Monday Nov 25, 2024
Monday Nov 25, 2024
Thursday, 5 September 2013 00:00 - - {{hitsCtrl.values.hits}}
Opening the session with a few introductory comments, Mihular said that the session’s objective was to facilitate business and industry 
professionals in obtaining an enhanced understanding of the new standards and the impact such changes would have on financial reporting when made mandatory. He mentioned that it was important that these issues were made clear to board members of companies, as it requires influence and knowledge of contracts which cannot be left to CFOs and accountants alone.
Explaining that Sri Lanka had just adopted the IFRS in 1012, he said that the decision to defer the introduction of the new standards was to allow a buffer period. According to Mihular, under IFRS 10, the whole emphasis has moved from equity to control as it looks at controlled resources, and their reflection in financial statements while the company’s structuring and method of decision making affect consolidation.
In reference to IFRS 11, there were critical decisions that have a direct impact on the financials such as the size of the balance sheet. Mihular mentioned that there are terms and conditions under which proportional consolidation may happen and certain contracts have to be whetted, so that it can be ensured that there are no undesirable contracts. We have enough issues on how assets are valued. IFRS 13 tries to bring some sense into how things are valued.
Hassan then took over the session, reflecting on the changes in the accounting mindset. These changes have spanned from accounting to business to IFRS itself, whose guidelines have expanded tenfold since its inception. He extrapolated that it is something the board, and everybody in the business needs to look at along with questioning who genuinely controls the company. Hassan mentioned that he was conducting a session in Dubai as its property bubble burst during the global financial crisis, during which a question arose whether the IFRS and accounting caused the financial crisis. The answer, he blithely informed the audience was, “If you have a fever, do you blame the thermometer?”
Presenting his perspective on this, Hassan stated, “The way I see accounting, is from a sports perspective – as a scorekeeper. The regulator is the referee, the accountant is a scorekeeper. IFRS is a way of keeping score across companies and countries. People use the score to motivate themselves and make key decisions.”
He went on to discuss changes in scorekeeping methods and mechanisms, explaining that things are getting so complicated because transactions and businesses have been getting increasingly complex and the IFRS has to respond and evolve to keep up with these complications.
IFRS globally – movement towards adoption?
Hassan explained that over 150 countries are already on IFRS, which means people are increasingly following the global accounting language as the world becomes a smaller place and requires a common way of scorekeeping. There are some anomalies, such as China and Japan. Although China has not adopted the IFRS, they have translated the standards locally thus indirectly conforming. The recent changes in the IFRS also cater to Chinese situations, making concessions to include comprehensive state-owned entities. India is another emerging market which was supposed to adopt IFRS in 2011 but has not as yet due to various local economic and political issues.
The United States have also not adopted IFRS due to a fundamental difference: the US’s GAAP is rules based, while IFRS is principle based. While the advantage of rules is consistency, the disadvantage is that things end up structured around the rule. Thus it seems unlikely that the two will converge. Hassan explained that there can be problems with rules-based standards. For example, both Enron and the Lehmann Brothers technically followed the rules while lacking principles.
Changes ahead
Hassan detailed the necessity of change as business and transactions evolve. IFRS changes the definition of control, leaving only three 
possibilities- the first and best situation, in which your control conclusion remains relevant, or you may have to consolidate something you did not previously or you have to deconsolidate something.
He explained that IFRS 11 is a consolidation method for joint ventures. If you are jointly controlling an assets through a company you should be getting jointly controlled asset accounting, not equity accounting. A lot of consolidation is going to be based on judgment calls disclosed in the financial statement. If you are consolidating something you only have a 10% share in, you need to explain to your stakeholders within your financial statements that you have an explicit agreement.
Hassan also mentioned that there was already an amendment to IFRS 10 as banks panicked as they realised they would suddenly have to consolidate a lot of things such as the lending and consolidation of the assets of their small funds. So a unique exception was introduced, as investment entities need not consolidate, and subsidiaries must be measured via fair value.
He went on to explain that IFRS 13 was a standard on fair value measurement which does not dictate when but how valuations should be done, with a convenient and comprehensive guidebook on how to measure and disclose.
Hassan mentioned a few existing or previous accounting measures and their issues. IFRS 9 gets rid of all the previous categories and creates a total financial overhaul by presenting something more business focused rather than arbitrary and definition focused. It uses an incurred loss model of recognising losses which was criticised during the financial crisis as “waiting until something happens”. There was also a consideration of a return to prudent accounting, which entails booking losses on the expectation to lose. This is a theoretical requirement of expected or anticipated costs, which didn’t reflect well in reality.
Another example discussed was the financial statements of airlines, most of which do not include aircrafts. With 194 aircraft in the Emirates fleet, the balance sheet only shows 10 airplanes at maximum. This is because they are mostly leased, despite Dubai not imposing taxes. Hassan explained that operating lease structuring keeps assets and liabilities off your balance sheet. Airlines boast the number ordered, not “bought” as they don’t want the liability on their balance sheet. This makes it difficult to assess the debt to equity ratio. The standards sector realised this and saw it as a deficiency of the system.
The leasing exposure draft makes every lease a finance lease for the balance sheet regardless of the period, which may be a breach of governance. This is an imminent standard change, perhaps by 2016. Every lease will be present on the balance sheet. He further mentioned that unless a company is in the telecom industry, the revenue recognition standard doesn’t change much.
Most queried IFRS issues in the region
The most frequently questioned issues involving IFRS in the South East Asia region include accounting for real estate such as investment property and IAS 11 versus IAS 18 accounting for developers, impairment such as financial instruments and bad loans, and miscellaneous issues such as contributions- government grants versus shareholders, and the effective standardisation for accounting of Sharia products.
The biggest issues are with investment property which is usually held for capital appreciation. Most entities in the Gulf invested their property at fair value. When property values sky rocketed there was a drastic increase in value. Shareholders saw the income flow in the income statement, and asked for proportionate dividends. In the UAE, there was no formal law on dividends, so when the property bubble burst, the entities were rendered helpless as you can change from cost to fair value, but you can’t go back.
Another big question for developers was whether they should they recognise revenue during the construction stages or only at completion? Hassan mentioned that if impairment was a big issue, so is restructuring. Companies make massive profits on restructuring their liabilities.
IFRS 10: Consolidation
According to the KPMG literature, the new IFRS 10 standard requires a broader understanding of circumstances in assessing control. Previously disregarded facts could become relevant and could even tilt the balance of the overall analysis under the new standard. Even if the consolidation conclusion does not change, the related disclosure standard has its own challenges and may require additional data collection on relationships with other entities- whether or not consolidated.
Hassan explained that financial statements are prepared for a group with a parent and its subsidiaries. When there is control, we will consolidate, except for investment entities. If there is joint control, we will do equity accounting or proportional consolidation. Only when you have a contract that shares control will you have joint control. Significant influence uses equity accounting, with navigation skills. With no control at all you have a financial instrument. Levels of voting rights generally help determine things. With 20-50%, you have significant influence to participate but not control, whereas joint control and joint ventures can exist at any level of voting rights.
The IAS 27 control model was defined as “the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities”. The rebuttable presumption is that there is more than half of voting power. SIC 12 on the other hand, ignores voting rights. The problem lies in the fact that there are two conflicting models, which present the choice to either consider or ignore voting rights. One looks at control, whereas the other looks at risks and rewards.
IFRS 10 is very similar, bringing these two models together. Under this standard, control equals power and exposure to variability in returns plus a link between power and returns.
Hassan explained further, stating that “to have power , it is necessary for the investor to have existing rights that give it current ability to direct the activities that significantly affect the investee’s returns i.e. the relevant activities”. Under IFRS 10, control is assessed on a continuous basis. In the consolidation model, over 50% shares meant lifetime consolidation. The IFRS assessment says that things may change, and representation may get diluted over time. This means that there could be changes in the control conclusion. There are big changes expected in financial bodies.
The new single control model can be simplified as such: 1. Identify the investee and whether they are a legal entity or silo, 2. Identify the relevant activities of the investee that significantly affect investee’s returns, 3. Identify how decisions about the relevant activities are made (are voting rights relevant in assessing investor power?), 4. Assess whether the investee has power over the relevant activities, 5. Assess whether the investor is exposed to variability in returns, 6. Assess whether there is a link between power and returns by questioning whether the investor is a principle or an agent.
Hassan further mentioned that there were four key steps to IFRS 10 transition:
