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 meetings on 11 and 12 December 2019.
The full update, as published by the IASB, can be found here.
ONEROUS CONTRACTS - COST OF FULFILLING A CONTRACT (AMENDEMENTS TO IAS 37)
The Board discussed the effective date for the amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets, which clarify that the ‘cost of fulfilling’ a contract for the purpose of assessing whether that contract is onerous, comprises the costs that related directly to the contract
The Board tentatively decided that entities should apply the amendments for annual periods beginning on or after 1 January 2022, with earlier application permitted
ACCOUNTING POLICIES AND ACCOUNTING ESTIMATES (AMENDMENTS TO IAS 8)
The Board discussed transition requirements and effective date for the amendments to IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, and tentatively decided to:
- require entities to apply the amendments only to changes in accounting policies and changes in accounting estimates that occur on or after the start of the first annual period in which the entity applies the amendments; and
- require entities to apply the amendments to annual periods beginning on or after 1 January 2022, with earlier application permitted – and not require them to disclose the fact that they have applied the amendments for an earlier period.
UPDATING A REFERENCE TO THE CONCEPTUAL FRAMEWORK (AMENDMENTS TO IFRS 3)
The Board discussed feedback on the Exposure Draft Reference to the Conceptual Framework, in which the Board proposed amendments to IFRS 3 Business Combinations, and tentatively decided to confirm the proposals set out in the Exposure Draft to:
- add to IFRS 3 an exception to its recognition principle, for liabilities and contingent liabilities within the scope of IAS 37 Provisions, Contingent Liabilities and Contingent Assets or IFRIC 21 Levies. The Board tentatively decided not to add an exception for current tax assets and liabilities within the scope of IFRIC 23 Uncertainty over Income Tax Treatments.
- locate all the recognition requirements for provisions, contingent liabilities and contingent assets within the section headed ‘Exception to the recognition principle’.
BUSINESS COMBINATIONS UNDER COMMON CONTROL
On the ongoing BCUCC project, the Board tentatively decided:
- to require the receiving entity to recognise any excess fair value of the acquired identifiable net assets over the fair value of the consideration transferred as an increase in the receiving entity’s equity (contribution), and not as a gain on a bargain purchase in the statement of profit or loss.
- not to require the receiving entity to identify, measure and recognise a distribution.
LATEST MATTERS ARISING FROM THE IFRS INTERPRETATIONS COMMITTEE (IC)
The following is a summarised update of the main discussion held by the IC at its meeting on 26 November 2019.The full update, as published by the IASB, can be found here.
TENTATIVE AGENDA DECISIONS
The Committee tentatively decided not to add the following matters to its standard-setting agenda because the principles and requirements in IFRS already provide an adequate basis:
Player Transfer Payments (IAS 38 Intangible Assets)
The Committee received a request about the recognition of player transfer payments received: does the entity recognize the payment received as revenue applying IFRS 15 Revenue from Contracts with Customers or recognize the gain or loss arising from the derecognition of the intangible asset in profit or loss applying IAS 38?
The Committee considered the following pattern:
- a football club (entity) transfers a player to another club (receiving club). When the entity recruited the player, the entity registered the player in an electronic transfer system. Together the employment contract and registration in the electronic transfer system are referred to as a ‘registration right’.
- the entity had recognised costs incurred to obtain the registration right as an intangible asset applying IAS 38. The entity uses and develops the player through participation in matches, and then potentially transfers the player to another club. The entity views the development and transfer of players as part of its ordinary activities.
- the entity and the receiving club enter into a transfer agreement under which the entity receives a transfer payment from the receiving club. The transfer payment compensates the entity for releasing the player from the employment contract. The registration in the electronic transfer system is not transferred to the receiving club but is legally extinguished when the receiving club registers the player and obtains a new right.
- the entity derecognises its intangible asset upon the receiving club registering the player in the electronic transfer system.
Accordingly, the entity must apply derecognition requirements in IAS 38 on derecognition of the registration right. Paragraph 113 of IAS states that the entity recognises in profit or loss from the derecognition of an intangible asset, but not as revenue, the difference between the net disposal proceeds and the carrying amount of the registration right.
Recognising the transfer payment received
In the fact pattern described in the request, the entity recognises the transfer payment received as part of the gain or loss arising from the derecognition of the registration right (paragraph 113 of IAS 38), not as revenue, applying IFRS 15.
Circumstances may exist in which registration rights associated with some players meet the definition of inventories. In applying that definition, on initial recognition such an entity would consider whether the registration right is acquired for development and sale in the ordinary course of business. Whether a registration right meets the definition of inventories requires an assessment of the facts and circumstances. If the entity classifies the registration right as inventories, the entity would apply IFRS 15 in accounting for the transfer payment received so long as the transfer agreement itself were within the scope of IFRS 15).
Multiple tax consequences of recovering an asset (IAS 12 Income Taxes)
The Committee received a request about deferred tax when the recovery of the carrying amount of an asset gives rise to multiple tax consequences, in how the tax base of the asset is determined and how it accounts for deferred tax, considering the following pattern.
- an entity acquires an intangible asset with a finite useful life (a licence) as part of a business combination. The carrying amount of the licence at initial recognition is CU100. The entity intends to recover the carrying amount of the licence through use, and the expected residual value of the licence at expiry is nil.
- the applicable tax law prescribes two tax regimes: an income tax regime and a capital gains tax regime. Tax paid under both regimes meets the definition of income taxes in IAS 12. Recovering the licence’s carrying amount through use has both of the following tax consequences:
- under the income tax regime—the entity pays income tax on the economic benefits it receives from recovering the licence’s carrying amount through use, but receives no tax deductions in respect of amortisation of the licence (taxable economic benefits from use); and
- under the capital gains tax regime—the entity receives a tax deduction of CU100 when the licence expires (capital gain deduction).
- the applicable tax law prohibits the entity from using the capital gain deduction to offset the taxable economic benefits from use in determining taxable profit.
Paragraph 10 of IAS 12 states that ‘where the tax base of an asset or liability is not immediately apparent, it is helpful to consider the fundamental principle upon which this Standard is based’ and, ‘that an entity shall, with certain limited exceptions, recognise a deferred tax liability (asset) whenever recovery or settlement of the carrying amount of an asset or liability would make future tax payments larger (smaller) than they would be if such recovery or settlement were to have no tax consequences’.
In the fact pattern described in the request, the tax base of the asset is not immediately apparent and the recovery of the asset’s carrying amount gives rise to two distinct tax consequences: taxable economic benefits from use and a capital gain deduction that cannot be offset in determining taxable profit.
An entity identifies temporary differences in a manner that reflects these distinct tax consequences by comparing:
- the portion of the asset’s carrying amount that will be recovered under one tax regime; to
- the tax deductions that will be received under that same tax regime (which are reflected in the asset’s tax base).
In the fact pattern described in the request, the Committee concluded that the entity identifies both:
- a taxable temporary difference of CU100—the entity will recover the licence’s carrying amount (CU100) under the income tax regime, but will receive no tax deductions under that regime (that is, none of the tax base relates to deductions under the income tax regime); and
- a deductible temporary difference of CU100—the entity will not recover any part of the licence’s carrying amount under the capital gains tax regime but will receive a deduction of CU100 upon expiry of the licence (that is, all of the tax base relates to deductions under the capital gains tax regime).
The entity then applies the requirements in IAS 12 considering the applicable tax law in recognising and measuring deferred tax for the identified temporary differences.
The Committee decided not to add the following matter to its standard-setting agenda because the principles and requirements in IFRS already provide an adequate basis for an entity to determine the appropriate treatment.
LEASE TERM AND USEFUL LIFE OF LEASEHOLD IMPROVEMENTS (IFRS 16 Leases and IAS 16 Property, Plant and Equipment)
The Committee received a request about cancellable or renewable leases.
The request asked two questions:
- how to determine the lease term of a cancellable lease or a renewable lease. Specifically, the request asked whether, when applying paragraph B34 of IFRS 16 and assessing ‘no more than an insignificant penalty’, an entity considers the broader economics of the contract, and not only contractual termination payments
- whether the useful life of any related non-removable leasehold improvements is limited to the lease term determined applying IFRS 16.
Paragraph 18 of IFRS 16 requires an entity to determine the lease term as the non-cancellable period of a lease, together with both (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; and (b) periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.
Paragraph B34 of IFRS 16 requires an entity to determine the period for which the contract is enforceable and specifies that ‘a lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the other party with no more than an insignificant penalty’.
The Committee observed that, in applying paragraph B34 and determining the enforceable period of the lease described in the request, an entity considers:
- the broader economics of the contract, and not only contractual termination payments; and
- whether each of the parties has the right to terminate the lease without permission from the other party with no more than an insignificant penalty.
Useful life of non-removable leasehold improvements
Paragraph 50 of IAS 16 requires an item of property, plant and equipment (asset) to be depreciated over its useful life. Paragraphs 56 and 57 of IAS 16 provide further requirements on the useful life of an asset.
If the lease term of the related lease is shorter than the economic life of those leasehold improvements, the entity considers whether it expects to use the leasehold improvements beyond that lease term. If the entity does not expect to use the leasehold improvements beyond the lease term of the related lease then, applying paragraph 57 of IAS 16, it concludes that the useful life of the non-removable leasehold improvements is the same as the lease term. The Committee observed that, applying paragraphs 56–57 of IAS 16, an entity might often reach this conclusion for leasehold improvements that the entity will use and benefit from only for as long as it uses the underlying asset in the lease.
Interaction between lease term and useful life
In assessing whether a lessee is reasonably certain to extend (or not to terminate) a lease, paragraph B37 of IFRS 16 requires an entity to consider all relevant facts and circumstances that create an economic incentive for the lessee. An entity therefore considers the broader economics of the contract when determining the enforceable period of the lease described in the request.
RSM INSIGHTS FROM AROUND THE WORLD
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:
- Applying IFRS 9 – Financial Instruments
- RSM UK’s Lee Marshall explains the impact of the upcoming interest rate benchmark reform.
- Henk Heymans of RSM South Africa considers: Are auditors marking their own IFRS homework?
IFRS QUERY OF THE MONTH
Each month, we will share an IFRS query from matters raised with RSM member firms around the world. The advice contained in the response is general in nature and should not be relied on for an entity’s specific circumstances. The example below is a similar question raised to the IFRS discussion group on September 25, 2019 surrounding variable lease payments and onerous lease provisions. Please see link for full details.
- Retailer A enters into a ten-year lease contract with fixed annual payments per year. Also included in the contract are payments for common area maintenance costs and property taxes, which are based on the retailer’s proportionate share.
- Retailer A has elected to combine lease and non-lease components as a single component. However, since the common area maintenance costs and property taxes are not based on an index or rate, these are excluded from the initial lease liability.
- At the end of year 4, the retailer has vacated the property. There are no opportunities to sub-lease the property and no buy-out options. The RoU asset has been tested for impairment under IAS 36, and has been impaired to a nil value.
- Retailer A anticipates having to pay $5,000 in common area maintenance costs and $10,000 in property taxes each year.
Should Retailer A recognise an onerous provision for any variable lease payments not recognised in the lease liability?
There are two views here.
Proponents of not recognizing a lease liability refer to IFRS 16’s lack of guidance surrounding onerous contracts, and the fact that IAS 37 paragraph 5(c) excludes leases from the scope of the standard unless they:
- Become onerous before the commencement date of the lease
- Are short-term leases or low-value leases
These proponents would say that, since the fact pattern above does not fall under the scope criteria of IAS 37, no provision should be recognised, and the variable payments should be expensed as incurred for the remaining lease term.
In contrast, proponents of recognizing a lease liability cite the following guidance in IAS 37 paragraph 5: “When another Standard deals with a specific type of provision, contingent liability or contingent asset, an entity applies that Standard instead of this Standard.”
This guidance is stated prior to the specific examples of provisions such as leases in IAS 37. However, since variable payments not based on an index or rate are excluded from the calculation of the lease liability under IFRS 16, they fall in the scope of IAS 37, and therefore, an onerous provision should be recognised.