IASB Updates

16 February, 2016

 

New standard on leases 

 

The IASB has published IFRS 16 ‘Leases’, completing its long-running project on lease accounting.

 

The new Standard, which is effective for accounting periods beginning on or after 1 January 2019, requires lessees to account for leases ‘on-balance sheet’ by recognising a ‘right of use’ asset and a lease liability. It will affect most companies that report under IFRS and are involved in leasing, and will have a substantial impact on the financial statements of lessees of property and high value equipment. For many other businesses, however, exemptions for short-term leases and leases of low value assets will reduce the impact (see below). The table summarises the main changes at a glance. 

 

Issue Effect  Who’s affected?  • entities that lease assets as a lessee or a lessor

What’s the impact on lessees?  all leases will be accounted for ‘on-balance sheet’, other than short-term and low value asset leases  lease expense will typically be ‘front-loaded’  lease liability will exclude:  –  option periods unless exercise is reasonably certain  –  contingent payments that are linked to sales/usage and future changes in an  index/rate

What’s the impact on lessors?  • only minor changes from the current Standard, IAS 17 ‘Leases’

Are there other changes?  a new definition of a lease will result in some arrangements previously classified as leases ceasing to be so, and vice versa  new guidance on sale and leaseback accounting  new and different disclosures

When are the changes effective?  annual periods beginning on or after 1 January 2019  various transition reliefs  early application is permitted provided IFRS 15 ‘Revenue from Contracts with  Customers’ is applied.

 

Definition of a lease

 

Because the new lease accounting model brings many more leases ‘on-balance sheet’, the evaluation of whether a contract is (or contains) a lease becomes even more important than it is today.

 

Under IFRS 16 a lease is defined as: ‘a contract, or part of a contract, that conveys the right to use an asset for a period of time in exchange for consideration’.

 

A contract can be (or contain) a lease only if the underlying asset is ‘identified’. Having the right to control the use of the identified asset requires having the right to:

 

• obtain all of the economic benefits from use of the
• identified asset; and
• direct the use of the identified asset.

 

In practice, the main impact of IFRS 16’s new definition and supporting guidance is likely to be on contracts that are not in the legal form of a lease but involve the use of a specific asset and may therefore contain a lease.

 

Lessee accounting

 

Subject to the optional accounting simplifications discussed below, a lessee will be required to recognise its leases on the balance sheet. This involves recognising:

 

• a ‘right-of-use’ asset; and
• a lease liability.

 

The lease liability is initially measured as the present value​ of future lease payments. For this purpose, lease payments include fixed, non-cancellable payments for lease elements, amounts due under residual value guarantees, certain types of contingent payments and amounts due during optional periods in which extension is ‘reasonably certain’.

 

In subsequent periods, the right-of-use asset is accounted for similarly to a purchased asset and depreciated and reviewed for impairment. The lease liability is accounted for similarly to a financial liability using the effective interest method.

 

Optional accounting simplifications

 

IFRS 16 provides important reliefs or exemptions for:

 

• short-term leases (a lease is short-term if it has a lease term
• of 12 months or less at the commencement date).
• low-value asset leases (the assessment of value is based on the value of the underlying asset when new and therefore
• requires judgement. In the Basis for Conclusions which accompanies the Standard, however, the IASB notes that they had in mind leases of assets with a value when new of around US $5,000 or less).

 

If these exemptions are used, the accounting is similar to operating lease accounting under the current Standard IAS 17 ‘Leases’. Lease payments are recognised as an expense on a straight-line basis over the lease term or another systematic basis (if more representative of the pattern of the lessee’s benefit).

 

 

To mark the publication of IFRS 16, we will be issuing a special edition of IFRS News which will look in detail at the Standard’s new requirements and provide practical insights into the changes that may arise from them.

 

Lessor accounting

 

IFRS 16’s requirements for lessor accounting are similar to IAS 17’s. In particular:

 

• the distinction between finance and operating leases is retained
• the definitions of each type of lease, and the supporting indicators of a finance lease, are substantially the same as IAS 17’s
• the basic accounting mechanics are also similar, but with some different or more explicit guidance in a few areas. These include variable payments; sub-leases; lease modifications; the treatment of initial direct costs; and lessor disclosures.

 

Effective date and transition IFRS 16 is effective for annual periods beginning on or after 1 January 2019. Early application is permitted provided IFRS 15 ‘Revenue from Contracts with Customers’ is also applied.

 

In terms of transition, IFRS 16 provides lessees with a choice between two broad methods:

 

• full retrospective application – with restatement of comparative information in accordance with IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’
• partial retrospective application – without restating comparatives. Under this approach the cumulative effect of initially applying IFRS 16 is recognised as an adjustment to equity at the date of initial application. If a lessee chooses this method, a number of more specific transition requirements and optional reliefs also apply.

 

Bringing all leases on-balance sheet is controversial. The IASB has therefore made compromises to reduce the controversy, in particular exemptions for short-term and low value asset leases. As a result businesses that lease only assets such as printers and laptops will face only a limited impact. For businesses that lease ‘big-ticket’ assets, such as property and high-value equipment, this will however be a major change. Whatever your views on the new Standard, businesses would be well-advised to start an impact analysis sooner rather than later. 

 

IASB postpones changes to IFRS 10 and IAS 28 

 

‘Sale or Contribution of Assets between an Investor and its Associate or Joint Venture – Amendments to IFRS 10 and IAS 28’ was issued in 2014 and addressed an acknowledged inconsistency between IFRS 10 and IAS 28 relating to how to account for transactions in which a parent entity loses control of a subsidiary by contributing it to an associate or joint venture.

 

The 2014 Amendments required entities to recognise:

 

• a full gain or loss when a transfer to an associate
• or a joint venture involves a business; and
• a partial gain or loss if the asset transferred does not contain a business. The gain or loss that is not recognised is eliminated against the cost of the investment in the associate or joint venture.

 

The 2014 Amendments were due to become effective for accounting periods beginning on or after 1 January 2016. A number of questions were however raised over the application of the Amendments. The IASB decided that it would be best to consider these questions more fully as part of its research project on equity accounting rather than make more changes now.

10 and IAS 28’ therefore defers indefinitely the mandatory effective date of the 2014 Amendments. The underlying issues will instead be considered in the IASB’s research project on equity accounting. Entities will still be permitted to apply the 2014 Amendments if they wish to. Any proposal to insert a new effective date will be exposed for public comment.

 

We agree with the proposal to defer the effective date of the 2014 Amendments. We believe it does not make sense to require entities to change the way they apply IAS 28 now if further amendments are likely to arise from the IASB’s research project on the equity method of accounting in the near future. 

 

A new effective date has not yet been determined. Despite this change, the 2014 Amendments may still be adopted early if entities wish to do so. 

 

Annual improvements proposals published 

 

 

Proposed amendments address non-urgent (but necessary) minor amendments.

 

The IASB has published an Exposure Draft ‘Annual Improvements to IFRSs 2014-2016 Cycle’ which proposes minor amendments to three Standards.

 

The proposals are the latest under the IASB’s annual improvements process, which aims to make non-urgent, but necessary, minor amendments to IFRSs.

 

A summary of the proposals, which reflect issues discussed by the IASB in a project cycle that began in 2014, is set out in the table. 

 

Main issues addressed in the Exposure Draft

 

Standard  IFRS 1 ‘First- time Adoption of International Financial Reporting Standards’  Issue  Deletion of short-term exemptions for first-time adopters  Proposed change  A number of short-term exemptions are proposed to be deleted because the reliefs provided are no longer available or because they were relevant for reporting periods that have now passed.

IFRS 12 ‘Disclosure of Interests in Other Entities’  Clarification of the scope of the disclosure requirements

 

IASB proposes changes to insurance contracts standard to provide relief from IFRS 9 

 

 

Proposals are a reaction to concerns over the impact of the different effective dates of two major new standards on the insurance industry.

 

The IASB has issued an Exposure Draft ‘Applying IFRS 9 Financial Instruments with IFRS 4 Insurance Contracts’ to address the temporary accounting consequences of the different effective dates of IFRS 9 ‘Financial Instruments’ and the anticipated new insurance contracts Standard. The new insurance contracts Standard is yet to be finalised but, when it is, its effective date is expected to be at least three years later. This means the mandatory effective date of the new insurance Standard will be after the 2018 effective date of IFRS 9.

 

As companies that issue insurance contracts will be affected by both IFRS 9 and the new insurance Standard, there was considerable concern over the practical challenges of implementing these two significant accounting changes on different dates. Further concerns were raised over the potential for increased volatility in profit or loss if IFRS 9’s new requirements for financial instruments come into force before the new insurance accounting rules.

 

To address these concerns while still fulfilling the needs of users of financial statements, the IASB is proposing the following two amendments to IFRS 4:

 

The ‘overlay approach’

 

• an option for all entities that issue insurance contracts to adjust profit or loss to remove some of the additional ‘accounting volatility’ that may arise as a result of IFRS 9

 

The ‘deferral approach’

 

• an optional temporary exemption from applying IFRS 9 for entities whose predominant activity is issuing insurance contracts.

 

The overlay approach

 

The overlay approach aims to remove from profit or loss any additional volatility that may arise if IFRS 9 is applied together with IFRS 4. All entities would be permitted to apply it but only to certain assets (see below). Furthermore, the approach must be chosen on the initial adoption of IFRS 9.

 

Entities applying the overlay approach would be required to apply IFRS 9 from its 1 January 2018 effective date. However they would be permitted to reclassify from profit or loss to other comprehensive income an amount equal to the difference between:

the amount reported in profit or loss when IFRS 9 is applied to the qualifying financial assets (that are newly measured at fair value through profit or loss under IFRS 9); and the amount that would have been reported in profit or loss if IAS 39 were applied to those assets.

 

The reclassification would be shown as a separate line item in the statement of profit or loss, other comprehensive income or both, with additional disclosures being given in order to enable users to understand it.

Only financial assets that meet both of the following criteria would qualify for the overlay approach:

the financial assets are measured at fair value through

profit or loss when applying IFRS 9 but would not have been so measured in their entirety when applying IAS 39

the financial assets are designated by the entity as relating to insurance contracts for the purposes of the overlay approach.

 

The deferral approach

 

The deferral approach would permit entities whose predominant activity is issuing insurance contracts to defer the application of IFRS 9 until the earliest of:

 

 

• the application of the new insurance contracts Standard
• 1 January 2021.

 

If an entity elects to use this temporary exemption, it would continue to apply IAS 39 and provide some key disclosures to assist users of financial statements to make comparisons with entities that apply IFRS 9.

 

Entities are eligible for the deferral approach only if their ‘predominant activity’ is issuing insurance.

The IASB’s intention is that predominance should be interpreted as a high threshold and should be assessed at group-level. Predominance should be assessed by comparing the amount of an entity’s insurance contract liabilities with the total amount of its liabilities.

 

Unlike the overlay approach, the temporary exemption would be applied to all, rather than some, financial assets of the limited population of entities that qualify for and elect to apply this approach.

 

The Exposure Draft is open for comment until 8 February 2016. 

 

Transfers of investment property 

 

 

The IASB has issued an Exposure Draft which looks to clarify when a property under construction or development that is classified as inventory can be transferred to investment property on a change of use.

 

This issue has been raised because IAS 40 ‘Investment Property’ currently lists the circumstances that provide evidence of a change in use of a property. This list does not cover the situation in concern.

 

The IASB therefore proposes to re-characterise the list of circumstances set out in the Standard as non-exhaustive examples of evidence of a change in use (ie, not an exhaustive list). The Exposure Draft does not propose adding more examples because the focus should instead be on the principle that transfers to, or from, investment property should occur on a relevant change in use that is supported by evidence. If adopted, the proposed changes would be retrospectively applied. 

 

Areas of regulatory focus 

 

 

Most jurisdictions around the world have established systems to enforce accounting requirements, including those of IFRS.

Many of the regulatory bodies responsible for accounting enforcement publish some form of feedback from past reviews as well as information about priority areas for the next review cycle. Drawing on reports and feedback from several enforcement bodies around the world, we have identified the following common themes, which we discuss in more detail below:

 

• telling a coherent story use of judgements and estimates
• consolidation issues
• financial instruments valuations
• impairment testing
• revenue recognition policies
• exceptional items
• tax
• cash flow statements.

 

With the 2016 reporting season upon us, we believe these common themes will help you in preparing your financial statements. Of course the matters above are not intended to be a definitive list and regulators will no doubt raise points on many other areas in the forthcoming reporting season. It is also worth being aware that market conditions related to matters such as the slide in oil prices or reduced economic activity in China will affect the issues and sectors that regulators will concentrate on in the coming months.

 

Telling a coherent story In recent years, regulators and many others have encouraged companies to ensure their notes are tailored to reflect the individual circumstances of the reporting entity. These efforts to ‘cut the clutter’ and focus on the matters that are important to the company in concern have been supplemented by the IASB’s own ‘Disclosure Initiative’ which seeks to improve the disclosure of financial information and ensure that companies are able to use judgement when preparing their financial statements.

 

Over the last 12 months, we have seen a number of regulators going even further and encouraging or instructing issuers to streamline their accounting policies where irrelevant or immaterial policies have been included. The table sets out some pointers which may help users to provide more concise and meaningful information to users, while at the same time linking their financial report together in a more consistent and meaningful way.

 

Tips for more meaningful disclosure

 

important messages need to be highlighted and supported with relevant context and not be obscured by immaterial detail

effective cross-referencing needs to be provided and repetition avoided the language used needs to be precise and explain complex issues clearly jargon and ‘generic’ wording should be avoided items in the financial statements should be reported at an

appropriate level of aggregation to convey the essential messages and avoid unnecessary detail tables of reconciliations need to be supported by and consistent with the accompanying narrative preparers should avoid a mentality of erring on the side of

caution by seeking to include each and every disclosure requirement regardless of materiality.

 

Also of importance to telling a coherent story, is the need for consistency within the different parts of the financial statements and accompanying reports. Regulators commonly raise concerns about a lack of consistency both within the financial statements and between the statements and accompanying management commentary-type reports. Apparent inconsistencies can lead to various accounting treatments and disclosures being challenged. Particular areas to note include: 

 

 

Use of judgements and estimates

 

Various aspects of IAS 1 ‘Presentation of Financial Statements’ remain a source of regulatory scrutiny. Regulators continue
to stress the importance of adequate and meaningful disclosure of:

 

• the significant judgements that management makes in the process of applying the company’s accounting policies
• sources of estimation uncertainties.

 

Consolidation issues

 

Regulators have raised a number of issues relating to consolidations, including:

 

• acquisition dates
• whether an acquisition constitutes an asset acquisition or a
• business combination
• determining the accounting acquirer
• separation of identifiable assets from goodwill.

 

​Acquisition date

 

IFRS 3 ‘Business Combinations’ differentiates between the acquisition date, which is the date on which an acquirer obtains control of an acquiree, and the closing date, which is the date on which the acquirer legally transfers the consideration, acquires the assets and assumes the liabilities of the acquiree. The acquisition date drives the fair value-based business combination accounting.

 

Some companies disclose a date for their business combinations without saying whether this is the acquisition date, the closing date or something else (eg the agreement date). A lack of clarity about this may lead to questions from regulators and suggest – perhaps incorrectly – that IFRS 3 has been applied on the wrong date.

 

Whether an acquisition constitutes an asset acquisition or a business combination IFRS 3 provides guidance on identifying a business combination and the definition of a business. Applying the definition of a business can require significant judgement. In borderline situations regulators will look for an explanation of management’s judgement and the basis for reaching the particular conclusion.

 

Determining the accounting acquirer

 

IFRS 3 provides further guidance on identifying the accounting acquirer in situations where this remains unclear following the application of IFRS 10 ‘Consolidated Financial Statements’.

 

Where a company needs to refer to this additional guidance to determine the acquirer, it is likely that significant judgements will have been made, and these should be disclosed as such. Similar reasoning applies when a reverse acquisition occurs. Given the complexity of some acquisition transactions, regulators are likely to demand expanded disclosures in
these areas.

 

Separation of identifiable assets from goodwill

 

IFRS 3 requires all identifiable assets to be recognised separately from goodwill. Regulators have therefore challenged companies when intangibles such as technology or customer- and brand-related intangibles seem to be subsumed into goodwill.

 

Financial instruments valuations

 

Regulators have regularly raised questions relating to disclosures about financial instruments designated as measured at fair value. Companies have been criticised here for failing to state the valuation techniques and inputs used to determine the fair value of certain financial assets and liabilities. In particular, questions have been raised over the level of detail behind ‘Level 3’ valuations and the disclosure of appropriate quantitative sensitivity analysis.

 

Regulators have also reminded companies that they should cover all financial receivables (eg deferred consideration)
and not just trade receivables when making their credit risk disclosures. 

 

Regulatory points regarding impairment 

Impairment testing

 

Impairment testing is a frequent focus for regulators, with concerns being frequently raised over:

 

• the level of companies’ impairment assessments
• the supportability of management’s underlying
• assumptions
• the transparency and adequacy of the related disclosures.

 

Executing the impairment assessment at the appropriate level is critical to ensuring that an over-performing asset or CGU does not mask an impairment of an under-performing asset or group of CGUs. The table above illustrates some points that are regularly raised by regulators.

 

Revenue recognition policies

 

The revenue recognition policy is often the most important accounting policy in a company’s financial statements. This continues to be a key area of focus and scrutiny for regulators.

 

Common (and recurring) criticisms from regulators when reviewing disclosures of revenue recognition accounting policies include:

failure to provide an accounting policy for revenue recognition that is tailored to the company’s operations failure to disclose the accounting policy for all significant categories of revenue, particularly when other parts of the report indicate multiple revenue streams recording revenues on a gross basis for transactions where an entity has been acting as agent insufficient explanation of areas of significant judgement.

 

Given the inadequacy of some disclosures, regulators continue to ask management for additional information. Common questions include:

 

• revenue for services – how has management satisfied itself that the stage of completion of a contract to provide services can be determined reliably?
• multiple element arrangements – when revenue relates to both the sale of goods and the rendering of services, how has the overall consideration been allocated among the various components?
• significant judgments and estimates – what are the key areas of judgement and estimation uncertainty and are they adequately disclosed?

 

Exceptional items

 

Regulators have commented on the need to improve the reporting of exceptional items. In brief, companies should have a clear accounting policy for exceptional items and should recognise items as exceptional when they are ‘one-off’ items. Companies can expect to be challenged by regulators where items are disclosed as ‘exceptional’ yet seem to occur on a recurring basis.

 

Conversely, companies may also be challenged if regulators identify items which they believe to be one-off yet have not been disclosed as exceptional.

 

Companies are also likely to be challenged if they:

 

• keep changing their definition of ‘exceptional’ items
• make selective or inconsistent use of exceptional items, by presenting certain types of loss as exceptional but presenting gains arising in similar circumstances as ‘normal’ • treat a provision as exceptional in one year but then treat a subsequent release of an unused portion of the same provision as ‘normal’. 

 

Tax

 

Regulators continue to raise various tax-related questions including:

 

• requesting evidence supporting the recognition of a deferred tax asset when a company has suffered a loss in the current or preceding period and the utilisation of the deferred tax asset is dependent on future taxable profits in excess of the profits arising from the reversal of existing taxable temporary differences
• requesting explanations around the reconciliation of tax expense (income) and accounting profit multiplied by the applicable tax rate(s).

 

Cash flow statements

 

Cash flow statements are a primary source of financial information and are valued by investors because they help them to assess the company’s ability to convert profits to cash. Regulators have frequently identified misclassifications of cash flow items between operating, investing and financing activities. They have also urged companies to beware of unusual or non-recurring cash flows as these may still fall within the definition of operating cash flows. Some examples of misclassifications are:

 

• business acquisition expenses classified as investing activities that should have been classified as operating activities
• costs of early settling a foreign currency derivative being classified as financing rather than operating activities
• purchase of own shares being classified as investing rather than financing activities
• loans to related parties being classified as financing rather than investing activities. 

 

Draft guidance published on applying materiality 

 

The IASB has taken the next step in its ongoing ‘Disclosure Initiative’. It has published a draft Practice Statement entitled ‘Application of Materiality to Financial Statements’. This responds to concerns that management are often uncertain about how to apply the concept of materiality – especially to disclosures. The IASB believes this uncertainty has contributed to what some commentators describe as a ‘checklist mentality’ when deciding what needs to be disclosed.

 

A Practice Statement is not a Standard and its application is not required in order to state compliance with IFRS. Instead the aim is to provide guidance to assist management in applying the concept of materiality when preparing their financial statements.

The draft Practice Statement provides guidance in the following three main areas:

 

• characteristics of materiality;
• how to apply the concept of materiality when making
• decisions about presenting and disclosing information in the financial statements; and
• how to assess whether omissions and misstatements of information are material to the financial statements.

 

It also contains a short section on applying materiality when applying recognition and measurement requirements.

 

The draft guidance on materiality complements a 2014 amendment made to IAS 1 ‘Presentation of Financial Statements’. This clarified that companies do not need to apply the specific disclosure requirements in IFRSs if the information is not material. That amendment also specified that a company should consider whether to provide additional disclosures when compliance with specific requirements in a Standard would be insufficient in disclosing material information.

 

The Exposure Draft is open for comment until 26 February 2016. 

 

IASB

 

IASB sets up procedure for submitting issues on the IFRS for SMEs

The IASB has set up a procedure to enable small companies and other interested parties to submit implementation issues on the IFRS for SMEs for public consideration. Issues submitted will be dealt with in one of two ways:

 

• by referral to the SME Implementation Group (SMEIG) if the issue is likely to meet the criteria for consideration by the SMEIG and the IASB staff believe that the SMEIG will be able to reach a consensus on it
• by the IASB staff considering them when updating the IASB’s education material or holding them for consideration during the next periodic review of the IFRS for SMEs.

 

IASB comments on EDTF report on expected credit losses and disclosures

The Financial Stability Board’s Enhanced Disclosure Task Force has published a report proposing updated risk disclosures for banks in the context of an expected credit loss framework.

 

The recommended disclosures are intended to help prepare the market for the fundamental change in impairment accounting that will be introduced by IFRS 9 ‘Financial Instruments’ by enhancing the understanding of that Standard’s use of expected credit losses.

 

The EDTF report concludes that for many banks significant changes to systems and processes may be required, which will require substantial time and resources to deliver. It also concludes that some banks will need to develop and enhance governance over the recognition and measurement of credit losses, particularly to develop capability to make informed judgements about the use of forward- looking information.

 

ITG discusses implementation of impairment requirements in IFRS 9 The IFRS Transition Resource Group for Impairment of Financial Instruments (‘ITG’), on which Grant Thornton is represented, held its third meeting in December to discuss implementation issues arising from IFRS 9’s new impairment requirements. Among the issues discussed were whether IFRS 9 requires the consideration of multiple forward looking scenarios and how the provision for expected credit losses should be presented in the primary financial statements.

 

This was the last scheduled meeting of the ITG, although the group will continue to exist during the implementation timeline. The IASB’s questions submission page will however remain open and it is possible that the receipt of significant additional questions may result in the ITG being reconvened at a later date.