Key Principles of International Financial Reporting Standards

Why This Matters

When you're analyzing financial statements, you're not just reading numbers—you're interpreting information that's been shaped by specific accounting standards. IFRS provides the rulebook that determines how companies recognize revenue, when they record assets and liabilities, and what they must disclose. Understanding these standards isn't optional; it's the foundation for comparing companies across industries and borders, spotting red flags in financial reporting, and making informed investment decisions.

You're being tested on your ability to apply these standards analytically, not just define them. Examiners want to see that you understand the underlying principles—concepts like substance over form, matching, prudence, and faithful representation. Each standard below illustrates one or more of these principles in action. Don't just memorize the standard numbers; know what problem each standard solves and how it affects the financial statements you'll be analyzing.

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Recognition and Measurement Foundations

These standards establish the core rules for when items appear on financial statements and how they're initially valued. They answer the fundamental question: what qualifies as an asset, liability, or expense?

IAS 1: Presentation of Financial Statements

• Framework for all financial reporting—establishes the structure, content, and minimum requirements for a complete set of financial statements
• Complete statement package includes statement of financial position, profit or loss, changes in equity, cash flows, and notes with accounting policies
• Materiality principle guides what to aggregate or present separately—information is material if omitting it could influence economic decisions

IAS 2: Inventories

• Lower of cost and net realizable value (NRV)—this conservative measurement basis prevents overstating assets on the balance sheet
• Cost determination methods permitted include FIFO and weighted average cost; notably, LIFO is prohibited under IFRS
• Write-downs to NRV must be disclosed, signaling potential obsolescence or market decline to analysts reviewing inventory quality

IAS 12: Income Taxes

• Balance sheet approach drives deferred tax accounting—focus on temporary differences between carrying amounts and tax bases
• Deferred tax assets and liabilities arise from timing differences that will reverse in future periods, affecting future cash flows
• Effective tax rate reconciliation disclosure helps analysts identify non-recurring items and assess sustainable tax positions

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Long-Term Asset Accounting

These standards govern assets that provide economic benefits over multiple periods. The key analytical concept is matching—spreading costs over the periods that benefit from the asset's use.

IAS 16: Property, Plant and Equipment

• Initial recognition at cost includes purchase price plus directly attributable costs to bring the asset to working condition
• Subsequent measurement uses cost model (cost less accumulated depreciation and impairment) or revaluation model with fair value updates
• Component depreciation required when parts have different useful lives—affects depreciation expense and replacement timing analysis

IAS 38: Intangible Assets

• Three recognition criteria—identifiability, control over the resource, and probable future economic benefits must all be met
• Research vs. development distinction is critical: research costs are expensed, while development costs meeting specific criteria are capitalized
• Indefinite-life intangibles (like certain brands) aren't amortized but require annual impairment testing under IAS 36

IAS 36: Impairment of Assets

• Recoverable amount test compares carrying value to the higher of fair value less costs of disposal and value in use
• Impairment indicators trigger testing—includes market decline, obsolescence, physical damage, or worse-than-expected performance
• Goodwill impairment cannot be reversed once recognized, making acquisition analysis and CGU allocation crucial for analysts

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Revenue and Contract Accounting

Modern revenue standards shift focus from risks and rewards to control transfer—a fundamental change that affects when companies can book revenue and how they must disclose contract details.

IFRS 15: Revenue from Contracts with Customers

• Five-step model structures all revenue recognition: identify contract → identify performance obligations → determine transaction price → allocate price → recognize when satisfied
• Control transfer replaces risks-and-rewards approach—revenue recognized when customer can direct use of and obtain benefits from the asset
• Variable consideration must be estimated and constrained to amounts highly probable of not reversing, affecting reported revenue timing

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Liabilities and Obligations

These standards determine when and how companies must recognize obligations—both certain liabilities and uncertain future commitments. The analytical focus is on completeness of liability recognition.

IFRS 16: Leases

• Single lessee model brings most leases onto the balance sheet—no more distinguishing operating from finance leases for lessees
• Right-of-use asset and lease liability recognized at present value of future payments for leases exceeding 12 months
• Front-loaded expense pattern results because interest expense is higher in early years while depreciation remains straight-line

IAS 37: Provisions, Contingent Liabilities and Contingent Assets

• Recognition threshold requires present obligation, probable outflow, and reliable estimate—all three conditions must be met
• Contingent liabilities are disclosed but not recognized when outflow is possible but not probable, or amount cannot be measured reliably
• Best estimate measurement uses expected value for large populations of items or most likely outcome for single obligations

IFRS 9: Financial Instruments

• Classification drives measurement—financial assets classified by business model (hold to collect, hold to collect and sell, or other) and cash flow characteristics
• Expected credit loss (ECL) model requires forward-looking impairment recognition, replacing the old incurred loss approach
• Three-stage impairment model escalates from 12-month ECL to lifetime ECL as credit quality deteriorates, accelerating loss recognition

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Quick Reference Table

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Self-Check Questions

1. Which two standards both require impairment testing but apply to fundamentally different asset types? What triggers testing under each?

2. Compare the recognition criteria for a provision under IAS 37 with the recognition of a lease liability under IFRS 16. Why might one appear on the balance sheet when the other doesn't?

3. A company capitalizes development costs under IAS 38 but expenses similar research costs. What principle explains this difference, and how would you verify the treatment is appropriate?

4. IFRS 15 replaced the risks-and-rewards approach with control transfer. For a software company selling licenses with ongoing support, how might this change affect revenue timing compared to legacy standards?

5. If an FRQ asks you to assess a company's "true" leverage position, which standards would you examine beyond traditional debt, and what adjustments might be necessary for meaningful peer comparison?