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.
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:
22-23 September 2020
27-29 October 2020
18 November 2020 jointly with FASB
14-16 December 2020
Maintenance and consistent application
LEASE LIABILITY IN A SALE AND LEASEBACK
After its September discussion, the Board issued exposure-draft ED/2020/4 Lease liability in a Sale and Leaseback in November 2020.
The amendments to IFRS 16 proposed by the ED only concern sale and leaseback transactions that satisfy the requirements of IFRS 15, Revenue from Contracts with Customers, to be accounted for as a sale of the asset and should impact only those transactions that include variable lease payments.
Among the amendments proposed:
- Relating to initial recognition:
- The seller-lessee shall determine the amount of right-of-use asset by comparing the present value of the expected lease payments, discounted using the rate specified in paragraph 26 of IFRS 16, to the fair value of the asset sold.
- The lease liability is initially measured at the present value of the expected lease payments that are not paid at the commencement date.
- Hence, contrary to leases entered into without any preceding sale transaction, where variable lease payments not depending on an index or a rate are excluded from the calculation, such payments are considered as expected lease payments. The seller-lessee shall estimate them over the lease term to be able to measure the lease liability and right-of-use asset.
- Relating to subsequent measurement:
- Any difference between the actual payments made for the lease (excluding any above-market terms) and the expected lease payments is recognised in profit or loss for the reporting period as specified in paragraph 38.
- If there are shortfalls in the actual payments made (i.e. the payments made are less than the payments due) or recoveries of shortfalls, the seller-lessee shall also adjust the carrying amount of the lease liability and make a corresponding adjustment as specified in paragraph 38.
- The lease liability is reassessed in case of a change in the lease term or in case of a lease modification that is not accounted for as a separate lease according to applicable requirements of IFRS 16, except that the revised lease payments as described in those paragraphs shall be the revised expected lease payments at the date of remeasurement. In other words, revised variable lease payments not depending on an index or a rate are included in the revised lease payments at that date.
- Except for a change in the lease term or a lease modification, the seller-lessee shall not remeasure the lease liability to reflect a change in future variable lease payments.
- Relating to transition, a seller-lessee shall apply the amendment retrospectively in accordance with IAS 8 to sale and leaseback transactions entered into after the date of initial application of IFRS 16, unless retrospective application would be possible only with the use of hindsight. Specific requirements apply in the case of hindsight starting from the beginning of the annual reporting period in which the seller-lessee first applies the amendment.
- Relating to illustrative examples, an additional example is provided with a sale and leaseback transaction including variable lease payments.
Proposed amendments appear then to lead to accounting treatments that are substantially and surprisingly different depending on whether the lease is entered into with or without a preceding sale of the asset to the lessor. Entities concerned shall need to tag their lease contracts accordingly in order for them to be able to apply each accounting treatment consistently over the lease term, reassessments and modifications. A Board member has expressed an alternative view for more consistent requirements between both types of lease transactions (see appendix to the ED).
Invitation to comments is open until March 29, 2021.
DEFERRED TAX RELATED TO ASSETS AND LIABILITIES ARISING FROM A SINGLE TRANSACTION (AMENDMENTS TO IAS 12)
In its October and November meetings, the Board discussed feedback on its Exposure Draft, Deferred Tax related to Assets and Liabilities arising from a Single Transaction, and effective date, regarding exceptions to the recognition of deferred tax.
As for the recognition of deferred taxes, the Board tentatively decided to:
- confirm its proposal to narrow the scope of the recognition exemption in paragraphs 15 and 24 of IAS 12, Income Taxes, so that it would not apply to transactions that give rise to equal amounts of taxable and deductible temporary differences;
- remove the capping proposal—in other words, include no requirement to limit the recognition of a deferred tax liability to the amount recognised for a deferred tax asset;
- provide no application guidance or examples illustrating how an entity determines whether tax deductions relate to the lease asset or lease liability; and
- provide an illustrative example explaining the deferred tax accounting for advance lease payments and initial direct costs.
As for transition requirements, the Board tentatively decided to:
- require entities to apply the amendments to transactions that, on initial recognition, give rise to equal amounts of taxable and deductible temporary differences.
- require entities already applying IFRS Standards to apply the amendments for the first time by:
- recognising deferred tax for all temporary differences related to leases and decommissioning obligations at the beginning of the earliest comparative period presented, with the cumulative effect recognised as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate) at that date; and
- applying the amendments prospectively to transactions other than leases and decommissioning obligations (in other words, only to such transactions that occur on or after the beginning of the earliest comparative period presented).
- require first-time adopters to recognise deferred tax for all temporary differences related to leases and decommissioning obligations at the date of transition to IFRS Standards.
As for the effective date, the Board tentatively decided that entities should apply the amendments for annual periods beginning on or after 1 January 2023, with earlier application permitted.
The Board expects to issue the amendments in the second quarter of 2021.
IFRS INTERPRETATIONS COMMITTEE (IC) LATEST DECISIONS SUMMARY
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:
15 September 2020
1–2 December 202
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.
SALE AND LEASEBACK OF AN ASSET IN A SINGLE-ASSET ENTITY (IFRS 10, CONSOLIDATED FINANCIAL STATEMENTS AND IFRS 16 LEASES)
The Committee received a request about the applicability of the sale and leaseback requirements in IFRS 16 to a transaction in which:
- an entity sells all its equity interest with loss of control in a wholly owned subsidiary that only holds a building;
- the subsidiary has no liabilities and the held building does not meet the definition of a business given by IFRS 3, Business Combinations;
- the entity leases the building back with payments at market rates;
- the transfer of the building satisfies the requirements in IFRS 15, Revenue from Contracts with Customers to be accounted for as a sale of the building;
- the sales price equals the fair value of the building at the date of the transaction and exceeds its carrying amount.
The request asked whether the entity in its consolidated financial statements applies the sale and leaseback requirements in IFRS 16 and therefore recognises only the amount of the gain that relates to the rights transferred to the third party.
Considering the transaction described, the Committee concluded that the entity both applies:
- paragraphs 25 and B97-B99 of IFRS 10, Consolidated Financial Statements, relating to the loss of control in the subsidiary; in particular, paragraph B98 requires the entity to derecognise the building held by the subsidiary and recognise the fair value of the consideration received;
- paragraph 100(a) of IFRS 16, since the transfer satisfies the requirements to be accounted for as a sale, which implies:
- measuring the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the building that relates to the right of use it retains; and
- recognising only the amount of any gain that relates to the rights transferred to the third party; and
- also recognising a liability at the date of the transaction, the initial measurement of which is a consequence of how the right-of-use asset is measured.
Consequently, the gain the entity recognises on the transaction reflects the requirements in paragraph 100(a) of IFRS 16.
The Committee provides the tentative decision with an illustrative example and accompanying accounting entries.
CLASSIFICATION OF DEBT WITH COVENANTS AS CURRENT OR NON-CURRENT (IAS 1, PRESENTATION OF FINANCIAL STATEMENTS)
In response to feedback and enquiries from some stakeholders, the Committee discussed how an entity applies to particular fact patterns the IAS 1 amendments issued in January 2020 and effective for annual reporting periods beginning on or after 1 January 2023, with earlier application permitted.
Specifically, the Committee discussed how an entity, applying paragraph 69(d) of IAS 1, determines whether it has the right to defer settlement of a liability for at least twelve months after the reporting period when:
- the right to defer settlement is subject to the entity complying with specified conditions; and
- compliance with the specified conditions is tested at a date after the end of the reporting period.
In the fact patterns discussed, it is assumed that the criteria in paragraph 69(a)–(c) of IAS 1 are not met.
The Committee discussed three fact patterns with a loan that requires an entity to maintain a particular working capital ratio. In all fact patterns, the entity is assessing whether it classifies the loan as current or non-current at the end of the reporting period (31 December 20X1).
|12/31/20x1||Case 1||Case 2||Case 3|
|Loan characteristics||Repayable in 5 years, or on demand if covenants not met||Repayable in 5 years, or on demand if covenants not met||Repayable in 5 years, or on demand if covenants not met|
|Covenant terms||Working capital Ratio >1.0 each 12/31, 03/31, 06/30, 09/30||Working capital Ratio >1.0 each 03/31||
Working capital Ratio:
>1.0 at 12/31/20X1
>1.1 at 06/30/20X2 (and at each 06/30 thereafter)
|Covenant ratios as at reporting date||0.9 at 12/31/20X1||0.9 at 12/31/20X1||1.05 at 12/31/20X1|
|Covenant expectations||> 1.0 at 03/31, 06/30, 09/30/20X2||> 1.0 at 03/31/20X2||> 1.1 at 06/30/20X2|
|Other facts and circumstances||Waiver obtained before reporting date for 3 months||None||None|
|Application of IAS 1 to the fact pattern||Covenant breached at the end of reporting period; waiver only for 3 months||Covenant breached at the end of reporting period||Ratio of 1.05 complies with condition tested at the reporting date, but not with the condition that will be tested at 06/30/20X2: 1<1.05<1.1|
|Committee’s conclusion||No right at the end of reporting period to defer settlement for at least 12 months after reporting period è loan classified as current||No right at the end of reporting period to defer settlement for at least 12 months after reporting period è loan classified as current||No right at the end of reporting period to defer settlement for at least 12 months after reporting period è loan classified as current|
In all three fact patterns described in this agenda decision, the Committee concluded that the entity is required to classify the loan as current because the entity does not have the right at the end of the reporting period (31 December 20X1) to defer settlement of the loan for at least twelve months after the reporting period.
In reaching its conclusion, the Committee noted that the entity’s expectation that it will meet the condition tested after the reporting period does not affect its assessment of the criterion in paragraph 69(d) of IAS 1. Applying paragraphs 69(d) and 72A of IAS 1, the entity’s right to defer settlement of a liability for at least twelve months after the reporting period must exist at the end of the reporting period.
ATTRIBUTING BENEFIT TO PERIODS OF SERVICE (IAS 19, EMPLOYEE BENEFITS)
The Committee received a request about the periods of service to which an entity attributes benefit for a particular defined benefit plan. Under the terms of the plan:
- employees are entitled to a lump sum benefit payment when they reach a particular retirement age provided they are employed by the entity when they reach that retirement age; and
- the amount of the retirement benefit to which an employee is entitled depends on the length of employee service before the retirement age and is capped at a specified number of consecutive years of service.
To illustrate the fact pattern described in the request, the Committee assumed an entity sponsoring a defined benefit plan for its employees, under the terms of which:
- employees are entitled to a retirement benefit only when they reach the retirement age of 62 provided they are employed by the entity when they reach that retirement age;
- the amount of the retirement benefit is calculated as one month of final salary for each year of service before the retirement age;
- the retirement benefit is capped at 16 years of service (i.e. the maximum retirement benefit an employee is entitled to is 16 months of final salary);
- the retirement benefit is calculated using only the number of consecutive years of employee service immediately before the retirement age.
Based on the defined benefit plan illustrated in this agenda decision and on paragraph 73 of IAS 19, the Committee concluded that the entity attributes retirement benefit to each year in which the employee renders service from the age of 46 to the age of 62 (or, if employment commences on or after the age of 46, from the date the employee first renders service to the age of 62). In accordance with the fact pattern, the entity’s obligation to provide retirement benefits arises only from the age of 46 (or, if employment commences on or after the age of 46, from the date the employee first renders service).
CONFIGURATION OR CUSTOMISATION COSTS IN A CLOUD COMPUTING ARRANGEMENT (IAS 38, INTANGIBLE ASSETS)
The Committee received a request about the customer’s accounting for costs of configuring or customising the supplier’s application software in a Software as a Service (SaaS) arrangement. In the fact pattern described in the request:
- a customer enters into a SaaS arrangement with a supplier, where the service consists in providing access to a software asset over the contract term without providing the software itself;
- the customer incurs upfront costs of:
- configuring the software: setting ‘flags’ or ‘switches’, defining values or parameters, setting up software existing code;
- customising the software: modifying the code or writing additional code, thus changing or creating additional functionalities in the software.
In analysing the request, the Committee considered two questions:
- whether, applying IAS 38, the customer recognises an intangible asset in relation to configuration or customisation of the application software (Question I)?
- if an intangible asset is not recognised, how the customer accounts for the configuration or customisation costs (Question II)?
For question I, in the fact pattern described in the request, the supplier controls the application software to which the customer has access. The assessment of whether configuration or customisation of that software results in an intangible asset for the customer depends on the nature and output of the configuration or customisation performed. The Committee observed that, in the SaaS arrangement described in the request, the customer often would not recognise an intangible asset because it does not control the software being configured or customised and those activities do not create an asset that is separate from the software. In some circumstances however, the arrangement may result in, for example, additional code from which the customer has the power to obtain the future economic benefits and to restrict others’ access to those benefits. In that case, the customer assesses whether the additional code is identifiable and meets the recognition criteria in IAS 38 in determining whether to recognise the additional code as an intangible asset.
For question II, the Committee observed that the customer recognises the costs as an expense when it receives the configuration or customisation services, referring to paragraph 69 of IAS 38. Since IAS 38 does include requirements to identify when the services are received, the customer applies the requirements of IFRS 15, Revenue from Contracts with Customers:
- if the services the customer receives are distinct, then the customer recognises the costs as an expense when the supplier configures or customises the application software.
- if the services the customer receives are not distinct (because those services are not separately identifiable from the customer’s right to receive access to the supplier's application software), then the customer recognises the costs as an expense when the supplier provides access to the application software over the contract term.
Moreover, the customer recognises any prepayment as an asset and discloses its accounting policy for configuration or customisation costs when that disclosure is relevant to an understanding of its financial statements.
The Committee 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 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 the same date as, or a date later than, suppliers are paid.
The Committee confirmed in December meeting the tentative decision reached in June on the same matters:
- Presentation in the statement of financial position: the Committee only added a reference to paragraph 55 of IAS 1, Presentation of Financial Statements, which requires entities to present additional line items when such presentation is relevant to an understanding of the entity’s financial position. Consequently, an entity is required to determine whether to present liabilities that are part of a reverse factoring arrangement:
- within trade and other payables;
- within other financial liabilities; or
- as a line item separate from other items in its statement of financial position.
- Derecognition of a financial liability.
- Presentation in the statement of cash flows.
- Notes to the financial statements: the Committed only added a reference to paragraph 31 of IFRS 7, which requires an entity to provide information that enables users of its financial statements to evaluate the nature and extent of risks arising from financial instruments to which the entity is exposed.
In addition to the June update, the Committee also reported to the Board that respondents to the tentative agenda decision provided input on possible standard-setting the Board could undertake in relation to supply chain financing arrangements. The Board will consider at a future Board meeting whether to undertake such standard-setting, considering the feedback from those respondents, as well as feedback received from Committee members, users of financial statements and other interested parties.
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.
This month, we have issued the RSM Illustrative Financial statements for years ending 31 December 2020. There are 5 sets of financial statements covering various entities:
- Private company
- Listed company – interim example
- Listed company – practical example
- Listed company - exploration and mining example
- Listed company - comprehensive example
These example financial statements are an invaluable resource for anyone involved in the preparation or audit of a financial report under IFRS.
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.
An entity has issued a perpetual subordinated bond on 25 July 20X0 to finance its growth. The terms and conditions are as follows:
- duration: perpetual.
- options: the issuer may redeem the bond on 25 July 20XX and on each subsequent anniversary of the date of issue.
- interest: interest accrues on the basis of a variable interest rate plus a premium of 0,5%; from 25 July 20XX, the first date the issuer may exercise its option to redeem the bond, the premium rises from 0,5% to 0,75%. The interest payments are made at the issuer’s discretion.
- redemption and payment of interest: all the payments are subordinated to the solvency of the issuer, which considers, among other criteria, the ability to pay dividends on common shares and the effective payment of such dividends.
What definitions and criteria of IAS 32, Financial instruments: Presentation, apply to debt versus equity classification?
If an entity that has issued a financial instrument cannot avoid paying cash or remitting another financial asset to settle a contractual obligation, then the financial instrument meets the definition of a debt (IAS 32.19).
On the other hand, IAS 32 considers (by default) equity instruments as non-debt (IAS 32.16). These are instruments with an unconditional right not to pay cash (or remit another financial asset), i.e. which does not include a contractual obligation to make such a payment (either in the form of a capital repayment or in the form of revenue). For example, common equity shares issued are, from issuer’s point of view, equity instruments.
However, contracts that are to be settled in the entity’s own equity instruments are only considered equity if they meet the “fixed for fixed” test, that is, they deliver a fixed number of equity instruments for a fixed amount of cash. Contracts to deliver a variable number of equity instruments are treated as debt.
In addition, the following instruments are regarded as equity instruments in IFRS, provided they have certain characteristics and meet certain conditions (e.g. puttable instruments, such as UCITs shares):
- instruments that are refundable at the holder's discretion (the refund can be made throughout the life of the instrument, at the request of the holder) (IAS 32.16A);
- instruments, or instrument components that impose an obligation on the entity to give another party a share of the entity's net assets, only during liquidation (e.g., shares issued by restricted entities) (IAS 32.16C).
The debt-versus-equity determination must be performed "in substance", e.g. on the basis of the contractual substance of the contract instead of its economic substance or legal form. The classification is based on an assessment of the substance of contractual terms and the definitions of a financial liability and an equity instrument (IAS 32.AG26).
An analysis of the contractual characteristics of each instrument, in the light of the provisions of the standard, is then necessary. This is particularly the case for composite instruments that include both a debt component and an equity component (IAS 32.28): after assessing the "debt" component, the issuer of such an instrument obtains, by difference from the overall valuation of the composite instrument, the "equity" component (IAS 32.31).
The booking of the revenue associated with the issued liabilities (interest, dividends, as well as losses and gains recorded in the income statement) follows the classification of the instrument to which they are linked (IAS 32.36). Thus, interest or dividends are recorded:
- in financial charges, if the related instrument is a debt;
- equity, if the related instrument is an equity instrument;
- partly in financial expenses and partly in equity, in the case of a composite instrument.
The main characteristics for arbitrating in favour of a classification as a debt instrument or an equity instrument are presented in the table below:
|Criteria to recognize an equity instrument||Criteria to recognize a debt instrument|
|Full discretion not to make any payment.||Mandatory repayment clause, or conditional repayment clause (out of the control of both the issuer and holder, such as a subordinated liability).|
|No redemption date||Mandatory redemption date, or absence of redemption date for the principal but mandatory payment of a series of coupons to infinity.|
|Prohibited payments if no dividend is paid to common shares ("dividend stopper clause").||Obligation to pay a minimum dividend.|
|Elements tha do not preclude classification as an equity instrument||Elements that give rise to classification as a debt instrument|
|"Step-up" clause (i.e. sudden increase in discretionary dividends if the instrument has not been repaid on a certain date).||There is an indirect obligation to repay.|
|Repayment option held by the issuer.||Repayment option held by the holder.|
In all cases, a detailed analysis (based on the above-disclosed criteria) of the contractual terms shall be carried out in order to decide on the classification of the instrument.
In the example above, such a subordinated debt would be regarded as an equity instrument, as the issuer has full discretion to make any payments of principal or interest Redemption is only at the option of the issuer. Interest payments are not mandatory. The dividend stopper clause and step up clause do not impact classification. These clauses are designed to make it economically advantageous to the issuer to pay interest and/or redeem the bond to avoid higher finance charges. However, economic compulsion does not result in a financial instrument being classified as a liability. Obligations must be established through the terms and conditions of the financial instrument.