2.2.1 Repeat application of IFRS 1

IFRS 1 does not prohibit an entity from applying IFRS 1 more than once and, in fact, requires it in some cases. [IFRS 1.3(a)]. The IASB explained this issue with an example of an entity that had applied IFRS 1 in connection with a foreign listing, subsequently delisted from the foreign exchange and no longer presented IFRS financial statements, but is now adopting IFRSs again together with other entities in its local jurisdiction – see Example 5.4 below. This was clarified by the Board in the Annual Improvements to IFRSs 2009‑2011 Cycle, issued in May 2012. IFRS 1 was amended to clarify that an entity that stopped applying IFRSs in the past and chooses, or is required, to resume preparing IFRS financial statements has the option to apply IFRS 1 again. [IFRS 1.4A]. The Board reasoned that the entity should on cost-benefit grounds be allowed, rather than required, to apply IFRS 1 again. [IFRS1.BC6C]. If the entity chooses not to reapply IFRS 1, it must retrospectively restate its financial statements in accordance with IAS 8 as if it had never stopped applying IFRSs while disclosing (in addition to the disclosures required by IAS 8) the reasons why it stopped applying IFRSs and why it resumed applying IFRSs, as well as the reasons for choosing the retrospective restatement method. [IFRS1.4B, 23A, 23B].

2.3.1 Transition to IFRSs from a similar GAAP

One consequence of the ongoing harmonisation of accounting standards around the world is that many national GAAPs are now virtually identical to IFRSs. However, differences between these national GAAPs and IFRSs often exist regarding the scope, transitional provisions, effective dates and actual wording of standards. In addition, some national GAAPs contain accounting alternatives not permitted by IFRSs.

When an entity reporting under such a national GAAP (e.g. Singapore GAAP) adopts IFRSs there will often not be major changes required in its accounting policies to comply with IFRSs. However, under IFRS 1 it is not relevant whether or not a previous GAAP was very similar to IFRSs. Therefore, regardless of the absence of significant differences in accounting policies, that entity would be a first-time adopter when it includes an explicit and unreserved statement of compliance with IFRSs for the first time. So, even if the entity's accounting policies were already fully aligned with IFRSs:

1. it would be permitted to apply the IFRS 1 exemptions and required to apply the IFRS 1 exceptions;
2. it would need to restate items for which the applicable first-time adoption exceptions differ from the transitional rules applicable to ongoing reporters (e.g. classification and measurement of financial assets);
3. it would not be permitted to apply different versions of IFRSs that were effective at earlier dates; and
4. it would need to explain the transition to IFRSs.

Notwithstanding the above, we believe an entity that:

• reported under a national GAAP that is identical with IFRSs in all respects;
• applied the national GAAP equivalent of IFRS 1 when the entity adopted that national GAAP;
• made an explicit and unreserved statement of compliance with that national GAAP in its most recent financial statements; and
• could have made an explicit and unreserved statement of compliance with IFRSs in those financial statements, if required,

does not have to re-apply IFRS 1 the first time that it makes an explicit and unreserved statement of compliance with IFRSs.

For example, if an entity that meets the requirements described above decides to make an explicit and unreserved statement of compliance with IFRSs for the first time, either voluntarily or required to do so by a regulatory requirement related to an IPO, the entity would not be required to re-apply IFRS 1.

4.4.1 Paragraphs B5 and B6 of IFRS 1 when applying IFRS 9

Paragraphs B5 and B6 of IFRS 1 refer to ‘hedge relationship of a type’ and ‘conditions for hedge accounting’ when specifying the recognition of hedging relationships in the opening IFRS statement of financial position and subsequent accounting, respectively. These descriptions were not modified to reflect requirements of IFRS 9. However, IFRS 9 does not set out hedge relationship types or conditions for hedge accounting. Instead, it sets out qualifying criteria in paragraph 6.4.1, which consist of (a) eligibility, (b) formal designation and documentation, and (c) hedge effectiveness. Therefore, the wording in paragraphs B5 and B6 of IFRS 1 is obsolete, and IFRS 1 is relatively unclear as to whether the same two-step approach above (i.e. ‘type’ test and ‘condition’ test) continues to apply.

In our view, the IASB did not intend to change the requirements of IFRS 1 for recognising a hedging relationship in the opening IFRS statement of financial position or the subsequent accounting upon issuance of IFRS 9 and we expect the IASB to amend the wording to clarify that the reference to ‘a hedging relationship of a type that does not qualify for hedge accounting’ in paragraph B5 of Appendix B to IFRS 1 relates only to the qualifying criterion in paragraph 6.4.1(a) of IFRS 9 (i.e. eligible hedging instruments and hedged items) and the ‘conditions for hedge accounting’ in paragraph B6 of Appendix B to IFRS 1 relates to the qualifying criteria in paragraph 6.4.1(b)-(c) of IFRS 9. Discussions in 4.4 to 4.7 below are based on this view.

4.4.2 Applicability of IAS 39 hedge requirements

A transition requirement of IFRS 9 for hedge accounting permits an existing IFRS user to choose as its accounting policy to continue to apply the hedge accounting requirements of IAS 39 instead of the requirements in Chapter 6 of IFRS 9. [IFRS 9.7.2.21]. First-time adopters do not have this choice because paragraph 9 of IFRS 1 prohibits first-time adopters from applying the transition provisions in other IFRSs when adopting IFRS, except as specified in Appendices B-E. [IFRS 1.9]. Further, paragraphs B4 to B6 of IFRS 1 contain mandatory exceptions for hedge accounting, but they do not refer to the transition requirements of IFRS 9, and the basis for conclusion attached to IFRS 9 under the heading ‘Transition related to the hedge accounting requirements’ states ‘The IASB decided not to change the requirements of IFRS 1 for hedge accounting. The IASB noted that a first-time adopter would need to look at the entire population of possible hedging relationships and assess which ones would meet the qualifying criteria of the new hedge accounting model’. [IFRS 9.BC7.52]. Accordingly, a first-time adopter is not allowed to apply IAS 39 to a macro-hedging arrangement and its various components would have to be separately accounted for under IFRS 9. This is in contrast to an existing IFRS user, who would be permitted to apply IAS39 hedge accounting.

4.5.1 Measurement of derivatives and elimination of deferred gains and losses

Under its previous GAAP an entity's accounting policies might have included a number of accounting treatments for derivatives that formed part of a hedge relationship. For example, accounting policies might have included those where the derivative was:

• not explicitly recognised as an asset or liability (e.g. in the case of a forward contract used to hedge an expected but uncontracted future transaction);
• recognised as an asset or liability but at an amount different from its fair value (e.g. a purchased option recognised at its original cost, perhaps less amortisation; or an interest rate swap accounted for by accruing the periodic interest payments and receipts); or
• subsumed within the accounting for another asset or liability (e.g. a foreign currency denominated monetary item and a matching forward contract or swap accounted for as a ‘synthetic’ functional currency denominated monetary item).

Whatever the previous accounting treatment, a first-time adopter should isolate and separately account for all derivatives in its opening IFRS statement of financial position as assets or liabilities measured at fair value. [IFRS 1.B4(a)].

All derivatives are measured at fair value through profit or loss, other than those that are financial guarantee contracts, a commitment to provide a loan at a below-market interest rate, or a loan commitment that is subject to the impairment requirements of IFRS 9, as well as those that are designated and effective as hedging instruments. Accordingly, the difference between the previous carrying amount of these derivatives (which may have been zero) and their fair value should be recognised as an adjustment of the balance of retained earnings at the date of transition to IFRSs. [IFRS 1.IG58A]. If an entity cannot determine whether a particular portion of an adjustment is a transition adjustment (i.e. a change in accounting policy) or a change in estimate, it must treat that portion as a change in accounting estimate. [IFRS 1.IG58B, IAS 8.32‑40]. The distinction between changes in accounting policies and changes in accounting estimates is discussed in detail in Chapter 3 at 4.2.

Hedge accounting policies under an entity's previous GAAP might also have included one or both of the following accounting treatments:

• derivatives were measured at fair value but, to the extent they were regarded as hedging future transactions, the gain (or loss) arising was reported as a liability (or asset) such as deferred (or accrued) income;
• realised gains or losses arising on the termination of a previously unrecognised derivative used in a hedge relationship (such as an interest rate swap hedging a borrowing) were included in the statement of financial position as deferred or accrued income and amortised over the remaining term of the hedged exposure.

In all cases, an entity is required to eliminate deferred gains and losses arising on derivatives that were reported in accordance with previous GAAP as if they were assets or liabilities. [IFRS 1.B4(b)]. In contrast to adjustments made to restate derivatives at fair value, the implementation guidance does not specify in general terms how to deal with adjustments to eliminate deferred gains or losses, i.e. whether they should be taken to retained earnings or a separate component of equity.

The requirement to eliminate deferred gains and losses does not appear to extend to those that have been included in the carrying amount of other assets or liabilities that will continue to be recognised under IFRSs. For example, under an entity's previous GAAP, the carrying amount of non-financial assets such as inventories or property, plant and equipment might have included the equivalent of a basis adjustment (i.e. hedging gains or losses were considered an integral part of the asset's cost). Of course, entities should also consider any other provisions of IFRS 1 that apply to those hedged items, e.g. whether any of the exemptions such as those for business combinations (see 5.2 below) or deemed cost (see 5.5 below) will be used.

The following diagram illustrates the treatment of hedge accounting in the opening IFRS statement of financial position and subsequent periods. Hedge accounting in the opening IFRS statement of financial position will be discussed in the sub-sections following the diagram and hedge accounting after transition to IFRSs is dealt with at 4.6 below.

4.5.2 Hedge relationships reflected in the opening IFRS statement of financial position

The standard states that a first-time adopter must not reflect a hedging relationship in its opening IFRS statement of financial position if that hedging relationship is of a type that does not qualify for hedge accounting under IFRS 9, which consists only of eligible hedging instruments and eligible hedged items in paragraph 6.4.1(a). As examples of this it cites many hedging relationships where the hedging instrument is a stand-alone written option or a net written option; or where the hedged item is a net position in a cash flow hedge for another risk other than foreign currency risk. [IFRS 1.B5]. Previous GAAP hedge documentation and effectiveness that were not fully compliant with the criteria in paragraph 6.4.1(b)-(c) of IFRS 9 do not mean that the hedge relationship is of a type that does not qualify for hedge accounting under IFRS 9. (See 4.6 below for requirements for post transition date hedge accounting).

However, if an entity designated a net position as a hedged item under its previous GAAP, it may designate as a hedged item under IFRS an individual item within that net position, or a net position that meets the requirements in paragraph 6.6.1 of IFRS 9, provided that it does so no later than the date of transition to IFRSs. [IFRS 1.B5]. In other words, such designation would allow the hedge relationship to be reflected in the opening IFRS statement of financial position.

On the other hand, a hedge relationship designated under an entity's previous GAAP should be reflected in its opening IFRS statement of financial position if that hedging relationship consists of eligible hedging instruments and eligible hedged items in paragraph 6.4.1(a), regardless of whether or not the hedge designation, documentation and effectiveness for hedge accounting under IFRS 9 (paragraph 6.4.1 (b)-(c)) are met on the transition date. [IFRS 1.B4-B6, IG60A-60B].

4.5.3 Reflecting cash flow hedges in the opening IFRS statement of financial position

A first-time adopter may have deferred gains and losses on a cash flow hedge of a forecast transaction under its previous GAAP. If, at the date of transition, the hedged forecast transaction is not highly probable, but is expected to occur, the entire deferred gain or loss should be recognised in the cash flow hedge reserve within equity. [IFRS 1.IG60B]. This is consistent with the treatment required for deferred gains or losses on cash flow hedges applicable after the transition to IFRS (other than losses not expected to be recovered) (see Chapter 53). [IFRS 9.6.5.11].

How should an entity deal with such a hedge if, at the date of transition to IFRSs, the forecast transaction is highly probable? It would make no sense if the hedge of the transaction that is expected to occur were required to be reflected in the opening IFRS statement of financial position, but the hedge of the highly probable forecast transaction (which is clearly a ‘better’ hedge) were not.

Therefore, it must follow that a cash flow hedge should be reflected in the opening IFRS statement of financial position in the way set out above if the hedged item is a forecast transaction that is highly probable (see Example 5.9 below). Similarly, it follows that a cash flow hedge of the variability in cash flows attributable to a particular risk associated with a recognised asset or liability (such as all or some future interest payments on variable rate debt) should also be reflected in the opening IFRS statement of financial position. To do otherwise would allow an entity to choose not to designate (in accordance with IFRS 9) certain cash flow hedges, say those that are in a loss position, until one day after its date of transition, thereby allowing associated hedging losses to bypass profit or loss completely. However, this would effectively result in the retrospective de-designation of hedges to achieve a desired result, thereby breaching the general principle of IFRS 1 (i.e. a first-time adopter cannot designate a hedge relationship retrospectively).

If, at the date of transition to IFRSs, the forecast transaction was not expected to occur, consistent with the requirements of paragraphs 6.5.6‑6.5.7 and 6.5.12(b) of IFRS 9, a first-time adopter should reclassify any related deferred gains and losses that are not expected to be recovered into retained earnings.

4.5.4 Reflecting fair value hedges in the opening IFRS statement of financial position

If a first-time adopter has, under its previous GAAP, deferred or not recognised gains and losses on a fair value hedge of a hedged item that is not measured at fair value, the entity should adjust the carrying amount of the hedged item at the date of transition. The adjustment, which is essentially the effective part of the hedge that was not recognised in the carrying amount of the hedged item under the previous GAAP, should be calculated as the lower of:

1. that portion of the cumulative change in the fair value of the hedged item that was not recognised under previous GAAP; and
2. that portion of the cumulative change in the fair value of the hedging instrument and, under previous GAAP, was either (i) not recognised or (ii) deferred in the statement of financial position as an asset or liability. [IFRS 1.IG60A].

4.5.5 Reflecting foreign currency net investment hedges in the opening IFRS statement of financial position

IFRS 1 does not provide explicit guidance on reflecting foreign currency net investment hedges in the opening IFRS statement of financial position. However, IFRS 9 requires that ongoing IFRS reporting entities account for those hedges similarly to cash flow hedges. [IFRS 9.6.5.13]. It follows that the first-time adoption provisions regarding cash flow hedges (see 4.5.3 above) also apply to hedges of foreign currency net investments.

A first-time adopter that applies the exemption to reset cumulative translation differences to zero (see 5.7 below) should not reclassify pre-transition gains and losses on the hedging instruments that were recognised in equity under previous GAAP to profit or loss upon disposal of a foreign operation. Instead, those pre-transition gains and losses should be recognised in the opening balance of retained earnings to avoid a disparity between the treatment of the gains and losses on the hedged item and the hedging instrument. This means that the requirement to reset the cumulative translation differences also applies to related gains and losses on hedging instruments.

5.2.1 Definition of a ‘business’ under IFRS 3

As noted above, the business combination exemption applies only to the acquisition of a business as defined under IFRS 3. Therefore, a first-time adopter needs to consider whether past transactions would qualify as business combinations under IFRS 3. That standard defines a business combination as ‘a transaction or other event in which an acquirer obtains control of one or more businesses. Transactions sometimes referred to as “true mergers” or “mergers of equals” are also business combinations as that term is used in this IFRS.’ [IFRS 3 Appendix A]. The definition of a business, which was amended in 2018, is ‘an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing goods or services to customers, generating investment income (such as dividends or interest) or generating other income from ordinary activities.’ [IFRS 3 Appendix A]. In addition, IFRS 3 states that ‘if the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition’ (see 5.2.1.A below). [IFRS 3.3]. Distinguishing a business combination from an asset acquisition is described in detail in Chapter 9.

In October 2012, the IASB issued Investment Entities (Amendments to IFRS 10, IFRS 12 and IAS 27) (see 5.9.5 below). Amongst other changes, the amendment also makes it clear that Appendix C of IFRS 1, which deals with the business combinations exemption, should be applied only to business combinations within the scope of IFRS 3. This means that the exemption does not apply to mergers of entities that are not business combinations under IFRS 3. So a first-time adopter which had such mergers under previous GAAP should retrospectively apply IFRS applicable to those mergers. If the mergers are those of entities under common control, as there is no specific guidance under IFRS on accounting for them, we discuss this issue in Chapter 10.

5.2.2 Option to restate business combinations retrospectively

A first-time adopter must account for business combinations occurring after its date of transition under IFRS 3, i.e. any business combinations during the comparative periods need to be restated in accordance with IFRS 3 while it may elect not to apply IFRS 3 retrospectively to business combinations occurring before the date of transition. However, if a first-time adopter does restate a business combination occurring prior to its date of transition to comply with IFRS 3 it must also restate any subsequent business combinations under IFRS 3 and apply IFRS 10 from that date onwards. [IFRS 1.C1]. In other words, as shown on the time line below, a first-time adopter is allowed to choose any date in the past from which it wants to account for all business combinations under IFRS 3 and would not restate business combinations that occurred prior to such date. It must be noted that a first-time adopter availing itself of this option is required to apply the version of IFRS 3 effective at the end of its first IFRS reporting period to any retrospectively restated business combinations.

Even if a first-time adopter elects not to restate certain business combinations, it may still need to restate the carrying amounts of the acquired assets and assumed liabilities, as described at 5.2.4 below.

Although there is no restriction that prevents retrospective application by a first-time adopter of IFRS 3 to all past business combinations, in our opinion, a first-time adopter should not restate business combinations under IFRS 3 that occurred before the date of transition when this would require use of hindsight.

Extracts 5.3 below and 5.12 at 6.3 below illustrate the typical disclosure made by entities that opted not to restate business combinations that occurred before their date of transition to IFRSs, while Extract 5.4 below illustrates disclosures by an entity that chose to restate certain business combinations that occurred prior to its date of transition.

5.2.3 Classification of business combinations

IFRS 3 mandates a business combination to be accounted for as an acquisition or reverse acquisition. An entity's previous GAAP may be based on a different definition of, for example, a business combination, an acquisition, a merger and a reverse acquisition. An important benefit of the business combinations exemption is that a first-time adopter will not have to determine the classification of past business combinations in accordance with IFRS 3. [IFRS 1.C4(a)]. For example, a business combination that was accounted for as a merger or uniting of interests using the pooling-of-interests method under an entity's previous GAAP will not have to be reclassified and accounted for under the acquisition method, nor will a restatement be required if the business combination would have been classified under IFRS 3 as a reverse acquisition by the acquiree. However, an entity may still elect to do so if it so wishes without using hindsight (see 5.2.2 above).

5.2.4 Assets and liabilities to be recognised in the opening IFRS statement of financial position

In its opening IFRS statement of financial position, a first-time adopter should recognise all assets acquired and liabilities assumed in a past business combination, with the exception of: [IFRS 1.C4(b)]

• certain financial assets and liabilities that were derecognised and that fall under the derecognition exception (see 4.3 above); and
• assets (including goodwill) and liabilities that were not recognised in the acquirer's consolidated statement of financial position under its previous GAAP and that would not qualify for recognition under IFRSs in the separate statement of financial position of the acquiree (see 5.2.4.A and Example 5.14 below).

The entity must exclude items it recognised under its previous GAAP that do not qualify for recognition as an asset or liability under IFRSs (see 5.2.4.A below).

5.2.5 Restatement of goodwill

Under the business combinations exemption, a first-time adopter takes the carrying amount of goodwill under its previous GAAP at the date of transition to IFRSs as a starting point and only adjusts it as follows: [IFRS 1.C4(g)]

1. goodwill is increased by the carrying amount of any intangible asset acquired in a business combination under its previous GAAP (less any related deferred tax and non-controlling interests), that does not meet the recognition criteria under IFRSs. The first-time adopter accounts for the change in classification prospectively and does not, for example, reverse the cumulative amortisation on the item that it recognised as an intangible asset under its previous GAAP;
2. goodwill is decreased if a first-time adopter is required to recognise an intangible asset under IFRS that was subsumed in goodwill under its previous GAAP. It adjusts deferred tax and non-controlling interests accordingly; and
3. goodwill must be tested for impairment at the date of transition to IFRSs in accordance with IAS 36 regardless of whether there is any indication that the goodwill may be impaired (see Chapter 20); any resulting impairment loss is recognised in retained earnings unless IAS 36 requires it to be recognised in a revaluation surplus (see Chapter 20). The impairment test must be based on conditions at the date of transition to IFRSs.

Application of the above guidance may sometimes be more complicated than expected as is illustrated in the example below.

In economic terms it might be contended that the ‘deferred marketing costs’ intangible asset in the example above comprises the value that would have been attributable under IFRSs to the acquired customer relationships. However, unless Entity A concluded that not recognising the customer relationship intangible asset was an error under its previous GAAP, it would not be able to recognise the customer relationship intangible asset upon adoption of IFRSs.

Under IFRS 1, assets acquired and liabilities assumed in a business combination prior to the date of transition to IFRSs are not necessarily valued on a basis that is consistent with IFRSs. This can lead to ‘double counting’ in the carrying amount of assets and goodwill as is illustrated in the example below.

The IASB accepted that IFRS 1 does not prevent the implicit recognition of internally generated goodwill that arose after the date of the business combination. It concluded that attempts to exclude such internally generated goodwill would be costly and lead to arbitrary results. [IFRS 1.BC39].

As the business combinations exemption also applies to associates and joint arrangements, a transition impairment review should be carried out on investments in associates and joint arrangements if they include an element of goodwill. However, the goodwill embedded in the amount of an investment in an associate or an investment in a joint venture will not be subject to a separate impairment test. Rather the entire carrying amount of the investment is reviewed for impairment following the requirements of IAS 36. In performing this impairment review of the investment in associate or joint venture, in our view, an investor does not reverse a previous GAAP impairment that was recognised separately on the notional goodwill element embedded in the investment. However, if the previous GAAP impairment had been recognised as a reduction of the entire investment (without attribution to any particular embedded account), the first-time adopter is able to reverse such impairment if it is assessed to no longer be necessary. Consider the two scenarios below:

5.2.6 Currency adjustments to goodwill

A first-time adopter need not apply IAS 21 retrospectively to fair value adjustments and goodwill arising in business combinations that occurred before the date of transition to IFRSs. [IFRS 1.C2, IG21A]. This exemption is different from the ‘cumulative translation differences’ exemption, which is discussed at 5.7 below.

IAS 21 requires any goodwill arising on the acquisition of a foreign operation and any fair value adjustments to the carrying amounts of assets and liabilities arising on the acquisition of that foreign operation to be treated as assets and liabilities of the foreign operation. Thus they are expressed in the functional currency of the foreign operation and are translated at the closing rate in accordance with the requirements discussed in Chapter 15. [IAS 21.47]. For a first-time adopter it may be impracticable, especially after a corporate restructuring, to determine retrospectively the currency in which goodwill and fair value adjustments should be expressed. If IAS 21 is not applied retrospectively, a first-time adopter should treat such fair value adjustments and goodwill as assets and liabilities of the entity rather than as assets and liabilities of the acquiree. As a result, those goodwill and fair value adjustments are either already expressed in the entity's functional currency or are non-monetary foreign currency items that are reported using the exchange rate applied in accordance with previous GAAP. [IFRS 1.C2].

If a first-time adopter chooses not to take the exemption mentioned above, it must apply IAS 21 retrospectively to fair value adjustments and goodwill arising in either: [IFRS 1.C1, C3]

1. all business combinations that occurred before the date of transition to IFRSs; or
2. all business combinations that the entity elects to restate to comply with IFRS 3.

In practice the exemption may be of limited use for a number of reasons:

First, the exemption permits ‘goodwill and fair value adjustments’ to be treated as assets and liabilities of the entity rather than as assets and liabilities of the acquiree. Implicit in the exemption is the requirement to treat both the goodwill and the fair value adjustments consistently. However, the IASB apparently did not consider that many first-time adopters, under their previous GAAP, will have treated fair value adjustments as assets or liabilities of the acquiree, while at the same time treating goodwill as an asset of the acquirer. As the exemption under IFRS 1 did not foresee this particular situation, those first-time adopters will need to restate either their goodwill or fair value adjustments. In many cases restatement of goodwill is less onerous than restatement of fair value adjustments.

Secondly, the paragraphs in IFRS 1 that introduce the exemption were drafted at a later date than the rest of the Appendix of which they form part. Instead of referring to ‘first-time adopter’ these paragraphs refer to ‘entity’. Nevertheless, it is clear from the context that ‘entity’ should be read as ‘first-time adopter’. This means that the exemption only permits goodwill and fair value adjustments to be treated as assets and liabilities of the first-time adopter (i.e. ultimate parent). In practice, however, many groups have treated goodwill and fair value adjustments as an asset and liabilities of an intermediate parent. Where the intermediate parent has a functional currency that is different from that of the ultimate parent or the acquiree, it will be necessary to restate goodwill and fair value adjustments.

The decision to treat goodwill and fair value adjustments as either items denominated in the parent's or the acquiree's functional currency will also affect the extent to which the net investment in those foreign subsidiaries can be hedged (see also 4.5.5 above).

5.2.7 Previously unconsolidated subsidiaries

Under its previous GAAP a first-time adopter may not have consolidated a subsidiary acquired in a past business combination. In that case, a first-time adopter applying the business combinations exemption should measure the carrying amounts of the subsidiary's assets and liabilities in its consolidated financial statements at the transition date at either: [IFRS 1.IG27(a)]

1. if the subsidiary has adopted IFRSs, the same carrying amounts as in the IFRS financial statements of the subsidiary, after adjusting for consolidation procedures and for the effects of the business combination in which it acquired the subsidiary; [IFRS 1.D17] or
2. if the subsidiary has not adopted IFRSs, the carrying amounts that IFRSs would require in the subsidiary's statement of financial position. [IFRS 1.C4(j)].

The deemed cost of goodwill is the difference at the date of transition between:

1. the parent's interest in those adjusted carrying amounts; and
2. the cost in the parent's separate financial statements of its investment in the subsidiary. [IFRS 1.C4(j)].

The cost of an investment in a subsidiary in the parent's separate financial statements will depend on which option the parent has taken to measure the cost under IFRS 1 (see 5.8.2 below).

A first-time adopter is precluded from calculating what the goodwill would have been at the date of the original acquisition. The deemed cost of goodwill is capitalised in the opening IFRS statement of financial position. The following example, which is based on one within the guidance on implementation of IFRS 1, illustrates this requirement. [IFRS 1.IG Example 6].

If the cost of the subsidiary (as measured under IFRS 1, see 5.8.2 below) is lower than the proportionate share of net asset value at the date of transition to IFRSs, the difference is taken to retained earnings, or other category of equity, if appropriate.

Slightly different rules apply to all other subsidiaries (i.e. those not acquired in a business combination but created) that an entity did not consolidate under its previous GAAP, the main difference being that goodwill should not be recognised in relation to those subsidiaries (see 5.8 below). [IFRS 1.IG27(c)].

Note that this exemption requires the use of the carrying value of the investment in the separate financial statements of the parent prepared using IAS 27 – Separate Financial Statements. Therefore, if a first-time adopter, in its separate financial statements, does not opt to measure its cost of investment in a subsidiary at its fair value or previous GAAP carrying amount at the date of transition, it is required to calculate the deemed cost of the goodwill by comparing the cost of the investment to its share of the carrying amount of the net assets determined on a different date. [IFRS 1.D15]. In the case of a highly profitable subsidiary this could give rise to the following anomaly:

5.2.8 Previously consolidated entities that are not subsidiaries

A first-time adopter may have consolidated an investment under its previous GAAP that does not meet the definition of a subsidiary under IFRSs. In this case the entity should first determine the appropriate classification of the investment under IFRSs and then apply the first-time adoption rules in IFRS 1. Generally such previously consolidated investments should be accounted for as either:

• an associate, a joint venture or a joint operation: First-time adopters applying the business combinations exemption should also apply that exemption to past acquisitions of investments in associates, interests in joint ventures or interests in joint operations in which the activity of the joint operation constitutes a business, as defined in IFRS 3. [IFRS 1.C5]. If the business combinations exemption is not applicable or the entity did not acquire (i.e. created) the investment in the associate or joint venture, IAS 28 – Investments in Associates and Joint Ventures – should be applied retrospectively unless the entity applies the joint arrangements exemption. [IFRS 1.D31]. (See 5.18 below);
• an investment under IFRS 9 (see 5.11 below); or
• an executory contract or service concession arrangement: There are no first-time adoption exemptions that apply; therefore, IFRSs should be applied retrospectively. However, a practical relief is provided for a service concession arrangement if retrospective application is impracticable (see 5.14 below).

5.2.9 Measurement of deferred taxes and non-controlling interests

Deferred tax is calculated based on the difference between the carrying amount of assets and liabilities and their respective tax base. Therefore, deferred taxes should be recalculated after all assets acquired and liabilities assumed have been adjusted under IFRS 1. [IFRS 1.C4(k)].

IFRS 10 defines non-controlling interest as the ‘equity in a subsidiary not attributable, directly or indirectly, to a parent.’ [IFRS 10 Appendix A]. This definition is discussed in Chapter 6. Non-controlling interests should be calculated after all assets acquired, liabilities assumed and deferred taxes have been adjusted under IFRS 1. [IFRS 1.C4(k)].

Any resulting change in the carrying amount of deferred taxes and non-controlling interests should be recognised by adjusting retained earnings (or, if appropriate, another category of equity), unless they relate to adjustments to intangible assets that are adjusted against goodwill. See Example 5.29 below. [IFRS 1.IG Example 4].

In terms of treatment of a deferred tax, there is a difference depending on whether the first-time adopter previously recognised acquired intangible assets in accordance with its previous GAAP or whether it had subsumed the intangible asset into goodwill (in both cases, a deferred tax liability was not recognised under its previous GAAP but is required to be recognised under IFRS). In the first case it must recognise a deferred tax liability and adjust non-controlling interests and opening reserves accordingly. By contrast, in the second case it would have to decrease the carrying amount of goodwill, recognise the intangible assets and a deferred tax liability and adjust non-controlling interests as necessary, as discussed at 5.2.5 above. The IASB discussed this issue in October 2005, but decided not to propose an amendment to address this inconsistency.⁴

Example 5.29 below illustrates how to account for restatement of intangible assets, deferred tax and non-controlling interests where previous GAAP requires deferred tax to be recognised.

5.2.10 Transition accounting for contingent consideration

The business combination exemption does not extend to contingent consideration that arose from a transaction that occurred before the transition date, even if the acquisition itself is not restated due to the use of the exemption. Therefore, such contingent consideration, other than that classified as equity under IAS 32, is recognised at its fair value at the transition date, regardless of the accounting under previous GAAP. If the contingent consideration was not recognised at fair value at the date of transition under previous GAAP, the resulting adjustment is recognised in retained earnings or other category of equity, if appropriate. Subsequent adjustments will be recognised following the provisions of IFRS 3. [IFRS 3.40, 58].

5.3.1 Use of previously published fair values

There is no explicit requirement in IFRS 1 or IFRS 2 that any voluntary retrospective application of IFRS 2 must be based on the fair value previously published. This might appear to allow a first-time adopter the flexibility of using a different valuation for IFRS 2 purposes than that previously used for disclosure purposes. However, the requirements of IFRS 1 in relation to estimates under previous GAAP (see 4.2 above) mean that the assumptions used in IFRS must be consistent with those used in the originally disclosed valuation. The entity will also need to consider the implications of the assertion, in effect, that there is more than one fair value for the same transaction.

5.3.2 Restatement of costs recognised under previous GAAP

A first-time adopter may elect to take advantage of the transitional provisions in IFRS 1 which allow it not to apply IFRS 2 to equity-settled share-based payment transactions that were vested before the date of transition to IFRS, despite having recognised a cost for those transactions in accordance with its previous GAAP. Neither IFRS 1 nor IFRS 2 clearly indicates the appropriate treatment of the costs of share-based payment transactions that were recognised under the previous GAAP. There are mixed views on this issue in different jurisdictions, some of which are being driven by local regulatory expectations. In practice, either of the following approaches is considered acceptable, provided that the treatment chosen is disclosed in the financial statements if the previously recognised costs are material:

• not to change expense previously recognised under previous GAAP for equity instruments subject to transitional relief under IFRS 1. This approach is consistent with the approach for cash-settled share-based payment transactions that are settled prior to the date of transition to IFRS, since the entity must reflect the reduction in cash that was actually paid (and therefore the reduction in retained earnings) in the first IFRS financial statements; or
• to derecognise share-based payment expense under previous GAAP for equity instruments subject to transitional relief under IFRS 1. In other words, reverse cumulative amounts recognised in the retained earnings and equity accounts of the opening IFRS statement of financial position.

5.5.1 Fair value or revaluation as deemed cost

To deal with the problem of restatement of long-lived assets upon first-time adoption of IFRSs, the standard permits a first-time adopter – for the categories of assets listed below – to measure an item in its opening IFRS statement of financial position using an amount that is based on its deemed cost: [IFRS 1.D5, D6]

• property, plant and equipment including bearer plants (see 7.4 below); [IFRS 1.D5]
• investment property, if an entity elects to use the cost model in IAS 40. [IFRS 1.D7]. The fact that the exemption can only be applied to investment property accounted for under the cost model will not pose any problems in practice as the fair value model under IAS 40 requires an entity to measure its investment property at fair value at its date of transition to IFRSs;
• right-of-use assets under IFRS 16 – Leases; [IFRS 1.D7] and
• intangible assets (see 7.14 below) that meet:
  • the recognition criteria in IAS 38 (including reliable measurement of original cost); and
  • the criteria in IAS 38 for revaluation (including the existence of an active market). [IFRS 1.D7].

A first-time adopter cannot use this deemed cost approach by analogy for any other assets or for liabilities. [IFRS 1.D7].

The use of fair value or revaluation as deemed cost for intangible assets will be very limited in practice because of the definition of an active market in IFRS 13. An active market is defined as one in which transactions for the item take place with sufficient frequency and volume to provide pricing information on an ongoing basis. [IFRS 13 Appendix A]. It is therefore unlikely that a first-time adopter will be able to apply this exemption to any intangible assets (see Chapter 17).

It is important to note that this exemption does not take classes or categories of assets as its unit of measure, but refers to ‘an item of property, plant and equipment,’ and similarly for investment property, right-of-use assets under IFRS 16 and intangible assets. [IFRS 1.D5]. IAS 16 does not ‘prescribe the unit of measure for recognition, i.e. what constitutes an item of property, plant and equipment. Thus, judgement is required in applying the recognition criteria to an entity's specific circumstances’ (see Chapter 18). [IAS 16.9]. A first-time adopter may therefore apply the deemed cost exemption to only some of its assets. For example, it could apply the exemption only to:

• a selection of properties;
• part of a factory; or
• some of the right-of-use asset leased under a single lease agreement.

The IASB argued that it is not necessary to restrict application of the exemption to classes of assets to prevent arbitrarily selective revaluations, because IAS 36 ‘requires an impairment test if there is any indication that an asset is impaired. Thus, if an entity uses fair value as deemed cost for assets whose fair value is above cost, it cannot ignore indications that the recoverable amount of other assets may have fallen below their carrying amount. Therefore, the IFRS does not restrict the use of fair value as deemed cost to entire classes of asset.’ [IFRS 1.BC45]. Nevertheless, it seems doubtful that the quality of financial information would benefit from a revaluation of a haphazard selection of items of property, plant and equipment. Therefore, a first-time adopter should exercise judgement in selecting the items to which it believes it is appropriate to apply the exemption.

Extracts 5.6 and 5.7 below are typical disclosures of the use of the ‘fair value or revaluation as deemed cost’ exemption.

5.5.2 Event-driven fair value measurement as deemed cost

A first-time adopter may use fair value measurements that arose from an event such as a privatisation or initial public offering as deemed cost for IFRSs at the date of that measurement. [IFRS 1.D8].

IFRS 1 describes these revaluations as ‘deemed cost in accordance with previous GAAP’. Therefore, to the extent that they related to an event that occurred prior to its date of transition or during the period covered by the first IFRS financial statements, they can be used as the basis for deemed cost only if they were recognised in the first-time adopter's previous GAAP financial statements. As discussed in 5.5.2.C below, a first-time adopter is also allowed to use event-driven fair values resulting from such events that occurred subsequent to the first-time adopter's date of transition to IFRSs, but during the period covered by the first IFRS financial statements.

The ‘fair value or revaluation as deemed cost’ exemption discussed at 5.5.1 above only applies to items of property, plant and equipment, investment property, right-of-use assets under IFRS 16 and certain intangible assets. [IFRS 1.D5‑D7]. The event-driven deemed cost exemption, however, is broader in scope because it specifies that when a first-time adopter established a deemed cost in accordance with previous GAAP for some or all of its assets and liabilities [emphasis added] by measuring them at their fair value at one particular date … the entity may use such event-driven fair value measurements as deemed cost for IFRSs at the date of that measurement. [IFRS 1.D8, IFRS 1.BC46].

There are two important limitations in the scope of this exemption:

• while it applies, in principle, to all assets and liabilities of an entity, it does not override the recognition criteria in IFRSs. [IFRS 1.10]. Consequently, a first-time adopter should derecognise goodwill, assets (e.g. certain intangible assets such as brand names and research) and liabilities that do not qualify for recognition under IFRSs in the statement of financial position of the entity; and
• it cannot be used if the event-driven revaluation did not result in a re-measurement to full fair value (i.e. it cannot be used in the case of a partial step-up towards fair value).

If revaluations under previous GAAP did not satisfy the criteria in IFRS 1, a first-time adopter measures the revalued assets in its opening IFRS statement of financial position on one of the following bases: [IFRS1.IG11]

1. cost less any accumulated depreciation and any accumulated impairment losses under the cost model in IAS 16;
2. deemed cost, being the fair value at the date of transition to IFRSs; or
3. revalued amount, if the entity adopts the revaluation model in IAS 16 as its accounting policy under IFRSs for all items of property, plant and equipment in the same class.

Finally, although a first-time adopter may use an event-driven fair value measurement as deemed cost for any asset or liability, it does not have to use them for all assets and liabilities that were revalued as a result of the event.

5.5.3 Deemed cost for oil and gas assets

It is common practice in some countries to account for exploration and development costs for oil and gas properties in development or production phases in cost centres that include all properties in a large geographical area, e.g. under the ‘full cost accounting’ method. However, this method of accounting generally uses a unit of account that is much larger than that is acceptable under IFRSs. Applying IFRSs fully retrospectively would pose significant problems for first-time adopters because it would also require amortisation ‘to be calculated (on a unit of production basis) for each year, using a reserves base that has changed over time because of changes in factors such as geological understanding and prices for oil and gas. In many cases, particularly for older assets, this information may not be available.’ [IFRS 1.BC47A]. Even when such information is available, the effort and cost to determine the opening balances at the date of transition would usually be very high.

For these entities, use of the fair value as deemed cost exemption (see 5.5.1 above), however, was not considered to be suitable because: [IFRS 1.BC47B]

‘Determining the fair value of oil and gas assets is a complex process that begins with the difficult task of estimating the volume of reserves and resources. When the fair value amounts must be audited, determining significant inputs to the estimates generally requires the use of qualified external experts. For entities with many oil and gas assets, the use of this fair value as deemed cost alternative would not meet the Board's stated intention of avoiding excessive cost.’

The IASB therefore decided to grant an exemption for first-time adopters that accounted under their previous GAAP for ‘exploration and development costs for oil and gas properties in the development or production phases … in cost centres that include all properties in a large geographical area.’ [IFRS 1.D8A]. Under the exemption, a first-time adopter may elect to measure oil and gas assets at the date of transition to IFRSs on the following basis: [IFRS 1.D8A]

1. exploration and evaluation assets at the amount determined under the entity's previous GAAP; and
2. assets in the development or production phases at the amount determined for the cost centre under the entity's previous GAAP. This amount should be allocated to the cost centre's underlying assets pro rata using reserve volumes or reserve values as of that date.

For this purpose, oil and gas assets comprise only those assets used in the exploration, evaluation, development or production of oil and gas. [IFRS 1.D8A].

A first-time adopter that uses the exemption under (b) above should disclose that fact and the basis on which carrying amounts determined under previous GAAP were allocated. [IFRS 1.31A].

To avoid the use of deemed costs resulting in an oil and gas asset being measured at more than its recoverable amount, the Board also decided that oil and gas assets that were valued using this exemption should be tested for impairment at the date of transition to IFRSs as follows: [IFRS 1.D8A]

• exploration and evaluation assets should be tested for impairment under IFRS 6; and
• assets in the development and production phases should be tested for impairment under IAS 36.

The deemed cost amounts should be reduced to take account of any impairment charge.

Finally, a first-time adopter that applies the deemed cost exemption for oil and gas assets in the development or production phases in (b) above should also apply the exception to the IFRIC 1 – Changes in Existing Decommissioning, Restoration and Similar Liabilities – exemption to the related decommissioning and restoration obligation (see 5.13.2 below). [IFRS 1.D21A].

Extract 5.8 below presents disclosure of the use of the ‘deemed cost for oil and gas assets’ exemption.

5.5.4 Deemed cost for assets used in operations subject to rate regulation

Entities that hold items of property, plant and equipment, right-of-use assets under IFRS 16 or intangible assets that are used, or were previously used, in operations subject to rate regulation might have capitalised, as part of the carrying amounts, amounts that do not qualify for capitalisation in accordance with IFRSs. For example, when setting rates, regulators often permit entities to capitalise an allowance for the cost of financing the asset's acquisition, construction or production. This allowance typically includes an imputed cost of equity. IFRSs do not permit an entity to capitalise an imputed cost of equity. [IFRS 1.BC47F]. The IASB decided to permit a first-time adopter with operations subject to rate regulations to elect to use the previous GAAP carrying amount of such an item at the date of transition to IFRSs as deemed cost. [IFRS 1.D8B]. In the Board's view, this exemption is consistent with other exemptions in IFRS 1 in that it ‘avoids excessive costs while meeting the objectives of the IFRS.’ [IFRS 1.BC47I].

Operations are subject to rate regulation if they are governed by a framework for establishing the prices that can be charged to customers for goods or services and that framework is subject to oversight and/or approval by a rate regulator (as defined in IFRS 14 – Regulatory Deferral Accounts). [IFRS 1.D8B, IFRS 14 Appendix A].

Without this exemption, a first-time adopter with operations subject to rate regulations would have had either to restate those items retrospectively to remove the non-qualifying amounts, or to use fair value as deemed cost (see 5.5.1 above). Both alternatives, the Board reasoned, pose significant practical challenges, the cost of which can outweigh the benefits. [IFRS 1.BC47G]. Typically, once amounts are included in the total cost of an item of property, plant and equipment, they are no longer tracked separately. Therefore, their removal would require historical information that, given the age of some of the assets involved, is probably no longer available and would be difficult to estimate. For many of these assets, it may be impractical to use the fair value exemption as such information may not be readily available. [IFRS 1.BC47H].

A first-time adopter that applies this exemption to an item need not apply it to all items. At the date of transition to IFRSs, the first-time adopter should test for impairment in accordance with IAS 36 each item for which it used the exemption. [IFRS 1.D8B].

Extract 5.9 below illustrates disclosure of the use of the deemed cost exemption for property, plant and equipment and intangible assets used in operations subject to rate regulation although IFRS 14 is not applied.

While the current exemption in paragraph D8B of IFRS 1 provides a one-time relief to determine the transition date balances of the eligible property, plant and equipment, right-of-use assets under IFRS 16 and intangible assets, IFRS 14 is wider in scope (see 5.20 below).

5.7.1 Gains and losses arising on related hedges

Although IFRS 1 is not entirely clear whether this exemption extends to similar gains and losses arising on related hedges, we believe it is entirely appropriate for this exemption to be applied to net investment hedges as well as the underlying gains and losses.

Paragraph D13, which contains the exemption, explains that a first-time adopter need not comply with ‘these requirements.’ [IFRS 1.D13]. The requirements referred to are those summarised in paragraph D12 which explain that IAS 21 requires an entity:

1. to recognise some translation differences in other comprehensive income and accumulate these in a separate component of equity; and
2. on disposal of a foreign operation, to reclassify the cumulative translation difference for that foreign operation (including, if applicable, gains and losses on related hedges) [our emphasis] from equity to profit or loss as part of the gain or loss on disposal. [IFRS 1.D12].

The problem arises because paragraph D12 does not refer to the recognition of hedging gains or losses in other comprehensive income and accumulation in a separate component of equity (only the subsequent reclassification thereof). Accordingly, a very literal reading of the standard might suggest that an entity is required to identify historical gains and losses on such hedges. However, even if this position is accepted, the basis on which this might be done is not at all clear.

It is clear that the reasons cited by the IASB for including this exemption apply as much to related hedges as they do to the underlying exchange differences. The fact that IFRS 1 can be read otherwise might be seen as little more than poor drafting.

5.8.1 Consolidated financial statements: subsidiaries and structured entities

A first-time adopter must consolidate all subsidiaries (as defined in IFRS 10) unless IFRS 10 requires otherwise. [IFRS 1.IG26]. First-time adoption of IFRSs may therefore result in the consolidation for the first time of a subsidiary not consolidated under previous GAAP, either because the subsidiary was not regarded as such before, or because the parent did not prepare consolidated financial statements. If a first-time adopter did not consolidate a subsidiary under its previous GAAP, it must recognise the assets and liabilities of that subsidiary in its consolidated financial statements at the date of transition at either: [IFRS 1.IG27(a)]

1. if the subsidiary has adopted IFRSs, the same carrying amounts as in the IFRS financial statements of the subsidiary, after adjusting for consolidation procedures and for the effects of the business combination in which it acquired the subsidiary; [IFRS 1.D17] or
2. if the subsidiary has not adopted IFRSs, the carrying amounts that IFRSs would require in the subsidiary's statement of financial position. [IFRS 1.C4(j)].

If the newly-consolidated subsidiary was acquired in a business combination before the date of the parent's transition to IFRSs, goodwill is the difference between the parent's interest in the carrying amount determined under either (a) or (b) above and the cost in the parent's separate financial statements of its investment in the subsidiary. This is no more than a pragmatic ‘plug’ that facilitates the consolidation process but does not represent the true goodwill that might have been recorded if IFRSs had been applied to the original business combination (see 5.2.7 above). [IFRS 1.C4(j), IG27(b)]. Therefore, if the first-time adopter accounted for the investment as an associate under its previous GAAP, it cannot use the notional goodwill previously calculated under the equity method as the basis for goodwill under IFRSs.

If the parent did not acquire the subsidiary, but established it, it does not recognise goodwill. [IFRS 1.IG27(c)]. Any difference between the carrying amount of the subsidiary and the identifiable net assets as determined in (a) or (b) above would be treated as an adjustment to retained earnings, representing the accumulated profits or losses that would have been recognised as if the subsidiary had always been consolidated.

The adjustment of the carrying amounts of assets and liabilities of a first-time adopter's subsidiaries may affect non-controlling interests and deferred tax, as discussed at 5.2.9 above. [IFRS 1.IG28].

5.8.2 Separate financial statements: Cost of an investment in a subsidiary, joint venture or associate

When an entity prepares separate financial statements, IAS 27 requires a first-time adopter to account for its investments in subsidiaries, joint ventures and associates either: [IFRS 1.D14]

• at cost;
• in accordance with IFRS 9 – Financial Instruments; or
• using the equity method as described in IAS 28.

However, if a first-time adopter measures such an investment at cost then it can elect to measure that investment at one of the following amounts in its separate opening IFRS statement of financial position: [IFRS 1.D15]

1. cost determined in accordance with IAS 27; or
2. deemed cost, which is its:
   1. fair value at the entity's date of transition to IFRSs in its separate financial statements; or
   2. previous GAAP carrying amount at that date.

A first-time adopter may choose to use either of these bases to measure its investment in each subsidiary, joint venture or associate where it elects to use a deemed cost. [IFRS 1.D15].

For a first-time adopter that chooses to account for such an investment using the equity method procedures in accordance with IAS 28:

1. the first-time adopter applies the exemption for past business combinations in IFRS 1 (Appendix C) to the acquisition of the investment;
2. if the entity becomes a first-time adopter for its separate financial statements earlier than for its consolidated financial statements and:
   1. later than its parent, the entity would apply paragraph D16 of IFRS 1 in its separate financial statements;
   2. later than its subsidiary, the entity would apply paragraph D17 of IFRS 1 in its separate financial statements. [IFRS 1.D15A].

A first-time adopter that applies the exemption should disclose certain additional information in its financial statements (see 6.5.2 below).

5.9.1 Subsidiary becomes a first-time adopter later than its parent

If a subsidiary becomes a first-time adopter later than its parent, it should in its financial statements measure its own assets and liabilities at either:

1. the carrying amounts that would be included in the parent's consolidated financial statements, based on the parent's date of transition, if no adjustments were made for consolidation procedures and for the effects of the business combination in which the parent acquired the subsidiary; or
2. the carrying amounts required by the rest of IFRS 1, based on the subsidiary's date of transition. These carrying amounts could differ from those described in (a) when:
   1. exemptions in IFRS 1 result in measurements that depend on the date of transition;
   2. the subsidiary's accounting policies are different from those in the consolidated financial statements. For example, under IAS 16 the subsidiary may carry property at cost while the group uses the revaluation model, or vice versa. [IFRS 1.D16].

IFRS 1 does not elaborate on exactly what constitutes ‘consolidation procedures’ but in our view it would encompass adjustments required in order to harmonise a subsidiary's accounting policies with those of the group, as well as purely ‘mechanical’ consolidation adjustments such as the elimination of intragroup balances, profits and losses.

The following example, which is based on the guidance on implementation of IFRS 1, illustrates how an entity should apply these requirements. [IFRS 1.IG Example 8].

Under option (b) a subsidiary would prepare its own IFRS financial statements, completely ignoring the IFRS elections that its parent used when it adopted IFRSs for its consolidated financial statements.

Under option (a) the numbers in a subsidiary's IFRS financial statements will be as close to those used by its parent as possible. However, differences other than those arising from business combinations will still exist in many cases, for example:

• a subsidiary may have hedged an exposure by entering into a transaction with a fellow subsidiary. Such transaction could qualify for hedge accounting in the subsidiary's own financial statements but not in the group's consolidated financial statements; or
• a pension plan may have to be classified as a defined contribution plan from the subsidiary's point of view, but is accounted for as a defined benefit plan in the group's consolidated financial statements.

The IASB seems content with the fact that the exemption will ease some practical problems, [IFRS 1.BC62], though it will rarely succeed in achieving more than a moderate reduction of the number of reconciling differences between a subsidiary's own reporting and the numbers used by its parent.

More importantly, the choice of option (a) prevents the subsidiary from electing to apply any of the other voluntary exemptions offered by IFRS 1, since the parent had already made the choices for the group at its date of transition. Therefore, option (a) may not be appropriate for a subsidiary that prefers to use a different exemption (e.g. fair value as deemed cost) for property, plant and equipment due, for example, to a tax reporting advantage. Also, application of option (a) would require the subsidiary to adopt a new IFRS that becomes effective during any of the periods presented in the same manner it was adopted by the parent and is more difficult when a parent and its subsidiary have different financial years. In that case, IFRS 1 would seem to require the IFRS information for the subsidiary to be based on the parent's date of transition to IFRSs, which may not even coincide with an interim reporting date of the subsidiary; the same applies to any joint venture or associate.

Example 5.33 below explains interaction between D16 (a) of IFRS 1 (i.e. option (a) above) and the business combination exemptions in Appendix C of IFRS 1 applied by its parent.

A subsidiary may become a first-time adopter later than its parent, because it previously prepared a reporting package under IFRSs for consolidation purposes but did not present a full set of financial statements under IFRSs. The above election of D16 of IFRS 1 (a) may be ‘relevant not only when a subsidiary's reporting package complies fully with the recognition and measurement requirements of IFRSs, but also when it is adjusted centrally for matters such as review of events after the reporting period and central allocation of pension costs.’ [IFRS 1.IG31]. Adjustments made centrally to an unpublished reporting package are not considered to be corrections of errors for the purposes of the disclosure requirements in IFRS 1. However, a subsidiary is not permitted to ignore misstatements that are immaterial to the consolidated financial statements of the group but material to its own financial statements.

If a subsidiary was acquired after the parent's date of transition to IFRSs then it cannot apply option (a) because there are no carrying amounts included in the parent's consolidated financial statements, based on the parent's date of transition. Therefore, the subsidiary is unable to use the values recognised in the group accounts when it was acquired, since push-down of the group's purchase accounting values is not allowed in the subsidiary's financial statements. However, if the subsidiary had recognised those amounts in its previous GAAP financial statements, it may be able to use the same amounts as deemed costs under IFRSs pursuant to the ‘event-driven’ deemed cost exemption (see 5.5.2 above).

The exemption is also available to associates and joint ventures. This means that in many cases an associate or joint venture that wants to apply option (a) will need to choose which shareholder it considers its ‘parent’ for IFRS 1 purposes if more than one investor/joint venturer have already applied IFRS and determine the IFRS carrying amount of its assets and liabilities by reference to that parent's date of transition to IFRSs.

5.9.2 Parent becomes a first-time adopter later than its subsidiary

If a parent becomes a first-time adopter later than its subsidiary, the parent should, in its consolidated financial statements, measure the subsidiary's assets and liabilities at the carrying amounts that are in the subsidiary's financial statements, after adjusting for consolidation and for the effects of the business combination in which the entity acquired the subsidiary. The same applies for associates or joint ventures, substituting equity accounting adjustments. [IFRS 1.D17].

Unlike other first-time adoption exemptions, this exemption does not offer a choice between different accounting alternatives. In fact, while a subsidiary that adopts IFRSs later than its parent can choose to prepare its first IFRS financial statements by reference to its own date of transition to IFRSs or that of its parent, the parent itself must use the IFRS measurements already used in the subsidiary's financial statements, adjusted as appropriate for consolidation procedures and the effects of the business combination in which it acquired the subsidiary. [IFRS 1.BC63]. However, this exemption does not preclude the parent from adjusting the subsidiary's assets and liabilities for a different accounting policy, e.g. cost model or revaluation model for accounting for property, plant and equipment.

The following example, which is based on the guidance on implementation of IFRS 1, illustrates how an entity should apply these requirements. [IFRS 1.IG Example 9].

When a subsidiary adopts IFRSs before its parent, this will limit the parent's ability to choose first-time adoption exemptions in IFRS 1 freely as related to that subsidiary, as illustrated in the example below. However, this does not mean that the parent's ability to choose first-time adoption exemptions will always be limited. For example, a parent may still be able to deem a subsidiary's cumulative translation differences to be zero because IFRS 1 specifically states that under the option ‘the cumulative translation differences for all [emphasis added] foreign operations are deemed to be zero at the date of transition to IFRSs’ (see 5.7 above). [IFRS 1.D13].

5.9.3 Implementation guidance on accounting for assets and liabilities of subsidiaries, associates and joint ventures

The requirements of IFRS 1 for a parent and subsidiary with different dates of transition do not override the following requirements of IFRS 1: [IFRS 1.IG30]

• the parent's election to use the business combinations exemption in Appendix C discussed at 5.2 above, which applies to assets and liabilities of a subsidiary acquired in a business combination that occurred before the parent's date of transition to IFRSs. However, the rules summarised at 5.9.2 above (parent adopting IFRSs after subsidiary) apply only to assets acquired and liabilities assumed by the subsidiary after the business combination and still held and owned by it at the parent's date of transition to IFRSs;
• to apply the requirements in IFRS 1 in measuring items in the financial statements for which the provisions in paragraphs D16 and D17 of IFRS 1 are not relevant (for example, the use of the exemption in D16(a) to measure assets and liabilities at the carrying amounts in the parent's consolidated financial statements does not affect the use of the exemption in D12‑13 to deem the cumulative translation differences for all foreign operations are zero at its date of transition, discussed in 5.7 above, since this is neither an asset nor a liability); and
• a first-time adopter must give all the disclosures required by IFRS 1 as of its own date of transition to IFRSs – see 6 below.

5.9.4 Adoption of IFRSs on different dates in separate and consolidated financial statements

An entity may sometimes become a first-time adopter for its separate financial statements earlier or later than for its consolidated financial statements. Such a situation may arise, for example, when a parent avails itself of the exemption under paragraph 4 of IFRS 10 from preparing consolidated financial statements and prepares its separate financial statements under IFRSs. Subsequently, the parent may cease to be entitled to the exemption or may choose not to use it and would, therefore, be required to apply IFRS 1 in its first consolidated financial statements.

Another example might be that, under local law, an entity is required to prepare its consolidated financial statements under IFRSs, but is required (or permitted) to prepare its separate financial statements under local GAAP. Subsequently the parent chooses, or is required, to prepare its separate financial statements under IFRSs.

If a parent becomes a first-time adopter for its separate financial statements earlier or later than for its consolidated financial statements, it must measure its assets and liabilities at the same amounts in both financial statements, except for consolidation adjustments. [IFRS 1.D17]. As drafted, the requirement is merely that the ‘same’ amounts be used, without being explicit as to which set of financial statements should be used as the benchmark. However, it seems clear from the context that the IASB intends that the measurement basis used in whichever set of financial statements first comply with IFRSs must also be used when IFRSs are subsequently adopted in the other set.

5.9.5 Application to investment entities under IFRS 10

IFRS 10 requires a parent that is an ‘investment entity’ as defined in the standard (see Chapter 6) to account for most of its subsidiaries at fair value through profit or loss in its consolidated financial statements rather than through consolidation. This exception from normal consolidation procedures does not apply to:

• a parent entity that owns a subsidiary which is an investment entity but the parent itself is not an investment entity; [IFRS 10.33] or
• a parent that is an investment entity in accounting for subsidiary that is not itself an investment entity and whose main purpose and activities are providing services that relate to the investment entity's investment activities. [IFRS 10.32].

In IFRS 1, there are exemptions relating to a parent adopting IFRSs earlier or later than its subsidiary. Below, we deal with situations where:

• a subsidiary that is required to be measured at fair value through profit or loss adopts IFRSs after its parent which is an investment entity (see 5.9.5.A below); or
• a parent that is not an ‘investment entity’ adopts IFRSs after a subsidiary which is an investment entity (see 5.9.5.B below).

5.11.1 Designation of financial asset as measured at fair value through profit or loss

IFRS 9 permits a financial asset to be designated as measured at fair value through profit or loss if the entity satisfies the criteria in IFRS 9 at the date the entity becomes a party to the financial instrument. [IFRS 9.4.1.5].

Paragraph D19A of IFRS 1 allows a first-time adopter to designate a financial asset as measured at fair value through profit or loss on the basis of facts and circumstances that exist at the date of transition to IFRSs. [IFRS 1.D19A]. If this exemption is used, paragraph 29 of IFRS 1 would require certain additional disclosures (see 6.4 below).

5.11.2 Designation of financial liability at fair value through profit or loss

IFRS 9 permits a financial liability to be designated as a financial liability at fair value through profit or loss if the entity meets the criteria in IFRS 9 at the date the entity becomes a party to the financial instrument. [IFRS 9.4.2.2].

Paragraph D19 of IFRS 1 allows a first-time adopter to designate, at the transition date, a financial liability as measured at fair value through profit or loss provided the liability meets the criteria in paragraph 4.2.2 of IFRS 9 at that date. If this exemption is used, paragraph 29A of IFRS 1 would require certain additional disclosures (see 6.4 below). [IFRS 1.D19].

5.11.3 Designation of investment in equity instruments

At initial recognition, an entity may make an irrevocable election to designate an investment in an equity instrument not held for trading or contingent consideration recognised by an acquirer in a business combination to which IFRS 3 applies as at fair value through other comprehensive income in accordance with IFRS 9. [IFRS 9.5.7.5].

Paragraph D19B of IFRS 1 allows a first-time adopter to designate an investment in such an equity instrument as at fair value through other comprehensive income on the basis of facts and circumstances that exist at the date of transition to IFRSs. [IFRS 1.D19B].

5.11.4 Determination of an accounting mismatch for presenting a gain or loss on financial liability

IFRS 9 requires a fair value gain or loss on a financial liability that is designated as at fair value through profit or loss to be presented as follows unless this presentation creates or enlarges an accounting mismatch in profit or loss: [IFRS 9.5.7.7]

• the amount of change in the fair value of the financial liability that is attributable to changes in the credit risk of that liability should be presented in other comprehensive income; and
• the remaining amount of change in the fair value of the liability should be presented in profit or loss.

Paragraph D19C of IFRS 1 requires a first-time adopter to determine whether the treatment in paragraph 5.7.7 of IFRS 9 would create an accounting mismatch in profit or loss on the basis of facts and circumstances that exist at the date of transition to IFRSs (see Chapter 48). [IFRS 1.D19C].

5.13.1 IFRIC 1 exemption

Under IAS 16 the cost of an item of property, plant and equipment includes ‘the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.’ [IAS 16.16(c)]. Therefore, a first-time adopter needs to ensure that property, plant and equipment cost includes an item representing the decommissioning provision as determined under IAS 37. [IFRS 1.IG13].

An entity should apply IAS 16 in determining the amount to be included in the cost of the asset, before recognising depreciation and impairment losses which cause differences between the carrying amount of the decommissioning liability and the amount related to decommissioning costs to be included in the carrying amount of the asset.

An entity accounts for changes in decommissioning provisions in accordance with IFRIC 1 but IFRS 1 provides an exemption for changes that occurred before the date of transition to IFRSs and prescribes an alternative treatment if the exemption is used. [IFRS 1.IG13, IG201-IG203]. In such cases, a first-time adopter should:

1. measure the decommissioning liability as at the date of transition in accordance with IAS 37;
2. to the extent that the liability is within the scope of IFRIC 1, estimate the amount that would have been included in the cost of the related asset when the liability first arose, by discounting it to that date using its best estimate of the historical risk-adjusted discount rate(s) that would have applied for that liability over the intervening period; and
3. calculate the accumulated depreciation on that amount, as at the date of transition to IFRSs, on the basis of the current estimate of the useful life of the asset, using the entity's IFRS depreciation policy. [IFRS 1.D21].

From the above example it is clear that the exemption reduces the amount of effort required to restate items of property, plant and equipment with a decommissioning component. In many cases the difference between the two methods will be insignificant, except where an entity had to make major adjustments to the estimate of the decommissioning costs near the end of the life of the related assets.

A first-time adopter that elects the deemed cost approaches discussed in 5.5 above and elects to use the IFRIC 1 exemption to recognise its decommissioning obligation should be aware of the interaction between these exemptions that may lead to a potential overstatement of the underlying asset. In determining the deemed cost of the asset, the first-time adopter would need to make sure that the fair value of the asset is exclusive of the decommissioning obligation in order to avoid the potential overstatement of the value of the asset that might result from the application of the IFRIC 1 exemption.

5.13.2 IFRIC 1 exemption for oil and gas assets at deemed cost

A first-time adopter that applies the deemed cost exemption for oil and gas assets in the development or production phases accounted for in cost centres that include all properties in a large geographical area under previous GAAP (see 5.5.3 above) should not apply the IFRIC 1 exemption (see 5.13.1 above) or IFRIC 1 itself, but instead:

1. measure decommissioning, restoration and similar liabilities as at the date of transition in accordance with IAS 37; and
2. recognise directly in retained earnings any difference between that amount and the carrying amount of those liabilities at the date of transition determined under previous GAAP. [IFRS 1.D21A].

The IASB introduced this requirement because it believed that the existing IFRIC 1 exemption would require detailed calculations that would not be practicable for entities that apply the deemed cost exemption for oil and gas assets. [IFRS 1.BC63CA]. This is because the carrying amount of the oil and gas assets is deemed already to include the capitalised costs of the decommissioning obligation.

5.15.1 Borrowing cost exemption

For many first-time adopters, full retrospective application of IAS 23 – Borrowing Costs – would be problematic as the adjustment would be required in respect of any asset held that had, at any point in the past, satisfied the criteria for capitalisation of borrowing costs. To avoid this problem, IFRS 1 allows a modified form of the transitional provisions set out in IAS 23, which means that the first-time adopter can elect to apply the requirements of IAS 23 from the date of transition or from an earlier date as permitted by paragraph 28 of IAS 23. From the date on which an entity that applies this exemption begins to apply IAS 23, the entity:

• must not restate the borrowing cost component that was capitalised under previous GAAP and that was included in the carrying amount of assets at that date; and
• must account for borrowing costs incurred on or after that date in accordance with IAS 23, including those borrowing costs incurred on or after that date on qualifying assets already under construction. [IFRS 1.D23].

IAS 23 applies to borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset, that is defined in IAS 23. If a first-time adopter established a deemed cost for an asset (see 5.5 above) then it cannot capitalise borrowing costs incurred before the measurement date of the deemed cost (see 5.15.2 below). [IFRS 1.IG23].

5.15.2 Interaction with other exemptions

There are limitations imposed on capitalised amounts under IAS 23. IAS 23 states that when the carrying amount of a qualifying asset exceeds its recoverable amount or net realisable value, the carrying amount is written down or written off in accordance with the requirement of other standards. [IAS 23.16]. Once an entity uses the ‘fair value as deemed cost exemption’ described at 5.5 above and has recognised an asset at fair value, in our view, the entity should not increase that value to capitalise interest incurred before that date. Interest incurred subsequent to the date of transition may be capitalised on a qualifying asset, subject to the requirements of IAS 23 (see Chapter 21).

5.20.1 Defined terms in IFRS 14

IFRS 14 defines the following terms in connection with regulatory deferral accounts. [IFRS 14 Appendix A].

Rate regulated activities: An entity's activities that are subject to rate regulation.

Rate regulation: A framework for establishing the prices that can be charged to customers for goods or services and that framework is subject to oversight and/or approval by a rate regulator.

Rate regulator: An authorised body that is empowered by statute or regulation to establish the rate or a range of rates that bind an entity. The rate regulator may be a third-party body or a related party of the entity, including the entity's own governing board, if that body is required by statute or regulation to set rates both in the interest of the customers and to ensure the overall financial viability of the entity.

Regulatory deferral account balance: The balance of any expense (or income) account that would not be recognised as an asset or a liability in accordance with other standards, but that qualifies for deferral because it is included, or is expected to be included, by the rate regulator in establishing the rate(s) that can be charged to customers.

5.20.2 Scope

An entity is permitted to apply IFRS 14 in its first IFRS financial statements, if the entity conducts rate-regulated activities and recognised amounts that qualify as regulatory deferral account balances in its financial statements under its previous GAAP. [IFRS 14.5]. The entity that is within the scope of, and that elects to apply, IFRS 14 should apply all of its requirements to all regulatory deferral account balances that arise from all of the entity's rate-regulated activities. [IFRS 14.8].

The entity that elected to apply IFRS 14 in its first IFRS financial statements should apply IFRS 14 also in its financial statements for subsequent periods. [IFRS 14.6].

5.20.3 Continuation of previous GAAP accounting policies (Temporary exemption from paragraph 11 of IAS 8)

In some cases, other standards explicitly prohibit an entity from recognising, in the statement of financial position, regulatory deferral account balances that might be recognised, either separately or included within other line items such as property, plant and equipment, in accordance with previous GAAP accounting policies. However, in accordance with paragraph 9 and 10 of IFRS 14, an entity that elects to apply this standard in its first IFRS financial statements applies the exemption from paragraph 11 of IAS 8. [IFRS 14.10]. In other words, on initial application of IFRS 14, an entity should continue to apply its previous GAAP accounting policies for the recognition, measurement, impairment, and derecognition of regulatory deferral account balances except for any changes permitted by the standard and subject to any presentation changes required by the standard. [IFRS 14.11]. Such accounting policies may include, for example, the following practices: [IFRS 14.B4]

• recognising a regulatory deferral account debit balance when the entity has the right, as a result of the actual or expected actions of the rate regulator, to increase rates in future periods in order to recover its allowable costs (i.e. the costs for which the regulated rate(s) is intended to provide recovery);
• recognising, as a regulatory deferral account debit or credit balance, an amount that is equivalent to any loss or gain on the disposal or retirement of both items of property, plant and equipment and of intangible assets, which is expected to be recovered or reversed through future rates;
• recognising a regulatory deferral account credit balance when the entity is required, as a result of the actual or expected actions of the rate regulator, to decrease rates in future periods in order to reverse over-recoveries of allowable costs (i.e. amounts in excess of the recoverable amount specified by the rate regulator); and
• measuring regulatory deferral account balances on an undiscounted basis or on a discounted basis that uses an interest or discount rate specified by the rate regulator.

The accounting policy for the regulatory deferral account balances, as explained above, must, of course, be consistent from period to period unless there is an appropriate change in accounting policies. [IFRS 14.12].

5.20.4 Recognition as regulatory deferral account balances

The regulatory deferral account balances to be recognised are restricted to the incremental amounts from what are permitted or required to be recognised as assets and liabilities under other IFRS. [IFRS 14.7]. Therefore, the measurement of these balances effectively entails a two-step process:

1. An entity would first determine the carrying amount of its assets and liabilities under IFRS, excluding IFRS 14.
2. These amounts would then be compared with the assets and liabilities determined under the entity's previous GAAP (i.e. its rate-regulated balances).

The differences would represent the regulatory deferral account debit or credit balances to be recognised by the entity under IFRS 14.

Some items of expense (income) may be outside the regulated rate(s) because, for example, the amounts are not expected to be accepted by the rate regulator or because they are not within the scope of the rate regulation. Consequently, such an item is recognised as income when earned or expense as incurred, unless another standard permits or requires it to be included in the carrying amount of an asset or liability. [IFRS 14.B3].

The following are examples of the types of costs that rate regulators might allow in rate-setting decisions and that an entity might, therefore, recognise in regulatory deferral account balances: [IFRS 14.B5]

• volume or purchase price variances;
• costs of approved ‘green energy’ initiatives (in excess of amounts that are capitalised as part of the cost of property, plant and equipment in accordance with IAS 16);
• non-directly-attributable overhead costs that are treated as capital costs for rate regulation purposes (but are not permitted, in accordance with IAS 16, to be included in the cost of an item of property, plant and equipment);
• project cancellation costs;
• storm damage costs; and
• deemed interest (including amounts allowed for funds that are used during construction that provide the entity with a return on the owner's equity capital as well as borrowings).

5.20.5 Changes in accounting policies

An entity should not change its accounting policies in order to start to recognise regulatory deferral account balances. [IFRS 14.13]. Also, changes in its accounting policies for the recognition, measurement, impairment and derecognition of regulatory deferral account balances are only allowed if it would result in financial statements that are more relevant to the economic decision-making needs of users and no less reliable, or more reliable and no less relevant to those needs. The judgement of relevance and reliability is made using the criteria in IAS 8. [IFRS 14.13, IAS 8.10]. It should be noted that IFRS 14 does not exempt entities from applying paragraphs 10 or 14‑15 of IAS 8 to changes in accounting policy. [IFRS 14.14].

The application guidance in IFRS 14 clarifies that regulatory deferral account balances usually represent timing differences between the recognition of items of income or expenses for regulatory purposes and the recognition of those items for financial reporting purposes. When an entity changes an accounting policy on the first-time adoption of IFRS or on the initial application of a new or revised standard, new or revised timing differences may arise that create new or revised regulatory deferral account balances. The prohibition in paragraph 13 of this standard that prevents an entity from changing its accounting policy in order to start to recognise regulatory deferral account balances does not prohibit the recognition of the new or revised regulatory deferral account balances that are created because of other changes in accounting policies required by IFRS. This is because the recognition of regulatory deferral account balances for such timing differences would be consistent with the existing recognition policy and would not represent the introduction of a new accounting policy. Similarly, paragraph 13 of this standard does not prohibit the recognition of regulatory deferral account balances arising from timing differences that did not exist immediately prior to the date of transition to IFRS but are consistent with the entity's accounting policies established in accordance with paragraph 11 of IFRS 14, for example, storm damage costs. [IFRS 14.B6].

5.20.6 Presentation and disclosures

5.20.7 Interaction with other standards

Any specific exception, exemption or additional requirements related to the interaction of IFRS 14 with other standards are contained within IFRS 14. In the absence of any such exception, exemption or additional requirements, other standards must apply to regulatory deferral account balances in the same way as they apply to assets, liabilities, income and expenses that are recognised in accordance with other standards. The following sections outline how some other IFRSs interact with the requirements of IFRS 14. In particular, the following sections clarify specific exceptions to, and exemptions from, other IFRSs and additional presentation and disclosure requirements that are expected to be applicable. [IFRS 14.16, IFRS 14.B7-B28].

6.3.1 Disclosure of reconciliations

A first-time adopter is required to present:

• reconciliations of its equity reported under previous GAAP to its equity under IFRSs at:
  • the date of transition to IFRSs; and
  • the end of the latest period presented in the entity's most recent annual financial statements under previous GAAP;
• a reconciliation to its total comprehensive income under IFRSs for the latest period in the entity's most recent annual financial statements. The starting point for that reconciliation should be total comprehensive income under previous GAAP for the same period or, if an entity did not report such a total, profit or loss under previous GAAP; [IFRS 1.24] and
• an explanation of the material adjustments to the statement of cash flows, if it presented one under its previous GAAP. [IFRS 1.25].

These reconciliations should be sufficiently detailed to enable users to understand the material adjustments to the statement of financial position, statement of profit or loss (if presented) and statement of profit or loss and other comprehensive income. [IFRS 1.25]. While the standard does not prescribe a layout for these reconciliations, the implementation guidance contains an example of a line-by-line reconciliation of the statement of financial position, statement of profit or loss and other comprehensive income. [IFRS 1.IG Example 11]. This presentation may be particularly appropriate when a first-time adopter needs to make transitional adjustments that affect a significant number of line items in the primary financial statements. If the adjustments are less pervasive a straightforward reconciliation of equity, total comprehensive income and/or profit or loss may provide an equally effective explanation of how the adoption of IFRSs affects the reported financial position, financial performance and cash flows.

If a first-time adopter becomes aware of errors made under previous GAAP, it should distinguish the correction of errors from changes in accounting policies in the above reconciliations. [IFRS 1.26]. This means that the adoption of IFRSs should not be used to mask the error.

The example below illustrates how these requirements apply to an entity whose first IFRS financial statements are for the period ending on 31 December 2020 and whose date of transition to IFRSs is 1 January 2019.

First-time adopters should not apply the requirements of IAS 8 relating to the changes in accounting policies because that standard does not apply to the changes in accounting policies an entity makes when it adopts IFRSs or changes in those policies until after it presents its first IFRS financial statements. [IFRS 1.27].

A first-time adopter should explain changes in accounting policies or in its use of exemptions during the period between its first IFRS interim financial report and its first IFRS annual financial statements (see 6.6 below) and update the reconciliations of equity and total comprehensive income discussed herein. [IFRS 1.27A]. This requirement is necessary since the first-time adopter is exempt from the requirements of IAS 8 concerning reporting of such changes. [IFRS 1.BC97].

6.3.2 Line-by-line reconciliations and detailed explanations

The extract below from the 2011 financial statements of Bombardier Inc. complies with the versions of IFRS 1 and IAS 1 that were effective in 2011. However, it still provides a good example of an entity that not only provides summary reconciliations of equity and profit or loss, but also line-by-line reconciliations, as suggested by the Implementation Guidance of IFRS 1, and detailed explanations of the reconciling items.

The exceptions and exemptions used by Bombardier on transition are shown in Extract 5.12 above. The following extract does not include all of Bombardier's detailed explanations of the reconciling items.

6.3.3 Recognition and reversal of impairments

If a first-time adopter recognised or reversed any impairment losses on transition to IFRSs it should disclose the information that IAS 36 would have required if the entity had recognised those impairment losses or reversals in the period beginning with the date of transition to IFRSs (see Chapter 20). [IFRS 1.24]. This provides transparency about impairment losses recognised on transition that might otherwise receive less attention than impairment losses recognised in earlier or later periods. [IFRS 1.BC94].

6.3.4 Inclusion of IFRS 1 reconciliations by cross reference

The reconciliation disclosures required by IFRS 1 are generally quite lengthy. While IFRS 1 allows an entity's first interim report under IAS 34 to give certain of these disclosures by way of cross-reference to another published document, [IFRS 1.32‑33], there is no corresponding exemption for disclosure in the entity's first annual IFRS financial statements. Therefore, a first-time adopter should include all disclosures required by IFRS 1 within its first annual IFRS financial statements in the same way it would need to include other lengthy disclosures such as those on business combinations, financial instruments and employee benefits. Any additional voluntary information regarding the conversion to IFRSs that was previously published but that is not specifically required by IFRS 1 need not be repeated in the first IFRS financial statements.

6.5.1 Use of fair value as deemed cost

If a first-time adopter uses fair value as deemed cost for any item of property, plant and equipment, investment property, right-of-use asset under IFRS 16 or an intangible asset in its opening IFRS statement of financial position (see 5.5.1 above), it should disclose for each line item in the opening IFRS statement of financial position: [IFRS 1.30]

• the aggregate of those fair values; and
• the aggregate adjustment to the carrying amounts reported under previous GAAP.

This disclosure is illustrated in Extracts 5.6 and 5.7 at 5.5.1 above.

6.5.2 Use of deemed cost for investments in subsidiaries, joint ventures and associates

If a first-time adopter measures its investments in subsidiaries, joint ventures or associates at deemed cost in the parent (joint venturer or investor) company's opening IFRS statement of financial position (see 5.8.2 above), the entity's first IFRS separate financial statements should disclose:

1. the aggregate deemed cost of those investments for which deemed cost is their previous GAAP carrying amount;
2. the aggregate deemed cost of those investments for which deemed cost is fair value; and
3. the aggregate adjustment to the carrying amounts reported under previous GAAP. [IFRS 1.31].

6.5.3 Use of deemed cost for oil and gas assets

If a first-time adopter uses the deemed cost exemption in paragraph D8A(b) of IFRS 1 for oil and gas assets (see 5.5.3 above), it should disclose that fact and the basis on which carrying amounts determined under previous GAAP were allocated. [IFRS 1.31A].

6.5.4 Use of deemed cost for assets used in operations subject to rate regulation

If a first-time adopter uses the exemption for assets used in operations subject to rate regulation (see 5.5.4 above), it should disclose that fact and the basis on which carrying amounts were determined under previous GAAP. [IFRS 1.31B].

6.5.5 Use of deemed cost after severe hyperinflation

If a first-time adopter uses the exemption to elect fair value as the deemed cost in its opening IFRS statement of financial position for assets and liabilities because of severe hyperinflation (see 5.17 above), it should disclose an explanation of how, and why, the first-time adopter had, and then ceased to have, a functional currency that has both of the following characteristics: [IFRS 1.31C]

1. a reliable general price index is not available to all entities with transactions and balances in the currency; and
2. exchangeability between the currency and a relatively stable foreign currency does not exist.

6.6.1 Reconciliations in the interim financial reports

If a first-time adopter presents an interim financial report under IAS 34 for part of the period covered by its first IFRS financial statements: [IFRS 1.32]

1. each such interim financial report should, if the entity presented an interim financial report for the comparable interim period of the immediately preceding financial year, include:
   • a reconciliation of its equity under previous GAAP at the end of that comparable interim period to its equity under IFRSs at that date; and
   • a reconciliation to its total comprehensive income under IFRSs for that comparable interim period (current and year to date). The starting point for that reconciliation is total comprehensive income under previous GAAP for that period or, if an entity did not report such a total, profit or loss under previous GAAP.
2. in addition, the entity's first interim financial report under IAS 34 for part of the period covered by its first IFRS financial statements should include the reconciliations described at 6.3.1 above or a cross-reference to another published document that includes these reconciliations.

For an entity presenting annual financial statements under IFRSs, it is not compulsory to prepare interim financial reports under IAS 34. Therefore, the above requirements only apply to first-time adopters that prepare interim reports under IAS 34 on a voluntary basis or that are required to do so by a regulator or other party. [IFRS 1.IG37].

Examples 5.38 and 5.39 below show which reconciliations should be included in half-year reports and quarterly reports, respectively.

As can be seen from the tables in Example 5.38, the additional reconciliations and explanations required under (b) above would be presented out of context, i.e. without the statement of financial position, statement of profit or loss (if presented), statement of profit or loss and other comprehensive income and statement of cash flows to which they relate. For this reason, we believe a first-time adopter should either (1) include the primary financial statements to which these reconciliations relate or (2) refer to another published document that includes these primary financial statements. The following example showing the various reconciliations to be included in the financial statements of a first-time adopter is based on the Illustrative Examples of IFRS 1: [IFRS 1.IG Example 10]

If a first-time adopter issues interim financial report in accordance with IAS 34 for part of the period covered by its first IFRS financial statements and changes accounting policies or its use of exemptions contained in IFRS 1, the first-time adopter is required to explain the changes in each such interim financial report in accordance with paragraph 23 and update the reconciliation required by paragraph 32 (a) and (b) of IFRS 1. [IFRS 1.32(c)].

6.6.2 Disclosures in the interim financial report

Interim financial reports under IAS 34 contain considerably less detail than annual financial statements because they assume that users of the interim financial report also have access to the most recent annual financial statements. [IFRS 1.33]. However, they would be expected to provide disclosure relating to material events or transactions to allow users to understand the current interim period. Therefore, a first-time adopter needs to consider what IFRS disclosures are material to an understanding of the current interim period. A full set of IFRS accounting policy disclosures and related significant judgements and estimates should be included as well as information on the IFRS 1 exemptions employed. In addition, consideration should be given to both new disclosures not previously required under previous GAAP, and disclosures made under previous GAAP but for which the amounts contained therein have changed significantly due to changes in accounting policies resulting from the adoption of IFRSs.

It is also important to note that such disclosures apply to balances in both the opening and comparative year-end statement of financial position, each of which could be included in the first IFRS interim financial report (see 6.6.1 above). First-time adopters should expect to include significantly more information in their first IFRS interim report than would normally be included in an interim report (alternatively, it could cross refer to another published document that includes such information). [IFRS 1.33].

Examples of additional annual disclosures under IFRSs to be included in the entity's first IAS 34 compliant interim financial report could include disclosures relating to retirement benefits, income taxes, goodwill and provisions, amongst other items that significantly differ from previous GAAP and those required IFRS disclosures that are more substantial than previous GAAP.

7.2.1 Changes in IFRS accounting policies during the first IFRS reporting period

A first-time adopter may find that it needs to change IFRS accounting policies after it has issued an IFRS interim report but before issuing its first IFRS financial statements. Such a change in accounting policies could relate either to the ongoing IFRS accounting policies or to the selection of IFRS 1 exemptions.

IAS 8 does not apply to the changes in accounting policies an entity makes when it adopts IFRSs or to changes in those policies until after it presents its first IFRS financial statements. [IFRS 1.27]. Therefore, ‘if during the period covered by its first IFRS financial statements an entity changes its accounting policies or its use of the exemptions contained in this IFRS’, it should explain the changes between its first IFRS interim financial report and its first IFRS financial statements in accordance with paragraph 23 of IFRS 1 (see 6.3.1 above) and update the reconciliations required by paragraphs 24(a) and (b) of IFRS 1 (see 6.3.1 above). [IFRS 1.27A]. A similar requirement applies to the disclosures in a first-time adopter's interim financial reports (see 6.6 above). [IFRS 1.32(c)].

The distinction between changes in accounting policies and changes in accounting estimates is discussed in detail in Chapter 3.

7.2.2 Changes in estimates and correction of errors

An entity that adopts IFRSs needs to assess carefully the impact of information that has become available since it prepared its most recent previous GAAP financial statements because the new information:

• may be a new estimate that should be accounted for prospectively (see 4.2 above); or
• may expose an error in the previous GAAP financial statements due to mathematical mistakes, error in applying accounting policies, oversights or misinterpretations of facts and fraud. In the reconciliation from previous GAAP to IFRSs such errors should be disclosed separately from the effect of changes in accounting policies (see 6.3.1 above).

7.3.1 Previous revaluation of plant, property and equipment treated as deemed cost on transition

In some cases IFRS 1 allows an entity, on transition to IFRSs, to treat the carrying amount of plant, property or equipment revalued under its previous GAAP as its deemed cost as of the date of revaluation for the purposes of IFRSs (see 5.5.1 above).

Where an asset is carried at deemed cost on transition but the tax base of the asset remains at original cost, or an amount based on original cost, the previous GAAP revaluation will give rise to a temporary difference which is typically a taxable temporary difference associated with the asset. IAS 12 requires deferred tax to be recognised at transition on any such temporary difference.

If, after transition, the deferred tax is required to be remeasured, e.g. because of a change in tax rate, or a re-basing of the asset for tax purposes, the entity elects the cost model of IAS 16 and the asset concerned was revalued outside profit or loss under previous GAAP, the question arises as to whether the resulting deferred tax income or expense should be recognised in, or outside, profit or loss.

In our view, either approach is acceptable, so long as it is applied consistently.

The essence of the argument for recognising such income or expense in profit or loss is whether the reference in paragraph 61A of IAS 12 to the tax effects of ‘items recognised outside profit or loss’ means items recognised outside profit or loss under IFRSs, or whether it can extend to the treatment under previous GAAP. [IAS 12.61A].

Those who argue that it must mean solely items recognised outside profit or loss under IFRSs note that an asset carried at deemed cost on transition is not otherwise treated as a revalued asset for the purposes of IFRSs. For example, any impairment of such an asset must be accounted for in profit or loss. By contrast, any impairment of plant, property or equipment treated as a revalued asset under IAS 16 would be accounted for outside profit or loss – in other comprehensive income – up to the amount of the cumulative revaluation gain previously recognised.

Those who hold the contrary view that it need not be read as referring only to items recognised outside profit or loss under IFRSs may do so in the context that the entity's previous GAAP required tax income and expense to be allocated between profit or loss, other comprehensive income and equity in a manner similar to that required by IAS 12. It is argued that it is inappropriate that the effect of transitioning from previous GAAP to IFRSs should be to require recognition in profit or loss of an item that would have been recognised outside profit or loss under the ongoing application of either previous GAAP or IFRSs. The counter-argument to this is that there are a number of other similar inconsistencies under IFRS 1.

A more persuasive argument for the latter view might be that, whilst IFRSs do not regard such an asset as having been revalued, it does allow the revalued amount to stand. IFRSs are therefore recognising an implied contribution by owners in excess of the original cost of the asset which, although it is not a ‘revaluation’ under IFRSs, would nevertheless have been recognised in equity on an ongoing application of IFRSs.

7.3.2 Share-based payment transactions subject to transitional provisions of IFRS 1

While IFRS 1 provides exemptions from applying IFRS 2 to share-based payment transactions that were fully vested prior to the date of transition to IFRSs, there are no corresponding exemptions from the provisions of IAS 12 relating to the tax effects of share-based payment transactions. Therefore, the provisions of IAS 12 relating to the tax effects of share-based payments apply to all share-based payment transactions, whether they are accounted for in accordance with IFRS 2 or not. A tax-deductible share-based payment transaction is treated as having a carrying amount equivalent to the total cumulative expense recognised in respect of it, irrespective of how, or indeed whether, the share-based payment is itself accounted for.

This means that on transition to IFRSs, and subject to the restrictions on recognition of deferred tax assets (see Chapter 33), a deferred tax asset should be established for all share-based payment awards outstanding at that date, including those not accounted for under the transitional provisions.

Where such an asset is remeasured or recognised after transition to IFRSs, the general rule regarding the ‘capping’ of the amount of any tax relief recognised in profit or loss to the amount charged to the profit or loss applies (see Chapter 33 at 10.8.1). Therefore, if there was no profit or loss charge for share-based payment transactions under the previous GAAP, all tax effects of share-based payment transactions not accounted for under IFRS 2 should be dealt with within equity. [IAS 12.68C].

7.3.3 Retrospective restatements or applications

The adjustments arising from different accounting policies under previous GAAP and IFRS should be recognised directly in retained earnings (or, if appropriate, another category of equity) at the date of transition to IFRSs. [IFRS 1.11].

IAS 12 requires current tax and deferred tax that relates to items that are recognised, in the same or a different period, directly in equity, to be recognised directly in equity. However, as drafted, IAS 12 can also be read as requiring any subsequent remeasurement of such tax effects to be accounted for in retained earnings because the amount to be remeasured was originally recognised in retained earnings. This could give rise to a rather surprising result, as illustrated by Example 5.40 below.

We question whether it was really the intention of IAS 12 that these remeasurements be recognised in retained earnings. There is a fundamental difference between an item that by its nature would always be recognised directly outside profit or loss (e.g. certain foreign exchange differences or revaluations of plant, property and equipment) and an item which in the normal course of events would be accounted for in profit or loss, but when recognised for the first time (such as in Example 5.40 above) is dealt with as a ‘catch up’ adjustment to opening retained earnings. If it had done so, all the charge for environmental costs (and all the related deferred tax) would have been reflected in profit or loss in previous income statements. Therefore, it is our view that subsequent changes to such items recognised as a ‘catch-up’ adjustment upon transition to IFRSs should be recognised in profit or loss.

7.3.4 Defined benefit pension plans

IAS 19 requires an entity, in accounting for a post-employment defined benefit plan, to recognise actuarial gains and losses relating to the plan in other comprehensive income. At the same time, service cost and net interest on the net defined benefit liability (asset) is recognised in profit or loss.

In many jurisdictions, tax relief for post-employment benefits is given on the basis of cash contributions paid to the plan fund (or benefits paid when a plan is unfunded).

This significant difference between the way in which defined benefit plans are treated for tax and financial reporting purposes can make the allocation of tax between profit or loss and other comprehensive income somewhat arbitrary.

The issue is of particular importance when a first-time adopter has large funding shortfalls on its defined benefit schemes and at the same time can only recognise part of its deferred tax assets. In such a situation the method of allocation may well affect the after-tax profit in a given year. In our view (see Chapter 33), these are instances of the exceptional circumstances envisaged by IAS 12 when a strict allocation of tax between profit or loss and other comprehensive income is not possible. Accordingly, any reasonable method of allocation may be used, provided that it is applied on a consistent basis.

One approach might be to compare the funding payments made to the scheme in a few years before the adoption of IFRS with the charges that would have been made to profit or loss under IAS 19 in those periods. If, for example, it is found that the payments were equal to or greater than the charges to profit or loss, it could reasonably be concluded that any surplus or deficit on the statement of financial position is broadly represented by items that have been accounted for in other comprehensive income.

7.4.1 Depreciation method and rate

If a first-time adopter's depreciation methods and rates under its previous GAAP are acceptable under IFRSs then it accounts for any change in estimated useful life or depreciation pattern prospectively from when it makes that change in estimate (see 4.2 above). However, if the depreciation methods and rates are not acceptable and the difference has a material impact on the financial statements, a first-time adopter should adjust the accumulated depreciation in its opening IFRS statement of financial position retrospectively. [IFRS 1.IG7]. Additional differences may arise from the requirement in IAS 16 to review the residual value and the useful life of an asset at least each financial year end, [IAS 16.51], which may not be required under a first-time adopter's previous GAAP.

If a restatement of the depreciation methods and rates would be too onerous, a first-time adopter could opt instead to use fair value as the deemed cost. However, application of the deemed cost exemption is not always the only approach available. In practice, many first-time adopters have found that, other than buildings, there are generally few items of property, plant and equipment that still have a material carrying amount after more than 30 or 40 years of use. Therefore, the carrying value that results from a fully retrospective application of IAS 16 may not differ much from the carrying amount under an entity's previous GAAP.

7.4.2 Estimates of useful life and residual value

An entity may use fair value as deemed cost for an item of property, plant and equipment still in use that it had depreciated to zero under its previous GAAP (i.e. the asset has already reached the end of its originally assessed economic life). Although IFRS 1 requires an entity to use estimates made under its previous GAAP, paragraph 51 of IAS 16 would require the entity to re-assess the remaining useful life and residual value at least annually. [IAS 16.51]. Therefore, the asset's deemed cost should be depreciated over its re-assessed economic life and taking into account its re-assessed residual value.

The same applies when an entity does not use fair value or revaluation as deemed cost. If there were indicators in the past that the useful life or residual value changed but those changes were not required to be recognised under previous GAAP, the IFRS carrying amount as of the date of transition should be determined by taking into account the re-assessed useful life and the re-assessed residual value. Often, this is difficult, as most entities would not have re-assessed the useful lives contemporaneously with the issuance of the previous GAAP financial statements. Accordingly, the fair value as deemed cost exemption might be the most logical choice.

7.4.3 Revaluation model

A first-time adopter that chooses to account for some or all classes of property, plant and equipment under the revaluation model needs to present the cumulative revaluation surplus as a separate component of equity. IFRS 1 requires that ‘the revaluation surplus at the date of transition to IFRSs is based on a comparison of the carrying amount of the asset at that date with its cost or deemed cost.’ [IFRS 1.IG10].

A first-time adopter that uses fair value as the deemed cost for those classes of property, plant and equipment would be required to reset the cumulative revaluation surplus to zero. Therefore any previous GAAP revaluation surplus related to assets valued at deemed cost cannot be used to offset a subsequent impairment or revaluation loss under IFRSs. The following example illustrates the treatment of the revaluation reserve at the date of transition based on different deemed cost exemptions applied under IFRS 1.

7.4.4 Parts approach

IAS 16 requires a ‘parts approach’ to the recognition of property, plant and equipment. Thus a large item such as an aircraft is recognised as a series of ‘parts’ that may have different useful lives. An engine of an aircraft may be a part. IAS 16 does not prescribe the physical unit of measure (the ‘part’) for recognition i.e. what constitutes an item of property, plant and equipment. [IFRS 1.IG12]. Instead the standard relies on judgement in applying the recognition criteria to an entity's specific circumstances. [IAS 16.9]. However, the standard does require an entity to:

• apply a very restrictive definition of maintenance costs or costs of day-to-day servicing which it describes as ‘primarily the costs of labour and consumables, and may include the cost of small parts. The purpose of these expenditures is often described as for the “repairs and maintenance” of the item of property, plant and equipment’; [IAS 16.12]
• derecognise the carrying amount of the parts that are replaced; [IAS 16.13] and
• depreciate separately each part of an item of property, plant and equipment with a cost that is significant in relation to the total cost of the item. [IAS 16.43].

Based on this, it is reasonable to surmise that parts can be relatively small units. Therefore, it is possible that even if a first-time adopter's depreciation methods and rates are acceptable under IFRSs, it may have to restate property, plant and equipment because its unit of measure under previous GAAP was based on physical units significantly larger than parts as described in IAS 16. Accounting for parts is described in detail in Chapter 18.

In practice, however, there is seldom a need to account for every single part of an asset separately. Very often there is no significant difference in the reported amounts once all significant parts have been identified. Furthermore, as explained in Chapter 18, an entity may not actually need to identify the parts of an asset until it incurs the replacement expenditure.

7.7.1 Sensitivity analysis for each significant actuarial assumption

IAS 19 requires the disclosures set out below about sensitivity of defined benefit obligations. Therefore for an entity's first IFRS financial statements careful preparation must be done to compile the information required to present the sensitivity disclosure for the current and comparative periods. IAS 19 requires an entity to disclose: [IAS 19.145]

1. a sensitivity analysis for each significant actuarial assumption as of the end of the reporting period, showing how the defined benefit obligation would have been affected by changes in the relevant actuarial assumption that were reasonably possible at that date;
2. the methods and assumptions used in preparing the sensitivity analyses required by (a) and the limitations of those methods; and
3. changes from the previous period in the methods and assumptions used in preparing the sensitivity analyses, and the reasons for such changes.

7.7.2 Full actuarial valuations

An entity's first IFRS financial statements reflect its defined benefit liabilities or assets on at least three different dates, that is, the end of the first IFRS reporting period, the end of the comparative period and the date of transition to IFRSs (four different dates if it presents two comparative periods). If an entity obtains a full actuarial valuation at one or two of these dates, it is allowed to roll forward (or roll back) to another date but only as long as the roll forward (or roll back) reflects material transactions and other material events (including changes in market prices and interest rates) between those dates. [IFRS 1.IG21].

7.7.3 Actuarial assumptions

A first-time adopter's actuarial assumptions at its date of transition should be consistent with the ones it used for the same date under its previous GAAP (after adjustments to reflect any difference in accounting policies), unless there is objective evidence that those assumptions were in error (see 4.2 above). The impact of any later revisions to those assumptions is an actuarial gain or loss of the period in which the entity makes the revisions. [IFRS 1.IG19].

If a first-time adopter needs to make actuarial assumptions at the date of transition that were not necessary for compliance with its previous GAAP, those actuarial assumptions should not reflect conditions that arose after the date of transition. In particular, discount rates and the fair value of plan assets at the date of transition should reflect the market conditions at that date. Similarly, the entity's actuarial assumptions at the date of transition about future employee turnover rates should not reflect a significant increase in estimated employee turnover rates as a result of a curtailment of the pension plan that occurred after the date of transition. [IFRS 1.IG20].

If there is a material difference arising from a change in assumptions at the transition date, consideration needs to be given to whether there was an error under previous GAAP. Errors cannot be recognised as transition adjustments (see 6.3.1 above).

7.7.4 Unrecognised past service costs

IAS 19 requires immediate recognition of all past service costs. [IAS 19.103]. Accordingly, a first-time adopter that has unrecognised past service costs under previous GAAP must recognise such amount in retained earnings at the date of transition, regardless of whether the participants are fully vested in the benefit.

7.8.1 Functional currency

A first-time adopter needs to confirm whether all entities included within the financial statements have appropriately determined their functional currency. IAS 21 defines an entity's functional currency as ‘the currency of the primary economic environment in which the entity operates’ and contains detailed guidance on determining the functional currency. [IAS 21.8‑14].

If the functional currency of an entity is not readily identifiable, IAS 21 requires consideration of whether the activities of the foreign operation are carried out as an extension of the reporting entity, rather than being carried out with a significant degree of autonomy. [IAS 21.11]. This requirement often leads to the conclusion under IFRSs that intermediate holding companies, treasury subsidiaries and foreign sales offices have the same functional currency as their parent.

Many national GAAPs do not specifically define the concept of functional currency, or they may contain guidance on identifying the functional currency that differs from that in IAS 21. Consequently, a first-time adopter that measured transactions in a currency that was not its functional currency under IFRS would need to restate its financial statements because IFRS 1 does not contain an exemption that would allow it to use a currency other than the functional currency in determining the cost of assets and liabilities in its opening IFRS statement of financial position. The exemption that allows a first-time adopter to reset the cumulative exchange differences in equity to zero cannot be applied to assets or liabilities (see 5.7 above). The IFRIC considered whether a specific exemption should be granted to first-time adopter to permit entities to translate all assets and liabilities at the transition date exchange rate rather than applying the functional currency approach in IAS 21 but declined to offer first-time adopters any exemptions on transition on the basis that the position under IFRS 1 and IAS 21 was clear.⁵

The principal difficulty relates to non-monetary items that are measured on the basis of historical cost, particularly property, plant and equipment, since these will need to be re-measured in terms of the IAS 21 functional currency at the rates of exchange applicable at the date of acquisition of the assets concerned, and recalculating cumulative depreciation charges accordingly. It may be that, to overcome this difficulty, an entity should consider using the option in IFRS 1 whereby the fair value of such assets at the date of transition is treated as being their deemed cost (see 5.5.1 above).

7.9.1 Transition impairment review

A first-time adopter of IFRSs is required by IFRS 1 to perform an impairment test in accordance with IAS 36 to any goodwill recognised at the date of transition to IFRSs, regardless of whether there is any indication of impairment. [IFRS 1.C4(g)(ii)]. IFRS 1 specifically notes that its provisions with regard to past business combinations apply also to past acquisitions of investments in associates, interests in joint ventures and interests in joint operations (in which the activity of the joint operation constitutes a business, as defined in IFRS 3). [IFRS 1.C5]. Therefore, a transition impairment review must be undertaken for investments in associates or joint venture whose carrying value includes an element of goodwill. This impairment review will, however, need to be carried out on the basis required by IAS 28 as described in Chapter 11. See also 5.2.5 above.

8.1.1 SEC guidance

A foreign private issuer that is registered with the US Securities and Exchange Commission (SEC) is normally required to present two comparative periods for its statement of profit or loss and other comprehensive income (or statement of profit or loss, if presented), statement of cash flows and statement of changes in equity. Converting two comparative periods to IFRSs was considered to be a significant burden to companies. Therefore, in April 2005, the SEC published amendments to Form 20‑F that provided for a limited period a two-year accommodation for foreign private issuers that were first-time adopters of IFRSs.⁶ In March 2008, the SEC extended indefinitely the two-year accommodation to all foreign private issuers that are first-time adopters of IFRSs as issued by the IASB.⁷

The amendment states that ‘an issuer that changes the body of accounting principles used in preparing its financial statements presented pursuant to Item 8.A.2 of its Form 20-F (“Item 8.A.2”) to International Financial Reporting Standards (“IFRS”) issued by the International Accounting Standards Board (“IASB”) may omit the earliest of three years of audited financial statements required by Item 8.A.2 if the issuer satisfies the conditions set forth in the related Instruction G. For purposes of this instruction, the term “financial year” refers to the first financial year beginning on or after January 1 of the same calendar year.’ The accommodation only applies to an issuer that (a) adopts IFRSs for the first time by an explicit and unreserved statement of compliance with IFRSs as issued by the IASB and (b) the issuer's most recent audited financial statements are prepared in accordance with IFRSs.

First-time adopters that rely on the accommodation are allowed, but not required, to include any financial statements, discussions or other financial information based on their previous GAAP. If first-time adopters do include such information, they should prominently disclose cautionary language to avoid inappropriate comparison with information presented under IFRSs. The SEC did not mandate a specific location for any previous GAAP information but did prohibit presentation of previous GAAP information in a side-by-side columnar format with IFRS financial information.

In addition, the accommodation only requires entities to provide selected historical financial data based on IFRSs for the two most recent financial years instead of the normal five years. Selected historical financial data based on US GAAP is not required for the five most recent financial years. Although the SEC does not prohibit entities from including selected financial data based on previous GAAP in their annual reports, side-by-side presentation of data prepared under IFRSs and data prepared under previous GAAP is prohibited. In addition, inclusion of previous GAAP selected financial data will trigger the requirement for the corresponding reconciled US GAAP selected financial data.⁸

Where a narrative discussion of its financial condition is provided, the accommodation requires management to focus on the financial statements prepared under IFRSs as issued by the IASB for the past two financial years.

IFRS 1 requires a first-time adopter to present reconciliations from its previous GAAP to IFRSs in the notes to its financial statements and allows certain exemptions from full retrospective application of IFRSs in deriving the relevant data. Under the SEC's accommodation, any issuer relying on any of the elective exemptions or mandatory exceptions from IFRSs that are contained within IFRS 1 will have to disclose additional information which includes:

• to the extent the primary financial statements reflect the use of exemptions permitted or required by IFRS 1:
  • detailed information for each exemption used, including:
    • an indication of the items or class of items to which the exemption was applied; and
    • a description of what accounting principle was used and how it was applied; and
  • where material, qualitative disclosure of the impact on financial condition, changes in financial condition and results of operations that the treatment specified by IFRSs would have had absent the election to rely on the exemption.

8.1.2 IPTF guidance

In November 2008, the Center for Audit Quality SEC Regulations Committee's International Practices Task Force (‘IPTF’) provided guidance as to the reconciliation requirements of an SEC foreign private issuer the first time it presents IFRS financial statements in its Form 20‑F, when that issuer previously used US GAAP for its primary financial statements filed with the SEC. 9 Among others, the IPTF guidance addresses the concern that the reconciliations called for by IFRS 1, which are prepared using the issuer's local GAAP rather than US GAAP, would not have sufficient information to help US investors to bridge from the prior US GAAP financial statements filed with the SEC to IFRSs. Accordingly, the IPTF guidance requires additional detailed reconciliations in these circumstances from US GAAP to IFRSs either in a one step or a two-step format (see below).

The reconciliation requirements for each of the scenarios are described below:

• SEC Foreign Private Issuers who currently report under their local GAAP and provide a reconciliation from their local GAAP to US GAAP – In the year of adoption of IFRSs, these entities will be allowed to file two years rather than three years of profit or loss statements, shareholders’ equity and cash flows prepared in accordance with IFRSs. As part of the IFRS transition, these entities will provide the disclosures and reconciliations required under IFRS 1 including:
  • an equity reconciliation as at the date of the transition and as at the comparative year-end;
  • a comprehensive income (or statement of profit or loss, if presented) reconciliation for the comparative year; and
  • an explanation of material adjustments to the statement of cash flows for the comparative year.

• If the IFRS 1 disclosures and reconciliations are prepared using the local GAAP as the issuer's previous GAAP rather than US GAAP, no additional US GAAP to IFRSs or US GAAP to local GAAP reconciliations will be required.

• SEC foreign private issuers that currently report under US GAAP only – Some SEC foreign private issuers currently use US GAAP as their primary GAAP in both their home jurisdiction and the United States without reconciliation. These registrants would also be eligible to file two years rather than three years of statements of profit or loss and other comprehensive income, shareholders’ equity and cash flows in their first set of IFRS financial statements. In the year of adoption of IFRSs, these entities will be required to provide the IFRS 1 disclosures and reconciliations described above. Such disclosures will be prepared using US GAAP as the issuer's previous GAAP.
• SEC foreign private issuers that currently report under local GAAP for local reporting and under US GAAP in their SEC Form 20‑F filings (assuming these issuers adopt IFRSs in the current period for both local and SEC reporting purposes) – These registrants would also be eligible to file two years rather than three years of statements of profit or loss and other comprehensive income, shareholders’ equity and cash flows in their first set of IFRS financial statements. Under IFRS 1, such entities might conclude their local GAAP is their previous GAAP and their IFRS 1 disclosures and reconciliations would be prepared on that basis. As no reconciliation from their local GAAP to US GAAP was previously provided, the SEC will require additional disclosure in the Form 20‑F to enable investors to understand material reconciling items between US GAAP and IFRSs in the year of adoption. Two possible forms of disclosure are acceptable:
  • One-Step Format – Registrants can provide an analysis of the differences between US GAAP and IFRSs in a tabular format (consistent with Item 17 of Form 20‑F) for the same time period and dates that the IFRS 1 reconciliations are required. The registrant must provide this disclosure for equity as at the beginning and end of the most recent comparative period to the year of adoption and of comprehensive income (or profit or loss) for the most recent comparative year. A description of the differences between US GAAP and IFRSs for the statement of cash flows is not necessary because registrants are not required to reconcile IAS 7 statement of cash flows to those prepared under US GAAP.
  • Two-Step Format – Registrants can choose to disclose a two-step reconciliation which would include a quantitative analysis of the differences between US GAAP and their local GAAP and between their local GAAP to IFRSs. The registrant must provide these reconciliations for equity as of the beginning and end of the most recent comparative period to the year of adoption of IFRSs and for comprehensive income (or profit or loss) for the most recent comparative year. Registrants will also be required to provide an explanation of the material differences between the statement of cash flows under US GAAP and the statement of cash flows under their local GAAP for the most recent comparative period to the year of adoption of IFRSs.
• SEC foreign private issuers that currently report under IFRSs for local reporting and under US GAAP in their SEC Form 20‑F filings (assuming these issuers adopted IFRSs for local reporting in a period that preceded the earliest period for which audited financial statements are required in their SEC filing) – These registrants would not be eligible to file two years of statements of profit or loss and other comprehensive income, shareholders’ equity and cash flows the first time they file IFRS financial statements with the SEC, since they are not first-time adopters of IFRSs. Rather, they are required to present a complete set of IFRS financial statements for all periods required by the Form 20‑F. In addition, these issuers will be required to present a reconciliation that enables US investors to bridge their previous US GAAP to IFRSs. Such a reconciliation will be similar to the One-Step Format described above, except that the periods presented will be for equity as of the most recent comparative period presented and for comprehensive income (or profit or loss) for the two most recent comparative periods. However, if the issuers are required to present a statement of financial position as of the end of the earliest comparative period, the reconciliation will also be required of the equity as of the end of that period.

8.2.1 IFRS guidance

Although IFRS 1 provides detailed rules on disclosures to be made in an entity's first IFRS financial statements and in interim reports covering part of its first IFRS reporting period, it does not provide any guidance on presenting a reconciliation to IFRSs in financial reports before the start of the first IFRS reporting period. An entity wishing to disclose information on the impact of IFRSs in its last financial statements under its previous GAAP cannot claim that such information is prepared and presented in accordance with IFRSs because it does not disclose all information required in full IFRS financial statements and it does not disclose comparative information.

As the extract below illustrates, in practice, some entities get around this problem by disclosing pro forma IFRS information and stating that the pro forma information does not comply with IFRSs.

8.2.2 Disclosure of expected changes in accounting policies

In certain countries, publicly listed companies are required by regulation to disclose the potential impact that recently issued accounting standards will have on their financial statements when such standards are adopted in the future. The Canadian Securities Administrators (the CSA) in their Management's Discussion & Analysis (MD&A form)¹⁰ require this disclosure for changes in accounting policies that registrants expect to make in the future. In connection with the transition to IFRSs, the CSA issued a Staff Notice¹¹ clarifying that ‘changes in an issuer's accounting policies that an issuer expects to make on changeover to IFRSs are changes due to new accounting standards and therefore fall within the scope of the MD&A form.’ Among other matters, the CSA Staff Notice requires certain disclosures of companies that have developed an IFRS changeover plan, in interim and annual MD&A forms starting three years before the first IFRS financial statement date, including the following:

• accounting policies, including choices among policies permitted under IFRSs, and implementation decisions such as whether certain changes will be applied on a retrospective or a prospective basis;
• impact on information technology and data systems;
• changes to internal control over financial reporting;
• impact on disclosure controls and procedures, including investor relations and external communications plan;
• enhancements to financial reporting expertise, including training requirements; and
• changes in business activities, such as foreign currency and hedging activities, as well as matters that may be influenced by GAAP measures such as debt covenants, capital requirements and compensation arrangements.

The CSA Staff Notice also specified requirements for update for periods up to the year of changeover, including discussion of the impact of transition for issuers that are well advanced in their plans.

An entity that is planning to adopt IFRS should take note of the regulatory requirements in its jurisdiction or the exchange where it is listed to determine the form of communication that is required in advance of publishing its first IFRS financial statements.