Today’s accounting world works on a single set of accounting and financial reporting standards. As a basis, IFRSs happen to play a crucial role. Nowadays, we are witnessing a huge progress of convergence to IFRS—not only by US GAAP, but also other countries are adopting more and more IFRS rules to their own accounting rules.
I have a feeling that until recently, this process has affected mostly bigger multinational companies who were required to report their financial results and position in accordance with both IFRS and their local accounting standards. That’s not a problem for them – usually, those companies are very well equipped with all necessary human capital, software and business processes to make account transformation process running smoothly.
But! The things change every minute. One day, also small and medium sized enterprises might find themselves in a situation when making two sets of financial statements becomes absolute necessity and a must. And we know all very well, that the first steps have already been made—IASB has already issued and published International Financial Reporting Standard (IFRS) designed for use by small and medium-sized entities (SMEs).
Maybe you work for SME that would find presenting your financial position and results under IFRS beneficial or necessary from various reasons:
- maybe you would like to attract some foreign capital, whether new shareholders or other finance providers
- maybe you would like to extend your business overseas and need to cultivate your financial image
- maybe your company is big enough to have foreign subsidiaries that need to be consolidated under uniform standards
- maybe you are a foreign subsidiary that needs to submit its IFRS financial statements to the parent company
- and many more
You always have the choice to start with external consultants with broad experience in this field. They can design full process step-by-step, implement it and educate you to use it—but often you find out that cost of hiring consultants might be too high. Then, you can start to do this yourself from scratch. If you do it properly, it will cost you only your time and you will have a good basis for further conversion process.
So let me try to guide you on where to start. Each step will be illustrated with hypothetical example from practice.
Step 1: Identify financial statements’ items with differences
That’s probably the most difficult and demanding part. You shall possess a solid knowledge about both your local GAAP and IFRS so that you can identify which transactions have been shown differently under your local GAAP than would have been shown under IFRS.
In my opinion, the best approach is always systematic. Take your financial statements—balance sheet and income statement—and go through each caption. Alternatively, you can do it on a more detailed level—instead of taking financial statements, take a trial balance or general ledger where accounts are not grouped. Ask yourself what major transactions have been recorded under those captions and whether applied local principles and IFRS are the same or not.
What captions can be affected? Well, every single one. The most common adjustments include finance leases, fair value adjustments, deferred tax adjustments, adjustments related to construction contracts, intangible assets and their recognition, and many more.
Here I would like to draw your attention to the standard IFRS 1—First-time Adoption of International Financial Reporting Standards which sets out the procedures that you must follow when adopting IFRSs for the first time. There are some basic rules and requirements related to assets and liabilities recognition, reclassifications, measurement, exceptions and exemptions when you do it for the first time. I highly recommend reviewing this standard before attempting to prepare the list of potential adjustments.
Example: You are in the process of preparing IFRS financial statements as of 31 December 20X1 and you find a significant rental expense related to leases in your income statement. You are sure that those leases are finance in accordance with IAS 17. However, your local GAAP treats finance lease payments as expenses to the income statement with no asset and lease liability recognition. This seems like significant adjustment that you will focus on during later stages of your accounts transformation.
Step 2: Prepare all information for IFRS adjustments related to each difference
Once you identified all potential differences between local GAAP and IFRS affecting your financial statements, you shall gather all related numerical information. This involves 2 stages:
2.1 Determine precisely how the transaction has been reported under local GAAP
That means the necessity to obtain all accounting entries related to the transaction from its beginning until the reporting date. You don’t need to obtain literally every single entry—this would not be practical. But you need to obtain at least total amounts that have been recognized to the individual captions in the financial statements (or general ledger) from the initial recognition of the transaction until the reporting date.
Example: You have identified that the following numbers have been recorded as rental expense related to finance leases since their initial recognition until 31 December 20X1:
| Description | Amount in EUR | Debit | Credit |
|---|---|---|---|
| Rental expenses (financial leases)—previous period | 1 200 000 | IS—rental expense | Cash at bank |
| Rental expenses (financial leases)—current period | 250 000 | IS—rental expense | Cash at bank |
Please note that periods from initial recognition until 31 December 20X0 are referred to as “previous periods” and a year ended 31 December 20X1 is referred to as “current period”. IS means “income statement”.
You should make sure that you gathered data only for finance leases still open or closed during the reporting period, because finance leases closed during previous reporting periods probably do not make any difference.
2.2 Precisely determine how the transaction should have been presented under IFRS
Now you have to apply your IFRS knowledge. You should calculate total amounts related to each affected transaction that should have been recognized in individual captions of the financial statements in line with IFRS.
Example: You have identified that the following numbers should have been recorded with respect to finance leases since their initial recognition until 31 December 20X1:
| Description | Amount in EUR | Debit | Credit |
|---|---|---|---|
| PPE—cost of assets held under finance leases at initial recognition | 1 400 000 | PPE—cost | Finance lease liabilities |
| Deprecation expense—previous period | 700 000 | IS—deprecation expense | PPE—accumulated deprecation |
| Deprecation expense—current period | 120 000 | IS—deprecation expense | PPE—accumulated deprecation |
| Lease payments—capital part, previous period | 900 000 | Finance lease liabilities | Cash at bank |
| Lease payments—interest, previous periods | 300 000 | IS—interest expense | Cash at bank |
| Lease payments—capital part, current period | 170 000 | Finance lease liabilities | Cash at bank |
| Lease payments—interest, current period | 80 000 | IS—interest expense | Cash at bank |
For every potential difference in accounting treatment of certain transactions in line with your local GAAP and IFRS, make similar accounting entries table. In this example, I just made up those figures out of a thin air. However, you shall prepare all the calculations in supporting documentation. In this specific finance lease example, you should really prepare a worksheet in which you split every single lease payment between repayment of a lease liability and interest payment, applying actuarial method. Not sure how to do it? Please watch out our video on IAS 17—Leases included in the IFRS Kit and you will find step-by-step process explained in a great detail. Plus you can download an excel file with all the calculations prepared for you.
In the second part of this article, we will look how to prepare a transformation bridge from local accounts to IFRS and how to verify everything makes sense.
However, if you find anything you have read so far difficult, I would like to point you to my course How to Make IFRS Financial Statements where all these steps are clearly explained and illustrated on a real-life example! This course is a part of the IFRS Kit.