International Financial Reporting Standards and International Accounting Standards - Coursework Example

IAS vs. IFRS: Review Introduction International Financial Reporting Standards (IFRS) provides a common medium for global business affairs in order that financial statements would be comprehensive and comparable in spite of cross border differences. The increasing rate of international shareholding and trading activities makes it necessary for multinational corporations to have such a common global reporting system so as to manage their accounting operations smoothly. It is interesting to see that IFRS are eventually replacing many national reporting standards and developing an integrated, common global platform for the preparation of final accounts. In countries that follow the IFRS, accountants are required to follow the reporting rules set out under this reporting framework. Although IFRS were initially introduced in an effort to bring accounting practices and processes into line, the value of coordination made this concept attractive worldwide. However, the success of the harmonization still remains to be a debatable topic. IFRS were previously called International Accounting Standards (IAS). The Board of International Accounting Standards Committee (IASC) issued IAS over the period 1973-2001. The new International Accounting Standards Board (IASB) acquired the responsibility for setting IAS from the IASC on 1st April 2001. During its first meeting, the IASB passed a resolution to adopt the existing IAS and Standing Interpretations Committee standards in addition to developing new International Financial Reporting Standards. This paper will review a set of scholarly articles to analyze the accounting definition and accounting treatments relating to IAS/IFRS, and it will also illustrate some real life examples. Accounting Definition The IAS provide a number of accounting definitions related to key financial instruments, and they are really beneficial for the users to gain basic understanding of the various accounting practices. Such definitions and other recognition criteria are of great importance when it comes to the reporting of items in the financial statements. Common accounting definitions of key financial instruments are inevitable for a global audience to form a shared understanding of the firm’s financial position and accounting practices. Hence, these accounting definitions must be comprehensive enough to give the audience a clear idea of the accounting treatments required to report an item appropriately in the financial statement. In order to have a deeper knowledge of the accounting definitions and their scope set out in the IAS/IFRS framework, it is good to consider and analyze IAS 39 as an example. As described in Deloitte article IAS 39 — Financial Instruments: Recognition and Measurement (n.d.), IAS 39 provides a clear definition of accounting for financial instruments, and it also gives a clear understanding of the classification of those issuing financial instruments as either financial liabilities or equity instruments. It is important to note that the IAS 39 does not consider accounting for equity instruments and the reporting entity issues whereas it addresses accounting for financial liabilities (Deloitte, IAS 39). When it comes to the classification of financial assets, IAS 39 states that financial assets should be classified in one of the categories including financial assets at fair value through profit or loss, available for sale financial assets, loans and receivables, and held to maturity investments (Deloitte, IAS 39). These categories are effective to provide crucial information about the recognition and measurement of a specific financial asset in the financial statements. The first category (financial asset at fair value through profit or loss) is subcategorized into two such as designated and held for trading. The subcategory of designated indicates a particular financial asset that, on initial recognition, is designated as an asset which has to be measured at fair value through profit or loss (Deloitte, IAS 39). The second subcategory reflects financial assets which are held for trading. On the initial recognition, the available for sale financial assets are designated as available for sale. In the balance sheet treatment, the available for sale assets should be measured at fair value. Loans and receivables are regarded as the fixed or clearly identifiable payments but are not quoted in an active market. In case of some loans and receivables, the holder may not recover the complete initial investment due to credit deterioration (Deloitte, IAS 39). Those loans and receivables should be treated as available for sale. It is also important to note that amortized cost is set as a basis for measuring loans and receivables. While evaluating the held to maturity investments, it seems that these non-derivative financial assets are not designated as ‘assets at fair value through profit or loss’ or ‘available for sale’ on the initial recognition (Deloitte, IAS 39). They are identified as the fixed or determinable payments that an organization wants to hold to maturity. Like the case of loans and receivables, amortized cost is used as the basis for measuring hold to maturity investments (Deloitte, IAS 39). If an organization is forced to sell its held-to-maturity investment as a result of an unforeseen event, then the entity is required to reclassify the other held to maturity investments as available for sale for the present and the following two financial reporting periods. IAS 39 also deals with the classification of financial liabilities. According to this rule, there are two sets of financial liabilities such as ‘financial liabilities at fair value through profit or loss’ and ‘other financial liabilities measured at amortized cost’ based on the effective interest method (Deloitte, IAS 39). Comparing to financial assets, the second category of financial liabilities also has two subcategories – designated and held for trading (Deloitte, IAS 39). Designated implies that a financial liability is designed as a ‘liability at fair value through profit or loss’ during initial recognition by the organization (Ibid). Under the second subcategory, a financial liability is grouped as a liability held for trading. According to IAS 39, recognition of a financial asset or a financial liability is required only when the organization is an authorized party to the instrument’s contractual provisions. Generally, trade date or settlement date accounting is used to recognize and derecognize a financial asset’s purchase or sale (Deloitte, IAS 39). This entity is required to use this method consistently for all the purchases and sales of financial assets that represent the same category according to the recognition criteria set out in IAS 39 (Deloitte, IAS 39). Accounting Treatments The five-steps model framework described in IFRS 15 can be considered a better example of accounting treatments under IAS/IFRS. “The core principle of IFRS 15 is that an entity will recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services” (FASB, “Why did the FASB…”). This basic principle is depicted using a five-step model framework. The five steps of the IFRS 15 revenue model include identifying the contract(s) with a customer, identifying the performance obligations within the contract, determining the transaction price, allocating the price to performance obligations, and recognizing revenue with the fulfillment of performance obligations (Deloitte, IFRS 15). These five steps, as found in Deloitte IFRS 15 (n.d.), are discussed below in detail. Step 1: Identifying the contract(s) with a customer As described in Deloitte, IFRS 15 (n.d.), five conditions need to be met for the contract with a customer to be within the scope of IFRS 15. First, the contrast must be approved by all the parties to the contract. Second, the rights of each party with regard to the goods or services to be transmitted can be identified (Deloitte, IFRS 15, n.d.). Third, the terms concerning the payment of goods or services can be identified. Fourth, the contract should have a commercial substance. Fifth, the consideration to which the entity is obliged to exchange goods or services will be collected (Deloitte, IFRS 15). Step 2: Identifying the performance obligations within the contract It is essential for the entity to recognize the performance obligations within the contract at the inception of the contract. The entity has the responsibility to deliver a distinct good or service (or bundle of goods or services) to the customer (Deloitte, IFRS 15). Step 3: Determining the transaction price Transaction price is the amount of money an entity is paid in exchange for the transfer of goods and services. While determining the transaction price, the entity should take past customary business practices into account. When a contract contains the elements of variable consideration, the entity needs to calculate the amount of variable consideration to which it is entitled under that contract (Deloitte, IFRS 15). Step 4: Allocating the price to performance obligations If the contract has multiple performance obligations, then the entity is required to allocate the transaction price to all the performance obligations in accordance with their relative standalone selling prices. IFRS 15 suggests various methods to estimate a standalone selling price if it is not directly observable. Those methods include residual approach, adjusted market assessment approach, and expected cost plus a margin approach (Deloitte, IFRS 15). Step 5: Recognizing revenue with the fulfillment of performance obligations Revenue is recognized with the pass of control, either over a particular period of time or at a particular point of time. Control of an asset can be simply referred to the ability to regulate the use of and to gain all of the remaining benefits substantially from the asset (Deloitte, IFRS 15). Update The IAS 39 Financial Instruments: Recognition and Measure was replaced by the new standard introduced by the IASB called IFRS 9 ((IFRS, IFRS 9 Financial Instruments, n.d.). In other words, IFRS 9 is the update of IAS 39. IFRS 9 is an International Financial Reporting Standard developed and introduced by the International Accounting Standards Boards (IASB). This standard was issued on 24th July 2014 and it addresses the accounting of financial instruments (IFRS). IFRS 9 will be mandatorily applied to reporting periods beginning on or after 1st January 2018. This standard mainly addresses three topics including classification and measurement of financial instruments, impairment of financial assets, and hedge accounting (IFRS, n.d.). The initial work of the IFRS 9 began as a joint project between IASB and FASB. These two boards jointly published a discussion paper in March 2008 stating a goal of eventually reporting all financial instruments at fair value. The global financial crisis 2008-09 persuaded the boards to revise their accounting standards for financial instruments so as to address perceived deficiencies, which were believed to have increased the magnitude of the crisis. Although the two boards initiated this project jointly, they disagreed on several important matters including the development of the new financial instruments standard. In spite of the policy disagreements in several areas of the project, both IASB and FASB worked together to design a model for impairment of financial assets. Classification and Measurement As described in IFRS website, the classification provision of the IFRS 9 suggests how financial assets and financial liabilities should be treated or presented in financial statements. This standard also describes how those financial instruments should be measured on an ongoing basis. IFRS 9 also introduced a logical model for the classification of financial assets based on cash flow characteristics and the business model that deals with the holding of an asset. This approach supersedes the current rule-based approach which is complex and difficult to apply (IFRS, IFRS 9 Financial Instruments, n.d.). IFRS 9 also permits the reclassifications between the categories although this practice is not expected to be frequent (IFRS). Impairment During the recent global financial crisis, there was a delay in the recognition of credit losses on loans and other financial instruments, and this situation was identified to be a major weakness in the existing accounting standards (IFRS, n.d). In response to this adverse situation, IASB introduced an expected loss impairment model as part of IFRS 9 with intent to accomplish more timely recognition of expected credit losses. According to the new accounting standard, entities are required to account for expected credit losses since the time they first recognize financial instruments (IFRS, n.d.). This provision will lower the threshold for recognizing the full lifetime expected losses. The IASB has declared that it would create a transition resource group to assist stakeholders to adapt to the new impairment requirements (Ibid). Real life Examples The very Deloitte article IAS 39 — Financial Instruments: Recognition and Measurement (n.d.) illustrates some common examples of financial instruments within the range of IAS 39, and they are; “cash, demand and time deposits, commercial paper accounts, notes, and loans receivable and payable, debt and equity securities” along with “investments in subsidiaries, associates, and joint venture,s asset backed securities such as collateralised mortgage obligations, repurchase agreements, and securitised packages of receivables derivatives” Deloitte article IAS 39). According to London Financial Studies (n.d.), the following can be considered as two real life examples of IFRS 9; “an RBS deleveraging securitisation executed with Blackstone and an investment fund sponsored by Deutsche Bank” (London Financial Studies). Hedge Accounting Hedge accounting is another provision introduced by the IFRS 9 to deal with risk management, but hedge accounting requirements are optional. IFRS 9 provides a substantially-reformed model characterized with improved disclosures about risk management for hedge accounting (IFRS, n.d.). The major objective of the hedge accounting is to support the accounting treatment of risk management activities thereby enabling entities to better present these activities in their financial statements (IFRS, n.d.). On the strength of this new standard, the users of the financial statements will be really informed of the risk management and the effect of the hedge accounting on financial statements. The provisions made in IFRS 9 are helpful for even non-financial entities to make use of hedge accounting. If a set of eligibility and qualification criteria are met, the concept of hedge accounting can assist an entity to demonstrate risk management activities in its financial statements by linking gains or losses on financial hedging instruments with those on the risk exposures they hedge. It is important to note that the hedge accounting approach described in IFRS 9 is not meant to accommodate hedging of open and dynamic portfolios. According to one Deloitte article IFRS 9 — Financial Instruments (n.d.), some criteria need to be met necessarily for a hedging relationship to get qualified for hedge accounting. First, only eligible hedging instruments and hedged items should constitute the hedging relationship. At the beginning of the hedging relationship, there must be a formal documentation of the hedging relationship, the entity’s risk management objective, and the hedging strategy (IFRS 9). Conclusions The continuous and comprehensive efforts to standardize the accounting systems has evolved and tested a number of mechanisms in the process of redefining the conservative and localized financial instruments. From among the many systems, the better considered IAS 39 seemed to limit its scope and extent to specific financial constraints regarding the valuation norms for assets and liabilities in connection with the preparation of the financial statements. As a result, the accounting principles based on IFRS evolved with provisions for various accounting treatments by introducing IFRS. The latest evolution of IAS 39 to IFRS 9 focuses on the consolidation of standards related to financial instruments. On the basis of the interpretations made in the discussion, it is clear that the introduction of IFRS played a notable role in the formation of a common global language for accounting purposes by merging and expanding all the experimented mechanisms and tools for standardizing the art and legitimacy of accounting. Works Cited Deloitte. “IFRS 15 — Revenue from Contracts with Customers”. March 5, 2015. http://www.iasplus.com/en/standards/ifrs/ifrs15 Deloitte. “IFRS 9 — Financial Instruments”. March 5, 2015. http://www.iasplus.com/en/standards/ifrs/ifrs9 Deloitte. “IAS 39 — Financial Instruments: Recognition and Measurement”. March 5, 2015. http://www.iasplus.com/en/standards/ias/ias39 FASB. “Why did the FASB issue a new standard on revenue recognition”. March 5, 2015. http://www.fasb.org/jsp/FASB/Page/BridgePage&cid=1351027207987 IFRS. “IFRS 9 Financial Instruments (replacement of IAS 39)”. March 5, 2015. http://www.ifrs.org/current-projects/iasb-projects/financial-instruments-a-replacement-of-ias-39-financial-instruments-recognitio/Pages/Financial-Instruments-Replacement-of-IAS-39.aspx London Financial Studies. “Accounting for Financial Instruments and Consolidation in Banks (IFRS 9 and IFRS 10)”. March 5, 2015. https://www.londonfs.com/programmes/Accounting-for-financial-instruments-consolidation-in-banks-IFRS%209-and-IFRS%2010/Overview/ Read More