Impact of Adoption of International Financial Reporting Standard on Reporting Entities
Discuss about the IFRS on Thinly Capitalised Position.
Corporations that are carrying out their operations in Australia have been considerably impacted by the adoption of International financial reporting standard. In this particular assignment, the impact of the adoption of accounting standard on the financial statements has been illustrated. The objective of carrying out research on this particular paper is to identify the impact of the reporting standard at international level on the capitalized position of the companies or reporting entities conducting their business in Australia (Barac et al. 2016).
The International financial reporting standard has made an announcement regarding the adoption of the standard by different countries. The standard was made applicable and it was to be commenced after or on 1st January, 2005. Adoption of “International Financial Reporting Standards” by the reporting entities operating in Australia was concluded by the International financial reporting council. Adopting the standard by companies would help in facilitating comparison between the reporting standard followed by different companies operating in different countries and thereby improving the transparency. Such transparency would help in bringing better contracts among the several participants in the capital market. Moreover, adoption of the international standard would help companies in enhancing their ability to raise the finds by reducing the cost of capital and their chances of being listed on different stock exchanges of the world (Donelson et al. 2016). Reporting entities have been able to witness considerable amount of changes in their accounting standard and the accounting treatment of different accounts due to embracing the International financial reporting standard. This also had an insightful impact on the measurement, disclosure and recognition of equities, liabilities and profitability level of reporting entities. It was also ascertained that various aspects of financial reporting and treatment of taxation was fundamentally impacted by the process that was involved in concerting into the international reporting standard (Beck et al. 2017). It was required by organization to implement the new accounting standard by making changes in the accounting treatment. Moreover, it is certainly possible that the computation of thin capitalization of firms would be adversely affected by the adoption of international financial reporting standard. It is of crucial importance to consider the fact that entities adapting to the international standard might be denying the deductions associated with the income tax in respect of the related amount of borrowing fees and payment of interest by the company.
Impact of International Financial Reporting Standards on Thin Capitalization Position of Reporting Entities
The purpose of carrying out research on the International financial reporting standard is to identify the impact of such standard on the thin capitalization position of companies operating in Australia and equivalent to Australia. In the first aspect, the purpose of conducting the research is to how and why the thin capitalization is considerably impacted by the standard and whether they are currently complying with the same. Secondly, it is required to determine the changes quantitatively by linking it back to the initiatives of accounting and taxation policies (Hoque 2018).
The dividend decision of the reporting entities was phenomenally impacted by the adoption process of IFRS as on after 1st January, 2005. Some of the other accounting decision that was influenced by the firms included the position of capitalization, franking policy employed by organization, consolidation of income tax and Australia entities application with tax holding. However, some of the groups associated with accounting department in Australia such as Institute of Chartered Accountants and 100 (G100) were of view that there would be adverse and negative consequence due to changes tax treatment resulting from the adoption of standard (Parrott 2017). However, such impact is to be evaluated in terms of thin position relating to firms capitalization. The reporting entities complying with the rules of thin capitalization under the GAAP (Generally Accepted Accounting Principles) would fail the test due to the alterations in the accounting treatment in respect of valuation and recognition of liabilities, assets and equities (Luo and Warfield 2014). Nevertheless, due to the mandatory compliance of entities with the IFRS would not lead to such failure impacting the financial operations and financial structure.
The Federal Treasurer directed the adoption of IFRS so that a transitional period of three years after adopted where they are provided with the option of electing on annual basis for complying with the GAAP or IFRS for the computation of thin capitalization of firms. It was argued in light of rules of thin capitalization, it was pointed by Institute of Chartered Accountants in Australia that a significant amount of time would be required for assuring that reporting entire would not be worse off compared to the situation before the adoption of international standard (Beattie 2014).
The adoption of IFES would have listed below consequences and they are as follows:
- Under the GAAP provisions, there is no recognition of liabilities and assets unlike the adoption of IFRS would make it mandatory to record such liabilities and assets resulting from the fair value accounting treatment. The introduction of fair value accounting under IFRS would change the accounting treatment of certain liabilities sand assets (Coad et al. 2016).
- On the date of presenting the balance sheet, a higher amount of liabilities and assets are required to be reporting and disclosed by entities under the provisions that are laid down under IFRS. It can be explained with the help of an example that any amount of unrealized loss resulting from derivative instruments will be treated as liabilities and this would impact the computation of thin capitalization and influencing relevantly the net amount of assets reported on the balance sheet.
- The overall net position of reporting entity might be reduced as under the IGRS provisions, it is required by entities to account for the volatilities resulting from some external factors. Such impacts of volatility were not accounted for under the GAAP provisions (Otley 2016).
Reporting entities adopting the IFRS have the main concern about their solvency position as the provisions under such standard would lead to increasing value of debt to capital ratios. Values will increase to such extent that in order to seek external funding, it would be required by companies to have a debt limit of 75%. There is a significant increase in possibility of widening the debt limit ranges if prior to the adoption of IFRS, the range of debt to capital ratios is 60%-75%. Regarding the debt to capital ratios, 75% of assets value of operations of companies that is net off investment and liabilities that are not bearing interest are made by associates (Mellen 2018). The firms intending to cross the limit as identified in the safe harbour would have the consequence of disallowance of statute and payment of interest on debt value. Recapitalisation programs were undertaken by Australian companies in order to avoid bearing the consequence of exceeding the debt limit and where the debt limit under such programs are maintained within the range of 50%-75% of the Australian group. Reporting entities are able to achieve this limit of safe harbour by adjusting the assets net of revaluations and incorporation of debt in the corporate group of Australia. The compliance within the provision of thin capitalization of Australian firms is also expected to be influenced with the introduction of IFRS by making changes in the elements of balance sheets (Balakrishnan et al. 2016).
Quantitative Analysis of Changes in Thin Capitalization Position Due to Adoption of International Financial Reporting Standard
Implementation of IFRS and GAAP have substantial amount of differences in the accounting treatment. The thin capitalization position of Australian firms is influenced in a significant way by the flow of impacts brought about by the variations due to the adoption of such standard. The thin capitalization position is impacted in terms of measurement, classification and recognition of liabilities, assets, goodwill, assets impairment and equities. The reason attributable to changes in the values of such financial elements is that debt capital, liabilities, assets and equities value are treated by complying with the accounting standard. In respect of the application of provisions of thin capital, the IFRS provisions would have a significant impact in relation to accounting standard such as AASB 138 Intangible assets, AASB 112 Income Taxes, AASB 139 Financial Instruments in relation to and AASB 132 Financial Instruments in relation to disclosure and presentation (Chen et al. 2016).
It is assumed that there would be industry specific impacts due to provisions of IFRS on thin capitalization position. In light of adoption of AASB 139: Financial Statements: Measurement and Recognition, it is ensured by reporting entity that there is adequate recognition of all financial instruments of assets and liabilities at fair value in the balance sheet along with items available for sale on investment. Such financial instruments re not recognized in the balance sheet under the IFRS provisions. The changed provisions as per the IFRS would have substantial impact on valuations of such assets. Such changes in valuation would have ultimate impact on provisions of thin capitalization of reporting entities. In addition to this, the temporary differences in the deferred tax balances according to the provisions of the AASB 112 Income taxes (Conaway et al. 2016). This facilitates the comparison between the tax base of liabilities and assets. In event of fair value adjustments and revaluation of assets, organization is required to make the recognition of deferred tax liabilities and deferred tax assets. Some of the considerable amount of financial instruments provisions of the AASB 132 significant is classified as debt rather than equity. Any intangible assets that is internally generated by organization such as customer lists, goodwill, brands, mastheads and any other items of similar nature are not recognized and recorded according to provisions of the AASB 138. In event of reporting entities shaving large amount of intangible assets recorded in the statement of financial position leads to great valuation in the present value of assets. Such treatment would have impact on the provisions of thin capitalization for the purpose of capitalization.
Industry Specific Impacts of International Financial Reporting Standards on Thin Capitalization Position of Reporting Entities
In order to evaluate the impact of adoption of the IFRS on thinly capitalized companies, the research work is conducted by choosing a sample of 105 of non-AID, top non-financial and non insurance companies listed on stock exchange. It is crucial to identify the impact of standard on thinly Capitalized Company in light of rules of capitalization as it is relevant to entities that finance its assets by relying on higher level of debt compared to equity financing. The objective of company relying on debt for financing their purchase or assets is attributable to the fact of taking advantage in terms of tax deductibility of payment of interest that are permitted for Australian companies. It is stated by treasury that adoption of such standard does not requires making the valuation of financial elements involved in the process of thin capitalization. It is viewed by the treasury analysis that there would be transparency, comprehensiveness and objectivity in the reporting process due to the adoption of IFRS. It is the multinational companies that are subjected to the rules of thin capitalization that intend to adopt IFRS for taking the benefits of rules of thin capitalization (Cooper 2015).
Furthermore, it can be seen that there is a development of proxy measure in relation to safe harbour resulting from considerable increase in interest bearing liabilities due to the adoption of standard. Under the GAAP provisions, such proxy measure of debt is at the mean value of 37.98% lead to increase by value 13.19% to a value of 42.99% resulting from the adoption of IFRS. This particular example is an illustrative of the fact that thin capitalization position of reporting entities are considerably impacted by the adoption of standard. Furthermore, such changes have further significant impact on policies of companies. The adoption if fair value accounting is one of the important implications of policy in relation to adoption of the standard. After the adoption of IFRS, significant amount of changes have been witnesses in respect of the provisions of liabilities and assets. The valuation of liabilities, equities and assets is impacted due to involvement of high amount of assumptions on part of management as a part of valuation methodology (Henderson et al. 2015). This has the implication in terms of inherent uncertainty that is present in such financial assets and liabilities valuation under fair accounting provisions. Such process of recognition and measurement would have impact on the provisions of thin capitalization of reporting entities.
Conclusion
Another implication of policy is related to the compliance cost of thin capitalization. There can be considerable increase in the cost of compliance under the provisions of IFRS as independent verification of the revalued assets are required to be conducted by companies under the assessment of fair value of liabilities and assets under IFRS provisions. Since the adoption of standard leads to increasing the alignment between the accounting standard and provisions of taxation, there is reduction in stakeholder uncertainty. Such uncertainty reduction has ultimate impact on increasing the consistency and reducing the cost of compliance (Turton 2017). Nonetheless, there can be significant increase in compliance cost due to variation in capitalisation position depending upon the position of measurement of fair value.
Conclusion:
In this particular assignment, research is conducted for determining the impact of thin capitalization of firms resulting from the adoption of IFRS. Concerning this, the adoption of IFRS on selected sample of 105 Australian listed companies have been quantified in relation to interest bearing liabilities and computing the debt amount range as safe harbour. It can be inferred from the analysis presented above that there can be over time decline in the thin compliance cost resulting from the adoption of IFRS and its ultimate impact on the accounting standard and convergence of tax. The provisions under IFRS in terms of adoption of fair value accounting have the implications in terms of reducing compliance cost and thin capitalization position of firms. In addition to this, the provision of thin capitalization as introduced by the IFRS is likely to facilitate the comparisons between the thin capitalization positions of firms across several jurisdictions. It can also be inferred from the discussion above in relation to the adoption of standard that there are considerable amount of policy implications that would significantly impact the process of capitalization and its associated costs.
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