IFRS News in Brief - April 2011

PUBLICATIONS AND ANNOUCEMENTS

Three new draft Q&As on the IFRS for SMEs open for comment until 15 June 2011

On 14 April 2011, the SME Implementation Group (SMEIG) published for public comment three question and answer documents (Q&As) addressing whether captive insurance companies and investment funds with only a few participants are publicly accountable and how broadly should ‘traded in a public market’ be interpreted in the definition of public accountability.

For more information: http://www.ifrs.org/IFRS+for+SMEs/Q+and+A+IFRS+for+SMEs.htm

Preliminary conclusions of the Trustees' strategy review open for comment until 25 July 2011

In their  report “IFRSs as the Global Standard: Setting a Strategy for the Foundation’s Second Decade” published on 28 April 2011, the Trustees of the IFRS Foundation set out a series of recommendations addressing four areas: the IFRS Foundation’s mission (specifically the public interest served), governance, the process and procedures used by the Foundation and the IASB and the organisation’s financing.

For more information: http://www.ifrs.org/News/Announcements+and+Speeches/trustee+preliminary+conclusions+2011.htm


INTERNATIONAL ACCOUNTING STANDARDS BOARD

LATEST DECISIONS SUMMARY

The following is a summarised update of the main provisional decisions taken by the IASB at its recent meetings in London, including joint meetings with the FASB:

• 12-15 April 2011 (http://media.iasb.org/IASBUpdateApril2011.html)

• 27 April 2011 (http://media.iasb.org/IASBUpdate27April2011.html)
• 4 May 2011 (http://media.iasb.org/IASBUpdate4May2011.html) 

Leases 

• Measurement of the lessee's liability and the lessor's receivable should include lease payments that are in-substance fixed but structured as variable in form and exclude amounts that are less certain. 

• A contract contains a lease if, based on the contract’s substance, fulfilment depends on the use of a specified asset (ie an asset that is explicitly or implicitly identifiable) and the contract conveys the right to control (ie the customer has the ability to direct and receive the benefit from) the use of the specified asset for a period of time.
  
  A physically distinct portion of a larger asset of which a customer has exclusive use is a specified asset, whereas a capacity portion of a larger asset that is not physically distinct (eg a capacity portion of a pipeline) is not a specified asset.

• Lessees should determine which of two accounting approaches to apply, based on guidance similar to that in IAS 17. Under both approaches, the lessee should initially recognise a liability to make lease payments and a right-of-use asset (both measured at the present value of lease payments) and subsequently measure the liability using the effective interest method.

  • For finance leases: amortise the right-of-use asset on a systematic basis that reflects the pattern of consumption of the expected future economic benefits (in accordance with IAS 38); present amortisation of the right-of-use asset and interest expense on the liability to make lease payments either in profit or loss or in the notes.
    

  • For other-than-finance leases: amortise the right-of-use asset in a manner that would result in total lease expense being recognised over the lease term on a straight-line basis (representing the sum of amortisation of the asset and interest expense on the liability), unless another systematic basis is more representative of the time pattern of the total lease expense; present amortisation and interest expense together as a single line item within operating expense.

• Lessors should determine which of two accounting approaches to apply, based on guidance similar to that in IAS 17.

Revenue Recognition

• To determine transaction price, an entity should estimate either the probability-weighted amount or the most likely amount, depending on which is most predictive of the amount of consideration to which the entity will be entitled under the contract.

• Revenue should not be recognised in the following circumstances where the entity is not reasonably assured to be entitled to the amount allocated to a satisfied performance obligation: 

  • The customer could avoid paying an additional amount of consideration without breaching the contract (eg a sales-based royalty).

  • The entity has no experience with similar types of contracts.

  • The entity has experience but that is not predictive of the outcome of the contract (based on the criteria proposed in the exposure draft such as susceptibility to factors outside the influence of the entity, the amount of time until the uncertainty is resolved, the extent of the entity's experience, and the number and variability of possible consideration amounts).

• In allocating the transaction price, if the standalone selling price of a good/service underlying a separate performance obligation is highly variable, the most appropriate technique would be to determine a standalone selling price by reference to the total transaction price less the standalone selling prices of other goods/services in the contract (residual technique).

• A portion of (or a change in) the transaction price should be allocated entirely to one (or more) performance obligation if both of the following conditions are met:  

  • the contingent payment terms of the contract relate specifically to the entity's efforts to satisfy that performance obligation or a specific outcome from satisfying it, and

  • the amount allocated (including the change in the transaction price) to that particular performance obligation is reasonably relative to all of the performance obligations and payment terms (including other potential contingent payments) in the contract. 

   

• For contracts in which the entity grants a license or other rights to a customer, the promised rights give rise to a performance obligation that the entity satisfies at the point in time when the customer obtains control (ie the use and benefit) of the rights. If there are other performance obligations in the contract, an entity should consider whether the rights give rise to a separate performance obligation.

• Costs incurred before a contract is obtained represent costs of fulfilling a contract with a customer if they relate specifically to an anticipated contract. Costs of abnormal amounts of wasted materials, labour or other resources that were not considered in the price of the contract should be recognised as an expense when incurred.

• A sale and repurchase agreement where the customer has a significant economic incentive to exercise the right to require the entity to repurchase the asset at a price below the original sales price should be accounted for as a lease (the customer effectively pays the entity for the right to use the asset for a period of time).
  
  To determine whether a customer has a significant economic incentive to exercise their right, an entity should consider various factors including the relationship of the repurchase price to the expected market value of the asset at the date of repurchase and the amount of time until the right expires.
  
  

Financial Instruments: Impairment

• Interest revenue should be determined by applying the effective interest rate to an amortised cost balance that is not reduced for credit impairment.

• Measurement of expected losses (using a variety of techniques) should reflect the effect of discounting. The unwinding of the discount would be included in the impairment losses line item.
  

Financial Instruments: hedge accounting

• For exposures that affect comprehensive income, hedge accounting would be allowed only for equity investments at fair value through other comprehensive income, with any hedge ineffectiveness presented in other comprehensive income (OCI).

• For an asset/liability with a negative spread, an entity could designate all of the cash flows of the entire financial asset/liability as the hedged item with regard to benchmark interest rate risk (despite possible hedge ineffectiveness).  

• Cash instruments measured at amortised cost would not be eligible hedging instruments for risks other than foreign exchange risk.

• Financial liabilities for which the part of the fair value change related with own credit is recognised in OCI under the fair value option would not be eligible as hedging instruments.

• The accounting treatment (still to be determined) for changes in the time value of options and ‘zero-cost collars’ should be aligned.

  
  A 'zero-cost collar' is a combination of a purchased and a written options, one being a put and the other a call option, that at inception has a net nil time value. 
   

• Gains/losses from hedging instruments and hedged items for the hedged risk of a fair value hedge would be presented in profit or loss with a mandatory disclosure, in one single note, of the effects of fair value hedges and cash flow hedges on profit or loss and on OCI (including gross gain/loss from the hedged item and the hedging instrument and hedge ineffectiveness). In the statement of financial position, a direct adjustment of the hedged item would be retained, with disclosure of the fair value hedge adjustment in the notes.

• A layer component of the nominal amount of an item would be eligible for designation as a hedged item, with the following restrictions when the item includes a prepayment option (with no differentiation between written and purchased) whose fair value is affected by changes in the hedged risk:
  

  • For partially prepayable items, a layer-based designation of the hedged item would be allowed for those amounts that are not prepayable at the time of designation.
    

  • Designation of a layer as the hedged item should be allowed if it includes the effect of a related prepayment option when determining the change in fair value of the hedged item.
    
    

Insurance contracts

• In applying the ‘top-down approach’ to determine discount rates that reflect the characteristics of the insurance contract liability:

  • An insurer determines an appropriate yield curve on the basis of current market information (eg based on a yield curve that reflects current market returns for the actual portfolio of assets held or for a reference portfolio of assets with characteristics similar to those of the insurance contract liability). In the absence of observable market prices for some points on that yield curve, the insurer should refer to the guidance on fair value measurement (in particular Level 3).

  • Cash flows of the instruments are adjusted so that they reflect the characteristics of the cash flows of the insurance contract liability, mainly:
    

    • adjustment for differences between the timing of the cash flows to ensure that the assets in the portfolio (actual or reference) selected as a starting point are matched with the duration of the liability cash flows, and
      

    • adjustment for risks inherent in the assets that are not inherent in the liability.
      

  • No adjustments are needed for remaining differences between the liquidity inherent in the liability cash flows and the liquidity inherent in the asset cash flows.

     

    In a top-down approach to determine discount rates that reflect the characteristics of the insurance contract liability, the insurer starts with the expected current market return on assets and deducts from that expected current market return the premium that market participants require for bearing the risks (including credit risk) that are associated with those asset returns but are not present in the liability. Having estimated and excluded these asset risks, the top-down approach assumes that any other spread relates to the illiquidity premium. In a bottom-up approach, the insurer captures the characteristics of the net liability by starting from a risk-free discount rate and adding to that rate an adjustment to reflect the extent of illiquidity present in the insurance contract liability.

• An insurer should reduce measurement of the pre-claims obligations over the coverage period on the basis of time, but on the basis of the expected timing of incurred claims and benefits if that pattern differs significantly from the passage of time. Also, acquisition costs would be deducted from the pre-claims obligation measurement. 

• An insurer should perform an onerous contract test if facts and circumstances indicate that the contract has become onerous in the pre-claims period.

• Explicit account balances that are credited with an explicit return that is based on the account balance should be separated from an insurance contract (based on same criteria in the revenue recognition project for identifying separate performance obligations); implicit account balances would not unbundled.

UPCOMING COMMENT DEADLINES

 

Click here to download a PDF of IFRS News in Brief for April 2011