7.1 International accounting standards

International accounting standards provide a common language for global business, enabling companies to communicate financial information across borders. For SMEs in international consulting, understanding these standards is crucial for credibility, attracting foreign investment, and facilitating cross-border transactions.

Key organizations like the IASB and FASB develop global and US standards respectively. The IFRS Foundation oversees the IASB, promoting worldwide adoption of IFRS. Core principles include relevance, faithful representation, and comparability of financial information.

Overview of international accounting standards

• International accounting standards provide a common global language for business affairs, enabling companies to communicate and compare financial information across international boundaries
• Adopting a single set of worldwide standards helps improve the consistency, comparability, and efficiency of financial reporting, which benefits investors, auditors, and other stakeholders in the global economy
• For small and medium-sized enterprises (SMEs) engaged in international consulting, understanding and complying with international accounting standards is crucial for establishing credibility, attracting foreign investment, and facilitating cross-border transactions

Key organizations in international accounting

IASB vs FASB

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• The International Accounting Standards Board (IASB) is an independent, private-sector body that develops and approves International Financial Reporting Standards (IFRS)
• The Financial Accounting Standards Board (FASB) is the organization responsible for establishing generally accepted accounting principles (GAAP) in the United States
• While both organizations aim to improve financial reporting quality, the IASB focuses on global standards (IFRS), while the FASB focuses on US standards (US GAAP)

Role of IFRS Foundation

• The IFRS Foundation is a not-for-profit, public interest organization established to develop a single set of high-quality, understandable, enforceable, and globally accepted accounting standards (IFRS)
• The Foundation oversees the IASB and is responsible for its governance, funding, and oversight
• It also engages with stakeholders around the world to promote the adoption and consistent application of IFRS

Core principles of IFRS

Qualitative characteristics of financial information

• Relevance: Information must be capable of making a difference in users' decisions
• Faithful representation: Information must be complete, neutral, and free from error
• Comparability: Users must be able to compare financial statements across entities and over time
• Verifiability: Different knowledgeable and independent observers should reach consensus that information is faithfully represented
• Timeliness: Information must be available to decision-makers in time to be capable of influencing their decisions
• Understandability: Information should be presented clearly and concisely

Underlying assumptions

• Accrual basis: Transactions are recognized when they occur, not when cash is received or paid
• Going concern: Financial statements are prepared on the assumption that an entity will continue in operation for the foreseeable future

Major IFRS standards

Presentation of financial statements (IAS 1)

• Sets out overall requirements for the presentation of financial statements, guidelines for their structure, and minimum content requirements
• Requires a complete set of financial statements to include a statement of financial position, statement of profit or loss and other comprehensive income, statement of changes in equity, statement of cash flows, and notes

Inventories (IAS 2)

• Prescribes the accounting treatment for inventories, including cost determination and expense recognition
• Requires inventories to be measured at the lower of cost and net realizable value (NRV)
• Cost includes all costs of purchase, conversion, and other costs incurred in bringing inventories to their present location and condition
• Expense recognition occurs when inventories are sold, exchanged, or distributed

Statement of cash flows (IAS 7)

• Requires entities to present a statement of cash flows that reports cash inflows and outflows during a period, classified into operating, investing, and financing activities
• Operating activities include the principal revenue-producing activities of the entity and other activities that are not investing or financing
• Investing activities include the acquisition and disposal of long-term assets and other investments not included in cash equivalents
• Financing activities include activities that result in changes in the size and composition of the contributed equity and borrowings of the entity

Property, plant and equipment (IAS 16)

• Prescribes the accounting treatment for property, plant, and equipment (PPE) so that users can discern information about an entity's investment in its PPE and the changes in such investment
• PPE are tangible items held for use in the production or supply of goods or services, for rental to others, or for administrative purposes, and are expected to be used during more than one period
• Initial measurement is at cost, which includes the purchase price, any directly attributable costs of bringing the asset to working condition, and the initial estimate of the costs of dismantling and removing the item and restoring the site
• Subsequent measurement can follow either the cost model (cost less accumulated depreciation and impairment losses) or the revaluation model (fair value at revaluation date less subsequent depreciation and impairment losses)

Leases (IFRS 16)

• Establishes principles for the recognition, measurement, presentation, and disclosure of leases
• Requires lessees to recognize most leases on their balance sheets as lease liabilities with corresponding right-of-use assets
• Lessor accounting remains similar to the previous standard (IAS 17), classifying leases as operating or finance
• For operating leases, lessors continue to recognize the underlying asset; for finance leases, lessors derecognize the underlying asset and recognize a net investment in the lease

Revenue from contracts with customers (IFRS 15)

• Establishes a comprehensive framework for determining whether, how much, and when revenue is recognized
• Applies to all contracts with customers, except leases, financial instruments, and insurance contracts
• Introduces a five-step model for revenue recognition:
  1. Identify the contract with a customer
  2. Identify the performance obligations in the contract
  3. Determine the transaction price
  4. Allocate the transaction price to the performance obligations
  5. Recognize revenue when (or as) the entity satisfies a performance obligation

Differences between IFRS and US GAAP

Conceptual framework comparison

• Both IFRS and US GAAP aim to provide useful financial information to investors and creditors, but there are differences in their conceptual frameworks
• IFRS places more emphasis on principles than rules, while US GAAP tends to be more rules-based
• IFRS emphasizes the importance of the balance sheet, while US GAAP focuses more on the income statement

Key accounting policy differences

• Inventory valuation: IFRS prohibits the use of the Last-In-First-Out (LIFO) method, while US GAAP allows it
• Impairment of assets: IFRS requires a one-step impairment test and the reversal of impairment losses in certain circumstances, while US GAAP uses a two-step test and prohibits reversal of impairment losses
• Development costs: IFRS allows capitalization of development costs if certain criteria are met, while US GAAP requires expensing of all development costs
• Classification of liabilities: IFRS classifies liabilities as current if they are due within 12 months after the reporting period or if the entity does not have an unconditional right to defer settlement for at least 12 months, while US GAAP generally classifies liabilities as current if they are expected to be settled within the entity's normal operating cycle or within 12 months

Adoption of IFRS

Current state of global adoption

• As of 2021, over 140 countries require or permit the use of IFRS for domestic listed companies
• Major economies that have adopted IFRS include the European Union, Australia, Canada, and South Korea
• The United States has not adopted IFRS but allows foreign private issuers to use IFRS in their SEC filings

Benefits vs challenges of IFRS adoption for SMEs

Benefits:

• Improved access to international capital markets
• Enhanced comparability of financial statements across countries
• Reduced cost of capital due to increased transparency and credibility
• Simplified reporting for SMEs with foreign subsidiaries or cross-border transactions Challenges:
• Transition costs, including staff training and IT system updates
• Potential for increased volatility in reported financial results due to fair value measurements
• Difficulty in interpreting and applying principles-based standards consistently
• Limited resources and expertise compared to larger entities

Auditing considerations with IFRS

Impact on audit planning and procedures

• Auditors need to be knowledgeable about IFRS requirements and their application to the specific entity
• Risk assessment procedures should consider the potential impact of IFRS adoption on the entity's financial reporting
• Auditors may need to adjust audit procedures to address IFRS-specific risks and requirements (e.g., fair value measurements, impairment testing)
• Communication with those charged with governance should include discussions on the entity's IFRS implementation process and any significant issues encountered

Auditor's report under IFRS

• The auditor's report should refer to the financial statements being prepared in accordance with IFRS
• Key audit matters (KAMs) should be included in the auditor's report for listed entities, describing the most significant matters in the audit of the financial statements
• The auditor's opinion should state whether the financial statements give a true and fair view (or present fairly, in all material respects) in accordance with IFRS

Future developments in international accounting

Convergence projects between IASB and FASB

• The IASB and FASB have been working on convergence projects to reduce differences between IFRS and US GAAP
• Some notable joint projects include revenue recognition (IFRS 15 and ASC 606), leases (IFRS 16 and ASC 842), and credit losses (IFRS 9 and ASC 326)
• Despite progress in convergence, significant differences remain, and complete convergence is unlikely in the near future

Upcoming changes to major IFRS standards

• IFRS 17 Insurance Contracts (effective 2023): Establishes principles for the recognition, measurement, presentation, and disclosure of insurance contracts
• Amendments to IAS 1 Classification of Liabilities as Current or Non-current (effective 2023): Clarifies the criteria for classifying liabilities as current or non-current
• Amendments to IFRS 3 Reference to the Conceptual Framework (effective 2022): Updates references to the revised Conceptual Framework for Financial Reporting
• Annual Improvements to IFRS Standards 2018-2020 Cycle (effective 2022): Makes minor amendments to IFRS 1, IFRS 9, IFRS 16, and IAS 41