International Accounting Standards - the basics

What is happening?

From 2005 all listed companies (listed on an EU regulated Stock Exchange) across the European Union will have to prepare their consolidated financial statements based upon International Financial Reporting Standards (IFRS). They will no longer be able to produce accounts based upon UK GAAP.

In addition to the EU member states, over 70 countries currently permit or require the use of IFRS by some or all of their domestic listed companies or have announced plans to do so.

Why is this happening?
The EU wishes to try to develop a single capital market. One element of this is to have a common ‘language’ for the financial information provided to that single market – in other words common accounting standards.

The requirement to adopt IFRS therefore applies only to those companies that are active direct participants in the capital market – in other words those that have securities that are publicly traded on recognised stock markets.

There are estimated to be about 7,000 such companies, of whom 2,500 are in the UK.

When will this happen?
Any companies that meet the above definition will need to prepare consolidated financial statements using IFRS for accounting periods commencing on or after 1 January 2005. So for December year-ends the first set of accounts prepared under IFRS will be for the year ending 31 December 2005.

Under IFRS 1, comparative figures also need to be disclosed based upon IFRS. So again taking December year-ends as an example, figures for the year ending 31 December 2004 will also have to be prepared under IFRS.

Companies who have a listing in New York may have to restate their 2003 accounts to IFRS.

Who needs to make the change to IFRS? At a minimum all listed companies in the EU will need to make this change for their consolidated accounts.

Member states have the option to extend the impact either as a requirement or as an option to other sorts of company and accounts. In the UK, the Department of Trade & Industry has announced that:

• Publicly traded companies in the UK will also be permitted to use IFRS in their individual accounts from the same date; and

• Other companies and limited liability partnerships in the UK will be permitted to use IFRS in both their individual and consolidated accounts from the same date.

It likely that subsidiaries and associates of listed companies will need to supply consolidation information based on IFRS. A number of unlisted companies, especially those considering listing in the near future, may well want to take up this option.

What are the key differences between UK GAAP and IFRS?
The most significant difference in terms of broad treatments of items between UK GAAP and IFRS in the following areas:

• Pension costs for defined benefit schemes
• Deferred tax, especially on revaluations and discounting of provisions
• Financial instruments, especially on accounting for derivatives and investments at fair values
• Hedge accounting
• Preference shares and convertible bonds
• Merger accounting
• Goodwill amortisation
• Negative goodwill
• Investment properties, especially the treatment of revaluations
• Proposed dividends
• Finance leases – some operating leases under UK GAAP may be finance leases under IFRS

There are many differences in wording and emphasis in the two sets of standards even when the overall treatment of items is broadly the same and these differences can be significant in borderline decisions.

The disclosures required under UK GAAP and IFRS are different in some cases.

What is going to happen to UK GAAP?
All UK companies not using IFRS for their accounts will be expected to continue to comply with UK standards and the accounting requirements of the Companies Act.

However, the Accounting Standards Board (ASB) believes that there is no case for the use in the UK of two sets of wholly different accounting standards. It has therefore announced its intention to:

• Issue no new standards that are more demanding or more restrictive than IFRS.

• Make a concerted effort to bring UK GAAP into line with IFRS.

The ASB’s aim is to achieve convergence between UK GAAP and IFRS as quickly as possible whilst at the same time avoiding the burden of excessive changes in one year and, in particular, minimising the cases where an entity using UK standards may be required to make successive changes of accounting policy in respect of the same matter.

To this end, the ASB has issued a discussion paper on its strategy for convergence, the comment period for which closes on 30 June 2004. This proposes adopting a number of international standards in 2005 and 2006 and making further ‘step changes’ thereafter.

Ultimately UK GAAP and IFRS should be virtually identical.

What should I be doing now?
In most cases this process of adopting IFRS should already be underway. However, research suggests that many companies have made little or no progress towards this goal. If this includes you, you could begin by:

• Ensuring that you have appropriate staff in place to manage the change.
• Starting to understand IFRS and becoming familiar with the new standards especially those with a particular impact on your business.
• Assessing the changes that will be required and considering any new accounting policies that may be needed.
• Communicating the changes in information needs, systems and procedures to those involved with producing the financial information on any new basis.
• Quantifying the changes by restating the appropriate opening balance sheet.
• Preparing comparative information on the new basis.

What deadlines do I need to adhere to?
This obviously depends on your year-end. For companies with December year-ends, their first external deadline will be the publication of their interim figures for the six months ending 30 June 2005. The first full set of accounts prepared under IFRS will be those for the year ending December 2005.

However, as comparative figures need to be disclosed it is advisable for companies to act now. With a December year-end it is necessary to prepare an opening balance sheet as at 1 January 2004 – the beginning of the first accounting period for which IFRS numbers must be disclosed.

This opening balance sheet must be prepared retrospectively using standards that will be in place at 31 December 2005 – but the IASB has announced that there will be no further changes in IFRS between now and then so you can begin preparing your opening balance sheet under IFRS today!

Do I have to adopt all IFRS?
You cannot pick and choose which standards you adopt. Listed companies must adopt all IFRS whereas for everyone else it is an all or nothing choice.

An entity whose financial statements comply with IFRS must make an explicit and unreserved statement of such compliance in the notes to its accounts. Financial statements shall not be described as complying with IFRSs unless they comply with all the requirements of IFRSs.

The IASB are currently in the process of discussing an international version of FRSSEs for small and non-publicly accountable entities.

What if I don’t adopt IFRS?
Any listed UK companies that file consolidated accounts that are not in compliance with IFRS will risk being referred to the Financial Reporting Review Panel and ultimately subject to the enforcement powers available to them and the UK Listing Authority. Being de-listed is a real possibility.

For unlisted companies, while an option to comply with IFRS exists there is no compulsion to do so. Any companies not taking up this option will have to continue to comply with UK standards and the accounting requirements of the Companies Act.