July 2016 - Issue 28
RSM reporting Technical developments in global accounting and reporting.
THE POWER OF BEING UNDERSTOOD AUDIT | TAX | CONSULTING
Welcome Dear reader, In this issue we bring to the fore the important debate about the changes in the role of our profession. Technology and business models have profound effects on our profession, making certain features of the accountant’s role less distinctive and others much more relevant. In the opinion of Michael Wells, former Head of the IFRS Global Education Initiative, there is no doubt that these changes are relieving our profession of its clerical aspects, while the more professional components gain ever more importance. Michael’s emphasis on the importance of professional judgement is echoed by Henric Larsolle, who shares with us his insight into the practical application of IFRS 8 Operating Segments in small and medium-sized enterprises. Henric’s analysis of a large sample of companies results in some remarkable findings in terms of lack of commonality in the interpretation of this Standard. Also in this issue, Joelle Moughanni sheds light on the application of IFRS 16, the new Leases Standard, providing practical and well-supported answers to 16 questions about its application. RSM keeps contributing to disseminating good practices on the application of IFRSs, in particular by providing technical advice to its member firms’ clients. An example of this is given at the end of this issue on the allocation of an impairment loss to non-current assets within a disposal group. Enjoy your reading! Marco
Dr Marco Mongiello ACA m.mongiello@surrey.ac.uk
“the changes in the role of our profession. Technology and business models have profound effects on our profession, making certain features of the accountant’s role less distinctive and others much more relevant. ”
Michael Wells is an independent accounting education and training consultant working with development agencies, business schools, academic and professional accounting associations and others to deepen understanding of international financial reporting requirements and fostering capacity to make/audit/regulate the judgements necessary to apply them. For over a decade, he led the International Accounting Standards Board (IASB) Education Initiative developing the Framework-based approach for teaching International Financial Reporting Standards (IFRS) and spreading it across the world. He qualified as a South African Chartered Accountant with Ernst & Young (now EY) before being seconded to work out of the firm’s Detroit office. He subsequently joined the academic world and became the Associate Professor responsible for the inancial reporting section of a South African University.
A conversation with Michael Wells on the future of the accounting profession by Marco Mongiello, Editor Many among us may sense that the combination of technological developments, financial market innovation and changes in business models impacts our profession more than ever before. This may well make the profession all the more interesting, but it also creates some dissonance with the wider perception of accountants, which often associates us with conservative principles and unchanging techniques. It is therefore timely that we debate whether we should embrace ‘change’ to successfully drive accounting into the future before ‘change’ becomes imposed on us as a necessity, in order to maintain our highly impactful role in advancing firms’ good stewardship. This debate needs many contributors, from many jurisdictions and from the different roles that constitute our profession. So, I thought we should start by discussing the matter with the person who has been, for the best part of the last decade, at the heart of how accounting is to be understood, taught and learnt globally – Michael Wells, who was kindly willing to share with us his point of view. MM: What is brewing in the debate on the future of our profession? MW: For nearly a decade I served on the Consultative Advisory Group (CAG) that advises the International Federation of Accountants (IFAC) and the International Accounting Education Standard Board (IAESB) that set the International Education Standards (IESs) for the accounting profession. We had very good debates at the CAG about the qualities that are needed today, i.e. what qualities a professional accountant should have and how they have evolved over time. I believe that IAESB has effectively 1 2
He serves on a number of international accounting education advisory groups including the International Association for Accounting Education and Research (IAAER) Board of Advisors and the American Accounting Association (AAA) Education Committee. For nearly a decade he served as a member of the International Federation of Accountants (IFAC) International Accounting Education Standards Board (IAESB) Consultative Advisory Group (CAG). He also served as an independent evaluator of professional qualifying examinations. updated the IESs, moving from an input-based approach to a more competence-based approach, driven by some real champions of the new approach. Among them, the Canadians are a great example of a profession that leads by mapping the competencies that an accountant needs today and then aligns the professional qualification accordingly to produce accountants who have those qualities. Their work is built on by others too. The South Africans, for example, embraced the Canadian competence-based approach when they realigned their professional qualification. In the US too, there is a Pathways Commission1 that is doing ground-breaking work; this is changing the view of what accountants do and the qualities that aspirant professional accountants need to develop to excel. If we ask the average person in the street ‘what is an accountant?’ the picture they have in their mind is usually the grey boring old ‘bean counter’. Today, the qualities of an accountant are necessarily very different. Part of the work of the Pathways Commission2 is to change the image of the accountant, but of course, this requires changing the way we produce accountants so that they have the skills that businesses need today. The main drivers of change are technology and, perhaps to a lesser extent, globalisation. Just before this interview you paid for our coffees using your iPhone; all the bookkeeping of that purchase has been automatically captured by the technology that enables the contactless transaction, and that was a very small coffee shop. At Tesco [a major international supermarket chain], when I do my grocery shopping I use a hand-held scanner to
The Pathways Commission on Accounting Higher Education was created by the American Accounting Association (AAA) and the American Institute of CPAs. See their full report here.
scan the products I put in my basket. All the bookkeeping is done by the system. The days of bookkeeping are gone. Too many people in the education of accounting are still training bookkeepers though. This is not to say that people should not know how to do journal entries, but the real skills that accountants need for the future (and even today) are the ability to make judgements and estimates, and the ability to apply principle-based standards. The skill set has changed a lot; there were a great number of people in the accounting profession whose jobs involved mainly bookkeeping, and I think those jobs are gone. The good thing for us accountants is that we will no longer be seen as ‘bean counters’, because there is no more bean counting left to be done! The real job of the profession is now based on higher level skills, making judgements and estimates, understanding the economics of a transaction and then making sure that the accounts reflect the economics. I think that it is a much more exciting time to be an accountant now! The image of the accountant is lagging behind the role of the accountant. Some of the institutes in the world are battling to re-align their education to the needs of the market, and it is not an easy thing to do. If, for example, you come from a system that mass-produces accountants, and you rely on machine marking multiple-choice questions then those are environments that make it difficult to change. But some of the institutions at the higher end of the profession have not focused on mass production of accountants. I think that they have the competitive advantage of becoming much better in the future because they are already effectively providing skills that the market demands. Some parts of the world through globalisation have received a disproportionate share of bookkeeping through outsourcing; in those jurisdictions people feel that there is an increased demand for bookkeeping, but this is just temporary. In the same way bookkeeping is disappearing today in the UK, it will disappear tomorrow from those jurisdictions that currently do the outsourcing because the technology is changing very effectively and the outsourcing is creating a temporary distortion that could lead some jurisdictions to develop large numbers of bookkeepers. And the last thing a professional institute should do is to produce bookkeepers who will not get jobs! Some of the research that has been done by the biggest professions in the world is about how to respond to changes.
The American Institute, for example, looked at how they should revise their qualifying examinations to provide the skills that are more appropriate to today’s market. However, I think they found it difficult to fully implement the recommendations that flow from their research, because it is difficult to change one’s model. Introducing innovations like capstone multidisciplinary case studies and testing high-order skills (like judgements and estimates) when using machine grading systems is difficult. The education technology is lagging behind, in terms of producing tests that can assess judgements and estimates. Maybe the technology, in time, will be able to assess judgements and estimates, but the technology does not seem to be there yet. There is such a human element in judgement, because economic transactions can be very dynamic. How I see it is that you will not be training drivers when driverless cars will be common technology; similarly we should not be training bookkeepers if soon there will not be any bookkeeping left to do! Rather, for the foreseeable future, accountants need more and more high-order skills in data-mining and analyses and in making judgements and estimates. MM: Are there two levels of judgement? One level applied by the preparers of the accounts and the other applied by the users for the interpretation of the accounts? MW: The preparer makes judgements in preparing the accounts. The auditor audits those judgements. The regulator regulates those judgements. The user has to understand those judgements, so that when they apply their own modelling, they understand what those judgements mean and put them in context with other analyses. It’s a judgements continuum and the users have to use that extra layer of judgement on, for example, what the future economy is going to look like, what the development of technology will be and all of those other aspects that can affect the firm’s performance. MM: So, preparers, auditors and regulators have to apply their judgement while keeping in mind the final users of the accounts. However, nowadays many companies that are heralded among the most successful globally, show remarkably low profits (if not losses) and may struggle even to return significantly positive cash flows. Are these companies’ accounts apt to support analysis and evaluation of corporate performance?
MW: Well, there is more to it. Take a company like Apple, they outsource everything. In the traditional model of manufacturing your main asset would be your factory. This is no longer the case; now your main assets are intangible, and accounting fails on intangible assets, because most of them are off the books.3 For accounting to be moving with the times, and for accounting to provide information that is most relevant to the end users, it needs to capture more of the economics, because, as you say, with the evolution of time it is not the physical easy-to-measure assets that are the main assets. The main assets are intangible and off their books. I think it is a failing of accounting that these are not captured in the reporting, because the end user has to, almost in a vacuum, try to make their own estimation of the value of those things. So, if the company was required to provide their view, their quantification, of the market perspective of what those assets are worth, showing what the process was that they used for that calculation, the user would have much more information to try and make their own estimates on the basis of the inputs that are provided by the company. Currently there is just no information!4 MM: Following up on your example of Apple, I would add that not only is the production almost completely outsourced, but also the product itself is not a product in the traditional meaning of the word; it is a platform that enables services to be exchanged by third parties, which often have nothing to do with Apple. This makes the estimate of the value of the product even more difficult. MW: If we want financial information to be useful, which is the purpose of what we are doing, I think that we are due to make changes in what is on the balance sheet. Some of these things are fairly difficult to measure and the measurements are not precise, but that makes it all the more important that information is provided in financial statements on these most important things! Many people will argue that what we cannot do so precisely, and what’s not ‘reliable’, should not be reported, but I think we should focus on relevance, and put it on the balance sheet and disclose the inputs used so that users can make their own assessments of the judgements and estimates. My feeling is that if you get preparers to provide all the relevant inputs, they may as well also provide their own estimate of the value, as this would help the users to understand more about the management, given that the managers’ decisions will be based on those evaluations. Also, in this way the users may adjust the inputs according to their
own understanding and, therefore, compare the results they find with those of the managers. Furthermore, changing the inputs and reflecting on the reasons for these changes help understanding how the economics have changed from one period to another period; the users have a view of how the inputs should have changed from one period to the other and they will question why preparers have used different inputs in different periods. All of this is good and valuable information. It is not the final number that is so important, it is the richness of the data that sits behind that number that is most valuable. Paragraph 125 of IAS 1 requires disclosure of the most sensitive measurement assumptions (key sources of estimation uncertainty), so that you, me and the other readers can use them and make a judgement and understand them. How this input information changes over time is very important but you can also use it to compare across companies in the same industry. You can compare Volkswagen, Toyota and General Motors and ask why this one is using these inputs instead of those. Why is one using this model and another using another model when they are essentially in the same global market? Of course, comparison would be even more meaningful if all companies in the motor vehicle sector prepared their financial information using the same set of international standards. This point, I understand, Ford has expended a great deal of energy in making. No matter how the image of a car brand can be ‘dressed up’ to appear to be different from another, essentially the products, the cars, I think are all essentially the same (this is perhaps why the adverts of cars are all about feelings and image, rather than the technical differences). MM: I remember reflecting with my students, quite a few years ago, on the income statement of British Airways, which was showing a long and detailed list of costs below its turnover lines of revenues from cargo and passengers. They would show all these costs as an implicit invite to the users to make their own calculation of gross profit and different levels of operating profit. My students and I reckoned, at the time, that this was determined by the elusive concept of service provided by airliners; was it just taking people or goods from A to B, everything else being administrative ancillary services, or were all these other services embedded in the main service? The choice of BA’s accountants seemed to be, at the time, to let the users decide.
Editor’s note: this is a moot point that surely will spark some debate among our readers, since many intangible assets are indeed in the balance sheet (face of the accounts), but not necessarily supported in the notes by sufficient information to grasp the way they have been valued. 4 Editor’s note: see previous note. 3
MW: It makes a lot of sense to me and that is the reason why we [accountants] do not [have to] specify gross profit. For example, if you are in the agriculture business, you will realise that you must show the fair value of your biological assets. You show the fair value change at the time when it changes, not at the point of sale and this makes a lot of sense to me. Car manufacturers, by way of contrast, report gross profit when they sell a car. However, I think that there is real economics that happen when they take the raw material and the labour and transform them into a car. I think that this is where most of the value comes from. They are recognising no income from the compilation of these inputs and they recognise all of the profit at the time of sale; essentially saying that it is the sale activity that generates all the profit is simply not true! In agriculture they reflect the increase in value of the biological assets as it transforms; how different is a biological transformation from the transformation of raw materials into finished products, like building a car? I think there is little difference, but we have for so long been used to recognising profit only when sales occur that people might find it strange to recognise profit as the fair value of inventories change. Why do we not recognise the value when it is created? That is indeed a change in an asset! MM: Are these reflections driven by the changes in business models and technology or would they have been applicable years ago, in the context of more traditional economies? MW: I think we should have always done things differently. I think that what we did historically did not reflect the economics. I grew up in a farming family. We were required to do tax reporting. However, my father and uncle were in partnership and many times I heard them discussing: “how much could we sell this or that asset, or everything that we have accumulated in the business?” They were always looking at the fair value. Using the historical cost would have been completely meaningless. The fact that we have been doing accounting mainly using historical costs does not mean that we should continue doing it that way. In addition, markets have become more developed, and the more developed markets are, the easier it is to estimate fair value. Anyway, I do not think that if something is difficult, that is a good reason for not doing it. Lots of people have in their minds that accounting should just reflect what is certain, but there is little that is certain – everything is an estimate. If you use historical cost accounting for a machine, you must:
5
Editor’s note: ‘noise’ as in statistics for ‘unexplained variations or errors’.
(i) determine the depreciation method that most closely reflects how the entity consumes that machine’s service potential; (ii) identify significant components that have a consumption pattern different from other components of the machine; (iii) estimate the machine’s useful life; and (iv) estimate its residual value. Remember, residual value is essentially the fair value of an older asset. Moreover, when using the cost model impairment testing involves at least the same, if not more, judgement than fair value because you must estimate value in use and fair value less costs to sell. And on top of that, you must keep track of what the depreciated historical cost would be for the purposes of accounting for the reversal of prior period impairments. So, the argument that there is more subjectivity in fair value accounting than historical cost accounting to me is nonsense. MM: From the users’ point of view, having to analyse so much more information may become difficult, unless technology can help. MW: The most important thing is that the relevant information (numbers and words) is reported. Users particularly need information about the most sensitive judgements and the most sensitive measurement inputs. The value added is in forming a view on how that data will change as the economics changes going forward. One of the dangers is that some people may be tempted to crunch all sorts of information and try to give them a meaning they do not have. You can crunch as much irrelevant information as you like but if it is rubbish in, it is rubbish out. What you need is good quality information coming in and then good modelling for good quality information to come out. This is why taking ratios from databases, which pretend that the operating profit of different companies have the same meaning, is dangerous and can lead to wrong conclusions being drawn. Even if you adjust the numbers for exceptional items, discontinued operations and other data that you may think is ‘noise’5, what is the quality of that number anyway if, for example, one company is revaluing its assets using revaluation and depreciation and another is using the historical
cost depreciation? You cannot use those two operating numbers in a very comparable way. They are very different. When you have done revaluation, the depreciation has economic relevance, whereas the historical cost depreciation can be totally irrelevant and you are not necessarily provided with the information needed to adjust the irrelevant one to the meaningful one. Depreciation reflects the consumption of service potential. When the asset is measured at fair value, you are showing a relevant economic consumption. Whereas the historical cost depreciation will show assumptions of the service potential but it is, if significant price changes have occurred, just an allocation of a now irrelevant number and that can be misleading. For example, when using the cost model, if you have two companies that manufacture cars, where one went to an emerging economy first to establish a factory at a relatively low cost and the other followed soon after when the cost of establishing a factory had become much higher, you may find that the first company reports selling cars profitably at prices significantly below the cost at which the second manufacturer can build its cars. This is rubbish! If the first company was to revalue their factory and therefore reflect in their depreciation real economic consumption, it would come out that they are losing money! Of course, it can be economically rational to sell cars below cost to penetrate a market, but to pretend in the accounting that you are making a profit when you are making an economic loss is just pretend! You are giving away revenue to get market share. A numerical example: I spend one million dollars building a car-making factory in a country that has significant car import tariffs. Subsequently, due to great improvement in the economy of the country, competitors also want a car factory there. Competitors come along and offer to buy my factory for four million. I reject their offers and a competitor builds a factory just like mine but costing four million. Now we are competing; in an attempt to stave off the competition I drop the price at which I sell cars to below the cost at which my competitor can manufacture its cars. The competitor sells its cars at that price too. If I use the cost model I show a healthy gross profit; if I use the revaluation model I, like my competitor, show a loss for every car that I sell. The cost model ignores the economics that both the competitor and I are consuming a four million factory! This is the craziness; IFRS allows me to show the profit or to show the loss. I can choose to pretend. IFRS also allows me to provide information that reflects the economics of a business and
therefore I can choose to provide more relevant information, yet some companies still choose to pretend. I like to think that good companies will choose to show the economics. Why would they want to pretend? MM: So to ensure that we develop our profession in the right direction, to be relevant in the future, what should we do? MW: We should be developing the ability to make judgements and estimates, because that is what the accountants of tomorrow must be able to master. There will be no jobs for the bookkeepers; the machines have replaced the bookkeepers! Where the accountants will make a difference will be to make the judgements and estimates that are necessary to prepare, to audit, to regulate and to use the information. There will need to be more emphasis on valuation in the qualification of accountants, less emphasis on bookkeeping, more emphasis on understanding the economics, more emphasis on decision-making, more emphasis on sensitivity analysis, more judgements and estimates focus, and less focus on routine bookkeeping. The key is the integration of different subjects like finance, because being able to value something requires finance techniques.6 MM: …but also other subjects, which enable an understanding of the economic environment, the market potential of assets. MW: Certainly: fair value is pervasive of many aspects of accounting. Take financial assets - even for those financial assets measured using a cost model, their fair value must be disclosed in the notes. MM: The same goes with marketing, human resources, strategy, innovation and any subject that helps the accountants to gain a firmer grasp of the economics of a business and a better insight into the rationale underpinning its managers’ choices. The accountants will then be better equipped to rely on fully informed professional judgement and they will make estimates that truly reflect the intention of the company’s managers. Moreover, the accountants will provide the users with explanations of both judgements and estimates that really shed light on the economics of firms, helping the users to confidently navigate the challenging waters of fast-changing business models and markets. In one sentence: lots of excitement ahead for our profession!
Editor’s note: although it is refreshing to notice that many professional bodies in Europe, the US, Canada and Australia and others do include a range of integrated subjects in their curricula, Michael Wells’ sobering observation makes us reflect on the differences in approach in many other places in the world.
6
Aggregation of operating segments – tendencies among public companies By Henric Larsolle7, RSM Sweden In this article I present a review of the annual reports of 97 publically traded entities on the Small- and Mid-Cap list of NASDAQ OMX Nordic Exchange in Stockholm for the financial year 2015.8 The focus of my review has been disclosures on operating segments, as I find this to be a topic of continuous debate. Key focus areas have been on the definition of the Chief Operating Decision Maker, aggregation of operating segments and a qualitative analysis of entities that report only one segment (‘one-segment entities’). In my review I addressed the following questions: What argument do listed entities use when aggregating operating segments? Who is identified as the Chief Operating Decision Maker (‘CODM’)? What impact might the determination of CODM have on the definition of reportable segments?
Introduction The core principle of the standard on segment reporting (IFRS 8) emphasises the importance of segment disclosures that enables users of the financial statements to evaluate the nature and financial effects of the operations, and the economic environment in which an entity operates. The method for determining what information to report is referred to as the ‘management approach’. The management approach is based on the way that management organises the segments within the entity for making operating decisions and assessing performance. In spite of the number of years IFRS 8 has been in place, it continues to constitute a challenge for many preparers and is still a topic subject frequently discussed among preparers, auditors and users of financial information. Aggregation of operating segments is one of the more judgmental areas9 of operating segments disclosures. The principle of aggregation is that separate reporting will not add significantly to the understanding of a segment, if the segments have characteristics that are so similar that they
The author is an IFRS technical consultant within RSM Sweden. The views expressed herein are those of the author and do not necessarily reflect the views of RSM Stockholm AB nor the views of any other member firm or staff member within the RSM network. 8 The entities subject to our review have been Midcap and Small cap entities on the NASDAQ OMX Stockholm. 9 The topic of professional judgement is addressed in this newsletter by Mike Wells 7
are expected to have the same future outcome. However, meeting all the aggregation criteria is a rather high hurdle. In my experience I noticed that most entities will have more than one operating segment and fewer than ten, if the core principle is applied to the letter and when evaluating the financial information actually available – but possibly not always included in the CODM report, i.e. the reports on which the management monitors and makes decisions about the operations. I have intentionally excluded the large cap list in this review and focused on the small- and mid-sized publically traded entities. Key data that I have reviewed are disclosures regarding identification and description of the CODM and the number of segments disclosed. I have given the ‘one-segment’ entities extra focus, to evaluate if it would have been helpful to read about the operations with less aggregated information. I also have tried to understand the rationales of the one-segment entities for aggregating operating segments into one. Summary of the review Based on my review I found a mix of good and lower quality examples of segment disclosures. A review of annual reports is limited in the sense that the management arguments for how to display segments are not fully disclosed. Entities reviewed by industry and by listing: Small cap
Mid cap
Total
Consumer goods
3
4
7
Consumer services
5
3
8
Financials
4
10
14
Health care
14
6
20
Industrials
18
9
27
Materials
3
0
3
Oil and gas
0
1
1
Technology
13
2
15
Telecom
2
0
2
Total
62
35
97
To my surprise I found a large number of entities displaying only one segment; in total, 37 companies of the 97 I looked at disclosed only one segment. Among the one-segment entities, there were several with international operations, and/ or several product/service lines. Many companies also held subsidiaries in more than one country. ‘Global operations with major geographic differences’ is a quote I found in one of the entities as a headline in the beginning of the annual report. The entity reported its operations as one segment. This is a group with subsidiaries in 16 countries spread over four continents.
A common argument I have found for reporting only one segment is that the operations are monitored at group level. The generic arguments keep coming back, with slight variations. An example that is recurring, with more or less the same content, is: ‘The company has to identify the level at which the company’s most senior executive decision-maker makes regular reviews of sales and operating income. These levels are defined as segments. The company’s most senior executive decisionmaker is the company’s CEO. The regular internal reporting of income to the CEO, which fulfils the criteria to constitute a segment, is done for the Group as a whole, and we therefore report the total Group as the company’s only segment.’ The quote above is collected from a company that operates in 14 countries, promoting at least two different sets of products. The question that might come to one’s mind is ‘Shouldn’t this company monitor and evaluate their operations in more detail than at group level?’. Another interesting argument for disclosing only one segment is: ‘The Company’s top executive decision-makers govern and manage the operations based on legal corporations. The number of legal corporations within the Company is about 60, and so, according to the IFRS 8 standard, the Group has that number of segments. Because the presentation of 60 segments would entail excessively detailed information, the standard proposes aggregating these at a suitable level if there are similar economic characteristics and the segments resemble one another. We cannot see how such an aggregation, into no more than ten segments, could be done so that the information was comprehensible. Thus the Company has chosen to aggregate all segments into a main segment.’ In this case the rationale for displaying only one segment is that each operating segment is so different in character that aggregation is not possible. The CODM in this entity was not clearly identified, which might be a factor for not monitoring the operations on a more aggregated level. The argument is hardly acceptable in that surely some detail must be better than no detail at all. Chief Operating Decision Maker (CODM) and operating segments IFRS 8 defines an operating segment as a component of an entity: that engages in revenue-earning business activities, whose operating results are regularly reviewed by the chief operating decision maker. The term ‘chief operating decision maker’ is not defined in IFRS 8, but the Standard clearly refers to a function rather than a title (in some entities the function could be fulfilled by a group rather than an individual), and for which discrete financial information is available.
Deciding who the CODM is can be difficult and judgement is often needed to ensure that the right person or persons have been identified. In the following chart (Chart 1) I have summarised the different categories disclosed in the annual reports. Different terms might have been used; for example, if the CODM has been described as Board of Directors and CEO I have included it in the category Group Management or similar.
the CODM, but rather working at a more strategic level. In the one-segment entities (Chart 2), the proportion of entities which did not clearly specify their CODMs was even higher.
24%
Not clearly specified
30%
Group Management or similar Board of Directors
19%
Not clearly specified
38%
Group Management or similar
32%
14%
CEO or president
Board of Directors
35% 8%
CEO or president
Chart 1 – CODM by category Depending on which level in the organisation the CODM is identified, the granularity of information reviewed by the CODM may vary. Understanding the organisational structure of an entity is important to understand how the identification of the CODM has been done by the reporting entity; however, approximately 19% of the entities did not clearly specify the function neither in the accounting policies nor in the note regarding segments. General information that should be disclosed in accordance with the Standard comprises factors used to identify the entity’s reportable segments, including the basis of organisation. In my view, a clear understanding of who the CODM is helps a reader of the report to understand how operations are managed and monitored. This can be easily achieved by disclosing an organisational structure, e.g. through a chart or detailed description of how the operations are managed. The review indicates that 38% of the investigated companies have identified the CEO or President as the CODM. 35% of the entities reported that Group Management or similar was the CODM. As the sample encompasses only small- and mid-cap entities, I anticipated that the Board of Directors would have been represented by the most senior positions.10 Regardless of how the CODM is determined, it is important that they are involved in the process of monitoring, evaluating and allocating resources. A Board of Directors or Group Management that simply approves management’s decisions would not, in my opinion, constitute a CODM, even though I would agree that the Board of Directors normally would not be
Chart 2 – CODM in one-segment entities Looking at the sub-sample of one-segment entities only, the CODM is defined as a group of managers, more often than in the entire sample. This might explain why only one segment has been identified, i.e. the internal reports support decisionmaking at the higher level. In addition to the arguments proposed by the entities in their annual reports, management might find segment disclosures sensitive by nature and show their reluctance to disclose the segments by providing generic explanations;. As an advisor to companies, I seek ‘evidence’ on how the CODM monitors the operations, e.g. through a reporting package. However, with the advancement of technology I often find that information could be found outside the reporting package and that additional information is actually being reviewed by individuals forming part of the management team. So, at what level are the operations actually monitored? If the CODM reporting package is the key factor for determining operating segments, information reviewed outside the reporting package might be important as well – if reviewed on a recurring basis by the CODM and used in the decision-making process. Reportable segments Once an operating segment has been identified, the entity needs to report segment information if the segment meets any of the following quantitative thresholds: Its reported revenue (external and inter-segment) is 10% or more of the combined revenue, internal and external, of all operating segments. Its reported profit or loss is 10% or more of the greater, in absolute amount, of (i) the combined profit of all operating segments that did not report a loss and (ii) the combined loss of all operating segments that reported a loss.
10 Editor’s note: the author refers to the fact that CEOs of small- and medium-sized entities have less capacity to delegate the role of Chief Operating Decision Maker to other members of the entity. It is therefore more likely that the role of CODM is taken by more senior people in smaller entities than in larger entities as confirmed by the data and evidence mentioned in this article.
Its assets are 10% or more of the combined assets of all operating segments. IFRS 8 states that if the total external turnover reported by the operating segments identified by the size criteria is less than 75% of total entity revenue, then additional segments need to be reported on until the 75% level is reached. I found several entities disclosing information about operating segments but then arguing that the reportable segments are something else, due to the aggregation criteria. Besides the one-segment entities, geography was often stated as the segmentation. My data demonstrates that this is more common among smaller entities, rather than the large cap entities. The Standard states that an operating segment generally has a segment manager who is directly accountable to and maintains regular contact with the CODM to discuss operating activities, financial results, forecasts, or plans for the segment. If an entity has operations in several countries, discrete financial information often is available and a country manager is appointed. Financial information regarding products, services or business lines might require more from an ERP11 system – something that all the smaller entities might not have invested in. This might be a reason for the high%age of entities displaying geography as their segments. The category ‘other’ includes business lines, products, services, sub-groups, distribution channels, category of customer and sometimes a mix of these categories. See Chart 3.
3% Not clearly specified
25% Other
34% One segment
38%
Geography
If management reporting is prepared on a geographical basis, the same criteria for aggregation apply. In order to be aggregated, each of the geographical areas must have the same economic characteristics, which might constitute a problem. Besides assessing the products and services, an entity needs to consider economic conditions, exchange control regulations and currency risks associated with the geographic areas when determining if each geographic area can be aggregated or not. In addition, even though some geographic areas can be aggregated there are entity-wide disclosure requirements meaning that revenues and assets of each material country must be disclosed. I found several of the entities aggregating the ‘Nordics’, defined as the region that includes Sweden, Denmark, Finland and Norway, into one segment, on the basis that these countries have similar characteristics. The first observation that arises is that the four countries have four different currencies (SEK, DKK, EUR and NOK). The exposure to currency risk is one factor implying that these four countries should not be aggregated if each of these countries is identified as an operating segment. However, if they are monitored as one geographic area it would be correct to disclose them as one reportable segment. With reference to the example above with 60 operating segments, the group has employees in more than 40 countries and five continents. Entity-wide disclosures are reported for 15 geographical areas. When having the criteria for aggregation in mind, I could agree with management’s conclusion, i.e. the geographic areas might not display similar economic characteristics. However, I would anticipate such an international business to have some kind of monitoring of regions as well as discrete financial information on a more grouped level. In addition, having the core principle of IFRS 8 in mind, I would say information on a more detailed level would have facilitated the users’ understanding of the operations - even though it would have meant aggregating characteristically different operating segments. The main explanations disclosed by the one-segment entities for having only one segment were: 1.
Chart 3 – Segment by category Aggregation of operating segments The main principle of aggregation is that separate reporting will not add significantly to the understanding of a segment if the segments have characteristics that are so similar that they are expected to have the same future outcome. However, meeting all the aggregation criteria is in my opinion a rather high hurdle. If operating segments have similar economic characteristics, then they can be aggregated into a single reportable segment and viewed together for the purposes of the size criteria.
11
ERP: Enterprise Resource Planning
Monitoring and analysis of the operations are performed for the group as a whole.
2. All operating segments are similar so we aggregate them into one. None of the above 29 entities of the 37 reporting only one segment argued that they monitor the group as a whole. In total there were 22 entities reporting only one segment that, however, have operations in at least two countries. The frequency of one segment only in small cap and mid cap in my sample was 40% and 34% respectively, which, considering the information given in the management disclosures regarding the companies’ operations, is a higher frequency than I expected. In particular, the entities that use
the argument number two above may come across as having weak internal controls. If operations exist in several countries and/or there are several business lines, one might expect more detailed monitoring and available discrete financial information. 72 companies reported three or fewer segments. The number of segments reported is illustrated in Chart 4:
40% 30%
Small cap
20%
Mid cap
On e
se gm en Tw t o se gm en Th ts re e se gm en ts Fo ur +s eg m en ts No se gm en ti nf o.
10%
Chart 4 – entities by number of reported segments Final remarks I do acknowledge the difficulties of disclosing comprehensive information regarding operating segments and defining the CODM and the level of detail of the information reviewed on a regular basis. However, financial reports must contain disclosures that enable the user to understand the significance of each service line, geographical area or category of products; seeing evidence that operations are actually monitored and evaluated in a structured manner makes the user more comfortable with the quality of the financial reporting. Some recommendations based on this analysis and my professional experience on segment disclosure: Remember the core principle of the Standard: disclose information regarding segments so that users can actually evaluate the nature and financial effects of the operations. As a rule of thumb, businesses, even among small- and mid-cap entities, tend to have more than one and fewer than ten operating segments. Do not refer only to the reporting package provided to the CODM. Evaluate the information that is actually being reviewed and analysed on a regular basis by management, even though it might not be included in the CODM package. Evaluate the sensitivity of not disclosing segment information, as well as the sensitivity of disclosing this information.
Spotlight on the new Leases Standard – IFRS 16 in 16 Q&As by Joelle Moughanni, RSM 1. What’s new? After an extensive consultation process, the International Accounting Standards Board (IASB) issued IFRS 16 Leases in January 2016, thereby completing its major project to improve the financial reporting of leases. Effective from 1 January 2019, the new Standard replaces IAS 17 Leases and related Interpretations, and sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, i.e. the lessee and the lessor. For lessees that have entered into contracts classified as operating leases under IAS 17, the new requirements could have a huge impact on the financial statements: almost all leases will be recognised on the balance sheet as a rightof-use asset and a financial liability, with more expenses recognised in profit or loss during the earlier life of a lease, and an associated impact on key accounting metrics. Some industry sectors are expected to be more affected than others, with considerable variations between companies within a sector.
leases end up on the balance sheet while most result only in a rent expense in the income statement and no balance sheet items. Thus, it is difficult for investors and other users of financial statements to get an accurate picture of a company’s lease assets and liabilities, compare companies that lease assets with those that buy assets, and estimate the amount of off balance sheet obligations. IFRS 16 aims at meeting investors’ needs by making financial reporting for leases more relevant and understandable. 3. What is changing for entities? In addition to bringing substantial new assets and liabilities onto a lessee’s balance sheet, IFRS 16 will have an effect on reported profit and performance measures. With the changed definition of a lease, it is likely that there will be some additional contracts within the scope of the new Standard, which need to be considered by both lessors and lessees.
Although IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17, it is likely to have significant business implications.
For lessees, IFRS 16 eliminates the classification of leases as either operating or finance; instead it introduces a single lessee accounting model.
The accounting change for leases is just the tip of the iceberg. Entities should take advantage of the relatively long implementation period to undertake an in-depth review of the changes and assess the impact on financial ratios and performance metrics (including debt covenants), business operations, systems and data, business processes and controls to understand the implementation issues and contain compliance costs and risk.
Lessor accounting is substantially carried forward from IAS 17, with some additional disclosure requirements.
2. Why change lease accounting?
4. Are there any exemptions to the new leases accounting model?
Leases are an important and flexible source of financing: listed companies using IFRS or US GAAP are estimated to have around US$3.3 trillion lease commitments, of which more than 85% do not appear today on the balance sheet. Because accounting by lessees under IAS 17 depends on whether the lease qualifies as an operating lease or a finance lease, some
Yes. In response to concerns expressed about cost and complexity, IFRS 16 does not require a lessee to recognise assets and liabilities for short‑term leases, and for leases of low-value items. If the exemptions are used (both are optional), then the current IAS 17 operating lease accounting
The impact on sectors and individual entities within each industry will vary according to their particular circumstances. Some sectors will be affected more than others, in particular those using off balance sheet leases extensively (e.g. airlines, retailers, transport, and travel and leisure).
is applied (i.e. rent expense is recognised in the income statement on a straight-line basis). Short-term leases are defined as leases with a lease term of 12 months or less and containing no purchase options. If a lessee elects this exemption, it must apply it by class of underlying asset, and treat any subsequent modification or change in lease term as resulting in a new lease. For leases of underlying assets of low value, IFRS 16 does not define the term ‘low value’, but the Basis for Conclusions explains that the Board had in mind assets of a value of US$5,000 or less when new. Examples of assets of low value are personal computers, telephones and small items of office furniture. The exemption is not applicable for certain assets that are dependent on, or highly interrelated with, other underlying assets. The election can be made on a lease-by-lease basis, and it does not take into account whether low-value assets in aggregate are material. Accordingly, although the aggregated value of the assets captured by the exemption may be material the exemption is still available. In addition, both lessees and lessors can apply IFRS 16 accounting to a portfolio of leases with similar characteristics if the entity reasonably expects that the resulting effect is not materially different from applying the Standard on a lease-bylease basis. 5. Is the definition of a lease changed under IFRS 16? IFRS 16 retains the definition of a lease in IAS 17, but changes the guidance setting out how to apply it. The changes are not expected to affect conclusions about whether contracts contain a lease for the vast majority of contracts (i.e. a lease under IAS 17 is generally expected to be a lease applying IFRS 16). However, it is expected that IFRS 16 will exclude from its scope a number of service contracts that may have been considered to be leases applying IAS 17 (e.g. some supply contracts). IFRS 16 defines a lease as a contract that conveys to the customer (i.e. the lessee) the right to use an asset for a period of time in exchange for consideration (the ‘right-of-use model’). A lease exists when a customer controls the right to use an identified asset, which is when the customer has the right to obtain substantially all of the economic benefits from the use of the asset and the right to direct the use of the asset, i.e. to decide how and for what purpose it is used. Judgements will apply often with a focus on whether an asset is identified. An asset might appear to be explicitly or implicitly specified by being made available, but it will be necessary to establish whether the supplier has the ability to substitute an alternative asset during the period of the contract. If the supplier can practically substitute another asset (excluding
any obligation to replace a defective asset) and there is a clear economic benefit for the supplier to do so, it will not be considered specific and therefore the contract would not be considered a lease. At first sight, the definition looks straightforward. But, in practice, it can be challenging to assess whether a contract conveys the right to use an asset or is, instead, a contract for a service that is provided using the asset. In a lease contract, it is the customer who controls the use of the item, as opposed to a service contract in which the supplier controls the use of the item. The definition of a lease is now much more driven by the question of which party to the contract controls the use of the underlying asset for the period of use. It is not sufficient any more for a customer to have the right to obtain substantially all of the benefits from the use of an asset; the customer must also have the ability to direct the use of the asset. 6. What will IFRS 16 change for lessees in particular? Lessees will no longer distinguish between finance lease contracts (on balance sheet) and operating lease contracts (off balance sheet), but they are required to recognise a rightof-use (ROU) asset and a corresponding lease liability for almost all lease contracts. This is based on the principle that, in economic terms, any lease contract is the acquisition of a right to use an underlying asset with the purchase price paid in instalments. Consequently, lessees will account for all of their leases in a manner similar to how finance leases are currently treated applying IAS 17. The most obvious effect of this approach is a substantial increase in the amount of recognised assets and financial liabilities for entities that have entered into significant lease contracts that are currently classified as operating leases under IAS 17. Thus, under the new accounting model, a lessee will: recognise in the balance sheet ROU assets and lease liabilities, recognise in the income statement depreciation of ROU assets and interest on lease liabilities, present in the cash flow statement the amount of cash paid for the principal portion of the lease liability within financing activities, and the amount paid for the interest portion within either operating or financing activities (in accordance with IAS 7), and disclose relevant information: breakdown of lease costs, information on lease cash flows, maturity analysis of undiscounted commitments, information on ROU assets by major class of underlying asset, etc.
7. How are lease liabilities measured and recognised?
is reasonably certain that the lessee will exercise the option.
IFRS 16 requires a lessee to recognise the lease liability at the commencement day and to measure it at an amount equal to the present value of future lease payments. However, to reflect the flexibility obtained by a lessee (e.g. extension options, or payments that vary based on sales or the use of an asset) and to reduce complexity, lease liabilities include only economically unavoidable payments. Thus, lease liabilities include fixed payments, variable lease payments that depend on an index or a rate, and only those optional payments that the lessee is reasonably certain to make. Lease liabilities exclude variable lease payments linked to sales or use; such payments are simply expensed as incurred rather than being estimated up-front.
IFRS 16 has a similar definition of lease term to IAS 17, in particular it is still based on a reasonable certainty threshold, but with clarification that periods covered by a termination option are included if it is reasonably certain the termination option will not be exercised.
In subsequent periods, the lease liability is measured using the effective interest rate method. 8. How are lease assets measured and recognised? The ROU asset is recognised at the commencement day and measured at cost, consisting of the amount of the initial measurement of the lease liability, plus (i) any lease payments made to the lessor at or before the commencement date, (ii) the initial estimate of restoration costs and (iii) any initial direct costs incurred by the lessee, and less any lease incentives received. Subsequently, the ROU asset is depreciated in accordance with the requirements in IAS 16 Property, Plant and Equipment (i.e. on a straight-line basis or another systematic basis) and submitted to the impairment requirements in IAS 36 Impairment of Assets. However, IFRS 16 contains two alternatives to the cost model: A ROU asset that meets the definition of investment property must be subsequently measured in accordance with the fair value model in IAS 40 if the lessee has elected the fair value model in IAS 40 for its investment property. A ROU asset can be subsequently measured at the revalued amount in accordance with IAS 16 if it relates to a class of PPE to which the lessee applies the revaluation model. 9. How is the lease term determined? IFRS 16 defines a lease term as the non-cancellable period for which the lessee has the right to use an underlying asset, including optional periods when the lessee is reasonably certain to exercise an option to extend (or not to terminate) a lease. Entities need to consider all relevant facts and circumstances that create an economic incentive for the lessee to exercise the option when determining the lease term. The option to extend the lease term should be included in the lease term if it
A lessee is required to reassess the option when significant events or changes in circumstances occur that are within the control of the lessee. 10 What about contracts that contain both leases and services (e.g. lease of a car with maintenance services)? Leases are different from service contracts: while a lease provides a customer with the right to control the use of an asset, the supplier retains such control in a service contract. Currently, many companies that have contracts which include both an operating lease and a service do not separate the operating lease component. This is because the accounting for an operating lease and a service/supply arrangement is the same (that is, there is no recognition on the balance sheet and straight-line expense is recognised in profit or loss over the contract period). Under IFRS 16, the treatment of the two components will differ, and thus the components must be separated (IFRS 16 applies only to the lease components). The requirements of IFRS 16 for separating lease and nonlease components and allocating the consideration to separate components will require management judgement when identifying those components and applying estimates to determine the observable standalone prices. Only the amounts that relate to the lease will have to be capitalised on the lessee’s balance sheet, as IFRS 16 does not change accounting for services. As a practical expedient, a lessee may decide by class of underlying asset not to separate non-lease components (services) from lease components; then, each lease component and any associated non-lease component is accounted for as a single lease component. So the service component will either be separated or the entire contract will be treated as a lease. 11. What does IFRS 16 change for lessors? There is little change for lessors, as the IASB decided to substantially carry forward the lessor accounting requirements in IAS 17. Applying IFRS 16, a lessor continues to classify its leases as operating leases or finance leases, depending on whether substantially all of the risk and rewards incidental to ownership of the underlying asset have been transferred, and to account for those two types of leases differently.
Although accounting remains substantially the same for lessors, the changes made by the new Standard are still relevant. In particular, lessors should be aware of the new guidance on the definition of a lease, subleases and the accounting for sale and leaseback transactions. IFRS 16 also requires lessors to provide enhanced disclosures about their risk exposure arising from leasing activities. It is worth mentioning that the changes in lessee accounting might also have an impact on lessors as lessee’s needs and behaviours change. 12. When and how does IFRS 16 become effective, in particular is there any relief on transition?
Lease liabilities are considered to be financial liabilities that should be disclosed separately from other liabilities. Applying the requirements in IAS 1, a lessee is required to present lease liabilities as a separate line item, or together with other similar liabilities, in a manner that is relevant to understanding the lessee’s financial position. A lessee will also split lease liabilities into current and non‑current portions, based on the timing of payments. A lessee should present lease assets on the balance sheet either together with owned property, plant and equipment, or as their own line item(s) if that is relevant to understanding the lessee’s financial position.
IFRS 16 replaces IAS 17, effective for annual periods beginning on or after 1 January 2019, with substantive transition relief for companies. Early application is permitted, as long as IFRS 15 Revenue from Contracts with Customers is also applied.
Applying the new model, the income statement will disaggregate the presentation of lease expenses for former off balance sheet leases (i.e. splitting the expense into two components) and in a manner that explicitly recognises the financing element inherent in leases. This will change the pattern of expense recognition on an individual lease.
A lessor is not required to make any adjustments on transition and shall account for its leases applying IFRS 16 from the date of initial application. An entity does not reassess sale and leaseback transactions entered into before the date of initial application to determine whether the transfer of the underlying asset satisfies the requirements in IFRS 15 to be accounted for as a sale.
IFRS 16 relies on the requirements of IFRS 7 Financial Instruments: Disclosure for the disclosure of a maturity analysis of lease liabilities. This means that the same approach a company takes to analyse its other financial liabilities should apply to lease liabilities (e.g. judgement in determining which time bands should be disclosed to provide useful information to investors).
On transition, a lessee may choose to retain existing accounting treatment for existing finance leases. For existing operating leases, a lessee may choose between a full retrospective approach and a modified retrospective approach. The latter includes an exemption from recognising lease assets and liabilities for leases ending within 12 months of transition date, an exemption from restatement of comparatives (instead, opening equity is adjusted for the catch-up effect), and a choice (on a lease-by-lease basis) of measurement of ROU assets (as if IFRS 16 had always been applied or at an amount based on the lease liability).
In addition, for leases that contain complex features (e.g. variable lease payments, extension options and residual value guarantees), IFRS 16 requires a company to disclose material company-specific information that is not covered elsewhere in the financial statements.
In addition, lessees and lessors are not required to reassess whether existing contracts contain a lease based on the revised definition of a lease, but can choose to carry forward the assessments under IFRIC 4 and IAS 17, and apply the definition of a lease only to new contracts entered into after the date of initial application. 13. What about presentation and disclosures? Unlike IAS 17, IFRS 16 does not include a list of prescriptive disclosures. Instead, it sets out objectives and requires companies to determine the information that would satisfy those objectives.
14. How will subleases and sale and lease back transactions be reflected under IFRS 16? A common scenario is for properties to be leased by an intermediate company and subleased to an occupier, or for properties to be leased and partially occupied with the remainder sublet. The intermediate lessor/lessee will assess whether the sublease is a finance or operating lease by reference to the value and economic life of its ROU asset. When the sublease is classified as a finance lease, the appropriate portion of the ROU asset will be derecognised and the net investment in the sublease recognised. Any difference will be recognised in profit or loss. Many companies use sale and leaseback transactions of property as a means of raising finance. Under IFRS 16, the immediate gain recognised on such transactions will be lower than before. Whether there is a sale will be determined under IFRS 15, and if so an asset recognised for the ROU leased back. However, the gain on such transactions will only reflect
the extent to which the ROU has transferred, i.e. the ROU asset retained by the seller will be reflected as a portion of its previous carrying amount. 15. What about convergence with US GAAP?
The income statement will offer more detail - The new model will align the income statement expense treatment for all leases by replacing today’s straight-line operating lease expense with a depreciation charge for the ROU asset and an interest expense on the lease liability.
Convergence has been a priority for both IASB and FASB (the Boards) throughout the Leases project: joint deliberations, joint proposals for public consultation (the 2009 Discussion Paper, and the 2010 and 2013 Exposure Drafts), joint outreach, etc.
Financial ratio analysis will be affected - The changes to presentation of lease expense will be noticeable to investors when analysing ratios such as EBITDA margin. This is because, unlike under IAS 17, EBITDA calculated under IFRS 16 does not include expenses related to leases.
The Boards reached the same conclusions in many areas of lease accounting: definition of a lease, recognition and measurement of lease assets and liabilities, carry forward of previous lessor accounting, etc. However, they reached different conclusions in a few areas, most importantly on lessee expense recognition: FASB decided to retain a dual accounting model for lessee vs a single model for IASB. Consequently, the income statement and cash flow statement will look very different using one GAAP or the other.
Improved disclosures about leases - Because the information presented today is considered by many to be inadequate, improving the quality of disclosures was necessary. Among the new disclosures investors can look forward to are more details about the lease expense and lease assets by class of asset. IFRS 16 also requires disclosure of a maturity analysis of lease liabilities similar to that for all financial liabilities. For both lessees and lessors, IFRS 16 adds significant new, enhanced disclosure requirements.
16. To summarise, what are the key changes to expect from IFRS 16? There is no doubt that lessees will be greatly affected by the new leases Standard. Although lessors’ accounting largely remains unchanged, lessors might see an impact on their business model and lease products due to changes in needs and behaviours if companies decide to buy more assets and, as a consequence, lease fewer assets, or turn more to services rather than assets. IFRS 16 will affect virtually all commonly used financial ratios and performance metrics such as gearing, current ratio, asset turnover, interest cover, EBITDA, EBIT, operating profit, net income, and operating cash flows. These changes may affect loan covenants, credit ratings and borrowing costs, and could result in other behavioural changes. These impacts may compel many organisations to reassess certain ‘lease versus buy’ decisions. The key changes to expect are the following: Balance sheets will get bigger - By bringing lease assets and liabilities onto the balance sheet, companies with material off balance sheet leases will report higher assets and financial liabilities than they currently do.
Since changes in accounting requirements do not change the amount of cash transferred between the parties to a lease, IFRS 16 will not have any effect on the total amount of cash flows reported. However, IFRS 16 is expected to have an effect on the presentation of cash flows related to former off balance sheet leases, reducing operating cash outflows, with a corresponding increase in financing cash outflows, compared to the amounts reported when applying IAS 17. For an individual former off balance sheet lease, IFRS 16 results in a different total expense recognition pattern compared to IAS 17. This is because interest expense is typically higher in the earlier years of a lease than in the later years. When combined with typically straight-line depreciation of lease assets, this results in a total lease-related expense (interest plus depreciation) that is higher than a straight-line lease expense during the first half of the lease term. The opposite is true in the second half of the lease term. Over the lease term, the total amount of expense recognised is the same.
We focused on: ‌ allocation of an impairment loss to non-current assets within a disposal group
What is the issue? Company XYZ is seeking advice for the recognition of an impairment loss on a disposal group, in particular, whether the allocation of such impairment loss can reduce the carrying amount (that is not less than the amount of the impairment loss) of non-current assets that are within the scope of the measurement requirements of IFRS 5 to an amount that is lower than their fair value less costs to sell.
What is the proposed solution? In determining the order of allocation of an impairment loss for a disposal group to non-current assets that are within the scope of the measurement requirements of IFRS 5 Noncurrent Assets Held for Sale and Discontinued Operations, paragraph 23 of the Standard refers to paragraph 104(a)-(b) of IAS 36 Impairment of Assets. However, IFRS 5 does not refer to paragraph 105 of IAS 36, which restricts the impairment loss allocated to individual assets by requiring that an asset is not written down to less than the higher of its fair value less costs of disposal, its value in use and zero. Consequently, since the restriction in IAS 36.105 does not apply when allocating an impairment loss for a disposal group to the non-current assets that are within the scope of the measurement requirements of IFRS 5, the allocation of the amount of loss recognised for a disposal group to the assets in the disposal group, that are within the measurement requirements of IFRS 5, should not be restricted by their fair value less costs to sell.
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Editor Dr 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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