www.pwc.com.au IAG Conference Accounting Update Emerging issues in the public sector 20 November 2014 Michael Crowe Yannick Maurice
Agenda Introduction Key topics o Fair value o PPP Projects Refinancing considerations o Leasing update o Considerations relating to privatisation o Grants and contributions o Revenue recognition o Consolidation for NFPs 2
Fair value 3
AASB 13 Fair Value Measurement Objectives - Reminder Provide single source of guidance Clarify definition of fair value Provide clear framework for measuring fair value Enhance fair value disclosures Exit Price Not settlement or extinguishment The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Not liquidation/forced sale Not entity-specific 4
AASB 13 Fair Value Measurement Main themes Highest & best use (non fin assets) Principal market Bid-Ask Price Credit risk Disclosure requirements Application AASB 13 is to be applied prospectively Disclosure requirements under AASB 13 need not be applied in comparative information provided for periods before initial application of this standard 5
AASB 13 Fair Value Measurement Challenges in implementation by the public sector Many assets in the public sector have no known or observable markets and have few or no alternative uses; many infrastructure assets are specialised and depreciable replacement cost is the fair value technique adopted. Many public service assets may have uses that appear sub-optimal from a market participant perspective consider restriction on use of assets (e.g. heritage assets) service potential considerations NCAP 3 clarifies the application of AASB 13 to some of these assets 6
AASB 13 Fair Value Measurement Disclosures Disclosures required for: valuation techniques and inputs used fair value hierarchy effect on P&L / OCI of recurring level 3 measurements Next reporting period will require comparatives Applies to: recurring and non-recurring fair value measurements after initial recognition financial and non-financial instruments Plan ahead and develop proforma disclosures to avoid a last minute scramble for information 7
AASB 13 Fair Value Measurement Potential ways to address the challenges Prepare an inventory of assets and update regularly to keep up to date - Categorise assets into classes - Understand restrictions on assets Document the previous valuation methodology performed (e.g. full valuation, indexation etc) Re-assess fair value methodology overtime. This may involve early consultation with the Valuers Engage with the Valuer on information that must be included in valuations Implementation was time consuming fine tuning and comparative information will be the same 8
PPP projects Refinancing considerations 9
Refinancing impact of PPP Projects Certain PPP projects are accounted for as a lease by the State in accordance with APG17 and may be classified as finance lease under AASB 117 Refinancing of the operator s external debt may occur during the lease term The State may be entitled to refinancing benefits. 10
Accounting treatment of refinancing arrangement Refinancing structured through adjustment in service payments Lack of guidance in AASB 117 as to how to recognise changes in Minimum Lease Payments (MLPs) that are subsequently fixed or adjusted Follow AASB 108 requirements to develop a relevant and reliable policy to account for the above changes Considerations under AASB 139 Substantial modification to be treated as an extinguishment of original financial liability & recognition of a new financial liability Not a substantial modification accounting choice available Using modification of debt principles under AASB 139 - Net refinancing gain or loss to be recognised over the modified instrument s remaining life - Adjust original lease amortisation schedule to reflect the estimated changes to future payments; calculate a new implicit interest rate in the lease 11
Accounting treatment of refinancing arrangement Refinancing structured through adjustment in service payments Not a substantial modification (cont d) - No impact on lease liability at the date of refinancing - Future periods lease liability and interest expense profile will change Disclosure impact on financial statements will be a change to specifically: Nominal MLPs and present value of MLPs Total future period finance charges Interest rate disclosure Disclose the nature and details of refinancing if it is considered relevant to users' understanding of the lease liability under AASB 101 principles 12
Leasing update 13
Lease project - Timeline Aug. 2010 Dec. 2010 Jan. 2011 May 2013 Sept. 2013 2015 2018/2019? Exposure draft issued Comment period ended Re-deliberations begin Re-exposure Comment Final standard Effective date? period ends; Re-deliberations begin Why is there a leases project? The proposal aims to improve the quality and comparability of financial reporting and provide greater transparency about the leverage and risks arising from lease transactions in particular retail, transportation and telecommunications companies by bringing all leases greater than 12 months on balance sheet; Existing lease accounting is criticised for omitting significant assets and liabilities arising from operating leases. Despite differences, the Boards have reiterated their commitment to seek a converged solution. Key messages Joint lease project is continuing and while the boards need to revisit crucial elements such as the single model vs dual model, operating leases will come on balance sheet and be treated as a debt-like obligation; All operating leases will be affected, even those entered into before the effective date of the standard i.e. no grandfathering; Consider what the impact the lease project will have on business strategy (sale & leasebacks), timing of sales and lease renewals; understanding the rate charged by the lessor; Perform balance sheet impact assessment (in particular debt as lease liability equivalent to debt); Manage stakeholder expectations, internal (treasury & investor relations) and external (e.g. credit rating agencies and banking relationships); Although credit ratings agencies are already making adjustments for operating leases in their assessments, these adjustments are likely to differ materially from the likely impact of the proposed leasing standard; and Systems readiness to track all operating leases. August 2014 14
Identifying a lease changing guidance Definition of a lease (distinguishing a lease from a service) Current guidance A lease conveys the right to use a specific asset for a period of time in exchange for a payment. Right to use Right to operate asset; or Right to control access to asset; or Take most of output and the price is neither fixed nor market Revised ED proposals A lease conveys the right to control the use of a identified asset for a period of time in exchange for consideration. Right to control use Ability to direct use of asset; and Ability to derive benefits from use Current lease guidance views control on a benefits basis only versus a power and benefits basis as in other areas of the literature. What is the impact of the changing guidance? At present, given under the current accounting is generally the same for an operating lease and a service arrangement there is likely to be a greater focus on identifying whether an arrangement is a lease or a service given the proposal that all leases greater than 12 months will be recognised on balance sheet; There is no significant change under the current and proposed guidance in relation to whether an asset is a specific or identified asset; The right to use concept has been refined to consider the ability to direct the use of the asset where the contract gives the customer the ability to make decisions about the use of the asset which most significantly affect the economic benefits to be derived i.e. How and for what purpose the asset is used during the term; How the asset is operated during the term of the contract; or Who the operator of the asset is. Where there are few substantive decisions to be made, an assessment will be made as to whether the ability to direct the use was conveyed through the design of the asset or the terms and conditions of the contract. The ability to derive substantially all of the potential economic benefits from the use of an asset throughout the term differs from current guidance where a right to use is conveyed where the lessee takes substantially all of the output/utility and the price paid is not fixed per unit of output or current market price at time out of delivery. What do analysts and credit rating agencies think? Analysts and credit rating agencies see a clear distinction between a lease and a service; Leases are different from service / executory contracts i.e. typically the asset is not obtained at start of a service / executory contract; In a lease the customer controls the use of the asset; In a service / executory contract the supplier controls the use of the asset; and Revised lease definition may provide structuring opportunities to keep debt like obligations off-balance sheet and encourage the use of short term leases. August 2014 15
Issues relating to privatisation 16
Issues relating to privatisation Accounting for internal restructures and vesting of assets/entities between government entities Accounting for long term arrangements with the private sector (e.g. licences, concessions, leases) Value of residual interest in relation to assets returning to government at the end of long term lease arrangements Treatment of employee arrangements on transfer to the private sector Determining financial reporting requirements for new or changed Government entities & clarity over accounting impacts on Government entities financial statements 17
Grants and contributions 18
Accounting for grants and contributions For profit Apply AASB 120 to account for govt grants Not for profit Is it a non-reciprocal transaction? No Apply revenue standard (AASB 118) Yes The entity providing the grant does not receive equal value in return for their contribution Yes Apply contributions standard (AASB 1004) Is it contributions by owners? Future economic benefits contributed by parties external to the entity, that give rise to a financial interest in the net assets of the entity No Recognise directly in equity Recognise income at fair value 19
Other form of investments Capital Contributions Consideration needs to be given to assess the nature of funds provided by the Federal Government to determine whether the funds provided to finance the projects are in the form of a loan or a contribution. The main factors to consider when capital contributions are received are: AASB 1004 Contributions may be the applicable standard Capital contribution can be recognised as income or a direct adjustment to equity depending on the nature of the contribution If the contribution is classified as a contribution by owner it is recognised directly in equity If not, it is recorded as income The definition of contribution by owner is that the contributing party has rights to the net assets of the receiving party The contributions should be recognised when the cash is received from the federal government 20
Other form of investments Loans When funding is received by way of a loan, consideration needs to be given to whether the loan should be treated as concessional. A concessional loan is a loan provided on more favourable terms than the borrower could obtain in the market place either in the form of lower interest rates, longer loan maturity or grace periods before repayments - Accounting Guidance Note No. 2010/2 On Day 1, the market based loan and the discount component need to be separated and accounted for as follows: The loan should be recognised at fair value in accordance with AASB 139, typically inclusive of transaction costs. The loan is then subsequently measured at amortised cost using the effective interest rate method. The discount component is recognised immediately in the profit and loss. The discount component is then subsequently unwound through the P&L over the life of the loan. 21
IFRS 15 Revenue from contracts with customers Transition timeline and alternatives FY 2017 FY 2018 Effective date = 1 Jan 2017 Impact Option 1 Full retrospective NEW GAAP Cumulative effect at 1 July 2016 NEW GAAP Double revenue or lost revenue between FY16 and FY17 Option 2 Prospective OLD GAAP NEW GAAP Double revenue or lost revenue between FY17 and FY18 Cumulative effect at 1 July 2017 Disclose OLD GAAP Which is better? It depends. 22
IFRS 15 Revenue from contracts with customers Key changes in new standard Comment on concessional loans AASB 118 /111 IFRS 15 Separate models for: Construction contracts Goods Services Single model for performance obligations: Satisfied over time Satisfied at a point in time Focus on risk and rewards Focus on control Limited guidance on: Multiple element arrangements Variable consideration Licences More guidance: Separating elements, allocating the transaction price, variable consideration, licences, options, repurchase arrangements and so on. 23
IFRS 15 Revenue from contracts with customers The five step approach Comment Core principle on concessional loans Revenue recognised when the goods or services are transferred to the customer, at the transaction price. Step 1 - Identify the contract with the customer Step 2 - Identify the performance obligations in the contract Step 3 - Determine the transaction price Step 4 - Allocate the transaction price Step 5 - Recognise revenue when (or as) a performance obligation is satisfied 24
Control considerations 25
Control considerations Overview Application for not-for-profit entities NFP entities are required to apply AASB 10 Consolidated financial statements and AASB 12 Disclosures of interests in other entities for reporting periods beginning on or after 1 January 2014. The AASB has issued AASB 2013-8 Australian implementation guidance for not-for-profit entities - control and structured entities. This guidance clarifies how AASB 10's criteria for assessing control should be applied in the not-for-profit space and includes some detailed examples. AASB 2013-8 also includes some guidance on how not-for-profit entities should identify and disclose relationships with structured entities in accordance with AASB 12 26
Control considerations Overview Defining control An investor controls an investee when the investor is exposed, or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee - AASB 10 Paragraph 5 Issue: This definition is applicable to for-profit entities but may be difficult to apply to not-for-profit and public sector entities Application to public sector: control for the public sector should be assessed from the perspective of which party has the ability to exercise power to affect the public service benefit being provided Implications for the public sector: some entities not previously consolidated may need to be consolidated August 2014 27
Control considerations Key accounting considerations Determining control For-profit entities: Not-for-profit entities: Power over the investee Exposure to variable returns from involvement with the investee Ability to use power over investee to affect the amount of investor s returns Power through statutory, legislative or contractual rights assess whether they are substantive or protective Exposure to public service benefits project assets ability to meet the public service obligation Ability to use power to effect public service benefits sufficient power over decisions about the design and operation of the project to achieve the desired public service benefit August 2014 28
Control considerations Upcoming Guidance Consolidation for not-for-profits (NFRs) Could significantly impact consolidation by NFPs as entities not previously consolidated might be deemed to be controlled Effective for reporting periods after 1 January 2014 NFP needs to assess whether any power they have over another entity is exercised in their own right, or on behalf of another entity. Key differences for NFPs: Likely impact more consolidated entities than previous years Same definition of control with additional implementation guidance Power often not driven by voting/ equity share Returns consider both financial and non-financial benefits (e.g. further social objective through provision of community housing to homeless) August 2014 29
Control considerations Illustrative example: The State has established a program that provides community housing The program is operated by an incorporated special purpose vehicle (SPV )which has not issued any equity instruments The program s objective is to provide shelter to the homeless to benefit the community and is funded through State grants and fundraising initiatives The State directs the operations of the program and the budget although non-state employees run day-to-day operations The State does not receive any financial returns from the SPV Question: Does the State control the SPV? August 2014 30
Contacts To have a deeper discussion about these issues please contact: Michael Crowe Partner Assurance P: +61 (7) 3257 5383 E: michael.crowe@au.pwc.com Yannick Maurice Director Accounting advisory P: +61 (7) 3257 5058 E: yannick.x.maurice@au.pwc.com 31