The Impact of IFRS Adoption on Thinly Capitalized Australian Companies

This report examines the significant impact of International Financial Reporting Standards (IFRS) adoption on the financial statements and capitalization of Australian companies. It provides an overview of the background and implications of IFRS adoption, highlighting the changes in accounting treatment, particularly in areas like fair value accounting and the recognition of liabilities and assets. The report discusses the major impacts of IFRS on financial reporting, including changes in debt-to-capital ratios, and the key distinctions between IFRS and Generally Accepted Accounting Principles (GAAP). The analysis focuses on how IFRS affects the thin capitalization of companies, considering aspects like tax implications and the measurement of financial elements, such as liabilities, assets, goodwill, and equities. The research methodology involved analyzing a sample of non-AID, top non-financial, and non-insurance companies listed on the stock exchange to evaluate the impact of IFRS on their financial positions. The study also explores the impact on dividend decisions, franking policies, and the consolidation of income tax. The report concludes by emphasizing the importance of understanding the financial implications of IFRS adoption for Australian companies, especially those that are thinly capitalized, and the need for adapting to changes in accounting standards to maintain financial health and transparency.

Running head: IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED
POSITION OF AUSTRALIAN COMPANIES
Impact of Adoption of IFRS on the Thinly Capitalised Position of Australian Companies
Name of the Student:
Name of the university:
Authors Note:

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
Table of Contents
Introduction:...............................................................................................................................2
Overview and background:........................................................................................................2
Implication of the adoption of IFRS:.........................................................................................2
Major impact of the adoption of the IFRS:................................................................................2
Key distinction factors in the provisions of the GAAP and the IFRS rules...............................2
Discussion relating to effect of adoption of IFRS on thinly capitalised company of Australia:2
Conclusion:................................................................................................................................2
Reference....................................................................................................................................2

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
Introduction:
Corporations that are carrying out their operations in Australia have been
considerably impacted by the adoption of International financial reporting standard. In this
particular assignment, the impact of the adoption of accounting standard on the financial
statements has been illustrated. The objective of carrying out research on this particular paper
is to identify the impact of the reporting standard at international level on the capitalized
position of the companies or reporting entities conducting their business in Australia (Barac
et al. 2016).
Overview and background:
The International financial reporting standard has made an announcement regarding
the adoption of the standard by different countries. The standard was made applicable and it
was to be commenced after or on 1st January, 2005. Adoption of “International Financial
Reporting Standards” by the reporting entities operating in Australia was concluded by the
International financial reporting council. Adopting the standard by companies would help in
facilitating comparison between the reporting standard followed by different companies
operating in different countries and thereby improving the transparency. Such transparency
would help in bringing better contracts among the several participants in the capital market.
Moreover, adoption of the international standard would help companies in enhancing their
ability to raise the finds by reducing the cost of capital and their chances of being listed on
different stock exchanges of the world (Donelson et al. 2016). Reporting entities have been
able to witness considerable amount of changes in their accounting standard and the
accounting treatment of different accounts due to embracing the International financial
reporting standard. This also had an insightful impact on the measurement, disclosure and
recognition of equities, liabilities and profitability level of reporting entities. It was also
ascertained that various aspects of financial reporting and treatment of taxation was

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
fundamentally impacted by the process that was involved in concerting into the international
reporting standard (Beck et al. 2017). It was required by organization to implement the new
accounting standard by making changes in the accounting treatment. Moreover, it is certainly
possible that the computation of thin capitalization of firms would be adversely affected by
the adoption of international financial reporting standard. It is of crucial importance to
consider the fact that entities adapting to the international standard might be denying the
deductions associated with the income tax in respect of the related amount of borrowing fees
and payment of interest by the company.
Implication of the adoption of IFRS:
The purpose of carrying out research on the International financial reporting standard
is to identify the impact of such standard on the thin capitalization position of companies
operating in Australia and equivalent to Australia. In the first aspect, the purpose of
conducting the research is to how and why the thin capitalization is considerably impacted by
the standard and whether they are currently complying with the same. Secondly, it is required
to determine the changes quantitatively by linking it back to the initiatives of accounting and
taxation policies (Hoque 2018).
The dividend decision of the reporting entities was phenomenally impacted by the
adoption process of IFRS as on after 1st January, 2005. Some of the other accounting decision
that was influenced by the firms included the position of capitalization, franking policy
employed by organization, consolidation of income tax and Australia entities application with
tax holding. However, some of the groups associated with accounting department in Australia
such as Institute of Chartered Accountants and 100 (G100) were of view that there would be
adverse and negative consequence due to changes tax treatment resulting from the adoption
of standard (Parrott 2017). However, such impact is to be evaluated in terms of thin position

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
relating to firms capitalization. The reporting entities complying with the rules of thin
capitalization under the GAAP (Generally Accepted Accounting Principles) would fail the
test due to the alterations in the accounting treatment in respect of valuation and recognition
of liabilities, assets and equities (Luo and Warfield 2014). Nevertheless, due to the mandatory
compliance of entities with the IFRS would not lead to such failure impacting the financial
operations and financial structure.
The Federal Treasurer directed the adoption of IFRS so that a transitional period of
three years after adopted where they are provided with the option of electing on annual basis
for complying with the GAAP or IFRS for the computation of thin capitalization of firms. It
was argued in light of rules of thin capitalization, it was pointed by Institute of Chartered
Accountants in Australia that a significant amount of time would be required for assuring that
reporting entire would not be worse off compared to the situation before the adoption of
international standard (Beattie 2014).
Major impact of the adoption of the IFRS:
The adoption of IFES would have listed below consequences and they are as follows:
 Under the GAAP provisions, there is no recognition of liabilities and assets unlike the
adoption of IFRS would make it mandatory to record such liabilities and assets
resulting from the fair value accounting treatment. The introduction of fair value
accounting under IFRS would change the accounting treatment of certain liabilities
sand assets (Coad et al. 2016).
 On the date of presenting the balance sheet, a higher amount of liabilities and assets
are required to be reporting and disclosed by entities under the provisions that are laid
down under IFRS. It can be explained with the help of an example that any amount of
unrealized loss resulting from derivative instruments will be treated as liabilities and

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
this would impact the computation of thin capitalization and influencing relevantly
the net amount of assets reported on the balance sheet.
 The overall net position of reporting entity might be reduced as under the IGRS
provisions, it is required by entities to account for the volatilities resulting from some
external factors. Such impacts of volatility were not accounted for under the GAAP
provisions (Otley 2016).
Reporting entities adopting the IFRS have the main concern about their solvency
position as the provisions under such standard would lead to increasing value of debt to
capital ratios. Values will increase to such extent that in order to seek external funding, it
would be required by companies to have a debt limit of 75%. There is a significant increase
in possibility of widening the debt limit ranges if prior to the adoption of IFRS, the range of
debt to capital ratios is 60%-75%. Regarding the debt to capital ratios, 75% of assets value of
operations of companies that is net off investment and liabilities that are not bearing interest
are made by associates (Mellen 2018). The firms intending to cross the limit as identified in
the safe harbour would have the consequence of disallowance of statute and payment of
interest on debt value. Recapitalisation programs were undertaken by Australian companies
in order to avoid bearing the consequence of exceeding the debt limit and where the debt
limit under such programs are maintained within the range of 50%-75% of the Australian
group. Reporting entities are able to achieve this limit of safe harbour by adjusting the assets
net of revaluations and incorporation of debt in the corporate group of Australia. The
compliance within the provision of thin capitalization of Australian firms is also expected to
be influenced with the introduction of IFRS by making changes in the elements of balance
sheets (Balakrishnan et al. 2016).

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
Key distinction factors in the provisions of the GAAP and the IFRS rules:
Implementation of IFRS and GAAP have substantial amount of differences in the
accounting treatment. The thin capitalization position of Australian firms is influenced in a
significant way by the flow of impacts brought about by the variations due to the adoption of
such standard. The thin capitalization position is impacted in terms of measurement,
classification and recognition of liabilities, assets, goodwill, assets impairment and equities.
The reason attributable to changes in the values of such financial elements is that debt capital,
liabilities, assets and equities value are treated by complying with the accounting standard. In
respect of the application of provisions of thin capital, the IFRS provisions would have a
significant impact in relation to accounting standard such as AASB 138 Intangible assets,
AASB 112 Income Taxes, AASB 139 Financial Instruments in relation to and AASB 132
Financial Instruments in relation to disclosure and presentation (Chen et al. 2016).
It is assumed that there would be industry specific impacts due to provisions of IFRS
on thin capitalization position. In light of adoption of AASB 139: Financial Statements:
Measurement and Recognition, it is ensured by reporting entity that there is adequate
recognition of all financial instruments of assets and liabilities at fair value in the balance
sheet along with items available for sale on investment. Such financial instruments re not
recognized in the balance sheet under the IFRS provisions. The changed provisions as per the
IFRS would have substantial impact on valuations of such assets. Such changes in valuation
would have ultimate impact on provisions of thin capitalization of reporting entities. In
addition to this, the temporary differences in the deferred tax balances according to the
provisions of the AASB 112 Income taxes (Conaway et al. 2016). This facilitates the
comparison between the tax base of liabilities and assets. In event of fair value adjustments
and revaluation of assets, organization is required to make the recognition of deferred tax
liabilities and deferred tax assets. Some of the considerable amount of financial instruments

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
provisions of the AASB 132 significant is classified as debt rather than equity. Any
intangible assets that is internally generated by organization such as customer lists, goodwill,
brands, mastheads and any other items of similar nature are not recognized and recorded
according to provisions of the AASB 138. In event of reporting entities shaving large amount
of intangible assets recorded in the statement of financial position leads to great valuation in
the present value of assets. Such treatment would have impact on the provisions of thin
capitalization for the purpose of capitalization.
Discussion relating to effect of adoption of IFRS on thinly capitalised company of
Australia:
In order to evaluate the impact of adoption of the IFRS on thinly capitalized
companies, the research work is conducted by choosing a sample of 105 of non-AID, top
non-financial and non insurance companies listed on stock exchange. It is crucial to identify
the impact of standard on thinly Capitalized Company in light of rules of capitalization as it is
relevant to entities that finance its assets by relying on higher level of debt compared to
equity financing. The objective of company relying on debt for financing their purchase or
assets is attributable to the fact of taking advantage in terms of tax deductibility of payment
of interest that are permitted for Australian companies. It is stated by treasury that adoption of
such standard does not requires making the valuation of financial elements involved in the
process of thin capitalization. It is viewed by the treasury analysis that there would be
transparency, comprehensiveness and objectivity in the reporting process due to the adoption
of IFRS. It is the multinational companies that are subjected to the rules of thin capitalization
that intend to adopt IFRS for taking the benefits of rules of thin capitalization (Cooper 2015).
Furthermore, it can be seen that there is a development of proxy measure in relation to
safe harbour resulting from considerable increase in interest bearing liabilities due to the

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
adoption of standard. Under the GAAP provisions, such proxy measure of debt is at the mean
value of 37.98% lead to increase by value 13.19% to a value of 42.99% resulting from the
adoption of IFRS. This particular example is an illustrative of the fact that thin capitalization
position of reporting entities are considerably impacted by the adoption of standard.
Furthermore, such changes have further significant impact on policies of companies. The
adoption if fair value accounting is one of the important implications of policy in relation to
adoption of the standard. After the adoption of IFRS, significant amount of changes have
been witnesses in respect of the provisions of liabilities and assets. The valuation of
liabilities, equities and assets is impacted due to involvement of high amount of assumptions
on part of management as a part of valuation methodology (Henderson et al. 2015). This has
the implication in terms of inherent uncertainty that is present in such financial assets and
liabilities valuation under fair accounting provisions. Such process of recognition and
measurement would have impact on the provisions of thin capitalization of reporting entities.
Another implication of policy is related to the compliance cost of thin capitalization.
There can be considerable increase in the cost of compliance under the provisions of IFRS as
independent verification of the revalued assets are required to be conducted by companies
under the assessment of fair value of liabilities and assets under IFRS provisions. Since the
adoption of standard leads to increasing the alignment between the accounting standard and
provisions of taxation, there is reduction in stakeholder uncertainty. Such uncertainty
reduction has ultimate impact on increasing the consistency and reducing the cost of
compliance (Turton 2017). Nonetheless, there can be significant increase in compliance cost
due to variation in capitalisation position depending upon the position of measurement of fair
value.

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
Conclusion:
In this particular assignment, research is conducted for determining the impact of thin
capitalization of firms resulting from the adoption of IFRS. Concerning this, the adoption of
IFRS on selected sample of 105 Australian listed companies have been quantified in relation
to interest bearing liabilities and computing the debt amount range as safe harbour. It can be
inferred from the analysis presented above that there can be over time decline in the thin
compliance cost resulting from the adoption of IFRS and its ultimate impact on the
accounting standard and convergence of tax. The provisions under IFRS in terms of adoption
of fair value accounting have the implications in terms of reducing compliance cost and thin
capitalization position of firms. In addition to this, the provision of thin capitalization as
introduced by the IFRS is likely to facilitate the comparisons between the thin capitalization
positions of firms across several jurisdictions. It can also be inferred from the discussion
above in relation to the adoption of standard that there are considerable amount of policy
implications that would significantly impact the process of capitalization and its associated
costs.

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IMPACT OF ADOPTION OF IFRS ON THE THINLY CAPITALISED POSITION OF
AUSTRALIAN COMPANIES
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