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.
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:
23, 25 June 2020
22 and 23 July 2020
The full update, as published by the IASB, can be found here.
Disclosure Initiative—Accounting Policies
The Board met on 24 June 2020 to discuss the feedback on its Exposure Draft Disclosure of Accounting Policies, which proposed amendments to IAS 1 Presentation of Financial Statements, and IFRS Practice Statement 2 Making Materiality Judgements.
The Board tentatively decided that all types of accounting policy information should be subject to materiality judgements when deciding whether to disclose accounting policy information that is based on requirements in IFRS Standards.
The Board tentatively decided to add:
- an explanatory paragraph to the proposed amendments to IAS 1. This paragraph would:
- clarify that entities are permitted to provide immaterial accounting policy information as long as it does not obscure material accounting policy information; and
- prompt entities to consider whether they are obscuring material accounting policy information with immaterial accounting policy information.
- further guidance to the proposed amendments to IFRS Practice Statement 2 relating to paragraph 117B of IAS 1 and the changes to the amendments to IAS 1 described in (a).
The Board´s discussion continued on July 22 and tentatively decided to require an entity to disclose in the period of first application of the amendments material accounting policy information for that period. The Board noted that paragraph 38 of IAS 1 specifies that comparative information would be required only if it is relevant to understanding the current period’s financial statements.
The Board also tentatively decided to require an entity to apply the amendments to IAS 1 to annual reporting periods beginning on or after 1 January 2023 and permit early application.
The Board tentatively decided to change the effective date of the amendments to IAS 8 resulting from the Accounting Policies and Accounting Estimates project to annual reporting periods beginning on or after 1 January 2023 and permit early application.
The Board plans to issue the amendments to IAS 1 and IFRS Practice Statement 2 in the fourth quarter of 2020.
Classification of Liabilities as Current or Non-current (Amendments to IAS 1)
The Board met on 24 June 2020 to discuss feedback on the May 2020 Exposure Draft Classification of Liabilities as Current or Non-current—Deferral of Effective Date, which amends IAS 1 Presentation of Financial Statements. The Exposure Draft proposed deferring for one year the effective date of Classification of Liabilities as Current or Non-current issued in January 2020. The amended effective date would be 1 January 2023.
The Board issued the amendment in July 2020.
Maintenance and consistent application
The Board met on 22 July 2020 to discuss requirements for the transition to and early application of the proposed amendment to IAS 21 The Effects of Changes in Foreign Exchange Rates.
The proposed amendment to IAS 21 would:
(a) define exchangeability and thus a lack of exchangeability; and
(b) specify how an entity determines the spot exchange rate when a currency lacks exchangeability.
Regarding Transition, the Board tentatively decided to propose that an entity would apply the amendment prospectively from the beginning of the annual reporting period in which it first applies the amendment and not restate comparative information. An entity that:
- reports foreign currency transactions in its functional currency would:
- translate foreign currency monetary items, and non-monetary items measured at fair value in a foreign currency, at the date of initial application using the estimated spot exchange rate at that date; and
- recognise any effect of initially applying the amendment in opening retained earnings.
- uses a presentation currency other than its functional currency (or translates a foreign operation) would:
- translate all assets and liabilities at the date of initial application using the estimated spot exchange rate at that date;
- translate equity items at the date of initial application using the estimated spot exchange rate at that date if the entity’s functional currency is hyperinflationary; and
- recognise any effect of initially applying the amendment as an adjustment to the cumulative amount of translation differences in equity.
For First-time adopters, the Board tentatively decided to:
- provide no specific exemption for a first-time adopter from the proposed amendment to IAS 21; and
- align the wording in paragraph D27(b) of IFRS 1 First-time Adoption of International Financial Reporting Standards with the definition and description of a lack of exchangeability in the proposed amendment.
Regarding Early application, the Board tentatively decided to permit an entity to apply the proposed amendment earlier than the effective date.
LATEST MATTERS ARISING FROM THE IFRS INTERPRETATIONS COMMITTEE (IC)
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:
16 June 2020
The full update 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:
Supply Chain Financing Arrangements—Reverse Factoring
The Committee received a request about reverse factoring arrangements. Specifically, the request asked:
- how an entity presents liabilities to which reverse factoring arrangements relate (ie how it presents liabilities to pay for goods or services received when the related invoices are part of a reverse factoring arrangement); and
- what information about reverse factoring arrangements an entity is required to disclose in its financial statements.
In a reverse factoring arrangement, a financial institution agrees to pay amounts an entity owes to the entity’s suppliers and the entity agrees to pay the financial institution at a date later than suppliers are paid.
The Committee concluded that an entity presents a financial liability as a trade payable only when it represents a liability to pay for goods and services, is invoiced or formally agreed upon with the supplier and is part of the working capital used in the entity’s normal operating cycle. Other payables are presented together with trade payables only when their nature and function is similar to trade payables, for example, when they are part of the working capital used in the entity’s normal operating cycle. Liabilities that are part of a reverse factoring arrangement are presented separately when their size, nature or function makes separate presentation relevant to an understanding the entity’s financial position. In making this determination, the entity considers the amounts, nature and timing of the liabilities. The entity might also consider other factors such as whether additional security was provided as part of the arrangement or whether the terms of the liabilities are substantially different from those of the entity’s other trade payables.
If the entity considers the nature of the liabilities that are part of the reverse factoring arrangement to be trade or other payables that are part of the working capital used in the entity’s principal revenue generating activities, the cash outflows to settle the liabilities will be presented as operating activities in the statement of cash flows. In contrast if the entity considers the nature of the liabilities to be borrowings, the cash outflows to settle the liabilities will be presented as financing activities.
The entity should also consider disclosures in relation to the liquidity risk arising from the reverse factoring arrangements, for example, concentration of a portion of its liabilities with one financial institution rather than a diverse group of suppliers or the risk that suppliers may be accustomed to or rely on earlier repayment of their trade receivables under the reverse factoring arrangement.
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.
Sale and Leaseback with Variable Payments (IFRS 16 Leases)
The Committee received a request about a sale and leaseback transaction with variable payments. In the transaction described in the request:
- 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 transfer of the PPE satisfies the requirements in IFRS 15 Revenue from Contracts with Customers to be accounted for as a sale of the PPE. The amount paid by the buyer-lessor to the seller-lessee in exchange for the PPE equals the PPE’s fair value at the date of the transaction.
- payments for the lease (which are at market rates) include variable payments, calculated as a percentage of the seller-lessee’s revenue generated using the PPE during the five-year lease term. The seller-lessee has determined that the variable payments are not in-substance fixed payments as described in IFRS 16.
The request asked how, in the transaction described, the seller-lessee measures the right-of-use asset arising from the leaseback, and thus determines the amount of any gain or loss recognised at the date of the transaction.
To measure the right-of-use asset arising from the leaseback, the seller-lessee determines the proportion of PPE transferred to the buyer-lessor that relates to the right of use retained. It does so by comparing, at the date of the transaction, the right of use it retains via the leaseback to the rights comprising the entire PPE. IFRS 16 does not prescribe a method for determining that proportion. In the transaction described in the request, the seller-lessee could determine the proportion by comparing for example, (a) the present value of expected payments for the lease (including those that are variable) with (b) the fair value of the PPE at the date of the transaction.
The amount of gain or loss recognized by the seller-lessee relates only to the rights transferred to the buyer-lessor. The seller-lessee also recognizes a liability at the date of the transaction, even if all the lease payments are variable and do not depend on an index or a rate. The initial measurement of the liability is a consequence of how the right-of-use asset is measured and how the gain or loss on the sale and leaseback transaction is determined.
Deferred Tax related to an Investment in a Subsidiary (IAS 12 Income Taxes)
The Committee received a request about how an entity, in its consolidated financial statements, accounts for deferred tax related to its investment in a subsidiary. In the fact pattern described in the request:
- undistributed profits of the subsidiary give rise to a taxable temporary difference associated with the entity’s investment in the subsidiary.
- the entity has determined that the conditions in paragraph 39 of IAS 12 for applying the exception from recognising a deferred tax liability related to its investment in the subsidiary are not satisfied because the entity expects the subsidiary to distribute its profits (which are available for distribution) in the foreseeable future.
- the entity and subsidiary operate in a jurisdiction in which:
- profits are taxable only when distributed—that is, the income tax rate applicable to undistributed profits is nil (undistributed tax rate).
- a 20% tax rate applies to profit distributions (distributed tax rate). However, profit distributions made by the entity are not taxable to the extent that the subsidiary has already been taxed on that profit—that is, profit distributions are taxed only once.
The request asked whether the entity recognises a deferred tax liability for the taxable temporary difference associated with its investment in the subsidiary.
In the fact pattern described in the request, there is a taxable temporary difference associated with the entity’s investment in the subsidiary and the recognition exception in paragraph 39 of IAS 12 does not apply, Accordingly, the Committee concluded that the entity recognizes a deferred tax liability for the taxable temporary difference. The entity expects to recover the carrying amount of its investment through distributions of profits by the subsidiary which would be taxed at the distributed tax rate of 20%. Accordingly, the Committee concluded that the entity uses the distributed tax rate to measure the deferred tax liability related to its investment in the subsidiary.
Player Transfer Payments (IAS 38 Intangible Assets)
The Committee received a request about the recognition of player transfer payments received. In the fact pattern described in the request:
- 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. Registration means the player is prohibited from playing for another club, and requires the registering club to have an employment contract with the player that prevents the player from leaving the club without mutual agreement. 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. As part of its ordinary activities, the entity uses and develops the player through participation in matches, and then potentially transfers the player to another club.
- 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 before the contract ends. The registration in the electronic transfer system is not transferred to the receiving club but, legally, is 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.
The request asked whether the entity recognises the transfer payment received as revenue applying IFRS 15 Revenue from Contracts with Customers or, instead, recognises the gain or loss arising from the derecognition of the intangible asset in profit or loss applying IAS 38.
The transfer payment arises from the transfer agreement, which requires the entity to release the player from the employment contract. The entity is required to take an action in order for the right to be extinguished. Accordingly, the transfer payment compensates the entity for its action in disposing of the registration right and thus is part of the net disposal proceeds described in paragraph 113 of IAS 38.
The Committee therefore concluded that, 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 applying paragraph 113 of IAS 38 and does not recognise the transfer payment received, or any gain arising, as revenue applying IFRS 15.
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.
Query of the month
Entity A issues a convertible bond with the following key terms:
The principal amount is HK$250 million
The initial conversion price is fixed at HK$1 per share subject to normal anti-dilution adjustments
Interest of 2% per annum is due on the principal amount outstanding payable half-yearly
The bond may be converted into ordinary shares at any time prior to maturity at the option of the bondholder
Any principal amount outstanding at the maturity date, being 5 years from the date of issue, will be mandatorily converted into ordinary shares
Upon occurrence of any event of default the bondholder has the right to require Entity A to redeem the outstanding principal and accrued interest in cash
Events of default are defined in the bond agreement and include, among others, the following:
Non-payment of any interest due on the bond
An event of default on any of Entity A’s other borrowings
The liquidation of Entity A or the appointment of a receiver of the whole or a material part of Entity A’s assets or undertaking
Entity A’s shares are suspended from trading on the Hong Kong Stock Exchange or Entity A is delisted
How should Entity A classify the convertible bond applying IAS 32 Financial Instruments: Presentation?
Entity A’s obligation to make the interest payments half-yearly gives rise to a financial liability.
Entity A also has an obligation to settle the principal amount in cash upon request by the bondholder but only upon occurrence of an event of default. This is what is commonly referred to as a contingent settlement provision – where the requirement to deliver cash is dependent on the occurrence or non-occurrence of uncertain future events or the outcome of uncertain circumstances. Unless the contingencies are within its control Entity A does not have an unconditional right to avoid delivering cash and will recognize a financial liability in respect of the principal amount of the bond.
The future revenues, net income or debt to equity ratio are given as examples in IAS 32 of contingencies beyond the control of the issuer. Entity A’s ability to generate adequate resources to make payments on the bond and its other borrowings when due depends primarily on its future revenues and net income. These contingencies are therefore considered beyond the control of Entity A. While obligations that arise only upon liquidation are ignored for classification purposes, events that are similar to but do not lead to liquidation of the entity such as receivership must be considered. The appointment of a receiver could occur due to Entity A’s failure to make payments on its debts when due. This contingency is also considered beyond the control of Entity A therefore for similar reasons as above. The reasons for a suspension of trading or delisting of Entity A’s shares also need to be evaluated based on the listing rules in the relevant jurisdiction. In Hong Kong these reasons are considered not always to be within the control of Entity A.
Accordingly, Entity A will recognize its obligation to pay the principal amount of the bond upon an event of default as a financial liability.
The convertible bond will be classified as a compound financial instrument as the equity component (the conversion feature) is on fixed-for-fixed terms.