Every year, the IFRS experts at accounting firm Grant Thornton International publish what they call the “IFRS Top 20 Tracker.” It contains the 20 disclosure and accounting issues they think will pose potential challenges to IFRS preparers – CFOs, chief accounting officers, financial controllers – for the year.
“The IFRS Top 20 Tracker is not of course intended to be a comprehensive list of issues that companies may face during this financial reporting season,” they make clear. “It is intended to highlight areas that we expect to be particularly significant for many Grant Thornton clients, and in turn to assist management in prioritization and review.”
The Top 20
For 2014, the Tracker focused on the following themes, keyed to existing, newly issued and in-the-works standards:
- consistency of management commentary with financial statements
- reduction of ‘clutter’
- financial statements, including estimation uncertainty, disaggregation and capital management disclosures
- alternative performance measures
Areas of regulatory focus
- ‘going concern’ status, disclosures and consistency with other areas
- operating segments, including aggregation criteria, information about major customers and restatements
- impairment assessments and disclosure
- revenue recognition
- statement of cash flows
Complex areas of accounting
- income taxes
- share-based payment arrangements
- business combinations
- hedge accounting
Standards effective for the first time
- consolidation package
- IFRS 13: Fair Value Measurement
- accounting for pension costs
Issues on the horizon
- IFRIC 21: Levies
- investment entities
- IFRS 9: Financial Instruments
- revenue for future developments
Five standards issued in 2011 became effective on or after 1 January 2013, although the European Union and some other jurisdictions have extended the effective date to 1 January 2014. These are:
- IFRS 10: Consolidated Financial Statements, which supersedes IAS 27: Consolidated and Separate Financial Statements and SIC 12: Consolidation – Special Purpose Entities
- IFRS 11: Joint Arrangements, which supersedes IAS 31 ‘Interests in Joint Ventures’
- IFRS 12: Disclosure of Interests in Other Entities
- IAS 27 (Revised): Separate Financial Statements
- IAS 28 (Revised): Investments in Associates and Joint Ventures
Grant Thornton focuses on the first three standards.
IFRS 10. Grant Thornton highlights the new, principle-based definition of control under IFRS 10. In the previous standards, control was largely determined through powers such as voting rights exercised by the entity over the investee, and consolidation was required if a special purpose vehicle exposes the entity to risks and rewards.
Under IFRS 10, “significant judgment will be needed in certain situations in applying the definition of control, and in some of those situations the decisions over which entities are consolidated may change,” says Grant Thornton.
For example, exposure to risks and rewards of a special purpose vehicle is now only an indicator of control, and not something that would lead on its own to consolidation, as was the case under SIC 12. “IFRS 10 requires a more specific identification of the decisions that have the greatest effect on returns, and who takes them,” notes Grant Thornton.
Preparers may now need to reconsider previous consolidation decisions. Grant Thornton gives some examples in the table below:
Click image to enlarge
Examples of consolidation decisions that may change
Source: IFRS Top 20 Tracker 2014
IFRS 11. This newly effective standard “aims to improve on [IAS 31] . . . by establishing principles for accounting for joint arrangements (an arrangement over which two or more parties have joint control) that focus more on the nature of the investors’ rights and obligations and less on the legal form.”
IFRS 11 replaces the three categories under IAS 31 with just two:
- a joint operation, in which the joint operators have rights to the assets, and obligations for the liabilities, relating to the arrangement
- a joint venture, in which the joint venturers have rights to the net assets of the arrangement
Those arrangements categorized as “jointly controlled operations” or “jointly controlled assets” under IAS 31 will now be classified under the joint operation category. In many instances, an entity previously classified as a “jointly controlled entity” will now be categorized as a “joint venture.”
In some instances, however, a jointly controlled entity may be classified as a joint operation. Broadly, this may be the case “when the venturers have rights and exposure to the underlying assets and liabilities.”
“This determination requires an assessment of the legal form of the vehicle, other contractual arrangements and other facts and circumstances (such as whether the activities of the arrangement are primarily designed for the provision of output to the parties).”
The categorization is important because it will determine the disclosure requirement the preparer must comply with under IFRS 12.
IFRS 12. This newly effective standard complements the other new standards by setting out “consistent disclosure requirements for subsidiaries, joint ventures and associates, as well as unconsolidated structured entities.”
Some preparers should expect to make more extensive disclosures, especially those in companies that have material non-controlling interests that previously were not required to disclose a high level of information.
Among the new disclosures are the following:
- significant judgments and assumptions (and changes) made by the reporting entity in determining whether it controls another entity
- the interest that the non-controlling interests have in the group’s activities
- the effect of restrictions on the reporting entity’s ability to access and use assets or settle liabilities of consolidated entities
- the nature of, and changes in, the risks associated with the reporting entity’s interests in consolidated structured entities, joint arrangements, associates and unconsolidated structured entities
Getting Fair Value Right
If IFRS 13: Fair Value Measurement seems irrelevant to some preparers, they should take a second look. In fact, say Grant Thornton, “fair value measurements are much more prevalent in IFRS than may at first be appreciated.”
The obvious areas where measuring fair value is required include IAS 39: Financial Instruments: Recognition and Measurement, and IAS 40: Investment Property. But there are also “significant fair value measurement requirements” in IFRS 3: Business Combinations, IAS 16: Property, Plant and Equipment and IAS 36: Impairment of Assets, to name just a few.
“In addition to items measured at fair value in the primary statements,” Grant Thornton adds, “IFRS 13 also applies to items that are fair valued for disclosure purposes only.”
Inputs. The newly effective standard establishes a hierarchy of inputs to valuation techniques that can be used to measure fair value. These categories previously applied only to financial instruments, but are now applicable to everything that require to be fairly valued to aid consistency and comparability.
- Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the entity can access at the measurement date
- Level 2 inputs are those other than the quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly
- Level 3 inputs are unobservable inputs for the asset or liability
Disclosures. The newly effective standard extends the fair value disclosures required under IFRS 7: Financial Instruments to non-financial items measured at fair value and to certain items not measured at fair value.
What is required to be disclosed is affected by the fair value hierarchy discussed above. More disclosure is required when Level 2 and especially Level 3 inputs are used. Since most reported assets and liabilities do not have quoted prices, fair value will need to be estimated in many instances.
The impact “will ultimately depend on the items being fair valued and the techniques currently used,” reckons Grant Thornton. “Even entities largely unaffected by the valuation guidance are likely to be affected by IFRS 13’s extensive disclosure requirements.”
What to expect from regulators. According to Grant Thornton, a number of regulators have indicated that they will pay special attention to two specific issues when assessing how entities under their supervision are implementing IFRS 13: the characteristics of the asset or liability and the risk of non-performance.
Taking into account the characteristics of the asset or liability. This can be done to make a fair value estimation if, 1) the characteristics are those of the asset or liability in question, rather than of the entity that holds the item, or 2) if the characteristics would influence the pricing decisions made by market participants.
IFRS 13 indicate that taking these characteristics into account could result, in some cases, in adjustments to the observable market inputs. For example, a control premium may be taken into account when measuring the fair value of a controlling interest.
However, taking characteristics into account can only be done if this is consistent with the unit of account. “Questions have . . . been raised as to what is the appropriate unit of account in certain scenarios,” notes Grant Thornton. The issue is still being discussed by the International Accounting Standards Board.
“Pending clarification of this matter by the IASB, regulators have indicated that they expect issuers to disclose clearly their analysis regarding the unit of account,” says Grant Thornton.
Non-performance risk. The newly effective standard requires that the estimated fair value of a liability should reflect the effect of non-performance risk. “This is particularly relevant to entities that have entered into derivative transactions or have designated financial liabilities to be measured at fair value in accordance with IAS 39’s fair value option,” says Grant Thornton.
In estimating the fair value of financial liabilities, including derivatives, the effect of and changes in the entity’s credit risk should be taken into account. Typically, this will involve incorporating a debit valuation adjustment (DVA).
On the other hand, “there should also be proper recognition of counterparty credit risk when determining the fair value of financial instruments and providing relevant disclosures,” Grant Thornton adds. “This generally requires making a credit valuation adjustment (or CVA).”
Preparers should provide information on the methodologies they used for both measurements when the amounts involved are significant. This is an expectation expressed by some regulators, both on the effects of counterparty credit risk on the measurement of the fair value of assets, and of non-performance risk on the measurement of the fair value of liabilities.
Accounting for Pension Costs
IAS 19 (Revised 2011), which became effective for periods ending on or after 1 January 2013, changes the way defined-benefit pension schemes are accounted for to improve the recognition, presentation, and disclosure of defined-benefit plans.
The major changes include:
- immediate recognition of all estimated changes in the cost of providing defined benefits and all changes in the value of plan assets. The ‘corridor’ method and other methods that allowed deferral of some gains or losses have been eliminated
- new presentation approach that breaks down the different types of gains and losses arising from defined-benefit plans, and requires that all gains and losses are presented in profit or loss, except for remeasurements, which are presented in other comprehensive income
- new way of calculating net interest cost. Instead of separate calculations of the expected return on plan assets and the interest cost of funding the defined benefit obligation, a single rate, usually the market yield on high quality corporate bonds, is applied. It’s possible that many companies will see a reduction in profits as a result
Photo credit: Shutterstock