Story Stephanie Kemp
The Lord of the Rings isn’t the only significant trilogy – check out these three new standards that govern the presentation of financial reports post-2005.
The transition to international harmonisation will make some significant changes to the way in which our financial statements look. This article examines the new standards that govern the presentation of financial reports post-2005.
Requirements dealing with the presentation of financial reports after 2005
can be found in the new Accounting Standards:- AASB 101 ‘Presentation of Financial Statements’
- AASB 107 ‘Cash Flow Statements’
- AASB 108 ‘Accounting Policies, Changes in Accounting Estimates and Errors’.
They replace:- AASB 1018 ‘Statement of Financial Performance’
- AASB 1034 ‘Financial Report Presen-tation and Disclosure’
- AASB 1040 ‘Statement of Financial Position’.
Which were the standards commonly referred to as ‘the trilogy’.
AASB 101: ‘PRESENTATION OF FINANCIAL STATEMENTS’
This standard covers ground dealt with in the trilogy, together with the disclosure of accounting policies aspects of AASB 1001. It applies to all entities required to lodge a financial report with Australian Securities & Investments Commission (ASIC) under Chapter 2M of the Corporations Act and to all other reporting entities from 1 January 2005.
The term ‘financial statements’ in the title is used by the International Account-ing Standards Board (IASB) in the same way that we are used to using the term ‘financial reports’. In the body of the standard, however, the AASB has used the familiar term ‘financial reports’.
AASB 101 sets out the components of a financial report and the overall considerations an entity should take into account in presenting a financial report; in other words, all the basic tenets of accounting, such as going concern, materiality, offsetting and the accrual basis of accounting.
It is worth noting that AASB 101 supersedes AASB 1014 ‘Set off and Extinguishment of Debt’, effectively removing much of the guidance on offsetting and replacing it with a short paragraph stating that offsetting is only permitted where allowed in an Aust-ralian accounting standard.
The rules for offsetting assets and liabilities are now contained in AASB 132 ‘Financial Instruments Presentation and Disclosure’ (paragraph 42).
The financial report contains:- A balance sheet
- An income statement – like the old profit and loss account
- A cash flow statement
- A statement of changes in equity. New to Australian financial reporting, this statement summarises all the movements in equity, such as reserve movements, adjustments to retained earnings and distributions to shareholders
- Notes to the accounts, including a summary of significant accounting policies.
While the standard stipulates line items, it does not prescribe set formats for the financial statements. These are found in Appendix 1 to the standard, which contains ‘Illustrative Financial Report Structures’ and the ‘Australian Implementation Guidance’ that follows. Australian entities will have to follow one of these formats, unless an alternative format is more helpful to the reader.
In preparing their balance sheets, entities can use a current/non-current approach or a liquidity basis, as at present. However, an entity will also be allowed to use a combination of the two approaches in a diversified business if that is the most appropriate display for the entity. The application of the current/non-current distinction to liabilities is stricter in AASB 101.
Where a financial liability is due within 12 months after the reporting date and the entity does not have an unconditional right to defer its settlement for at least 12 months after the reporting date, the liability is classified as current, even where there is an agreement to refinance or reschedule payments completed before the financial report is issued.
Similarly when a loan covenant has been breached, the liability is reclassified as current, even if the lender has agreed not to demand payment as a result of the breach.
Income and expenses
In preparing the income statement, expenses can be displayed by nature or function as at present, but there is a distinction between revenue and other income, which is not made in current Australian standards in the example disclosures in paragraphs 91 and 92.
This distinction comes from the new ‘Framework for the Preparation and Presentation of Financial Statements’, which uses the term “income” where Australians have hitherto used “revenue”.
Under AASB 118 ‘Revenue’ the term “revenue” means income attributable to ordinary activities, such as the sale of goods and the use by others of assets yielding interest, royalties and dividends, hence the distinction between “revenue” and “other income” in AASB 101. This is shown in the pro-forma income statements in the Australian Implementation Guidance (AIG).
AASB 101 requires disclosure of the material items of income and expense, similar to the items required by AASB 1018. However, the new standard does not contain the requirements relating to the amount of emphasis to be given to these disclosures. Extraordinary items are now prohibited. Paragraph 85 states: “An entity shall not present any items of income and expense as extraordinary items, either on the face of the income statement or in the notes.”
DISCLOSURES
AASB 101 gives more direction as to note disclosures, including requiring the layout to follow the format of the financial statements and the notes to be cross-referenced. The summary of significant accounting policies or other notes must include the judgements management has made in the process of applying the entity’s accounting policies. The entity must also disclose information about the key assumptions concerning the future and other sources of estimation uncertainty. As a result of the HIH Royal Commission findings, AASB 101 requires extensive disclosure of auditor remuneration.
While stopping short of allowing a true and fair view override, AASB 101 contemplates rare circumstances where compliance with a requirement in an Australian accounting standard would be misleading and requires specific additional disclosures in these circumstances.
AASB 107
The form and content of the Cash Flow Statement are covered by AASB 107, which is applicable to all entities that have to prepare financial reports under Chapter 2M as well as to all reporting entities, unlike AASB 1026, which only applies to reporting entities.
Like AASB 1026, the cash flows must be classified as arising from operating investing or financing activities. The main difference between the old and new standards is the definition of “cash equivalents”, which is potentially wider under AASB 107.
Under AASB 1026, cash equivalents must be able to be converted to cash at the investor’s option, whereas under AASB 107 short-term money market investments that are convertible to cash, but not at the investor’s option, may also be included.
AASB 108
The way these topics have been split in the new standards is slightly different. The actual disclosure of accounting policies is covered in AASB 101, rather than being with the selection of accounting policies in this standard as we are used to in AASB 1001.
AASB 108 is applicable to “each entity that is required to prepare financial reports in accordance with Part 2M.3 of the Corporations Act” like the current trilogy. This effectively extends the applicability of these requirements to all entities that lodge with ASIC and not just reporting entities.
Paragraph 7 states: “When an Australian Accounting Standard specifically applies to a transaction, other event or condition, the accounting policy or policies applied to that item shall be determined by applying the Australian Accounting Standard …” The Institute of Chartered Accountants in Australia is interpreting this as meaning that if the application paragraph in any specific standard only refers to “reporting entities”, then non-reporting entities do not have to apply it, as at present. The guidance on changes in accounting policies, accounting estimates and errors will however apply to non-reporting entities that lodge with ASIC.
There are one or two big changes from Australian Generally Accepted Accounting Principles (GAAP), as we know it:
1. Prudence is back. As in current Australian GAAP, accounting policies have to produce information that is relevant and reliable but, under AASB 108, prudence is specified as an attribute of reliability.
2. Retrospective application, ie. going back and restating the figures as if they had always been prepared under the changed accounting policy or as if the error had never occurred.
When the entity changes accounting policy, other than under specific transitional provisions of a new standard, or discovers a material error in a prior year, it has to go back and restate the comparatives and opening retained earnings for the current year.
It may be necessary to go back as far as the opening retained earnings for the comparative year. The only let-out is when such restatement is impracticable.
There are worked examples of retrospective application in the Implementation Guidance published by the IASB. The examples show retrospective application of the change in an accounting policy and correction of an error. Note that there is no distinction between material errors and fundamental errors as in the current standards. AASB 108 is drafted as applying to material errors.
ACCOUNTING POLICIES SELECTION
For the most part, the selection of an appropriate accounting policy is driven by an AASB or Urgent Issues Group (UIG) that is directly relevant to the transaction in hand. However, in some instances, a transaction is outside the scope of issued standards. In this case, other sources of guidance are referred to in paragraphs 10–11, in this order:
1. The requirements and guidance in the standards and UIG interpretations dealing with similar and related issues
2. The definitions, recognition criteria and measurement concepts for assets, liabilities income and expenses in the framework.
Paragraph 12 also permits management to consider the most recent pronouncements of other standard setting bodies that use a similar conceptual framework. Consequently, Australian entities will be able to refer to new International Financial Reporting Standards (IFRSs) that have yet to become applicable in Australia, such as the new IFRS on Extractive Industries and the proposed amendments on financial instruments when they become standards.
In the context of the transition to international standards in 2005, this hierarchy has potential implications for entities that have been operating under industry-specific Australian standards, where there is no matching international requirement. IFRS 1 makes it clear that an entity cannot state that it complies with IFRS unless it complies with all the standards.
Companies currently applying accounting policies based on standards that do not have an international equivalent may have to look to the generally applicable standards, such as Intangible Assets, Financial Instruments and Impairment in formulating an appropriate IFRS compliant accounting policy.
CHANGES IN ACCOUNTING POLICY
A change in accounting policy is only permitted where it is required by a standard or where it results in more relevant and reliable financial information. Where the change arises from a new accounting standard, the standard generally contains transitional provisions governing how the change is to be effected. In other cases, the change has to be applied retrospectively; ie. by adjusting the opening balance of equity for the earliest prior period presented in the financial report and restating comparatives as if the new policy had always applied, or from the earliest date practicable.
The standard requires extensive disclosures describing the effect of the change in the year in which the change takes place, including the impact on earnings per share. However, disclosure of a change in accounting policy made in the previous year that has a material effect in the current year is no longer required.
In addition, when a new accounting standard has been issued but is not yet effective, the impact of the new standard on the entity’s financial report in the period of initial application must be disclosed.
NEW REQUIREMENTS
Although members’ first Australian equivalent to International Financial Reporting Standard will be for the year ended 31 December 2005 at the earliest, comparatives will be required for the year ended 31 December 2004. It is vital to be comfortable with the new requirements and how the retrospective application of changes in accounting policies and the correction of errors could affect them.
DISCLAIMER: The views and opinions of the authors appearing in Charter are not necessarily those of the Institute of the Chartered Accountants and should be viewed as such.
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