International Financial Reporting Standards From accounti n g directives to the global standards

1. USAID “International Business Standards and Corporate Governance” Project, Ukraine FMI International Financial Reporting Standards From accounting directives to the global standards Prepared by: Boris Palienko Tallinn September 15 -19, 2003

2. McKinsey Global Investor Opinion on Corporate Governance in 2002 Surveyed 201 professional investors from institutions with an estimated $9 trillion under management. Covered 31 countries. • To what extent is a single global accounting standard desirable • If an existing standard were to be chosen as a global one, which one would you prefer • What are the clear issues at all levels that impact on the investment decision • What are the top reform priorities for policymakers

3. Single Accounting Standard 5% - Undesirable 5% - Not sure 90% - desirable

4. What standard to chose as a global standard ? 78 22 Western Europe IAS 76 24 Eastern Europe/Africa GAAP 65 35 Asia 41 Latin America 41 59 North America 24 76

5. Issues that impact the investment decisions Accounting disclosure 71 Shareholder equality 47 43 Market regulation and infrastructure International Accounting Standards 42 Market liquidity 37 Property rights 46 Pressure on corruption 32 Insolvency and bankruptcy regulation 32 Fiscal environment 31 Banking system 30

6. What are the top reform priorities for policymakers 33 Strengthen shareholder rights Improve accounting standards 32 More effective disclosure 31 Stronger enforcement 27 Percentage of investors selecting this option; multiple responses possible

7. IAS / IFRS - Recent progress in Europe June 2000 EC Recommendations on IAS submitted to Council and Parliament February 2001 Proposal to require IAS for listed companies April 2001 EC Comparisons of IAS with Directives July 2001 EU Economic and Social Committee indorsed the Proposal that would adopt IAS in Europe by 2005

8. IAS / IFRS - Recent progress in Europe (cont’d) October 2001 Parliament and Council amend the accounting Directives EFRAG Reports on Consistency of modernized Directives and IAS December 2001 December 2001 ECOFIN, European Parliament discuss the proposed IAS regulation March 2002 European Parliament overwhelmingly adopts IAS resolution

9. IAS / IFRS - Recent progress in Europe (cont’d) Parliament and Council amend the accounting Directives April 2002 EU proposes revised accounting Directives May 2002 June 2002 The Council of the EU has adopted an “IAS Regulation” May 2003 The Council of Ministers has adopted proposals to modernize the existing Accounting Directives

10. IAS - Key challenges • Convergence with US GAAP and acceptance of IAS by the US SEC NYSE - total number of listed companies - 2,800 companies valued at nearly $15 trillion in global market capitalization. Non-U.S. issuers - 470 companies are valued at $4.6 trillion. Nasdaq - About 5,000 companies listed, 342 are non-US companies. All these non-U.S. issuers have to prepare or reconcile their reports to US GAAP

11. Convergence of US GAAP and IFRS IFRS 34 standards and 33 interpretations Principle based Overriding principle of true and fair view/fair presentation US GAAP 150 standards Rule based No concept of true and fair view

12. Selected examples of differences between IFRS and US GAAP Experts identify about 95 KEY Differences ! Comparative prior year financial statements IFRS: One year comparative financial information is required. US: US GAAP states that comparatives are "desirable". SEC regulations generally require two years of comparative financial information. . .

13. Selected examples of differences between IFRS and US GAAP Classification of interest received and paid in the cash flow statement IFRS: May be classified as an operating, investing, or financing activity. US: Must be classified as an operating activity. Basis of reportable segments IFRS: Lines of business and geographical areas. US: Components for which information is reported internally to top management, which may or may not be based on lines of business or geographical areas.

14. Selected examples of differences between IFRS and US GAAP Basis of property, plant, and equipment IFRS: May use either fair value or historical cost. US: Generally required to use historical cost. . Special purpose entities(SPE) IFRS: Consolidate if "controlled". Generally follow the same principles for commercial entities in determining whether or not control exists. US: Consolidate if certain criteria for "qualifying SPEs" are not met. Generally look to whether or not the SPE has a sufficient level of equity "at risk".

15. Selected examples of differences between IFRS and US GAAP Different accounting policies of investor and associate IFRS: Must either (a) conform policies or, (b) if that is not practicable, disclose that fact. US: No requirement to conform policies. Classification of convertible debt instruments by the issuer IFRS: Split the instrument into its liability and equity components. US: Classify the entire instrument as a liability.

16. IAS - Key challenges • Enforcement of IAS / IFRS In the US, SEC examines the reports and in the event of non-compliance with GAAP can force the companies to restate their financials. In Europe, the Committee of European Securities Regulators (CESR) is developing the standards for enforcement of IAS / IFRS. Deadline - January 2005. But if the capital markets are intended to be global and that accounting standards are to be truly global, it seems only logical to have global enforcement.

17. One more survey - GAAP Convergence 2002 59 countries surveyed. Some of the concerns expressed about impediments to achieving IFRS convergence. % 51 47 39 35 30 21 18 • Complicated nature of particular standards • Tax driven nature of the national accounting regime • Disagreement with certain significant IFRS • Insufficient guidance on first time application of IFRS • Limited capital markets • Satisfaction with national accounting standards among investors/users • Translation difficulties

18. Understanding IAS / IFRS Existing IAS / IFRS - basically represent the set of standards and interpretation on how to account for certain transaction and what disclosure should be made in the financial statements. The spirit, concepts and principles of IAS/IFRS are proclaimed in: Framework For The Preparation And Presentation Of Financial Statements

19. Framework for the preparation and presentation of IAS/IFRS financial statements • describes the basic concepts by which financial statements are prepared • serves as a guide to the IAS Board in developing accounting standards and as a guide to resolving accounting issues that are not addressed directly in an IAS or IFRS. Framework is not the standard !

20. Framework for the preparation and presentation of IAS/IFRS financial statements • defines the objective of financial statements; • identifies the qualitative characteristics that make information in financial statements useful; and • defines the basic elements of financial statements and the concepts for recognising and measuring them in financial statements.

21. Framework for the preparation and presentation of IAS/IFRS financial statements Financial position - balance sheet Performance - income statement and statement of changes in equity Changes in financial position - cash flow statement. Notes and supplementary schedules

22. Framework for the preparation and presentation of IAS/IFRS financial statements Underlying assumptions Accrual Basis. The effects of transactions and other events are recognized when they occur, rather than when cash or its equivalent is received or paid, and they are reported in the financial statements of the periods to which they relate. Going Concern. The financial statements presume that an enterprise will continue in operation indefinitely or, if that presumption is not valid, disclosure and a different basis of reporting are required.

23. Framework for the preparation and presentation of IAS/IFRS financial statements • Qualitative characteristics of financial statements • Understandability • Relevance • Reliability • Comparability

24. Framework for the preparation and presentation of IAS/IFRS financial statements Elements of financial statements The elements directly related to financial position (balance sheet): Assets =Liabilities Equity The elements directly related to performance (income statement). Income Expenses

25. Framework for the preparation and presentation of IAS/IFRS financial statements Measurement of the elements of financial statements Measurement involves assigning monetary amounts at which the elements of the financial statements are to be recognised and reported. The Framework acknowledges that a variety of measurement bases are used today to different degrees and in varying combinations in financial statements, including: Historical cost Net realizable (settlement) value Current costPresent value (discounted)

26. New vision of IFRS - Fair value measurement It is a new vision of IFRS that considers fair value measurement to be paramount. A Balance Sheet Oriented, Fair Value Model This vision is based on an approach to company financial reporting that has been developed over the past several years by a group of Anglo-Saxon accounting standard setters, and has now been adopted by the International Financial Reporting Standards Board. It is a balance sheet oriented, fair value model, where the emphasis is on measuring the fair values of companies' assets and liabilities.

27. New vision of IFRS - Fair value measurement The accounting process will be focused extensively on the recognition, de-recognition and measurement at fair value of companies' assets and liabilities. The measurement of income will rely heavily on changes in the fair value of net assets. Income will be reported in a single statement of financial performance that aggregates all accrual-based income with all value changes, whether realized or unrealized

28. New vision of IFRS - Fair value measurement Measurement using the fair value will create big challenges for many companies, especially in developing countries, where the capital markets are not liquid: - fair value estimate should be accurate - fair value estimate should be reliable

29. Conclusion and summary • Globalization of capital markets requires the single global accounting, reporting and disclosure set of standard; • IFRS makes significant progress toward global recognition - Europe adopts IFRS for listed companies beginning January 2005; • Major differences between US GAAP and IFRS impede recognition of IFRS by the US SEC; • Development of IFRS enforcement standards will be completed in Europe by 2005; • IFRS Framework - foundation of the international financial reporting standards; • IFRS new vision - emphasis on fair value measurement

30. For Indonesia and GAAP comparison, please refer to the additional material (Deloitte, 2007: IFRS and Indonesian GAAP – A Comparison)

31. Answer, Discuss, Evaluate and Present the following questions: Do you think IFRS will promote more relevance, reliability and comparable financial statements and information? Why and Why not? Should Indonesia FULLY ADOPTING IFRS, or SELECTED AND ADJUSTABLE IFRS only?? For complementary reading: please refer to the additional material: A Globally Conceptual Framework (Barth, Hague and Linsmeier, 2008) IFRS and Indonesian GAAP: A Comparison (Deloitte, 2007) Assignments