IASB published the ED of IFRS 1 and IFRS 5

The International Accounting Standards Board (IASB) today, 25 September 2008 published for public comment an exposure draft (ED) of proposed amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards.

The exposure draft propose : (1) to exempt companies from retrospective application of IFRSs for oil and gas assets using the full cost method and for operations subject to rate regulation, (2) to exempt companies with existing leasing contracts accounted for in accordance with IFRIC 4 Determining whether an Arrangement contains a Lease from reassessing the classification of those contracts according to IFRSs when the same classification has previously been made in accordance with national GAAP.

In addition, at the same date, IASB also published for public comment an ED of proposed amendments to IFRS 5 Non-current Assets Held for Sale and Discontinued Operations.

The proposals are to revise the definition of discontinued operations and require additional disclosure about component of an entity that have been disposed of or are classified as held for sale.

The proposals are the result of a joint project by the IASB and the US FASB to develop a common definition of discontinued operations and require common disclosures about them.

The deadline for public comment for these ED is 23 January 2009.

Here is the link to the above IASB Press Release : IASB proposes amendments to the retrospective application (IFRS 1) and IASB proposes revised definition of discontinued operations (IFRS 5)

Fair Presentation and Compliance with IFRS, how IAS 1 rules it ?

IAS 1 Presentation of Financial Statements paragraphs 15-24 rules the fair presentation and compliance with IFRS of financial statement presentation.

Par. 15 stated that financial statements shall present fairly the financial position, financial performance and cash flows of an entity. Fair presentation requires the faithful representation of the effects of transactions, other events and conditions in accordance with the definitions and recognition criteria for assets, liabilities, income and expenses set out in the Framework.

The application of IFRSs, with additional disclosure when necessary, is presumed to result in financial statements that achieve a fair presentation.

Par. 16 expressed that an entity whose financial statements comply with IFRSs shall make an explicit and unreserved statement of such compliance in the notes. An entity shall not describe financial statements as complying with IFRSs unless they comply with all the requirements of IFRSs.

In virtually all circumstances, an entity achieves a fair presentation by compliance with applicable IFRSs.

A fair presentation also requires an entity:

(a) To select and apply accounting policies in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. IAS 8 sets out a hierarchy of authoritative guidance that management considers in the absence of an IFRS that specifically applies to an item.

(b) To present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information.

(c) To provide additional disclosures when compliance with the specific requirements in IFRSs is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the entity’s financial position and financial performance.

Par. 18 rules that an entity cannot rectify inappropriate accounting policies either by disclosure of the accounting policies used or by notes or explanatory material.

While in par. 19, it stated that in the extremely rare circumstances in which management concludes that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, the entity shall depart from that requirement in the manner set out in paragraph 20 if the relevant regulatory framework requires, or otherwise does not prohibit, such a departure.

Par. 20 said that when an entity departs from a requirement of an IFRS in accordance with par. 19, it shall disclose :

(a) That management has concluded that the financial statements present fairly the entity’s financial position, financial performance and cash flows;

(b) That is has complied with applicable IFRSs, except that it has departed from a particular requirement to achieve a fair presentation;

(c) The title of the IFRS from which the entity has departed, the nature of the departure, including the treatment that the IFRS would require, the reason why that treatment would be so misleading in the circumstances that it would conflict with the objective of financial statements set out in the Framework, and the treatment adopted; and

(d) For each period presented, the financial effect of the departure on each item in the financial statements that would have been reported in complying with the requirement.

Further, par. 21 of IAS 1 stated that when an entity has departed from a requirement of an IFRS in a prior period, and that departure affects the amounts recognized in the financial statements for the current period, it shall make the disclosures set out in paragraph 20(c) and (d).

Par. 21 applies, for example, when an entity departed in a prior period from a requirement in an IFRS for the measurement of assets or liabilities and that departure affects the measurement of changes in assets and liabilities recognized in the current period’s financial statements.

Par. 23 stated that in the extremely rare circumstances in which management concluded that compliance with a requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, but the relevant regulatory framework prohibits departure from the requirement, the entity shall, to the maximum extent possible, reduce the perceived misleading aspects of compliance by disclosing:

(a) The title of the IFRS in question, the nature of the requirement, and the reason why management has concluded that complying with that requirement is so misleading in the circumstances that it conflicts with the objective of financial statements set out in the Framework; and

(b) For each period presented, the adjustments to each item in the financial statements that management has concluded would be necessary to achieve a fair presentation.

Latest, par. 24 stated that for the purpose of par. 19-23, an item of information would conflict with the objective of financial statements when it does not represent faithfully the transactions, other events and conditions that it either purports to represent or could reasonably be expected to represent and, consequently, it would be likely to influence economic decisions made by users of financial statements.

When assessing whether complying with a specific requirement in an IFRS would be so misleading that it would conflict with the objective of financial statements set out in the Framework, management considers :

(a) Why the objective of financial statements is not achieved in the particular circumstances; and

(b) How the entity’s circumstances differ from those of other entities that comply with the requirement. If other entities in similar circumstances comply with the requirement, there is a rebuttable presumption that the entity’s compliance with the requirement would not be so misleading that it would conflict with the objective of financial statements set out in the Framework.

The Outlook and Issues of the First-time Adoption of IFRS

Following are excerptions taken from WILEY – IFRS 2008 Interpretation and Presentation of IFRS.

While IFRS had been gaining adherents on a slow but steady pace for many years, 2005 was a true watershed in that over 7,000 publicly traded companies in nations of the European Union were required to begin reporting group (consolidated) financial statements using IFRS, vastly increasing the total number of companies world-wide employing international standards.

Other nations have recently either embraced IFRS, announced plans to do so, or are endeavoring to “converge” their national GAAP with IFRS.

The US standard-setting body, FASB, agreed on a program to converge with IFRS in 2002, and in the past several years a number of US GAAP standards have been modified to conform to their IFRS equivalents (and several international standards have been modified to converge to US GAAP equivalents, where that was deemed appropriate).

Most recently, the US securities regulatory authority, the SEC, has agreed to accept filings by foreign private issuers (i.e., foreign registrants in the US) with financial statements prepared in conformity with IFRS, making wider acceptance of IFRS in the US a near certainty – perhaps signaling the ultimate superseding of US GAAP by IFRS.

With this developments and prospective events in mind, IASB issued a comprehensive standard on “first-time adoption,” IFRS 1, in mid-2003.

When a reporting entity prepares its financial statements in accordance with international accounting standards for the first time, a number of implementation questions need to be addressed and resolved.

IASB’s predecessor standard setter, IASC, had provided only limited guidance on this matter, which was set forth in SIC 8. This was superseded by the more comprehensive standard, IFRS 1, First-time Adoption of IFRS. IFRS 1 differed in several important respects from SIC 8.

The word wide trend toward universal adoption of IFRS has continued, extending beyond the EU action of 2005. Several nations have since announced plans to drop existing national GAAP in favor of IFRS.

Canada will converge to or adopt IFRS by 2011 (Canadian GAAP is currently very similar to US GAAP), China is converging to IFRS beginning in 2007, and even Japan appears to be accelerating its IFRS converging efforts. Indonesia standard-setting body, IAI, is in the plan to convergence the Indonesian GAAP (PSAK) with IFRS by 2012. Many more countries in Eastern Europe, South Asia, and the Far East are planning to be included in the growing list of new converts to IFRS. It is within this context that IASB decided to promulgate a standard on this subject as its maiden pronouncement, notwithstanding the existing guidance on this topic (SIC 8).

IASB endeavored to provide a “stable platform” of standards, with few revisions and no new standards having near-term effective dates, in order to facilitate the transition process by EU-based public companies.

IASB has announced that any new standards to be issued in the near-term will likely have implementation dates of 2009 or later, and indeed subsequent pronouncements (e.g., revised IAS 1, IFRS 8) have 2009 mandatory effective dates, although earlier application is permitted. This was intended to provide a respite from the challenges of dealing with constantly evolving standards.

A proposed standard would remove the discussion of specific exemptions and exceptions, currently part of the body of IFRS 1, to appendices to the standard. Furthermore, exemptions would be categorized as either permanent (e.g., waiving the need to account for the liability component of compound financial instruments when the component is no longer outstanding) or temporary (e.g., certain requirements relative to applying fair value measurements to financial instruments).

If this is done, the temporary exemptions will be removed as they become no longer relevant (that is, as the passage of time makes these moot).

Current issues regarding on implementation of IFRS for U.S. GAAP

CFO.com in its August 27, 2008 article titled “The End of GAAP Could Begin Next Year” wrote that the Securities and Exchange Commission has raised the possibility that some U.S. publicly traded companies will be able to use international financial reporting standards next year.

Further, it reported that on Wednesday, the SEC commissioners proposed a timetable for transitioning all public companies from U.S. generally accepted accounting standards to IFRS within eight years, with the allowance for some companies to begin using the global rules earlier. If this so-called roadmap is approved, the SEC estimates that 110 companies would be eligible to use IFRS at the end of fiscal years ending after December 15, 2009, depending on their size and industry.

The roadmap further calls for the SEC to make a decision in 2011 regarding whether to require all of its registrants to use IFRS. The commissioners would base their decision on the progress made on, among other things, funding the International Accounting Standards Committee Foundation (which governs the International Accounting Standards Board), IFRS data tagging, and accounting education.

Here is the SEC Proposed Timeline for Moving Companies to IFRS :

1. End of 2009 – limited group of large companies given the option to use IFRS. SEC estimates 110 U.S. companies will be able to take advantage of the offer

2. 2011 – SEC evaluates the progress of achieving proposed milestones, and makes a decision about whether to mandate adoption of IFRS. If IFRS is mandated, the commission will develop a staged roll out, starting with the largest public companies first.

3. 2014 – Year the first wave of companies will be mandated to report financial results using international accounting standards, if IFRS requirements are adopted in 2011.

4. 2016 – Year that all public companies, big and small, will be mandated to report financial results using international accounting standards, if IFRS requirements are adopted in 2011.

Sources of this article : WILEY – IFRS 2008 the interpretation and application of IFRS and CFO.com (The End of GAAP Could Begin Next Year)

The push to move U.S. companies to international accounting standards is a myth-laden ?

CFO.com in its September 11, 2008 Today in Finance article titled "Regulator Rips into Global Accounting Plan" said that 'Recent effort to move the United States toward adoption of international accounting standards is a politically motivated effort that will hurt the standing of the United States in the World's capital markets, a prominent accounting regulator said today'

Further, it wrote the statement of a member and former acting chair of the Public Company Accounting Oversight Board, Charles Niemeier who said that 'A precipitous move away from U.S Generally Accepted Accounting Principles will undermine the U.S. regulatory system, and thereby "put in jeopardy the thing that gives the U.S. a competitive advantage'

Niemeier also said it is a myth that IFRS is based more on principles than the rules-heavy U.S GAAP.

"IFRS in not more principles-based, it's just younger," said Niemeier, repeating a charge that he has made in the past.

GAAP, he said, also started with principles. However, he said, that changed after U.S. v.Simon, a 1969 court decision that found that presenting financial information in conformity with generally accepted accounting principles may not be a sufficient defense against charges of violating the antifraud provision of U.S. securities laws.

That case, he said, was a "shock to the system," and spurred a large number of the rules that exist in GAAP today, which were demanded by companies and auditor seeking a level of predictability and consistency.

Read the rest of this article in here :  Regulator Rips into Global Accounting Plan (CFO.com), and also another related article in her : Regulator pans U.S. move toward IFRS accounting

IAS 2 Inventories, How and When to Determine the Ownership of Goods

Inventory can only be an asset of the reporting entity if it is an economic resource of the entity at the date of the statement of financial position.

In general, an enterprise should record purchases and sales of inventory when legal title passes. Although strict adherence to this rule may not appear to be important in daily transactions, a proper inventory cut off at the end of an accounting period is crucial for the correct determination of periodic results of operations. Thus, for accounting purposes, to obtain an accurate measurement of inventory quantity and corresponding monetary representation of inventory and cost of goods sold in the financial statements, it is necessary to determine when title has passed.

The most common error made in this regard is to assume that title is synonymous with possession of goods on hand. This may be incorrect in two ways: (1) the goods on hand may not be owned, and (2) goods that are not on hand may be owned.

There are four matters that may cause confusion about proper ownership: (1) goods in transit, (2) consignment sales, (3) product financing arrangements, and (4) sales made with the buyer having generous or unusual right of return.

Good in transit. At year end, any goods in transit from seller to buyer may properly be includable in one, and only one, of those parties’ inventories, based on the terms and conditions of the sale.

Under traditional legal and accounting interpretation, goods are included in the inventory of the firm financially responsible for transportation costs. This responsibility may be indicated by shipping terms such as FOB, which is used in overland shipping contracts, and by FAS, CIF, C&F and ex-ship, which are used in maritime contracts.

The term FOB stands for “free on board”. If goods are shipped FOB destination, transportation costs are paid by the seller and title does not pass until the carrier delivers the goods to the buyer; thus these goods are part of the seller’s inventory while in transit.

If goods are shipped FOB shipping point, transportation costs are paid by the buyer and title passes when the carrier takes possession; thus these goods are part of the buyer’s inventory while in transit.

The terms FOB destination and FOB shipping point often indicate a specific location at which title to the goods is transferred, such as FOB Milan. This means that the seller retains title and risk of loss until the goods are delivered to a common carrier in Milan who will act as an agent for the buyer.

A seller who ships FAS (free alongside) must bear all expense and risk involved in delivering the goods to the dock next to (alongside) the vessel on which they are to be shipped. The buyers bears the cost of loading and of shipment; thus title passes when the carrier takes possession of the goods.

In a CIF (cost, insurance and freight) contract the buyer agrees to pay in a lump sum the cost of the goods, insurance costs, and freight charges.

In a C&F contract, the buyer promises to pay a lump sum that includes the cost of the goods and all freight charges.

In either case, the seller must deliver the goods to the carrier and pay the costs of loading; thus both title and risk of loss pass to the buyer upon delivery of the goods to the carrier.

A seller who delivers goods ex-ship bears all expense and risk until the goods are unloaded, at which time both title and risk of loss pass to the buyer.

Consignment sales. There are specifically defined situations where the party holding the goods is doing so as an agent for the true owner.

In consignments, the consignor (seller) ships goods to the consignee (buyer), which acts as the agent of the consignor in trying to sell the goods.

In some consignments, the consignee receives a commission; in other arrangements, the consignee “purchases” the goods simultaneously with the sale of goods to the final customer.

Goods out on consignment are properly included in the inventory of the consignor and excluded from the inventory of the consignee.

Disclosure may be required of the consignee, however, since common financial analytical inferences, such as days’ sales in inventory or inventory turnover, may appear distorted unless the financial statement users are informed. However, IFRS does not explicitly address this (to be continued).

Source of this article : WILEY - IFRS 2008 Interpretation and Application of IFRS

Revised IAS 2 Inventories, the history and the main changes

The History

IAS 2 Inventories was issued by the International Accounting Standards Committee (IASC) in December 1993. It replaced IAS 2 Valuation and Presentation of Inventories in the Context of the Historical Cost System (originally issued in October 1975).

The Standing Interpretations Committee developed SIC-1 Consistency-Different Cost Formulas for Inventories, which was issued in December 1997.

Limited amendments to IAS 2 were made in 1999 and 2000.

In December 2003, the IASB issued a revised IAS 2, which also replaced SIC-1.

The Main Changes of Revised IAS 2

The main changes from the previous version of IAS 2 are described below.

Objective and scope

The objective and scope paragraphs of IAS 2 were amended by removing the words ‘held under the historical cost system’, to clarify that the Standard applies to all inventories that are not specifically excluded from its scope.

Scope clarification

The Standard clarifies that some types of inventories are outside its scope while certain other types of inventories are exempted only from the measurement requirements in the Standard.

Paragraph 3 establishes a clear distinction between those inventories that are entirely outside the scope of the Standard (described in paragraph 2) and those inventories that are outside the scope of the measurement requirements but within the scope of the other requirements in the Standard.

Scope exemptions

The Standard does not apply to the measurement of inventories of producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realizable value in accordance with well-established industry practices.

The previous version of IAS 2 was amended to replace the words ‘mineral ores’ with ‘minerals and mineral products’ to clarify that the scope exemption is not limited to the early stage of extraction of mineral ores.

The Standard does not apply also to the measurement of inventories of commodity broker-traders to the extent that they are measured at fair value less costs to sell.

Cost of Inventories

IAS 2 does not permit exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency to be included in the costs of purchase of inventories.

This change from the previous version of IAS 2 resulted from the elimination of the allowed alternative treatment of capitalizing certain exchange differences in IAS 21 The Effects of Changes in Foreign Exchange Rates.

That alternative had already been largely restricted in its application by SIC-11 Foreign Exchange - Capitalization of Losses from Severe Currency Devaluation. SIC-11 has been superseded as a result of the revision of IAS 21 in 2003.

Paragraph 18 was inserted to clarify that when inventories are purchased with deferred settlement terms, the difference between the purchase price for normal credit terms and the amount paid is recognized as interest expense over the period of financing.

Cost formulas

The Standard incorporates the requirements of SIC-1 Consistency-Different Cost Formulas for Inventories that an entity use the same cost formula for all inventories having a similar nature and use to the entity. SIC-1 is superseded.

The Standard does not permit the use of the last-in, first-out (LIFO) formula to measure the cost of inventories.

Recognition as an expense

The Standard eliminates the reference to the matching principle.

The Standard also described the circumstances that would trigger a reversal of a write-down of inventories recognized in a prior period.

Disclosure

The Standard requires disclosure of the carrying amount of inventories carried at fair value less costs to sell.

The Standard also requires disclosure of the amount of any write-down of inventories recognized as an expense in the period and eliminates the requirement to disclose the amount of inventories carried at net realizable value.

Business Combinations of Entities under Common Control, how IFRS guide it?

IFRS 3 Business Combinations (as revised by January 2008) required a business combination transaction be accounted for by applying the acquisition method, unless it is a combination involving entities or business under common control.

IFRS 3 Business Combinations applies to a transaction or other event that meets the definition of business combination.

An entity shall determine whether a transaction or other event is a business combination by applying the definition in this IFRS, which requires that the assets acquired and liabilities assumed constitute a business. If the assets acquired are not a business, the reporting entity shall account for the transaction or other event as an asset acquisition.

This IFRS defines a business combination as a transaction or other event in which an acquirer obtains control of one or more business. Transactions sometimes referred to as ‘true mergers’ or ‘mergers of equals’ are also business combination as that term is used in this IFRS.

As mentioned above, this IFRS only applies to a transaction or other event that meets the definition of a business combination, and does not apply to: (a) the formation of a joint venture, (b) the acquisition of an asset or a group of assets that does not constitute a business, and (c) a combination of entities or business under common control

Business combinations of entities under common control

Paragraph B1-B4 of IFRS 3 provide guidance apply to business combinations of entities under common control.

Paragraph B1 stated that this IFRS does not apply to a business combination of entities or business under common control. A business combination involving entities or business under common control is a business combination in which all of the combining entities or businesses are ultimately controlled by the same party or parties both before and after the business combination, and that control is not transitory.

Following, paragraph B2 expressed that a group of individuals shall be regarded as controlling an entity when, as a result of contractual arrangements, they collectively have the power to govern its financial and operating policies so as to obtain benefits from its activities.

Therefore, a business combination is outside the scope of this IFRS when the same group of individuals has, as a result of contractual arrangements, ultimate collective power to govern the financial and operating policies of each of the combining entities so as to obtain benefits from their activities, and that ultimate collective power is not transitory.

Further, paragraph B3 stated that an entity may be controlled by an individual or by a group of individuals acting together under a contractual arrangement, and that individual or group of individuals may not be subject to the financial reporting requirements of IFRSs.

Therefore, it is not necessary for combining entities to be included as part of the same consolidated financial statements for a business combination to be regarded as one involving entities under common control.

Latest, paragraph B4 stated that the extent of non-controlling interests in each of the combining entities before and after the business combination is not relevant to determining whether the combination involves entities under common control.

Similarly, the fact that one of the combining entities is a subsidiary that has been excluded from the consolidated financial statements is not relevant to determining whether a combination involves entities under common control.

WILEY – IFRS 2008 Interpretation and Application of IFRS described that IFRS 3 explicitly does not apply to entities under common control (e.g., brother-sister corporations).

A question arises, however, when a parent (Company P) transfers ownership in one of its subsidiaries (Company B) to another of its subsidiaries (Company A) in exchange for additional shares of Company A.

In such an instance, A’s carrying value for the investment in B should be P’s basis, not B’s book value. Furthermore, if A subsequently retires the interests of minority owners of B, the transaction should be accounted for as a purchase, whether it is effected through a stock issuance by A or by a cash payment to the selling shareholders.

Furthermore, when a purchase transaction is closely followed by a sale of the parent’s subsidiary to the newly acquired (target) entity, these two transactions should be viewed as a single transaction. Accordingly, the parent should recognize gain or loss on the sale of its subsidiary to the target company, to the extent of minority interest in the target entity.

As a result, there will be a new basis (step-up) not only for the target company’s assets and liabilities, but also for the subsidiary company’s net assets. Basis is stepped up to the extent of minority participation in the target entity to which the subsidiary company was transferred (Hrd) ***

IAS 23 versus SFAS 34 – several main differences

The Basis for Conclusions on IAS 23 Borrowing Costs which accompanies, but not as part of IAS 23, revealed out several major differences between IAS 23 and FASB Statement of Financial Accounting Standards (SFAS) No. 34 Capitalization of Interest Cost.

Definition of borrowing costs

IAS 23 uses the term ‘borrowing costs’ whereas SFAS 34 uses the term ‘interest costs’. ‘Borrowing costs’ reflects the broader definition in IAS 23, which encompasses interest and other costs, such as : (a) exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs; and (b) amortization of ancillary costs incurred in connection with the arrangement of borrowings.

EITF issues No. 99-9 concludes that derivative gains and losses (arising from the effective portion of a derivative instrument that qualifies as a fair value hedge) are part of the capitalized interest cost. IAS 23 does not address such derivative gains and losses.

Definition of a qualifying asset

The main differences are as follows:

(a) IAS 23 defines a qualifying asset as one that takes a substantial period of time to get ready for its intended use or sale. The SFAS 34 definition does not include the term substantial.

(b) IAS 23 excludes from its scope qualifying assets that are measured at fair value. SFAS 34 does not address assets measured at fair value.

(c) SFAS 34 includes as qualifying assets investments in investees accounted for using the equity method, in some circumstances. Such investments are not qualifying assets according to IAS 23.

(d) SFAS 34 does not permit the capitalization of interest costs on assets acquired with gifts or grants that are restricted by the donor or grantor in some situations. IAS 23 does not address such assets.

Measurement

When an entity borrows funds specifically for the purpose of obtaining a qualifying asset:

(a) IAS 23 requires an entity to capitalize the actual borrowing costs incurred on that borrowing. SFAS 34 states that an entity may use the rate of that borrowing.

(b) IAS 23 requires an entity to deduct any income earned on the temporary investment of actual borrowings from the amount of borrowing costs to be capitalized. SFAS 34 does not generally permit this deduction, unless particular tax-exempt borrowings are involved.

SFAS 34 requires an entity to use judgement in determining the capitalization rate to apply to the expenditures on the asset-an entity selects the borrowings that it considers appropriate to meet the objective of capitalizing the interest costs incurred that otherwise could have been avoided.

When an entity borrows funds generally and uses them to obtain a qualifying assets, IAS 23 permits some flexibility in determining the capitalization rate, but requires an entity to use all outstanding borrowings other than those made specifically to obtain a qualifying asset.

Disclosure requirements

IAS 23 requires disclosure of the capitalization rate used to determine the amount of borrowing costs eligible for capitalization. SFAS 34 does not require this disclosure.

SFAS 34 requires disclosure of the total amount of interest cost incurred during the period, including the amount capitalized and the amount recognized as an expense. IAS 23 requires disclosure only of the amount of borrowing costs capitalized during the period. IAS 1 Presentation of Financial Statements requires the disclosure of finance costs for the period.

(Source of this article : IAS 23 BC - Basis for Conclusions on IAS 23 Borrowing Costs)

The Core Principles of IAS 23 Borrowing Costs

IAS 23 (revised March 2007) uses the following terms with the meanings specified :

Borrowing costs are interest and other costs that an entity incurs in connection with the borrowing of funds.

A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.

An entity shall capitalize borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognize other borrowing costs as an expense in the period in which it incurs them (par. 8).

To the extent that an entity borrows funds specifically for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization as the actual borrowing costs incurred on that borrowing during the period less any investment income on the temporary investment of those borrowings (par. 12).

To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization by applying a capitalization rate to the expenditures on that asset. The capitalization rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs that an entity capitalizes during a period shall not exceed the amount of borrowing costs it incurred during that period (par. 14).

An entity shall begin capitalizing borrowing costs as part of the cost of a qualifying asset on the commencement date. The commencement date for capitalization is the date when the entity first meets all of the following conditions :

1. It incurs expenditures for the assets;

2. It incurs borrowing costs; and

3. It undertakes activities that are necessary to prepare the asset for its intended use or sale.

The activities necessary to prepare the asset for its intended use or sale encompass more than the physical construction of the asset. They include technical and administrative work prior to the commencement of physical construction, such as the activities associated with obtaining permits prior to the commencement of the physical construction. However, such activities exclude the holding of an asset when no production or development that changes the asset’s condition is taking place.

For example, borrowing costs incurred while land is under development are capitalized during the period in which activities related to the development are being undertaken. However, borrowing costs incurred while land acquired for building purposes is held without any associated development activity do not qualify for capitalization.

An entity shall suspend capitalization of borrowing costs during extended periods in which it suspends active development of a qualifying asset (par. 20).

An entity shall cease capitalizing borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete (par. 22).

An asset is normally ready for its intended use or sale when the physical construction of the asset is complete even though routine administrative work might still continue. If minor modifications, such as the decoration of a property to the purchaser’s or user’s specification, are all that are outstanding, this indicates that substantially all the activities are complete.

When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity shall cease capitalizing borrowing costs when it completes substantially all the activities necessary to prepare that part for its intended use or sale (par. 24).

An entity shall apply this standard for annual periods beginning on or after 1 January 2009.

This standard supersedes IAS 23 Borrowing Costs revised in 1993.

The Chronology of IAS 23 Borrowing Costs and why it was revised

IAS 23 Borrowing Costs was issued by the International Accounting Standards Committee in December 1993. It replaced IAS 23 Capitalisation of Borrowing Costs (issued March 1984).

In April 2001 the International Accounting Standards Board resolved that all Standards and Interpretation issued under previous Constitutions continued to be applicable unless and until they were amended or withdrawn.

IAS 23 was amended by IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors (issued December 2003).

In March 2007 the IASB issued a revised IAS 23.

The following Interpretations refer to IAS 23 :

· IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities (issued May 2004 and subsequently amended)

· IFRIC 12 Service Concession Arrangements (issued November 2006 and subsequently amended)

The revisions to IAS 23 result from the International Accounting Standards Board’s Short-term Convergence project.

The project is being conducted jointly with the United States standard-setter, the Financial Accounting Standards Board (FASB).

The objective of the project is to reduce differences between IFRSs and US generally accepted accounting principles (GAAP) that are capable of resolution in a relatively short time and can be addressed outside major projects.

The revisions to IAS 23 are principally concerned with the elimination of one of the two treatments that exist for borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset.

The application of only one method will enhance comparability.

For the reasons set out below, the Board decided to eliminate the option of immediate recognition of such borrowing costs as an expense. It believes this will result in an improvement in financial reporting as well as achieving convergence in principle with US GAAP.

The Board considered whether to seek convergence on the detailed requirements for the capitalization of borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset.

However, the Board noted statements by the US Securities and Exchange Commission (SEC) and the European Commission that the IASB and FASB should focus their short-term convergence effort on eliminating major differences of principle between IFRSs and US GAAP.

For their purposes, convergence on the detailed aspects of accounting treatments is not necessary.

The Board further noted that both IAS 23 and SFAS 34 Capitalization of Interest Cost were developed some years ago. Consequently, neither set of specific provisions may be regarded as being of a clearly higher quality than the other.

Therefore, the Board concluded that if should not spend time and resources considering aspects of IAS 23 beyond the choice between capitalization and immediate recognition as an expense.

(This article was excerpted from IAS 23 Borrowing Costs)