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Friday, December 3, 2021

A Summary of Recent Changes to Accounting Standards

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As the world becomes more globalised, investors expect greater comparability between the financial statements of companies listed on stock exchanges far apart from each other. They expect to be able to directly compare the earnings-per-share of a Hong Kong property company with the same metric published by a UK-based construction firm. 

This is only possible due to the trend of integration of accounting and financial reporting standards that firms sign up to when publishing their results in the public domain. 

Beginning in 1973, a committee formed from several national financial reporting bodies began to publish a joint series of standards called the International Financial Reporting Standards (IFRS). These would be widely adopted by regulated stock exchanges across the world over the succeeding decades. 

Now, a company must apply IFRS when preparing their financial statements if they are listed on the London Stock Exchange, the Tokyo Stock Exchange or even the Beirut Stock Exchange in Lebanon. 

International accounting firms now train their employees in IFRS because it is one of the most common frameworks applied by companies.

This has led to a golden era for financial analysts looking to compile meaningful benchmarks and compares companies across the globe. 

Thanks to the increase in global trade, businesses are increasingly competing for the same customers, but they’re now also competing for the same investors. The fact that these international investors can read, understand and compare the annual reports of businesses regardless of their domicile is a testament to the homogenous set of international rules. 

The IFRS has continued to evolve 

Integration of rules is not the only priority for the International Accounting Standards Board, which sets theIFRS rules. The standard of the rules themselves is an ever-increasing target. 

The IASB seeks to provide greater transparency with minimal burden upon the finance teams of large corporations. 

As a result, it regularly issues a new standard (in the form of an IAS# or IFRS#) or revised an old standard. It may do this to close a loophole, increase the minimum level of disclosure, or ensure that the financial statements of businesses continue to fairly represent the reality on the ground. 

Examples of recent updates to the IFRS include the launch of three new standards: IFRS 15 Revenue, IFRS 16 Leases, and IFRS 9 Financial Instruments.

Rather than representing brand new rules, these each replace an older set of rules. IFRS 15 replaces IAS 18, IFRS 16 replaces IAS 17, and IFRS 9 replaces parts of IAS 39 & 32. Given that each change has introduced some significantly different accounting treatments for common accounting scenarios, the Board felt that it would be clearer to produce entirely new standards and retire an old set rather than publish a host of incremental changes. 

Summary of recent changes to the revenue accounting standards

IFRS 15 Revenue fundamentally changed the way that companies account for revenue. In particular, revenue arises over a period of time in connection to a contract. 

Under previous GAAP, companies would link revenue on a contract to a specific milestone and recognise income as those milestones were passed. 

The new rules introduce a 5 step process for methodically dividing a total contract value between the separately identifiable promises made to customers. Revenue is now recognised as those promises to customers fulfilled, either at a point in time or gradually over time in the case of a subscription service. 

A real example of the impact of the implementation of IFRS 15 concerns administrative or set-up fees, such as those charged to customers as a ‘joining fee’ when they sign up to a gym or golf club. 

Under the old rules, these would be linked to a milestone that was deemed to be passed as soon as the customer had obligated themselves to make the non-refundable payment. 

The new rules don’t regard sign-up as a milestone in itself, because it doesn’t represent a distinct promise made to a customer. In other words, the customer sees no benefit from the fee and doesn’t regard this as a distinct part of the service or experience that they are paying for.

The revenue from a sign-up fee is now allocated across other promises such as the provision of gym services across the year. The impact of these new principles is that companies are now gradually recognising administrative fees across the contract period rather than up-front. 

This is just one example of how the IASB continues to tweak existing rules to encourage businesses to produce financial statements that reflect the underlying performance of their businesses.

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