Overview of IFRS for Micro Finance Reporting Discussion July 2009

FSWG – MFRSI Overview of IFRS in Microfinance Reporting page 1

IFRS and IAS in Microfinance Reporting

IFRS Scope and Applicability:

When applied, IFRS compliance is generally relevant to:

• Publicly traded companies, and

• Organizations and companies that are considered to be “publicly accountable” e.g.

banks, insurance companies, etc.

Microfinance institutions – whether regulated or not – are financial service providers that

finance operations with deposits, investments or donations of public and private funds. Their

dual purpose mission addresses social performance and financial sustainability.

Question: Should MFIs – specifically unregulated MFIs and NGO registered MFIs – be subject to

IFRS reporting standards?

Although the reporting requirements may be considered onerous, the changing context, role

and investment opportunities of MFIs do increase their “public accountability.” Is there validity

in encouraging IFRS compliance as a “best practice” in the sector.

IFRS for Small and Medium Enterprises: The draft of IFRS for SME’s was in draft form from early 2007 to July 2009. It is intended to apply

to privately owned entities and firms. The standards applicable to SME’s – proposed in the draft

– are not as complex, and more straightforward. However, the concepts are based on the

overall Framework for IFRS and IAS

Question: Is it reasonable to expect the final IFRS for SMEs shortly? Is there validity in exploring

these standards for unregulated or NGO registered MFIs?

List of International Financial Reporting Standards – Relevance

to Microfinance Discussion

List of International Financial Reporting Standards

IFRS Standard

Number

Standard Application to Microfinance

IFRS 1 First-time Adoption of

International Financial Reporting

Standards

Applicable. If an MFI changes from GAAP

(or other accounting standards) to IFRS

accounting, the change must be fully

disclosed in the notes; and implications to

the financial statements should be

highlighted and elaborated.

Previous year audited financial statements

must be re-stated for the new policies for


IFRS Standard

Number


comparative purposes.

All changes made at transition must be

disclosed and reported on as

appropriately including recognition of

assets and liabilities, de-recognition of

assets and liabilities not allowed,

reclassification, measurement and

mandatory and voluntary exceptions.

Previously recorded business

combinations may need to be restated

and reviewed. All adjustments to the

Statement of Financial Position must be

made to retained earnings or other

appropriate category of equity.

IFRS 2 Shared-based Payment Applicable but not very likely. If an MFI

entity receives goods or services in return

for the issue of its own shares or equity

instruments it accounts for the fair value

of those goods or services as an expense

or as an asset. The concept of share-based

payments is broader than employee share

options, and includes share appreciation

rights, employee share purchase plans,

employee share ownership plans, share

option plans and plans where the issuance

of shares (or rights to shares) may depend

on market or non-market related

conditions.

It is recognised as an expense over the

vesting period. Goods and services in a

share-based payment transaction are

recognised when goods are received or as

services are rendered at fair value (other

methods may be applied if fair value is not

available). A corresponding increase in

equity is recognised if goods and services

were received in an equity-settled share-

based payment transaction or a liability if

these were acquired in a cash-settled

share-based payment transaction.

IFRS 3 Business Combinations Applicable but not very likely. An MFI that


IFRS Standard

Number


acquires or purchases another entity it is

considered a business combination or

event in which an acquirer obtains control

of one or more businesses. A business is

defined as an integrated set of activities

and assets that is capable of being

conducted and managed for the purpose

of providing a return directly to investors

or other owners, members or participants.

This standard does not apply to the

formation of a joint venture, combinations

of entities or businesses under common

control.

The Standard outlines guidelines on the

assessment, valuation and measurement

of the separate assets, liabilities and

contingent liabilities in the business it has

acquired. This can include identification of

intangible assets, for example customer

relationships, which are not commonly

recognised except on acquisitions (e.g.

goodwill).

The Standard also prescribes full

disclosure of all business combinations.

The purchase method of accounting is

required and the pooling of interest

method is prohibited.

IFRS 4 Insurance Contracts Not applicable

IFRS 5 Non-current Assets Held for Sale

and Discontinued Operations

Applicable but unlikely. If an MFI decides

to sell, wind up or discontinue operations,

the Standard outlines a number of

guidelines with respect to disclosure and

reporting. Operations are classified as

discontinued when they have been

disposed of or are classified as held for

sale.

IFRS 6 Exploration for and Evaluation of

Mineral Assets

Not applicable

IFRS 7 Financial Instruments:

Disclosures

Applicable. This Standard outlines specific

issues on disclosure of all financial

instruments (bank accounts, term deposit


IFRS Standard

Number


or certificate investments, loans and

receivables, and available-for-sale

financial instruments. Entities including

MFIs are required to disclose accounting

policies and information related to

financial instruments, disclose

transactions, gains and losses either on

the Balance Sheet or the Income

Statement. They are also required to

disclose the nature and extent of risks of

the financial instruments, both qualitative

and quantitative risk including credit risk,

liquidity risk, interest rate risk, rates,

maturity and options. The disclosure on

risk should include any changes from

previous periods and management’s

objectives and strategies in managing

those risks.

IFRS 8 Operating Segments Applicable. This Standard generally refers

to publicly traded companies, and

ensuring that all business units within

holding companies are reported for

separately and consolidated. There are

some relevant reasons why MFIs should

report by operating segments (supported

by CGAP Disclosure Guidelines as well), for

internal monitoring, and perhaps external

assessments. Examples would include

segmenting microfinance operations from

other activities of the entity (training,

consulting or business development

services), and segmenting Head Office

from branch reports, and by various

branches (for internal monitoring

purposes). A consolidated set of financials

should also be prepared.

List of International Accounting Standards – Relevance to

Microfinance Discussion

List of International Accounting Standards

IAS Standard

Number

Standard Implications for Microfinance


IAS Standard

Number


IAS 1 Presentation of Financial

Statements

Applicable. The Standard is applicable to MFIs

including the complete set of financial

statements and related notes and disclosures

about relevant information not on the face of

the financial statements.

IAS 2 Inventories Usually not applicable as MFIs do not carry

inventory of any stock on their Balance Sheet.

IAS 3 Consolidated Financial

Statements (Originally issued

1976, effective 1 Jan 1977.

Superseded in 1989 by IAS 27

and IAS 28

Applicable if the MFI is owned by other parties

– e.g. a holding or parent company. The parent

company would report consolidated financial

statements for all its operations.

IAS 4 Depreciation Accounting Not applicable. Withdrawn in 1999, replaced

by IAS 16, 22, and 38, all of which were issued

or revised in 1998.

IAS 5 Information to be disclosed in

Financial Statements

Originally issued October 1976, effective 1

January 1997. Superseded by

IAS 1 in 1997.

IAS 6 Accounting Responses to

Changing Prices

Not applicable. Superseded by IAS 15, which

was withdrawn December 2003.

IAS 7 Statement of Cash Flows Applicable – Cash Flow statements (historical --

not projections) are part of the financial

statements expected of organisations.

IFRS cash flow statements show movements in

cash and cash equivalents. This includes cash

on hand and demand deposits, short term

liquid investments readily convertible to cash

and overdrawn bank balances where these

readily fluctuate from positive to negative

(IAS7.6 to 9).

Cash flow statements may be presented using

either a direct method, in which major classes

of cash receipts and cash payments are

disclosed, or using the indirect method,

whereby the profit or loss is adjusted for the

effect of non-cash adjustments (IAS7.18).

Items on the cash flow statement are classified

as operating activities, investing activities and

financing (IAS7.10). There is flexibility in

selecting which category to place some items,

but once selected, the presentation should be

consistent from period to period.


IAS Standard

Number


IAS 8 Accounting Policies, Changes in

Accounting Estimates and

Errors

Applicable. The change and the reason for

changing should be disclosed in the notes.

Previous period statements should be re-

classified retroactively as if the policy was in

effect at the time. The changes of such

adjustments are disclosed in the Statement of

Changes in Equity.

IAS 9 Accounting for Research and

Development Activities

Superseded by IAS 38 effective 1 July 1999.

IAS 10 Events after the Reporting

Period

Applicable. Full presentation in the disclosure

notes of post-balance sheet events is required.

IAS 11 Constructions Contracts Generally not applicable for MFIs. It applies to

entities that engage in constructing their own

buildings.

IAS 12 Income Taxes Applicable. Taxes payable in respect of current

and prior periods are recognised as a liability to

the extent they are unpaid at the balance

sheet date (IAS 12.12).

IAS 13 Presentation of Current Assets

and Current Liabilities

Superseded by IAS 1

IAS 14 Segment Reporting Applicable. MFIs that own other entities should

present segmented and consolidated reports.

MFIs should report financial and non-financial

activities separately if they are a “multi-sector”

organization. However, reporting operational

results by Branch, report by Branch, Head

Office and consolidation of results is important

for internal management purposes.

IAS 15 Information Reflecting the

Effects of Changing Prices

Not applicable. Withdrawn December 2003

IAS 16 Property, Plant and Equipment Applicable. Property, plant and equipment

(PPE) is usually measured initially at cost

(IAS16.15). Cost can include borrowing costs

directly attributable to the acquisition,

construction or production if the entity opts to

adopt such a policy consistently (IAS23.11).

Property, plant and equipment may be re-

valued to fair value if the entire class of assets

to which it belongs is so treated (for example,

the revaluation of all freehold properties)

(IAS16.31 and 36). Surpluses on revaluation are

recognised directly to equity, not in the income

statement; deficits on revaluation are


IAS Standard

Number


recognised as expenses in the income

statement (IAS16.39 and 40).

Depreciation is charged to write off the cost or

valuation of the asset over its estimated useful

life down to the recoverable amount

(IAS16.50). The cost of depreciation is

recognised as an expense in the income

statement unless it is included in the carrying

amount of another asset (IAS16.48).

IAS 17 Leases Applicable. Leases are classified as:

a) Finance leases, being a lease which transfers

substantially all the risks and rewards

incidental to ownerships to the lessee. Finance

leases are recognised on the balance sheet as

an asset (the asset being leased) and as a

liability (liability to the leaser) (IAS17.4, 20 and

25)

b) Operating leases, being a lease other than a

finance lease. An expense is recognised in the

income statement over the time period that

the asset is used (IAS17.4 and 33).

IAS 18 Revenue Not Applicable? According to this standard,

revenue is measured at the fair value of

consideration received or receivable (IAS18.9).

For microfinance, the writer’s opinion is that

interest revenue from loans should be

recognised at their nominal cost received.

Revenue for rendering of services is accounted

for to the extent that the stage of completion

of the transaction can be measured reliably

(IAS18.20).

Income from financial assets should be

recognised at the effective interest rate

method. (An October 2008 announcement

permits loans receivable to be classified on a

cost model; revenue would be recognized at

nominal amounts. The July 14 2009 Release on

IASB Proposal to Improve Financial Instruments

Accounting brings further changes that would

likely affect revenue recognition from Loans

Receivable).


IAS Standard

Number


IAS 19 Employee Benefits Employee costs are recognised when an

employee has rendered service during an

accounting period (IAS19.10). This requires

accruals for short-term compensated absences

such as vacation (holiday) pay (IAS19.11). Profit

sharing and bonus plans require accrual when

an entity has an obligation to make such

payments at the reporting date (IAS19.17).

IAS 20 Accounting for Government

Grants and Disclosure of

Government Assistance

Applicable: accrual basis and matching

principle call for the use of deferred grant

revenue for donations of cash and fixed assets.

Revenue from grants and donations should be

disclosed separately from operating revenues.

IAS 21 The Effects of Changes in

Foreign Exchange Rates

Applicable since some of an MFI’s assets and

liabilities may be denominated in foreign

currencies

IAS 22 Business Combinations Not applicable. Superseded by IFRS 3 effective

31 March 2004.

IAS 23 Borrowing Costs Applicable

IAS 24 Related Party Disclosures Applicable

IAS 25 Accounting for Investments Not applicable. Superseded by IAS 39 and IAS

40 effective 2001.

IAS 26 Accounting and Reporting by

Retirement Benefit Plans

Not Applicable unless the MFI has a registered

retirement plan.

IAS 27 Consolidated and Separate

Financial Statements

Applicable.

IAS 28 Investments in Associates Applicable, though not likely.

IAS 29 Financial Reporting in

Hyperinflationary Economies

Applicable. If an MFI operates in what is

considered in a hyper-inflationary environment

(100% over 3 years is considered hyper-

inflationary).

IAS 30 Disclosure in the Financial

Statements of Banks and

Similar Financial Institutions

Not applicable. Superseded by IFRS 7 effective

2007.

IAS 31 Interests in Joint Ventures Applicable but highly unlikely. Joint ventures

are investments other than subsidiaries where

the investor has a contractual arrangement

with one or more other parties to undertake

an economic activity that is subject to joint

control (IAS31.3).

IAS 32 Financial Instruments:

Presentation

Applicable. However, disclosure provisions

superseded by IFRS 7 effective 2007.


IAS Standard

Number


IAS 33 Earnings per Share Applicable. If the MFI is structured by share

capital, it is required to disclose the earnings

per share. This is generally on the face of the

Income Statement, with fuller explanation in

the disclosure notes as needed.

IAS 34 Interim Financial Reporting Applicable

IAS 35 Discontinuing Operations Not applicable. Superseded by IFRS 5 effective

2005

IAS 36 Impairment of Assets Applicable?? The Allowance for Loan

Impairments -- also called the Loan Loss

Reserve or the Impairment Loss Allowance is

necessary for prudent presentation of Loans

Receivable.

However, the narrow definition and

application of “impairments” might be

challenging. “A financial asset or group of

assets is impaired, and impairment losses are

recognized, only if there is objective evidence

as a result of one or more events that occurred

after the initial recognition of the asset.” Does

portfolio risk as measured by delinquency

meet the criteria of “objective evidence of

impairment?” Is a schedule of historical write-

offs needed as “objective evidence” of

impairment?

Goodwill is not subject to amortisation, but is

assessed for impairment at least annually

(IFRS3.54 and IAS36.10). Impairment is charged

to the income statement (IAS36.60).

Impairment provisions on goodwill are not

subsequently reversed (IAS36.124).

IAS 37 Provisions, Contingent

Liabilities and Contingent

Assets

Applicable. Provisions are liabilities of

uncertain timing or amount (IAS37.10).

Provisions are recognised when an entity has,

at the balance sheet date, a present obligation

as a result of a past event, when it is probable

that there will be an outflow of resources (for

example a future cash payment) and when a

reliable estimate can be made of the obligation

(IAS37.14). Restructuring provisions are

recognised when an entity has a detailed plan

for the restructuring and has raised an

expectation amongst those affected that it will


IAS Standard

Number


carry out the restructuring (IAS37.72).

IAS 38 Intangible Assets Applicable to goodwill – if there has been a

valuation, and some consideration for

goodwill. In-house software development

The difference between the cost of the

business combination and the fair value of the

assets and liabilities acquired represents

goodwill (IFRS3.51).

IAS 39 Financial Instruments:

Recognition and Measurement

Applicable but questions and issues! The

Standard defines a contract that gives rise to a

financial asset of one entity and a financial

liability or equity instrument of another entity.

The Standard Cash Financial asset: Any asset

that is:

• cash; demand and time deposits,

commercial paper

• accounts, notes and loans receivables

• an equity instrument of another entity;

• a contractual right:

o to receive cash or another financial

asset from another entity; or

o to exchange financial assets or financial

liabilities with another entity under

conditions that are potentially favorable

to the entity; or

• a contract that will or may be settled in the

entity's own equity instruments and is:

o a non-derivative for which the entity is

or may be obliged to receive a variable

number of the entity's own equity

instruments; or

o a derivative that will or may be settled

other than by the exchange of a fixed

amount of cash or another financial

asset for a fixed number of the entity's

own equity instruments. For this

purpose the entity's own equity

instruments do not include instruments

that are themselves contracts for the

future receipt or delivery of the entity's


IAS Standard

Number


own equity instruments.

Financial liability: Any liability that is:

• a contractual obligation:

o to deliver cash or another financial asset

to another entity; or

o to exchange financial assets or financial

liabilities with another entity under

conditions that are potentially

unfavorable to the entity; or

• a contract that will or may be settled in the

entity's own equity instruments (Debt and

equity securities)

Financial assets and liabilities can be measured

at fair value or amortized cost. October 2008

change seems to indicate that loans and

receivables can be classified and measured at

cost and their revenues at nominal values. The

July 14 2009 IASB Proposal to Improve

Financial Instruments Accounting clarifies and

simplifies this further.

IAS 40 Investment Property Not applicable. This Standard applies to

entities that own property (buildings or land)

for the purpose of rental income or capital

appreciation. In the highly improbable event

that an MFI would own such property, the

Standard would apply. If applied, the method

of measurement must be selected and

disclosed – whether fair value or cost model

accounting. All changes to values, depreciation,

net carrying value, additions and disposals of

Investment Property must be disclosed in the

financial statements.

IAS 41 Agriculture Not applicable.

Disclosure of Financial Information:

Full financial disclosure is a mandatory part of financial reporting standards according to

International Financial Reporting Standards and best practices in microfinance. Full disclosure

promotes transparency and accountability in financial reporting, and may strengthen investors’

understanding and confidence in the MFI and its management.


Notes to the financial statements are normally part of the MFI’s report to the Board of Directors,

and must be part of the audited financial statements. Typically, this includes an overview of key

accounting policies, operational details, and supporting schedules that have been part of the

accounting process that produced the financial statements. Common disclosure expectations

and practice in preparing and presenting financial statements are listed below. Further items are

elaborated in the CGAP resource “Microfinance Consensus Guidelines: Disclosure Guidelines for

Financial Reporting by Microfinance Institutions” (Rosenberg, 2003).

Notes to the Statements:

The Accounting Policies applied in the preparation of the accounts are detailed in the Notes. For

example, they include, but are not limited to, the following:

• Notes on the MFI’s Business Activities: The Notes will briefly outline the core activities

of the MFI, its business approach, objectives, and methodologies used in its operations.

• Ownership, Board composition, and governance: The Notes provides details about the

legal structure and registration of the MFI, the Board of Directors, where they come

from, and their terms on the Board. The Notes also list the structure of the

Management Committee, which is the executive management team of the MFI.

• Shareholder Capital disclosure – classes of shares, amounts authorized, issued,

redeemed. Details of all dividends declared and / or paid.

• Measurement basis of accounting (historical cost, fair value, other): One of the

fundamental policies is the basis of accounting – and for the most part, this continues to

be historical cost basis. International Accounting Standards promote fair value

accounting for financial instruments, but application to MFIs may be rather limited.

MFIs who engage in more sophisticated investments, real estate transactions or

mergers and acquisitions should refer to International Accounting Standards for specific

details in fair value accounting.

• Accrual basis of accounting: This policy is another one of the fundamentals of

accounting practice, and must be disclosed. Very few MFIs practice a cash basis of

accounting, since most national accounting standards recommend that they apply

accrual accounting. The policy on loan interest accruals should be described, particularly

if there is an exception to accrual accounting for loan repayments. Any policies on when

to stop accruing for delinquent loans, or a reversal of interest on delinquent loans

previously accrued should be clearly described.

• Fixed asset capitalisation policy: Assets over a stated value will be capitalised on the

balance sheet and depreciated in future periods. Those under the stated value will be

expensed in the current year, and the Notes must disclose the policy.

• Depreciation rates: The Notes also list the depreciation rates applied to various classes

of assets. They may refer to the rates acceptable by local tax laws, but not necessarily.

• The Impairment Loss Allowance policy: The MFI’s policy for the Impairment Loss

Allowance must also be disclosed, whether it is based on the MFI’s history of write-offs,

an estimation of risk based on delinquency, or on international best practices for

microfinance.

• The Write-off policy: The Write-off policy is disclosed in a note. The details of current

and previous period write-offs should be disclosed.

• Loans and Borrowings: The details of all loans should be disclosed, including terms,

conditions, currency, maturity, repayment schedules, restrictions, security on all

borrowings from banks, investors, and overdraft agreements must be disclosed in detail.


The supporting schedules will outline the specific values of both secured and non-

secured loans, but the basic agreements will be outlined in this Note.

• Contingent liabilities: Contingent liabilities are possible liabilities that may arise in

future periods, but have not yet been declared or confirmed to the MFI. Examples could

include potential law suits, any third party financial guarantees, or tax re-assessments in

process.

• Guarantees: Any guarantees that the MFI itself or directors have provided to third

parties must be disclosed in the Notes to the financial statements.

• Shareholdings and capital accounts: The Notes should disclose the details and specific

types of shareholding and capital accounts – including contributed capital, donated

capital, paid up capital and the types of shares allowed and already issued.

• Details of Prior Period Adjustments, if any: If the MFI has posted any Prior Period

Adjustments in the year, these details must be disclosed in the Notes, if not in the

details of the Equity Statement.

• Securitization of assets -- as applicable.

• Post-balance sheet events: Any major events that take place following the date of the

balance sheet and before the date of the Auditor’s Report should be highlighted in the

Notes. This might include a lawsuit, the effects of a natural disaster, a major fraud

expected to have a material effect on the MFI’s financial position, a change in legal

registration, a major new grant or investor, or a change in ownership or controlling

interest.

• Related party transactions: The Notes should outline any related party transactions

undertaken by the MFI, for example, advances or loans to Board of Directors,

agreements or transactions with related NGOs, parent companies or organisations, and

the like.

• Relevant details of any legal obligations: Any legal obligations, both confirmed and

pending must also be disclosed in the Notes.

• Interest rate and market rate risk

• Asset and Liability Maturity Tables

• Credit Risks – financial management strategies to minimize risk

• Effective interest rate risk –

• Liquidity risks

Supporting Schedules to the Financial Statements

The supporting schedules provide additional detail and breakdown of aggregated figures

reported on the balance sheet. Typically, this includes:

• Fixed Asset schedules: The Fixed Asset schedules will show the summarised asset

classes taken from the ledger, additions and disposal of assets, historical accumulated

depreciation, adjustments to accumulated depreciation from disposals, current year

depreciation and rates, current year accumulated depreciation, and the net book value

of assets. The balance sheet usually shows the total of all net fixed assets.

• Provision for Loan Impairments: These schedules will vary depending on the method

used in making provisions and write-offs. First, the movements in the Loans Receivable

account are usually detailed, opening balance, disbursements, less collections, and the

ending balance. If write-offs are made against the Impairment Loss Allowance, a

schedule showing the changes in the Allowance (Balance Sheet) and Provision accounts

(Income and Expense Statements) is expected.


• Aging Schedule: The portfolio aging schedule is a standard schedule to be produced. It

should disclose the late loans in categories suggested by international best practices for

microfinance. This is generally 0 – 30 days, 31 – 60 days, 61 – 90 days, 91 – 180 days,

over 180 days (and in some cases over 365 days late).

• Cash and Bank: The details of the MFI’s bank accounts are also disclosed in a schedule,

including the currency of the account, the detailed balances, and where held. Various

cash accounts are also detailed, including any Cash in Transit.

• Accounts Receivable and Accounts Payable schedules: Details of various accounts

receivable and payable are also listed in various schedules, specifying the vendor and

the amount. Any loans and advances to staff, management or the Board of Directors

must be disclosed in these schedules.

• Accumulated grants and donations in equity: Although not always required by national

accounting standards, it is good practice for MFIs to highlight the source of various

donors in their accumulated grants and donations. The most important disclosure is to

ensure that retained earnings or deficits show the amount of earnings or losses related

to operations, and the amount from donations. Details would be in presented in the

Statement of Changes in Equity

• Liabilities: Any type of investments, bank loans – whether secured or unsecured should

be disclosed in detail. This would include the loan term, interest rate, interest payable,

security and other relevant details.

• Income and Expense schedules: Since the financial statements usually aggregate

accounts, both income and expense accounts are usually detailed in a variety of

schedules.

Documents

Overview of IFRS for Micro Finance Reporting Discussion July 2009