What Is IFRS Accounting and How Does It Work?

International Financial Reporting Standards, or IFRS, represent a unified set of accounting rules used for the financial statements of public companies. The objective of these standards is to establish a common accounting language that can be understood globally, making financial statements consistent, transparent, and comparable across different countries. This shared framework helps businesses and investors make educated financial analyses and decisions by standardizing how transactions are reported, which can improve capital allocation.

The IFRS Foundation and Global Application

The development and issuance of IFRS are managed by the International Accounting Standards Board (IASB), an independent body operating under the IFRS Foundation. The IASB is responsible for all technical matters, which includes preparing and issuing new standards after public consultation. Its board is composed of members from various geographical backgrounds with experience in standard-setting, auditing, and using financial reports.

Global adoption of IFRS is widespread, with public companies in more than 140 jurisdictions required to use them. This includes major economic areas like the European Union, Canada, and Australia. The IFRS Foundation tracks the use of its standards in 166 jurisdictions, providing transparency on the extent of adoption worldwide.

The Conceptual Framework for Financial Reporting

The foundation of IFRS is the Conceptual Framework for Financial Reporting, which sets out the underlying concepts for preparing financial statements. While not a standard itself, it provides direction to the IASB when developing new standards and helps preparers develop consistent accounting policies. The framework’s objective is to ensure financial information is useful to investors, lenders, and other creditors.

A defining characteristic of IFRS is its “principles-based” approach, which contrasts with a more “rules-based” system. The standards provide broad principles and require judgment from preparers and auditors in applying them to the substance of transactions, encouraging financial statements that faithfully represent a company’s economic reality.

For financial information to be useful, the Conceptual Framework identifies two fundamental qualitative characteristics: relevance and faithful representation. Relevant information can make a difference in decisions, while faithful representation means the information is complete, neutral, and free from error.

The framework also outlines four enhancing qualitative characteristics:

• Comparability allows users to identify and understand similarities and differences among items.
• Verifiability helps assure users that information is faithfully represented.
• Timeliness means having information available to decision-makers in time to influence their decisions.
• Understandability requires that financial information be presented clearly and concisely.

Finally, the Conceptual Framework defines the core elements of financial statements:

• Assets: A present economic resource controlled by the entity as a result of past events.
• Liabilities: A present obligation of the entity to transfer an economic resource as a result of past events.
• Equity: The residual interest in the assets of the entity after deducting all its liabilities.
• Income: Increases in assets or decreases in liabilities that result in increases in equity, other than contributions from equity holders.
• Expenses: Decreases in assets or increases in liabilities that result in decreases in equity, other than distributions to equity holders.

Primary Differences Between IFRS and US GAAP

While both IFRS and U.S. Generally Accepted Accounting Principles (GAAP) aim to provide high-quality financial information, they differ in several key areas. A primary difference relates to the valuation of inventory. IFRS prohibits the use of the Last-In, First-Out (LIFO) method, whereas U.S. GAAP permits it, which can significantly impact reported profits and tax liabilities.

Another divergence is in the accounting for intangible assets, particularly development costs. Under IFRS, certain development costs can be capitalized as an intangible asset if a company meets several criteria, including technical feasibility and the intent to complete the asset. U.S. GAAP requires that most research and development costs be expensed as incurred.

The accounting for property, plant, and equipment (PP&E) also presents a notable contrast. IFRS allows companies to choose between the cost model and the revaluation model. The revaluation model permits assets to be carried at fair value, a practice not permitted under U.S. GAAP, which requires PP&E to be carried at historical cost less accumulated depreciation.

The standards also differ on the treatment of impairment losses. IFRS uses a single-step approach and allows for the reversal of an impairment loss for most assets if the asset’s recoverable amount subsequently increases. U.S. GAAP uses a two-step impairment test and prohibits the reversal of impairment losses once recognized.

Required Financial Statements Under IFRS

A complete set of financial statements prepared under IFRS provides a comprehensive view of a company’s financial health, as outlined in IAS 1. This standard ensures the statements are comparable with a company’s past results and with other entities. The required components are:

• A statement of financial position as at the end of the period. Often called a balance sheet, this presents an entity’s assets, liabilities, and equity at a specific point in time.
• A statement of comprehensive income for the period. This can be a single statement or two separate statements (an income statement and a statement of other comprehensive income, or OCI). OCI includes items like revaluation gains not recognized in profit or loss.
• A statement of changes in equity for the period. This details all changes in a company’s equity, including profit or loss, OCI items, and transactions with owners like issuing shares or paying dividends.
• A statement of cash flows for the period. This provides information about changes in cash, classifying flows into operating, investing, and financing activities.
• Notes, comprising a summary of significant accounting policies and other explanatory information. The notes provide narrative details necessary to understand the company’s financial position and performance.

Transitioning to IFRS Standards

The process for a company adopting IFRS for the first time is governed by IFRS 1. The objective is to ensure an entity’s first IFRS financial statements contain high-quality, transparent, and comparable information, providing a suitable starting point for accounting under the new standards.

The fundamental principle of IFRS 1 is that a company must apply IFRS on a fully retrospective basis. This means the entity must prepare an opening IFRS statement of financial position at the “date of transition,” which is the start of the earliest period for which it presents full comparative information. At this date, the company must recognize all assets and liabilities required by IFRS and reclassify items from its previous accounting framework.

Recognizing that full retrospective application can be difficult, IFRS 1 includes certain mandatory exceptions and voluntary exemptions. The exceptions are areas where retrospective application is prohibited, largely to prevent using hindsight. For example, a company’s estimates at its transition date must be consistent with estimates made for the same date under its previous framework, unless there was an error.

IFRS 1 also provides voluntary exemptions to ease the transition. These allow companies to avoid retrospective application for certain complex areas. For instance, a first-time adopter can elect not to restate business combinations that occurred before the transition date or can elect to use an asset’s fair value as its “deemed cost” at that date.