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 June 2021
20-21 July 2021
The full update, as published by the IASB, can be found here.
MAINTENANCE AND CONSISTENT APPLICATION
SUPPLIER FINANCE ARRANGEMENTS
In its June meeting, the Board discussed proposed disclosure requirements for supplier finance arrangements. It is not expected that supplier finance arrangements will be strictly defined, but the Board have represented that they will provide explanations of the types of arrangements included within the scope of the disclosure requirements.
To meet the proposed disclosure objectives, entities will be required to:
- Describe the key terms and conditions of the arrangement;
- Disclose the aggregate amount of payables recognised as a result of the arrangement at the start and end of the reporting period, as well as the amount for which suppliers have already received payment from the finance provider;
- Describe the range of payment terms of payables recognised as a result of supplier finance arrangements and separately, those payment terms of payables that do not form part of such arrangements.
Amendments are also proposed to IAS 7 Statement of Cash Flows to provide quantitative information to explain the effects of supplier finance arrangements on the entity’s financial position and cash flows, as well as qualitative information to provide details on the risks that arise as a result of the arrangements.
It was also tentatively decided that supplier finance arrangements would be included as an example within the liquidity risk disclosure requirements in IFRS 7 Financial Instruments: Disclosures.
CLASSIFICATION OF DEBT WITH COVENANT AS CURRENT OR NON-CURRENT
In its June meeting, the Board discussed the technical analysis and conclusions in the Committee’s recent tentative agenda decision, which assists in the application of IAS 1 Presentation of Financial Statements to particular fact patterns.
It was tentatively decided to amend IAS to stipulate that compliance with conditions after the reporting period would not affect whether there is a right to defer settlement at the reporting date, when assessing the classification of a liability as current or non-current.
It was also tentatively decided to include disclosure requirements regarding non-current liabilities subject to conditions. An entity would be required to disclose the conditions the liabilities are subject to, including the nature and date by which the entity must comply, explain whether the conditions would be met based on the conditions at the reporting date, and whether the entity expects to comply with the condition at the contractual testing date.
A new category would also be introduced in the statement of financial position to separately present the non-current liabilities subject to conditions in the next 12 months. This line item would include liabilities classified as non-current for which the right to defer settlement for at least 12 months is subject to the entity complying with conditions after the reporting date.
An entity does not have a right to defer settlement at the reporting date when the related liability could become repayable within 12 months (at the discretion of the counterparty or a third party) or if an uncertain future event occurs (or does not occur) and the event’s occurrence (or non-occurrence) is unaffected by the entity’s future actions
The proposed amendments would also defer the effective date of the 2020 amendments to no earlier than 1 January 2024. An entity can apply the apply the proposed amendments earlier than the effective date.
Entities to apply the proposed amendments retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors; and provide no exemption for first-time adopters.
CLASSIFICATION OF INCOME AND EXPENSES IN THE FINANCING CATEGORY OF THE STATEMENT OF PROFIT OR LOSS
The Board tentatively decided to require an entity to classify (in the financing category of the statement of profit or loss) all income and expenses from liabilities that arise from transactions that involve only the raising of finance; and specified income and expenses from other liabilities.
Transactions that involve only the raising of finance: The Board tentatively decided to require an entity to describe a transaction that involves only the raising of finance as a transaction that involves the receipt by the entity of cash, an entity’s own equity instruments or a reduction in a financial liability; and the return by the entity of cash or an entity’s own equity instruments.
Hybrid contracts with host liabilities and embedded derivatives: the Board tentatively decided that an entity should classify income and expenses related to separated host liabilities in the same way as income and expenses related to other liabilities; classify income and expenses related to separated embedded derivatives in the same way as income and expenses related to stand-alone derivatives; and classify income and expenses related to contracts that are not separated, in the same way as income and expenses related to other liabilities.
The entity should also disclose situations in which it designates an entire hybrid contract as at fair value through profit or loss and as a result does not separate from the host financial liability an embedded derivative that is otherwise required to be separated by IFRS 9 Financial Instruments.
Liabilities arising from transactions that do not involve only the raising of finance (except some such liabilities specified by the Board), the Board tentatively decided to require an entity to classify, in the financing category of the statement of profit or loss, interest expense and the effect of changes in interest rates, when such amounts are identified applying the requirements of IFRS Standards.
This does not apply to liabilities that arise from transactions that do not involve only the raising of finance and that are hybrid contracts in the scope of IFRS 9 measured at amortised cost and transactions that include an embedded derivative, the economic characteristics and risks of which are closely related to the economic characteristics and risks of the host contract. The Board is still exploring an approach that would classify all income and expenses in the financing category for these specific liabilities.
CLASSIFICATION OF FAIR VALUE GAINS OR LOSSES ON DERIVATIVES AND HEDGING INSTRUMENTS
The Board tentatively decided to require an entity to:
- classify fair value gains or losses on financial instruments designated as hedging instruments, applying IFRS 9 or IAS 39 Financial Instruments: Recognition and Measurement in the category of the statement of profit or loss affected by the risk the entity manages (except when doing so would involve the grossing up of fair value gains or losses). In such a case, an entity classifies all fair value gains or losses on the hedging instrument in the operating category.
- classify fair value gains or losses applying the requirements in (a) to derivatives used for risk management if those derivatives are not designated as hedging instruments applying IFRS 9 or IAS 39 (except when doing so would involve undue cost or effort). In cases that involve undue cost or effort, an entity classifies all fair value gains or losses on the derivative in the operating category.
- classify fair value gains or losses on derivatives not used for risk management in the operating category of the statement of profit or loss, unless a derivative relates to financing activities and is not used in the course of the entity’s main business activities. When the derivative relates to financing activities and is not used in the course of the entity’s main business activities, an entity classifies all fair value gains or losses on the derivative in the financing category.
CLASSIFICATION OF FOREIGN EXCHANGE DIFFERENCES
The Board tentatively decided to require an entity to classify foreign exchange differences included in the statement of profit or loss in the same category of the statement of profit or loss as the income and expenses from the items that gave rise to the foreign exchange differences (except when doing so would involve undue cost or effort). In such cases, an entity should classy the foreign exchange differences on the item in the operating category.
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:
8-9 June 2021
The full updates, as published by the IASB, can be found here.
TENTATIVE AGENDA DECISIONS
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 for determining the appropriate accounting treatment.
TLTRO III TRANSACTIONS (IFRS 9 FINANCIAL INSTRUMENTS AND IAS 20 ACCOUNTING FOR GOVERNMENT GRANTS AND DISCLOSURE OF GOVERNMENT ASSISTANCE)
The Committee received a request about how to account for the third programme of the targeted longer-term refinancing operations (TLTROs) of the European Central Bank (ECB).
- Does the TLTRO III tranches represent loans with a below-market interest rate and, if so, is the borrowing bank is required to apply IFRS 9 or IAS 20 to account for the benefit of the below-market interest rate;
- if the bank applies IAS 20 to account for the benefit of the below-market interest rate:
- how should it assess in which period(s) it recognises that benefit; and
- should the bank add the amount of the benefit to the carrying amount of the TLTRO III liability;
- how should the bank calculate the applicable effective interest rate;
- should the bank apply paragraph B5.4.6 of IFRS 9 to account for changes in estimated cash flows resulting from the revised assessment of whether the conditions attached to the liability have been met; and
- how should the bank account for changes in cash flows related to the prior period that result from the bank’s lending behaviour or from changes the ECB makes to the TLTRO III conditions.
APPLYING THE REQUIREMENTS IN IFRS STANDARDS
The Committee discussed that IFRS 9 is the starting point for the borrowing bank to determine its accounting for TLTRO III transactions because each financial liability arising from the bank’s participation in a TLTRO III tranche is within the scope of IFRS 9. The bank should:
- determine whether it bifurcates any embedded derivatives from the host contract as required by paragraph 4.3.3 of IFRS 9;
- initially recognise and measure the financial liability i.e. the fair value of the financial liability, accounting for any difference between the fair value and the transaction price and calculate the effective interest rate; and
- subsequently measures the financial liability, which includes accounting for changes in the estimates of expected cash flows.
INITIAL RECOGNITION AND MEASUREMENT OF THE FINANCIAL LIABILITY:
Applying paragraph 5.1.1 of IFRS 9, at initial recognition a bank measures each TLTRO III tranche at fair value plus or minus transaction costs, if the financial liability is not measured at fair value through profit or loss. A bank therefore determines the fair value of the liability using the assumptions that market participants would use when pricing the financial liability as required by IFRS 13 Fair Value Measurement. The fair value of a financial instrument at initial recognition is normally the transaction price—that is, the fair value of the consideration given or received (paragraphs B5.1.1 and B5.1.2A of IFRS 9). If the fair value at initial recognition differs from the transaction price, paragraph B5.1.1 requires a bank to determine whether a part of the consideration given or received is for something other than the financial liability.
Determining whether an interest rate is a below-market rate requires judgement based on the specific facts and circumstances of the relevant financial liability. Nonetheless, a difference between the fair value of a financial liability at initial recognition and the transaction price might indicate that the interest rate on the financial liability is a below-market rate.
- If the consideration received is for only the financial liability, the bank should apply paragraph B5.1.2A of IFRS 9 to account for that difference.
- If the consideration received is for more than just the financial liability, the bank assesses whether that difference represents a government grant as defined in IAS 20. The Committee noted that if the difference represents a government grant, paragraph 10A of IAS 20 applies only to that difference. The bank should apply IFRS 9 to account for the financial liability.
DO TLTRO III TRANCHES CONTAIN A GOVERNMENT GRANT IN THE SCOPE OF IAS 20?
The Committee observed that TLTRO III tranches would contain a government grant in the scope of IAS 20 only if it were determined that the ECB meets the definition of government in IAS 20, the interest rate charged on the TLTRO III tranches is a below-market interest rate and the TLTRO III transactions with the ECB are distinguishable from the borrowing bank’s normal trading transactions.
Making these determinations require judgement based on the specific facts and circumstances. The Committee was therefore not in a position to conclude on whether the TLTRO III tranches contain a government grant in the scope of IAS 20. If the TLTRO III tranches contained a government grant in the scope of IAS 20, the bank should refer to the requirements in IAS 20 which provide an adequate basis to determine how to account for that government grant.
CALCULATING THE EFFECTIVE INTEREST RATE ON INITIAL RECOGNITION OF THE FINANCIAL LIABILITY:
In calculating the effective interest rate for a TLTRO III tranche on initial recognition, the question arises as to what to consider in estimating the expected future cash flows and, specifically, whether the expected future cash flows reflect an assessment of whether the bank will satisfy the conditions attached to the liability.
The Committee concluded that considering how to reflect uncertain conditions in calculating the effective interest rate is a broader matter, which it should not analyse solely in the context of TLTRO III tranches. This is because such an analysis could have unintended consequences for other financial instruments, the measurement of which involves similar questions about the application of IFRS Standards. The Committee agreed that this matter should be considered as part of the post-implementation review of the classification and measurement requirements in IFRS 9.
SUBSEQUENT MEASUREMENT OF THE FINANCIAL LIABILITY AT AMORTISED COST:
The contractual terms of the TLTRO III tranches require interest to be settled in arrears on maturity or on early repayment of each tranche. There is therefore only one cash flow on settlement of the instrument.
The original effective interest rate is calculated based on estimated future cash flows at initial recognition as required by IFRS 9. The Committee noted that whether a bank adjusts the effective interest rate over the life of a tranche depends on the contractual terms of the financial liability and the applicable requirements in IFRS 9. Paragraphs B5.4.5 and B5.4.6 of IFRS 9 specify requirements for how an entity accounts for changes in estimated future cash flows.
(Applies to floating-rate financial liabilities)
(Applies to changes in estimated future cash flows of financial liabilities other than those dealt with in paragraph B5.4.5)
Estimated future cash flows are revised to reflect movements in the market rates of interest. Periodic re-estimations of those cash flows to reflect such movements alter the effective interest rate.
IFRS 9 does not elaborate on what is meant by floating rate. However, the Committee observed that a financial instrument with variable contractual cash flows—which can periodically be adjusted to reflect movements in the market rates of interest—is a floating-rate financial instrument.
The Committee also observed that a floating-rate financial instrument may consist of a variable interest rate element, which is reset to reflect movements in the market rates of interest (for example, the ECB rate on the main refinancing operations) plus or minus other elements, which are fixed and therefore not reset to reflect movements in the market rates of interest (for example, the fixed 50 basis points discount given by the ECB on particular TLTRO III tranches for a fixed period).
When considering how to account for changes in cash flow estimates, the Committee noted that paragraph B5.4.5 of IFRS 9 applies only to the variable interest rate element of a floating-rate instrument (as far as it reflects movements in the market rates of interest) and not to other interest rate elements of the instrument.
When changes in contractual cash flows arise from a modification, an entity assesses whether those changes result in the derecognition of the financial liability and the initial recognition of a new financial liability by applying paragraphs 3.3.2 and B3.3.6 of IFRS 9.
The Committee considered a situation in which, as a result of a modification that does not result in derecognition or other changes in expected future cash flows, a bank estimates the final repayment cash flow relating to a TLTRO III tranche to be different from that used in determining the carrying amount. In such a situation, the bank adjusts the carrying amount to reflect the modification or other change in expected future cash flows and recognises the difference immediately in profit or loss. The bank therefore makes no adjustment to interest recognised in prior periods.
The Committee also noted that application of paragraph B5.4.6 of IFRS 9 relates to a bank’s estimates of expected future cash flows in calculating the effective interest rate on initial recognition of the financial liability. This is because, applying B5.4.6, the original effective interest rate is used to discount the revised cash flows.
If a bank determines that the ECB meets the definition of government in IAS 20 and that it has received government assistance from the ECB, the bank needs to provide the information required by paragraph 39 of IAS 20 with respect to government grants and government assistance that does not meet the definition of a government grant.
Given the judgements required and the risks arising from the TLTRO III tranches, a bank should disclose information that includes its significant accounting policies and the assumptions and judgements that management has made in the process of applying the bank’s accounting policies and that have the most significant effect on the amounts recognised in the financial statements. (inline with paragraphs 117,122 and 125 of IAS 1 Presentation of Financial Statements, as well as paragraphs 7, 21 and 31 of IFRS 7 Financial Instruments: Disclosures).