International Financial Reporting Standards in Russia

Interview with Leonid Schneidmant

The government’s plans to introduce International Financial Reporting Standards (FRS) in Russia in 2000 were never realized. What are the chances that the transition to FRS will take place by 2005?

This timeframe definitely appears to be more realistic. While it’s relatively simple to change the rules and standards, these rules must actually be put into practice and accountants and users should have the chance to study and understand them. Finally, there should be a system for monitoring the level of adherence [to the new rules]. And, all of this together presents a task on a considerably larger scale. At the same time, I don’t agree with the claim that the first stage of reforms didn’t bring any results. First of all, a number of fundamentally new concepts were borrowed from IAS and introduced into Russian Accounting Rules. For instance, such concepts as «related parties», «goodwill», «segment information» and «contingent liabilities». Secondly, Russia won recognition among the international professional community, and a representative from Russia now sits on the LFRSC. Third, the Institute of Professional Accountants of Russia was founded, and become a member of International Federation of Accountants

and it’s difficult to overestimate the positive role that this professional association has played in transforming the field of accounting. Fourth, more and more companies are intentionally switching over to IAS. Before 1998 switching over to IAS was merely a way of showing that a company was up with the latest business trends, it was just a symbol of success – like buying the latest model Mercedes. Fifth, Russian universities have started to include IAS as a separate discipline in their curriculum. Wouldn’t you call these real results? But, for sure, one always wants to achieve more.

What are the conceptual differences between IAS and Russian Accounting Rules (RAR)?

RAR represent a system of instructions on specific issues, whereas IAS merely set the requirements and principles for financial reporting, which individual accountants must implement using their own professional judgment. Under IAS, economic substance prevails over form. The substance of a transaction is what’s important, not the type of contract it was carried out under. Take, for instance, a lease agreement. If it is drawn up so that all relevant risks and benefits remain with the lessee, then according to IAS the subject of the lease will be recorded in the latter’s reports (although the lessor retains the right of ownership as before).

There are also differences concerning the volume of disclosed information. Although significant steps forward have been made in Russian Accounting Rules, given that they now require disclosure of a volume of information that simply would have been impossible to imagine just a few years ago. Nonetheless, it is still not quite the volume that is required under IAS.

But, don’t you think that the forced introduction of IAS will only give rise to new problems?

The transition to IAS is a worldwide trend. Sticking to old standards simply means that one is swimming against the current. If Russia has resolved to build a Western-type economy, then it should strive to conform to the standards of such an economic model. And, that includes accounting practices.

I’m confident that it won’t take Russia long to «catch up» with the West and that the country will soon emerge as a strong player. However, this will happen only if Russian accountants are diligent students. At the turn of the 19th and 20th centuries, the Russian school of accounting was one of the world’s strongest. This gives us reason to expect that, instead of being an outsider, Russia is capable of becoming a leader in this field.

Internal Russia-specific factors aside, there are also external factors that hinder Russia’s transition to IAS. Take, for instance, the unresolved issue of whether IAS should be recognized on an equal footing with US GAAP in international capital markets…

The less-then-complete recognition of IAS in the United States is no reason to justify a go-slow approach to adopting IAS in Russia. The differences between IAS and US GAAP cannot possibly be compared with the differences between Russian Accounting Rules and IAS. In the first case, the distinction lies in particular issues, rather than in fundamental principles and concepts. This allows for a relatively easy transition from IAS accounts to US GAAP accounts. But, transitioning from Russian accounting reports into IAS accounts is a significantly more complex process. Besides, a whole series of special measures are now being taken to secure the recognition of IAS in the US market. And, we can already see definite progress in this area.

Will the transition to IAS encourage an influx of investment?

Yes and no. It will, because investors will be able to receive information that will help them to assess the object of a potential investment. Consequently, investment risks will go down, while trust in Russian management will grow. But, on the other hand, it will not, since accounting is not the sole issue here. Yes, the quality of a company’s financial statements tends to attract investment, but is not the crucial factor. The transition to IAS will not bring any downpour of golden rain in its wake. There are things that are more important for creating a favorable investment climate.

How will Russian companies benefit from switching to IAS?

This is probably the most complicated question of all. At first glance, it appears that IAS will primarily facilitate a company’s entry into global financial markets. Nevertheless, most Russian enterprises are anticipating quite another benefit. The application of IAS gives managers access to information that can be used to significantly enhance management effectiveness, and enables them to have a knowledgeable dialogue with shareholders and the marketplace, as well as enhance corporate transparency, strengthen corporate governance, and, consequently, bolster trust in management. Aside from this, using IAS helps to improve the overall business climate in the country and strengthens a businessperson’s sense of confidence.

How can companies adapt IAS with minimum losses?

First and foremost, companies should not be forced to undergo the transition process overnight. This would only cause anxiety among accountants and nothing good would come out of it. Secondly, IAS should be adapted to the Russian economic environment. Thirdly, demand for IAS information should be stimulated. The process will become much less painful when managers and Russia’s investment community understand the advantages that IAS can bring them. Furthermore, it may be apropos here to recall the once popular in the Soviet Union slogan: one must learn, learn and learn some more. And, we should begin not with the specific rules themselves, but by first studying the fundamental philosophy on which they are based.

Russian accounting may differ from that required by IAS because of the absence of specific Russian rules on recognition and measurement in the following areas:

• the classification of business combinations between acquisitions and unitings of interest: IAS 22.8
• provisions in the context of business combinations accounted for as acquisitions: IAS 22.31
• consolidation of special purpose entities: SIC 12
• the restatement of financial statements of a company reporting in the currency of a hyperinflationary economy in terms of the measuring unit current at the balance sheet date: IAS 29.8
• the translation of the financial statements of hyperinflationary subsidiaries: IAS 21.36
• the treatment of accumulated deferred exchange differences on disposal of a foreign entity: IAS 21.37
• impairment of assets: IAS 36
• derecognition of financial assets: IAS 39.35
• the recognition of operating lease incentives: IAS 17.25; SIC 15
• accounting for defined benefit pension plans and some other types of employee benefits: IAS 19.52
• accounting for deferred tax: IAS 12
• accounting for an issuer’s financial instruments: IAS 32.18/23
• hedge accounting for derivatives: IAS 39.142
• the treatment of exchange differences resulting from severe devaluation or depreciation of a currency: IAS 21.21; SIC 11
• recognition of a decline, other than temporary, in the carrying amount of long-term investments, other than marketable equity securities: IAS 25.23

There are no specific rules requiring disclosures of:

• a primary statement of changes in equity: IAS 1.7
• a primary statement of cash flows; and the notion and definition of cash equivalents, and detailed guidance on the preparation of cash flow statements: IAS 7
• the FIFO or current cost of inventories valued on the LIFO basis: IAS 2.36
• the fair values of financial assets and liabilities: IAS 32.77
• the fair values of investment properties: IAS 40.69
• related parties information except by certain reporting companies with specific legal form (joint stock companies); the definition of a related party is a narrower one, based on legislation: IAS 24.1-4
• discontinuing operations: IAS 35
• certain segment information (e.g. a reconciliation between the information by reportable segment and the aggregated information in financial statements, significant non-cash expenses, other than depreciation and amortization, that were included in segment expense and, therefore, deducted in measuring segment result – for each reportable segment): IAS 14.61/67

There are inconsistencies between Russian and IAS rules that could lead to differences for many enterprises in certain areas. Under Russian rules:

• research costs can be capitalized under certain conditions: IAS 38.42/51
• goodwill is calculated by reference to the book values of acquired net assets: IAS 22.40
• proportionate consolidation may be used for subsidiaries in which the parent has 50 per cent or less of the voting power: IAS 27.15
• revaluation of property, plant and equipment is allowed but gives different results than IAS and need not be kept up-to-date: IAS 16.29
• the useful life of property, plant and equipment is usually determined using periods prescribed by government for tax purposes which are longer than those for which the assets are expected to be used: IAS 16.6/41
• if investment properties are revalued, they are still depreciated: IAS 40.27
• if investment properties are revalued, the gains and losses are not required to be taken to the income statement: IAS 40.28
• finance leases are generally defined in legal terms and capitalization is allowed but not required: IAS 17.3/12.28
• lessors recognize finance lease income differently: IAS 17.30
• the completed contract method can be used for the recognition of revenues on construction contracts when the outcome of a construction contract can be estimated reliably: IAS 11.22
• trading, available-for-sale and derivative financial assets are not recognized at fair value: IAS 39.69
• trading and derivative liabilities are not recognized at fair value: IAS 39.93
• provisions can be established more widely or less widely than under IAS, and there is no requirement for discounting: IAS 37.14/45
• own (treasury) shares are shown as assets: SIC 16
• classification of cash flows between investing and financing activities in the cash flow statement may be different from IAS: IAS 7.6/16/17
• cash flow statements reconcile to cash rather than to cash and cash equivalents: IAS 7.45
• the correction of fundamental errors is included in the determination of the net profit or loss for the reporting period, but separate disclosure and pro-forma restated comparative information are not required: IAS 8.34/38
• revenue recognition rules do not differentiate between exchanges of goods of similar nature and value and exchanges of dissimilar goods, and do not discuss adjustment for the amount of cash or cash equivalents transferred in exchanges for dissimilar goods: IAS 18.12; IAS 16.21/22
• the definition of extraordinary items is broader: IAS 8.6/12

In certain enterprises, these other issues could lead to differences from IAS:

• some parent companies do not prepare consolidated financial statements: IAS 27.7/11
• in the definition of control, the ability to govern decision-making is not required to be accompanied by the objective of obtaining benefits from the entity’s activities: IAS 27.6
• investments in certain securities held for the short term are not required to be carried at the lower of cost and market value or at market value: IAS 25.19/23
• certain subsidiaries may be excluded from consolidation beyond those referred to in IAS: IAS 27.13
• a subsidiary that is a bank may be excluded from consolidation if it is dissimilar from the rest of the group: IAS 27.14
• certain set-up costs that have been paid by a company’s founder can be capitalized: IAS 38.57
• internally generated brands and similar items can be capitalized if the enterprise has an exclusive legal right: IAS 38.51
• inventories are generally carried at cost rather than at the lower of cost and net realizable value; this is often not an important difference because of inflation: IAS 2.6
• the realizable value of inventories can be measured without deduction of selling costs: IAS 2.6
• certain overheads in addition to those related to production can be capitalized: IAS 2.7

Leonid Schneidman, Partner of PricewaterhouseCoopers and Head of the Audit and Accounting Methodology Department. This interview has been reprinted from the RBCC Bulletin (№2, 2002) with the permission of PricewaterhouseCoopers.