IFRS adoption – first lessons learned
As of January 2017 we have seen an increase in the number of companies that prepare their financial statements in accordance with the International Financial Reporting Standards, either in order to comply with their legal obligation or exercising their right to do so.
2016 was a year of preparation for IFRS accounting for these entities, and we (as auditors and advisors) had the opportunity to monitor the preparations of a number of companies. Our experience suggests that transition to IFRS accounting presented a major challenge even for those companies which had prepared IFRS financial statements or so-called IFRS reporting packages for group consolidation purposes even before the transition.
The preparation for transition mostly concerns the accounting department; however, it cannot be considered a purely accounting task as it impacts all of the company's functions, including business, risk management, legal, finance and IT areas, as well as HR. In our experience, even balance sheet items which had seemed simple in terms of transition often caused difficulties, and resolving the issue required cooperation among multiple areas. For instance, there were entities which faced challenges in managing the significant volume of tangible assets which were written down to zero but were still in use. For property, plant and equipment and intangible assets, some companies even had to seek assistance by their engineers and IT experts in order to perform the annual review of useful lives. For several companies, processes which are required for disclosures concerning related parties could be developed only with the help of the legal department.
Based on our experience, issues were often encountered in the following areas:
- Tangible assets (assets written down to zero but still in use, component-based measurement, regular review of depreciation)
- Capitalisation and measurement of intangible assets
- Recognition of government grantsFree-of-charge shareholder services and transfers of assets
- Determining the amortised cost of loans received and granted
- Determining the impairment of trade receivables
- Treatment of investments in subsidiaries, associates and joint ventures under IFRS
- Hedge accounting
Issues involving the derecognition of loans received and granted
Even after obtaining the auditor's report which confirms readiness for transition to IFRS, there was still a long way to go in terms of preparations. For most companies, IT development and testing and the preparation of the required policies continued until the date of transition.
In summary, transition to IFRS accounting is not only an exceptionally complex and time-consuming endeavour, but it's also a challenge which an isolated accounting area is unable to cope with by itself, meaning that the entire company needs to adopt the IFRS way of thinking.
We are certain that the number of entities opting for reporting under IFRSs will increase considerably in the coming years. The key points of adopting IFRS reporting are summarised below:
The legislative background of transition to IFRS as the primary accounting basis is set forth in Act C of 2000 on Accounting (hereinafter: "Accounting Act").
Under Section 9/A of the Accounting Act, affected companies fall into one of two main categories depending on whether the preparation of annual financial statements under IFRS is mandatory or optional for them:
- The following entities are required to prepare their annual financial statements in accordance with IFRSs (mandatory):
- entities whose securities are listed on a regulated market of any Member State of the European Economic Area, starting from 2017;
- credit institutions, as well as financial enterprises subject to prudential requirements equivalent to those applying to credit institutions, starting from 2018.
The following entities may prepare their annual financial statements in accordance with IFRSs (optional):
- entities whose direct or indirect parent company prepares its consolidated annual financial statements in accordance with IFRSs;
- insurance companies;
- other institutions supervised by the National Bank of Hungary;
- entities subject to statutory audits;
- Hungarian branches of foreign-registered companies
Challenges posed by IFRS adoption
Prior to adopting IFRSs, an entity must address the following questions:
- What are the differences between IFRS and Hungarian accounting regulations, the relevant new disclosure requirements and their information requirements?
- What additional actions are required in the business/industry/sector where the entity operates, and are there any special requirements concerning IFRS adoption?
- Does the efficient production and subsequent storage and use of the necessary information require IT development, and if so, then what resource requirements does it involve?
- What management decisions need to be made in order to draw up the accounting policy?
- What kind of one-off and long-term tax implications does IFRS adoption have?
Key steps of transition to IFRS
IFRS adoption can be split into three main stages in both the financial and non-financial industries. An initial Gap analysis is followed by the implementation, and the process is concluded by the testing stage, ending on the day of IFRS transition.
The time requirement of the Gap analysis and the testing phase is largely identical, while implementation takes longer. The last stage of implementation also includes the auditor's confirmation of readiness.
Critical accounting areas
- Classification and initial recognition of financial assets and liabilities at fair value
- Separate presentation of investment property and assets held for sale
- Presentation of guarantees given by the parent company
- Recognition of deferred tax assets and liabilities
- Classification of assets under financial or operating leases
- Capital increase and additional capital contribution
- For first-time adopters of IFRS: scope, purpose, exceptions and exemptions under IFRS 1
- Modelling tasks:
- Amortised cost
- Impairment calculation
- Fair value
- Deferred tax
- Process regulation
- IT development
- Measurement of financial assets and liabilities subsequent to initial recognition
- Measurement of shares and participations
- Review of the useful lives of tangible and intangible assets which have been written down to zero but are still in use
- Application of component-based accounting
- Recognising the interest differences of loans received or granted at conditions more favourable than fair market conditions as assistance/benefit received
- Measurement of employee benefits
- Hedge accounting and application of hedge accounting
- Compiling the first IFRS financial statements and their content elements
- Separate IFRS accounting policies
- Policies and estimates
- Additions to the chart of accounts
- Documenting the annual review of useful lives