June 7, 2017 Narrow-scope amendments to Section 3856 Financial Instruments The views expressed in this presentation are those of the presenter, not necessarily those of the Accounting Standards Board.
Background November 2014 the AcSB launched a Post-implementation Review (PIR) of Section 3856 Financial Instruments The PIR was designed to allow the AcSB to assess: if the Section provides useful information; whether there are unexpected costs of applying the Section; and whether there are areas of the Section that should be changed.
Background - continued During the PIR, the AcSB talked to: 86 practitioners 21 financial statement users 2 financial statement preparers; and 1 academic A copy of the AcSB s feedback statement on the PIR is available here.
Background - continued The Board reviewed topics identified by respondents to the PIR and assessed whether they had merit of being added to its project plan As part of this process, the Board: Prioritized some narrow-scope issues and included them in this project; Identified other larger projects that will be considered in the context of its broader agenda.
Topics included in this project The following topics have been included in this project: initial recognition of related party financial instruments; measurement of related party compound financial instruments; classification of impairment and forgiveness of related party loans; scope of accounting for modifications and extinguishments of related party financial liabilities; and financial instrument disclosure (excluded from this discussion)
The Board s current thinking The Board is reviewing and evaluating different alternatives to address the topics included in this project The proposed alternatives included in this presentation are preliminary and may change as the result of additional outreach or the AcSB s due process activities
Purpose of this meeting Obtain feedback regarding some of the alternatives being explored by the AcSB to address the narrow-scope issues included in this project, including: Any comments you may have on the alternatives discussed; and Your views on the effects of the alternatives being explored.
8 Topic #1 Scope of accounting for related party financial instruments What we heard from respondents: Confused as to whether related party financial instruments are in the scope of Section 3856 or Section 3840 after initial recognition
9 Topic #1 Scope of accounting for related party financial instruments (cont d) The AcSB heard the following from additional practitioner outreach: This issue is more than just a navigation issue - Entities struggle to apply the concepts in Section 3840 (carrying amount and exchange amount) to financial instruments Why? The theoretical starting point for the standards is in conflict
10 Topic #1 Scope of accounting for related party financial instruments (cont d) Section 3856 Section 3840 Para. 3856.07 Para. 3840.10 Financial instruments are initially measured at fair value Related parties are presumed to not be dealing at arm s length. A transaction between related parties cannot be presumed to have been entered into at fair value.
11 Topic #1 Scope of accounting for related party financial instruments (cont d) Potential alternative being considered Include initial measurement guidance for related party financial instruments in Section 3856 Related party financial instruments would be initially measured at the: undiscounted cash flow(s) of the instrument (excluding interest and dividend payments); cost of the instrument (if it does not have contractual cash flows); or
12 Topic #1 Scope of accounting for related party financial instruments (cont d) Potential alternative being considered (cont d) fair value (if the entity is required or intends to remeasure the instrument at fair value after initial recognition)
13 Topic #1 Scope of accounting for related party financial instruments (cont d) Application of undiscounted cash flow alternative : Scenario #1 Company A transfers land to Company B in a tax planning arrangement and takes back redeemable preferred shares. The carrying amount of the land is $90,000, its fair value is $100,000. The redemption amount and fair value of the redeemable preferred shares is $100,000. The redeemable preferred shares do not meet the requirements of paragraph 3856.23 and therefore have been classified as a liability by the issuer.
14 Topic #1 Scope of accounting for related party financial instruments (cont d) Transferor accounting: Dr. Investment 100,000 Cr. Land 90,000 Cr. Contributed surplus 10,000 Transferee accounting: Dr. Land 90,000 Dr. Equity 10,000 Cr. P/S liability 100,000
15 Topic #1 Scope of accounting for related party financial instruments (cont d) Application of cost alternative: Scenario #2 Company A transfers land to Company B and takes back common shares (Company B is not publicly traded). The carrying amount of the land is $90,000, its fair value is $100,000.
16 Topic #1 Scope of accounting for related party financial instruments (cont d) Transferor accounting: Dr. Investment 90,000 Cr. Land 90,000 Transferee accounting: Not in the scope of Section 3856 as this would be an equity (common share) transaction for this entity.
17 Topic #2 Measurement of related party compound financial instruments What we heard from respondents: Questioned whether guidance in Section 3856 para. 22 is available to compound financial instruments (i.e. measure the equity component as zero) In practice, practitioners and preparers are allocating a nominal amount of the proceeds from these instruments to the equity component (generally $0 or $1)
18 Topic #2 Measurement of related party compound financial instruments Potential alternative being considered If always in Section 3856 (see discussion in topic 1) then mitigates confusion regarding availability of measurement options in Section 3856. The Board may clarify that the initial measurement guidance for related party financial instruments should be applied to the instrument as a whole and that the allocation of proceeds should be considered from the context of paragraph 3856.20-22.
Topic #3 Classification of impairment and forgiveness of related party loans What the AcSB heard from respondents: Accounting for the impairment and / or forgiveness of a related party loan is unclear Should the impairment of a related party loan be recorded in equity? Should both the impairment and subsequent forgiveness be accounted for together through income or through equity?
20 Topic #3 Classification of impairment and forgiveness of related party loans Key observations from lender users consulted: Primarily concerned with leakage Once the money has left the entity, the related party loan has no value unless it is secured; Generally have protective rights that would restrict management from removing capital or assets from the entity. Users were less concerned with the nature of the relationship (i.e. management or shareholder) and more concerned with the original transaction.
21 Topic #3 Classification of impairment and forgiveness of related party loans Key observations from lender users consulted (cont d): If the original transaction was in the normal course of operations the impairment and forgiveness should be recognized through profit or loss; If not, it should be recognized through equity.
22 Topic #3 Classification of impairment and forgiveness of related party loans Key observations from practitioners consulted: In practice related party accounts often include a mixture of transactions (normal course and not normal course) and that it would be impracticable to determine the nature of cash flows within these accounts.
23 Topic #3 Classification of impairment and forgiveness of related party loans Potential alternatives being considered a) Clarify that the impairment indicators in para. 3856.A15 are not exclusive to third party financial assets; b) Clarify that impairments, are recognized in income as indicators arise;
24 Topic #3 Classification of impairment and forgiveness of related party loans c) Add guidance that the forgiveness of related party financial assets should be recognized in: Income, if the original transaction that brought rise to the asset was in the normal course of operations; or Equity if: The original transaction that brought rise to the asset was not in the normal course of operations; or It is impracticable to determine whether the amount forgiven originated in the normal or non-normal course of operations.
25 Topic #3 Classification of impairment and forgiveness of related party loans Forgiveness of loans with an individual that is acting solely in capacity of senior management (i.e. is not also a shareholder) is compensation and should be recognized in income.
26 Topic #4 Scope of accounting for modifications and extinguishments of related party loans Key observations from practitioners consulted: ASPE preparers struggle to apply the 10% test (for both related and third party modifications) Modification of related party loans is often done for tax purposes (similar to forgiveness); Para. 3856.28 requires the difference between the carrying amount of the FL and consideration paid to be recognized in accordance with Section 3840.
27 Topic #4 Scope of accounting for modifications and extinguishments of related party loans Potential alternative being considered All modifications or related party financial liabilities are accounted for as an extinguishment with the new instrument measured in accordance with the initial measurement guidance alternative explored in Topic #1.
June 7, 2017 For more information, visit www.frascanada.ca Contacts Andrew White, CPA, CA Kelly Khalilieh, CPA, CA Principal, AcSB Senior Principal, AcSB Phone: +1 (416) 204-3487 +1 (416) 204-3453 Email: awhite@cpacanada.ca kkhalilieh@cpacanada.ca