IFRS 1: first-time adoption of IFRS

A company that has used its local accounting rules for years decides to follow International Financial Reporting Standards (IFRS). It cannot simply start. Its old figures were built on different rules, and its comparatives will be wrong unless they are rebuilt. IFRS 1 sets out how to make the switch fairly and at a reasonable cost.

This topic covers the terms in IFRS 1, the opening statement of financial position, full retrospective application, the optional exemptions and mandatory exceptions, presentation, the reconciliations and worked examples. The previous topics covered the analysis of statements. The next topics cover insurance contracts and the smaller entity standard. The latest Pathfinder diets have no stand-alone IFRS 1 question, but it is examinable.

Key terms in plain English

Syllabus check

IFRS 1 is examinable under syllabus area C. This topic covers:

• the opening IFRS statement of financial position, the exemptions and exceptions;
• presentation and disclosure by a first-time adopter, including the reconciliations.

CAMA 2020 and first-time adoption

The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow IFRS and give a true and fair view.

The opening statement and policies

The entity prepares an opening IFRS statement of financial position at the date of transition. It uses the same accounting policies in that statement and in all periods in its first IFRS statements. These policies follow each IFRS effective at the end of the first IFRS reporting period. It does not use earlier versions. It may use a new IFRS that is not yet mandatory if early application is allowed.

Full retrospective application

In the opening statement the entity must:

• recognise all assets and liabilities that IFRS requires
• not recognise any that IFRS does not allow
• reclassify items that IFRS classifies differently
• apply IFRS in measuring all assets and liabilities

The adjustments are recognised directly in retained earnings (or another category of equity) at the date of transition. Full retrospective restatement can be very hard, so IFRS 1 gives two kinds of exception.

Optional exemptions

There are over twenty. The main ones:

• Business combinations: IFRS 3, IFRS 10 and IAS 21 need not be applied to combinations before the date of transition (or before an earlier date chosen). If not applied retrospectively, the previous carrying amounts become the basis, goodwill written off is not reinstated, and goodwill at transition is tested for impairment. Goodwill and fair value adjustments on a foreign operation need not be retranslated for earlier combinations.
• Deemed cost: property, plant and equipment, certain intangibles, investment property and some other assets may be stated at the date of transition at fair value, a previous revaluation, cost adjusted by an inflation index or, for oil and gas and rate-regulated activities, the previous carrying amount.
• Cumulative translation differences: they need not be identified before the date of transition (they are set to zero).
• Investments in subsidiaries, joint ventures and associates in separate statements: cost under IAS 27, deemed cost (fair value or previous carrying amount), or IFRS 9.
• Designation of previously recognised financial instruments at fair value through profit or loss may be made at the date of transition.

Mandatory exceptions

These stop retrospective application:

• Estimates: estimates under IFRS must be consistent with those made at the same date under the previous GAAP, unless there is objective evidence of an error.
• Derecognition of financial assets and liabilities: apply IFRS 9 prospectively from the date of transition (items derecognised earlier are not brought back, although consolidation of a vehicle may bring them back).
• Hedge accounting: hedges cannot be designated retrospectively. All derivatives are measured at fair value and deferred gains and losses are removed.
• Non-controlling interests: the IFRS 10 rules (including losses allocated to a deficit NCI and changes in ownership) apply prospectively.
• Classification and measurement and impairment of financial assets, embedded derivatives and government loans.

Note: ICAN’s chapter lists seven exceptions and does not list estimates. Its own Question 1 solution cites the estimates rule (paragraph 14), so we have included it.

Presentation and disclosure

• At least one year of comparatives. So the date of transition cannot be later than the start of the previous financial year.
• Three statements of financial position: the current year end, the comparative year end and the date of transition. A statement of profit or loss and other comprehensive income, a statement of cash flows, a statement of changes in equity and notes, each with comparatives.
• Three reconciliations from the previous GAAP to IFRS: (1) equity at the date of transition; (2) equity at the end of the last period under the previous GAAP; (3) total comprehensive income (or profit or loss) for that last period. They explain the effect on financial position, performance and cash flows.
• Material errors found during the transition, shown separately from policy changes, and an explanation of the policy choices made (exemptions used).

Typical areas of adjustment in Nigeria

The rules in more depth

Why the same policies throughout

A reader must be able to compare the years. If each year used a different version of IFRS, the comparison would mean nothing.

Why there are exemptions

Rebuilding the cost of an asset bought twenty years ago, or recomputing every old acquisition, can cost more than it is worth. The exemptions give a shortcut.

Why there are exceptions

Applying hindsight to estimates or to hedges would let management rewrite history. The exceptions prevent that.

Effect on analysis

The adjustments usually change equity and the ratios at once: deemed cost raises assets, leases raise debt, and pensions lower equity. Users need the reconciliations to see which changes are one-off.

Worked examples

1. The date of transition is 1 January 20X7 (the start of the comparative year).
2. It applies the IFRS effective at 31 December 20X8 to the opening statement at 1 January 20X7, to the statements at 31 December 20X7 and 20X8, and to all notes.
3. It may apply a new standard that is not yet mandatory if early application is allowed.

1. Assets change by +300 − 50 − 70 = +180.
   Liabilities change by +220.
   Net assets change by −40, to 3,140.
2. Equity: a revaluation (deemed cost) reserve of 190 is created and retained earnings fall by 230 (to 1,950).
   The total change is 190 − 230 = −40.
3. This is the form of the reconciliation: previous GAAP, adjustments and IFRS in three columns.

1. Net adjustment.
   120 − 40 − 85 − 60 + 18 = −47.
2. Opening IFRS equity.
   2,800 − 47 = ₦2,753m.

1. PPE: 480 to 620, an uplift of 140.
2. Software: 60 to nil, an adjustment of (60).
3. Deferred tax:
   30% × 140 = (42) liability.
4. Net adjustment to equity.
   140 − 60 − 42 = +₦38m, taken to retained earnings (or a reserve if so designated).
5. Disclosure: the equity reconciliation at 1 January 20X4 shows previous GAAP equity, adjustments of +140, −60 and −42, and IFRS equity ₦38m higher.
6. Ratios: capital employed rises (₦620m against ₦480m of PPE) while operating profit is unchanged, so ROCE falls; equity rises, so gearing falls.

Note: ICAN’s answer adds the retained earnings of ₦200m to the net assets (₦740m and ₦778m). Retained earnings are part of equity and not an asset, so we have not repeated that line. The ₦38m adjustment is right.

1. Roof: reclassify cost 200 and accumulated depreciation 100 to a separate component. No change to net assets. Future depreciation is by component.
2. Goodwill:
   IFRS 250 less Nigerian GAAP 150 = +100 to equity at transition.
3. Investment property: transfer 180 from PPE to investment property at 240; Cr retained earnings 60.
4. Deferred tax on the uplift of 60: 30% = (18).
5. Equity at transition:
   100 + 60 − 18 = +₦142m.
6. 2015: goodwill amortisation of 30 is reversed (+30).
   The fair value gain 260 − 240 = +20 goes to profit or loss, with deferred tax of 6.
   Profit before tax is ₦50m higher than under Nigerian GAAP.
7. Equity at 31 December 2015:
   142 + 30 + 20 − 6 = +₦186m.
8. Earnings quality: part of the higher profit is a non-cash fair value gain, and profit becomes more volatile. Goodwill must be tested for impairment each year, so a downturn could cause a large write-down.

Note: ICAN’s solution credits retained earnings with the whole ₦250m of goodwill (equity +₦292m at transition and +₦336m at the year end), although its own report section refers to goodwill of +₦100m. Goodwill of ₦150m was already recognised, so only the difference of ₦100m is an adjustment. Our answer is slightly different from ICAN’s. In the exam, show the Nigerian GAAP balance and the difference.

How to score full marks

• State the dates (transition, comparative, first reporting date) first.
• Set out the adjustments in columns: previous GAAP, adjustment and IFRS, with a reference to each.
• Show the difference between the old and new carrying amount, not the whole new amount.
• Include deferred tax on the adjustments.
• Name the exemption or exception used and the reason.
• Give the three reconciliations and say what each is for.
• Explain the effect on ratios (ROCE, gearing, liquidity, volatility).

Common mistakes in the exam

• Giving the transition date as the start of the current year.
• Applying different IFRS versions to different years.
• Crediting the whole IFRS figure to equity instead of the difference.
• Forgetting deferred tax on revaluations and fair value uplifts.
• Confusing an optional exemption with a mandatory exception.
• Showing two statements of financial position instead of three.
• Leaving out the reconciliation of total comprehensive income.

Quick revision

• Date of transition: start of the earliest comparative period.
• Same policies throughout, the IFRS in force at the first reporting date.
• Full retrospective application, with optional exemptions and mandatory exceptions.
• Adjustments go to retained earnings (or a reserve).
• Three statements of financial position and three reconciliations.
• CAMA 2020: ss. 377(1), 378, 379 to 381, 374(1), 385, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

Spotted a mistake? Tell us and we will check it.