The IASB issued IFRS 1 First-time Adoption of International Financial Reporting Standards in 2003. Under IFRS 1, entities switching to IFRS Standards must apply those standards in full, with some limited transitional modifications. The Basis for Conclusions on IFRS 1 describes the decision-making framework the IASB used in deciding what transitional modifications to include in IFRS 1.
In 2003, the IASB expected that this decision-making framework would not, in most cases, lead to the transitional modifications being the same as the transitional provisions that individual IFRS standards specify for entities already applying IFRS Standards. But, contrary to that expectation, the IASB has since 2003 often put into IFRS 1 transitional modifications that are the same as transitional provisions in new or amended individual Standards.
That outcome suggests that IASB Board members are now either supplementing the framework with other factors not discussed there, or not paying much attention to that framework. Perhaps IASB Board members no longer know why transitional modifications in IFRS 1 may need to differ from transitional provisions in individual IFRS standards.
This post provides a reminder of what that framework is, under the following headings:
- basic principles
- factors that might justify an exemption or exception
- factors not normally justifying an exemption or exception
- new exemptions and exceptions after 2003
Some terms used in this post
First IFRS financial statements: the first annual financial statements in which an entity adopts International Financial Reporting Standards (IFRSs) by an explicit and unreserved statement of compliance with IFRS Standards
First-time adopter: an entity that presents its first IFRS financial statements
Date of transition to IFRSs: the beginning of the earliest period for which a first-time adopter presents full comparative information in its first IFRS financial statements
Opening IFRS balance sheet: a first-time adopter’s statement of financial position at the date of transition to IFRSs
IFRS 1 First-time Adoption of International Financial Reporting Standards governs how companies must switch to IFRS Standards when they adopt those standards for the first-time. Under IFRS 1, first-time adopters must apply those IFRS Standards that are in effect at the end of the latest reporting period covered by their first IFRS financial statements—though with some limited transitional modifications.
IFRS 1’s transitional modifications differ from the transitional provisions in individual IFRS standards for entities that are already applying the whole body of IFRS Standards. Those transitional modifications are of 2 kinds:
- exemptions: optional modifications that a first-time adopter may elect to use; and
- exceptions: modifications that a first-time adopter must use.
When the IASB issues or amends an IFRS Standard, it considers case by case whether a first-time adopter should apply the changes retrospectively (without modification) or prospectively (with some modification). In principle, that assessment is separate from the IASB’s assessment of whether transitional provisions are needed for entities. Those assessments are separate because they consider different factors.
In 2003, the IASB developed some basic principles underlying the main decisions it made then on including transitional modifications in IFRS 1. The Basis for Conclusions on IFRS 1 summarises those basic principles (in paragraphs BC10, BC14 and BC27):
- the IASB’s primary objective was ‘to achieve comparability over time within a first-time adopter’s first IFRS financial statements and between different entities adopting [IFRS Standards] for the first time at a given date’.
- although the IASB also had an objective of achieving comparability between first-time adopters and entities that already apply IFRS Standards, that objective was only secondary.
- IASB considered benefits and costs in deciding whether to require, permit or prohibit retrospective application. In balancing benefits and costs, the IASB ‘took as its benchmark an entity that plans the transition well in advance’. With such planning, an entity could ‘collect most information needed for its opening IFRS balance sheet at, or very soon after, the date of transition to IFRSs.’
- the IASB ‘expects that retrospective application will be appropriate in most cases, given its primary objective of comparability over time within a first-time adopter’s first IFRS financial statements.’ [emphasis added]
Retrospective in most cases
The IASB concluded that retrospective application would be appropriate in most cases. In my view, 2 factors drove that conclusion:
- the emphasis on comparability within an entity’s first IFRS financial statements. Prospective application of a new (or amended) standard during the periods covered by those first financial statements would add an extra layer of change in those financial statements.
Coming on top of the change resulting from the entity’s switch to IFRS Standards, that extra layer of change would add complexity for users of financial statements and disrupt users’ ability to understand an entity’s financial performance and financial position.
- the assumption that first-time adopters plan the switch to IFRS early—early enough that they can collect most information needed for the opening IFRS balance sheet at, or very soon after, the date of transition to IFRS.
Factors that might justify an exemption or exception
Paragraph BC12 of the Basis for Conclusions explains that the IASB might provide:
- an exemption from applying an IFRS Standard retrospectively if retrospective application would be difficult or would involve costs exceeding the likely benefits.
- an exception prohibiting retrospective application in some cases when management might need to make judgements about past conditions. Requiring retrospective judgements might permit abuse if management already knows the outcome of a particular transaction.
Factors not normally justifying an exemption or exception
Paragraph BC13 discusses 3 other reasons underlying requests to permit or require prospective application in some cases:
- to alleviate unforeseen consequences if another party uses financial statements to monitor compliance with a contract or agreement.
- to give a first-time adopter the same accounting options as an entity that already applies IFRS Standards.
- to avoid difficult distinctions between changes in estimates and changes in the basis for making estimates.
As explained below, the IASB considered (in 2003) that those factors would not generally justify prospective application.
Some people suggested that the IASB should provide exemptions from applying an IFRS Standard retrospectively to avoid unforeseen consequences if another party uses financial statements to monitor compliance with a contract or agreement. The IASB did not provide such exemptions. In the IASB’s view, it would be ‘up to the parties to an agreement to determine whether to insulate the agreement from the effects of [future changes to IFRS Standards] and, if not, how they might renegotiate [the agreement] so that it reflects changes in the underlying financial condition rather than changes in reporting’. (see also paragraph 13 of the Preface to IFRS Standards)
Same accounting options as other entities
Some people suggested that the IASB should give first-time adopters all accounting options available to entities that already apply IFRS Standards. However, to avoid conflicts with the IASB’s primary objective of comparability within a first-time adopter’s first IFRS financial statements, the IASB did not adopt that suggestion.
Changes in estimates
Sometimes, retrospective application of a new (or amended) standard would require difficult distinctions between changes in estimates and changes in the basis for making estimates. If an entity had not made the necessary estimate for an earlier date, making that estimate retrospectively for that date may be difficult and subject to bias.
This difficulty does not arise for first-time adopters if—as the IASB assumed—they can collect most information needed for their opening IFRS balance sheet at, or very soon after, the date of transition to IFRS. Thus, the IASB provided no exception or exemption on these grounds.
In general, first-time adopters may elect not to use exemptions provided by IFRS 1. However, to avoid abuse of retrospective estimates, IFRS 1 requires a first-time adopter to use some of the exemptions in some or all cases (eg for derecognition of financial instruments).
New exemptions and exceptions after 2003
In issuing IFRS 1, the IASB said that it expected that it would, ‘in most cases’, require first-time adopters to apply IFRS Standards retrospectively. For 2 main reasons, that expectation has perhaps not been met in the 19 years since then:
- it soon became apparent that there is often a need for one type of short-term exemption not identified in developing IFRS 1.
- the IASB appears to have given more weight than it originally expected to creating a level playing field between first-time adopters and entities already applying IFRS Standards.
As noted above, in assessing costs and benefits, the IASB’s benchmark was an entity that plans the transition well in advance. Such an entity can collect most information needed for its opening IFRS balance sheet at, or very soon after, the date of transition to IFRS.
However, suppose the IASB issues or amends a Standard during the periods covered by a first-time adopter’s first IFRS financial statements. The first-time adopter may not be able to set up systems needed to gather the information to apply the new or amended Standard in its opening IFRS balance sheet. In such cases, if entities adopt IFRS Standards shortly after the publication of the new or amended Standard, they may need a short-term exemption. That short-term exemption might need to be the same as for entities already applying IFRS Standards, or it might need to differ.
The need for such short-term exemptions arises quite often, and they have only a short shelf life. As a result, in restructuring IFRS 1 in 2008, the IASB added a separate appendix housing those exemptions. The IASB reviews that appendix periodically. It then deletes those short-term exemptions which (because of the passage of time) can no longer affect future first-time adopters.
Level playing field
It seems that the IASB has become more receptive over time to level-playing field arguments than it had expected in 2003. Re-expressing the IASB’s 2003 thinking in slightly different words:
- if the IASB provides an exemption to entities already applying IFRS Standards, it would not routinely provide the same exemption to first-time adopters.
- the IASB would consider separately whether first-time adopters need that exemption (or, indeed, some other exemption). Creating an exemption would often conflict with the IASB’s primary objective. So, in most cases, the IASB would conclude that first-time adopters do not need an exemption.
In practice, the IASB seems to have moved to a different approach:
- if the IASB provides an exemption to entities already applying IFRS Standards, it often provides the same exemption to first-time adopters. Doing this creates a level playing field. This is perhaps now the IASB’s default setting—unlike in 2003.
- if the IASB thinks that first-time adopters do not need the exemption, it might not give them an exemption. When IASB Board members assess whether first-time adopters need an exemption, it is not always clear whether their assessment is still based rigorously on the same basic principles set out in the Basis for Conclusions on IFRS 1.
The Basis for Conclusions on IFRS 1 describes the decision-making framework the IASB used in 2003 in deciding what exemptions and exceptions to provide for first-time adopters.
It has since become clear that this framework was an incomplete basis for future decisions. It did not identify one common need for short-term exemptions. That need arises when a new (or amended) Standard comes into effect during the periods covered by a first-time adopter’s first IFRS financial statements.
As far as I am aware, the framework is still valid in all other respects. I expect it to produce appropriate decisions. However, the IASB seems to have moved towards a default practice of giving first-time adopters the same exemptions (and exceptions) as it gives to entities already applying IFRS Standards. It is not clear whether the IASB still considers, and applies rigorously, the framework described in the Basis for Conclusions on IFRS 1. Applying that framework in a disciplined way might lead to more efficient decision-making and more appropriate decisions.
That framework might also help the IASB in another way. Some components of that framework might form a suitable basis for developing some components of a framework for making decisions about transition by entities already applying IFRS Standards. To the best of my knowledge, the IASB does not have such a framework.