IFRS Briefing IFMA , 8 October 2014 with Dr. Christopher Nobes

1. IFRS BriefingIFMA, 8 October 2014withDr. Christopher Nobes

2. Seminar Leader: • Dr Christopher Nobes is Professor of Accounting at the Universities of London and Sydney, and Adjunct Professor at the Norwegian Business School. He has also taught in Universities in Italy, New Zealand and the USA. • He was a member of the Accounting Standards Committee of the UK and Ireland (1987-90) and of the Board of the International Accounting Standards Committee (1993-2001). • He is the author of 14 books and former co-editor of Accounting and Business Research. He was the 2002 “Outstanding International Accounting Educator” of the American Accounting Association.

3. Agenda I Overview of world developments II Changes to IFRS IIIRevenue IVReceivables V Leases VIPractical questions on liabilities VII Differences between US GAAP and IFRS

4. I World Developments

5. World Developments • US clearly not adopting or allowing IFRS (except for foreign registrants) • FASB no longer the IASB’s working partneron insurance or the Framework, and only partly on leases • Russia adopted IFRS for 2012; India not yet; voluntary adoptions in Japan are growing fast (already over 40 large companies)

6. IFRS for SMEs • Comprehensive review (ED 2013) • Small changes, e.g. to align deferred tax with IAS 12 • Adopted (exactly or approximately) in South Africa, Hong Kong, Malta • UK adopts version of IFRS for SMEs for 2015 • Other countries (e.g. Norway) planning to do so

7. UK in 2015+ • EU-IFRS for listed companies’ consolidated statements (and optional for any other reporting) • EU-IFRS with reduced disclosures, available for subsidiaries of groups using IFRS • FRS 102 (loosely based on IFRS for SMEs) for other unlisted companies • FRS 102 with reduced disclosures, available for subsidiaries • ASB’s FRSSE for ‘small companies’ (under 50 employees, etc.)

8. II Changes to IFRS

9. New IFRS coming into force in 2014 • IAS 32 amendment • Investment entities • Levies (IFRIC 13)

10. IAS 32 • Off-setting of assets and liabilities is not generally allowed by IAS 1 • IAS 32 allows it when there is a legal right of set-off • Amendment to IAS 32 clarifies that ‘currently has a legally enforceable right of set-off’ covers all circumstances

11. Investment entities Definition of investment entities: - only substantive activity is investing in multiple entities for capital gain or income; and - investors in the entity buy units Investment entity is exempt from producing consolidated statements if it uses FVTPL

12. Levies (IFRIC 21) • Levies on something other than income (∴ does not overrule IAS 12) • Obligating event is activity that triggers payment of levy • ‘Going concern’ does not imply present obligation to pay future amounts • Recognise levy progressively if obligating event occurs over time

13. Examples of levies • Using the principles of the previous slide, when should a levy be recognised in the following cases (consider also the interim report of June 2014)?: - W pays a levy progressively as it generates sales in 2014. - X pays a levy (based on sales in 2013) as soon asit makes any sales in 2014 (which happens on3 January 2014). - Y (a bank) pays a levy (based on its total assets) if it operates as a bank on 31 December 2014. - Z pays a levy (on the year’s sales) when sales for 2014 exceed CF 100 million, which happens on 17 July 2014.

14. New IFRS, not in force (I) • “Regulatory deferral accounts”: IFRS 14(first-time-adoption simplifications, for Canada) • “Revenue recognition”: IFRS 15 (joint with FASB) • “Financial Instruments”: IFRS 9; full new version, including amendments on credit losses (bad debts)

15. New IFRS, not in force (II) • Amending IAS 41 on bearer plants (treating them as PPE) • Result is that: • dead biological assets are ? • living biological assets (except bearer plants) are accounted for as follows ? • bearer plants are treated like ? • farm buildings/machinery are ?

16. IFRS developments (I) • IAS 27 amended in August 2014 to allow use of equity method in parent statements for holdings in subsidiaries, JVs and associates • ED of 2013 on leases; and August 2014 ‘Update’ • ED of 2013 on insurance contracts (still no target date for IFRS); I interviewed Hans Hoogervorst in June, when he promised that there would be a new Standard this year (!?!)

17. Framework project • Original Framework issued in 1989 • Chapter 1 (Objective) and Chapter 3 (Qualitative Characteristics) revised in 2010, jointly with FASB • Chapter 2 (Reporting Entity): ED of 2010 • Work re-started in 2012, without FASB • Revised DP of full CF issued in July 2013; aiming for ED at end of 2014; and completion in 2015 • Expected to change future IFRSs, and decisions on policies under IAS 8

18. Controversies • Note the singular “Objective”: “information … useful … in making decisions about providing resources to the entity”; “prospects for future net cash inflows” • “Reliability” replaced by “Faithful representation”; “Verifiability” is merely an enhancing characteristic; “Prudence” deliberately deleted; “substance over form” not specifically mentioned • Is that all about making it easier to require fair value?

19. IFRS developments (II) • IASB decisions on conceptual framework (May 2014): - re-introduce stewardship as a separate objective - re-introduce prudence - re-introduce substance over form - do not re-introduce reliability

20. III Revenue, IFRS 15

21. Introduction to IFRS 15 • In force for periods beginning on 1.1. 2017, or earlier • Retrospective application • Joint with US. So, are US ‘Interpretations’ relevant? But, note the creation of the ‘IASB/FASB Transition Resource Group’ • Excludes transactions covered by leases, insurance, financial instruments (including dividend receipts) • Only covers revenue from contracts with customers; revenue defined as ‘income arising in the course of ordinary activities’ (not defined)

22. Summary of effects • More performance obligations separated (e.g. some warranties are a separate obligation, so revenue is reduced by size of expected repairs) • Include contingent consideration in revenue • Costs of obtaining a contract can be assets • Recognition: no percentage of completion method (unless control is passed as production proceeds)

23. Step 1: Identify the contracts • Probable collection is implied, but collectability is not included in measurement • Combine contracts that have a single objective or performance obligation • Month-to-month contracts have a series of renewal options, but should be seen as separate contracts • Contract modifications (i.e. when both parties agree) which add new types of goods/services and are at market prices are treated as new contracts • Otherwise, re-calculate the existing contract

24. Step 2: Identify the obligations • Performance obligation is a distinct good or service (or series of them) • They are separate if they are sold separately • But, even then, they can be bundled together if highly integrated • A free month of service can be a separate performance obligation • An option (at non-market prices) is a separate obligation

25. Examples of performance obligations? • Air miles? • One-year warranty, which is required by law? • Warranty for year 2, which is sold separately?

26. Step 3: Calculate the price • Exclude sales taxes • Exclude collectability • Discount for time value, if more than one year • Non-cash consideration at FV • Include variable consideration, which can be positive (e.g. performance bonus) or negative (e.g. right of return)

27. Positive variable consideration • Include if “highly probable” that there will be no significant reversal • Measure at either “expected value” or “most likely amount”

28. Negative variable consideration • A right of return gives rise to: - revenue net of any expected refund - refund liability - asset (right to recover asset) • Suppose: cash sale of 1000, cost of sales 600, expected return of 200. What are the double-entries?

29. Step 4: Allocate the price • In proportion to stand-alone prices, estimated if necessary • Allocate any discount proportionally

30. Step 5: Recognition • Performance obligation is satisfied by transfer to customer: - point in time (e.g. delivery), or - over time • ‘Over time’ when one of: (i) customer consumes as receives, (ii) customer controls asset as it is created, or (iii) asset has no alternative use, and supplier has right to payment for work completed

31. Are these ‘over time’? (I) • (i) an office-cleaning contract to provide similar services each day for a year, • (ii) a year’s contract to run the payroll processing of another entity (which involves potentially different activities day-by-day or month-by-month), • (iii) constructing a building on a customer’s premises, with the customer bearing the risks,

32. Are these ‘over time’? (II) • (iv) a typical audit or consultancy project contract, • (v) a contract to build a customised satellite for a government, with continuous right to payment for work done, • (vi) a contract to build a customised boat in the supplier’s boatyard, with stage payments but 40% of price waiting until delivery.

33. Step 6: Asset and liability balances • Costs • Receivables • Contract assets • Contract liabilities

34. Costs • Contract costs are those incremental to obtaining the contract and directly related to fulfilling the contract • They are an asset if recoverable • Immediate expensing allowed for contracts of one year or less • Add to another asset (e.g. inventory or PPE) or create a contract asset • Amortise as goods are transferred

35. Examples of contract costs? • Taking customers out to lunch? • Sales commissions? • Administrative costs?

36. Receivables etc • ‘Receivable’ if amounts are due from customer • ‘Contract asset’ if goods/services are transferred (performance obligations achieved) before cash or receivable • ‘Contract liability’ if there is cash or receivable before transfer; or if there is a refund liability (cash received but refund expected)

37. Transition • Periods beginning on or after 1.1. 2017, but earlier application allowed • Retrospective application (e.g. for 2017 application): • either fully, with cumulative effect recognised as at 1.1.2016 for those presenting two years • or only to contracts incomplete at 1.1.2017, with cumulative effect as at 1.1.2017

38. IV Financial instruments

39. IFRS 9 Revised in 2014 • Includes new rules on impairments of receivables (bad debt provisions): “expected credit losses” • IFRS 9 in force for years beginning on or after 1.1.2018

40. Expected credit losses (I) • Move away from the present “incurred loss model” • Expected credit losses recognised from start (yield then includes a return to cover those losses) • Lifetime expected credit losses (LECL) recognised when credit quality is worse than at start • Trade receivables and lease receivables must use LECL method throughout

41. Expected credit losses (II) • At start, recognise credit losses expected in next 12 months (interest revenue calculated on gross asset) • When credit quality deteriorates significantly to below investment grade (or payments are 30+ days overdue), recognise lifetime expected credit losses (interest revenue still on gross asset) • When credit loss occurs, start calculating interest revenue on net carrying amount (amortised cost)

42. Expected credit losses (III) • LECL is a DCF measure of weighted average of probabilities of default • 12-month expected credit losses are amount of the LECL associated with probability of default in next 12 months

43. V Leases

44. Summary • IAS 17 issued in 1982; not much changed since then • DP of 2009 and ED of 2010; all leases to be treated as finance leases • ED of 2013: all leases capitalised by lessee, but Type B leases (property) to be treated like rentals in the income statement • ‘Project Update’ of August 2014: lessee treats leases like finance leases, but lessor uses operating/finance split • New standard expected in 2015

45. Lessee • In the balance sheet, leases are treated as finance leases, except for: • option to treat leases of 12 months or less as rentals • (probably) small assets, e.g. laptops • It is not a lease if the supplier can substitute the asset or if only a capacity proportion is obtained • Measure asset and liability at DCF of lease payments • Exclude variable lease payments, and most optional payments • Add direct costs to the asset

46. Lessor • Unchanged from IAS 17: operating leases on balance sheet; finance leases as receivables

47. Session VI Practical Questions on Accounting for Liabilities under IFRS

48. L.1On 1 January 2013, ABC awards its employees a cash bonus based on the company’s performance in 2013. 50% is to be paid at the end of February 2014 and the rest at the end of 2014, as long as the employees are still working for the company at each point. How should the bonus expense be recognised? L.2 ABC acquired 100% of the shares in DEF from XYZ for CHF100m in cash. At the time of acquisition, DEF is the plaintiff in a court case in which a set of DEF’s customers allege that its products are faulty, and are suing DEF for damages of CHF30m. The litigation is thought to be 60% likely to succeed. XYZ has indemnified ABC for losses up to CHF20m. How should DEF and ABC account for all this in their unconsolidated balance sheets?

49. L.3 PQR is a UK subsidiary of a Swiss group, with a 31 December year-end. The UK government announced a Budget in June 2012 that included reductions in the main rate of corporation tax from 28% to 24% by 1 April 2016. As of July 2012, a reduction in corporation tax rate from 28% to 27% was substantively enacted. On 29 March 2013, a further reduction in the main rate of corporation tax to 26% effective from 1 April 2013 was approved (by a resolution having statutory effect). Additionally, there were further decreases proposed to be included in future finance bills. How should PQR account (in its 2013 accounts) for the changes in tax rates that have been announced?

50. L.4Suisseco SA has two obligations to be settled on 31 March 2015, as follows: - to deliver 10,000 of its own shares to X Inc - to deliver CHF2 million worth of its own shares to Y Inc (calculated using market value as on 31 March 2015) How should it show these obligations in its 2014 balance sheet?