2004 PUBLIC SECTOR IFRS CONFERENCE

Presentation to 2004 Public Sector IFRS Conference, Canberra

By Wayne Cameron
Auditor-General of Victoria

1 June 2004

Good morning, It’s nice to be here, and to help set the scene for the 2004 Public Sector IFRS Conference - in the nation’s capital.

The program is comprehensive and the topic is timely. Some saw the recent debate around the Financial Reporting Council table about the likelihood of the original timetable being met as the possibility of deferral in application date for the introduction of the new stable platform of accounting standards, but I’m hear to tell you that the original target application dates are going to be met. We can all look forward to the new standards applying to reporting periods commencing on or from 1 January 2005.

We can also look forward to preparing the prior year comparatives. And we can also look forward to rechecking the applicability of Urgent Issues Group abstracts (but more about them later).

For some, the implementation timetable is much earlier than their June 2006 accounts.

• If you are a university, you will know that the 31 December 2005 year is your target date.

• If you prepare interim financial statements in the year of application, you will need to apply the new stable platform.

The only relief (if that’s possible) is that for any standards that are not part of the stable platform with a later application date – early adoption is available. Early adoption is not possible for the stable platform!

Overview

The AASB workload has not only been hectic, but has in fact been hampered by:

• The unplanned requirement to harmonise IFRS, when the IFRSs themselves were the subject of review and change. Indeed, the last set of changes to the “stable platform” was to have been completed by 31 March – to let national standard-setters enough time to codify the standards in their own format. Still, some major editorial changes are coming through – hence, the reason why the pending standards process has been adopted (as well as to ensure that all of the standards comprising the stable platform were promulgated at the same time).

• Some discussion remains about the “stable platform”. When will it be finalised – given the frequency of changes by the IASB to its standards. The AAASB has stated they are those in place at 31 March 2004, any changes to the international standards since that date will not form part of the stable platform and will, therefore, have a later application date – although early adoption is both an option and, more importantly, preferable.

• The second FRC strategic direction to harmonise GAAP and GFS – which has impacted on the AASB program to review certain public sector specific standards - AAS 27, 29 and 31.

• The need to provide access to the new Australian standards in a way that does not breech copyright requirements of the IASs – although this is slowly being sorted out, it has only just been resolved for the supporting guidance material. One of the early issues has been the issue of access and copyright. Access to the CPA website or the AASB website will get you there.

This presentation will cover:

• AASB work program

• IFRS and the public sector

• Public sector impacts

• What to do next (and who will do it!).

AASB work program

Current state of play

As of today, 33 standards have been posted, or are about to be posted, onto the AASB noticeboard as pending standards. In other words, they are complete – note, however, that they can be subject to editorial change, (between now and 30 June 2004), following changes made by the IASB to the relevant IAS.

That means that the only remaining standards forming part of the stable platform that are yet too be completed and posted onto the AASB website are:

• Revised SAC 1 and 2 (ED 124)

• AASB 1048 SIC/IFRIC/UIG Abstracts

• AASB 124 Related Party Disclosures

• AASB 1023 and 1038 Insurance Phase I

• Extractive Industries Phase I to be completed later.

It is expected that the above will be approved next month, placed on the website as pending, then all standards promulgated through the parliamentary process immediately after 30 June 2004.

Status of UIG abstracts

All existing abstracts will have been reviewed by 30 June and, where they remain relevant, will be reissued and have the same force of law as the standards. The reissued ones will also include the IFRICs since they too will be part of the interpretive platform to the standards.

In all, about 9 abstracts have been withdrawn because they have been superseded by other standards or other UIG abstracts, or otherwise no longer required. A further 26 will be withdrawn when the stable platform become operative, 19 more will be retained until an Australian standard addressing the issue becomes operative, and 11 SIC/IFRIC interpretations converted into the Australian set of abstracts.

Other standards under development

• Specialised industry standards - insurance standards (3), and a standard for the extractive industry.

• Revision of public sector standards AAS 27 (ED 124 issued), AAS 29 (work underway) and AAS 31 (affected by the GFS/GAAP harmonisation degree by the FRC.

• Conceptual framework – CFP1 – SAC 3 and 4 withdrawn and replaced by IASB conceptual framework.

IFRS and the public sector

Basic principle is that the standards are sector neutral. However, there are some standards that contain an exemption for application to the public sector, e.g.:

• Related Parties standard

• Segment Reporting

• Remuneration Disclosures.

And there are others that contain differing treatments for the public sector (not-for-profit entities) – so be aware, for example:

• Inventory standard - Inventory held for distribution

• For profit sector – Lower of cost or NRV

• Not-for-profit - Lower of cost or current replacement cost.

All standards clearly state the source of the standard. And state the changes to existing standards. One such source is IPSAS. The standards seek to incorporate relevant IPSASs into the standard. But in some cases, the existing IPSAS has not been included – where the IPSAS has not previously been exposed in Australia. IFAC PSC is currently rechecking the 20 IPSASs on issue against the IASs to bring them up-to-date. We should become more aware of these IPSASs in the future since they seek to specifically recognise some of the unique issues of the public sector, e.g. the 2 ITC out for comment are on:

• Revenue from non-exchange transactions

• Accounting for social policies of governments.

Options in standards

One of the problems we in Australia have had in converging with the IASs is the risk that such a step would be regressive. Having travelled so far on the standard-setting path, simple adoption fully could, in some instances, loosen rather than strengthen the value of standards. This is particularly germane for standards such as the insurance standard when the development of the standard is to be covered in 2 phases – the intermediate phase causing the industry to take a step back in time, but in the knowledge that phase 2 is most likely to re-instate many of the current good practices. This dilemma has caused the AASB to have to, on occasion, make some decisions about whether the options in a standard are really in the best interests of the economy. In some cases, it has deleted the availability of the other option.

Some argue that this action is not consistent with the harmonisation process. That assertion is not true. A preparer will still have harmonised with the IAS even when the available options are limited.

Aus paragraphs

In a number of cases, the standards include Aus paragraphs. These have been named so as to enable the preparer to understand clearly what has been added from the IAS. They are added to assist in application of the standard. One rare occasions such as the remuneration disclosure or share-based payments, additional black letter requirements have been included as AUS paragraphs – but this is done to meet local Australian expectations, but in the main they are included as guidance.

Application date: For annual reporting periods commencing on or from 1 January 2005.

Compliance statement: I have just forgotten where this requirement is but basically it expects reporting entities to say that they have applied Australian accounting standards and comply with IAS.

GBEs are to be treated as for-profit entities – more about who is a for-profit entity later.

Impact for new standards

Significant issues facing public sector entities

• The distinction between a for-profit and a not-for-profit entity.

• Employee benefits: The defined benefit plan surplus or deficit will create a new asset or liability on the balance sheet (already a requirement in the Victorian public sector) However, additional volatility may result from using the projected unit credit method of actuarial valuation (if not already used), and in measuring plan assets at fair value.

• Unlikely that directors/auditor will be able to refer to compliance with IFRS if Aus clauses are invoked in producing the reports of a not-for-profit entity.

• Income taxes will apply to tax-equivalent entities in the public sector. The move from the transaction approach to a balance sheet approach will be challenging both within the private and public sectors.

• Intangible assets will only be recognised at fair value if there exists an active market to support the use of fair value. Internally-generated intangible assets must not be recognised and research cost must be expensed.

• In accounting for foreign exchange, offshore operations should be accounted for in their functional currency, which is determined according to criteria set down in the standard. However, the presentation currency is optional. Very unlikely that other than AUD would be used, central agencies could provide a lead and issue a directive to agencies.

• Practical implications of consolidating a for-profit entity into a not-for-profit economic entity.

AASB 101

• Terminology is different, and at times confusing.

• Statement of changes in equity – local government has always had it.

• Current assets/liabilities definition reinforces use of the operating cycle/or liquidity basis.

• Recycling seems possible in some standards, e.g. financial instruments, - increments/ decrements through P&L.

• Report by function or nature.

• Extra ordinaries now completely out.

Budget impact

• Greater fluctuations

Impact of new standards

Property plant and equipment standard

• Cost or fair value.

• Assets at fair value – standard allows for difficulty in getting fair value – not-for-profits can use depreciated replacement cost.

• Increase/decrease can be done by class in the public sector. Private sector has to do it by asset.

• Assets received (donated) – can use fair value be assigned (in the absence of historical cost).

• Disclosure (fair value normally requires cost to be shown in the notes) – we don’t need to show this in the public sector.

Impairment

• Not-for-profit dispensation - easier to apply.

• Don’t need to deal with nasties - value in use and cash-generating units.

• For not-for-profits - hard to work out - go to value in use, plus depreciated replacement cost.

• Standard has impairment indicators.

Financial instruments

• Much broader scope than what people think, e.g. look at terms of trade.

• No public dispensation.

• Classification is important, e.g. hold to maturity portfolios.

• Because “financial instruments” is broadly defined, standards AASB 132 and AASB 139 will have a significant impact on financial reports. Financial instruments covers cash, debtors, creditors and a broad range of financial contracts, including derivatives. Hence, not only the treasury corporations of the public sector should be interested, but also all departments and agencies will be impacted, even if not dealing in derivatives.

• Presentation and disclosure: Both private and public sector entities will be affected. Principal changes include limiting the valuation of compound instruments with outstanding debt components to valuing the debt component, with equity being the residual difference. The move to AASB 132 will result in more instruments being classified as debt.

• Recognition and measurement: The most significant change will be to bring financial instruments on to the balance sheet at fair value, with changes in the fair value being recognised as income or expense. Financial instruments will be classified into 4 categories, being loans/receivables, held-to-maturity, available for sale or trading. The classification, in turn, will determine which valuation methodology applies, being either amortised cost or fair value, hedge accounting cannot only be implemented if tight criterion are met, otherwise all gains must be transferred to income or expense.

Inventory

• Use of the lower of cost or replacement value (compared with net realisable value in the private sector).

AASB 1047 sets out the disclosure requirements of adopting the new standards:

• For 30 June 2004: Disclose the impacts in a note. Likely to be narrative only since many will not be able to quantify these impacts. Our expectation is that many will simply identify the main standards that will impact on measurement, e.g. treatment of goodwill, revaluation of property, plant and equipment whether adoption of AASB 139 is likely to impact and on what line items etc.

• For 30 June 2005: Disclose your quantified effects on the reported result and key balance sheet values. You will have done this for the comparative, which will be required for the following reporting year in any case.

AASB 1 – First time adoption of Australian Equivalents to International Financial Reporting Standards

The first time adoption/transitional arrangements allow for first time adoption adjustments to be taken directly to equity:

• Opening AEIFRS balance sheet:

• Recognise all assets and liabilities whose recognition is required

• Not recognise assets and liabilities if not permitted

• Reclassify items previously recognised per new standards

• Apply AIFRP in measuring all assets and liabilities

• Retrospective application

• Targeted exemptions

• Must apply latest version of the standard

• Estimates at the same date

• Transitional provisions not applicable to first time adopter

• Enhanced disclosure.

Objectives

• Transparency.

• Comparable.

• Suitable starting point.

• Costs not to exceed benefits.

Scope

• Explicit and unreserved statement of compliance.

• Each interim report covered by the above.

What to do next

Familiarise yourself with the breadth of the news standards.

Develop an implementation timetable.

Acquire resources to handle the changes.

Brief audit committee and board early and frequently on progress with the implementation plan and any impacts:

• Budget

• Expected outturn

• Performance measures

• Resources and advice.

Remember, some of the changes may need accounting systems changes.

Some accounting treatment responses will require guidance from DOFA/DTF to avoid confusion with quite different treatments being adopted in like industries.

In summary

There is no doubt that we have a lot ahead of us. But it’s not that daunting.

We need to prepare now, not next year, but now.

To avoid needlessly wasting time on reinventing the wheel on how to respond to the numerous issues, leadership from central agencies is required. What do I mean by that I hear you say, and why?

Why because in the absence of clear leadership the public sector runs the risk of spending time on things that won’t matter on, more importantly, risk choosing different paths in like circumstances in the same industry – thus stretching the credibility of the new standards.

A good example of what I mean relates to the decision of whether to remain on historical cost on initial adoption, or embark on the revaluation option. For 2 or more organisations in the same industry – say the water industry – to choose a different option (allowable under the standard) would be hard to explain to the public and to parliament.