Sri Lanka converges with IFRS

Arjuna Herath

The dawn of January 1, 2011 brought a whole new dimension to the corporate financial reporting in Sri Lanka.

In line with the global trend in enabling a common language for financial reporting process, the Institute of Chartered Accountants of Sri Lanka have taken steps to adopt International Financial Reporting Standards (IFRS) by issuing Sri Lanka Financial Reporting Standards (SLFRS) and Sri Lanka Accounting Standards (LKAS) for annual financial periods beginning on or after January 1, 2012.

The timetable for this far reaching activity is short. Who will be most affected? The short answer is that just about every entity that operates locally and internationally will be, if only because even if companies themselves are not moving to international standards, some of their biggest competitors are (or will be).

A snap shot of the changes With the adoption of the new Sri Lanka Financial Reporting Standards, entities are required to apply SLFRS 1 First time adoption of Sri Lanka Financial Reporting Standards.

The key principle of SLFRS 1 is full retrospective application of all accounting standards in effect as of the closing balance sheet date. Doing so will mean that the financial statements of an entity for 2012 will reflect the financial position and performance of as if that entity has always reported its financial statements using the new SLFRS.

As a result the following complexities will surface in 2012.

* Preparation of the last three years balance sheets based on the new/revised standards. i.e. Balance Sheets as at the closing of 2010 and 2011 are required to apply the new SLFRS for the purpose of comparatives for the year 2012.

* Retrospective application of accounting policies for the 3 years preceding 2012 financial year end

* Availability of information to re-measure balances under new accounting principles, in complying with the new SLFRS.

* Ability of IT systems to generate information required for the measurement of account balances and for disclosure purposes.

* Business processes to be re-engineered to capture necessary data.

Ernst & Young Country Managing Partner Asite Talwatte, comments: With the introduction and recent amendments of many standards, there is an intensifying need for changes in accounting and reporting, business processes as well as IT systems.

For example, LKAS 23 Borrowing Costs requires borrowing costs to be capitalised if they are directly attributable to the acquisition, construction or production of a qualifying asset.

Thus, Management will need to carefully assess the new requirements which are inevitable and modify the systems to capture and record the relevant data as required.

A glimpse of key issues

LKAS 32 Financial Instruments: Presentation, LKAS 39 Financial Instruments: Recognition and Measurement and SLFRS 7 Financial Instruments: Disclosures deal with presentation, recognition and measurement and disclosure aspects of financial instruments, in a comprehensive manner.

LKAS 32 requires the issuer to classify instruments as a liability or equity on initial recognition along with a split of convertible financial instruments into its equity and liability components for accounting purposes.

As per LKAS 39, all financial assets are to be classified into four categories namely, Fair Value through Profit and Loss (FVPL), Available for Sale (AFS), Held to Maturity (HTM) and Loans and Receivables (L&R) and all financial liabilities are to be classified as FVPL or other liabilities. Adding views on the introduction of LKAS 32 Financial Instruments: Presentation and LKAS 39 Financial Instruments: Recognition and Measurement, Ernst & Young's Assurance Head Manil Jayesinghe says: According to the new standards, the initial and subsequent measurement of financial instruments will significantly change with fair value coming into play.

Also, LKAS 39 requires a provision for impairment to be recognized as soon as there is a risk that the initial value of an asset may not be recovered.

These changes will have a significant impact on a company's financial statements. Some of the key issues foreseen in adopting SLFRS

Converging with IFRS will entail that 28 existing accounting standards will be revised, 12 new standards will be issued and about 26 IFRICs will be in force beginning 01st January 2012.

A few common issues that may affect the companies in Sri Lanka would be;

Item Issue Impact Revenue

* Revenue recognition based on Fair value

* When goods and services are sold as a bundled package, these bundled items should be unbundled, and revenue should be recognized at fair value.

* Free gifts, reward points should be accounted for at Fair value, resulting in possible deferment of revenue

* Timing of revenue recognition for service contracts to reflect provision of services, as opposed to agreed payment plans with customers.

* Intercompany pricing methods may need to be revisited, as the purpose for which such pricing was done may not be met due to new measurement requirements adopted in preparing financial statements. Share based payments

* Share based payments to be recorded at fair value

* Recognition of share based payments in the income statement at fair value Financial Instruments

* Recognition, Classification, measurement and disclosure

* Investments (Equity investments, treasury bills, bonds, commercial papers, etc), trade receivables, trade payables, borrowings to be measured and disclosed as per LKAS 32, 39 and SLFRS 7.

* Bad and doubtful debt provisioning to be replaced with impairment testing.

* Off balance sheet items such as, interest rate swaps, currency swaps, forwards, guarantees to be fair valued and brought in to the balance sheet.

* Off market loans to both related parties and non-related parties to be fair valued.

* Disclosure of Risk management policies of the company. Leases

* Sale and lease back arrangements

* Arrangements that contains a lease

* When assets sold are leased back under operating leases, the gain on sale to reflect any off market interest rates.

* Outsourcing arrangements that is or contains a lease in substance, should be identified and recorded either as an operating lease or a finance lease.

When will the process be over?

IFRSs have evolved over the years and it continues to involve due to the complexities of the operations that companies involve in. From 2012 onwards Sri Lanka will envelope such changes no sooner the changes are issue.

Hence, being complaint with Sri Lanka Financial Reporting Standards becomes a moving target.

As the new accounting framework matures, there will continue to be changes in accounting practices in the next decade. Companies will need to keep up-to-date on SLFRS-related developments to ensure compliance with accounting requirements in the future as well.