1. Welcome to this seminar CIMA in-house training for IFRS Briefing IFMA, 8 October 2014 with Dr. 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 IOverview of world developments IIChanges to IFRS IIIRevenue IVReceivables VLeases VIPractical questions on liabilities VIIDifferences 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 partner on 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 as it makes any sales in 2014 (which happens on 3 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.2ABC 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.3PQR 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.4 Suisseco 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?

51. L.5IJK has a bank covenant in place on its long-term bank borrowings which, if breached, would lead to the borrowings being repayable on demand. The covenant is expected to be breached on 31 December 2014, the company’s year-end. If this does occur, the company will then ask the bank for a waiver of the covenant. How should the loan be classified in the 2014 year-end accounts of IJK?

52. L6 An Investment Company (IC) receives money (e.g. CHF 100m) from clients and passes it on to an independent asset manager (AM) which buys a portfolio of investments registered in the name of IC. AM spends 10% of the money on buying shares in IC. As the portfolio rises or falls in value, so does IC’s obligation to the clients. IC is allowed to settle its obligation in cash or in the related investments. Questions: (a)On whose balance sheet(s) should the investments be shown: the client’s, the fund’s, IC’s or AM’s? (b)What items are shown on IC’s balance sheet? (c)What happens to IC’s balance sheet when all the investments rise in value by 20%?

53. Session VII Differences between US GAAP and IFRS

54. Table A Where IFRS and US rules are incompatible IAS 1Extraordinary Items. The IAS does not allow any item to be described as extraordinary, whereas certain items are extraordinary under US GAAP. IAS 2Inventories. For the ‘lower of cost and market’ rule, the IAS requires the use of net realisable value for ‘market’, whereas US GAAP generally means current replacement cost, except that this should not exceed net realisable value.

55. Inventories at “Market” Case ICase II Net realisable value$8m$10m Current replacement cost$10m$8m Which case is likely to be true for the inventory of a manufacturing company (e.g. half-finished tractors)?

56. Table A Where IFRS and US rules are incompatible IAS 19Pensions. US requires actuarial gains and losses to be split between income and OCI (with later reversal out of OCI). IFRS requires full immediate charge to OCI. IAS 21Currency Translation. IAS 21 requires financial statements of foreign subsidiaries in hyperinflationary economies to be restated using price indices. US GAAP requires the US dollar to be used as the functional currency.

57. Table A Incompatibilities (contd) IAS 32Financial Instruments. The IAS requires compound instruments to be classified on the basis of their substance and to be split into component parts, whereas the US requirements do not always do this. IAS 36Impairment. The IAS test and measure uses the higher of fair value and discounted future cash flows. The US test uses undiscounted cash flows, but recoverable amount is based on fair value. IAS 36Impairment Losses. The IAS requires these to be reversed under suitable circumstances, but that is not allowed in the US.

58. Impairment SFAS 121 and 144 (a)INDICATION (e.g. physical damage) (b)TEST Carrying value (e.g. $10m) v. Undiscounted cash flows (e.g. $9m) (c)MEASURE Carrying value v. Fair value (if no market, DCF, e.g. $6m) IAS 36 COMBINED TEST AND MEASURE Carrying value v. Recoverable amount (higher of DCF and NRV)

59. Impaired Asset Carrying value (NBV)= 8 Net realisable value = 4 Undiscounted cash flows= 9 Discounted cash flows= 6 IFRS Impairment= ? US Impairment= ?

60. Table A incompatibilities (contd) IAS 38Development expenditure. The IAS requires development expenditure which meets certain criteria to be capitalised. This is not allowed by US GAAP. IAS 39Debt Issue Costs. The IAS records the liability net, whereas US GAAP records the costs as assets. IAS 39Unlisted Investments. The IAS requires fair value whereas US GAAP uses cost. IFRS 10Scope of group. IFRS uses ‘control’ whereas US GAAP excludes some minority-owned entities but includes VIEs even when not controlled.

61. Table B Where US practice is not usually consistent with IFRS - Intangibles (including goodwill) with indefinite lives. US GAAP allows an entity to assess whether an impairment is more likely than not, before doing an impairment calculation. IFRS 3 and IAS 38 do not.

62. US Goodwill Treatment ( 2011+) Goodwill is not amortised but, at the level of a “reporting unit”, annually there must be either: (a) an impairment calculation, based on fair value, or (b) an assessment of whether it is more likely than not that there is an impairment, followed by (a) if it is Reversals of impairment losses are not allowed.

63. US Intangibles (2012+) Internally generated intangibles can only be capitalised if they are specifically identifiable, have determinate lives and are not inherent and related to the entity as a whole. Intangibles with finite lives must be amortised For an intangible asset with an indefinite life, there must annually be either: (a) an impairment calculation, based on fair value, or (b) an assessment of whether it is more likely than not that there is an impairment, followed by (a) if it is

64. Table B Where US practice is not usually consistent with IFRS - Intangibles (including goodwill) with indefinite lives. US GAAP allows an entity to assess whether an impairment is more likely than not, before doing an impairment calculation. IFRS 3 and IAS 38 do not. - Inventories. IAS 2 does not allow LIFO, which is common in the US.

65. Inventory Cost Determination Methods (used by 600 companies) Last-in first-out408 First-in first-out366 Average cost235 Other52 Use of LIFO All inventories31 50% or more of inventories204 Less than 50% of inventories93 Not determinable 80 Companies using LIFO408

66. Inventories USLower of LIFO and CRC (no reversal of loss) IFRSLower of FIFO and today’s NRV

67. Table C Where practices allowed by IFRS are not allowed in US IAS 7Cash Flows. IAS allows choice for dividends and interest paid and received; US requires them all as operating, except that dividends paid are financing. IAS 16Property, Plant and Equipment. The IAS has an allowed alternative of fair valuation, whereas historical cost is required in the US. IAS 38Intangibles. The IAS has an allowed alternative of fair valuation, whereas historical cost is required in the US.

68. Percentage of policy choice by country and topic IFRS Policy ChoiceAUUKCACNHKFRESITDECH Income statement by nature3511542362996812429 Operating profit not shown4213129 300120 Equity profits in operating59354840823143539 Balance sheet showing net assets100760418200005 Balance sheet with liquidity decreasing1001010024141022292650 Indirect cash flows49810098100 919510095 Dividends received as operating8737855307939207143 Interest paid as operating86617447437952696164 Some property at fair value10 20500000 Investment property at fair value93683620942050580 Some fair value designation1031307244467 FIFO only214223515112219036 Actuarial gains/losses to OCI8589728366068305935 Proportionate consolidation of JVs62555807170381743

69. Table C Where practices allowed by IFRS are not allowed in US (contd) IAS 40Investment Properties. The IAS, unlike US rules, allows investment properties to be revalued and not depreciated. IFRS 3Calculation of non-controlling interests. The IFRS allows NCI to be calculated as the share of net assets (rather than at fair value).

70. Goodwill Calculation Assume the following: -Pay $100m cash for all the shares in S -Book value of net assets = $60m -Fair value of net assets = $80m -Restructuring of S = $15m -Lawyers, bankers, etc. = $10m What is the goodwill? -IFRS in 2009? -US in 2008? -IFRS/US in 2010?

71. Goodwill and NCI The calculation of the size of any non-controlling interests will also affect the calculation of goodwill. For example, suppose the following facts: -P acquires 80% of the shares of S -P pays $100m -The remaining 20% of the shares are valued at $22m (less per share than P’s stake because P paid a premium in order to get control) -S’s net assets at book value are $70m, but at fair value are$90m Under the traditional non-US method which measures NCI at share of net assets (still optional under IFRS 3), the goodwill is: ? Under the US method everything is measured at fair value, the consideration is grossed up, and the goodwill is: ?

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