RSM World of IFRS summarises key matters arising from recent IASB discussions and decisions, highlights RSM thought leadership from around the world, and addresses an IFRS application question each month.
Along with announcements made in the past, which included guidance on the application of IFRS 9 Financial Instruments and IFRS 16 Leases, the International Accounting Standards Board (IASB) has issued an amendment to IFRS 16 as well as proposed to extend the effective date of amendments to IAS 1 Presentation of Financial Statements.
AMENDMENT TO IFRS 16 LEASES
The IASB has issued an amendment to IFRS 16 to make it easier for lessees to account for Covid-19-related rent concessions while still providing useful information about their leases to investors (refer to the RSM update here for more details). The practical expedient allows lessees to make an election not to assess a rent concession, arising directly as a consequence of the Covid-19 pandemic, as a lease modification if it meets all of the following conditions:
- the change in lease payments results in revised consideration for the lease that is substantially the same as, or less than, the consideration for the lease immediately preceding the change
- any reduction in lease payments affects only payments originally due on or before 30 June 2021 (for example, a rent concession would meet this condition if it results in reduced lease payments on or before 30 June 2021 and increased lease payments that extend beyond 30 June 2021); and
- there is no substantive change to other terms and conditions of the lease.
The amendment is effective June 1, 2020, but to ensure the relief is available when needed most, lessees can apply the amendment immediately in any financial statements—interim or annual—not yet authorised for issue as of May 28, 2020.
Please see the attached link for more information:
PROPOSAL TO DEFER EFFECTIVE DATE OF AMENDMENT TO IAS 1
The IASB has also published an Exposure Draft, proposing to extend the effective date of amendments to IAS 1, Classification of Liabilities as Current or Non-Current, by one year to January 1, 2023. The deferral aims to provide operational relief to entities in application of the amendments.
LATEST MATTERS FROM THE INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB)
The following is a summarised update of key matters arising from the discussions and decisions taken by the IASB at its remote meetings on the following dates:
21, 22 and 23 April 2020
20 and 21 May 2020
The full update, as published by the IASB, can be found here.
Amendments to IFRS 17 INSURANCE CONTRACTS
The Board met to discuss the sweep issues identified during the balloting process and tentatively decided to require an entity:
- to include in the initial measurement of the contractual service margin of a group of insurance contracts, the effect of the derecognition of any asset or liability for cash flows related to that group that was recognised before the group is recognised;
- to also recognise an asset for cash flows when another IFRS Standard requires it to recognise a liability for future insurance acquisition cash flows before it recognises the related group of insurance contracts,;
- to use a systematic and rational method of allocation to apply the requirements in IFRS 17 relating to the recovery of losses from reinsurance contracts held when the entity groups together underlying onerous insurance contracts that are covered by a reinsurance contract held and other onerous insurance contracts the entity issues;
- to recognise insurance revenue when the entity recognises in profit or loss amounts related to income tax that are specifically chargeable to the policyholder under the terms of an insurance contract;
- to include in the definitions of the liability for remaining coverage and the liability for incurred claims all obligations arising from insurance contracts issued by an entity; and
- amend paragraph B96(c) of IFRS 17 to clarify the treatment of insurance finance income or expenses relating to investment components that are paid in a period when they were not expected to be paid, or not paid in a period when they were expected to be paid.
The Board also tentatively decided to amend the other comprehensive income option and the risk mitigation option in IFRS 17 to:
- specify that paragraphs 88 and 89 of IFRS 17 do not apply to the insurance finance income or expenses that arise from the application of the risk mitigation option; and
- add new requirements to the risk mitigation option that specify how to present insurance finance income or expenses that arise from the application of the risk mitigation option
FINANCIAL INSTRUMENTS WITH CHARACTERISTICS OF EQUITY
The Board continued its discussions on how to clarify the principles for classifying financial instruments settled in an entity’s own equity instruments. The principles in question are as follows:
Foundation principle - a derivative on own equity that meets the fixed-for-fixed condition should have a fair value on the settlement date (settlement value) that is:
- only affected by fluctuations in the price of the underlying equity instruments (exposed to equity price risk); and
- not affected by fluctuations in other variables that the holder of the underlying equity instruments would not be exposed to (not exposed to other risks).
Adjustment principle - if a derivative is subject to any adjustments to the amount of cash or another financial asset, or the number of own equity instruments, the adjustments would not preclude the derivative from meeting the fixed-for-fixed condition if the adjustments:
- preserve the relative economic interests of the derivative holder and the underlying equity instrument holder (‘preservation adjustments’); or
- compensate the issuer for the fact that the derivative will be settled at a future date (‘passage of time adjustments’)
With respect to the foundation principle, the Board tentatively decided that for a derivative on an entity’s own equity to meet the fixed-for-fixed condition in IAS 32 Financial Instruments: Presentation, the number of functional currency units to be exchanged with each underlying equity instrument must be fixed or only vary with:
- allowable preservation adjustments; or
- allowable passage of time adjustments.
Additionally, the Board tentatively decided to classify a contract that can be settled by exchanging a fixed number of non-derivative own equity instruments with a fixed number of another type of non-derivative own equity instruments as equity.
With respect to the adjustment principle, the Board tentatively decided an entity would be required to classify derivatives on own equity as equity instruments if preservation adjustments require the entity to preserve the relative economic interests of future shareholders to an equal or a lesser extent than those of the existing shareholders. The Board also tentatively decided that an entity would be required to classify derivatives on own equity as equity instruments if passage of time adjustments:
- are pre-determined and vary only with the passage of time; and
- fix the number of functional currency units per underlying equity instrument in terms of a present value.
MAINTENANCE AND CONSISTENT APPLICATION – LACK OF EXCHANGEABILITY (aMENDMENTS TO IAS 21)
The Board continued to discuss its proposed narrow-scope amendment to IAS 21 The Effects of Changes in Foreign Exchange Rates and tentatively decided that when an entity assesses exchangeability between two currencies in determining the spot exchange rate to use, the entity be required to:
- consider whether it could obtain the foreign currency within a time frame that includes a normal administrative delay.
- consider its ability to obtain foreign currency, and not its intention (or decision) to do so.
- consider only markets or exchange mechanisms that create enforceable rights and obligations.
- assume that the purpose of obtaining foreign currency is to:
- settle individual foreign currency transactions, or assets or liabilities related to those transactions, when it reports foreign currency transactions in the functional currency; or
- realise the entity’s net assets when it uses a presentation currency other than the functional currency (or to realise its net investment in a foreign operation when it translates the results and financial position of that foreign operation).
- conclude that a currency lacks exchangeability in circumstances in which it is able to obtain only some amounts of foreign currency, when, for a particular purpose, it is able to obtain no more than an insignificant amount of foreign currency. Additionally, when an entity (i) reports foreign currency transactions in its functional currency, and (ii) can obtain less than the amount of foreign currency it needs to settle all balances and transactions in that currency, the entity would be required to assess exchangeability on an aggregated basis for all the related foreign currency balances and transactions.
With respect to the exchange rate when a currency lacks exchangeability, the Board tentatively decided that:
- an entity be required to estimate the spot rate when a currency lacks exchangeability.
- The objective in the estimation process would require an entity to estimate a spot rate that:
- the entity would have been able to access at the reporting date had the currency been exchangeable;
- would have arisen in an orderly transaction between market participants; and
- would faithfully reflect the economic conditions prevailing at that date.
- an entity be permitted to use an observable rate (that does not meet the definition of a spot rate) if that rate approximates the spot rate in the following circumstances:
- when the observable rate meets the definition of a spot rate for particular transactions or balances but not those for which the entity assesses exchangeability; or
- when the observable rate is the first subsequent rate at which exchanges could be made if exchangeability is restored before financial statements are authorised for issue.
- an entity be required to apply an estimated exchange rate to:
- the entire transaction or balance of an asset or liability (when the entity reports foreign currency transactions in the functional currency); or
- the financial statements as a whole (when the entity uses a presentation currency other than the functional currency).
Additionally, the Board tentatively decided that, when a foreign operation’s functional currency lacks exchangeability, an entity be required to disclose:
- the name of the foreign operation, its nature (whether it is a subsidiary, joint operation, joint venture, associate or branch) and its principal place of business;
- summarised financial information about the foreign operation; and
- the nature and terms of any contractual arrangements that could require the entity to provide financial support to that foreign operation, including events or circumstances that could expose the reporting entity to a loss. The entity would also be required to disclose the balance of assets to which such arrangements give rise.
The Board will discuss the proposed amendment’s effective date and transition, as well as the Board’s compliance with applicable due process steps at a future meeting.
MAINTENANCE AND CONSISTENT APPLICATION – Lease liability in a sale leaseback
The Board tentatively decided to propose a narrow-scope amendment to IFRS 16 to specify that:
- in applying paragraphs 36–38 of IFRS 16 to a sale and leaseback transaction with variable lease payments, a seller-lessee be required:
- to determine the lease payments made (as described in paragraph 36(b)) as the payments included in the measurement of the lease liability. The payments included in that measurement are those that, when discounted using the discount rate described in paragraph 37, result in an amount equal to the carrying amount of the lease liability.
- not to remeasure the lease liability to reflect any reassessment of future variable lease payments.
- to apply paragraph 38 in accounting for any difference between the payments made for the lease and those included in the measurement of the lease liability.
- in applying paragraphs 40 and 45 of IFRS 16 to lease modifications and changes in the lease term related to a sale and leaseback transaction, a seller-lessee be required to determine the revised lease payments as the revised expected payments for the lease.
The Board also tentatively decided to develop an additional example that would illustrate how a seller-lessee would account for a sale and leaseback transaction with variable payments, both at the date of the transaction and subsequently throughout the lease term.
The Board plans to publish the exposure draft in Q3 2020.
The following is a summarised update of key matters arising from the discussions and decisions taken by the IFRIC at its meetings on the following dates:
3 March 2020
29 April 2020
The full update can be found here.
Sale and Leaseback with Variable Payments
In this fact pattern, an entity (seller-lessee) enters into a sale and leaseback transaction whereby it transfers an item of property, plant and equipment (PPE) to another entity (buyer-lessor) and leases the asset back for five years. The market-rate payments over the term are variable in nature, calculated as percentage of seller-lessee’s revenue generated using the PPE. The payments are not in-substance fixed payments, and the transaction satisfies the requirements of IFRS 15 Revenue from Contracts with Customers, with the amount paid by buyer-lessor being equal to the PPE’s fair value at date of the transaction. The question was posed as to how the seller-lessee measures the right-of-use asset arising from the leaseback, and the amount of any gain or loss to be recognized.
In applying the case facts to IFRS 16, the Committee stated that the seller-lessee should determine the proportion of the PPE transferred to the buyer-lessor as it relates to the right of use that is retained via leaseback. Even though IFRS 16 does not prescribe a method to do this, the entity could determine the proportion by comparing the present value of expected payments (including variable payments) to the fair value of the PPE at the date of transaction. The calculated proportion retained would be applied against the carrying value of the PPE to determine the value of the right-of-use asset. The measurement of the gain or loss would subsequently follow by applying the proportion transferred against the total gain on sale. The seller-lessee also recognises a lease liability at the date of the transaction, even though the payments are variable in nature. The initial measurement would be determined based on how the right-of-use asset and the gain or loss is measured as part of the overall transaction.
Furthermore, the Committee recommended that the IASB amend IFRS 16 to specify how the seller-lessee applies IFRS 16’s subsequent measurement requirements to the lease liability that arises in the sale and leaseback transaction.
Deferred Tax related to an Investment in a Subsidiary
An entity has an investment in a subsidiary that has undistributed profits giving rise to a taxable temporary difference. The entity expects the subsidiary to distribute its profits in the foreseeable future, and both operate in a jurisdiction where profits distributions are taxable at 20%, but only when distributed. Additionally, profits distributions are not taxable to the extent that the subsidiary has already been taxed on that profit. The question was posed on whether the entity recognises a deferred tax liability for the taxable temporary difference associated with its investment in the subsidiary.
Paragraph 39 of IAS 12 Income Taxes requires an entity to recognise a deferred tax liability for all taxable temporary differences associated with investments in subsidiaries, except to the extent that (a) the parent is able to control the timing of the reversal of the temporary difference; and (b) it is probable that the temporary difference will not reverse in the foreseeable future. Since profits are expected to be distributed in the foreseeable future, the recognition exemption does not apply and the entity would need to recognise a deferred tax liability. Since the entity expects to recover the carrying amount of its investment in the subsidiary through the distribution of profits, the entity would need to use the distributed tax rate to measure the liability.
Training Costs to Fulfil a Contract
A contract with a customer for the supply of outsourced resources leads an entity to incur costs to train its employees, so they may understand the customer’s equipment and processes. The training costs are deemed by the entity to not meet the definition of an intangible asset under IAS 38 Intangible Assets since the employees can leave the entity’s employment nor does it identify it as a performance obligation under IFRS 15. The contract permits the entity to charge to the customer the costs of training (i) the entity’s employees at the beginning of the contract, and (ii) new employees that the entity hires as a result of any expansion of the customer’s operations. The request asked whether the training costs are recognized as an asset or expense when incurred.
The first question to tackle in this scenario is to understand which IFRS Standard applies to the training costs. With respect to costs to fulfil a contract, paragraph 95 of IFRS 15 examines costs to the extent that they are not within the scope of another IFRS Standard. In addition, paragraph BC307 of IFRS 15 states that “if the other Standards preclude the recognition of any asset arising from a particular cost, an asset cannot then be recognised under IFRS 15”. When examining IAS 38, Paragraph 5 explicitly includes expenditure on training to be within the scope of IAS 38. Accordingly, the entity should apply IAS 38 accounting for the training costs incurred to fulfil the contract. Furthermore, IAS 38 explicitly includes expenditure on training activities as an example of expenditure that is incurred “to provide future economic benefits to an entity, but no intangible asset or other asset is acquired or created that can be recognised”. Conclusively, such expenditure on training activities should be recognised as an expense when incurred. The entity’s ability to charge to the customer the costs of training does not affect this conclusion.
Hyperinflationary Foreign Operation
The following fact pattern applies to the next few requests presented to the Committee:
An entity has a presentation currency that is different than its foreign operation’s functional currency, which is the currency of a hyperinflationary economy. In preparing the consolidated financial statements, the entity needs to translate the results and financial position of the hyperinflationary foreign operation into its presentation currency.
Translation of a Hyperinflationary Foreign Operation – Presenting Exchange Differences
In accordance with IAS 21, the entity first restates the results and financial position of the hyperinflationary foreign operation as per requirements set out in IAS 29 Financial Reporting in Hyperinflationary Economies, before applying the translation method. Therefore, there will be both a restatement and a translation effect on the entity’s net investment. The request asked how the entity presents these effects in its statement of financial position.
It was concluded that either the translation effect alone, or the combination of restatement and translation, meets the definition of an exchange difference per IAS 21. Requirements per IAS 21 specify that recognition of exchange differences should be done through profit or loss, or OCI and has no reference to equity. It was noted that exchange differences arising from translating the financial statements of a non-hyperinflationary foreign operation are recognised in OCI––and not in profit or loss––because “the changes in exchange rates have little or no direct effect on the present and future cash flows from operations”. It was observed that this explanation is also relevant if the foreign operation’s functional currency is hyperinflationary. Therefore, in this fact pattern, the entity presents:
- the restatement and translation effects in OCI, if the entity considers that the combination of those two effects meets the definition of an exchange difference in IAS 21; or
- the translation effect in OCI, if the entity considers that only the translation effect meets the definition of an exchange difference in IAS 21. In this case, consistent with the requirements in paragraph 25 of IAS 29, the entity presents the restatement effect in equity.
Cumulative Exchange Differences before a Foreign Operation becomes Hyperinflationary
Before the foreign operation becomes hyperinflationary, IAS 21 requires an entity to:
- present in other comprehensive income (OCI) any exchange differences from translating the results and financial position of that non-hyperinflationary foreign operation; and
- present in a separate component of equity the cumulative amount of those exchange differences (cumulative pre-hyperinflation exchange differences).
The request asked whether the entity transfers the cumulative pre-hyperinflation exchange differences to a component of equity that is not subsequently reclassified to profit or loss.
Per IAS 21, an entity is required to present the cumulative amount of exchange differences recognised in OCI in a separate component of equity “until disposal of the foreign operation”. It is required to reclassify the cumulative, or proportionate amount of exchange differences from equity to profit or loss on disposal, or partial disposal, respectively. In conclusion, an entity does not reclassify within equity the cumulative pre-hyperinflation exchange differences once the foreign operation becomes hyperinflationary.
Presenting Comparative Amounts when a Foreign Operation first becomes Hyperinflationary
The request asked whether the entity restates comparative amounts presented for the foreign operation in:
- its annual financial statements for the period in which the foreign operation becomes hyperinflationary; and
- its interim financial statements in the year after the foreign operation becomes hyperinflationary, if the foreign operation was not hyperinflationary during the comparative interim period.
On the basis of responses to outreach, comment letters received and additional research, little diversity was noted in the application of IAS 21 with respect to the questions in the request. In applying IAS 21, entities generally do not restate comparative amounts in their interim or annual financial statements for this particular fact pattern.
Recent articles from RSM firms around the world addressing complexities within accounting standards can be found on our website.
The following RSM Insights have been published on RSM Link:
- Coronavirus financial reporting implications Update
- Accounting for change to lease contracts
As a result of Covid-19, the government has imposed restrictions on business operations of the company. Employees have been sent home with pay. The employees are not expected to provide services at home, but are expected to return once the operations have resumed. Date for the resumption of operations is unknown at this point in time. Should wages or salaries paid to such employees while at home be estimated, accrued for and expensed at the time they become inactive, or should their wages and salaries continue to be accrued and expensed over time?
In this particular situation, IAS 19 Employee Benefits provides some direction as to how to account for the wages and salaries for these particular employees who have been sent home with pay.
One consideration through examination of IAS 19 is for an entity to recognise the expected cost of short-term employee benefits at the time they become inactive, since they can be viewed to be in the form of “non-accumulating paid absences”. The reason for waiting until the date of absence is “because employee service does not increase the amount of the benefit”. The triggering event is the point in time at which the employee stops providing services. At such point, the employer would estimate, accrue, and expense the amount to be paid to the employee over the course of the absence. If the amount is uncertain, an estimate should be made and subsequently updated as new information becomes available.
However, the second and more reasonable treatment is to accrue and expense the salaries and wages of inactive employees over time. Most employee contracts do not have clauses that contemplate a situation such as Covid-19. Nonetheless, it can be argued that employees are paid to stay at home partially because it will ensure a smooth transition once operations resume to normal levels. As a result, the employees are providing benefits to the employer throughout the period of inactivity. In addition, the period of absence is not determinable at the time the employee becomes inactive.
Therefore, the non-accumulating paid absences guidance in paragraphs 13(b) and 18 of IAS 19 results in salary continuation costs to be expensed as incurred. This is consistent with the expectation that the employees will return to work when called upon to do so.