The Consequences of Adoption of International Finance Reporting Standards in Australia

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Introduction

International Finance Reporting Standards (IFRS) is a set of accounting regulations that have been developed and adopted by the International Accounting Standard Board. The standards have been developed from the International Accounting Standards (IAS). The Australian decision to adopt IFRS has caused significant changes in the accounting procedures and reporting in Australia. The adoption was expected to be done through the Australian equivalents of International Financial Reporting Standards (AIFRS). The adoption and use of the standards were to commence on 1 January 2005. The adoption and subsequent introduction of the equivalents of International Financial Reporting Standards have changed the accounting standards and practices in Australia (Alfredson, 2003, pp. 3-7).

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The recognition of assets, revenue, liabilities, expenses, and equity to be included in financial statements and their measurements had been changed. These changes have impacted the reporting standards of APRA’s authorized deposit-taking institutions (ADIs), life companies, friendly societies, and general insurers. The changes have also affected superannuation entities as well as an approved trustee. The adoption of IFRS has limited a variety of tools that can be considered as Tier 1 capital for Authorised deposit-taking institutions and general insurers. The adoption of IFRS principles has altered the normal Australian standards regarding the Purchase and Supply of Assets such as securities issued by special purpose vehicles. Adoption of IFRS has resulted in increased instability to an institution’s financial position which must be attuned in prudential reporting to provide a true representation of the organization’s fundamental capital strength (Hulle, 1993a, pp. 54-59).

Problems that faced the adoption of IFRS in Australia

The adoption of IFRS accounting regulations in Australia in 2005 has been criticized as having come too soon for entities to prepare adequately for the changes. The adoption of the accounting principles has however been faced with some problems. These problems arise from the differences between the IFRS and Australian accounting standards regarding the process of accounting for income taxes, accounting for intangibles as well as accounting for defeasance. Some IFRS principles have no corresponding standards with Australian accounting principles such as accounting for agriculture and accounting for share-based payment. The adoption of IFRS has resulted in the emergence of new differences stemming from the revision of the AASB principles. The differences have created new problems of uncertainty. Another problem that has cropped up has been due to the disparity between the application of the true and fair view principle in IFRS and APRA. The true fair value of the IFRS has been overriding. Some organizations’ financial statements do not show the true and fair view after using IFRS. This has resulted in the organization abandoning the principles so that their statements can reflect the true and fair view of the organization (Thorell & Whittington, 1994, pp. 215-239).

Issues that created problems with the application of IFRS in Australia

IFRS is composed of many standards that formed the International Accounting Standards (IAS). In course of the change, some accounting principles were changed. The changes resulted in some problems in adopting the new principles. Australian accounting body was faced with such challenges. These challenges include problems on the classification of instruments, de-recognition of financial assets and consolidation of special purpose vehicles (SPVs), measurement of derivative instruments and hedge accounting, and measurements of financial assets and financial liabilities (Roberts, Weetman & Gordon, 2002, pp. 23-25).

The IAS definition of financial instruments was replaced by a new meaning of the same upon adoption of IFRS, the disclosure and presentation of equity changed. Adoption of IFRS resulted in the classification of hybrid instruments and some preference shares formally categorized as equity being classified as liabilities. Under the Australian Generally accepted accounting principles, an instrument qualifies to be an item of Authorised Deposit-taking Institution’s Tier 1 capital under APS 111, it must be classified as equity under the Australian GAAPs. IFRS does not recognize the Guidance notes which guide the issue of the capital instrument by APRA and authorized nonoperating holding companies. This principle, therefore, contradicted the Australian generally accepted accounting principles. In general, the adoption of International Finance Reporting Standards could have limited the varieties of instruments that could have qualified as Tier 1 capital for general insurers and ADIs. To lessen the implication of this problem, the Australian accounting body (APRA) however decided that all capital instruments that had been approved by APRA before 31 March 2004 and which were prone to negative impacts by the introduction of IFRS were to be eligible for a transitional arrangement that may be considered regarding the items included in the Tier 1 capital (Howieson, & Langfield 2003, pp. 17-26).

The adoption of IFRS in Australia meant that recognition and measurement of the financial instrument would change. This is because IFRS introduced severe requirements for the de-recognition of financial assets that were traded through securitization by special purpose vehicles. This could have resulted in financial assets such as mortgages being included as an item of the balance sheet. IFRS recommendations were that any financial asset that had been removed from the balance sheet before 1 January 2004 should not be included back onto the balance sheet of that organization if it does not meet the de-recognition test upon acceptance of AASB 139. Upon acceptance of the IFRS the already in place, securitization arrangements faced the challenge of lack of a good sale and divisional needs of prudential standards APS 120. This would have a significant negative impact on ADIs in their involvement in the securitization process in terms of prospective capital administration. This is because these financial assets might not be allowable to capital relief on loans that might be de-recognized after 1 January 2004. APRA maintained that ADIs should recognize and accept Australian accounting standards that were in use as of 31 December 2004 to the issue of ‘clean sale’ and ‘separation’ needs of Prudential Standards APS 120 (Hickey, Spencer, van Zijl & Perry, 2003b, pp. 12-19).

Another potential problem that was brought about by the adoption of IFRS was the measurements of derivative instruments and hedge accounting. According to AASB 139, the derivative instruments were supposed to be measured at fair value and be treated as an item of the balance sheet. This represents a change in the way these assets are recorded. The measurements of these derivative instruments will be done on- balance sheet as opposed to a balance sheet as it used to be (Chisnall, 2003, p. 83).

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The requirement for treatment of these assets by IFRS collided with the requirements of AASB 139 which brought in strict requirements for hedge risk derivative exposures to qualify for hedge accounting. These hedges that meet the requirements for hedge accounting are most likely to be considered as either cash flow hedges or fair value ones. Fair value hedges allow the conversion of fixed cash flows into variable cash flows. Gains or losses in these hedges are reported as either profit or loss in equity. Under IFRS, hedges are treated significantly differently than the accounting practice issued under AASB. The adoption of IFRS in Australia affected the methods and criteria used to measure financial assets and financial liabilities. AASB 139 allowed the entities to choose specific classifications for the financial assets it would hold for trading and financial liabilities. Each category was accorded its own accounting rules for assessment and reporting which included either use of fair value or amortized cost (Nobes, 1993, p. 93).

The classification labeled available for sale uses fair value measurements with fair value profits and losses unrealized inequity and transferred directly to profit and loss once realized. The use of IFRS has resorted to implications for accounting reporting systems in terms of profit and losses as well as the balance sheet. General insurers, friendly societies, and life companies use the application of fair value measurements to the measurements of their financial assets. The change of accounting principles from IASs to IFRS created problems in the Australian accounting principles, and hence there was a need to amend them to be in line with the Australian accounting requirements (Haswell & McKinnon, 2003, pp. 8-16).

Difficulties by GCC when adopting the IFRS

Gulf Cooperation Council (GCC) is a cooperation of six Arab states from the Persian Gulf region with similar social and economic objectives. These states include Bahrain, Oman, Saudi Arabia, Kuwait, Qatar, and United Arab Emirates. The GCC country’s economies are dominated by small and medium-sized enterprises. This has made it easy for these countries to adopt IFRS. In Oman (for example) 80 to 85 percent of the companies are small and therefore the application of IFRS was mandatory by the end of 2009. According to the research was done by Al-Shammari, Brown, and Tarca, compliance with IFRS was highest in Oman and Kuwait. Other member countries were reluctant to adopt IFRS as a whole and some adjustments were to be made to their accounting standards to reflect IFRS standards. According to the Kuwait Association of Accountants and Auditors (KWAAA), all entities in Kuwait are required to adapt to IFRS standards in their financial reporting. These entities are supposed to adopt these standards within the time frame that was given by International Accounting Standards Board (Tay & Parker, 1990, pp. 71-88).

Reference List

Alfredson, K., 2003, Pathway to 2005 IASB Standards. Australian Accounting Review, Vol. 13, No.1, pp. 3 – 7.

Chisnall, P., 2003, Financial Reporting: Financial Instruments – a Final Opportunity On IAS 32 and IAS 39. Accountancy, Vol.132, No.1322,p. 83.

Haswell, S., & McKinnon, J., 2003, IASB Standards for Australia by 2005: Catapult Or Trojan Horse? Australian Accounting Review, Vol.13, No.1, pp. 8 – 16.

Hickey, L., Spencer, J., van Zijl, T., & Perry, J., 2003, Financial Reporting – Now and in 2005. Chartered Accountants Journal, Vol. 82, No. 6, pp. 12 – 19.

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Howieson, B., & Langfield, S. I. (2003). The FRC and Accounting Standard-Setting: Should I Still Call Australia Home? Australian Accounting Review, Vol.13, No.1, pp.17 – 26.

Hulle, V. K., 1993, Harmonisation of Accounting Standards in the EC: Is it the Beginning or is it the End? European Accounting Review, Vol. 2, No.2.

Nobes, C.,1993, The True and Fair View Requirement: Impact on and of the Fourth Directive. Accounting and Business Research, Vol. 24, No. 93.

Roberts, C., Weetman, P., & Gordon, P., 2002, International Financial Accounting – A Comparative Approach (2nd Ed.). Harlow: Pearson Education Limited.

Simpkins., 2003, Not-for-Profit Faces IFRS. Chartered Accountants Journal, Vol. 82, No. 6, pp.23 -25.

Tay, J., & Parker, R.,1990, Measuring Harmonisation and Standardisation. Abacus, 71 – 88.

Thorell, P., & Whittington, G..,1994, The Harmonisation of Accounting within the EU Problems, Perspectives and Strategies. European Accounting Review, Vol. 3, No. 2, pp. 215 -239.

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