5 KEYS FOR UNLOCKING AN UNDERSTANDING OF AN INTERNATIONAL FINANCIAL REPORTING STANDARD (IFRS)

The International Financial Reporting Standards (IFRSs) are the ‘in-thing’ in the world of accounting. With the promulgation of the Financial Reporting Act 2011 (which repealed the Nigerian Accounting Standards Board Act, No 22 of 2003), Nigeria as a nation, joined the bandwagon of

countries (more than 150 countries) who have adopted the standards in it entirety or in slightly modified form as the de-facto principles guiding the accounting treatments given to items of transactions and events; and the standards guiding the preparation and presentation of financial statements.

This behoves on any accounting students and practicing professional accountants alike to keep abreast of the latest standards as well as the amendments to the subsisting ones. A thorough understanding of the standards is also required in their application to items of transaction and event. This in effect makes accounting a dynamic profession as against it static outlook of yesteryears because it is evolved to keep abreast of changes in economic circumstances within the business world.

Against this backdrop, a thorough understanding of each standard is compulsory for every ICAN student especially those writing financial accounting at foundation level, financial reporting at application level and corporate reporting at professional level of the Institute of Chartered Accountants of Nigeria's exams. To facilitate such understanding, this article streamlines and profiles the ‘architectural design’ of IFRS or the’ template’ used by the developer of IFRS that is, the International Accounting Standards Board (IASB) to come up with the standards. These are examined in these 5 keys for unlocking an understanding of an IFRS.

Key 1: DEFINITION: MATERIAL WORDS ARE DEFINED

In every IFRS there are definitions of terms and technical words used in the standard. This usually starts with the definition of the key word in the standard that serves as the centrepiece. For example, IAS 16, Property, Plant and Equipment has as it key word the title it bears i.e. Property, Plant and Equipment (PPE).

In most definition of the key word in a standard, there is usually found an allusion to the nature of the item, its purpose and the timing. By its nature, the standard tries to state whether the item under consideration is an asset or otherwise, and tangible or intangible. Its purpose is premised on whether it is for use in the ordinary course of business, for sale or for maintenance purpose. While timing refers to whether the item will be available for use within 1 period or more than a period i.e. short term or long term.

To illustrate this, considered the definition of PPE according to IAS 16 where they are defined as  tangible items that are held for use in the production or supply of goods or services, or for rental to others, or for administrative purposes and are expected to be used during more than one period. In this definition, the nature of PPE is given as ‘tangible’, their purpose is ‘held for use in the production or supply of goods’ and their timing is given as ‘during more than one period’

Other terms associated with the key word are also defined in every standard issued by the IASB.

Key 2: RECOGNITION CRITERIA: WHEN AND HOW ARE TRANSACTIONS RECORDED?

Every standard usually states how an item of transaction or event is recognized. Recognition answers the questions: Should the item be brought into the book of accounts i.e. recorded? And secondly, it asks what should it be recorded as if it is to be brought into the book of accounts? Should it be recorded as an asset, liability, expense or revenue? In a succinct language, recognition answers the question: should it be capitalized or expensed?

Recognition issue refers to the difficulty of deciding when and how a business transaction should be recorded. The point at which transaction is recorded in the book of accounts is the RECOGNITION POINT. For instance, should revenue be recognized at the point when a sales order is received, goods sent to the customer, invoice raised or money is received.

Every standard gives the criteria or bases or benchmark for determining whether to accord recognition to the item under consideration or not. According to the Framework, every item of transaction and event can be accorded recognition if:

a.       There is probability that the future economic benefits from such item of transaction or event will flow either directly or indirectly to or from the entity. Note that the future economic benefits here refer to quantifiable benefits measured in monetary terms such as revenue, net cash flow, net income etc.

b.      The reliability of measurement of the cost attributable to the item of transaction.

For example, consider this transaction:

Kwara United FC, a football club registered in Nigeria signed a player by name Agboola Chukwuma in the transfer window of 2013/2014 season for a sum of =N=1.5 million, from Shooting Star FC.  This registration or transfer is to be settled by Kwara United FC in three instalments over a period of 18 months.

Here is the question: Should this transaction be recognized in the book of accounts of Kwara United FC?

To answer this question the recognition criteria questions would have to be answered:

1.      Is there a probability of future economic benefits from the item of transaction directly or indirectly to Kwara United FC?

2.      Can the cost attributable to the item be reliably measured?

Looking keenly at this scenario it can be deduced that this transaction satisfies the two recognition criteria. Registration or transfer fee is usually paid for the acquisition of a player by a football club from another. To any club, players constitute its prized assets and in the scenario above, a player – Agboola Chukwuma – is the item of transaction. Since, the club will likely feature this player on the field of play, and he (the player) will contribute his part towards winning matches for the club; we can safely conclude that there is a probability that future economic benefits will flow to Kwara United FC directly from the use of the player and possibly, directly from his sale in the future. Thus, this transaction can be recognized as an asset in the book of accounts possibly with the heading “Registration of Player”. In addition, the cost attributable to the “Registration of Player” can be reliably measured. Here no soothsayer is required to figure out the cost as =N1.5 million.

Key 3: MEASUREMENT CRITERIA: AT WHAT VALUE SHOULD ITEM BE RECORDED?

Measurement is the act of assigning value to an item of transaction or event. It answers the question: Can it be reduced to a currency value (i.e. naira or dollar value) or can it be reliably quantified using currency as the unit of measure? Measurement deals with the value placed on an item at both the point of recognition and as well as subsequent periods after this time. Measurement is the basis of valuation.

The criteria for measurement in most IFRSs are premised on:

a.       Time of measurement: The time of measurement refers to the point in time when a value is placed or attributed to an item deemed worthy of recognition. The point in time can be both at Initial Recognition and subsequently after recognition.

b.      Bases of measurement: The bases of measurement refer to the fundamental assumptions from which the value placed or attributed to an item is calculated or derived. The underlying assumptions or bases can be any of the following: Historical cost, Fair value or Revalued amount, Market value, Net Realizable value, Replacement cost and Deprival value.

Note that measurement tries to answer the question of what value to attach to an item upon recognition and subsequently after. This may seem an easy task on face value but when view deeply it will be easy to recognize that there are varying values competing to be attributed to an item upon recognition.

For example, XYZ ltd purchased a second-hand Mazda 626 from company ABC plc for a sum of =N=0.8 million. At the exact time of purchase various other information and data were available. The same vehicle of the same make with the same number of millage covered can be bought from an open market for the sum of =N=0.9 million. Similarly, a professional auto dealer hinted the company that the vehicle was somewhat over-priced that it ought to go for =N=0.75 million as against a price of =N=0.8 million. The management of the organization (i.e. XYZ ltd) were of the opinion, based on expert advice, that the vehicle could be replaced for a price of =N=0.85 million. While the company’s insurer insured it for a sum of =N=0.72 million. The question is, among the arrays of values we are presented with, which should be accorded to the vehicle upon recognition?

Key 4: WHAT INFORMATION SHOULD BE DISCLOSED?

Each standard also includes a section on disclosure. Disclosure answers the question: What should be included with respect to the item in question in both the financial statements and/or notes to the accounts. It is the revealing of all the various aspects and important information about the item of transaction and event.

Disclosure is the act of making something evident about an item. Disclosure deals with the information and other items to be shown in the financial statements as regards the item under consideration. Disclosure for example with respect to an item of property, plant and equipment could include information such as the basis of measurement, depreciation method, depreciation rate etc

Key 5: HOW IS THE ITEM TO BE PRESENTED IN THE FINANCIAL STATEMENTS?

Presentation deals with how items of expense, revenue, liability and asset are laid out in the financial statements. For example, grant can be presented in one of two ways according to IAS 20, Accounting for government grants and disclosure of government assistance: It can either be presented as deferred income and recognized as income yearly over the useful life of the asset on a systematic and rational basis, or the grant can be deducted before arriving at the carrying amount of the asset.

CONCLUSION

Some of the standards usually include derecognition criteria. Derecognition is the cessation of the initial recognition accorded the item as an asset. Derecognition could occur when the asset is disposed, or when no future economic benefits are expected from the use of the item or its disposal.

These points should help an average reader of the IFRS to comprehend the standard. It is just a matter of answering the questions: what is the definition accorded to the cogent terms in the standard, what are the recognition criteria for the item, at what value is it to be brought into the book of accounts, what are the information about the item that need to be disclosed or shown in the financial statements, how is the item to be presented in the financial statements and the derecognition criteria to be accorded the item.