January 2023- Your Global Summary of IFRS News and Developments

LATEST MATTERS FROM THE INTERNATIONAL ACCOUNTING STANDARDS BOARD (IASB)

The following is a summarised update of key matters arising from the discussions taken by the IASB at its meetings in: 

• September 2022   
• October 2022   
• November 2022   
• December 2022 

The full updates can be found here https://www.ifrs.org/news-and-events/updates/iasb/  

Post-Implementation Review of IFRS 9—Classification and Measurement 

At its September meeting, the IASB decided to consider matters raised in the feedback on the classification and measurement requirements of IFRS 9, Financial Instruments. The IASB decided to consider matters related to purchased or originated credit-impaired financial assets when it analyses feedback on the upcoming post-implementation review of the impairment requirements in IFRS 9. 

At its October meeting, the IASB tentatively decided to amend paragraph 11A of IFRS 7, Financial Instruments, to require disclosure of: 

a. The aggregated fair value of equity investments for which the presentation option of other comprehensive income (OCI) is applied at the end of the reporting period and 

b. Changes in fair value recognised in OCI during the period 

The IASB, responding to concerns raised about the potential outcomes of applying the derecognition requirements in IFRS 9 to the settlement of a financial asset or financial liability via electronic cash transfers, also tentatively decided to develop an accounting policy choice to allow an entity to derecognise a financial liability before it delivers cash on the settlement date when specific criteria are met. 

In November, the IASB decided to take no further action on matters identified in the feedback related to 

a. The requirements for classification and measurement of financial liabilities and 

b. The presentation of changes in own credit risk 

The IASB decided that adequate work had been performed to conclude the Post-implementation Review. 

Amendments to the Classification and Measurement of Financial Instruments 

In November, the IASB discussed proposed amendments to IFRS 9, Financial Instruments and IFRS 7, Financial Instruments: Disclosures. 

The IASB discussed a sweep issue on the scope of transactions to which the requirements in IFRS 9 for contractually linked instruments apply and reached a tentative decision that when an entity determines whether a transaction contains contractually linked instruments as described in IFRS 9, any financial instruments held by the transferor of the underlying assets in the transaction are excluded. 

The IASB further considered criteria that would allow an entity to derecognise a financial liability before it delivers cash on the settlement date. A tentative decision was reached that an entity has an accounting policy choice to derecognise a financial liability before the settlement date when: 

a. the entity does not have the ability to withdraw, stop or cancel an electronic payment instruction; 

b. the entity has lost the practical ability to access the cash as a result of the electronic payment instruction; and 

c. the settlement risk associated with the electronic payment instruction is insignificant. 

Settlement risk is considered insignificant if the payment system used has these characteristics: 

a. the period between the payment initiation date and the settlement date is relatively short and is standardised for the particular payment system concerned; and 

b. completion of the payment instruction follows a standard administrative process so that the debtor has reasonable assurance that the transfer will be completed and the cash will be delivered to the creditor. 

The IASB tentatively decided to limit the scope of this accounting policy choice to electronic payment systems. 

The IASB then discussed due process steps with respect to this project and tentatively decided to set a comment period of 120 days for the exposure draft being developed for the project. 

No IASB members indicated an intention to dissent from the proposals in the exposure draft. The IASB members confirmed that they believed sufficient consultation and analysis had been undertaken to begin a balloting process for an exposure draft on this project. 

Financial Instruments with Characteristics of Equity 

At its September meeting, the IASB reached a tentative decision to propose amendments to IAS 32 Financial Instruments: Presentation to clarify: 

a. That paragraph 23 applies to an obligation to redeem an entity’s own equity instruments that is required to be settled in a variable number of a different type of the entity’s own equity instruments. 

b. the accounting on initial recognition of the obligation to redeem an entity’s own equity instruments, if the entity does not already have access to the returns associated with an ownership interest. 

i. If the obligation involves non-controlling interests, the debit entry is recognised against a component of equity other than non-controlling interests.    
ii. In the case of an entity’s other obligations to purchase its own shares, the debit entry is recognised against a component of equity other than issued share capital. 

c. that on expiry of a written put option on an entity’s own equity instruments: 

i. the financial liability is reclassified to the same component of equity as that from which it was reclassified on initial recognition of the put option; and    
ii. the cumulative amount in retained earnings related to remeasuring the financial liability could be reclassified to another component of equity but is not reversed in profit or loss. 

Additionally, a tentative decision was reached to clarify that written put options and forward purchase contracts on an entity’s own equity instruments are required to be presented gross, instead of net. 

In December, the IASB tentatively decided against adding presentation requirements in IAS 32 for financial liabilities. However, the IASB also tentatively decided to require an entity with financial liabilities measured at FVTPL that contain a contractual obligation to pay the holder an amount based on the entity’s performance or changes in the entity’s assets to disclose in each reporting period, the total gains or losses that arise from remeasuring such financial liabilities. These disclosures, together with the proposed disclosures of terms and conditions tentatively agreed to by the IASB in April 2021, will help meet the information needs of users of the financial statements. 

Equity Method 

In September, the IASB discussed the application of the equity method to changes in an associate’s net assets that change the investor’s ownership interest from the issue of equity instruments. Tentative decisions were reached that:

a. when the investor’s ownership interest increases and retains significant influence, an investor applying the preferred approach would recognise that increase as a purchase of an additional interest. 

b. when the investor’s ownership interest increases and retains significant influence, an investor applying the preferred approach would recognise that increase as a purchase of an additional interest. 

In December, the IASB reached a tentative decision that amended a tentative decision reached in June. The December tentative decision takes the position that when applying the IASB’s preferred approach to the equity method, an investor is measuring a single investment in an associate. Accordingly, when an investor is applying the preferred approach in a partial disposal, the investor would measure the portion of the investment to be derecognised as a proportion of the carrying amount of the investment at the disposal date. 

A tentative decision was reached that an investor would recognise its share of an associate’s comprehensive income until its interest in the associate is reduced to zero. Once an investor has reduced the carrying amount of its investment in an associate to zero, the investor would recognise separately its share of each component of the associate’s comprehensive income. 

The IASB also tentatively decided that an investor that has reduced the carrying amount of its investment in an associate to zero and, therefore, has stopped recognizing its share of the associate’s losses would not recognise any unrecognized losses upon the purchase of an additional interest in the associate. Another tentative decision was reached that if an investor’s share of an associate’s comprehensive income is a loss that exceeds the carrying amount of its investment in the associate, an investor would recognise, in order:  

a. its share of the associate’s profit and loss; and  

b. its share of the associate’s other comprehensive income.  

Contractual Cash Flow Characteristics of Financial Assets 

The IASB reached a number of tentative decisions in its September discussion: 

With respect to general requirements, the IASB reached tentative decisions to amend IFRS 9 to clarify that: 

a. for contractual cash flows of a financial asset to be ‘solely payments of principal and interest on the principal amount outstanding’, a basic lending arrangement does not cause variability in cash flows arising from risks or factors that are unrelated to the borrower, even if such terms and conditions are common in the specific market in which the entity operates; and 

b. a financial asset that includes contractual terms that change the timing and amount of the contractual cash flows would be consistent with ‘a basic lending arrangement’, if: 

i. the contractual cash flows that could arise from any contingent events are solely payments of principal and interest in all circumstances (that is, the probability of a contingent event occurring is not considered); 

ii. the contingent event is specific to the borrower; 

iii. the timing and amount of any variability in contractual cash flows are determinable and specified in the contract; and 

iv. the contractual cash flows arising from the contingent event do not represent an investment in the borrower or exposure to the performance of any underlying assets. 

When discussing financial assets with non-recourse features and contractually linked instruments, the IASB tentatively decided to amend IFRS 9 to clarify that a financial asset with non-recourse features exposes the lender to the performance risk of underlying assets throughout the life of the asset, and also restricts the lender’s contractual right to receive contractual payments over the life of the instrument to the cash flows generated by the underlying assets. 

In addition, the IASB tentatively decided to clarify that the unique characteristics of a structure of contractually linked instruments are: 

a. the use of multiple contractually linked instruments; 

b. the presence of non-recourse features; 

c. the prioritisation of payments through a waterfall payment structure; and 

d. concentrations of credit risk that disproportionately reduce contractual rights in the event of cash flow shortfalls. 

The IASB also tentatively decided to clarify that the reference to ‘instruments’ in paragraph B4.1.23 of IFRS 9 includes financial instruments that are not entirely in the scope of IFRS 9, such as lease receivables. 

At its October meeting, the IASB tentatively decided to propose adding disclosure requirements to IFRS 7 for entities to disclose information for each class of financial assets and financial liabilities not measured at fair value. 

In addition, tentative decisions were reached that: 

a. an entity should apply the clarifying amendments to IFRS 9 retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, except that the entity would not be required to restate comparative information; 

b. if, on the initial application of the amendments, an entity changes the classification of a financial asset, the entity should disclose: 

i. the previous measurement category and the carrying amount determined immediately before applying these amendments; and 

ii. the new measurement category and the carrying amount determined after applying these amendments. 

c. the effective date will be determined after exposure of the proposed amendments; and 

d. early application of the amendments is permitted. 

Primary Financial Statements 

The IASB continued its discussion of this project at its September meeting. The topics discussed, and the related tentative decisions, were as follows: 

a. Unusual income and expenses—The IASB tentatively decided that it will not proceed with any specific requirements for unusual income and expenses as part of this project. 

b. Entities with specified main business activities—Associates and joint ventures—The IASB tentatively decided that an entity with specified main business activities would be required to classify income and expenses from associates and joint ventures accounted for using the equity method in the investing category. 

c. investments in subsidiaries, associates and joint ventures—The IASB tentatively decided to clarify that income and expenses from associates and joint ventures not accounted for using the equity method includes income and expenses from associates and joint ventures accounted for:  

i. at cost (paragraph 10(a) of IAS 27 Separate Financial Statements); 

ii. in accordance with IFRS 9 Financial Instruments (paragraph 10(b) of IAS 27); and   

iii. at fair value through profit or loss in accordance with IFRS 9 (paragraph 18 of IAS 28 Investments in Associates and Joint Ventures). 

d. Classification of incremental expenses—The exposure draft had included a requirement for entities to classify incremental expenses in the investing category. At this meeting, the IASB tentatively decided to withdraw that requirement. 

e. Specified subtotals—Paragraph 104 of the exposure draft had included a number of specified subtotals. At this meeting, the IASB tentatively decided to make changes to those specified subtotals, including adding “operating profit or loss and expenses from investments accounted for using the equity method” to the list. 

f. Presentation of operating expenses—The IASB tentatively decided: 

I. to expand the explanation in the description of the function of expense method to clarify how the function of expense method involves allocating and aggregating operating expenses according to the activity to which the consumed economic resource relates. 

II. to provide application guidance to clarify the role of primary financial statements and the aggregation and disaggregation principles in applying the function of expense method. 

III. to require an entity to include in cost of sales the carrying amount of inventories recognised as an expense during the period when presenting cost of sales. 

IV. to require an entity that presents functional line items to disclose a narrative description of what types of expenses (based on their nature) are included in each functional line item. 

In addition to the tentative decisions above, the IASB also tentatively decided: 

a. to confirm the proposals to require operating expenses to be presented in the statement of profit or loss using a classification based either on their nature or function and include application guidance on deciding which method provides the most useful information; 

b. to withdraw the proposed prohibition on a mixed presentation of operating expenses; 

c. to provide application guidance to clarify the requirement for consistent presentation of operating expenses from one reporting period to the next and how to label nature line items when a mixed presentation is used. 

Goodwill and Impairment 

At its November meeting, the IASB tentatively decided to retain an impairment-only model for the subsequent accounting for goodwill. 

In December, the IASB discussed the views it had set out in the Discussion Paper Business Combinations—Disclosures, Goodwill and Impairment. The meeting included discussion on the following: 

a. moving the project to the standard-setting work plan—the IASB decided to add the project to its standard-setting work plan and to change the name of the project to “Business Combinations—Disclosures, Goodwill and Impairment” 

b. the identifiable intangible assets acquired in a business combination—the IASB tentatively decided to make no changes to the recognition criteria in IFRS 3, Business Combinations for identifiable assets acquired in a business combination 

c. the presentation of total equity excluding goodwill—the IASB tentatively decided not to require an entity to present the amount of total equity excluding goodwill as a separate line item on its statement of financial position. This represents a change to the preliminary view on this topic. 

d. Other topics—the IASB tentatively decided not to consider additional topics that had been suggested by respondents in this project, except for two topics related to possible improvements to the effectiveness of the impairment test of cash-generating units containing goodwill. 

Disclosure Initiative—Subsidiaries without Public Accountability 

At its November meeting, the IASB tentatively decided to confirm an earlier decision that an entity will be permitted to apply the new IFRS Accounting Standard if: 

a. it is a subsidiary at the end of the reporting period. 

b. it has an ultimate or intermediate parent that produces consolidated financial statements that:    
i. comply with IFRS Accounting Standards.    
ii. are available for public use. 

At the December meeting, the IASB tentatively decided to confirm that the disclosure requirements in IFRS 8, Operating Segments, IFRS 17, Insurance Contracts, and IAS 33, Earnings per Share remain applicable for a subsidiary applying the standard that would result from this project. The IASB also tentatively decided to retain the proposal to include reduced disclosure requirements for IAS 34, Interim Financial Statements. 

IFRS INTERPRETATIONS COMMITTEE (IC) LATEST DECISIONS SUMMARY 

The IC met in September and November 2022. The following is a summary of the discussions at those meetings. 

The IC had previously published tentative agenda decisions on three topics, which are summarized in our newsletters of April 2022 and September 2022, and followed up with consideration of the feedback at its September meeting. 

• Multi-currency Groups of Insurance Contracts    
   
• Special Purpose Acquisition Companies (SPAC) Accounting for Warrants at Acquisition    
   
• Lessor Forgiveness of Lease Payments (IFRS 9 Financial Instruments and IFRS 16 Leases) 

On each of these agenda decisions, the IC concluded its discussion and the topics were discussed at the October IASB meeting. No IASB member objected to any of the agenda decisions. 

In December, the IC discussed a request about how to assess whether a contract contains a lease. The items included in the request were: 

• At what level should the evaluation of whether a contract contains a lease be made when the contract is for the use of more than one similar asset? Should assets be considered individually, or all assets be considered together?    
   
• How should the assessment of whether a contract contains a lease be performed when the supplier has the practical ability to substitute alternative assets throughout the period of use, but would not benefit economically from exercise of that substitution right throughout the period of use? 

The IC noted that in application of paragraph B12 of IFRS 16, the customer assesses whether the contract contains a lease for each potential separate lease component. Paragraph B32 of IFRS 16 provides application guidance on separate lease components – the right to use an underlying asset is a separate lease component if both (i) the lessee can benefit from the underlying asset on its own or together with other resources readily available to it and (ii) the underlying asset is neither highly dependent on, nor highly interrelated with, the other underlying assets in the contract. 

The IC also noted that because, in the fact pattern, each asset was specified, unless the supplier had a substantive right to substitute another asset throughout the period of use, each asset is an identified asset, meaning that the condition in paragraph B14(a) of IFRS 16 had been met. However, in the fact pattern, the supplier would not have benefitted economically for the first three years of the arrangement. Therefore, the condition in paragraph B14(b) of IFRS 16 had not been met. 

Therefore, the IC concluded that IFRS 16 provides an adequate basis for an entity to evaluate the level at which to assess whether the contract contains a lease and whether there is an identified asset in the fact pattern provided in this request. Consequently, the IC decided not to add a standard-setting project. 

QUERY OF THE MONTH – IFRS 3: CONTINGENT PAYMENTS TO VENDORS 

Question 

My client has acquired a business for $22m. The vendors were two individual shareholders, each of whom owned 50% of the shares. The terms of the same were: 

• Vendor A will receive $10m in cash, payable immediately.    
   
• Vendor B will receive $12m in cash. However, this Is held in escrow and will only be paid after he completes 12 months of employment with the acquiring company. If he leaves before this, he receives nothing. 

How should I account for this? What is the consideration payable in the business combination? 

Response 

The key to the query here is understanding what is part of the business combination, and what is not. Payments to acquire the business are included in the acquisition accounting, and the determination of goodwill. Payments for subsequent services, including remuneration of employees, are not part of the business combination. Contingent payments to vendor shareholders are dealt with in Paragraph B54 and B55 of IFRS 3. In particular, they include the following requirements: 

B55(a) Continuing employment—The terms of continuing employment by the selling shareholders who become key employees may be an indicator of the substance of a contingent consideration arrangement. The relevant terms of continuing employment may be included in an employment agreement, acquisition agreement or some other document. A contingent consideration arrangement in which the payments are automatically forfeited if employment terminates is remuneration for post-combination services. Arrangements in which the contingent payments are not affected by employment termination may indicate that the contingent payments are additional consideration rather than remuneration. 

(b) Duration of continuing employment—If the period of required employment coincides with or is longer than the contingent payment period, that fact may indicate that the contingent payments are, in substance, remuneration. 

(c) Level of remuneration—Situations in which employee remuneration other than the contingent payments is at a reasonable level in comparison with that of other key employees in the combined entity may indicate that the contingent payments are additional consideration rather than remuneration. 

If we were to read paragraph (a) above literally, we might conclude that the entire amount payable to Vendor B should be remuneration for employment, since it is all contingent on a period of service. However, that clearly would not reflect the substance of the transaction, as it would imply that Vendor B gave his 50% interest in the business away for free, when in fact it was worth $10m, as shown by the payment to Vendor A. Similarly, it would imply that he is receiving employment remuneration of $12m per year, which is unlikely to be the case for any employee. 

Therefore, in this example, we would determine the split between remuneration and consideration with reference to the price paid to Vendor A, which establishes the fair value of the shares. We have assumed a discount rate of 10% 

Note that the discount of 10% would be unwound over the following 12 months as an interest expense. 

Remuneration for Employment to Vendor B $0.9m – recognised on a straight-line basis as an employee expense over the 12 months of employment that Vendor B is required to complete.