Author: Terry O'Rourke
John McDonnell and Terry O'Rourke consider the accounting topics addressed in the ASB's convergence plan, focusing on the planned timing of convergence in the major areas where Irish GAAP differs from IFRS.
Most Irish companies, other than listed companies, have the choice of continuing to prepare their accounts under Irish GAAP or to switch to IFRS from 2005. Irish GAAP relies on the accounting standards issued by the UK Accounting Standards Board (ASB). Consequently, the ASB's plan to converge to IFRS is of significant interest and importance to Irish companies. In essence, the ASB's plan is to adopt a phased approach to convergence over the next four years, by which time there may well be little or no difference remaining between Irish GAAP and IFRS.
CONVERGENCE TO DATE Having issued no new FRSs between 2001 and 2003, the ASB issued a total of seven FRSs (FRS 20-26) between April and December 2004, all of them based on IFRS. See Table 1.
FRS 20, Share-based payments which introduced the requirement to expense the cost of share options and awards on the basis of their fair values.
FRS 21, Events after the balance sheet date which requires that proposed ordinary dividends and dividends declared after the balance sheet date will no longer be included as liabilities in the balance sheet.
FRS 21 applies to all companies for years commencing on or after 1 January 2005, while FRS 20 applies to listed companies for years commencing on or after 1 January 2005 and to all other companies for years commencing on or after 1 January 2006.
FRS 23 to 26 on foreign currency and financial instruments accounting were introduced by the ASB as a package of standards which are to be implemented simultaneously, but which are mandatory only for particular classes of company. For listed companies not using IFRS they are mandatory for 2005, while for companies that use fair value accounting for financial instruments, they are mandatory for 2006.
As this would have required Irish investment management companies to implement the full rigours of FRS 26, Irish law has been changed to allow such companies to use US, Canadian or Japanese GAAP, instead of either IFRS or Irish GAAP.
In relation to FRS 25, it is important to note that its presentation requirements apply to all companies for years commencing on or after 1 January 2005, a major consequence of which is that most preference shares will now be shown as liabilities in the balance sheet, rather than as non-equity shareholders' funds.
SCOPE OF CONVERGENCE ON FINANCIAL INSTRUMENTS Experience in companies that have switched to IFRS confirms that accounting for financial instruments, including derivatives, has posed the greatest challenge across all industries. This challenge includes coping with the volatility of the results under IFRS as well as upgrading accounting systems and documentation to track the fair values of financial instruments and derivatives and to justify hedge accounting. The open nature of Ireland's economy and the consequent volume of foreign currency transactions and investment means that the use of derivatives, such as forward contracts, is not at all confined to financial services businesses. These derivatives, as well as many other financial assets, have to be included in the balance sheet at their fair value under IFRS. Consequently, a key issue for Irish companies is when the ASB plans to extend the scope of FRS 26 to all companies. The ASB's most recent proposal is to converge fully on this difficult aspect of accounting for years commencing on or after 1 January 2007, a mere fifteen months away, although the ASB seems to be prepared to listen to arguments for deferring it to 2008.
TOPICS WHERE CONVERGENCE IS IMMINENT The ASB plans to introduce FRSs based on IFRS later in 2005 on inventories, construction contracts and related party disclosures. Irish GAAP is very similar to IFRS in these areas but some of the terminology and definitions will be new to Irish accounts preparers.
TOPICS WITH LIVE CONVERGENCE PROPOSALS In July 2005, the ASB issued four Exposure Drafts proposing convergence in principle to IFRS on accounting for: - FRED 36 - Business combinations - acquisition accounting and goodwill. - FRED 37 - Intangible assets. - FRED 38 - Asset impairments. - FRED 39 - Provisions and contingencies. Accounting for business combinations under IFRS is quite different to Irish GAAP - notably IFRS prohibits merger accounting, requires a more rigorous identification of the intangible assets acquired and prohibits goodwill amortisation. When Irish GAAP converges to IFRS, acquisitive Irish companies can expect to have to identify the intangible assets they have acquired and to amortise them over their useful lives as well as carrying out an annual impairment test on the goodwill to justify retaining its carrying value on the balance sheet.
Notwithstanding its overall policy of converging to IFRS, the ASB is considering whether to retain some form of goodwill amortisation. ASB also has reservations about other aspects of the proposed new IFRS on acquisition accounting so it will be interesting to see whether these concerns will impede its general approach to convergence with IFRS; in particular, whether convergence will be achieved for the original target date of 2007.
There are a number of accounting topics that are particularly relevant in acquisitions - intangible assets, provisions and asset impairment. The ASB is
proposing in principle to converge to IFRS on these topics at the same time as business combinations, again with some reservations.
Curiously, the recent exposure draft from the ASB on provisions and contingencies is called "non-financial liabilities" reflecting the title of the proposed new IFRS standard on this topic. One of ASB's reservations about the IFRS proposal on accounting for provisions is that they would be accounted for at the amount that the company "would rationally pay to settle the obligation or to transfer it to a third party on the balance sheet date". For example, where a company felt it had a 20% likelihood of losing a legal case against it, it might provide 20% of the claim, rather than merely disclosing it as it would currently do.
TOPICS FOR FUTURE CONVERGENCE (i) Presentation of Business Performance Accounting presentation is often seen as the poor relation when identifying areas of convergence to IFRS, with the main focus being on the measurement of profits, assets and liabilities. However, experience in companies that have already adopted IFRS has proven that accounting presentation can be an extremely difficult and sensitive issue for individual companies. For example, IFRS has more demanding disclosures on presenting performance by business segment which some company directors may feel takes transparency too far. IFRS also has different rules on how to present the results of discontinued operations in the profit and loss account, and on how to present fixed assets that are held for sale in the balance sheet, focusing very much on segregating these from the ongoing results and assets of the business.
The ASB plans to replace FRS 1 Cash Flow Statements, FRS 3 Reporting Financial Performance and FRS 18 Accounting Policies with their IFRS equivalents for 2007, and will also consider whether and when to converge on segmental reporting. A notable feature of IFRS is that it requires prior year restatements for all material errors, not just for fundamental errors.
The ASB acknowledges that the ongoing debate at IASB about how to report total recognised gains and losses, or "comprehensive income", may affect the timing of convergence in some of the areas discussed above.
(ii) Other Topics As deferred tax accounting under IFRS is due to be revised, probably during 2006, the ASB plans to wait for that revision before converging. However, there seems little doubt that Irish companies can expect to have to provide much more deferred tax, perhaps for 2007, as IFRS does not allow the FRS 19 exemptions from providing deferred tax on revaluation surpluses, roll-over relief and certain other differences between the accounting and tax measurement of assets and liabilities.
The ASB plans to issue an exposure draft on revenue recognition later this year, at the same time as the IASB issues its proposals to revise IAS 18.
While IAS 18 is quite similar to Irish GAAP, it would be worthwhile for Irish companies to examine the differences in order to anticipate any effects on their results. For example, IAS 18 is rather more specific about when revenue should be recognised, and companies currently in the process of adopting and embedding IFRS have had to re-examine their terms of sale to customers to identify whether they need to change their revenue recognition policy.
The ASB may well issue FRSs, based on IFRS, on the topics of deferred tax and revenue recognition with effect for 2007.
TOPICS WITH NO CONVERGENCE PROPOSALS There are two notable areas where the ASB has not indicated plans for convergence - pension accounting and accounting for substance over form.
Arguably, IFRS is converging toward FRS 17 on pension accounting so perhaps the ASB is regarded as having the better accounting standard on this topic, despite all the criticism and heartache that it has caused.
In relation to substance over form, the ASB has always been very proud of FRS 5, particularly as it stopped some accounting abuses that had gained acceptance purely on the basis of their legal form. Although the ASB proposes to converge to IFRS on the de-recognition of financial instruments, it appears to be intent on retaining most of FRS 5, its bulwark standard on reporting the substance of transactions in financial statements.
CONVERGENCE - WHAT DO YOU NEED TO CONSIDER? The first, albeit obvious, consideration for companies to address is when should they adopt IFRS, and with the convergence plans outlined above, it is really a question of when, not if.
If your company chooses to stay with Irish GAAP for the time being you may still need to determine to what extent your systems and personnel will be able to cope with the increasing convergence to IFRS. For example, how will you cope with the fair value requirements for financial instruments and derivatives; the strict requirements necessary to avail of hedge accounting, including upfront designation and continuous measurement of hedge effectiveness; the fair value requirements relating to share options and to intangible assets obtained through acquisition; and the annual goodwill impairment testing using appropriate cash flow and discount rates.
Finally, as Irish GAAP converges to IFRS, it will be important for management to be well prepared to explain to all the stakeholders why the bottom line has changed and become more volatile.
Tables have been omitted from the online version of this article. Click here to subscribe to Accountancy Ireland