Study Notes on International Financial Reporting Standards (IFRS)

Chapter 1: International Financial Reporting Standards

Visual Overview

Objective

The objective of this chapter is to introduce sources of authority in international financial reporting.

Accounting Principles

What is GAAP?

GAAP (generally accepted accounting principles) is a general term referring to a set of financial accounting standards and reporting guidelines used to prepare accounts in a given environment. Specific terms like UK GAAP or US GAAP are used to refer to the particular set of standards within those jurisdictions. Notably, the term "GAAP" may or may not carry legal authority within a given country.

Sources of GAAP

Key Point

Accounting standards alone do not constitute a complete regulatory framework.

1.2.1 Regulatory Framework

The primary source of GAAP is the regulatory framework encompassing a body of rules and regulations that an entity must adhere to when preparing accounts in a particular country for a specified purpose. Examples include:

  • Statute: Such as the Companies Acts, which legally regulate company matters.

  • Accounting Standards: Standards provided by recognized bodies, for example:

    • International Financial Reporting Standards (IFRS Accounting Standards)

    • Financial Reporting Standards (UK)

    • Indian Accounting Standards (India)

1.2.2 Other Sources

In addition to statutory regulations, other sources of GAAP include best practices, which are accounting methods developed by companies in the absence of explicit rules in certain areas, and inputs from industry groups, such as:

  • The Oil Industry Accounting Committee (OIAC)

  • British Bankers' Association (BBA)

Role of Statute and Standards

Key Point

The structure of US GAAP is fundamentally rules-based, contrasting with the principles-based structure of IFRS Standards.

Detailed Legal Frameworks

Some countries employ a strictly legalistic approach to financial reporting, drafting legal rules that provide detailed guidance for financial statements, often aiming to calculate a profit figure for taxation purposes. On the other hand, countries may blend statutory regulation with standards that outline detail, for example:

  • Statute: Companies Acts 2006 in the UK

  • Standards: Financial Reporting Standards (FRS)

Alternatively, some countries might have minimal statutory guidance, opting instead to depend primarily upon standards. For instance, in the United States, the Financial Accounting Standards Board (FASB) issues accounting standards known collectively as the Accounting Standard Codification (ASC). Presently, in the US, IFRS Accounting Standards are permitted for listings by foreign corporations, while domestic public companies must adhere to US GAAP.

IFRS Accounting Standards vs Local GAAP

Numerous countries have adopted IFRS Accounting Standards as their accounting framework, with local GAAP being phased out or only applied by unlisted companies. Those without local GAAP categories often adopt IFRS as their local standard.

1.4.1 Advantages

Adopting IFRS Accounting Standards comes with several advantages:

  • Provides a single international accounting model.

  • Improves the quality and credibility of reports, facilitating access to global funds.

  • Reduces training costs since accountants need to learn only one model.

  • Recognized on a global scale.

1.4.2 Disadvantages

Conversely, there are notable disadvantages:

  • Incurred cost in the conversion from local GAAP where relevant.

  • Potential reluctance by entities to embrace changes.

  • Occasional requirements exist for both statutory and IFRS financial statements.

  • The perception of difficulty in transitioning to IFRS.

Standard-setting Bodies of the IFRS Foundation

2.1 Overview

The IFRS Foundation is a not-for-profit organization established to develop high-quality, understandable, enforceable accounting and sustainability disclosure standards on a global scale. This foundation encompasses two primary standard-setting bodies:

  • The International Accounting Standards Board (IASB)

  • International Sustainability Standards Board (ISSB)

2.2 Objectives of the IFRS Foundation

The IFRS Foundation aims to:

  1. Develop high-quality, understandable, enforceable and globally accepted standards for general-purpose financial reporting grounded in clearly articulated principles.

  2. Promote the application and rigorous usage of IFRS Standards.

  3. Acknowledge the diverse needs of entities of different sizes and types across varying economic contexts.

  4. Facilitate and promote the adoption of IFRS Standards through the convergence of national and regional standards with IFRS Standards.

The IASB and Standard Setting

Key Point

The IASB is tasked with developing accounting standards known as IFRS Accounting Standards.

3.1.1 National and Regional Network

The IASB receives support from a network of national accounting standard-setting bodies and regional organizations engaged in accounting standards development, collectively referred to as National Standard Setters (NSS). The International Forum of Accounting Standard Setters (IFASS) comprises national standard setters globally along with organizations involved in financial reporting matters.

3.1.2 Due Process

The IASB employs a due process—which is a set of consultative procedures—as defined by the Board and the Trustees of the IFRS Foundation. This aims to ensure transparency and considers a broad spectrum of perspectives from interested stakeholders, including:

  • Accountants, financial analysts, and users of financial statements.

  • The business community.

  • Securities regulators and legal authorities.

  • Academics and other concerned individuals or organizations.

The IASB utilizes due process to capture a comprehensive understanding of various accounting alternatives and the implications of proposals on involved parties. Adhering to an effective due process is crucial for developing high-quality accounting standards that cater to investors and other financial information users. The steps involved in the due process include:

  • Identification and review of related issues and assessing how the Conceptual Framework applies.

  • Exploration of national accounting requirements and practices, engaging in discussions with national standard setters.

  • Consulting the IFRS Advisory Council regarding the addition of topics to the IASB's work plan.

  • Formation of an advisory group to assist the IASB.

  • Publishing discussion documents for public input.

  • Publishing exposure drafts for public comment.

  • Review of all comments received during the comment period.

  • Conducting public hearings and field tests if deemed beneficial.

  • Achieving approval for standards by at least nine of the fourteen IASB members.

Discussion Papers

The IASB may publish discussion documents (discussion papers) open for public commentary. A discussion paper outlines the problem, project scope, financial reporting issues, discusses research findings, and presents alternative solutions and their implications.

Exposure Draft

Exposure drafts invite comments on all aspects of proposed IFRS Accounting Standards and provisional standards alongside any transitional provisions.

3.1.5 Voting

A "supermajority" of at least nine out of the fourteen IASB members, or eight if thirteen or fewer members are present, is required for the publication of a Standard, exposure draft, or final IFRIC interpretation. All other decisions necessitate a simple majority, mandatorily attended by at least sixty percent of the members for meetings.

3.1.6 Comment Period

A reasonable comment period must be provided to facilitate necessary translations of documents, typically lasting 90 to 120 days, with a minimum of 60 days for exposure drafts.

IASB Projects and Work Plan

3.2.1 Work Plan

The IASB's work plan includes:

  • Standard-setting projects aimed at developing new IFRS Accounting Standards or making significant amendments to existing standards.

  • Maintenance projects that deal with narrow-scope amendments to current IFRS Accounting Standards.

  • Research projects looking into issues surrounding existing IFRS Accounting Standards and potential remedies.

The IASB can amend standards via its Annual Improvements cycle, compiling proposed amendments to various Standards into a single "omnibus exposure draft". These amendments might involve:

  • Accounting changes.

  • Terminological or editorial changes.

3.2.2 Public Information

Transparency is foundational to the IASB's due process, ensuring that standard-setting is conducted transparently and that views of all affected parties are considered. The IASB seeks to keep its operations and considerations as open as possible, including:

  • Comprehensive details about IASB activities available on its website.

  • Open meetings that are web-streamed.

  • Issuing updates after every IASB and IFRS Forum meeting to summarize discussions and outcomes.

The Application of IFRS Accounting Standards

4.1 Key Point

IFRS Accounting Standards significantly contribute to international GAAP and are accepted broadly for financial statement preparation across various jurisdictions.

4.2 General Purpose Financial Statements

Definition: General purpose financial statements are intended to meet the needs of users who cannot require an entity to tailor reports to their specific information needs. IFRS Accounting Standards are applied to financial statements published by profit-oriented entities (including corporates, partnerships, not-for-profit activities, and public sector entities) and encompass:

  • Separate entity financial statements

  • Consolidated financial statements

Applicability Limitations: Any limitations regarding the applicability of a specific IFRS Accounting Standard will be detailed in the standard’s scope section.

4.3 Uses of IFRS Accounting Standards

IFRS Accounting Standards are utilized as:

  • National requirements or a basis for national regulations.

  • An international benchmark while developing local requirements.

  • By regulatory authorities and corporations.

  • Utilized by large multinationals for raising capital in international markets.

4.4 Benefits of IFRS Accounting Standards

These standards provide several benefits:

  • Enhance transparency and international comparability of financial information, empowering investors and market participants to make informed decisions.

  • Strengthen accountability by bridging the information gap between capital providers and recipients, placing pressure on management.

  • Foster economic efficiency by aiding investors in recognizing global opportunities and risks, ultimately improving capital allocation and lowering capital costs through a unified accounting language.

International Sustainability Disclosure Standards

5.1 Key Point

The ISSB is responsible for creating sustainability disclosure standards known as IFRS Sustainability Disclosure Standards, initiated in response to global investor demands for transparent, reliable reporting concerning climate, along with environmental, social, and governance (ESG) matters. The ISSB aims to be the global standard-setter for sustainability disclosures.

5.2 Responsibilities of the ISSB

The ISSB has comprehensive control over all sustainability-related technical aspects of the IFRS Foundation, which includes:

  • Full discretion in developing its technical agenda, subject to specific consultation requirements.

  • Preparation and issuance of IFRS Sustainability Disclosure Standards and exposure drafts following the IFRS Foundation's due process, akin to that of IFRS Accounting Standards.

5.3 ISSB Aims

The ISSB aims to deliver a global baseline of sustainability-related disclosure standards for informing investors and other capital market participants about sustainability-related risks and opportunities. They will build upon existing investor-focused reporting initiatives, having issued their first two Standards in June 2023.

IFRS S1 - An Underpinning Standard

6.1 Overview

IFRS Sustainability Disclosure Standard 1 (IFRS S1) establishes general reporting requirements, functioning as an underpinning standard—similar to how IFRS 18 relates to presentation and disclosure in financial statements. This includes conceptual foundations rooted in the qualitative characteristics outlined in the Conceptual Framework.

6.2 Objective of IFRS S1

IFRS S1 obliges entities to disclose information concerning sustainability-related risks and opportunities that are useful to primary users of general purpose financial reports for making informative resource allocation decisions. This relates to an entity's ability to generate cash flows and the interactions between the entity, stakeholders, society, economy, and the natural environment along the entire value chain.

Definitions:

  • Value Chain: The complete range of interactions, resources, and relationships associated with a reporting entity's business model and its external environment.

  • Business Model: An entity's method of converting inputs into outputs and outcomes intended to fulfill strategic objectives and create value over time, thus generating cash flows in the short, medium, and long term.

6.3 Scope of IFRS S1

IFRS S1 is applicable to sustainability-related financial disclosures in compliance with IFRS Sustainability Disclosure Standards, regardless of whether the financial statements are constructed per IFRS Accounting Standards or other GAAP. Sustainability-related risks and opportunities that are not reasonably expected to impact an entity's prospects fall outside the scope of this Standard. Terminology is primarily suited for profit-oriented entities, thus adjustments may be necessary for not-for-profit entities.

6.4 Conceptual Foundations of IFRS S1
6.4.1 Qualitative Characteristics

Sustainability-related financial disclosures form part of general purpose financial reports, thus applying the qualitative characteristics detailed in the Conceptual Framework, which are:

  • Fundamental: Relevance, Faithful representation

  • Enhancing: Comparability, Verifiability, Timeliness, Understandability

6.4.2 Materiality

Key Point: An entity must disclose material information about sustainability-related risks and opportunities that could impact the entity's prospects.

6.4.3 Connected Information

Connected information is required for sustainability-related financial information, aiming to enable users to comprehend connections between:

  1. The items the information relates to (e.g., risks and opportunities).

  2. Disclosures within sustainability-related financial disclosures and across other general purpose financial reports, such as related financial statements.

6.5 Core Content of IFRS S1

  • Governance: Processes and controls to oversee sustainability-related risks.

  • Strategy: Strategic management of sustainability-related risks and opportunities.

  • Risk Management: Processes for identifying, assessing, prioritizing, and monitoring sustainability-related risks and opportunities.

  • Metrics and Targets: Performance metrics and progress toward targets required by laws or regulations.

6.5.1 Governance

Disclosures must provide clarity on:

  • Oversight by the governance body.

  • Management roles in governance processes.

6.5.2 Strategy

Disclosures should illuminate:

  • The nature of risks and opportunities affecting prospects.

  • Their effects on business and value chain; strategy, decision-making; financial position, performance, cash flows;

  • Resilience of strategies to sustainability risks.

6.5.3 Risk Management

Required disclosures about:

  • Policies and processes for identifying and assessing sustainability-related risks and opportunities.

  • Integration of these processes with the overall risk management strategy.

6.5.4 Metrics and Targets

Entities should detail the metrics utilized for:

  • Measuring and monitoring risks or opportunities.

  • Progress against any legally mandated targets or those set by the entity itself.

6.6 General Requirements of IFRS S1

General requirements for disclosures aimed at primary users include:

  • Sources of guidance and relevant frameworks including other standards.

  • Disclosure locations within general purpose financial reports; reports to be issued concurrently with related financial statements for the same period.

  • Required comparative information, unless specified otherwise.

  • Explicit statement of compliance with the applicable standards.