18 March 2013

IASB/Hoogervorst: IFRS and Indonesian Accounting Standards 2013 and beyond

On 6 March, IASB Chairman Hans Hoogervorst delivered a speech at the IAI-AFA International Seminar in Jakarta, Indonesia. According to Hoogervorst, full adoption of IFRS can really help Indonesia to sustain its economic development.

Mr Hoogervorst explained how Indonesia can benefit from IFRS and how IFRS is close to becoming the global language of financial reporting.

It is important to understand that the full benefits of using the IFRS-brand can only be enjoyed if it is adopted fully. For foreign investors it is very difficult for investors to discern small differences from big ones. If a jurisdiction cannot state that it has fully adopted IFRS, investors are likely to think that the differences are much bigger than they really are. Mr. Hoogervorst warned: “If you have gone through all the trouble to adopt 95 per cent of IFRSs, please make sure you also do the last 5 per cent. Otherwise, you have all the pain of transition without the full gain of international recognition of that achievement.”

Almost all jurisdictions that adopt IFRS experience some challenges with adjusting domestic accounting practices to IFRS. That is to be expected. Often these problems can be resolved, sometimes it is more difficult, such as is the case with the issue of land rights in Indonesia.

Most jurisdictions have concluded that the credibility bonus of full adoption of IFRS outweighs the temptation to tinker with the standard to address local problems. Chances are that other jurisdictions are also having the same problems, so it is much better that they work together, to fix the problem centrally so that all IFRS adopters can benefit from such improvements.

Mr Hoogervorst went on to describe IASB's current work programme as well as IASB's plans for the future:

IASB's main priority is to complete the remaining elements of convergence projects with the FASB. They have four major projects awaiting completion. Mr Hoogervorst introduced two areas (Revenue Recognition, Leasing) where they were able to stay completely converged with the United States.

Regarding financial instruments, Mr Hoogervorst looked at the three phases.

Phase I: Classification and Measurement

The IASB and FASB started from two completely different perspectives. The FASB initially favoured a full fair value approach while the IASB chose mixed measurement. In early 2012 the IASB and the FASB jointly agreed on amendments to their respective models. For IFRS 9 these included clarifying the amortised cost business model and introducing a Fair Value through Other Comprehensive Income measurement category. At the same time, the FASB has moved to a mixed measurement approach which is very similar to IASB's.

Phase II: Impairment

The most challenging part of the revision of IAS 39 has turned out to be impairment. Currently, both IFRS and US GAAP use incurred loss impairment models. Many have voiced concerns that these models result in loan losses being recognised too little and too late. Both boards concluded they had to replace the incurred loss model by an expected loss model. After several false starts, they will publish their third and hopefully final Exposure Draft in the next few days. They believe their new expected loss model will result in more timely recognition of credit losses. Banks will be required to create a loss allowance for all loans based on a 12-month probability of default. If the credit quality of a loan has significantly deteriorated, banks will have to recognise the full expected lifetime loss. IASB's new model is a simplified version of an approach it had developed jointly with the FASB. In July last year, the FASB decided to develop its own model which requires entities recognise full lifetime expected losses on initial recognition of the related assets. In the coming months, both boards will receive feedback on their respective models.

Phase III: Hedge Accounting

The IASB had received feedback that the hedge accounting requirements in IAS 39 were seen as arbitrary, rules-based and detached from risk management. The IASB therefore proposed a fundamental overhaul of hedge accounting requirements to better reflect risk management activities. Also, the IASB wanted to make hedge accounting more accessible for non-financial institutions. The IASB is almost ready to publish the final standard which it believes to be a vast improvement over current practice.

Regarding Insurance project, Mr Hoogervorst mentioned that at this time, the IASB does not have a proper IFRS for insurance and the American standard is in need of updating. As a result, there is huge diversity and complexity in how insurance companies report their numbers under IFRSs. Investors often talk about insurance accounting being a ‘black box’. This lack of transparency comes with a corresponding risk premium, which can lead to insurance companies trading at a discount to their peers in other areas of financial services.

The project is challenging because different financial reporting practices have become embedded in different parts of the world. Many insurance companies are using out-dated assumptions in their measurement. This is particularly concerning because it is very likely that insurance companies are likely to be suffering in the current low-interest environment. Without a proper standard, investors cannot see properly how big these financial risks are.

The IASB has been working with the FASB to develop a model that lifts financial reporting for insurance contracts to a common and improved level. The IASB´s standards will not be completely converged, but they will both be based on current measurement. As a result they will vastly improve transparency in the insurance industry. An exposure draft is targeted in the first half of this year.

Press release

Full speech

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