If a firm’s parent company compiles its annual report according to IFRS, and therefore its Hungarian subsidiary has to prepare an IFRS report for the parent entity, it may well be time for the Hungarian subsidiary to prepare its individual annual report under IFRS, i.e. to opt for an IFRS transition.
Even where there is no IFRS reporting requirement from the parent company, it is still worthwhile contemplating a switch to IFRS because IFRS financial statements are prepared in a format that is considerably easier for international clients, future partners and investors to use and interpret.
Once the Hungarian company is convinced that it can opt for IFRS bookkeeping and could meet the requirements, there is nothing left other than to examine the accounting aspects of the IFRS transition and the steps involved. After the strategic aspects of IFRS transition in this article we deal with these steps.
Deciding the date and the currency for the IFRS transition
The first step is to decide the date for the IFRS transition, what the date for introducing IFRS should be. This is not really an accounting issue, but determining the date of the switch does entail some vital accounting steps and tasks.
If the company wants to prepare its first IFRS annual report on the 2019 financial year, then the reporting date for the IFRS report will be 31 December 2019, and for the sake of comparability, an IFRS report needs to be compiled as of 31 December 2018 as well, which will include the transition balance sheet as of 1 January 2018. So in this case, under IFRS, the IFRS transition date will be 1 January 2018.
The company also has to determine which currency to keep its accounting records in, and which currency the financial statements should be presented in. Under IFRS, companies can have different currencies to keep their books (functional currency) and prepare their reports (presentation currency). According to IFRS, companies must keep their accounting records in the currency of the primary economic environment in which they operate. In contrast to the IFRS system, the Hungarian Act on Accounting offers a choice of currencies for bookkeeping and reporting: HUF, EUR or USD.
In the next step the company has to examine evaluation procedures applied so far, the classifications of assets and liabilities and its own accounting policies; these have to be modified to ensure they comply with IFRS rules. It is important to mention that IFRS does not provide mandatory frameworks (for the income statement or balance sheet for example), but instead specifies guidelines and procedures. Companies have to design their own processes and evaluation t methods, ensuring that they are consistent with basic IFRS principles and the company’s circumstances.
Aspects of preparation of transition balance sheet
For those applying IFRS for the first time, IFRS 1 First-time Adoption of International Financial Reporting Standards governs the transition from a different accounting system to IFRS. First-time adopters of IFRS are considered to be those presenting their financial statements under IFRS for the first time.
According to IFRS 1, the transition balance sheet must be prepared as if the company had always applied IFRS. When compiling an opening balance sheet under IFRS:
- all assets considered marketable under IFRS must be recognised;
- all assets not considered marketable under IFRS must be omitted;
- assets must be classified in accordance with IFRS, and
- evaluated under IFRS;
- any differences between the two accounting systems must be recognised against the profit reserve, or, if more obvious, then against another item of equity.
There are of course cases where it is not possible to apply the basic principles, and so IFRS 1 formulates two exceptions to the application of the basic principles:
- the prohibition of retrospective application, when it is not necessary to act as if the company has always applied IFRS;
- relief and simplifications in certain situations.
The standard details exactly when these exceptions can be employed.
Challenges during classifying assets and liabilities
IFRS essentially uses the same categories of assets and equity/liabilities as the Accounting Act, but despite this, it is not as easy to classify and evaluating assets and liabilities as it might appear at first glance. For example, there are categories within IFRS that the Hungarian Accounting Act does not separate. One typical example of this is investment property. The Accounting Act treats properties for investment and for own use together, and does not prescribe any special presentation or evaluation obligations. If they support the company’s activity for more than one year then the properties are recognised under fixed assets, if they are held for sale then they are recognised under inventories. So the company has to decide which asset category to assign its properties to under IFRS, and measure them accordingly. In the event of any measurement difference, this must be recognised in equity.
So during an IFRS transition it is crucial to start in good time with identifying the company’s assets and liabilities, evaluate and recognising them under IFRS, and collecting all other information that may be required for the company to present its financial statements prepared under IFRS.
You can read about the strategic aspects of IFRS transition here, about its legal aspects here, and about its tax implications here.
