Understanding IFRS: A Comprehensive Guide

The International Financial Reporting Standards (IFRS) are a set of accounting standards developed by the International Accounting Standards Board (IASB). They are becoming the global standard for the preparation of public company financial statements. This blog post aims to provide a comprehensive summary of some key aspects of IFRS.

Correcting Prior Period Errors

Under IFRS, an entity must correct material prior period errors retrospectively in the first set of financial statements authorized for issue after their discovery. These corrections involve adjusting the opening balances of assets, liabilities, and equity for that period. The financial statements are presented as if the error had never occurred. Only when it’s impracticable to determine the cumulative effect of an error on prior periods can an entity correct an error prospectively.

Share-based Payment

IFRS 2 addresses the accounting for share-based payment transactions. An entity might modify its share options, for example, by repricing them or by changing them from cash-settled to equity-settled. For instance, if there is a downturn in the equity markets, an entity may modify its share options by reducing the exercise price. Reducing the exercise price would cause the fair value of the share-based payment to increase. IFRS 2 requires that this increase in value must be recognized over the remaining period until the options vest.

Cancellation and Reissuance of Share Options

An alternative to re-pricing the share options is to cancel them and issue new options based on revised terms. The end result is essentially the same as an entity modifying the original options and therefore should be recognized in the same way. Cancellations by the employee must be treated in the same way as cancellations by the employer, resulting in an accelerated charge to profit or loss of the unamortized balance of the options granted. 

Fair Value Measurement (IFRS 13)

IFRS 13 provides guidance on measuring fair value for various assets and liabilities. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Key points include:

Market Approach: This approach uses prices and other relevant information from market transactions. It’s particularly useful for quoted instruments like stocks and bonds.

Income Approach: This approach estimates fair value based on the present value of expected future cash flows. It’s commonly used for valuing businesses and intangible assets.

Cost Approach: This approach considers the cost to replace an asset. It’s relevant for unique or specialized assets.

Leases (IFRS 16)

IFRS 16 significantly changed lease accounting. It requires lessees to recognize most leases on their balance sheets as right-of-use assets and lease liabilities. Key points include:

Right-of-Use Assets: Lessees recognize an asset representing their right to use the leased item (e.g., office space, equipment) during the lease term.

Lease Liabilities: Lessees also recognize a liability for their obligation to make lease payments.

Interest and Depreciation: Over the lease term, lessees amortize the right-of-use asset and recognize interest expense on the lease liability.

Revenue Recognition (IFRS 15)

IFRS 15 outlines principles for recognizing revenue from contracts with customers. Key points include:

Five-Step Model: The standard provides a five-step model for revenue recognition: identify the contract, identify performance obligations, determine transaction price, allocate the price to performance obligations, and recognize revenue when performance obligations are satisfied.

Variable Consideration: If the transaction price includes variable consideration (e.g., discounts, bonuses), estimate it based on expected value or most likely amount.

Contract Modifications: When contract terms change, adjust revenue recognition accordingly.

Impairment of Assets (IAS 36)

IAS 36 provides guidance on assessing and recognizing impairment losses for assets. Key points include:

Impairment Test: Entities must assess whether an asset’s carrying amount exceeds its recoverable amount. If it does, an impairment loss is recognized.

Recoverable Amount: The higher of an asset’s fair value less costs of disposal and its value in use (present value of expected future cash flows).

Cash-Generating Units: Impairment is assessed at the level of cash-generating units (CGUs), which are the smallest identifiable groups of assets that generate cash inflows.

Employee Benefits (IAS 19)

IAS 19 covers accounting for employee benefits such as pensions, post-employment benefits, and other long-term employee benefits. Key points include:

Defined Benefit Plans: Entities must measure the defined benefit obligation and plan assets. Actuarial assumptions play a crucial role.

Service Cost: Recognize the cost of providing benefits during the period as an expense.

Net Interest: Recognize net interest on the net defined benefit liability (asset) or expense.

Financial Instruments (IFRS 9)

IFRS 9 addresses accounting for financial instruments. Key points include:

Classification and Measurement: Financial assets are classified into three categories: amortized cost, fair value through other comprehensive income (FVOCI), and fair value through profit or loss (FVPL).

Impairment: IFRS 9 introduces the expected credit loss model for recognizing impairment losses on financial assets.

Hedge Accounting: Entities can apply hedge accounting to manage risk exposure.

IAS 1 - Presentation of Financial Statements:

IAS 1 provides guidelines for the presentation of financial statements. It covers topics such as the structure of financial statements, disclosure requirements, and the classification of assets and liabilities.

IAS 2 - Inventories:

IAS 2 outlines the accounting treatment for inventories (such as raw materials, work-in-progress, and finished goods). It includes guidance on measurement, cost formulas, and impairment.

IAS 7 - Statement of Cash Flows:

IAS 7 sets out the requirements for presenting a statement of cash flows. It helps users understand an entity’s cash inflows and outflows during a specific period.

IAS 8 - Accounting Policies, Changes in Accounting Estimates, and Errors:

IAS 8 addresses accounting policies, changes in estimates, and correction of errors. It emphasizes consistency in applying accounting policies and provides guidance on handling changes and errors.