Author: Michael Wells

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1 Author: Michael Wells Vienna, Austria IFRS for SMEs Train the Trainers Workshop, February 2016 This event is co-funded by: Road to Europe: Program of Accounting Reform and Institutional Strengthening European Union

»Understand the hierarchy of assessments management makes in applying IFRS and the IFRS for SMEs»Understand when undue cost or effort exemptions

2 »Understand the hierarchy of assessments management makes in applying IFRS and the IFRS for SMEs»Understand when undue cost or effort exemptions apply»understand the judgements in making undue cost or effort assessments»understand the disclosures that apply when an undue cost or effort exemption is used 2

3 Assessment hierarchy 1 st assess materiality 2 nd undue cost or effort exemption applies 3 rd fair presentation override Threshold Applicability IFRS could reasonably be expected to affect users decisions on the basis of that information the incremental cost or effort substantially exceeds the benefits that those who are expected to use the financial statements would receive from having the information. compliance is so misleading that it would conflict with the objective of financial statements IFRS for SMEs pervasive only when specified extremely rare circumstances Note: The assessments management make (as set out above) are separate from the cost constraint that the IASB assesses when setting Standards 3

5 » Information is material when its omission or misstatement could influence the economic decisions of users made on the basis of the financial statements.» Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances.» An entity need not follow a requirement if the effect of doing so would be immaterial. Applies to all requirements including:» recognition;» measurement;» presentation; and» disclosure. 5

»IASB [draft] Practice Statement ED/2015/8 IFRS Practice Statement: Application of Materiality to Financial Statements provides guidance in the following three main areas: a) characteristics of

6 »IASB [draft] Practice Statement ED/2015/8 IFRS Practice Statement: Application of Materiality to Financial Statements provides guidance in the following three main areas: a) characteristics of materiality; b) how to apply the concept of materiality when making decisions about presenting and disclosing information in the financial statements; and c) how to assess whether omissions and misstatements of information are material to the financial statements. source: 6

7 »Entity A manufactures components for the motor vehicle industry. Since 2013 its property, plant and equipment has increased from 10 million to 12 million.»entity A is wholly owned by Ms A. It is funded 80% by bank loans.»entity A recognises in profit or loss in the year of their acquisition individual items of PPE that cost less than 200.»Is Entity A s policy of expensing PPE in the year of its acquisition contravening the IFRS for SMEs? Choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 7

8 »Would your answer change if management were deliberately acquiring more costly items of PPE in components that each cost less than 200 so as to recognise the cost of the PPE as an expense in profit or loss in the year of its acquisition?»choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 8

9 » Entity A enters into a lease for the first (and only) time in 2015.» The terms of the lease:» Entity A acquires the right of use of a photocopier for three years and, at the end of the lease term, legal ownership of the photocopier» Obliges Entity A to make, to the lessor, equal monthly cash payments (the present value of which equal the 1,000 cash cost of the photocopier at the inception of the lease).» Entity A does not recognise the lease in its statement of financial position. Instead it recognises lease payments as an expense of the period in which they are paid in accordance with the lease agreement.» Is Entity A s policy of expensing lease payments when they are made to the lessor contravening the IFRS for SMEs? Choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 9

10 »Would you answer change if recognising the finance lease in accordance with Section 20 Leases would have resulted in Entity A breaching a loan covenant at 31 December 2015?»Choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 10

12 » The IFRS for SMEs specifies a limited number of undue cost or effort exemptions» The exemption does not apply to other requirements» Management assesses whether obtaining or determining the information necessary to comply with the specified requirements would involve undue cost or effort.» such assessments require judgement» Whenever an undue cost or effort exemption is used, the entity discloses the reasons why applying the requirement would involve undue cost or effort.» note: alternative disclosures apply for the undue cost and effort exemption related to the recognition of intangible assets in a business combination. * source: paragraphs 2.14A to 2.14D of the IFRS for SMEs (2015) 12

»Full IFRS does not include any undue cost or effort exemptions»instances of the text undue cost or effort in IFRS for SMEs» 18 instances as first issued in 2009» Q&A issued by the SME

13 »Full IFRS does not include any undue cost or effort exemptions»instances of the text undue cost or effort in IFRS for SMEs» 18 instances as first issued in 2009» Q&A issued by the SME Implementation Group» 60 instances as amended in 2015»The 2015 amendments added:» a number of new undue cost or effort exemptions; and» guidance on how to assess undue cost or effort. 13

14 »Management uses its judgement in assessing whether obtaining or determining the information necessary to comply with the specified requirements would involve undue cost or effort.»the judgement depends on:» the entity s specific circumstances; and» management s judgement of the costs and benefits from applying that requirement.»the judgement requires consideration of how the economic decisions of those that are expected to use the financial statements could be affected by not having that information. * source: paragraphs 2.14A to 2.14D of the IFRS for SMEs (2015) 14

15 »An undue cost or effort exemption is not intended to be a low hurdle (paragraph BC240 of the IFRS for SMEs)»A requirement would involve undue cost or effort if:» the incremental cost (for example, valuers fees) or effort (for example, endeavours by employees)» substantially exceeds the benefits that those who are expected to use the SME s financial statements would receive from having the information. * source: paragraphs 2.14A to 2.14D of the IFRS for SMEs (2015) 15

16 »paragraph 34.6 provides application guidance when assessing whether the fair value of biological assets in agricultural activity is readily determinable without undue cost or effort» fair value may be readily determinable without undue cost or effort even though market determined prices or values are not available for a biological asset in its present condition. Any entity must consider whether the present value of expected net cash flows from the asset discounted at a current market determined rate results in a reliable measure of fair value. (paragraph 34.6(d)) 16

» Investment property whose fair value cannot be determined reliably on an ongoing basis without undue cost or effort is exempt from fair value measurement and must instead be carried using the cost

18 » Investment property whose fair value cannot be determined reliably on an ongoing basis without undue cost or effort is exempt from fair value measurement and must instead be carried using the cost model (ie historical cost less depreciation less impairment).» Mixed use property must be separated between investment property and PPE. However, if the fair value of the investment property component cannot be measured reliably without undue cost or effort, the entire property is accounted for as PPE (using the cost model).» The property-by-property option to include in Investment property carried at fair value, operating leasehold property interests that otherwise satisfy the definition of investment property, is subject to the fair value of the leasehold interest being reliably measured without undue cost or effort. 18

19 to 2040 Fair value changes property Cost model (undue cost or effort applies) Fair value model (undue cost or effort does not apply) 10,000,000 (20,000,000) Rental income 25,000,000 25,000,000 Depreciation (10,000,000) Profit or loss 15,000,000 15,000,000 Michael JC Wells 19

20 20 First half of the useful life of the building (2011 to 2020) Fair value changes property Cost model (undue cost or effort applies) Fair value model (undue cost or effort does not apply) 15,000,000 (5,000,000) Rent income 5,000,000 5,000,000 Depreciation (5,000,000) Profit or loss - 15,000,000 Michael JC Wells 20

21 Second half of the useful life of the building (2021 to 2040) Cost model (undue cost or effort applies) 21 Fair value model (undue cost or effort does not apply) Fair value changes building (20,000,000) Rental income 20,000,000 20,000,000 Depreciation (5,000,000) Profit or loss 15,000,000 - Michael JC Wells 21

22 » Entity A s main assets are ten investment properties: freestanding residential homes in a single development of over 1,000 near identical homes.» Each year about twenty to thirty of the homes in the development are sold. The prices at which land and buildings are sold is publicly available information from a free-to-access website maintained by the government.» About half of the homes are investment property rented to third party tenants. Although rentals are not publicly available, the rentals being asked are published when homes are advertised for rental.» Entity A is wholly owned by Ms A. Entity A is funded 80% by bank loans and tenant deposits.» Tenants must pay a deposit equal to twelve months rent before occupying a property. Tenant deposits are refundable at the end of the lease term provided that the property is returned to Entity A in the specified condition.» Entity A s annual financial statements, prepared in accordance with the IFRS for SMEs, are free to download from Country A s central repository with which all private companies are required to file their annual financial statements. 22

23 »Does measuring Entity A s investment property using the fair value model involve undue cost or effort? Choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 23

24 » Entity B s main assets are its ten investment properties. Its properties are in various towns in a country suffering a devastating civil war with significant bombings by a number of foreign forces. Over 10 per cent of the country s population is killed and more than 20 per cent of its population have fled its borders to seek asylum.» Although, using satellite technology, Entity B could verify whether its properties have been destroyed, it is unable to determine whether the tenants continue to occupy the homes. There is no evidence of any willing buyers for Entity B s investment properties and there is no evidence of arm s length transactions in the country s property market since the civil war started three years ago.» Mr B owns 55% of the equity of Entity B. The remaining equity is held by 1,000 individual investors that contributed capital to the entity through Entity B s crowd funding campaign some years before the outbreak of civil war. Entity A is funded 80 per cent by bank loans.» Does measuring Entity B s investment property using the fair value model involve undue cost or effort? Choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on) 24

25 » Entities whose accounting policy is to account for investments in associates or jointly controlled entities (or both) using the fair value model must use the cost model for any investment in an associate for which fair value cannot be measured reliably without undue cost or effort.» When measuring the best estimate of a contingent asset for disclosure purposes involves undue cost or effort, the entity is exempt from doing so provided the alternative disclosures are furnished.» Exemption from the requirement to measure defined benefit obligations using the projected unit credit (PUC) method if doing so involves undue cost or effort. In such cases, the specified simplified method is used instead of the PUC method (see paragraph 28.19). 25

26 » On 1 January 2013 Entity C introduces an experimental long-term bonus scheme to incentivise its most highly skilled employees to remain with the company from their 60 th birthday until mandatory retirement on their 70 th birthday.» For the further 10 years of continued service Entity C will pay each incentivised employee a bonus equal to the salary otherwise earned in the 12 months to their 70 th birthday.» Mrs C owns 60% of the equity of Entity C. The remaining equity is held by 5 members of Mrs C s family and 4 friends.» Entity C is funded 50% per cent by bank loans and 25% by its other creditors. 26 Michael JC Wells 26

27 27 Date Number of scheme employees Employees expected to remain to 31/12/2022 Current annual salary Estimated salary for 2022 Market yield on high quality corporate bonds maturing on 31/12/ /01/ $100,000 $235,795 9% 31/12/ $100,000 $162,520 10% 31/12/ $110,000 $197,947 3% 31/12/ $115,500 $246,215 8% Michael JC Wells 27

28 Date Expected vesting (employees) Expected 2022 salary Service factor = years service/10 Discount factor = 1/(1+i) n Amount ($) 01/01/2013 80 $235,795 0 0.

28 28 Date Expected vesting (employees) Expected 2022 salary Service factor = years service/10 Discount factor = 1/(1+i) n Amount ($) 01/01/ $235, Expense 551,395 31/12/ $162, ,395 Expense 1,636,258 31/12/ $197, , Expense 1,001,685 31/12/ $246, ,189,338 Michael JC Wells 28

Date Number of scheme employees Current annual salary Service factor = years service/10 Discount factor = 1/(1+i) n 29 Amount ($) 01/01/2013 100 $100,000 0 0.

29 Date Number of scheme employees Current annual salary Service factor = years service/10 Discount factor = 1/(1+i) n 29 Amount ($) 01/01/ $100, Expense 415,616 31/12/ $100, ,616 Expense 1,234,250 31/12/ $110, ,649,865 Expense 230,403 31/12/ $115, ,880,269 Michael JC Wells 29

30 »Does measuring Entity C s defined benefit post-employment obligation using the projected unit credit method likely involve undue cost or effort?»choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 30

31 » Exemption from the requirement to measure biological assets in agricultural activity at fair value less costs to sell when the fair value of the asset is not readily determinable without undue cost or effort. In such cases, the biological assets are measured using the cost model (historical cost less depreciation less impairment).» Exemption from the requirement to recognise a biological asset in agricultural activity when on contemplating its initial recognition neither the fair value nor the costs of the item can be measured reliably without undue cost or effort.» Note: fair value may be readily determinable without undue cost or effort even though market determined prices or values are not available for a biological asset in its present condition. Any entity must consider whether the present value of expected net cash flows from the asset discounted at a current market determined rate results in a reliable measure of fair value. (paragraph 34.6(d)) 31

33 »Addition of an undue cost or effort exemption from the requirement to recognise separately intangible assets acquired in a business combination»investments in non-convertible preference shares and nonputtable ordinary or preference shares the fair value of which cannot be measured reliably without undue cost or effort shall (after adopting the 2015 amendments) be measured at amortised cost (see paragraphs 11.14(c) and 12.8)» also relevant to such investments in associates and joint ventures» also relevant to unconsolidated subsidiaries (the one year rule) 33

34 »When the fair value of equity instruments issued in extinguishment (or part extinguishment) of debt in a renegotiation with a creditor, cannot be measured reliably without undue cost or effort, the equity instruments issued are measured at the fair value of the liability extinguished.»addition of an undue cost or effort exemption from the requirement to measure at fair value the liability to pay a noncash distribution. 34

35 » Entity D is wholly owned by the Fruity family. Entity D has farmed apples on its land for three generations of the Fruity family. It accounts for its apple trees using the fair value model but accounts for the land on which the trees grow using the cost model.» Because the neighbouring country to which Country D exported most of its harvested apples recently imposed trade sanctions on Country D, including banning the import of its apples, Country D is experiencing a glut of apples.» The sanctions have greatly impacted Entity D s cash flows and consequently it is renegotiating its debt and renegotiating terms of employment with its employees. In particular, it offers its employees a long-term bonus scheme in compensation for reducing their short-term employee benefits.» On 31 December 2015 Entity D distributed all of its unencumbered land to the Fruity family as a dividend.» Entity D s annual financial statements, prepared in accordance with the IFRS for SMEs, are free to download from Country D s central repository with which all private companies are required to file their annual financial statements. 35

36 »Does measuring the distribution of the land at its fair value involve undue cost or effort? Choose one of: 1) Yes; 2) No; or 3) It depends (specify what it depends on). 36

37 »Addition of an undue cost or effort exemption to the conditional requirements to offset: (i) current income tax assets and liabilities; and (ii) deferred income tax assets and liabilities» disclose the amounts that have not been offset and the reasons why applying the offset requirements would involve undue cost or effort 37

»Whenever an undue cost or effort exemption is used the entity discloses:» the fact; and» the reasons why applying the requirement would involve undue cost or effort.

39 »Whenever an undue cost or effort exemption is used the entity discloses:» the fact; and» the reasons why applying the requirement would involve undue cost or effort.»different disclosures apply for the undue cost and effort exemption related to the recognition of intangible assets in a business combination (see paragraph19.25(g)).» a qualitative description of the factors that make up goodwill recognised (including, for example, intangible assets not recognised when the undue cost or effort exemption has been applied) 39

41 »In extremely rare circumstances management might conclude that compliance with a requirement would be so misleading that it would conflict with the objective of financial statements.»in such extremely rare circumstances the entity would depart from the requirement, unless the relevant regulatory framework prohibits departure. 41

42» The issue centres on the dates of the problem trades, which the bank has said were put on afresh in 2008 after Mr Kerviel closed most of his positions at the end of 2007 at a 1.4bn ($2.

3bn loss it sustained in unwinding the 2008 trades for this year s books.

42 42» The issue centres on the dates of the problem trades, which the bank has said were put on afresh in 2008 after Mr Kerviel closed most of his positions at the end of 2007 at a 1.4bn ($2.1bn) profit. Accountants said the simplest treatment would be for the bank to book Mr Kerviel's 1.4bn profit in its recently published 2007 accounts and leave the 6.3bn loss it sustained in unwinding the 2008 trades for this year s books.» Regulators and accounting experts are questioning Société Générale s use of a "get out" clause in accounting rules to book losses from Jérôme Kerviel's alleged fraud in its 2007 accounts.» SocGen has not fully explained its rationale for the tactic, which is a last resort in accounting terms. Soon after it first revealed the losses, the bank indicated that it was seeking to book them in 2007 under a different accounting provision known as a "post balance sheet event". The fact that it has resorted to "true and fair" suggests it struggled to do so and underlines the bank s determination to wrap up the whole affair as soon as possible. source: Override that is dividing accountants with emphasis added 42

43 43»For Société Générale s 2007 statement of financial position what is the economics of the transactions in question?»choose one of: 1) Asset 2) Liability 3) Equity 4) No element because the transactions were yet to be entered into 43

44 44»Which IFRS requirements are relevant to the case study? Choose one of: 1) IAS 39 (now replaced by IFRS 9 Financial Instruments) for accounting for derivatives 2) IAS 1 for the fair presentation override and possibly going concern considerations 3) IAS 10 Events after the Reporting Period 4) All of the above 44

45 45»What accounting does IAS 39 specify for speculative derivatives?»choose one of: 1) Historical cost 2) Fair value through profit or loss 3) Cash accounting 4) An entity chooses whatever accounting it would like to do 45

46 46»Entering into and closing out the derivative positions in 2008 before the 2007 financial statements are authorised for issue are?»choose one of: 1) adjusting events; 2) non-adjusting events (disclosure only events); 3) basis of preparation events; 4) ignorable events; or 5) it depends (specify)? 46

47 47»Does Société Générale s use of the fair presentation override contravene IFRS?»Choose one of: 1) Yes 2) Maybe (I need more information to decide) 3) No»If yes, why do you think management inappropriately used the fair presentation override? 47

48 48» SocGen has not fully explained its rationale for the tactic, which is a last resort in accounting terms. Soon after it first revealed the losses, the bank indicated that it was seeking to book them in 2007 under a different accounting provision known as a "post balance sheet event". The fact that it has resorted to "true and fair" suggests it struggled to do so and underlines the bank s determination to wrap up the whole affair as soon as possible.» Separately, SocGen is set to announce today that its 5.5bn rights issue, launched to bolster its capital base, was at least 1.8 times subscribed, a result which is likely to be hailed by Daniel Bouton, chairman and chief executive, as a vote of confidence in its strategy. source: FT (12 March 2008) Override that is dividing accountants 48

EN Official Journal of the European Union L 320/373

29.11.2008 EN Official Journal of the European Union L 320/373 INTERNATIONAL FINANCIAL REPORTING STANDARD 3 Business combinations OBJECTIVE 1 The objective of this IFRS is to specify the financial reporting