How to Audit a First-Time IFRS Adoption Under IFRS 1

What IFRS 1 actually requires from the entity (and from you)

IFRS 1 governs the first set of financial statements in which an entity adopts IFRS. The standard’s core requirement sits in IFRS 1.6: the entity must prepare and present an opening IFRS statement of financial position at the date of transition to IFRS. That date is the beginning of the earliest comparative period presented. For a December 2025 year-end with one comparative year, the transition date is 1 January 2024.

The opening balance sheet is not a restatement exercise performed for convenience. IFRS 1.10 requires the entity to apply all IFRS standards effective at the end of its first IFRS reporting period, retrospectively, as if those standards had always applied. Every asset and liability gets remeasured. Equity components adjust accordingly. The cumulative effect of all adjustments hits opening retained earnings (or, where IFRS 1 specifies, another category of equity) under IFRS 1.11.

Your audit work on the opening balance sheet carries forward. ISA 510.6 requires you to obtain sufficient appropriate evidence that opening balances contain no misstatements materially affecting the current period. For a first-time adopter, that means auditing the transition adjustments themselves, not just the closing balances. If the entity switched from Dutch GAAP (RJ) to IFRS, every recognition difference (leases under IFRS 16 that were off-balance sheet under RJ 292, expected credit losses under IFRS 9 that were incurred-loss under RJ 290) becomes a transition adjustment you need to test.

The timeline you need to understand

Most first-time adoptions follow a predictable timeline, and each stage creates specific audit evidence you should obtain. The entity typically starts with a diagnostic phase twelve to eighteen months before the transition date, where it identifies the accounting differences between previous GAAP and IFRS. That diagnostic produces a gap analysis. Get it. It tells you which standards management considered and which adjustments they expect. If the entity skipped this step and went straight to preparing the opening balance sheet, your risk of missing adjustments is higher.

The second stage is the preparation of the opening IFRS balance sheet itself. This is where management makes its exemption elections, engages valuers for deemed cost measurements, recalculates lease liabilities under IFRS 16, runs IFRS 9 expected credit loss models, and quantifies every adjustment. Each of these workstreams should produce a working paper you can test.

The third stage is the preparation of the comparative period under IFRS (in our example, the year ended 31 December 2024) and the reconciliation disclosures. The entity needs to restate the full comparative year. This is not optional. IFRS 1.21 requires at least one year of comparative information under IFRS.

What the disclosures must show

The disclosure requirements sit in IFRS 1.23–1.33. The entity must present reconciliations of equity at the transition date and at the end of the last period reported under the previous GAAP, plus a reconciliation of total comprehensive income for the last period under previous GAAP. These reconciliations must give sufficient detail for users to understand the material adjustments. Vague one-line entries (“IFRS adjustment: €2.4M”) are not sufficient. Each adjustment needs a label, a standard reference, and an amount.

IFRS 1.23 also requires the entity to explain how the transition from previous GAAP to IFRS affected its reported financial position, financial performance, and cash flows. If the entity’s cash flow statement changes classification of items (operating to financing, for example, when IFRS 16 lease payments move to the financing section), that reclassification needs disclosure too.

Mandatory exceptions you cannot waive

IFRS 1.14 lists four categories of mandatory exception where retrospective application is prohibited. These are not optional. The entity cannot choose to apply full retrospective treatment in these areas, and you cannot accept a transition file that does. In practice, the mandatory exceptions exist because retrospective application would either require impossible reconstructions of historical data or allow entities to cherry-pick accounting outcomes using information they did not have at the time.

The derecognition exception (IFRS 1.B2–B3) requires the entity to apply IFRS 9 derecognition requirements prospectively from the transition date. Financial assets and liabilities derecognised under previous GAAP before the transition date stay derecognised. This matters for entities that factored receivables or transferred financial assets under less restrictive Dutch GAAP derecognition rules. If the entity attempts to reinstate previously derecognised items, that violates the mandatory exception. When reviewing the transition file, ask management to confirm that no derecognised items were reinstated. If receivable factoring arrangements exist, obtain the pre-transition derecognition analysis and verify it was not revisited.

Hedge accounting (IFRS 1.B4–B6) must be assessed at the transition date under IFRS 9 criteria. Hedging relationships that qualified under previous GAAP but fail to meet IFRS 9.6.4 requirements at transition cannot be carried forward. The entity discontinues them. Where hedging relationships do qualify, the entity measures them at fair value at the transition date and any cumulative gain or loss goes to other comprehensive income or retained earnings depending on the hedge type.

Estimates (IFRS 1.14(b) and IFRS 1.16) cannot be revised with hindsight. The entity uses the estimates it made under previous GAAP at the relevant date, adjusted only where those estimates need modification under IFRS. If the entity originally estimated an asset’s useful life at eight years under Dutch GAAP, it cannot retrospectively change that to six years just because IFRS would have produced a different answer. Hindsight adjustments are a red flag in every transition file. The practical test: look at the date the estimate was originally made. If the information used to change the estimate was not available at that date, the change is hindsight. IFRS 1.16 contains a narrow exception where new information triggers a genuine correction (for example, evidence that an estimate was an error under the previous GAAP), but the burden of proof sits with the entity.

Classification and measurement of financial instruments (IFRS 1.B8–B8C) requires the entity to assess business model and contractual cash flow characteristics at the transition date. The entity classifies financial assets based on facts and circumstances at that date, not at original recognition. This is a practical rule that avoids the impossible exercise of reconstructing historical intent for instruments that may have been on the books for years.

Optional exemptions and the audit risk they create

IFRS 1.D1–D39 contains over thirty optional exemptions. The entity chooses which to apply. Your job is to verify two things: that each applied exemption actually qualifies under the conditions IFRS 1 attaches to it, and that the entity documented its rationale for applying (or not applying) each one.

The most commonly applied exemption in European mid-market transitions is the deemed cost exemption for property, plant and equipment (IFRS 1.D5–D8B). An entity can use fair value at the transition date as deemed cost instead of reconstructing historical cost under IAS 16 back to original acquisition. This is popular because many Dutch GAAP entities lack historical cost records going back decades for real estate holdings. Your audit risk: the fair value used as deemed cost needs an IFRS 13 fair value measurement that you can test. If the entity used an external valuation, assess the valuer under ISA 500.8 and ISA 620.12. If management produced the valuation internally, test their assumptions.

The business combinations exemption (IFRS 1.C1–C4) allows the entity not to restate past business combinations under IFRS 3. For entities acquired under Dutch GAAP pooling or purchase methods, the exemption avoids a potentially impossible exercise of retrospective fair value allocation. But IFRS 1.C4 attaches conditions: the classification of the acquisition as either a business combination or an asset acquisition must still be assessed under IFRS 3, and any goodwill recognised under previous GAAP must be tested for impairment under IAS 36 at the transition date. Many files miss that impairment test. Goodwill from a 2015 acquisition that was amortised under Dutch GAAP gets frozen at its carrying amount at the transition date, but IAS 36 impairment still applies.

Cumulative translation differences (IFRS 1.D12–D13) can be deemed zero at transition. This is a common and low-risk exemption for entities with foreign operations. The audit implication is straightforward: verify that the cumulative translation adjustment was reclassified to retained earnings and that all subsequent translation differences after the transition date follow IAS 21.

The exemptions an entity chose not to apply also matter. If an entity with significant lease liabilities decided not to apply the IFRS 16 exemption in IFRS 1.D9B (which would have allowed measurement of lease liabilities at present value of remaining payments at transition, with right-of-use assets measured at an equal amount), it must instead apply IFRS 16 fully retrospectively. That means reconstructing lease calculations from inception for every lease on the books. Verify the entity understood the implications of its exemption choices before accepting the transition file.

The employee benefits exemption (IFRS 1.D10–D11) permits the entity to recognise all cumulative actuarial gains and losses in retained earnings at the transition date, effectively resetting the IAS 19 measurement. For entities with defined benefit pension obligations (common in Dutch and German subsidiaries), this can produce a large retained earnings adjustment. Your audit work: obtain the actuary’s report at the transition date, verify the discount rate and mortality assumptions against IAS 19.83–86, and recalculate the net defined benefit liability. The actuarial report at the transition date is separate from the annual IAS 19 valuation. If the entity used the same valuation for both purposes without adjusting for the different measurement dates, that is an error.

How the exemptions interact with each other

Some exemptions interact in ways that create compounding audit risk. An entity that applies the deemed cost exemption for PP&E (IFRS 1.D5) and also applies the business combinations exemption (IFRS 1.C1) may end up with a mix of measurement bases: acquired PP&E from a 2016 business combination carried at Dutch GAAP cost (frozen under the business combinations exemption) while the parent’s own PP&E is carried at fair value (under the deemed cost exemption). This is permitted, but it creates a disclosure obligation. IFRS 1.29 requires the entity to explain its accounting policies in the first IFRS financial statements, and users need to understand why different assets of the same class carry different measurement bases.

The cumulative translation differences exemption interacts with the business combinations exemption as well. If the entity deems cumulative translation differences zero at transition, but the foreign operation was acquired in a past business combination, IFRS 1.C2(f) requires the entity to treat the goodwill and fair value adjustments from that acquisition as assets and liabilities of the parent (not the foreign operation) for purposes of subsequent currency translation. Getting this wrong affects how disposal gains or losses are calculated if the foreign operation is subsequently sold.

Worked example: auditing a Dutch GAAP-to-IFRS transition

Client: Vermeer Coating Technologies B.V., a specialty coatings manufacturer based in Eindhoven. €68M revenue, December 2025 year-end. First IFRS financial statements. Transition date: 1 January 2024. Previously reported under Dutch GAAP (RJ).

1. Identify the transition date and confirm the opening balance sheet exists

Vermeer’s first IFRS reporting period ends 31 December 2025 with one comparative year. The transition date is 1 January 2024. Verify that the client prepared an opening IFRS balance sheet at that date.

2. Obtain the entity’s schedule of exemptions applied

Vermeer applied four optional exemptions: deemed cost for PP&E (IFRS 1.D5), the business combinations exemption (IFRS 1.C1), cumulative translation differences deemed zero (IFRS 1.D12), and the IFRS 16 transition exemption (IFRS 1.D9B). They did not apply the IFRS 9 classification overlay.

3. Test the deemed cost exemption for PP&E

Vermeer owns a production facility in Eindhoven carried at €11.2M under Dutch GAAP (historical cost less accumulated depreciation). Management engaged an external valuer (Cushman & Wakefield) who assessed fair value at 1 January 2024 at €14.8M. The €3.6M uplift hits opening retained earnings.

Test the valuation: review the Cushman & Wakefield report against ISA 620.12 (competence, capability, objectivity). Verify the valuation date matches the transition date. Check the valuation methodology against IFRS 13.61–66 (level 2 or level 3 inputs). Test key assumptions (comparable transactions, discount rate, remaining useful life). Recalculate the retained earnings adjustment.

4. Test the business combinations exemption and goodwill impairment

Vermeer acquired a Belgian subsidiary (Claessens Pigments NV) in 2019 for €5.1M under Dutch GAAP purchase method. Goodwill of €1.8M was recognised and amortised to a carrying amount of €0.9M at 1 January 2024. Under the IFRS 1.C1 exemption, Vermeer freezes this at €0.9M but must test for impairment under IAS 36 at the transition date.

Review management’s IAS 36 impairment assessment for the Claessens cash-generating unit. The recoverable amount (value in use based on a five-year DCF at 9.2% WACC) was €4.1M versus a carrying amount of €3.7M (including the €0.9M goodwill). Headroom of €0.4M is thin. Test the discount rate against the entity’s actual cost of capital and verify the terminal growth rate (management used 1.5%) against ECB long-term inflation targets.

5. Verify the reconciliation disclosures

IFRS 1.24(a) requires an equity reconciliation at 1 January 2024 and at 31 December 2024, and a comprehensive income reconciliation for the year ended 31 December 2024. Verify that Vermeer’s reconciliations are disaggregated by standard (IFRS 16 adjustment, IFRS 9 ECL adjustment, PP&E deemed cost uplift, goodwill amortisation reversal). Each line should identify the relevant IFRS standard and the amount.

The completed file shows a reviewer that every exemption election was documented and tested. Each one links to the specific IFRS 1 paragraph governing it. The reconciliation disclosures tie back to individual adjustment working papers.

Practical checklist for your engagement file

1. Confirm the transition date per IFRS 1.6 and verify the entity prepared an opening IFRS balance sheet at that date
2. Obtain and file the entity’s written schedule of exemptions applied and not applied, with rationale for each election (request this document if it does not exist)
3. For each optional exemption applied, verify the conditions in IFRS 1.D1–D39 are met and the amounts are supportable (test valuations, review business combination classifications, recalculate lease liabilities)
4. For each mandatory exception in IFRS 1.14–17, verify the entity did not apply retrospective treatment where prohibited (particularly: no hindsight on estimates, no reinstatement of derecognised financial instruments)
5. Test the retained earnings impact by reconciling total transition adjustments to the difference between previous GAAP equity and IFRS equity at the transition date
6. Verify IFRS 1.24 reconciliation disclosures are disaggregated by standard, each line ties to a working paper, and total comprehensive income for the last previous GAAP period is reconciled

Common mistakes

• Missing the goodwill impairment test at transition: applying the business combinations exemption (IFRS 1.C1) freezes goodwill at its carrying amount but does not exempt the entity from IAS 36 impairment testing at the transition date. The AFM has flagged insufficient impairment testing at transition in several first-time adoption files reviewed since 2022.
• Hindsight adjustments disguised as IFRS corrections: IFRS 1.14(b) prohibits revising estimates with hindsight. Changing a useful life or a provision estimate at the transition date using information that was not available when the original estimate was made is not an IFRS adjustment. It is an error.
• Incomplete reconciliation disclosures: IFRS 1.24 requires reconciliations of equity and comprehensive income, disaggregated with sufficient detail for users. A single-line “IFRS adjustments” entry without standard references and individual amounts fails this requirement.

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Frequently asked questions

Further reading and source references

• IFRS 1, First-time Adoption of International Financial Reporting Standards: the source standard governing all transition requirements.
• ISA 510, Initial Audit Engagements – Opening Balances: the audit standard requiring sufficient appropriate evidence on opening balances.
• IFRS 13, Fair Value Measurement: relevant to deemed cost valuations under IFRS 1.D5.
• IAS 36, Impairment of Assets: applies to goodwill impairment testing at the transition date under the business combinations exemption.