Accounting Regime Change on Financial Statements: Ghana (Part II)

Impact of Accounting Regime Change on Financial Statements: Ghana Switches from GNAS to IFRS (Part II)

In the last edition (see BF&T 8^th August 2011) the first part of this article was published. An attempt was made to discuss material accounting regime change effects on the financial statements of Ghanaian listed companies following the switch from Ghana National Accounting Standards to the International Financial Reporting Standards (IFRS). In this week’s edition, I extend this discussion by looking at the impact of accounting regime change on biological assets, income taxes particularly accounting for deferred taxes and accounting for financial instruments.

IFRS Impacts Biological Assets Recognition and Measurement

Until the adoption of IFRS, the Ghana National Accounting Standards did not have detailed guidance on the recognition and measurement of Biological Assets. In fact, just like any other fixed assets, biological assets were recognized and subsequently depreciated. Unlike GNAS, IAS 41, Accounting for Agriculture sets forth the Recognition and Measurement criteria of Biological Assets. For the sake of clarity, I explain what this standard is all about. This standard details how companies that engage in agricultural activities measure their assets. Companies in industries like the cultivation of farm produce eg. Timber, Palm trees, Sugar Cane, Dairy products, Wine production, Meat production etc. Forexample, Benso Oil Palm and Unilever are the two companies that have significant assets in the form of Palm trees. These palm trees by their nature are non-current assets but of a different characteristic as they are living things and will continue to grow and therefore it will be wrong to classify them as Property Plant and Equipment. The standard provides that, companies  should measure them at fair value and any resulting changes in fair values less estimated cost at the point of sale be recognized into the statement of comprehensive income. Contrary to this treatment, GNAS allowed companies to depreciate them just like any other non-current asset. Upon transition to IFRS, Unilever as one of the early adopters of IFRS, recognized as reversal of previously depreciated biological assets amounting to Gh¢ 1,111,000 in earnings. This reversal accounted for 4.2% of gross profit in 2006.  I show in the table below, the materiality of Biological Assets on the financial statement of two listed Companies on the Ghana Stock Exchange.

Size of Biological Assets on the Statement of Financial Position
All Amounts in Thousand Gh¢	2006	2007	2008	2009	2010
Benso Oil Plantation-Biological Assets	8,622	9,011	9,489	10,751	11,700
Benso Oil Plantation-Total Non-Currents  Assets	28702	28952	29077	31390	31702
Biological Assets as % of Total Non-Current Assets	30%	31%	33%	34%	37%
Unilever-Biological Assets	15,941	17,151	18,248	20,259	10,131
Unilever-Total Non-Currents  Assets	49,319	51,883	55,049	55,590	46,821
Biological Assets as % of Total Non-Current Assets	32%	33%	33%	36%	22%
Source: Company Statements, Own Calculations

Accounting for on average c32% annually, Biological Assets could have a material impact on the financial statements depending on the recognition approach used. In the case of GNAS, these would have been merely depreciated resulting in a reduction in earnings once the depreciation expense in recognized. In the case of IFRS, biological assets are neither depreciated nor amortized, but rather reviewed for impairments when necessary. Users of financial statements should note that fair value remeasurements of these assets could boost earnings significantly. I show in the table below the impact of fair value remeasurements of biological assets in earnings.

Materiality of Fair Remeasurement of Biological Assets in Earnings
All Amounts in Thousand Gh¢	2006		2007	2008	2009	2010
Unilever						AD
Fair Value Gains from Biological Assets	-		1,111	111	1,346	AD
Gross Profit	26,237		28,664	41,421	23,803	AD
Fair Value Gains from Biological Assets as % Gross Profit	0		3.88%	0.27%	5.65%	AD
Benso Oil Planation	2006		2007	2008	2009	2010
Fair Value Gains from Biological Assets		1,996	2,605	5,548	2,035	3,602
Gross Profit		650	44	69	824	346
Fair Value Gains from Biological Assets as % Gross Profit		33%	2%	1%	40%	10%
Source: Company Annual Report, own Calculations.  AD= Unavailable Data

IFRS Impacts Accounting for Income Taxes

Accounting for income taxes is another very complicated area most accountants struggle to cope with most especially dealing with different accounting rules as these rules determine how much taxes are payable. Upon the adoption of IFRS, most companies recorded significant movements in deferred taxes.  The reason for this upsurge in deferred taxes is due to the fact that under IFRS, deferred taxes are recognized for every temporary difference. However, GNAS only allowed for deferred taxes relating to timing differences on items relating to depreciation. I show in the table below the impact of deferred taxes in aggregate and income taxes in aggregate. Although there were early adopters of IFRS, in general, the movements of deferred taxes were larger between 2007 and 2008 when most companies officially adopted IFRS.

Figure 1: Deferred Taxes Versus Income Taxes. Data Source: Thomson DataStream, Own Calculations

Banks take a strong impact following accounting change

The switch from IFRS to GNAS had a significant impact on the financial statements of most bank listed companies. To illustrate the significance of this switch, I show excerpts of the financial statement reconciliations of HFC Bank. Bottom-line profits after adjustments from GNAS to IFRS showed a decline of c35%, for HFC Bank, c18% for CalBank, and c2.2% for UT Bank. Whilst some banks also recorded significant gains from these transition effect adjustments. This group includes, Ghana Commercial Bank, c30%, Standard Chartered Bank c11% and Eco Bank c1.32%

Excerpts from HFC Bank Ghana: Reconciliation of Profit Under GNAS to IFRS 2008
	GNAS 2007 Gh¢	Effect of IFRS Transition  Gh¢	2007 IFRS Gh¢	Effect of Transition as a % of GNAS
	GAS		IFRS
Interest income	22,951,258	184,108	23,135,366	1%
Interest expense	(10,957,924)	0	(10,957,924)
Net interest income	11,993,334	184,108	12,177,442	2%
Net fee and commission income	2,594,675	(1,821,447)	773,228	-70%
Other operating income	35,181	0	35,181
Other income	113,696	0	113,696
Operating income	14,736,886	(1,637,339)	13,099,547	-11%
Impairment charge for credit losses	(1,528,121)	311,195	(1,216,926)	-20%
Operating expenses	(8,833,473)	(156,614)	(8,990,087)	2%
Profit before tax	4,375,292	(1,482,758)	2,892,534	-34%
Tax	(1,169,175)	354,647	(814,528)	-30%
Profit after tax	3,206,117	(1,128,111)	2,078,006	-35%
Source: HFC Annual Report 2008, Own Calculations

On Aggregate, these transition effects have been largely felt by all Banks listed on the GSE. These transition effects came as a result of difference in measurement and recognition rules under IFRS and GNAS. Some of these differences are based on the principle of fair value accounting (I shall deal with this in future editions), recognition of commission income, valuation of Government securities, and valuation of staff loans. The most significant of them was the issue of commission income. Under IFRS, commitment fees that are an integral part of interest are spread over the tenor of the facility. This is not the case under GNAS hence resulting in huge transition effects for some companies and immaterial for others. I show in the table below, the transition effects on Net fee and commission income.

Impact of Accounting Change on Commission and Fees income recognition
(All amounts in thousands Gh¢)	GNAS	Transition Effect	IFRS	Transition Effect as % of GNAS
HFC	2,594	(1,821)	773	-70%
Eco Bank	20,336	(565)	19,771	-3%
CalBank	4,415	(458)	3,957	-10%
Standard Chartered Bank	21,695	(3,044)	18,651	-14%
UT Bank	601	(450)	151	-75%
The Trust Bank	5,292	(415)	4,877	-8%
Ghana Commercial Bank	36,471	(518)	35,953	-1%
Source: Company Annual Reports, Own Calculations

Overall Impact on profit

Gauging the impact of an accounting regime change is no mean task as uniformity in the presentation of financial statements differs from company to company and from year-to-year. A look at the profit numbers after the accounting change indicate that whereas UT Bank recorded accounting change impact adjustments up to 60% of operating income, Ghana Commercial Bank recorded 30% accounting change adjustments as a percentage of profit after taxes.

Evidently, these accounting transition effect impacts going forward will not recur as we have now agreed, in principle that, IFRS will provide users of financial statements with high quality accounting information. The key point to achieving this however is to strengthen the enforcement rules and to provide more guidance to the understanding and application of IFRS.