Here’s a situation recently considered by the Canadian IFRS Discussion Group:
- “Entity ABC Corp. plans to spin off a line of business that is not a legal sub-group and needs to prepare financial statements for this line of business. ABC Corp’s date of transition to IFRSs is January 1, 2010 and the line of business was part of ABC Corp’s operations at that date. The carve-out financial statements of the line of business are being prepared for the years ended December 2014 and 2013.
- For purposes of this discussion, carve-out financial statements are the financial statements of one or more components of a larger entity that are not part of a legal sub-group. This discussion assumes that the financial statements will comply with IFRSs and, therefore, will include a statement of compliance with IFRSs as issued by the IASB…”
The issue under discussion was whether IFRS 1 First-time Adoption of International Financial Reporting Standards can be applied to the carve-out financial statements of the line of business, when ABC Corp was already in full compliance with IFRSs. There are two ways of looking at this.
The first view is that IFRS 1 may indeed be applied: “In accordance with paragraph 3(d) of IFRS 1, since the line of business (i.e., the new reporting entity) did not present financial statements for previous periods separate from those of ABC Corp, the carve-out financial statements would be considered its first IFRS financial statements. This view is also supported by the exemption provided in paragraph D16 of IFRS 1, relating to when a subsidiary transitions to IFRSs later than its parent. The exemption reinforces the principle that IFRS 1 is applicable, even though the subsidiary was included in the parent’s transition to IFRSs as part of the consolidated financial statements. Although the line of business in the fact pattern is not a legal subsidiary of ABC Corp, it is controlled by ABC Corp. until such time as it is sold or spun off to third parties.”
Alternately, you might argue it’s not appropriate to apply IFRS 1: “carve-out financial statements are not being prepared for the first time because the reporter was extracted from an entity that has already transitioned to IFRSs. Therefore, the carve-out financial statements are not those of a first-time adopter. Further, absent any IFRS definition of “entity”, it may be argued that a component of an entity that is not a legal sub-group isn’t an entity as envisaged in IFRS 1. The exemption in paragraph D16 isn’t relevant as it relates to subsidiaries, associates and joint ventures that would themselves be entities.”
Or perhaps the analysis might go either way depending on the facts and circumstances, in particular the extent to which the carved-out entity substantively seems to represent a “new” reporting entity. Factors relevant to this might include: “whether the carve-out financial statements have necessitated such adjustments as corporate cost allocations, the allocation of corporate assets and the creation of intercompany accounts.”
The majority of group members took the view that IFRS 1 may (or even must) be applied. Others “expressed sympathy” for the second view, “noting that IFRS 1 is meant to assist entities in transitioning from their previous accounting framework to IFRSs. If the historical information of the entity is already accounted for under IFRSs, the relevancy in applying IFRS 1 should be questioned. One Group member pointed out that, in looking forward to a time when all entities have been applying IFRSs for many years, applying IFRS 1 to carve-out financial statements produces rather strange results.”
Those arguments don’t seem entirely wrong, except that the availability of IFRS 1 to first-time adopters has never been based on an assessment of whether they actually need it. A first-time adopter can choose to apply any or all of the relevant exemptions, even if it would be easily capable of computing amounts consistent with full retrospective adoption – the IASB discussed alternative approaches (such as whether an entity should be required either to use all the exemptions or else none of them) and decided on the broad existing “open door” policy. By now, this is so enmeshed in the collective reporting history of IFRS-compliant entities that it hardly seems fair or worthwhile to rekindle the cost-benefit discussion on the backs of carve-out entities (or to start slicing and dicing the population of carve-out entities into those which are or aren’t sufficiently “new”).
Assuming such an entity does apply IFRS 1, most group members expressed the view that it should apply all its requirements, including for instance presenting an opening statement of financial position. The report of the group’s discussion says that “a possible exception’ is providing reconciliations to previous GAAP “which may not be applicable to carve-out financial statements that have no previous GAAP basis of reporting.” Indeed, it’s hard to see why these reconciliations would be necessary: their broad purpose is to assist users in making the transition from the old to the new basis of financial reporting, but since in this case the carved-out entity has never issued anything on any other basis, reconciliations (whatever they might consist of) wouldn’t accomplish any useful purpose.
Plainly, the IASB doesn’t consider that the concessions allowed to first-time adopters carry huge ongoing importance: if it did, then affected entities would presumably have to disclose their ongoing impact for as long as it remained material, rather than only in the initial IFRS financial statements (the exemptions would seldom have a material impact on key performance measures). So when a new Canadian first-time adopter comes along, whether through a carve-out or otherwise, let’s just wave them through, making sure users have enough information to go on with, and thanking our lucky stars that IFRS 1 otherwise belongs mostly in our past…
The opinions expressed are solely those of the author