Accounting policy refers to the specific rule or principle that an entity applies to a transaction, other event or condition when preparing and presenting its financial statements. It encompasses everything from recognition and measurement to presentations and disclosures. For most transactions, other events or conditions, specific IFRS Standards apply. But what about the cases in which none apply?
Take, for example, the scenario in which a company purchases shares of another company that does not meet the definition of a business in accordance with IFRS 3 Business Combinations. This transaction, therefore, is not classified as a business combination. Instead, it is simply classified as an acquisition of an asset or group of assets and is not directly addressed by any IFRS Standard. (One exception is the purchase price allocation requirements established in IFRS 3.)
IAS 8.11 clarifies the solution for situations like this. It requires the entity to follow two subsequent steps (in the order presented) to develop an accounting policy that results in reliable and relevant information:
- In the absence of a specific IFRS Standard that applies to a transaction, other event or condition, the entity considers whether there is another IFRS Standard that deals with a similar and related issue.
- If no IFRS Standard dealing with a similar and related issue exists, the entity considers the applicability of the Conceptual Framework for Financial Reporting.
This sounds simple enough, but it’s easier explained than carried out because it requires a judgement.
To illustrate, let’s continue with the example of an acquisition of a group of assets that does not constitute a business. Imagine that the company purchased only 90 percent of the acquiree’s shares, so 10 percent of non-controlling interest (NCI) remains. What is the measurement basis for ordinary NCI on initial recognition for a transaction that is not a business combination?
Since there is no standard specifically addressing this issue, the most appropriate option seems clear: Consider IAS 8.11 and look for a standard dealing with a similar and related issue – in this case, IFRS 3. IFRS 3 allows an entity to elect, on a transaction-by-transaction basis, one of two initial measurement options: fair value or proportionate interest in the recognized amount of the identifiable net assets of the acquiree. As such, the accounting policy choice prescribed in IFRS 3 would seem to be the most appropriate measurement basis for this type of transaction.
By analogy, we could follow the same approach in order to identify appropriate disclosures for acquisitions of an asset or group of assets in the financial statements. The entity could follow IFRS 3 disclosure requirements. This would appear appropriate not only by aligning with IAS 8.11, but also by complying with IAS 1.112(c), as disclosing such information would probably be relevant to an understanding of financial statements.
The above example is less tricky given that an IFRS Standard dealing with a similar and related issue exists. There can be cases, however, when no IFRS Standard, not even one that appears related at first glance, can be used. At that point, it is up to the entity to exercise judgement and apply the Conceptual Framework to the best of its ability in order to develop an appropriate accounting policy that results in relevant and reliable information. Any entity using that approach should consider, not only disclosing the accounting policy as required by IAS 1.117, but also disclosing the key judgements used when determining the appropriate accounting policy, as required by IAS 1.122.
Last November, IASB issued a guide explaining how to apply IAS 8 requirements when selecting and applying accounting policies. It includes several comprehensive examples that may help you understand the process as well as the role and importance of judgement. We invite you to have a read & reach out with any questions!