Financial reporting developments

TAX NEWS - may 2010

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Projects

Fair value measurement






Consolidation




Leases












Insurance contracts






Financial statement presentation




 

ED = Exposure Draft, Q2 2010 = Second quarter of 2010.



Consolidation

The Boards tentatively decided that an investment company is an entity that meets all of the following criteria:

- Express business purpose — the express business purpose is investing for current income, capital appreciation, or both
- Exit strategy — the entity has identified potential exit strategies and a defined time when it expects to exit the investment
- Investment activity — substantially all of the entity's activities are investment activities carried out for the purpose of generating income or capital appreciation, or both
- Unit ownership — ownership is represented by units of investment
- Pooling of funds — owners' funds are pooled to provide owners with collective investment management
- Fair value — all investments are managed and performance evaluated on a fair value basis
- Reporting entity — the entity must be a reporting entity
- Debt — providers of debt to investees do not have direct recourse to any of the entity's other investees


Transition requirements

The Boards tentatively agreed that an entity not previously considered an investment company, that meets the new definition, should recognise its investments at fair value when it first applies the requirements, with an adjustment to retained earnings.



Leases

The Boards reached the following tentative decisions:

Accounting for sale and leaseback transactions

If the underlying asset has been sold, a sale and leaseback transaction should be treated as such, rather than as a financing transaction. The asset is considered sold if control has been transferred to the buyer and all but a trivial amount of the risks and benefits associated with the underlying asset have been transferred.


Lessor accounting for the performance obligation

The amortisation of the performance obligation of a lessor should be performed in a systematic and rational manner based on the pattern of use by the lessee. The Boards also asked staff to provide additional analysis of how revenue should be recognised on commencement of the lease.



Accounting for subleases

The intermediate lessor as a lessee in a head lease, accounts for the head lease using the lessee model. The intermediate lessor as a lessor in a sublease accounts for the sublease using the lessor model.

The intermediate lessor will present all assets and liabilities arising from lease contracts with subleases together in the statement of financial position. Rentals due to the head lessor will be presented separately.


Accounting for long-term leases of land

Long-term leases of land will not be excluded from the scope of the new standard.

Lessor accounting for purchase options

Purchase options will be accounted for by lessors in the same way as renewal or termination options. Therefore:
- Purchase options are not recognised as separate assets.
- The receivable and performance obligation are measured based on lease payments expected to be received. As such, if it is more likely than not that an option to purchase will be exercised, the lease receivable will include the exercise price of the purchase option.
- The likelihood of exercise is reassessed at each reporting date.
- Any change to the lease receivable resulting from this reassessment is recognised as an adjustment to the performance obligation.
- The performance obligation is recognised in income over the lease term in a manner that reflects the consumption pattern of the underlying asset by the lessee. The lessor's performance obligation relating to the purchase option is not recognised in income until it is exercised.

First time adoption

First-time adopters of IFRS will apply the transitional requirements of the standard, in the same way as other lessees and lessors applying the standard for the first time.



Consequential amendments

- IFRS 3 Business Combinations — at the acquisition date, the acquirer will measure the acquired lease assets and liabilities in accordance with the leases standard, rather than using fair value measurement.
- IAS 40 Investment Property — if an entity elects to use the fair value model, the right-of-use asset will be measured at fair value in accordance with IAS 40. If an entity elects to use the cost model, the right-of-use asset is measured in accordance with the leases standard.


Revaluation of right-of-use assets

A lessee will be permitted to revalue its right-of-use assets, even if there is no active market for those assets. If a lessee chooses to revalue its owned assets in a class of property, plant and equipment, they will be permitted to revalue any leased assets. Lessees will be required to revalue the entire class of property, plant and equipment to which the leased asset belongs, if it chooses to revalue leased assets.


Lessor accounting for impairment of assets

Under the performance obligation approach to lessor accounting, the lease receivable will first be evaluated for impairment. Any impairment would result in an adjustment to the lease receivable and the performance obligation, with any remaining difference being recognised in profit or loss. Lessors will also have to evaluate the leased asset for impairment.


Insurance contracts

The Boards continued their discussion on the two approaches to margins.


Risk adjustment and residual margin

The Boards tentatively decided that the residual margin should be part of the insurance liability rather than a separate liability. The IASB tentatively decided that the interest on residual margins should be accreted (the FASB took the view that it should not be).


Composite margin

The Boards tentatively agreed that if the initial measurement of an insurance contract results in a day-one loss, this should be recognised immediately in profit or loss. A day-one loss will only arise if the expected present value of outflows exceeds the expected present value of the premiums at inception. The Boards also decided that the composite margin should be released over both the coverage period and the claims handling period.

The IASB tentatively decided that the interest on composite margins should be accreted (the FASB took the view that it should not be).


Discounting

The Boards tentatively decided that the discount rate for insurance contracts should reflect the characteristics of the contract, rather than the characteristics of the assets held to back the contracts, unless they share the same characteristics.

Therefore:
- If the cash flows for insurance contracts do no depend on the performance of specific assets, the discount rate will be a risk free rate, adjusted for illiquidity.
- If the cash flows depend wholly or partly, on the performance of specific assets, the measurement of contracts should consider this.

The Boards also decided that the ED on insurance contracts should ask for specific input regarding concerns that there could be significant losses at the inception of some contracts and possible accounting mismatches if the discount rate does not take into account changes in market credit spreads.


Contract boundary

The Board tentatively decided that the boundary of an insurance contract is when the insurer either:
- Is no longer required to provide coverage or
- Has the right to reassess the risk of the policyholder, and can set a price that reflects that risk.


Recognition

The Board agreed in principle that an insurer should recognise the rights and obligations arising from an insurance contract at the earlier of:
- The insurer being on risk to provide coverage to the policyholder and
- The signing of the insurance contract.


Financial statement presentation

The Boards discussed the following issues.


Unusual or infrequently occurring items

The exposure draft will include the requirement to present unusual or infrequently occurring items in the statement of comprehensive income with disclosure of related information in the notes.


Guidance on classifying short-term assets and liabilities

The application guidance on the classification of assets and liabilities as current and non-current within IAS 1 Presentation of Financial Statements will not be included within the exposure draft because the proposed requirements are deemed sufficient.


Classification of debt

The Boards agreed to consider the different guidance in IFRS and US GAAP on the classification of financial liabilities as a separate project. The ED will retain the guidance in IAS 1 on classification of financial liabilities.


Mixed presentation in the statement of financial position

The guidance in IAS 1 on using a mixed basis of presentation (i.e., a combination of current, non-current and order of liquidity) in the statement of financial position will be retained in the exposure draft and its application will be clarified.


Supplemental cash flow information

The reconciliation of operating income and cash flows, and the presentation on non-cash transactions, as proposed in the exposure draft, will be an integral part of the statement of cash flows, not the notes.


Other disclosures from IAS 7 Statement of Cash Flows

IAS 7 currently encourages disclosure of the amount of undrawn borrowing facilities that may be available. The exposure draft will include this as a required disclosure.

Key discussion points

The Board tentatively decided to publish a limited scope exposure draft of the measurement uncertainty analysis disclosure, including the effect of correlation.

The Board also tentatively agreed to publish a Request For Views on the FASB's proposed amendments to Topic 820 (Fair Value Measurements and Disclosures).


The Boards made tentative decisions regarding the criteria that define an investment company, on which the Board intends to publish a limited scope exposure draft. The Boards also made tentative decisions on specific transition issues.


The Boards continued deliberating proposals for the ED and made tentative decisions on a number of issues:
- Accounting for sale and leaseback transactions
- Lessor accounting for the performance obligation
- Accounting for subleases
- Accounting for long-term leases of land
- Lessor accounting for purchase options
- First time adoption
- Consequential amendments
- Revaluation of right-of-use assets
- Lessor accounting for impairment of assets


The Boards discussed:
- Margins
- Discounting
- Contract boundary
- Recognition


The Boards discussed the following issues:
- Unusual or infrequently occurring items
- Guidance on classifying short-term assets and liabilities
- Classification of debt
- Mixed presentation in the statement of financial position
- Supplemental cash flow information
- Other disclosures from IAS 7 Statement of Cash Flows

Status

ED expected
May 2010





ED expected
Q2 2010



ED expected
Q2 2010











ED expected
Q2 2010





ED expected
Q2 2010