Beyond the GAAP - March 2019

The Exposure Draft is now scheduled for publication at the end of June, and the Board has tentatively decided that the comment period will be three months (thus including August). Meanwhile, the IFRS IC has been particularly busy, publishing eight agenda decisions, six of which are discussed in the ‘IFRS highlights’ section below. We particularly welcome the publication of clarifications as to when and how entities are expected to implement such agenda decisions.

IFRS highlights

Implementation period for accounting policy changes resulting from IFRS IC agenda decisions

The IFRS IC has clarified its position on how quickly entities should implement its published agenda decisions. First, it reminds entities that the process for publishing an IFRS IC agenda decision often provides new information that is useful in applying IFRSs and that was not otherwise available, which could therefore lead some entities to review their accounting policies. It then goes on to state that entities that need to change an accounting policy as a result of an IFRS IC agenda decision would be entitled to sufficient time to consider and implement the change (for example, an entity may need to obtain new information or adapt its systems to implement a change). As no further details are given on what constitutes ‘sufficient’ time, entities must make use of judgement to determine how much time is required to implement the accounting policy change. In addition to this clarification in IFRIC Update, an article written by Sue Lloyd (the vice-chair of the IASB and chair of the IFRS IC) was published on the IASB’s website on 20 March 2019. In the article, Ms Lloyd clarifies that the change an entity needs to make to the accounting treatment of a transaction as a result of an IFRS IC decision is not necessarily the correction of an error (i.e. the previous accounting treatment was not an error simply because it was inconsistent with an agenda decision). She also states that the IFRS IC envisaged a period of months, rather than years, for implementing such an accounting policy change.

IASB publishes update on Principles of Disclosure project

On 21 March, the IASB published a Project Summary on its Principles of Disclosure project, following up on the Disclosure Initiative – Principles of Disclosure Discussion Paper published in March 2017. The Project Summary explains how stakeholders’ feedback on the Discussion Paper will be taken into account.

Thus, the Board will not undertake the following activities, which stakeholders felt would not be effective in resolving the problems with financial disclosures:

• developing centralised disclosure objectives, as these are unlikely to be specific enough to be effective;
• developing principles of effective communication, as many respondents felt that these would be either too generic, or not necessary in any case, given that some entities have already improved their disclosures even without such principles. The Project Summary draws attention to the fact that the IASB has already published a document with examples of good practice in this regard, in October 2017 (Better communication in financial reporting – Making disclosures more meaningful);
• developing guidance on the location of disclosures on accounting policies;
• developing principles for the format of information and data disclosed in the notes;
• developing guidance on the placement of ‘IFRS information’ outside the financial statements and ‘nonIFRS information’ within the financial statements. Instead, the Board is pursuing the following activities:
• a targeted review of the disclosure requirements in individual standards, starting with IAS 19 – Employee Benefits and IFRS 13 – Fair Value Measurement. This will also help the IASB to develop its own principles for drawing up disclosure requirements;
• developing guidance on applying materiality judgements to accounting policy disclosures (on which an exposure draft is expected in a few months’ time);
• considering some topics as part of the IASB’s separate project on primary financial statements (the roles of the primary financial statements and the notes; presentation of aggregates relating to EBIT, etc.; unusual or non recurrent items; and presentation of performance measures);
• considering the implications of technology for financial communication as part of the IFRS Foundation Technology Initiative.

Taking account of credit enhancement in the measurement of expected credit losses

The IFRS IC was asked to clarify whether a financial guarantee or other credit enhancement should be taken into account in the measurement of expected credit losses on the asset to which it relates. The request related to situations in which the credit enhancement must be recognised separately under IFRSs. The IFRS IC referred back to paragraph B5.5.55 of IFRS 9, which states that a financial guarantee or other credit enhancement may only be included in the measurement of expected credit losses if it is both:

• part of the contractual terms of the asset in question; and
• not recognised separately.

Thus, the IFRS IC concluded that IFRS 9 is already sufficiently clear with regard to this situation. As the credit enhancement is already recognised in the balance sheet under the applicable standard, it shall not be taken into account when measuring expected credit losses on the asset to which it relates. Otherwise, this would run the risk of ‘double counting’ of these contractual rights.

Presentation of ‘cured’ credit-impaired financial assets in the statement of profit or loss

IFRS 9 specifies that interest revenue from credit-impaired financial assets (i.e. those at Stage 3 of the impairment model) shall be calculated on the basis of the gross carrying amount after impairment. In practice, this means that the interest revenue recognised is less than the contractual revenue, but this is not recognised as impairment. Instead, this results in reduced interest revenue. The IFRS IC received a request to clarify the correct presentation in the statement of profit or loss when the assets are either paid in full or reclassified from Stage 3 of the impairment model following an improvement in their credit risk level. The Committee concluded that IFRS 9 was sufficiently clear and that any adjustment should be presented as a reversal of expected credit losses, including any amount relating to unrecognised interest that was not recorded as impairment. Thus, the reversal of impairment losses may exceed the total amount of impairment losses recorded previously.

Real estate development and borrowing costs (IAS 23)

The IFRS IC has published an agenda decision on the capitalisation of borrowing costs relating to the construction of a residential multi-unit real estate development, sold as individual units. The question put to the IFRS IC was whether a real estate developer who borrowed funds specifically to construct such a complex could capitalise the borrowing costs as part of the cost of constructing the complex. The fact pattern presupposes that the housing complex is sold to end customers as individual units, under contracts that specify that control is transferred over time, i.e. as construction work progresses. Thus, the question was whether a qualifying asset exists in the specific case of real estate development when control is transferred over time. In its March 2019 agenda decision, the Committee concluded that:

• the receivable that the entity recognises in relation to its end customers, in accordance with IFRS 15, is a financial asset and therefore cannot be a qualifying asset (IAS 23.7);
• the contract asset (as defined in Appendix A of IFRS 15), which corresponds to revenue recognised over time for which the right to consideration has not yet been established, is not a qualifying asset because the intended use of the asset is to collect cash (or another financial asset) and this is not a use for which it necessarily takes a substantial period of time to get ready;
• unsold inventory under construction (i.e. units that are still on the market) is not a qualifying asset as it is ready for sale in its current condition. The developer intends to sell the part-constructed units as soon as it has the opportunity, i.e. as soon as it finds a buyer. In other words, work-in-progress will be transferred to the customer on signature of the contract.

This IFRS IC agenda decision is significant for real estate developers, as current practice is usually to capitalise specific borrowing costs. Thus, this will require a change in accounting policy for many entities. This must be carried out in a timely fashion, although entities are entitled to ‘sufficient’ time to implement the change, particularly if they need to obtain new information or adapt their systems (see the first item in ‘IFRS highlights’, above).

Customer’s right to receive access to a supplier’s software hosted on the cloud

The IFRS IC has published an agenda decision on how a customer accounts for its right to access software hosted on the cloud (Software as a Service or SaaS). The request submitted to the IFRS IC specified that the software runs on cloud infrastructure managed and controlled by the supplier, the customer accesses the software as needed (over the internet or via a dedicated line), and the contract does not convey to the customer any right to the infrastructure (i.e. the tangible assets). The IFRS IC was asked whether the customer received an intangible asset (the software) at the contract commencement date or a service over the contract term. Having noted that a customer receives a software asset at the contract commencement date only if either (a) the 4 | Beyond the GAAP no. 131 – March 2019 contract contains a software lease, or (b) the customer otherwise obtains control of the software at the contract commencement date, the IFRS IC considered whether either of these conditions is met.

Does the contract contain a software lease?

The Committee’s analysis began with the definition of a lease set out in IFRS 16, which states that a contract is a lease if it conveys to the customer the right to use an asset, i.e. if the customer has the right to obtain substantially all the economic benefits from use of the asset (an identified asset) and the right to direct the use of that asset. The IFRS IC noted that a right to receive future access to the supplier’s software, running on the supplier’s infrastructure, does not in itself convey the right to direct the use of the software (how and for what purpose to use the software). The Committee observed that the supplier would retain this right, e.g. by deciding how and when to update or reconfigure the software, or deciding on which hardware the software will run. Consequently, the Committee concluded that the contract does not contain a software lease if it only conveys to the customer the right to receive access to the supplier’s software over the contract term.

Does the customer receive a software intangible asset?

Starting with the definition of an intangible asset set out in IAS 38, the Committee observed that a contract that conveys to the customer the right to receive access to the supplier’s software over the contract term is not a contract that conveys to the customer the right to receive an intangible asset at the contract commencement date. The right to receive future access to the supplier’s software does not give the customer, at the contract commencement date, the power to obtain the future economic benefits flowing from the software itself and to restrict others’ access to those benefits. Consequently, the Committee concluded that a contract that only conveys to the customer the right to receive future access to the supplier’s software is a service contract.

Physical settlement of contracts to buy or sell non-financial items (IFRS 9)

Contracts to buy or sell non-financial items (such as commodities) are accounted for as IFRS 9 derivatives except when they are entered into and continue to be held for the purpose of the receipt, delivery or usage by the entity of a non-financial item (the ‘own-use scope exception’ defined in IFRS 9.2.4). The IFRS IC received a request relating to contracts that do not fall within the scope of the own-use exception but that may nonetheless be settled physically by the delivery of the underlying non-financial item. In the fact pattern in question, the derivatives are not designated as part of a hedging relationship either.

The question put to the IFRS IC was whether, having initially classified the derivative as a financial instrument and measured it at fair value through profit or loss, an entity could make an additional journal entry once the underlying item had been delivered, reversing the previous entry and making a corresponding adjustment. In this specific situation, the Committee concluded that physical settlement is not sufficient in itself to subsequently change the accounting treatment required under IFRS 9. Therefore, an entity is not permitted to retrospectively determine that the derivative meets the own-use scope exception or designate it as part of a hedging relationship at contract settlement. In other words, it is not possible to make an additional entry that would retrospectively change the impact on profit or loss of the entries made during the derivative’s term, which measured it at FVPL.

Application of the ‘highly probable’ criterion when the notional amount of the hedging instrument is dependent on the outcome of the hedged item (IAS 39/IFRS 9)

IFRS 9 (and IAS 39) permit forecast transactions to be designated as hedged items on condition that they are deemed to be ‘highly probable’. The request put to the IFRS IC asked how the ‘highly probable’ criterion should be applied when the notional amount of the hedging instrument (load following swap) is dependent on the outcome of a hedged transaction (forecast energy sales). The Committee reached the following conclusions:

• The fact that the Board did not carry forward the hedge accounting section of the IAS 39 Implementation Guidance into IFRS 9 does not mean it has rejected that guidance. In particular, this section includes additional guidance on hedging forecast transactions that is relevant here.
• When assessing whether a forecast transaction is highly probable, an entity must take account of uncertainty relating to both its timing and its magnitude (IAS 39.IG F3.7 and IAS 39.IG F3.11).
• In order for the forecast transaction to be eligible for a cash flow hedge, it must be documented with sufficient specificity that the entity can identify it when it occurs. Thus, specifying a percentage of forecast sales during a period is not sufficient as the entity would be unable to identify the particular transaction (IAS 39.IG F3.10 and IAS 39.IG F3.11).
• The terms of the hedging instrument (i.e. load following swap) are not taken into account when assessing whether the forecast transaction is highly probable.

Consequently, the hedging relationship described in the fact pattern put to the IFRS IC cannot be designated as a cash flow hedge, as the hedged forecast transaction does not meet the criteria to be classified as ‘highly probable’.