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International Convergence: Be Alert, But Not Alarmed
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Story Jeffrey Knapp CA

 
This month Jeffrey Knapp CA from the Institute’s Technical Standards Team provides an overview of the likely key changes in Australian GAAP resulting from 2005 international convergence 
 
Australian equivalent standards to the international financial reporting standards (IFRSs) will be in place for the preparation of financial reports that cover reporting periods beginning 1 January 2005. The International Accounting Standards Board (IASB) plans to have the suite of IFRSs for 2005 settled by 31 March 2004. The equivalent Australian Accounting Standards Board (AASB) standards should be in place shortly thereafter around 1 May 2004. While the application of 2005 standards applies to financial years beginning 1 January 2005, comparatives must be prepared on the same basis (with some limited exceptions), which means that international convergence effectively begins at 1 January 2004 rather than 1 January 2005. 
 
The message to members is to be alert rather than alarmed. It is worth noting that the AASB has been ‘harmonising’ with international standards since 1996, which means that the majority of Australian Generally Accepted Accounting Principles (GAAP) is already consistent with international GAAP. 
 
Harmonisation involved the issue of new and revised AASB standards that were drafted in such a way that compliance with the Australian standard would automatically ensure compliance with the relevant international standard. By contrast, convergence is more akin to outright adoption of all international standards, but with the AASB maintaining the power to veto any optional accounting treatments or other requirements that it deems not be in the interests of the Australian economy. 
 
The AASB’s general approach to 2005 is to make few changes to the wording and paragraph structure of each IFRS. The major source of change is likely to come from the AASB’s ongoing brief to issue sector neutral standards. Whereas the application of an IFRS is limited to the for-profit sector, the equivalent AASB standard must embrace the not-for-profit sector, including public sector entities.  
 
It is impossible to view the entire suite of 2005 standards at this stage, because the work of the IASB and AASB has some way to go. Nonetheless, based on events so far, it is possible to highlight some of the likely main changes to Australian GAAP that are in the 2005 pipeline. 
 
FINANCIAL STATEMENTS  
 
The ‘income statement’ and ‘balance sheet’ should return with an additional statement allowed to explain the changes in equity for the period.  
 
Correction of errors and changes in accounting policies should be adjusted as if the error or prior policy had never happened using a retrospective approach that requires the restatement of opening balances and comparatives. This differs from the current approach where adjustments are usually made in the current period. Extraordinary items should no longer appear either on the face of the income statement or in the notes. Non-current assets held for sale and the related liabilities, revenues and expenses should be shown separately on the face of the financial statements. 
 
A free choice of presentation currency should be allowed for the financial reports, thereby allowing a US-listed company to present its financial reports to Australian shareholders in US dollars. 
 
Revenues should be limited to inflows arising from ordinary activities with sales of assets other than goods shown as gains/losses on the face of the income statement. This narrowing of the revenue definition may impact on the large/small test for proprietary companies. Government grants received by for-profit entities may be accounted for using a matching approach, rather than the current approach of revenue recognition based on control of the contribution. However, the AASB is likely to retain the existing Australian requirements in the case of the not-for-profit sector. 
 
The equity classification should become more stringent, resulting in certain preference shares currently classified as equity being reclassified as debt. 
 
NEW STANDARDS 
 
New comprehensive standards should be in place dealing with accounting for intangibles, investment property, business combinations, share-based payments, impairment and financial instruments. 
 
The recognition of intangible assets should be more limited given that the costs of research, internally generated brands, publishing titles and customer lists must be expensed as incurred. The revaluation of intangibles to fair value is to be limited to those assets that have an active market, which includes the requirement that the price of the asset is publicly available. The systematic amortisation of intangibles is limited to those intangibles that have a limited useful life. Intangible assets deemed to have an indefinite useful life are to be subject to an annual impairment test.  
 
Accounting for investment property should allow a choice between a cost model and a fair value model, but the choice must be applied to all investment property that is held. The adoption of the cost model carries with it the requirement to depreciate investment property. While the adoption of the fair value model is akin to mark-to-market accounting with increments and decrements in carrying amounts being recognised immediately in the net profit or loss. 
 
Accounting for business combinations should require the recognition of an acquired contingent liability having a fair value that can be measured reliably in addition to the identifiable assets and liabilities. Transfers between entities subject to common control should be exempt from the application of the purchase method. Systematic amortisation of goodwill should be abolished in favour of annual impairment testing, or more frequently if events or changes in circumstances indicate that the asset might be impaired. Negative goodwill (discount on acquisition) should be immediately recognised in the net profit or loss for the period.  
 
Accounting for share-based payments should work from the principle that, irrespective of whether an entity gives up an asset, undertakes a liability, or issues equity in return for services, an expense must be recognised. The timing of expense recognition and fair value measurement are the major challenges to be resolved. 
 
The recoverable amount test should be applied in a relatively more structured manner. A set of asset impairment indicators is identified and the existence of one  
 
or more of these indicators obligates the entity to calculate an asset’s recoverable amount. The definition of recoverable amount is the higher of the asset’s net selling price and value in use. Considerable guidance should be included on the measurement of value in use using the present value of the expected net cash inflows, which means discounting is required. A framework for applying the recoverable amount test to groups of assets, including the allocation of goodwill, should be included based on the concept of cash generating units, which are the lowest aggregation of assets that generate largely independent cash inflows from continuing use. 
 
Accounting for financial instruments should generally follow a fair value model that is akin to mark-to-market accounting, except that instruments that qualify as cash flow hedges will have gains and losses recognised directly in equity before being recycled to the net profit or loss on realisation. 
 
OTHER  
 
Other notable expected developments include asset revaluations, jointly controlled entities, borrowing costs and income tax. The revaluation of property, plant and equipment should be accounted for on an asset-by-asset basis, rather than by class of asset. However, the AASB intends to retain asset revaluations by class of asset for the not-for-profit sector. 
 
Accounting for interests in jointly controlled entities should allow a choice between the equity method and the proportional consolidation method, whereas only the equity method is currently allowed. Accounting for borrowing costs should allow a choice between the models of capitalisation only for qualifying assets or all borrowing costs recognised as an expense.  
 
Accounting for income tax consequences using a balance sheet approach should finally be launched in Australia after having been delayed since 1 July 2002.