (e.g., to avoid nonconsolidation of special-purpose entities merely because majority ownership or a "participating interest" is not held by the reporting entity).
Amendment to the Seventh Directive to eliminate the opportunity for nonconsolidation of activities that are incompatible with those of the parent, and rejection of the former notion that such inclusion would fail to meet the requirement to give a true and fair view of the undertakings included therein taken as a whole.
A similar amendment to eliminate the exemption from consolidation of activities which are deemed immaterial to the reporting entity; thus, there will be no threshold for materiality insofar as presentation of consolidated financial statements is concerned.
The proposal also explicitly acknowledged that certain requirements under several IAS were found to not be in conflict with the Directives and thus necessitated no changes to them. These included the "corridor" approach for gain or loss recognition under IAS 19, the optional reporting of prior period errors under IAS 8, and the accounting for reverse acquisitions under IAS 22.
Other Recent Gestures of Support for IAS
National adoptions of IAS and endorsements by stock exchanges.
The IOSCO's and the European Union's gestures of support have apparently had an impact, as the pace of adoptions of IAS has accelerated worldwide. A growing list of important nations has either adopted IAS outright or has crafted national standards around a core of IAS principles. In some cases, nominally national standards are no more than thinly veiled international standards without any substantive departures, save the titles.
Greece requires IAS effective 2003.
Legislation passed by the Greek Government adopts International Accounting Standards for financial statements for the periods beginning after December 31, 2002, mandatory for all companies listed on the Athens Stock Exchange. Both individual and consolidated financial statements would be required to follow IAS under this statute, but it would be optional for other entities that are audited by the Institute of Certified Accountants and Auditors of Greece to use IAS.
Russia to adopt IAS starting 2004.
All companies and banks in Russia will be required to prepare their financial statements in accordance with IAS starting January 1, 2004. The Finance Ministry has been ordered to develop implementation guidelines for the accounting days by January 1, 2003.
Australia proposes to replace its national standards with IAS.
In July 2002, the Australian Financial Reporting Council (FRC) announced its support for the adoption of IAS by January 1, 2005. The FRC is the body established under Australian law to oversee the process for standard setting in Australia, including overseeing the operations of the Australian Accounting Standards Board (AASB). The FRC proposal, which is subject to the government's support for necessary amendments of the Corporations Act, would mean that from January 1, 2005, the accounting standards applicable to reporting entities under the Act would be the standards issued by the IASB. After that date, the audit reports would be required to refer to reporting companies' compliance with IASB standards.
Among the more important earlier converts to, or protagonists for, IAS are Germany, Belgium, France, Australia, and Italy. Other adopters include Hong Kong, Malta, Korea, Barbados, Zimbabwe, Turkey, Trinidad, Tobago, Uganda, and Mongolia. Countries like Kyrgyzstan and Guyana have recently passed laws adopting IAS. Many countries in the Middle East, including Bahrain, Kuwait, Jordan, Qatar, Lebanon, and Oman have adopted IAS as their national standard.
Acceptance by stock exchanges.
Most of the leading stock exchanges around the world now accept listings based on financial statements prepared in accordance with IAS. Included in this long list of IAS-friendly stock exchanges are the prominent ones in London, Zurich, Rome, Luxembourg, Australia, Amsterdam, Cyprus, Hong Kong, Stockholm, Copenhagen, Thailand, and many others. A new pan-European securities market (known as EASDAQ) now permits the use of IAS by its registrants. Furthermore, the Federation of Euro-Asian Stock Exchanges (FEAS), with twenty member exchanges in eighteen nations in Europe (outside the EU and EFTA), Central and South Asia, and the Middle East, has recommended that its members should require the use of IAS.
Another Breakthrough: The Basel Committee Supports the IASC Standards
The Basel Committee on Banking Supervision, an international organization of bank regulators, undertook a review of IAS at the request of the G7 Finance Ministers and Central Bank Governors. The review focused on fifteen IASC standards that have a significant effect on banks and paid special attention to two standards; namely, IAS 30 and 39.
The Basel Committee on Banking Supervision completed its comprehensive review of the IAS in April 2000 and, based on their review, announced its support for the IASC standards.
To summarize, the international accounting standard-setting process has evolved through three stages and is now poised on the brink of achieving widespread legitimacy which may result, over time, in the IASC's becoming the premier accounting standard setter. Hopefully, the IOSCO endorsement of the IASC standards may soon lead to unification of accounting standards globally and the emergence of the true "Esperanto" of accounting.
Dramatic Changes to the IASC Structure and Other Important Developments
The IASC structure has undergone dramatic changes in recent years. With diverse opinions emerging from different member bodies, it was indeed an uphill task to reach consensus on many issues. In fact, this made the restructuring process eventful. In order to understand how it all happened, it is important to look at certain events that occurred in recent years.
In September 1996, the IASC approved the creation of the Standing Interpretations Committee (SIC). Apart from the obvious wisdom of taking this step, it was also done to accommodate the wishes of IOSCO and in particular the US regulatory community, which was concerned that absent a mechanism to ensure that IAS were uniformly interpreted and applied, there was no assurance that current diversity of practice would really be narrowed as intended. This group held its organizational meeting in April 1997 and has already met several times and finalized interpretations on controversial accounting issues. These are listed at the end of this chapter and discussed in this book in the sections to which they pertain.
In December 1998, the IASC published a discussion paper issued for comment by its Strategy Working Party, Shaping IASC for the Future. The main recommendations emerging from this document focused upon issues of restructuring the IASC by expanding the IASC Board and setting up a new committee, to be known as the Standards Development Committee (SDC) which would primarily be responsible for developing the IAS in future. The SDC in this role will be supported by the already-existing Standing Interpretations Committee, the (proposed) new Standards Development Advisory Committee (SDAC) and the IASC Consultative Group. It was proposed that appointments to the IASC Board, the SDC, and the SIC would be made by "trustees" who will replace the existing IASC Advisory Council.
Alas, this bicameral concept was ultimately doomed by the adamant opposition of a number of national standard-setting bodies likely to have been key members of the Standards Development Committee, and by similar opposition from a few other important organizations, including the US SEC and the European Commission (whose objections were dissimilar, however). In response to overwhelming antagonism to this approach, the IASC withdrew the idea and substituted a new proposal for a unicameral body comprised of both full-time and part-time members.
Most importantly, a unicameral approach would ensure that the standards would be enacted by the same body that had developed them, without any sort of "second look" and veto power being granted to another entity.
IASC's New Constitution
After several debates at various board meetings over IASC's new constitution, the IASC Board finally endorsed a new structure for the IASC. In March 2000 the IASC Board approved the IASC's new constitution. This constitution was then submitted to the member bodies of the IASC who unanimously approved it in May 2000.
In order to usher in the new structure of the IASC, the IASC Board in December 1999 appointed a nominating committee. The then-US SEC Chairman, Mr. Arthur Levitt, was chosen to head this committee. This committee selected the initial group of nineteen trustees.
The trustees play a key role in the governance of the IASC. Besides other important tasks assigned to them under the new constitution, they have the duty to determine and create a new legal entity as a vehicle for the operations of the IASC. This legal entity will confer limited liability on the IASC members.
In order to ensure a broad international representation, the composition of the trustees will be a mix of representatives of the world's capital markets with diversity of geographical and technical backgrounds. As mandated by the new constitution of the IASC, the breakdown is as follows:
Six trustees to be appointed from North America;
Six trustees to be appointed from Europe;
Four trustees to be appointed from the Asia/Pacific region; and
Three trustees to be appointed from any other area, subject to establishing overall geographic balance.
Five of the nineteen trustees are nominated by the IFAC, subject to a process of consultation between the IFAC and the nominating committee or the trustees. Two of the five trustees nominated by the IFAC shall normally be senior partners/executives from prominent international accounting firms. Three of the other trustees are selected after consultation with international organizations of preparers, users, and academics for the purpose of obtaining one trustee from each of those backgrounds. Eleven "at-large" trustees are also selected. The at-large designation signifies that these trustees are not appointed through the consultation process. These trustees are expected to bring to IASC strong public interest backgrounds. Trustees shall normally be appointed for a three-year period, renewable once. The nominating committee shall appoint the first chairman of the trustees. (The former chairman of the US Federal Reserve Board, Mr. Paul Volcker, was appointed the first chairman of the trustees.)
The trustees appoint the members of the IASC Board which consists of fourteen members, twelve full-time and two part-time. Technical expertise, which presupposes both technical skills and experience, is the most important prerequisite for a board member. Although the selection of the members would not be based on geographical representation, yet the trustees would not allow any particular constituency or geographical interest to dominate. The constitution has provided detailed guidance relating to "criteria for board members" in an appendix. The eight criteria are
Proven technical competence and knowledge of standards
Ability to analyze
Judicial decision making
Awareness of global economic environment
Ability to respect viewpoints of other members
Demonstrated credibility, integrity and discipline
Commitment to the IASC's mission and public interests
To achieve a proper balance between perspective and experience, the following mix of representatives (on the board) has been prescribed by the constitution:
Minimum of five members having backgrounds as practicing auditors;
Minimum of three members with backgrounds as users of financial statements; and
At least one member with an academic background.
Furthermore, to achieve its objective of convergence of national accounting standards and to ensure promotion of IAS, the constitution requires that seven out of the twelve full-time members of the board will be expected to have formal liaison responsibilities with national standard setters.
Members of the board will be appointed for a term of up to five years, renewable once. The trustees shall appoint one of the full-time members as the chairman of the board, who shall also be the chief executive of the IASC. (The first chairman of the newly constituted board is Sir David Tweedie.)
The board has complete responsibility for all technical matters and shall have full discretion over the technical agenda of the IASC. In addition, the board's responsibilities also encompass the matters set forth below.
Forming steering committees;
Establishing procedures for review of comments received on documents published for comment;
Consulting the Standards Advisory Council on major projects;
Consider holding public hearings;
Issuing bases for conclusions with IAS and Exposure Drafts; and
Consider undertaking field trips with a view to ensuring proposed standards are practical and workable in all environments.
The IASC Foundation Trustees revised the Constitution to create the International Financial Reporting Committee (IFRIC), which functions as the successor to the former Standing Interpretations Committee (SIC) and is responsible for interpreting the application of the IASC standards in the context of the Framework. The IFRIC shall consist of twelve members who are appointed by the trustees for a term of three years. The trustees shall appoint a Board member of the IASB, the Director of Technical Activities or another senior member of the IASB staff, or another appropriately qualified individual, to chair the IFRIC. The Chair has the right to speak on the technical issues being deliberated upon, but not to vote; each member of the IFRIC has one vote. Approval of Drafts or final Interpretations require that not more than three voting members vote against the Draft or the final Interpretation.
The SAC provides a forum for participation by organizations and individuals with an interest in international financial reporting, primarily with the objective of giving advice to the board on its technical agenda. The trustees shall appoint the members of the SAC.
In June 2001, a forty-nine-member SAC was announced, which includes chief financial officers of some of the world's largest corporations, leading financial analysts and academics, regulators, accounting standard setters, and partners from leading accounting firms. This membership is drawn from six continents, twenty-nine countries, and five international organizations. SAC members serve for a renewable term of three years. Under the terms of the IASB's constitution, the IASB Chairman also chairs the SAC.
SAC will normally hold three meetings a year, which will be open to the public. Its mandate is to
Advise the IASB on priorities in the Board's work program;
Advise on technical accounting standards issues;
Inform the Board of the implications of proposed standards for users and preparers of financial statements; and
Give other advice to the Board or to the trustees.
The staff of the IASC includes a technical director and a commercial director, both appointed by the chief executive (the chairman of the board) in consultation with the trustees. The chief executive is responsible for the other staffing of the IASC as well.
IASC Foundation and the International Accounting Standards Board
Establishment of IASC Foundation and IASB.
In March 2001 the trustees agreed to activate the new Constitution approved in May 2000, effective immediately. This meeting established a not-for-profit Delaware corporation, named the International Accounting Standards Committee Foundation (IASC Foundation), to oversee the newly created International Accounting Standards Board (IASB).
The International Accounting Standards Board (IASB)
The newly constituted IASB rather quickly began to address both carryover projects from the old IASC and a newly devised listing of technical projects.
First technical agenda.
The first technical meeting of the new IASB was held in April 2001. It considered a list of forty-two topics that were recommended by the IASB members themselves, the IASB staff, the former IASC Board, accounting standard setters, the IOSCO, the European Commission, the international accounting firms, and other interested parties, as possible subject matter for future IASB projects. The recommended projects range from conceptual issues to convergence issues. A number of these are topics that are expected to result in entirely new standards, as contrasted to mere revisions or improvements to existing standards.
In firming up a definitive agenda, the IASB is required to consult with both the Standards Advisory Council and its partner national standard setters. The IASB is working with a plan that broadly groups its future projects into the following categories:
Critical path projects
Conceptual framework projects
Other financial reporting projects
Exposure Draft on Improvements Project.
In May 2002 the IASB published an Exposure Draft on its Improvements Project, which proposes amendments to twelve of its thirty-four active standards. The following standards are covered by this Improvements Project:
IAS 1, Presentation of Financial Statements
IAS 2, Inventories
IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies
IAS 10, Events After Balance Sheet Date
IAS 16, Property, Plant and Equipment
IAS 17, Leases
IAS 21, The Effects of Changes in Foreign Exchange Rates
IAS 24, Related-Party Disclosures
IAS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries
IAS 28, Accounting for Associates
IAS 33, Earnings Per Share
IAS 40, Investment Property
The IASB's Improvements Project addresses topics that can be dealt with fairly quickly and which are not individually sufficiently significant to be considered as separate or major projects. The objective is to raise the quality and consistency of financial reporting by drawing on best practices from around the world, and to eliminate alternatives permitted under current IAS.
IASB's new work program.
In June 2002 the IASB announced its new work program which will tackle areas that were carried forward on its initial agenda. The main work program concentrates on three areas, which are
Consolidations (including treatment of special-purpose entities, or "SPE");
Revenue—definition and recognition—and related aspects of liabilities;
Convergence on topics wherein high-quality solutions are available in international and national standards (such as accounting for income taxes, pensions, segment reporting, and business combinations).
Furthermore, the IASB intends to commence active research, often undertaken jointly with national standard setters, on topics such as
Accounting for small and medium-sized entities and entities in emerging economies;
Accounting for financial instruments; and
Accounting concepts, including a strategic review of the basic elements of accounting, and design work on measurement, focusing initially on impairments.
Looking further forward, the IASB will urge the national standard setters and others to carry out initial work on projects that may ultimately be included in the IASB's main agenda. Such projects are expected to include
Management reporting in relation to financial reports (usually referred to as "MD&A" reporting);
Accounting for extractive industries;
Accounting for public and other concessions (e.g., public to private arrangements for transport, health, and other infrastructure).
Preface to International Financial Reporting Standards (2002).
In May 2002, the IASB published a revised text for the Preface to International Financial Reporting Standard (the Preface). The purpose was to amend and reissue the existing Preface (which had most recently been amended in 1982) and to set forth the objectives, procedures and due process of the IASB and explain the scope and authority of IFRS. Certain matters addressed by the Preface are in fact clarifications of issues that have been debated for a long time. With these issues now having been categorically addressed by the Preface, the controversies formerly surrounding them will hopefully be laid to rest. Besides addressing issues such as the objectives of the IASB, which was also already dealt with by the Constitution, the Preface addresses the following matters:
Scope of IFRS
New standards to be issued by the IASB will be known as international financial reporting standards (IFRS);
All International Accounting Standards (IAS) and interpretations (SIC) issued by the former IASC and SIC continue to be applicable unless and until they are revised or withdrawn;
IFRS apply to the general-purpose financial statements of all profit-oriented entities regardless of their legal form. By implication, IFRS are not designed to apply to not-for-profit activities in the private sector, public sector or government; nevertheless, entities with such activities might find them appropriate;
IFRS apply both to individual and consolidated financial statements;
Traditionally, the standards issued by the IASC included paragraphs in bold italic type as well as paragraphs set in plain type. Some may have incorrectly interpreted the bold italic paragraphs as having greater authority than did the plain type materials. The paragraphs in bold italic type and plain type have equal authority, however. IFRS will present standards maintaining the "black-letter" and "gray-letter" distinction—with boldface type used to enunciate "fundamental principles" and normal type being used to present guidance thereon. These will continue to have equal weight and importance.
The IASB's due process has been set forth earlier in this chapter. The International Financial Reporting Interpretations Committee (IFRIC) also has an established protocol for its due process, which has also been presented above.
The Improvements Project in Greater Detail
The newly constituted IASB's initial undertaking, as noted above, has been the proposed revision to a number of extant IAS. These recommended changes are summarized below (and are further addressed, as appropriate, in subsequent chapters of this book).
Proposed changes to existing standards.
Amendments have been proposed to twelve of the existing standards. These are as follows:
IAS 1, Presentation of Financial Statements, will be revised to expound upon the "presents fairly" theme. "Presents fairly" will be defined as "represent[ing] faithfully the effects of transactions and other events in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework for Preparation and Presentation of Financial Statements." Financial statements that follow IFRS and Interpretations of IFRS, with additional disclosure when necessary, will be presumed to achieve a fair presentation. In those extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS or IFRIC would be so misleading that it would conflict with the objective of financial statements set out in the Framework, and the departure is not prohibited by national law, the reporting entity would be required to make that departure and provide specified disclosures. However, if the departure is prohibited by national law, the entity would have to reduce, to the maximum extent possible, the perceived misleading aspects of compliance by providing certain specified disclosures.
The amendment to IAS 1 would relocate existing guidance on selection of accounting policies to IAS 8.
In a significant change, balance sheet classification of assets and liabilities between current and noncurrent will be required unless a "liquidity presentation" (listing captions in decreasing order of liquidity without subtotals for current and noncurrent) provides more relevant and reliable information. Currently, IAS 1 allows free choice between current/noncurrent classification and a liquidity presentation. IAS 1 would stipulate that a refinancing after the balance sheet date should not be taken into account in classifying liabilities as current/noncurrent. If, at the balance sheet date, a lender has an absolute right to demand repayment immediately, the liability would have to be displayed as a current liability, even if, after the balance sheet date, the lender agreed not to demand payment. Finally, if a loan covenant making a liability payable on demand if certain conditions related to the borrower's financial position are breached, and such breach exists at the balance sheet date, the liability is classified as current, even if corrected after the balance sheet date. There would be an exception if, prior to the balance sheet date, the lender has granted a grace period in which to correct the breach and, when the financial statements are authorized for issue, either (1) the borrower has corrected the breach or (2) the grace period has not yet expired.
IAS 1 would also be modified to stipulate certain line-item disclosures that are required by other IAS to be on the face of the balance sheet (including investment property and biological assets) or on the face of the income statement (gain/loss on disposal of a discontinuing operation). Certain line-item disclosures on the face of the income statement will be eliminated, including results of operating activities, profit or loss from ordinary activities, and extraordinary items. Disclosure of the following items will be dropped: an entity's country of incorporation (but the required disclosure of domicile will not be dropped), the address of its registered office, and the number of its employees.
The proposed amendment to IAS 1 would add certain disclosures of accounting policies. One of these would deal with judgments made by management in applying the accounting policies that have the most significant effect on the amounts of items recognized in the financial statements. Another would require disclosure of key assumptions about the future, and other sources of measurement uncertainty, that have a significant risk of causing a material adjustment to the carrying amounts of assets and liabilities within the next financial year.
Restatement of comparative information under IAS 1 would be exempted when the restatement would cause undue cost or effort.
Finally, the current IAS 1 requirement to present a Statement Showing Changes in Equity will be replaced by a Statement of Changes in Equity that must show either (1) all changes in equity or (2) changes in equity other than those arising from capital transactions with owners and distributions to owners.
IAS 2, Inventories, will also be amended to ban use of the LIFO costing method. Currently, it is the allowed alternative under IAS 2. This particular proposal is controversial because LIFO is largely a tax-driven principle, and a "conformity rule" may prevent entities from using LIFO for tax purposes unless the financial statements do likewise.
The proposal also includes, as an additional required disclosure, the amount of writedowns of inventory to net realizable value.
Additional guidance will be provided for inventories of service providers. If revenues related to services provided have not been recognized, the remaining work in progress is considered to be inventory and is to be measured at the costs of production, which will not be permitted to include profit margins or nonproduction costs that are often factored into prices.
Finally, existing SIC 1, Consistency—Different Cost Formulas for Inventories, will be incorporated into IAS 2.
IAS 8, Net Profit or Loss for the Period, Fundamental Errors and Changes in Accounting Policies, would also be substantially altered if the improvements proposed are adopted. Its name would be changed to Accounting Policies, Changes in Accounting Estimates and Errors. A GAAP hierarchy would be incorporated into the revised standard, indicating that the following sources are to be applied in descending order of authoritativeness:
International Financial Reporting Standard, including any appendices that form part of the Standard (existing IAS are treated as IFRS for this purpose).
Appendices to an IFRS that do not form part of the Standard.
Implementation guidance issued by IASB in respect of the Standard.
Guidance regarding selection of accounting policies currently included in IAS 1 will be moved to IAS 8.
The current distinction made between fundamental and other errors in IAS 8 will be eliminated. Errors will be defined as newly discovered omissions or misstatements of prior period financial statements based on information that was available when the prior financial statements were prepared. All material errors will be accounted for retrospectively by restating all prior periods presented and adjusting the opening balance of retained earnings of the earliest prior period presented. Cumulative effect recognition in income, permitted under current IAS 8, will henceforth be prohibited.
An entity would be exempted from restating comparative information under IAS 1 only when the restatement would require "undue cost or effort." This differs from the existing exemption, which is based on "impracticability."
Voluntary changes in accounting policy will be accounted for retrospectively by adjusting the opening balance of retained earnings and restating prior periods. Cumulative effect recognition in current income would be prohibited.
In another major change, it has been proposed that extraordinary item classification be eliminated. All items of income and expense will henceforth be part of the ordinary activities of the entity.
Changes in the measurement basis or method applied would be treated as changes in accounting policy, not as changes in estimate.
Under the amended IAS 8, it will be necessary to disclose, when there has been enacted a new IASB standard that has not yet become effective, the nature of the future change in accounting policy, the date the entity plans to adopt the Standard, and the estimated effect of the change on financial position or, if such an estimate cannot be made without "undue cost or effort," a statement to that effect.
Finally, SIC 18, Consistency—Alternative Methods, will be incorporated into the amended IAS 8.
IAS 10, Events After the Balance Sheet Date, will be amended to clarify that an entity should not recognize a liability for dividends declared after the balance sheet date because it is not a present obligation at balance sheet date as described in IAS 37.
IAS 16, Property, Plant, and Equipment, will be revised in significant ways if the proposal is enacted. It will require that a components approach be used for depreciation, under which each material component of a composite asset with different useful lives or different patterns of depreciation must be accounted for separately for the purpose of depreciation and accounting for subsequent expenditure (including replacement and renewal). For example, in a building, the roof, the mechanical systems, and the ventilation and heating plant would be assigned individual lives.
Another major change would be the inclusion, in the acquisition cost of property, plant, and equipment, of the amount of an IAS 37 provision for the estimated cost of dismantling and removing the asset and restoring the site, including both provisions recognized when the asset is acquired and incremental provisions recognized over the period the asset is used. However, after a provision is recognized, an increase to the provision resulting from accretion of interest or a change in the discount rate will be charged to expense, not added to the asset cost.
Amended IAS 16 will stipulate that the accounting for incidental revenue (and related expenses) during construction or development of an asset is to depend on whether the incidental revenue is a necessary activity in bringing the asset to the location and working condition necessary for it to be capable of operating in the manner intended by management (including those to test whether the asset is functioning properly). Net sales proceeds received during activities necessary to bring the asset to the location and working condition necessary for it to be capable of operating properly are deducted from the cost of the asset. Revenue and related expenses would be separately recognized for operations that occur in connection with construction or development of an asset but that are not necessary to bring the asset to the location and working condition necessary for it to be capable of operating properly.
IAS 16 will shed its current references to start-up costs, preoperating costs, preproduction costs, and similar items; in their stead, more general principles will be provided. On the other hand, a more specific explanation of measurement of residual value would be provided; this would be based on current (i.e., asset acquisition date) prices for assets of a similar age and condition to the estimated age and condition of the asset when it reaches the end of its useful life.
Exchanges of similar items of property, plant, and equipment would be recorded at fair value, with gain or loss recognized, unless neither the fair value of the asset given up nor the fair value of the asset acquired could be measured reliably, in which case the cost of the acquired asset would be the carrying amount of the asset given up. This sharply contrasts with current rules, under which gain or loss is not recognized. This principle will also be extended to previously recognized intangible assets by amending IAS 38, though caution will be added in IAS 38 regarding the importance and difficulty of measuring the fair value of intangibles. The principle will not be extended to exchanges of goods and services of a similar nature under IAS 18, which would continue to be accounted for at carrying amounts.
The proposal would conform IAS 16 to IAS 37. While current IAS 16 appears to permit measurement of subsequent restoration expenditure at revalued amounts, whereas IAS 37 requires that a provision should be measured at the amount required to settle it or transfer it to a third party, the amended IAS 16 would adopt the IAS 37 approach.
The amendment would change the criteria for adding further costs to the recorded amounts of long-lived assets. Under current IAS 16, subsequent expenditures can be capitalized if the asset's originally assessed level of performance is enhanced by the expenditure. As amended, this will be possible only if the expenditure increases the asset's future economic benefits above those reflected in its most recently assessed level of performance.
In other proposed changes, SIC 6 (costs of modifying software) is to be withdrawn. Entities would be required to review an asset's estimated useful life at least at each financial year-end rather than "periodically" as currently required by IAS 16. Items of property, plant, and equipment that are idle or held for sale will continue to be depreciated and tested for impairment, and ceasing to use the asset will be identified as a trigger for impairment review under IAS 36. Third-party compensation for an item of property, plant, or equipment that was impaired, lost or given up will be includable in profit or loss for the period in which it is received, with appropriate disclosure.
The amendment will create additional disclosures regarding the methods and significant assumptions applied in estimating the assets' fair values; and regarding the extent to which the assets' fair values were determined directly by reference to observable prices in an active market or recent market transactions on arm's-length terms or were estimated using other valuation techniques.
IAS 17, Leases, has been targeted for several changes. First, when a single lease covers both land and buildings, the minimum lease payments at the inception of the lease (including any up-front payments) are to be allocated between the land and the buildings elements in proportion to their relative fair values. The land element is generally classified as an operating lease, while the buildings element is classified as an operating or finance lease by applying the criteria of IAS 17. However, if the lease payments cannot be allocated reliably between these two elements, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases.
Furthermore, the definition of investment property in IAS 40 will be amended so that property rights held under an operating lease can qualify as investment property if the other conditions for investment property are met and the lessee's policy is to account for investment property using the fair value model.
Finally, initial direct costs incurred by lessors will be capitalized and amortized over the lease term. The presently available alternative, to expense initial direct costs up front, will be eliminated. The costs to be capitalized will be limited to costs that are incremental and directly attributable to the lease and may include both internal and external costs.
IAS 21, Changes in Foreign Exchange Rates, is another standard that will receive significant revisions under the Improvements Project. First, in order to eliminate any potential inconsistency between IAS 21 and IAS 39, foreign currency derivatives that are within the scope of IAS 39 will be removed from the scope of IAS 21.
Second, IAS 21's concept of "reporting currency" will be superseded by two concepts: that of functional currency (the currency in which the enterprise measures the items in the financial statements) and that of presentation currency (the currency in which the enterprise presents its financial statements). Functional currency will be used in place of measurement currency (which is presently found in SIC 19) to converge with US GAAP and common usage. Functional currency is defined as "the currency of the primary economic environment in which the enterprise operates." Guidance in SIC 19 would be relocated to amended IAS 21. The measurement currency of each entity within a group is the currency of the country that drives that entity's economics; thus this is not subject to free choice.
Furthermore, under amended IAS 21, there will be no distinction between integral foreign operations and foreign entities. An entity that was previously classified as an integral foreign operation will have the same functional currency as the reporting entity. IAS 21's indicators of what is an integral foreign operation as opposed to a foreign entity are to be incorporated into the indicators of what is an entity's functional currency. As a result, operations that are presently classified as integral foreign operations would have the same functional currency as the reporting enterprise.
Fourth, as amended, IAS 21 will permit the reporting enterprise to present its financial statements in any currency (or currencies) that it chooses. The financial statements of any operation whose functional currency differs from the presentation currency used by the reporting enterprise would be translated as follows (assuming the functional currency is not hyperinflationary): assets, liabilities and equity items at closing rate; income and expense items at the rate on the transaction date; all resulting exchange differences recognized as a separate component of equity.
Fifth, the current allowed alternative under IAS 21, permitting capitalization of certain exchange differences, is to be eliminated. In most cases in which IAS 21 has allowed capitalization, the asset has also been subjected to restatement, in accordance with IAS 29. It has been concluded that to also capitalize exchange differences results in double counting.
Additionally, the choice of methods for translating goodwill and fair value adjustments to assets and liabilities that arise on the acquisition of a foreign entity is to be eliminated. Goodwill and fair value adjustments will be translated at the closing rate.
Seventh, amended IAS 21 will stipulate that any ineffectiveness that arises on a hedge of a net investment in a foreign entity should be reported in net profit or loss. This would conform to the treatment required for other kinds of hedges under IAS 39. The conditions for using hedge accounting for a hedge of a net investment in a foreign entity will be the same as for other kinds of hedges under IAS 39. All of the guidance on hedging that is presently found in IAS 21 will move to IAS 39.
Eighth, new guidance will be offered regarding translation of comparative prior period amounts. If the functional currency is not hyperinflationary, comparative assets and liabilities will be translated at the closing rate, and comparative income and expense items will be translated at historical exchange rates at the time the income was earned and expenses incurred. If the functional currency is hyperinflationary and the presentation currency is also hyperinflationary, all balance sheet and income statement items will be translated at the current closing rate. Finally, if the functional currency is hyperinflationary and the presentation currency is not hyperinflationary, prior period comparative amounts remain as previously reported, that is, they are not updated for subsequent changes in price levels or exchange rates.
IAS 21 would be amended to take account of the situation where a currency is suspended and this straddles a year-end. There is no current guidance on this matter. The revision states that where there is nonexchangeability of a currency at the year-end, the rate that should be used is the exchange rate at the date when exchangeability is first reestablished.
A number of existing SIC will be incorporated into revised IAS 21. These include most of the disclosure requirements found in SIC 30, as well as SIC 19 and SIC 30. SIC 11 will be withdrawn.
IAS 24, Related-Party Disclosures. The definition of related parties will be expanded or clarified to include (1) parties with joint control over the reporting entity, (2) joint ventures in which the reporting entity is a joint venturer, (3) individuals who control the reporting entity, (4) postemployment benefit plans for the benefit of employees of the entity, or of any entity that is a related party of the entity, and (5) nonexecutive directors. Also, further guidance will be provided regarding the definition of close family members (includes domestic partners and children or dependents of the individual or domestic partner).
The present exemption for state-controlled enterprises will be removed. Thus a state-controlled enterprise will have to disclose transactions with other state-controlled enterprises.
IAS 24 will be amended to clarify that it does not require remeasurement of the amounts of related-party transactions to an arm's-length amount. Also the existing requirement to disclose the basis of pricing related-party transactions will be removed, and it will be clarified that related-party transactions should not be described as having been made on terms equivalent to those that would prevail in arm's-length transactions only if such a statement can be substantiated.
Disclosure will be required of the amounts of transactions and outstanding balances with related parties, not just the proportions of such transactions and balances. Also, disclosures will be required about related-party balances: the terms and conditions of outstanding balances, including security, how repayment will be made, details of guarantees given or received, and amounts of any bad debts provisions.
IAS 27, Consolidated Financial Statements and Accounting for Investments in Subsidiaries, will be significantly revised, making the requirements for presentation of consolidated financial statements more expansive. Currently, it permits wholly owned (and virtually wholly owned) subsidiaries to be excluded from consolidation. The following new conditions would be imposed:
The wholly owned subsidiary's equity and debt securities could not be publicly traded;
It is not in the process of issuing equity or debt securities in public securities markets;
The immediate parent or ultimate parent publishes consolidated financial statements that comply with IFRS; and
If the subsidiary is not wholly owned, the parent obtains the approval of the owners of the minority interest. If nonconsolidation were to be elected, then the reporting entity should disclose
The reason for not publishing consolidated financial statements; and
The name of the parent that publishes consolidated financial statements that comply with IFRS.
Also proposed is the presentation of minority interest as part of equity, but separately from the parent's equity, precluding the current practice of displaying minority interest between liabilities and equity.
SIC 33 will be incorporated into IAS 27, but SIC 12, dealing with consolidation of SPE, will not be, since this issue will be subject to separate consideration.
Amended IAS 27 would tighten current exemptions from consolidation requirements. In the case of temporary investments, intended disposal within twelve months will be necessary to avoid consolidation, replacing the current, vague "in the near future" criterion. Regarding restrictions on transfer of funds, which currently can be used to justify nonconsolidation, this will be deleted (and also from standards dealing with equity method and joint venture accounting). All entities within the group will be required to use uniform accounting policies for like transactions and other events in similar circumstances. The practicability exemption in IAS 27 will be removed.
IAS 28, Investments in Associates. Investments that would otherwise be associates or joint ventures held by venture capital organizations, mutual funds, unit trusts, and similar entities that are measured at fair value in accordance with IAS 39, in accordance with well-established practice in those industries, will be excluded from the scope of IAS 28 and IAS 31. New guidance, and disclosures, for when it is appropriate to overcome the presumption that an investor has significant influence if it holds 20% or more of the voting power, will be provided in the amended standard. Conforming changes will be made consistent with IAS 27, noted above.
The revised standard will provide that an investor's share of losses of an associate should be recognized only to the extent of the investment in the associate. However, this will be clarified to state that an investment in an associate can include loans and long-term advances, which accordingly will affect the base to be reduced when an associate incurs losses. SIC 20 will be rescinded. SIC 3 and SIC 33 will be incorporated into IAS 28.
It will be made explicit that the date of the financial statements of an equity method associate used in applying the equity method must not be more than three months earlier than the financial statements of the investor. Also, the investor and equity method associates will be required to use uniform accounting policies for like transactions and events in similar circumstances. Finally, additional disclosures will be required, including fair values of investments in associates for which there are published price quotations; summarized financial information of associates; reasons for a departure from the 20% presumption of significant influence; differences in reporting dates; restrictions on an associate's ability to transfer funds; unrecognized losses of an associate; the investor's contingent liabilities with respect to the associate.
IAS 33, Earnings Per Share, is to be amended to require that basic and diluted EPS will be presented for (1) profit or loss from continuing operations and (2) net profit or loss, on the face of the income statement for each class of ordinary shares, for each period presented. Also, potential ordinary shares will be deemed dilutive only when their conversion to ordinary shares would decrease EPS from continuing operations (in contrast to the IAS 33 requirement that currently uses net income as the benchmark).
IAS 33 will be amended to include a rebuttable presumption that contracts that may be settled in cash or shares will be settled in shares, and SIC 24 will be withdrawn. Currently issuance of shares must be assumed, but national standards tend to permit the use of past experience to base expectations upon.
Under the terms of the proposed amendment, if an entity purchases (for cancellation) its own preference shares for more than their carrying amount, the excess (premium) should be treated as a preferred dividend in calculating basic EPS (deducted from the numerator of the EPS computation). Other amendments to IAS are promised, to deal with issues such as how to calculate the effects of contingently issuable shares; potential ordinary shares of subsidiaries, joint ventures, or associates; participating securities; written put options; and purchased put and call options.
IAS 40, Investment Property, will be amended to alter the definition of investment property, in order to permit a property interest held by a lessee under an operating lease to qualify as investment property provided that (1) the rest of the definition of investment property is met and (2) the lessee uses the fair value model.
Other proposals considered and consequential changes to be made
The IASB considered, but decided not to make, changes to IAS 15 and IAS 23 at this time.
IAS 15, Information Reflecting the Effects of Changing Prices, is to be withdrawn. This standard required enterprises electing to disclose the effects of changing prices by presenting supplementary information on one of two bases: (1) adjusted for changes in the general price level or (2) balance sheet items measured at replacement cost. After this originally mandatory disclosure was made voluntary in 1989, companies stopped providing the information. Subsequent standards, including IAS 16, 32, 36, 39, and 41, have addressed the effects of changing prices for individual classes of assets, permitting revaluations or requiring the use of fair value instead of historical cost. Thus IASB believes this standard is obsolete.
IAS 23, Borrowing Costs, had been under review for amendment as part of the Improvements Project. The issue was whether the currently available choice between expensing or capitalization of borrowing costs during asset construction would remain as options. IASB has decided to not address this at this time, however.
Certain consequential changes to other standards are also being proposed, as follows:
IAS 31, Investments in Jointly Controlled Entities, will be revised to state that investments that would otherwise be associates or joint ventures held by venture capital organizations, mutual funds, unit trusts, and similar entities that are measured at fair value in accordance with IAS 39 will be excluded from the scope of IAS 28 and IAS 31. Other changes would conform to those being made to IAS 28.
IAS 27, IAS 28, and IAS 31 will all be amended to stipulate that investments in subsidiaries, associates, and jointly controlled entities that are consolidated, proportionately consolidated, or accounted for under the equity method in the consolidated financial statements must either be carried at cost or be accounted for in accordance with IAS 39. Investments in subsidiaries, associates, and jointly controlled entities that are accounted for in accordance with IAS 39 in the consolidated financial statements must be accounted for in the same way in the investor's separate financial statements. Furthermore, an investor's separate financial statements would be required to disclose: the reasons why separate statements are prepared; the existence of consolidated, proportionately consolidated, or equity method financial statements: and a description of the method used to account for investments in subsidiaries, associates, and jointly controlled entities.
Various IAS will also be revised to incorporate new terminology that the Improvements Project has prescribed. For example, the former term enterprise is being superseded by entity. Also, the proposed elimination of separate income statement presentation of extraordinary items will affect a number of standards that made reference to this, such as the segment reporting standard, IAS 14.
A number of SIC are being withdrawn, generally because they are being incorporated into the IAS to which they relate. For example, SIC 1 is to be withdrawn because it was already covered in SIC 18, which is being incorporated into IAS 8. Also being withdrawn are SIC 2, 3, 6, 11, 14, 18, 20, 23, 24, 30, and 33.
EFRAG response to Improvements Project proposals.
Consistent with its stated due process efforts, EFRAG has responded to the twelve proposed amended IAS in some great detail. In some significant cases, EFRAG has registered its opposition to proposed changes. For example, regarding the "override" provisions of amended IAS 1 (which it generally supports), it objects to permitting alternative treatments according to the regulatory framework of the country where the statements are issued. It believes that to do so would create great uncertainty about the requirements of IFRS where there are conflicts between national regulatory requirements and IFRS.
Regarding the plan to eliminate the "extraordinary item" classification, EFRAG acknowledges abuses that have been well publicized, but expresses concern that other means of presenting information useful for predictive purposes—such as by distinguishing "nonrecurring," "unusual," "abnormal," or "other items"—will simply spring into existence to accomplish the same objective. It accordingly prefers that this entire issue be addressed in the upcoming Performance Reporting project.
EFRAG has also registered disapproval with the proposal that management be required to disclose the judgment made in applying the accounting policies that have the most significant effect on the amounts of items recognized in the financial statements, because of a concern that mere "boiler plate" disclosures will result.
The proposed change to require that essentially all exchanges of property be accounted for at fair value was also disapproved of by EFRAG, because of its belief that the current standard makes a sensible distinction between exchanges which are in effect sales of dissimilar items and swaps of similar assets that have a similar use in the same line of business (and have a similar fair value). It believes that notwithstanding some difficulties in practice, judgment can be exercised based on how the assets are used to determine the appropriate treatment under present IAS 16.
EFRAG also disapproves of the proposed requirement that amount of investments in associates to be reduced to nil when the associate incurs losses should include not only investments in the equity of the associate but also other interests such as long-term receivables. In its view, it could be inappropriate to effect a write-down of, for example, long-term receivables when good collateral is in place.
For the most part, EFRAG has communicated its support for the other amendments proposed in the Improvements Project.
US SEC's Concepts Release on IAS
In February 2000, the US SEC issued a Concepts Release on IAS, soliciting comments on various issues surrounding the possible use of IASC standards, including regulatory infrastructure issues and audit requirements. The main question, however, was whether the US SEC should modify its present requirement for financial statements of foreign registrants seeking US listings to be reconciled to US GAAP.
While the responses to this Concepts Release varied a great deal, there was consensus on certain issues. Some of the issues raised and views expressed thereon and reported in the IASC's newsletter (Insight, June 2000) are summarized below.
Many commentators indicated support for the IASC and also thought the core set of IASC standards were sufficiently comprehensive and high-quality. However, there was concern raised by most of the commentators about a need for a global enforcement mechanism to promote the uniform application of IAS.
Numerous commentators believed that active oversight by regulators is required and there is a need for a strong global regulatory body or system to ensure consistency and high-quality accounting positions that serve global concerns. In fact, many opined that the US SEC and other regulators should cooperate actively in developing a mechanism that would strengthen global regulations.
Divergent views emerged on the issue of a comprehensive infrastructure that must be in place so that high-quality international accounting and financial reporting standards can be used, interpreted, and enforced consistently throughout the world. Commentators believed that building such an infrastructure would require the cooperation of many international organizations like the IASC, IOSCO, the IFAC, the World Bank, the IMF etc. Some were of the opinion that until further steps are taken in this direction, the US SEC should not eliminate its reconciliation requirements to US GAAP for foreign registrants. Further, they believed the US SEC should work with other regulators to encourage the role of IAS at a national level since the more IAS are used by multinational companies, the better the chances of quickly achieving consistency in implementation and interpretation. Thus, they believed that the US SEC should state its intent to participate actively in the development of a global infrastructure and should be publicly supportive of other organizations doing so.
Preparers of financial statements stated that they understood and agreed with the US SEC's view that the US has a high-quality system of financial reporting and infrastructure. However, the International Association of Financial Executives Institutes (IAFEI) suggested that while issues of audit quality, regulatory oversight, and so forth are important, they should not be allowed to confuse the issue of whether IAS is yet an appropriate GAAP basis for at least cross-border listings.
Finally, on the most important issue of reconciliation to US GAAP, which was central to the US SEC's Concepts Release, the comments received were varied. In fact, many commentators questioned the usefulness of the reconciliations to US GAAP and several commentators even questioned whether it should be retained. Academic research of the measurement differences reflected in the US GAAP reconciliations shows that most differences appear to have no information value.
Based on these comments several possible solutions to the acceptance of IAS in US SEC filings that emerged were
Use of IAS without reconciliations;
Use of IAS without reconciliations, but with additional disclosures;
Narrative disclosure of significant areas of differences and partial reconciliations with quantification of the impact of specified important areas of differences, along with an emphasis paragraph in the auditor's report;
Adoption of a hierarchy of acceptable standards from a variety of sources from non-US registrants; and
Full reconciliation to US GAAP in the short term, but strong support of the IASC.
It has been over a year since the US SEC issued its concepts release to solicit comments about the possible use of IAS in the US securities markets, and about other issues related to international financial reporting. Reportedly, the US SEC staff has been analyzing the comment letters received, but the commission has said very little publicly about what it will do next. However, there have been strong messages that the US SEC's commitment towards working for global standards remains. Meanwhile, the IASC is confident that some accommodation for the IASC standards could reasonably be expected from the US SEC, keeping in mind the recent endorsement of these standards by global authorities like IOSCO, the European Commission and the Basel Committee. Since the US SEC is now being perceived by the world at large as a leader that will show the way and offer a vision to others, such an expectation by the IASC would not be considered unreasonable.
Furthermore, since the US SEC is the strongest member of IOSCO, the endorsement of the IASC standards by IOSCO has been regarded by many as signaling the US SEC's acquiescence. Whether it will be unqualified or with certain strings attached, like IOSCO"s endorsement, remains to be seen.
Officials of the US SEC have hinted at support for the initiative represented by the International Accounting Standards Board (IASB) and its liaison with other national accounting standard setters. Writing in the Financial Times in March 2001, Lynn Turner, the then chief accountant of the SEC, supported the creation of global accounting standards that promote and sustain investor confidence. Acknowledging the formation of the IASB, Mr. Turner expressed confidence that this was like "bringing the brightest minds together that can create 'best of breed' standards which promote and sustain investor confidence." Some say this appears to be a vote of confidence for the new IASB. Whether or not the US SEC will unequivocally endorse the IAS as the global standards remains a big question mark in the minds of many in the world of accounting.
The Way Forward for the IASB
Renewed appeal of "principles-based" standards.
The late 1990s and early 2000s were marked by a growing rate of incidences of financial reporting fraud, some of which, particularly Enron and WorldCom, have precipitated a crisis in the professional accounting community (e.g., the demise of formerly much-admired firm Andersen) and in the realms of professional regulations and government regulations (e.g., the mid-2002 passage of the Sarbanes-Oxley bill in the US Congress, establishing a new regulatory oversight regime and substantially increasing criminal penalties for perpetration of fraudulent financial reporting). The highly detailed, "rules-based" approach of US GAAP has been cited by some observers as being a contributing factor in certain of the infractions that have come to light. Specifically, some have argued that a more "principles-based" approach, ideally that of IAS, would have obviated these abuses.
This is a complex issue, and the claims of those citing IAS as having preventative properties need careful consideration. While it is true that the increasingly rules-based approach (which, it must be remembered, evolved over the past thirty years in response to increasingly complex business transactions and structures) of US GAAP has been accompanied by increasingly crafty responses by reporting entities committed to evading various reporting requirements, it is not clear that a less prescriptive approach would have been more effective. For example, while some critics have cited the Enron use of hundred of unconsolidated SPE as events which would not have occurred under IAS, it must be noted that neither would these have escaped consolidation under US GAAP, had it been properly applied. In fact, the belated correction of the Enron financial statements, in order to correctly reflect the SPE and to report the formerly concealed debt obligations as liabilities of Enron itself, to comply with US GAAP, was the event that precipitated the crisis. Thus it is simplistic to conclude that IAS would have been more effective than US GAAP in the Enron situation.
Nonetheless, it is reasonable to reexamine whether the US GAAP approach can hope to succeed in addressing every conceivable (and yet-to-be-conceived) mode of business structure and transaction type. IASB (and IASC before it) is committed to a principles-based set of standards, meaning that the vast, highly specific guidance offered by US GAAP standards and related literature will not be replicated under IAS. In part, this is a philosophical position, but is also based on IASB's more modest funding and consequent inability to develop and produce the sheer volume of particularized examples commonly found in FASB pronouncements. The recent crises, coupled with the opportunistic utterances of IAS advocates, has placed the "rules vs. principles" debate back on center stage, however, and even FASB is now reportedly giving some thought to this matter.
The recently enacted Public Accounting Reform and Investor Protection Act of 2002 (commonly referred to as Sarbanes-Oxley) requires the US SEC to conduct a study on the "adoption by the United States financial reporting system of a principles-based accounting system." This study is to delve into areas such as
The extent to which principles-based accounting and financial reporting exists in the US;
The length of time required for change from rules-based to a principles-based financial reporting system;
The feasibility of and proposed methods by which a principle-based system may be implemented; and
A thorough economic analysis of the implications of a principles-based system.
The US SEC is required to complete its study within one year and submit its report to the US Senate and the House of Representatives. While it is surely premature to predict the outcome of this study, or of the political reaction to it (for example, public interest in this topic may have vastly diminished by the time it is debated), if indeed the "principles-based" approach is found preferable, this will have significant implications. At the extreme, the US FASB could revise its standards or rapidly move to convergence by effectively adopting IAS. More likely, FASB would, on a going-forward basis, retreat from the type of highly prescriptive guidance it currently includes in its standards.
Whatever the ultimate outcome, the recent crisis has raised the profile of the IASB, and this surely does help it in both its funding efforts and in gaining new converts to IAS. It further adds to the momentum many perceive as already existing in favor of IAS as the ultimate survivor as global accounting standard setter.
Benefits from Convergence of National and International Accounting Standards
From the standpoint of the users of financial statements (e.g., bankers and investors), it is rather difficult to make relative evaluations of companies that use diverse accounting standards. This tends to restrict the market for the shares of these companies and therefore greatly affects their rankings and attributed value. Today, for most businesses, the biggest opportunities lie in international markets: They have economic activities that extend far beyond domestic markets, they seek investment capital in foreign countries, and they conduct their operations through facilities in foreign lands. It is also fairly evident that in the share market arena, global fighters are emerging as winners, since investors seem to be ignoring domestic competitors and clearly casting their ballots in favor of international champions. Thus, convergence of accounting standards worldwide will greatly help the users of accounting and financial information in making informed economic decisions about these companies.
From the standpoint of preparers of financial statements, the burden of financial reporting would be greatly lessened with increased harmonization, which would simplify the process of preparing individual as well as group financial statements. It is a well-known fact that multinational groups that have nondomestic subsidiaries suffer from added costs of preparation of financial statements. To elaborate the point, consider an example of a company that has a subsidiary that is operating out of Saudi Arabia, with its parent company based in the United Kingdom, and whose shares are listed on the New York Stock Exchange. This company will have to prepare three sets of financial statements.
Financial statements to comply with the Saudi standards, to meet the requirements of the Saudi Arabian company
Financial statements to comply with the consolidation requirements in the United Kingdom
Financial statements to meet the registration and filing requirements in the United States
This means that enormous additional financial costs have to be incurred not only in the preparation of such financial statements but also in getting them audited. Imagine if this company were a multinational corporation (MNC) operating out of fifty countries, most of which had local licensing regulations that required financial reporting to be tailored according to their national standards. The company's accounting travails would then be extremely unpleasant, to say the least. Thus, it is obvious that enormous benefits will emanate from convergence of accounting standards worldwide.
Reporting Anomalies Resulting from Diversity in Accounting Standards Worldwide
Significant diversity in accounting standards of different countries not only poses the problem of additional cost to be incurred for financial reporting but could cause other difficulties for multinational companies. For instance, it is quite possible for a transaction to give rise to a profit under the accounting standards of one country, whereas it would require a deferral under the standards of another country. When a multinational company has to report under the standards of both countries, one is amazed to see some extremely odd financial results that could sometimes also be embarrassing. The case of lopsided financial reporting that instantly comes to mind is that of German industrial giant Daimler-Benz AG (before its merger with Chrysler), which sought listing of its shares in the United States in 1993 and ended up reporting a massive loss of $1 billion under US GAAP, when in fact it had reported a profit of $370 million under its own national (German) GAAP.
Typology of Differences in National Accounting Standards
The following analysis is by no means an authoritative study of differences in accounting standards worldwide but is being attempted with the limited purpose of highlighting some of the well-known major differences in accounting standards. Four countries have been chosen for this comparison: the United Kingdom, the United States, France, and Japan.
Measurement subsequent to initial recognition of fixed assets (historical cost vs. revaluations). Revaluation is more of a choice than a requirement or stipulation. Even those standards that permit revaluations offer it as an alternative to the historical cost. It is prohibited in countries such as the United States and Japan, and if used would be considered a departure from GAAP. In the United Kingdom and France revaluation of assets is permitted, but not all assets are allowed to be carried at revalued amounts. In the United Kingdom the items that are permitted to be revalued are property, plant, equipment, and investments. In France, revaluations are rare except when prescribed by law.
Timing of recognition vs. deferrals. Recognition of profits and losses causes major differences in financial reporting. Sometimes the method used in recognizing profits or losses could cause differences, and sometimes the number of years over which amortization is spread could cause disparities in the reporting of financial results. Two examples illustrating the foregoing causes of differences follow.
Accounting for goodwill. There is great disparity among standards with regard to the accounting treatment of goodwill. Some countries have traditionally given a free choice of either writing it off to reserves on acquisition or capitalizing and recognizing it on the balance sheet. The other controversy is with regard to the number of years over which goodwill is to be amortized. The following summarizes these differences:
United States and France. Until mid-2001, both treated goodwill as an asset to be amortized over its useful life. Under former US GAAP, the amortization period was forty years, while in France no set limit is prescribed but shorter periods are used. As of mid-2001, a new requirement in the US (SFAS 142) requires that goodwill no longer be amortized, but rather, that it be reviewed for impairment on a regular basis, with charges to earnings when impairment is found to have occurred.
United Kingdom. Traditionally, alternatives are allowed: Goodwill could either be written off on acquisition by a charge to reserves (not to the income statement) or capitalized and amortized over its useful life. However, amendments to UK GAAP (FRS 10) have modified this approach.
Japan. Goodwill is capitalized and written off over five years, but this can be extended if a longer life can be justified.
Accounting for long-term contracts. Long-term contracts could be accounted for under either the percentage-of-completion method or the completed contract method. Profit recognition under the methods is vastly different. While the completed contract method postpones the recognition of profits until the contact is completed, the percentage-of-completion method recognizes profits during the life of the contract. Following are the methods prescribed under the various standards:
United States, France, and Japan. Both methods are permitted.
United Kingdom. Only the percentage-of-completion method is permitted.
Recognition of substance over form in accounting for leases: capital vs. operating
United Kingdom and United States. Certain categories of leases (called finance leases in the United Kingdom and capital leases in the United States) have to be capitalized (capital value of asset leased is recorded as an asset and future lease payments recorded as liability).
France. Capitalizing is prohibited, except for consolidated accounts, for which it is optional.
Japan. Although this treatment is not specifically prohibited, there are no accounting rules on this subject.
Financial statement disclosures
United States and France. There are significant disclosure requirements on related-party transactions.
United Kingdom. Traditionally, only details of certain transactions with directors (and other specified personnel) were required to be disclosed. However, with the promulgation of a new standard (FRS8), the related-party disclosure requirements have been broadened.
Japan. All material transactions with related parties must be disclosed under a footnote captioned "Conditions of Business Group."
United States. Applicable only to publicly held (listed) companies.
France and United Kingdom. Applicable in the case of all companies.
Japan. Applicable in the case of listed companies and should be reported by the parent company for the group; to be disclosed in a footnote captioned "Conditions of Business Group."
Relevance of IAS to the Developing Countries of the World
Many developing nations do not have their own national accounting standards. The generally accepted accounting principles (GAAP) that they follow are either the UK, US, or international standards. In certain countries, governments and central banks have made the IAS mandatory. Rather than reinventing the wheel, the adoption of IAS, which are high-quality standards developed after a truly international due process, seems to be a step in the right direction, as it will help the process of uniformity in international financial reporting.