First-time Application of International Financial Reporting Standards

The ASB is monitoring the IASB’s project on ‘First-time application of IFRS’. The IASB is expected to issue an exposure draft in the summer. The ASB will highlight issues of particular UK relevance.

IASB Preface

In May the IASB issued its Preface to International Financial Reporting Standards. The Preface sets out IASB’s objectives and arrangements for due process and explains the scope, authority and timing of application of IFRS.

The draft of the Preface that was published for comment proposed that IASB should discontinue the practice of having some paragraphs in bold type and others in plain type. In response to comments received (including from the ASB) this proposal has been dropped. The Preface emphasises, however, that the two kinds of paragraphs have equal authority.

A potentially important change from the published draft is the deletion of the statement that IFRS need not be applied to immaterial items.

Business combinations

The IASB is in process of drafting an Exposure Draft resulting from its high priority project on Business Combinations (Phase I). The project includes issues relating to accounting for goodwill (in particular its possible impairment) and intangible assets. As a result the Exposure Draft will include a proposed new standard on Business Combinations and revisions to IAS 36 Impairment of Assets and IAS 38 Intangible Assets.

The IASB’s Exposure Draft is expected in the second half of 2002 and the ASB will issue a UK FRED at the same time. This will include recommendations for implementing the proposed international standards in the UK.

A number of the IASB’s proposals differ from existing UK accounting as specified in FRS 6 ‘Acquisitions and Mergers’, FRS 7 ‘Fair Values in Acquisition Accounting’, FRS 10 ‘Goodwill and Intangible Assets’ and FRS 11 ‘Impairment of Fixed Assets and Goodwill’. Some of the more significant international proposals are:

• merger accounting (or the pooling of interests method) should not be permitted and all business combinations should be accounted for as acquisitions using the purchase method; one of the combining entities must be identified as the acquirer.

• purchased goodwill should be subject to an annual impairment test and not systematically amortised.

• any excess of the fair values of net assets acquired over the cost of the acquisition should no longer be described as ‘negative goodwill’ and should be recognised immediately as a gain in the income statement.

• it is presumed that an item meeting the definition of an intangible asset is always capable of reliable measurement and a list of examples is included of items meeting the definition, some of which would be unlikely to be recognised separately from goodwill in the UK at present.

• in-process research and development expenditure should be recognised as an intangible asset on acquisition if it meets the definition of an intangible asset; subsequent expenditure on the same project should only be capitalised if it meets the recognition criteria in IAS 38.

• there is an impairment test for goodwill different from the one applied to fixed assets; it will have two stages, a check for the existence (or otherwise) of an impairment followed, where an impairment exists, by a separate test to measure the amount of the impairment. This will be based on the fair values of the net assets of the cash-generating unit.

• there should no longer be a rebuttable presumption of a 20 year useful life for intangible assets (whether acquired in a business combination or not). There should be no requirement for an annual estimate of the recoverable amount of intangible assets with a finite useful economic life in excess of 20 years, unless there is an indication of impairment.

Insurance accounting

The IASB continues to work on insurance accounting as a priority project using as the basis of its discussion the draft Statement of Principles prepared by the former Steering Committee. The expected date for a final standard has now been delayed until after 2005; it may not be issued before 2007. This delay reflects the large number of difficult issues that need to be addressed in developing an international standard on insurance accounting. The IASB also recognises the need for field testing its proposals and to allow time for systems changes.

It seems likely that by 2005 an interim standard will be needed. This may allow local GAAP for insurance contracts to continue in most respects, subject to certain minimal requirements. There could also be disclosure requirements and guidance on applying present IASs to insurance companies in areas other than insurance contracts.

Revenue recognition

This project aims to address the current lack of a UK accounting standard governing the recognition and measurement of revenue, that is ‘sales’ or ‘turnover’. While there are some relevant standards in other jurisdictions, they are not widely considered to provide a satisfactory basis for convergence.

Several respondents to the ASB’s Discussion Paper specifically welcomed its approach, which is based on general principles. ASB shared its progress with the IASB and other standard setters in May, and work continues to develop a general standard and to consider how this would be applied in specific industries. IASB has now highlighted this as a priority project.

Derecognition

This project considers when assets and liabilities should cease to be recognised (ie should be derecognised) on the reporting entity’s balance sheet. The existing UK requirements are set out in FRS 5 ‘Reporting the Substance of Transactions’.

There are currently three main derecognition standards in issue: FRS 5, the USA’s FAS 140, and IAS 39 ‘Financial Instruments: Recognition and Measurement’. While FRS 5 applies to all assets and liabilities, FAS 140 and IAS 39 apply only to financial assets and financial liabilities. That means that, unless the IASB develops a standard on the derecognition of nonfinancial items by 2005, a gap will appear when FRS 5 ceases to apply to listed companies.

One of the objectives of the ASB’s work on derecognition is therefore to try to ensure that a satisfactory framework for the derecognition of non-financial items is incorporated in the IASB’s literature by 2005. Such a framework is necessary to ensure that Private Finance Initiative (PFI), Public-Private Partnerships (PPP) and similar service concession-type arrangements are accounted for properly. It also has implications for the accounting treatment of consignment stock, inventory sale and repurchase transactions and a range of other operating asset financing arrangements.

Leases

The ASB is continuing its work on developing proposals for an accounting standard that would require a single method of accounting for all leases. The implication is that the distinction made in present accounting standards between operating and finance leases would be discarded and that assets and liabilities would be reported for all leases in lessees’ balance sheets. The project is building on the responses to the Discussion Paper issued in December 1999.

At the May meeting of the IASB with its liaison standard setters, the ASB presented a paper that introduced issues concerning the presentation of assets and liabilities that arise from lease contracts and from other types of transactions where similar issues are involved, such as outsourcing and service concessions. The project is being monitored by the IASB with a view to its being taken on to the IASB’s agenda in due course.

Share-based payment

In July 2001, the IASB announced that it intended to develop an accounting standard on share-based payment. Since then it has reached the following tentative conclusions:

• Where a share-based payment has been made, the goods or services received in return (including any employee services) should be recognised in the financial statements. In the case of employee share-based payment transactions, for example, an expense should be recognised.

• That expense should in theory be measured at the grant date fair value of the share-based payment made. However, for practical purposes it will be sufficient to measure it at whichever is the more readily determinable of the fair value of the goods or services received or the grant date fair value of the equity instrument issued. This amount will represent the cost of the goods or services to be received.

• Where an observable market price does not exist, an option pricing model should be used to estimate the fair value of the share-based payment.

• Having established the cost of the goods or services received, that cost should not be adjusted subsequently in the light of experience or other events (ie for forfeiture or lapses).

• The repricing of share-based payment consideration should be accounted for by recognising additional remuneration expense based upon the incremental value given on repricing; in other words, the difference between the fair value of the repriced option (or other instrument) and that of the original option, both estimated as at the date of repricing.

The IASB is hoping to issue an exposure draft on share-based payments by the end of 2002.

Statement of Principles for the not-for-profit sector

This project is being carried out under the aegis of the Board’s Public Sector and Not-for-profit Committee (PSNC). The project is considering areas where the existing Statement of Principles may need a change of emphasis or reexpression to make it more applicable to not-for-profit entities.

A number of specific issues were identified for consideration following the receipt of comments from various interested parties. PSNC has been working through these issues, which include such fundamental matters as the interpretation of the definitions of assets and liabilities. Work is continuing on the project with a view to the publication of a Discussion Paper.