RSM World of IFRS summarises key matters arising from recent IASB discussions and decisions, highlights RSM thought leadership from around the world, and addresses an IFRS application question each month.
Latest matters from the international accounting standards board (IASB)
The following is a summarised update of key matters arising from the discussions and decisions taken by the IASB at its remote meetings from January to May 2021:
The full update, as published by the IASB, can be found here.
Maintenance and consistent application
BUSINESS COMBINATIONS UNDER COMMON CONTROL
The Board issued discussion paper DP/2020/2 Business Combinations under Common Control in November 2020.
IFRS 3 Business Combinations sets out the reporting requirements for mergers and acquisitions, which meet the definition of a business combination. However, the Standard scopes out and does not provide guidance on the accounting treatment of transactions that involve transfers of a business between companies within the same group. This is commonly known as a “common control transaction”. The Discussion Paper sets out the Board’s preliminary views on reducing diversity in practice and enhancing the disclosure in the financial statements with regards to business combinations under common control.
Summary of the Board’s preliminary views on business combinations under common control
Scope: The scope would include all transactions under common control in which a business is transferred.
Measurement method: The accounting treatment is dependent on the existence of non-controlling interests. Acquisition method should be applied to the business combination under common control that affect non-controlling shareholders of the receiving entity, subject to a cost-benefit trade-off and other potential considerations. The book-value method should be applied to all acquiring entities when there are no non-controlling interests.
The acquisition method: Under the acquisition method, if the consideration is less than the fair value of the identifiable assets and liabilities, the amount is recognised as a contribution to equity, instead of being recognised as a bargain purchase gain in the statement of profit or loss.
The book-value method: When applying the book-value method, the receiving entity should recognise any difference between the consideration and the book value of the net assets/ liabilities of the acquiree within equity. The book values are those recorded in the financial statements of the acquiree.
In addition, the Board reached the preliminary views that:
- If the receiving company’s shares are privately held:
- The receiving company should be permitted to use a book-value method if it has informed all of its non-controlling shareholders that it proposes to use a book-value method and they have not objected (“the optional exemption from the acquisition method”); and
- The receiving company should be required to use a book-value method if all of its non-controlling shareholders are related parties of the company (“the related party exception to the acquisition method”).
- If the receiving company’s shares are traded in a public market:
- the receiving company should be required to apply the acquisition method. Where the acquisition method is to be applied, the accounting must be in accordance with the requirements of IFRS 3.
Disclosures: The disclosure requirements in IFRS 3 should be disclosed when applying the acquisition method, including any improvements to those requirements resulting from the Discussion Paper Business Combinations- Disclosures, Goodwill and Impairment. Any pre-combination information is not required to be disclosed in the financial statements. In addition, the receiving company should disclose the following information:
- the amount recognised in equity for any difference between the consideration paid and the book value of the assets and liabilities received; and
- the components of equity that include the difference.
If the Board’s preliminary views are implemented, listed companies will apply the acquisition method and privately held companies will in most cases be permitted or required to apply a book value method. .
Invitation to comments is open until 1 September 2021.
IASB clarifies the accounting for deferred tax on leases and decommissioning obligations.
An amendment to IAS 12 Income Taxes has been published by the International Accounting Standards Board (IASB) to specify how companies should account for deferred tax on transactions such as leases and decommissioning obligations. The amendments are effective for annual reporting periods beginning on or after 1 January 2023, with early application permitted.
The amendment excludes from the scope of the initial recognition exemption those transactions that give rise to equal and offsetting temporary differences. This results in the recognition of a deferred tax asset and a deferred tax liability for temporary differences arising on initial recognition of leases and decommissioning obligations.
If companies previously recognised a deferred tax position on leases and decommissioning obligations under the net approach, the impact on transition would likely be to present the deferred tax asset and deferred tax liability separately. In addition, some companies which previously applied the initial recognition exemption may now have to recognise deferred tax assets or liabilities. The aim of the amendments is to reduce diversity in the reporting of deferred tax on leases and decommissioning obligations.
IFRS INTERPRETATIONS COMMITTEE (IC) LATEST DECISIONS SUMMARY
The following is a summarised update of key matters arising from the discussions and decisions taken by the IFRIC at its meetings on the following dates:
2 February 2021
16 March 2021
20 April 2021
The full updates, as published by the IASB, can be found here.
TENTATIVE AGENDA DECISIONS
The Committee decided not to add the following matters to its standard-setting agenda because the principles and requirements in IFRS already provide an adequate basis for determining the appropriate accounting treatment.
ACCOUNTING FOR WARRANTS THAT ARE CLASSIFIED AS FINANCIAL LIABILITIES ON INITIAL RECOGNITION (IAS 32)
The Committee received a request about the application of IAS 32 in relation to the reclassification of warrants. The request described a warrant that provides the holder with the right to purchase a fixed amount of equity instruments of the issuer at an exercise price to be fixed at a future date.
At initial recognition, the issuer would classify these instruments as financial liabilities because of the variability in the exercise price in accordance with the requirement in paragraph 16 of IAS 32. This is because for a derivative financial instrument to be classified as equity, the financial instrument must be settled by the issuer exchanging a fixed amount of cash or another financial asset for a fixed amount of its own equity instrument (‘fixed for fixed condition’).
The request asked whether the issuer reclassifies the warrant as an equity instrument following the fixing of the warrant’s exercise price after initial recognition as specified in the contract, given that the fixed for fixed condition would be met at that stage.
The Committee noted that IAS 32 does not contain general requirements for reclassifying financial liabilities and equity instruments after initial recognition when the instrument’s contractual terms are unchanged. The Committee acknowledged that similar questions in relation to reclassification arise in other circumstances. Reclassification by the issuer has been identified as one of the practice issues that the Board will consider addressing in its Financial Instruments with Characteristics of Equity (FICE) project. As a result, the Committee decided not to add a standard-setting project to the work plan.
COSTS NECESSARY TO SELL INVENTORIES (IAS 2)
The Committee received a request about the costs an entity includes as the ‘estimated costs necessary to make the sale’ when determining the net realisable value of inventories. The request asked whether an entity includes all costs necessary to make the sale or only those that are incremental to the sale.
The Committee observed that IAS 2 requires an entity to estimate the costs necessary to make the sale when determining the net realisable value of inventories. This requirement does not allow an entity to limit such costs to only those that are incremental, thereby potentially excluding costs the entity must incur to sell its inventories but that are not incremental to a particular sale.
The Committee concluded that an entity should estimate the costs necessary to make the sale in the ordinary course of business when determining the net realisable value of inventories. An entity uses its judgement to determine which costs are necessary to make the sale considering its specific facts and circumstances, including the nature of the inventories.
is the Committee concluded that the principles and requirements in IFRS Standards provide an adequate basis for an entity to determine whether the estimated costs necessary to make the sale are limited to incremental costs when determining the net realisable value of inventories. As a result, the Committee decided not to add a standard-setting project to the work plan.
Non-refundable Value Added Tax on Lease Payments (IFRS 16)
The Committee received a request about how a lessee accounts for any non-refundable value added tax (VAT) charged on lease payments. The request asked whether, the lessee should include non-refundable VAT as part of the lease payments for a lease when applying IFRS 16.
The fact pattern described in the request is as below:
- The lessee operates in a jurisdiction in which VAT is charged on goods and services. A seller includes VAT in an invoice for payment issued to a purchaser. In the case of leases, VAT is charged when an invoice for payment is issued by a lessor to a lessee.
- Under the applicable legislation:
- Seller is required to collect VAT and remit to the government; and
- Purchaser is allowed to recover VAT charged on payments for goods or services from the governmentc. Due to the nature of its operations, the lessee can recover only a portion of the VAT charged on purchased goods or services. This includes VAT charged on payments it makes for leases. Consequently, a portion of the VAT is non-refundable.
d. Lease agreements require the lessee to make payments to the lessor that include amounts related to VAT charged in accordance with the applicable legislation.
The Committee has not obtained evidence that the matter has widespread effect and has, or is expected to have, a material effect on those affected. The Committee decided not to add a standard-setting project to the work plan.
Preparation of Financial Statements When an Entity is No Longer a Going Concern (IAS 10)
The Committee received a request about the accounting applied by an entity that is no longer a going concern with the following questions:
Whether the entity can prepare financial statements for prior periods on a going concern basis if it was a going concern in those periods and has not previously prepared financial statements for those periods.
Whether the entity should restate comparative information to reflect the basis of accounting used in preparing the current period’s financial statements if it had previously issued financial statements for the comparative period on a going concern basis.
The Committee provided the following response to Question 1:
- IAS 1 para 25 requires an entity to prepare financial statements on a going concern basis unless management either intends to liquidate the entity or to cease trading or has no realistic alternative but to do so.
- IAS 10 para 14 states that an entity shall not prepare its financial statements on a going concern basis if management determines after the reporting period either that it intends to liquidate the entity or to cease trading, or that it has no realistic alternative but to do so.
Applying para 25 of IAS 1 and para 14 of IAS 10, an entity that is no longer a going concern cannot prepare financial statements, including those for prior periods that have not yet been authorised for issue on a going concern basis.
Therefore, the Committee concluded that the principles and requirements in IFRS Standards provide an adequate basis for an entity that is no longer a going concern to determine whether it prepares its financial statements on a going concern basis.
The Committee provided the following response to Question 2:
- The Committee observed no diversity in the application of IFRS Standards. Entities do not restate comparative information to reflect the basis of preparation used in the current period when they first prepare financial statements on a basis that is not a going concern basis.
The Committee decided not to add a standard-setting project to the work plan.
IFRS QUERY OF THE MONTH
Each month, we will share an IFRS query from matters raised with RSM member firms around the world. The advice contained in the response is general in nature and should not be relied on for an entity’s specific circumstances.
Entity A has entered into a contract with Entity B, in which Entity B will provide services to Entity A. As an incentive, Entity B has offered Entity A a “loyalty account”, which they have credited with $200,000 worth of cash available to Entity A to spend on additional goods with Entity B during the 3-year term of the contract. If the contract is terminated for any reason during the 3 years, by either party, the entitlement to the loyalty account is pro-rated for the number of months elapsed.
How should this “loyalty account” be recognised in Entity A’s financial statements?
From Entity B’s perspective, the relevant accounting standard would be IFRS 15 Revenue from Contracts with Customers. However, there is no standard that explicitly sets out how Entity A should account for it.
Since it is an incentive for Entity A to enter into the contract, and because the incentive is pro-rated in the event of termination of the contract, regardless of which party terminates the agreement, then an asset is recognised representing the accrued benefit over the contract period as time elapses.
For example, if the incentive was granted on 1 September 2021, then by 31 December 2021, the entity would have an asset of $16,667 (being $200,000 x 3 months / 36 months). If the entity had drawn down more than that amount by the end of the year, there would be a liability representing Entity A’s obligation to settle the excess in the event of termination of the contract.
Entity A would recognise the debit from the recognition of the asset against the related expense, as in effect, it represents a discount given by Entity B on the service contract.