February 2017 - Issue 29
RSM reporting Technical developments in global accounting and reporting.
THE POWER OF BEING UNDERSTOOD AUDIT | TAX | CONSULTING
Welcome
“2017 promises to be a rather momentous year, with international trade being re-shaped on both sides of the Atlantic and in the Pacific regions and with new business models stemming from innovative technology and enterprises. What does this mean for the future of accounting? ”
Dear reader, 2017 promises to be a rather momentous year, with international trade being re-shaped on both sides of the Atlantic and in the Pacific regions and with new business models stemming from innovative technology and enterprises. What does this mean for the future of accounting? In this issue we continue to provide some insight into the foreseeable developments of IFRS in Europe, in conversation with the CEO and Chairman of the Technical Experts Group of EFRAG, Andrew Watchman. We also continue to provide further guidance on the application of IFRS 7 Financial Instruments: Disclosures, with Eckhardt Gerber, from RSM in South Africa, focusing this time on liquidity risk management disclosures. This is a topic particularly timely as many of our readers are currently working on their 2016 Financial Reports. Along these lines, Joelle Moughanni provides ten key reminders for the preparation of 2016 IFRS annual reports. RSM keeps contributing to disseminating good practice on the application of IFRS, in particular by providing technical advice to its member firms’ clients – an example is given at the end of this issue with regard to measuring deferred tax for intangible assets with indefinite useful lives. In addition, RSM regularly contributes to the wider debate and development of IFRS as with the Comment Letter to the Exposure Draft Definition of a Business and Accounting for Previously Held Interests, reported in this issue. Enjoy your reading! Marco
Prof. Marco Mongiello, PhD, ACA m.mongiello@surrey.ac.uk
Andrew Watchman joined EFRAG as CEO and TEG Chairman in April 2016. Prior to joining EFRAG Andrew was the Global Head of IFRS for an interntional accounting firm, leading a team supporting the application of IFRS across the international network and chairing the firm’s global IFRS expert group. Andrew has also served as a member of the IFRS Interpretations Committee and as Accountancy Adviser to the UK’s Department of Trade and Industry (DTI), providing expert advice on public policy in financial reporting and the transition to IFRSs in the UK. Prior to that Andrew spent fourteen years in the audit practice of an international accounting firm, up to partner level.
the future of ifrs in europe - a change of direction ahead? Interview with andrew watchman, efrag teg chairman and ceo by the Editor The development of IFRS in Europe is an ongoing process, which is influenced by many different economic and political forces. One among them is Brexit, with still a fair amount of uncertainty as to when and how1 it will take place and what ramifications it will have on economies worldwide. Therefore, Brexit cannot be ignored in any thought-through insight into the future developments of international financial reporting. Following on from the interview with our previous issue’s guest contributor2, we have now approached Andrew Watchman, CEO and Chairman of the Technical Expert Group (TEG) at the European Financial Reporting Advisory Group (EFRAG), to find out how he sees the future developments in international accounting in the current geopolitical context. Andrew has a very pragmatic view, which he explains as follows: AW: You can envisage a number of scenarios for the development of IFRS in the UK post-Brexit.
Scenario 1: the UK decides to stay with the IFRS as endorsed by the EU. To me this seems an unlikely outcome, as it would need to be part of a broader agreement with the EU to remain part of the single market, which does not seem to be the current direction of travel. Scenario 2: the UK decides to drop IFRS and revert to UK GAAP. However, it would not quite be ‘reverting’ as such
because, although there is a body of UK GAAP for private companies, there is no body of UK GAAP for consolidated financial statements of listed companies. It seems unlikely to me that the UK would opt for some new version of GAAP for listed companies. There is broad consensus in the UK, even between ‘Remainers’ and ‘Brexiteers’, that the UK needs to remain internationally focused and outwards looking. The practical difficulty of creating a hypothetical new version of UK GAAP, and the long-term support that the UK has given to IFRS, makes it unlikely that IFRS would be ditched altogether. I believe that the UK will choose to stay with IFRS, under its own regime of checks and balances, creating two further possible scenarios:
Scenario 3: the UK decides to stay with IFRS as its starting point, but opts for a model similar to the Indian one, which can result in a potentially high number of adaptations. Scenario 4: the UK decides to stay with IFRS, putting in place an ‘adoption’ model subject to a national endorsement mechanism, similarly to the Australian, Canadian and Japanese models, which accept or reject each standard in its entirety. My best forecast is that the UK will embrace this latter scenario, which seems to strike the right balance to reflect the UK’s commitment to IFRS and the benefits of an endorsement mechanism. My opinion may be controversial for some, but I think that it is important to find the right balance between the benefits of relying on expert independent standard setters and the recognition that standards, which essentially have the form of law, need democratic oversight and political legitimacy. When you look around the world at different countries using IFRS, the vast majority have some form of adoption or endorsement mechanism. The details vary enormously. In many cases, there is a strong presumption that in practice every standard or amendment will be endorsed, except in extreme circumstances. One national standard setter based outside Europe described the rejection of an IFRS as the ‘nuclear option’3.
A Supreme Court ruling issued on 24th January 2017 established that the UK Prime Minister must consult Parliament prior to triggering the process of exiting the EU. The consultation took place a few days after and resulted in Parliament allowing the government to proceed. However, the timing and the way are not certain yet. 2 Mark Vaessen, Chairman at Accountancy Europe, formerly known as FEE. 3 Editor’s note: this expression is used also in Europe - see paragraph 8.1 of the ICAEW report ‘Moving to IFRS reporting: seven lessons learned from the European experience’, 2015. 1
Again, the UK has historically had a strong voice advocating for IFRS as issued by the International Accounting Standard Board (IASB). So, if you extrapolate that into the future, you can anticipate that the UK would produce few or no carveouts. But of course carve-outs are a rarity in the EU as well. In reality the occasional differences between IFRS as issued by the IASB and IFRS as endorsed by the EU are usually in the timing of their effective date. EFRAG has sometimes advised that European companies may need more time to prepare for new standards than IASB had allowed. The rarity of carve-outs and rejections is a sign that Europe has been able to exercise influence in the stages leading up to issuing a new standard by the IASB. Therefore, in practice, even if the UK goes for its own endorsement mechanism, I think there will be very little divergence between financial reporting in the UK and financial reporting in the EU. If any divergence does occur, it is more likely to be caused by long-held traditions to which different countries still adhere – and which can create regional and national ‘dialects’ in the application of IFRS. For example, the UK is historically a strong advocate of principle-based standards and the primacy of the true and fair view. Compared to counterparts elsewhere in Europe, UK companies tend to make greater use of the revaluation option in IAS 16 and more often use a ‘box presentation’ approach to show the effects of unusual or nonrecurring items. These tendencies reflect UK GAAP from the pre-IFRS days and these habits sometimes die hard. MM: Will EFRAG and the whole European endorsement process have less clout internationally when the UK is out of it? Will this allow more legitimacy for other countries to adapt the IFRS even more freely? AW: Assuming that the UK has its own version of the IFRS adoption, and is no longer subject to the EU IAS Regulation, the UK’s involvement in EFRAG would certainly change. There is a question over whether the UK will still provide funding to the EFRAG or have a seat on the EFRAG Board and EFRAG TEG. Either way, EFRAG already works with national standard setters from outside the EU. For example, we’ve undertaken projects in co-operation with the national standard setters of the US and Japan. We also have outreach groups, such as the Consultative Forum of Standard Setters, to which we invite the standard setter of Switzerland for example. Hence, I would expect that EFRAG would continue to work with the UK in some form.
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Even if the UK ceased to have any particular interest in the EU endorsement process, I still see scope for working together with the UK in this pre-issuance phase, to pursue a shared interest for the best possible standards. Whatever the UK decides to do, I doubt that Brexit will make too much difference to Europe’s influence over the future development of IFRS. Based on the market capitalisation of quoted companies, the EU without the UK would still be the IASB’s biggest customer in capital market terms – possibly followed by the UK. Add to this the long history of collaboration between EFRAG and the IASB, and I see the outcome of Brexit broadly neutral. Furthermore, if you look at how the IASB and the IFRS Foundation organise themselves, i.e. how the trustees of the IFRS Foundation are allocated geographically, you will notice that the IASB maintains the geographical balance in major geographical blocs. Europe, the Americas and Asia Pacific are treated as single blocs. In a post-Brexit world some might see the EU274 and the UK as separate spheres of influence but it is not clear whether the IASB and the IFRS Foundation would reconsider their geographic groupings. MM: Regardless of Brexit, IFRS is in continuous evolution. Is IFRS going to allow for more comprehensive metrics to evaluate companies’ performance? Perhaps IFRS could include indicators that measure companies’ most significant value drivers, rather than merely showing the profit and cash effects of these drivers. AW: As we move towards a knowledge- and technologybased economy, it is clear that less and less value of the companies is reflected on their balance sheets. Some commentators argue that this trend will lead to the financial statements losing relevance. My personal view may seem paradoxical but I believe the IASB should respond by focusing on the basics rather than trying to capture a greater share of ’value’ on the balance sheet. Value that is not on the balance sheet will come through in profits and cash flows at some point in the future. The comparative advantage of the financial statements over other sources of information is that they provide a reasonably objective and timely summary of the position and performance and are subject to various disciplines: rigorous standards, audit, regulatory oversight, etc.
Editor’s note: EU27 refers to the European Union after Brexit, i.e. currently the EU counts 28 members, but Brexit will bring the total down to 27.
Considerations in preparing and applying IFRS 7 Financial Instruments: Disclosures – A focus on liquidity risk management disclosures A requirement to publish audited financial statements that are reliable, consistent and comparable adds discipline to the dissemination of other types of information that takes place today and will do so increasingly in the future. So, although IFRS should evolve with the times, the focus should remain on providing an understandable, i.e. not unduly complex, summary of financial performance, cash flow and financial position. Financial statements should not anticipate future profits that do not represent assets, i.e. that do not meet certain criteria of control and identifiability and cannot be represented in the financial statements with an appropriate level of certainty. The financial statements are an important source of information that investors use to make their decisions but can only be one part of a wider information set. If the IASB sets out to make the financial statements an even greater part of that overall information set, the outcome could be a huge increase in complexity and a loss of focus on the basic role of financial statements. Companies have other tools to explain their business models, ideas and innovations – such as integrated reporting. These broader value drivers will come through (or will not come through) in the numbers in due course. In that way, financial statements are holding management to account for the messages they have communicated to stakeholders through these other channels, which is consistent with the stewardship role of financial statements.
the existing standards do not cater for? There is a strong argument that this is the case – at least to some extent5. For example, the standards do not define operating profit even though the majority of listed companies report this line item. Many investors crave better insight into financial performance – some measure of core or underlying financial performance, better visibility on items that are usual or nonrecurring and insight on the extent to which performance reflects the actions of management rather than factors outside management’s control such as profits or losses driven by changes in market values6. The IASB has a project on performance reporting: Primary Financial Statements. The better job that financial statements can do in explaining financial performance, the more effective those statements will be in their accountability role, showing how reliable the company is in its ability to communicate how investing in its value drivers, e.g. innovation, translates into future results.
MM: Yet IASB and national standard setters like FRC in the UK are more and more talking about Alternative Performance Measures (APMs), which are not audited. AW: The IASB cannot ignore APMs. However, some of them are entirely non-financial metrics, e.g. customer satisfaction indices that are clearly outside the boundaries of accounting. The IASB’s focus is on alternative measures of financial performance. We need to ask why companies provide these alternative measures. Is it to fulfil a user need that
Editor’s note: this is a wide debate to which EFRAG, too, contributes, see Link Editor’s note: for example the measure ‘replacement cost operating profit’ widely used by reporting entities in the extractive industry, which represents the operating profit excluding the effect of changes that occurred to the price of the underlying natural resource during the reporting period.
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IFRS 7 has seen amendments and improvements since it was issued more than 10 years ago, yet it is often still poorly applied in the preparation of financial statements. Although IFRS 7 is a fairly concise Standard, its requirements are unlikely to be fully appreciated without also studying the application guidance contained in its Appendix B and, to a lesser extent, the information contained in the Standard’s accompanying Implementation Guidance and Basis for Conclusions. Deficiencies in financial instruments risk management disclosures may also result from: risk management policies that are designed using standardised (boilerplate) policy wording that lack the qualitative detail required by IFRS 7;
MM: This is, in my opinion, a comforting conclusion. In a period of high uncertainty, created not just by geopolitical changes but also by fast developments in technology and business models, clarity about the priorities of accounting principles helps investors and users to base their decisions on solid ground.
In summary, my view is that the IASB should focus on the core comparative advantages of the financial statements over other forms or reporting, rather than trying to compete with other forms of reporting.
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by Eckhardt Gerber, RSM in South Africa
risk management policies that address business risks in general as opposed to those risks specific to financial instruments; and preparers of financial statements who lack the operational experience in understanding how the risks related to financial instruments are practically managed. Some of the more common disclosure deficiencies and errors, specifically related to the maturity analysis in respect of liquidity risk management, are discussed below. Current / non-current classification Before the maturity analysis can be prepared, the preparer should ensure that the current / non-current classifications in the Statement of Financial Position (SFP) are in accordance with the provisions of IAS 1. The classification as current or non-current is particularly challenging where the terms have not been agreed on a commercial basis, i.e. loans between related parties either with no stated repayment terms or where repayment is to be agreed between the parties from time to time.7 In these situations, loan liabilities with no stated repayment terms are generally classified as current, because the debtor has no unconditional right to defer payment for at least 12 months after the reporting date. However, a loan 7
Refer to RSM Reporting November 2016 – Issue 28 for a related discussion.
receivable might be classified as non-current to reflect the expectation of recovery rather than the entity’s right to call for repayment.
Example: Company B has received a loan from its holding Company A and, in turn, has advanced the funds as a loan to its own subsidiary Company C. The loan agreements for both loans state ‘no fixed terms of repayment’ and there are no other unusual covenants or restrictions in respect of repayment. Companies A and B do not anticipate calling for or realising their respective loan assets within the foreseeable future. Loan liability in Company B’s separate financial statements: As the loan agreement has no stated terms of repayment, the counterparty (Company A in this situation) could, even if unlikely to do so, call for repayment and the loan should therefore be classified as a current liability by Company B, which does not have an unconditional right to defer payment for at least 12 months after the reporting date. (IAS 1.69(d)) Loan asset in Company B’s separate financial statements: Unless there is an expectation to recover the loan asset within 12 months after the reporting period, it should not be classified as a current asset. The company’s expectation, rather than its right to call for repayment, is relevant when considering loan assets. Company B should therefore classify the loan asset on Company C as noncurrent. (IAS 1.66 (c)) Expected and contractual maturities IFRS 7 specifies that the maturity analysis should disclose the contractual maturities of its derivative and nonderivative financial liabilities. Accordingly, the maturity analysis will reflect the loan liability, in the above example, in the earliest time band presented within the maturity analysis (i.e. within one month) even if the reporting entity does not expect an outflow within the next 12 months.
However, IAS 1.65 encourages information about expected dates of realisation of assets and liabilities in assessing the liquidity of an entity, irrespective of whether assets or liabilities are classified as current or non-current. The recognition of the above loan liability as a current liability in the SFP and again under a current time band in the maturity analysis could potentially imply a significant liquidity risk, though the entity might not be expected to settle the liability for many years to come. In the event that the lender reflects a strong commercial financial position, it may have both the ability and intention in support of disclosures (in the borrower’s financial statements) as follows: 8
“The loan from the [shareholder / group company / related party] does not have fixed terms of repayment. As a consequence, the loan is presented as a current liability as management does not have an unconditional right to defer payment beyond 12 months. The expected maturity of this loan is, however, not expected to be (wholly) within the next 12 months as the lender has both the ability and the stated intention to not call this loan within the next 12 months. Except as noted above, the company expects to pay all financial liabilities on their contractual maturities and expects to meet such cash commitments through cash flows from operating activities and the utilisation of available finance facilities where required.”
Undiscounted cash flows IFRS 7 requires a maturity analysis that shows the remaining contractual maturities of its derivative and non-derivative financial liabilities and a description of how it manages the inherent liquidity risk. These analyses often reflect the discounted cash flows of the contractual maturities rather than the undiscounted cash flows, which are required to be disclosed as described in Appendix B (paragraph B11D) as follows:
Such undiscounted cash flows differ from the amount included in the statement of financial position because the amount in that statement is based on discounted cash flows. When the amount payable is not fixed, the amount disclosed is determined by reference to the conditions existing at the end of the reporting period. For example, when the amount payable varies with changes in an index, the amount disclosed may be based on the level of the index at the end of the period.”
“The contractual amounts disclosed in the maturity analyses as required by paragraph 39(a) and (b) are the contractual undiscounted cash flows, for example:
Therefore, the maturity analysis should disclose the gross lease payments due before deducting the unearned finance charges. Hence, one might conclude that the maturity analysis is essentially a cash flow forecast and to some extent it is but, as noted above, the analysis should present the contractual maturities which may be different to the expected maturities (as used for cash flow forecast purposes) of financial liabilities.
(a) gross lease liabilities (before deducting finance charges); (b) prices specified in forward agreements to purchase financial assets for cash; (c) net amounts for pay-floating/receive-fixed interest rate swaps for which net cash flows are exchanged; (d) contractual amounts to be exchanged in a derivative financial instrument (e.g. a currency swap) for which gross cash flows are exchanged; and (e) gross loan commitments.
Figure 1 – Example of maturity analysis of financial assets and liabilities at Royal Bank of Scotland (Annual Report 2016, p. 308)
Maturity analysis for financial assets Although the maturity analysis is only required for financial liabilities, disclosure is also required for financial assets if that information is necessary to enable users to evaluate the nature and extent of liquidity risk (see an example in Figure 1). This analysis is not always presented where it is necessary to describe how the entity expects to manage its liquidity risk. In situations where the reporting entity has a significant debtor book, the realisation of which is critical to its liquidity management, then to avoid duplication of disclosures the maturity analysis may make reference to the disclosure of the undiscounted cash flows within the trade receivables note. In this case the wording may be as follows:
“Liquidity risk management The maturity analysis presented here excludes financial assets, although the undiscounted cash flows of instalment sale receivables are material to this analysis. The undiscounted cash flows for instalment sale receivables are disclosed in the trade and other receivables note.” Time bands presented within the maturity analysis Another common deficiency is the time bands used for presenting the maturity analysis. A preparer is to determine an appropriate number of time bands, having regard for the nature of the financial instruments presented; for example:
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Editor’s note: these suggested words are purely illustrative and cannot constitute guidance as such.
(a) not later than one month; (b) later than one month and not later than three months; (c) later than three months and not later than one year; and (d) later than one year and not later than five years. In practice, the following time bands are very often used instead: (a) not later than one year; (b) later than one year and not later than five years; (c) later than five years. Time bands used in practice do not always provide information in addition to that which can already be gleaned from the SFP and related notes. Time bands that are too wide may also dilute the value of the maturity analysis as liquidity risk is often more critical in the short term and can generally be managed more easily over the longer term. The inclusion of non-financial instruments in the maturity analysis Although a less frequent occurrence, deferred revenue is sometimes included in the maturity analysis. By definition, deferred revenue does not qualify as a financial liability as it does not give rise to the outflow of cash or another financial asset. Similarly, a prepayment is also not a financial asset. A constructive obligation is not contractual and should therefore be excluded, as well as tax liabilities, as they arise from statute rather than contract. IAS 17, the existing standard on leases, requires the disclosure of commitments in respect of operating leases such as leases for premises, though not in the maturity analysis as operating leases are excluded from the scope of IAS 39 and IFRS 7. With the implementation of IFRS 16, the new standard on leases, these contractual commitments are to be recognised (other than for executory contracts where neither party has performed in terms of the agreement as yet) and are therefore required to be presented separately in the maturity analysis.
Presentation of items of other comprehensive income (OCI): distinction between items that may subsequently be reclassified to profit or loss and those that will not, and level of disaggregation of the items to provide relevant information to users.
TEN Key Reminders for 2016 IFRS Financial Reporting
Calculation and presentation of earning per share (EPS) and related disclosures in accordance with IAS 33: beware in particular of relatively complex computations (e.g. share options and convertible bonds), and reconciling the weighted average number of shares used to calculate basic and diluted EPS. 3. Distinction between equity instruments and financial liabilities
by Joelle Moughanni, RSM This article is of particular interest to preparers and auditors of 2016 financial statements in accordance with IFRS. It highlights some of the most common focus areas that appear to be many regulators’ priorities for 2016 IFRS financial statements. The article aims at identifying 10 financial reporting topics that companies and their auditors should particularly consider when preparing and auditing respectively the IFRS financial statements for the year ended 31 December 2016. Besides these most common priorities, national regulators might set additional enforcement priorities focusing on other relevant topics. 1. Disclosures on the impact of new Standards9 Not surprisingly, disclosures of the impact of the new Standards are one of regulators’ key priorities. In particular, with the effective dates of the new financial instruments, revenue, and leases Standards (IFRS 9, IFRS 15 and IFRS 16 respectively) fast approaching (at the start of 2018 and 2019), regulators expect entities to disclose, in accordance with IAS 8, information about Standards that have been issued but are not yet effective and their potential impacts in the entity’s year-end financial statements. Relevant entity-specific information about the impact of these new Standards should be given and more detailed information about the status or progress of their implementation provided rather than simply stating they are still assessing the impact. As a few aspects of these new Standards represent a significant change to the current ones, they may affect the recognition, measurement and presentation of assets, liabilities, income, expenses and cash flows. Consequently, entities should start preparing for these new Standards now, and some regulators, e.g. the European Securities and Markets Authority (ESMA), have urged entities to push their implementation projects forward. Some of the specific points to consider for 2016 annual financial statements include the following: A detailed description and explanation of how the key concepts included in the new Standards will be implemented and, where relevant, how this differs from the entity’s current accounting policies.
The distinction between debt and equity has long been one of the most complex aspects of IFRS financial reporting. For the several cases where the debt v/s equity assessment requires significant judgement, entities should focus on the general principle in IAS 32: whether the entity has an unconditional right to avoid delivering cash or another financial asset to settle the contractual obligation. However, depending on the terms of the issued instrument, assessing against this criterion may not be straightforward.
An explanation of the timeline for implementing the new Standards, and including which transitional provisions the entity expects to use. If known or reasonably estimable, a quantification of the possible impact of the new Standards. If the quantitative effect is not reasonably estimable, additional qualitative information to provide an understanding of the magnitude of the expected impact on the financial statements.
Some of the specific points to consider for 2016 annual financial statements include the following:
Disclosures of lease commitments already required under IAS 17 are even more relevant as they may assist users in understanding the impact of IFRS 16.
Focus on the general principles in IAS 32 on the distinction between liability and equity
2. Reporting financial performance
Consistent application and disclosure of accounting policies
Regulators continuously stress the importance of providing investors with clear and high quality information on financial performance. Entities are expected to present performance transparently and consistently in the primary financial statements, notes and documents accompanying financial statements.
Transparent disclosure of judgements and characteristics of instruments Presentation of additional line items – if material in the statement of financial position or in the statement of OCI – and disaggregation of all related cash flows in the statement of cash flows.
Some of the specific points to consider for 2016 annual financial statements include the following:
4. Impairment reviews
Where non-GAAP measures have been presented in the financial statements or accompanying documents, whether they have been presented in a transparent and unbiased way.
Impairment is an ongoing area of concern for many entities, and regulators remain focused on it and continue to push for increased transparency in disclosures. Entities holding significant amounts of goodwill and intangibles are at greater risk of a regulatory challenge to their impairment assessments and in particular the related disclosures.
Compliance with the newly effective amendments to IAS 1 relating to presenting additional line items, headings and subtotals in the statement of financial position and in the statement(s) of profit or loss and other comprehensive income.
Some of the specific points to consider for 2016 annual financial statements include the following:
Presentation of segment information ‘through the eyes of management’ in accordance with IFRS 8: segment identification, disclosure of judgements made in aggregating operating segments, reconciliation of total segmental figures to corresponding entity amounts, etc.
For the value-in-use (VIU) model, key assumptions should stand up against external market data, and cash flow growth assumptions should be comparable with upto-date economic forecasts. 11
While IAS 36 requires that the VIU model uses pre-tax cash flows discounted using a pre-tax discount rate, post-tax discount rates and cash flows are often used in practice. If theoretically the end result is the same, the need to consider deferred taxes makes this very complicated to achieve, so that when a post-tax VIU model results in a near miss11 the entity should then determine fair value less costs of disposal. The fair value model must use market participant assumptions (in accordance with IFRS 13), rather than those of management. Disclosure of the key assumptions (those that the recoverable amount is most sensitive to) and related sensitivity analysis (as per IAS 36), as well as disclosure of critical accounting judgements and of key sources of estimation uncertainty (as per IAS 1). 5. Fair value measurement and related disclosures One of the regulators’ recurring areas of interest is entities’ fair value measurement and related disclosures covered by IFRS 13. Some of the specific points to consider for 2016 annual financial statements include the following: The use of observable inputs should be maximised and the use of unobservable inputs minimised. When available, entities should use quoted prices in an active market without any adjustment (i.e. a Level 1 input). Entities should provide relevant information to meet IFRS 13’s objective, including when the fair value is determined by third parties. Entities should provide extensive disclosures as required by IFRS 13: description of the valuation techniques applied, any changes in the valuation techniques and reasons, levels of fair value hierarchy, the inputs used for Levels 2 and 3, the sensitivity to changes in unobservable inputs, whether current use differs from highest and best use, etc. 6. Reporting the effects of taxation Tax may be a complex area, especially for larger, multinational and more complex groups, and reporting of income tax often involves the exercise of significant judgement and estimations. These factors, combined with increased regulatory and media scrutiny of companies’ tax affairs, mean that there is evergrowing demand for transparency in annual reports about a company’s approach to tax, its tax strategy and policies, significant risks arising from tax and the accounting for, and disclosure of, tax. Investors have a heightened interest in wanting to understand the policy decisions made by companies and the impact these have on their current and future accounts. A recent thematic review into tax disclosures
Editor’s note: A near miss occurs when the VIU is not significantly higher than the CV of the cash generating unit
by the Financial Reporting Council (FRC), the UK regulator, highlighted that no FTSE 100 company reviewed stood out as a role model for their tax reporting. Thus, there remains scope for companies to improve (i) on articulating how they account for tax uncertainties, (ii) disclosure of the amounts subject to risk of material change in the following year, (iii) the quality of their effective tax rate reconciliations, and (iv) the transparency in relation to significant judgements and estimations of uncertain tax positions. Some of the specific points to consider for 2016 annual financial statements include the following: Accounting policies related to tax should be clear, specific to the entity’s circumstances and should address all key issues including the recognition and measurement of uncertain tax positions, if relevant. Income tax is a common source of estimation uncertainty, particularly in respect of uncertain tax positions. The disclosure requirements of IAS 1 in this respect, particularly if there is a significant risk of material adjustment in the next financial year, should be applied carefully and should include quantitative information, such as sensitivities or ranges of possible outcomes. IAS 12 requires an entity to disclose an effective taxrate reconciliation to explain the relationship between the total tax expense and profit before tax for the year. This reconciliation should provide clear information about the key factors affecting the effective tax rate and its sustainability in the future, including the nature of reconciling items and why they have arisen, distinguishing clearly between significant one-off or unusual items and those that are expected to recur. Entities are required to disclose the judgements made and evidence that supports the recognition of deferred tax assets derived from deductible temporary tax differences and unused tax losses. In many cases, the assessment as to whether the entity will generate future taxable income involves the use of significant judgement, for example the time period considered (which should be based on the facts and circumstances of the entity rather than an arbitrary limit), tax-planning strategies, impact of future contracts, etc. 7. Debt restructurings Restructuring of issued debt instruments is a complex area of accounting which can require significant judgement. Some of the specific points to remember for 2016 annual financial statements include the following: Determining whether the new and old debt have substantially different terms. Under IAS 39, where a
financial liability is exchanged or its terms are modified but the liability remains between the same borrower and the same lender, it is necessary to assess if the terms are substantially different. If they are substantially different, the transaction should be accounted for as an extinguishment of the original financial liability and the recognition of a new financial liability. Treatment of gain or loss on modification/ extinguishment. Treatment of fees incurred as part of the renegotiation – whether the fees should be recognised immediately or whether they can be capitalised. 8. Disclosing the effect of judgements, risks and uncertainties Regulators and users of annual reports expect more and more entities to provide them with appropriate insight into the risks and uncertainties they are facing and the judgements that have been made in preparing financial information. In particular, the disclosure of accounting policies should be sufficiently specific and granular to enable users to understand the choices and judgements made by the entity and the financial information provided in an annual report overall. The completeness of accounting policy disclosures should also be considered, particularly when dealing with a significant ‘one-off’ transaction such as the transfer of a business to an associate or an issue that has arisen for the first time (for example, a pension surplus in a scheme previously always in deficit). It is easy, while focusing on developing a proper accounting treatment, to overlook the need to properly disclose that new accounting policy. 12 In addition, the disclosures required by IAS 1 on critical judgements and sources of estimation uncertainty should be clear and entity specific. In particular, the quantitative elements of disclosures on estimation uncertainty should not be overlooked, as IAS 1 requires disclosure of the nature and carrying amount of assets and liabilities for which estimation uncertainty gives rise to a significant risk of material adjustment in the next financial year. The following disclosures might, alone or in combination, fulfil these requirements: (i) the nature of the assumption or other estimation uncertainty, (ii) the sensitivity of the carrying amounts of assets and liabilities to the methods, assumptions and estimates used in calculating those amounts, (iii) if resolution of an uncertainty is expected in the next financial year, that fact and the range of reasonably possible outcomes, and (iv) if an uncertainty remains unresolved, an explanation of any changes made to past assumptions. IFRS also include specific requirements for disclosure on assumptions used and uncertainties arising in specific areas,
such as for fair value measurement, recoverable amounts of assets or cash-generating units for impairment testing, sensitivity analyses, etc.
impairment of assets including exploration and evaluation costs capitalised under IFRS 6), but also on other entities such as airlines with oil being a key part of their costs.
9. The impact of market volatility
10. Entities potentially affected by Brexit
The current pervading political and economic uncertainty has translated to volatility in international markets and can have a number of direct and indirect effects on financial statements.
Taking into consideration the relevance of the UK’s referendum to leave the EU for many entities in Europe and also outside Europe (in particular the many multinationals doing business with the UK), entities potentially affected by the result are expected to assess and disclose the accounting implications of UK’s Brexit decision, the associated risks, and the expected impacts and uncertainties on their business activities.
Currency exchange rates - The most striking effect of the Brexit vote on the markets has been a significant fall in the value of Sterling (GBP) against other major currencies. This has significant direct effects in terms of the level of gains and losses on the translation of GBP balances into other currencies or, for entities with a GBP functional currency, of balances denominated in other currencies into GBP, and the translation of foreign operations. Also, it is important to consider whether the use of an average rate for translation of either foreign currency transactions or the income and expenses of a foreign operation remains appropriate given the level of volatility in exchange rates, or whether such an average needs to be adjusted to reflect the timing of transactions within the reporting period. Given the potential significant increase in the size of foreign currency movements, it should also be considered whether that effect should be given additional prominence in reporting the results for the year. In addition, items which may previously have been small (such as the effect of exchange rate changes in cash and cash equivalents reported at the bottom of a statement of cash flows) could now be much larger and thus subject to additional focus. Besides other effects, foreign currency movements could have an effect on financial instrument risk disclosures (e.g. it may be necessary to reassess the level of exchange rate movement that is considered ‘reasonably possible’ for the purposes of the sensitivity analysis required by IFRS 7), and on cash flow forecasts for impairment or going concern review purposes. Interest rates - Prevailing interest rates in many jurisdictions are low (even negative in some cases). As well as affecting the income or expense generated by lending or borrowing activities, market interest rates underpin the discounting applied across a variety of balances, such as defined benefit obligations (IAS 19), valuation of share-based payments (IFRS 2), long-term provisions (IAS 37), a value in use calculation (IAS 36), etc. Here again, sensitivity disclosures may be needed where a change in interest rates could have a significant effect. Commodity prices – Low commodity prices throughout 2016 had an impact in many industries, the most direct being in the extractive industry (particularly in respect of
The biggest immediate accounting impact for 2016 reporting should be disclosure to explain judgements and risks. Valuations, measurements and impairment calculations that use market inputs should also be updated. Some of the specific points to consider include: Critical judgements, sensitivities and risk exposures might have been significantly impacted by the potential economic consequences of Brexit. The extent of disclosures regarding estimation uncertainty might need to be increased. For example, more items would now be subject to a significant risk that the carrying amount might change materially within the next year. The disclosures regarding risks and uncertainties should include commentary on the potential impact of Brexit, although the full impact might not yet be clear. Management should assess the entity’s ability to continue as a going concern. Cash flow forecasts might need to be updated to reflect the potential impact of the referendum, and uncertainties over going concern should be disclosed. Review of specific contract terms (potentially) impacted by Brexit, including possible termination clauses. Assessment of covenants’ terms to identify any breaches as a result of changes in the value of assets and liabilities. Effect of increased volatility post-referendum on financial risks disclosure in accordance with IFRS 7: credit risk, liquidity risk, currency risk, and other price risks. Impairment assessments - For example, entities should assess if relevant triggers for the recognition of impairment losses in financial assets related to the significant or prolonged criteria in IAS 39 are met and/or if the recoverable amounts determined in accordance with IAS 36 decrease significantly.
We focused on:
We commented on:
… measuring deferred tax for intangible assets with indefinite useful lives
… Definition of a Business / Previously Held Interests in a Joint Operation
What is the issue?
What is the current state of the project?
Company XYZ is seeking advice for measuring deferred tax on an acquired trademark with an indefinite useful life, in particular on how to determine the expected manner of recovery of the intangible asset: should it be assumed, applying IAS 12.51B, that the carrying amount of such intangible asset with an indefinite useful life will be recovered through sale?
The Exposure Draft Definition of a Business and Accounting for Previously Held Interests (Proposed amendments to IFRS 3 and IFRS 11) (‘the ED’), issued on 28 June 2016, aims at clarifying (i) the definition of a business as opposed to a group of assets, and (ii) the accounting for previously held interests if acquiring control or joint control of a business that is a joint operation. Comments on the ED were requested by 31 October 2016.
What is the proposed solution?
What did RSM say on the ED?
Applying IAS 12 Income Taxes (paragraph 51), XYZ should reflect in the measurement of its deferred tax liabilities and assets the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover the carrying amount of the intangible asset.
use or sale of the asset. Thus, the recovery of the carrying amount of an asset does not depend on whether the asset is amortised. Therefore, the fact that an intangible asset with an indefinite useful life is not amortised does not necessarily mean that the entity will recover the carrying amount of that asset only through sale and not through use.
However, XYZ should not apply paragraph 51B of IAS 12 which requires the measurement of the deferred tax liability or asset that arises from a non-depreciable asset measured using the revaluation model in IAS 16 Property, Plant and Equipment to reflect the tax consequences of recovering the carrying amount of the nondepreciable asset through sale.
Therefore, XYZ is required to apply paragraphs 51 and 51A of IAS 12 in determining the expected manner of recovery of the carrying amount of its intangible asset with an indefinite useful life, and reflect the tax consequences that follow from that expected manner of recovery. Based on the specific facts and circumstances, XYZ may determine that the carrying amount of the trademark will be recovered through sale. In this case, the measurement of the deferred tax asset or liability will reflect the tax consequences of recovering the carrying amount of the asset through sale, which is similar to the treatment required applying paragraph 51B of IAS 12 for nondepreciable assets measured using the revaluation model in IAS 16. However, an entity should determine the manner of recovery based on the specific facts and circumstances when applying the requirements of paragraphs 51 and 51A of IAS 12, but should not assume that the carrying amount of an intangible asset with an indefinite useful life will be recovered only through sale.
This is because an intangible asset with an indefinite useful life is not a non-depreciable asset as envisaged by paragraph 51B of IAS 12. Since a non-depreciable asset has an unlimited (or infinite) life, and IAS 38 Intangible Assets explains that indefinite does not mean infinite, paragraph 51B of IAS 12 does not apply to XYZ’s trademark. According to IAS 38, the reason an intangible asset is not depreciated is not because it has an unlimited useful life, but rather because there is no foreseeable limit on the period during which an entity expects to consume the future economic benefits embodied in the asset. The carrying amount of an asset is recovered in the form of economic benefits that flow to the entity in future periods, which could be through
Regarding acquisitions of interests in businesses that are joint operations, we agreed with the proposed clarifying amendments to IFRS 3 Business Combinations and IFRS 11 Joint Arrangements as they are consistent with existing principles. In particular, previously held interests in the assets and liabilities of a joint operation should be remeasured on obtaining control (similar to a business combination achieved in stages), and not remeasured if obtaining joint control. Concerning the guidance on the definition of a business, we agreed overall with the proposed amendments to IFRS 3 as they provide a more comprehensive and pragmatic framework to help determine when an acquired set of assets and activities is a business, thus addressing some of the current assessment challenges. However, we proposed further enhancing clarifications. In particular, we supported the introduction of a screening test based as a first step on an assessment of concentration of fair value as described in the ED, in order to avoid unnecessary further analysis. However, we are of the opinion that if substantially all the fair value of the gross assets is concentrated in a single asset or group of similar assets, then that is an indicator that
the acquired set is not a business, but is not determinative on its own, as this might not give the right result in all practical circumstances. Therefore, we recommended that the ED be redrafted to make this a rebuttable presumption, instead of a firm determinative conclusion. In addition, we recommended that the IASB articulates in a more principle-based manner when assets can be deemed similar for this purpose, clarifying for example that the assets should be highly interrelated and their nature, risks and characteristics should be similar. View the full comment letter.
Global Contacts Americas
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Richard Stuart T +1 203 905 5027 E richard.stuart@rsmus.com
Chandra Sekaran T +965 2245 2680 E chandra.sekaran@rsm.com.kw
Europe
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Nicky Warburton T +44 1772 216000 E nicky.warburton@rsmuk.com
Simon Fisher T +254 20 4451747/8/9 E sfisher@rsm-ea.com
Asia Pacific
RSM Global Executive Office – UK
Gary Stevenson T +852 2598 5123 E garystevenson@rsmhk.com
David Carlisle T +44 20 7601 1080 E david.carlisle@rsm.global
Editor Prof. Marco Mongiello ACA Deputy Head of School Executive Director MBA and MSc Programmes Surrey Business School T +44 01483 683995 E m.mongiello@surrey.ac.uk
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