IFRS Financial Statements (Part 2)
Author:
John McDonnell
In the second of a two-part article, John McDonnell, IFRS Services Partner, PricewaterhouseCoopers, outlines what you can expect to see in the notes to IFRS compliant financial statements. [Tables have been omitted from the online version of this article].
The last issue of Accountancy Ireland examined the presentation of the primary statements in an IFRS compliant set of financial statements. In this, the second part of the article, we will consider the factors that management teams must bear in mind when preparing the disclosure notes for IFRS financial statements. We will highlight some of the similarities and differences between IFRS and Irish GAAP disclosures and examine, by way of example, some of the new disclosure notes required under IFRS.
We noted in part one that the initial transition to IFRS marks only the beginning of the choices, challenges and decisions facing company management teams when it comes to embedding IFRS in a company's day-to-day operations.
Additionally, management need to consider the needs of their stakeholders, their regulators and their statutory requirements. Although several methods of presentation may be equally valid, management will have to make decisions as to what constitutes, in their view, the best way to present their financial statements.
IFRS NOTE PREPARATION REQUIREMENTS
IAS 1, in conjunction with the relevant international accounting standards, provides a clear outline of the presentation requirements for the notes to the financial statements. In order to be IFRS compliant the notes must be presented in a systematic manner and must disclose the basis of preparation and accounting policies adopted in the preparation of the financial statements. The notes must also disclose any additional information required by IFRS that is not presented in the primary statements but is relevant to an understanding of those statements. In addition IAS 1 prescribes that the notes should also be cross-referenced to any related information in the notes.
IAS 1 sets out the disclosure order for notes to financial statements, as outlined below:
1. Statement of compliance with IFRS.
2. Information about the basis of preparation and the specific accounting policies selected and applied for significant transactions and events. This may be presented as a separate component of the financial statements.
3. Information relating to line items presented on the face of the financial statements. Each financial statement item should be cross-referenced to the appropriate note.
4. Other disclosures including contingencies, commitments and other financial disclosures, as well as non-financial disclosures.
Although widely recognised that the notes should typically be presented in the order of the primary statement line items to which they relate, IFRS recognises that in some cases it may be necessary or preferable to vary the order. IAS 1 cites the example of the disclosure of information on changes in fair value being combined with the disclosure of information on maturities of financial instruments even though one relates to the profit and loss account and the other to the balance sheet.
It is clear thus far that IFRS is prescribing presentation requirements that are largely similar to Irish GAAP. So should we expect to see any differences in the details of the notes themselves?
NOTES TO THE BALANCE SHEET
Similar to Irish GAAP, IAS 1 requires entities to disclose, either on the face of the balance sheet or in the notes, further sub-classifications of the line items presented, classified in a manner appropriate to the entity's operations.
The level of this sub-classification depends on the size, nature and function of the items involved and on any specific requirements in other standards and interpretations. IAS 1 provides the following examples of items that require sub-classification:
- Property, plant and equipment should be shown by class.
- Trade receivables, receivables from related parties, prepayments and other amounts should be shown separately.
- Inventories should be shown by class - common classifications are merchandise, production supplies, work in progress and finished goods.
- Provisions for employee benefit costs should be shown separately from other provisions.
- Equity capital and reserves should be disaggregated into classes such as paid-in capital, share premium and reserves.
In addition to this, IAS 1 also requires detailed disclosures for each class of share capital including a reconciliation of the number of shares at the beginning and end of the period, details of rights, preferences and restrictions attaching to each class of share and details of shares under option and sale contracts is required. Although there is a similar requirement under Irish GAAP, the Companies Acts specifically require the separate disclosure of reserves, including share premium account, revaluation reserve, capital redemption reserve and other reserves, whereas the only corresponding guidance given under IFRS is that the notes must disclose the nature and purpose of each reserve within equity.
NOTES TO THE PROFIT & LOSS ACCOUNT
There are three areas that should be considered when it comes to the notes disclosures in relation to the profit and loss account.
First, where items of income and expenditure are material, IFRS prescribes that their nature and amount should be disclosed separately, either on the face on the profit and loss account or in the notes to the accounts. Under Irish GAAP, FRS 3 identifies three categories of exceptional items ('super-exceptional') that must be shown after operating profit (even though they are often operating items). However under IAS 1, the total of the post-tax profit or loss of discontinued operations and the post-tax gain or loss recognised on the measurement to 'fair value less costs to sell' or on the disposal of the discontinued operation is shown after tax. Other exceptional items, which would be classed as super-exceptional under FRS 3, must be dealt with in the appropriate operating line item.
A second area to watch for is dividends. Under IFRS an entity must disclose the amount of dividends recognised during the period and the related amount per share. This disclosure may be given either on the face of the profit and loss account, in the statement of changes in equity, or in the notes. Previously Irish GAAP required the profit and loss account to show the aggregate amount of dividends both paid and proposed. However, dividends proposed or declared after the year-end are not regarded as a liability at the year-end under IFRS. Irish law will come into line with IFRS on this matter with the application of FRS 20, which comes into force for accounting years commencing on or after 1 January 2005.
Finally, under IFRS segmental reporting is required for all companies whose equity or debt securities (as of 2007) are publicly traded and for entities that are in the process of issuing equity or debt. Under Irish GAAP companies were able to apply the prejudicial exemption allowed by SSAP 25 and thereby avoid disclosing their activities on a segmental basis.
OTHER NOTES TO THE FINANCIAL STATEMENTS
In addition to notes supporting the profit and loss account and balance sheet, we are all aware from Irish GAAP accounts that there are many additional note requirements included to provide users of financial statements with an understanding of a company's performance for the year and its financial position at the year end date.
Figure 1 sets out some disclosures, and compares the disclosure requirements under IFRS to Irish GAAP. One of the initial changes that IFRS preparers will find in the notes of IFRS compliant financial statements is that the domicile and legal form of an entity, its country of incorporation and address of its registered office (or principal place of business, if different) must be disclosed. There is no equivalent requirement under Irish GAAP. In addition to this, IFRS requires a description of the entity's operations and its principal activities, something that under Irish GAAP was disclosed in the directors' report.
The other significant enhancement in the notes to the IFRS financial statements is that the judgements made by management in applying the accounting policies that have had the most significant effect on the amounts recognised in the financial statements need to be disclosed under IFRS.
ADDITIONAL IFRS 1 REQUIREMENTS FOR INTERIM FINANCIAL STATEMENTS
At this stage in 2005 it is appropriate to mention some of the additional disclosures that are required, under IFRS 1, to be included in an entity's first interim IFRS report. These additional disclosures include reconciliations of the effect of transition to IFRS on net income and equity at various dates (e.g. comparable interim period and opening balance sheet) and information regarding the use of certain exemptions.
IFRS 1 requires an entity to apply the IFRS standards that are in force at the closing balance sheet date of its first annual IFRS financial statements. This is 31 December 2005 for many Irish entities. However, these entities will have to prepare their first interim reports before this date. IFRS Accounting policies applied at the interim date may change at year-end.
Such changes may be necessary for:
- IFRIC interpretations issues after publication of the interim report that will be mandatory for 2005
- New IFRSs or amendments to IASs issued after publication of the interim report that permit early adoption and that these entities choose to adopt; and
- IFRIC interpretations issued after publication of the interim report that permit early adoption and that these entities choose to adopt.
Such entities will need to explain, in their interim reports, that their accounting policies will be determined with certainty only at their year end (First annual IFRS Financial statements).
CONCLUSION
Management will only start realising the extent of the choices and challenges they have during their conversion process and in preparing for the release of their first set of IFRS compliant financial statements.
The questions and issues that arise when an entity begins to prepare IFRS compliant statements are often specific to that company and difficult to predict. However the message is clear. Management need to proactively consider the effect that conversion to IFRS will have on their financial statements. They need to fully understand the requirements of IFRS and make an informed choice on the best way to present the information. As in all walks of life, different management teams will, no doubt, take different views on the best way to present information.
John McDonnell, IFRS Services Partner, PricewaterhouseCoopers. T: (01) 704 8559.