International Accounting Standards - Essay Example

Introduction International Accounting Standards (IAS) provides objective and detailed of accounting standards while developing financial statements. The aim is provide standardised, coherent, consistent, and useful information to various users of the financial information. To date, a total of 41 IAS have been released; however, 10 have been superseded by other IAS or IFRS (International Financial Reporting Standards); and 2 have been withdrawn by International Accounting Standards Board - IASB (IAS Plus, 2009). This paper provides a broad introductory review of the five standards from IAS; namely: IAS 16 - Property, Plant and Equipment IAS 17 - Leases IAS 23 - Borrowing Costs IAS 26 - Accounting and Reporting by Retirement Benefit Plans IAS 37 - Provisions, Contingent Liabilities, and Contingent Assets In addition to a description of each standard, this paper briefly discusses how the potential users of financial statement can benefit from the use of these standards. Moreover, in order to explain the concept, certain examples have been discussed for a hypothetical organisation - Noka. IAS 16 - Property, Plant and Equipment Introduction IAS 16 deals with recognition of property, plant and equipment; and their depreciation charge calculation. It also provides guidance on how to determine the carrying value of these assets and the treatment during disposal of these fixed assets. In order to facilitate the users in reading financial statements, IAS 16 standardises the recognition, measurement, revaluation, depreciation and de-recognition of property, plant and equipment; and provides guidance on accounting treatments. Initial Recognition IAS 16 requires that an asset (property, plan and equipment) should be recognised in books of accounts when the following two conditions are met (IAS Plus, 2009): The costs can be measured with degree of reliability The company will receive economic benefits in future from the use of the assets Initial Measurement The initial costs include not only purchase price but cost of delivery and installation etc. Carrying Value The standard provides flexibility to organisations in terms of subsequent measurement of value of the fixed asset. So, it can either be stated at original cost (less impairment and depreciation), or can be revalued to state its fair value (the current market value). The organisation must state the method used to measure the asset in the disclosure section of the financial statements. This would assist users in determining whether the original cost is used to value the asset or if the market value is used to provide a fair value closer to the current market value. But, in order to assure the users that revaluation was done properly, addition disclosures are required including date of revaluation, method used to revalue, if independent valuer was involved, etc. The implication of carrying value is significant. This is because in most circumstances, organisations would opt to incur additional expenses of revaluing the asset only if they are confident that revaluation will assist in increasing the carrying value of the asset. This directly impacts the balance sheet. Depreciation The depreciation is the charge on usage of the asset; and is treated as a non-cash expense. At the end of the year, depreciation is charged to the income statement of the organization. IAS 16 requires that organisations use a depreciation method consistent to the useful life of the asset (the period in which economic benefits can be obtained from the asset). The method used to calculate depreciation may vary. In addition, organisations are allowed to change the depreciation method but it has to be documented under disclosure section along with reasons for the change. The implications may be significant. If reducing balance method of depreciation is used, the company will be able to depreciate the asset faster in the beginning as opposed to straight line depreciation that requires same depreciation charge for the entire useful life of the asset. De-recognition or Disposal The asset is disposed off once it completes its useful life period. The standard requires that the gain or loss on the disposal of asset (with regard to its carrying value) should be booked in the income statement. So for instance, equipment that was installed for $100,000 ten years ago and was carried on the books at $90,000 (being fair market value); if sold for $95,000, the gain from sale of equipment (that is, $5,000) should be booked as income from other sources in the income statement. The remaining $90,000 should be recognised by debiting cash (or bank) and crediting the asset (equipment). Noka's Case The given case states that Noka's Board decided to change accounting policy in valuation of fixed assets from historical cost into market value. This change mandates complete and comprehensive disclosure in the financial statements. This would assist the reader to obtain complete information about Noka's fixed assets while reading the statements; thus enhancing understandability. IAS 17 - Leases Introduction IAS 17 provides guidance on "the appropriate accounting policies and disclosures to apply in relation to finance and operating leases" (IAS Plus, 2009) for lessors and lessees. The standard does not apply on operational and/ or financial leases of investment properties and biological assets. Classification of Leases The standard defines the types of leases as either operational or financial lease; and contrasts the two types on the basis of risks and rewards of ownership. Accounting Treatment for Finance Leases Noka, by virtue of entering into finance lease arrangement, becomes the lessee. Following accounting treatment should be carried out: Upon the start of lease contract, the leased asset should be booked in the balance sheet "as an asset and a liability at the lower of the fair value of the asset and the present value of the minimum lease payments" (IAS Plus, 2009). During the period of use, the leased asset should be depreciated using the same depreciation method as used for other assets of the company. The depreciation period should be shorter of the lease period and the useful life. Had the asset been rented as operating lease, the lease payments should be charged as expenses. Thus, accounting treatments are different for operating and finance leases. IAS 17 standardises the method to recognize and book leases in the financial statements. Thus the users of financial statements can easily determine the quantum of operational and/ or finance leases for the company. Disclosure requirements IAS 17 requires that users of financial statements should be provided with clear and complete information about the current carrying value of the leased assets; along with description of significant lease arrangements. Thus, the users should be able to decipher if the orgnisation has purchases its assets or have obtained them on lease. In addition to requirements for the lessees, the standard also provides specific guidance for lessor (the owner the asset), with regard to recording the lease agreement, rental income and other components. Noka's Case The specific case for Noka states that the company entered into a deal to rent an asset for substantially the whole of its useful economic life. Thus this type of lease should be classified as finance lease as per IAS 17. This is because the lease is valid through most of the period in which the asset is able to provide economic value. Noka should state the lease asset under assets section of the balance sheet as leased asset; and under liability section as lease payment payables. The carrying value should either be the fair value of the asset (market value or historical cost); or the present value of future lease payments; whichever is less. IAS 23 - Borrowing Costs Introduction IAS 23 provides valuable guidance on borrowing costs (interest on loans, amortisation of discounts, finance lease charges, etc.) and their accounting treatment. The standard defines borrowing cost as interest expense, finance charges in respect of finance leases recognised in accordance with IAS 17 Leases, and exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs" (IAS Plus, 2009). Recognition The standard provides two ways of recognising the borrowing costs. The borrowing costs associated with installing, ordering, implementing and/ or constructing a qualifying asset (one that requires significant time) are required to be capitalised. All other borrowing costs are required to be expensed out. Capitalisation of borrowing costs means that the costs will be divided over a number of years instead of recognising it as expense for current period. This is because the time required to implement the asset is significant. Noka's Case The given case states that Noka's Board decided to change the company's accounting policy from one of expensing the finance costs on building new retail outlets to one of capitalising such costs. This is in line with the IAS 23 requirements since constructing new retail outlets may require long time. Thus as per IAS 23 standard, Noka should capitalise the finance costs. However, the capitalisation should be initiated when the borrowing costs are incurred and should cease when the construction of retail outlet is completed. For the sake of users of financial statements, Noka is required by IAS 23 standard to disclose the amount of borrowing costs that is capitalised during 2008 and the capitalisation rate used for this purpose. This would assist the users to compare the borrowing costs for the company with other competitors and with company's own performance in previous years. IAS 26 - Accounting and Reporting by Retirement Benefit Plans Introduction IAS 26 provides guidance on "measurement and disclosure principles for the reports of retirement benefit plans" (IAS Plus, 2009). The standard requires that benefits and retirement plans should provide the following information in financial statements (IAS Plus, 2009): Statement of changes in net assets which are available for benefits Significant policies (accounting policies) Detailed information about the benefits plan and the effect of changes (if any) in the plan for the year The standard defines retirement benefit plan as a process by which organisation provides monetary or other benefits in form of annual or one time payments to its employees after their services with the company are terminated. Types of Retirement Benefit Plans The retirement benefit plans may differ in the way the benefits are calculated. Some retirement plans are based on the contribution by employer plus the interest income on this contribution (defined contribution plan) while others are based on fixed formula (defined benefit plan). Disclosure Requirements The standard defines various requirements for disclosure related to retirement benefit plans. These include statements for net assets for the benefit at the end of the year, statement of changes in net assets, details of the plan including details of funding process, and other components of the benefit plans. The purpose of stringent disclosure requirements is to ensure that employees' terminal and retirement benefits remain secure with the company with no or little possibility of delinquency with regard to extent or amount of funds or benefits. Noka's Case As per the given case, Noka changed its pension scheme in February 2008. As per the accounting standard, Noka is required to disclose complete information about the old plan, why the changes were made, what were the changes, the amounts and rates, and what is the expected affect of these changes on the retirement benefit plan. This is in addition to the required reports (as stated above) that Noka will need to develop. This would assist users of the financial statements in identifying the changes made to the retirement benefit plan for the company's ex-employees and the effect of these changes. IAS 37 - Provisions, Contingent Liabilities, and Contingent Assets Introduction IAS 37 deals with provisions and accounting treatment for provisions. The standard defines provision as "a liability of uncertain timing or amount" (IAS Plus, 2009). A provision can only be made if organisation has a liability. So for example, provisions cannot be held for planned future capital expenditure. Contingent liabilities are defined as obligations resulting from a future event which is uncertain as of date. Contingent assets, on the other hand, include potential assets which may or may not become assets for the company, depending on future uncertain events. Recognition IAS 37 requires that a provision be made if an obligation has arisen due to a past event; reliable estimation of amount can be made; and the payment is likely. The contingent assets and contingent liabilities are not required to be recognised. Measurement The value of the provision should be best guess estimates of the amount that the organisation would pay to settle the obligation. It requires an analysis of all applicable risks. Disclosure Requirements For each provision class, the standard requires that companies disclose the nature, timing, assumptions, reimbursement, and uncertainties which forced the company to make provisions. The contingent assets and contingent liabilities, although are not required to be recognised, but are required to be disclosed as per the standard. Accounting Treatment The provisions are charged to income statement as expenses. If, on the next balance sheet date, the organisation finds that the provisions are not desired (for example, if the outflow of cash is not probable), the organisation can reverse the provision. Noka's Case In the given case, Noka's Board has decided to close down a division but the decision will not be announced to the employees until the end of January 2009 (which is after the balance sheet issuance date). As per IAS 37, if an organisation is in the process of restructuring its operations by way of closure of business units, the provision need not be made until a detailed and formal plan of restructuring is developed and announced. Although the Board has decided, yet the Board's decision alone is not enough to recognise provisions. Thus, in the given case, Noka's management should not include provisions in the 2008 financial statement. Conclusion Accounting standards are developed to guide organisation while preparing their financial statements. An important benefit from IAS is the standardisation in developing financial statements. Thus the users of the financial statements can compare the statements with other companies to measure performance of a specific company in comparison to competitors. They also provide assurance to the users on relevance, reliability and completeness of information presented in the financial statements; and greatly assist users in understanding the financial statements regardless of industry and type of organisation. This paper presented a brief overview of five accounting standards along with their application for a hypothetical company. A detailed analysis is beyond the scope of this paper but the above discussion provided high level understanding of the main requirements of these five standards and their applicability. References IAS Plus. (2009). IAS Plus: Summaries of IFRSs and IASs. Retrieved 15 June 2009 from: http://www.iasplus.com/standard/standard.htm IAS Plus. (2009). IAS Plus: IAS 16 - Property, Plant and Equipment. Retrieved 15 June 2009 from: http://www.iasplus.com/standard/ias16.htm IAS Plus. (2009). IAS Plus: IAS 17 - Leases. Retrieved 15 June 2009 from: http://www.iasplus.com/standard/ias17.htm IAS Plus. (2009). IAS Plus: IAS 23 - Borrowing Costs. Retrieved 15 June 2009 from: http://www.iasplus.com/standard/ias23.htm IAS Plus. (2009). IAS Plus: IAS 26 - Retirement Benefit Plans. Retrieved 15 June 2009 from: http://www.iasplus.com/standard/ias26.htm IAS Plus. (2009). IAS Plus: IAS 37 - Provisions, Contingent Liabilities, and Contingent Assets. 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