2012 EDITIONIFRS Top 20 Tracker
Contents      Executive summary                                                                     11     Being consisten...
Executive summaryIntroduction                                          Key themesThe 2012 edition of the IFRS Top 20 Track...
1 Being consistentThe financial statements as a whole                           Regulators continue to focus on revenueMan...
2 Economic conditions and public  spending cutsBackground                                               Impact on manageme...
As well as any impact on expected future                 The requirements of IFRS 7 ‘Financialrevenues which will need to ...
3 Eurozone sovereign debt crisisBackground                                                  At the date of writing, we do ...
Effect of Eurozone sovereign debt crisis on              Disclosure about risks and uncertaintiesdiscount rates           ...
Events after the reporting period                       Going concern – Specific considerations forThe macro-economic situ...
4 Going concernGoing concern status                                        The guidance may be relevant to managementConti...
Disclosures                                               Part of being consistentWhen preparing financial statements, man...
5 Presentation of financial statementsStatement of comprehensive income                      When the revised IAS 1 was fi...
Key judgements                                           Key assumptions and sources of estimationRegulators have noted th...
6 Revenue recognitionRevenue recognition policies                                The primary issue when accounting for rev...
When writing the accounting policies,              Changes in the business modelmanagement should ask themselves “Does our...
7 The statement of cash flowsThe importance of the statement of cash flows                  Where the company’s bank balan...
Operating activities                                    Financing activitiesOperating activities are the main activities o...
8 Business combinationsIFRS 3 Revised                                           Identifying the acquirerThe revised IFRS 3...
Accounting for a reverse acquisition                      Contingent considerationIn a reverse acquisition, the accounting...
9 Impairment testing and disclosureImpairment testing and disclosure                       Identification of impairment in...
Disclosure requirements of IAS 36                        those should be used for the impairment test, withIAS 36 requires...
10 Asset disposals and discontinued   operationsDisposals of assets or operations                             In some case...
Exceptions to the measurement provisions of                   A discontinued operation is a component of anIFRS 5         ...
11 Share-based payment arrangementsShare-based payment arrangements                         The entity has the choice of s...
and obtain a refund of their contributions at any             The incremental fair value is then spread over thetime, but ...
12 Debt or equity? Identifying   financial liabilitiesIntroduction                                                Converti...
Variation clauses                                          Contingent settlement provisionsInstruments such as convertible...
13 Financial instruments disclosuresFinancial instruments disclosures                          Financial assets past due b...
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
GT IFRS Top 20 Tracker 2012 Edition
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GT IFRS Top 20 Tracker 2012 Edition

  1. 1. 2012 EDITIONIFRS Top 20 Tracker
  2. 2. Contents Executive summary 11 Being consistent 22 Economic conditions and public spending cuts 33 Eurozone sovereign debt crisis 54 Going concern 85 Presentation of financial statements 106 Revenue recognition 127 The statement of cash flows 148 Business combinations 169 Impairment testing and disclosure 1810 Asset disposals and discontinued operations 2011 Share-based payment arrangements 2212 Debt or equity? Identifying financial liabilities 2413 Financial instruments disclosures 2614 Capital management disclosures 2815 Hedge accounting 3016 The cutting clutter challenge 3217 Detail counts… 3418 Whats on the way for 2012? 3619 Whats on the way for 2013? 3720 Whats on the horizon? 39Important Disclaimer:This document has been developed as an information resource. It is intended as a guideonly and the application of its contents to specific situations will depend on the particularcircumstances involved. While every care has been taken in its presentation, personnel whouse this document to assist in evaluating compliance with International Financial ReportingStandards should have sufficient training and experience to do so. No person should actspecifically on the basis of the material contained herein without considering and takingprofessional advice. Neither Grant Thornton International Ltd, nor any of its personnel norany of its member firms or their partners or employees, accept any responsibility for anyerrors it might contain, whether caused by negligence or otherwise, or any loss, howsoevercaused, incurred by any person as a result of utilising or otherwise placing any relianceupon this document.
  3. 3. Executive summaryIntroduction Key themesThe 2012 edition of the IFRS Top 20 Tracker Key themes driving selection of the issues in thecontinues to take management through the top 20 2012 edition are:disclosure and accounting issues identified by • the need for a company’s managementGrant Thornton International Ltd (Grant commentary and financial statements toThornton International) as potential challenges for complement and be consistent with each otherIFRS preparers. • the effect that adverse economic conditions may The member firms within Grant Thornton have on a company’s financial statements, withInternational – one of the world’s leading particular emphasis on issues related to theorganisations of independently owned and Eurozone sovereign debt crisismanaged accounting and consulting firms – have • key areas of interest for regulatorsextensive experience in the application of IFRS. • challenging areas of accountingGrant Thornton International, through its IFRS • recent and forthcoming changes in financialteam, develops general guidance that supports its reporting.member firms’ commitment to high quality,consistent application of IFRS. The IFRS Top 20 Tracker is not of course intended This edition is based on IFRS applicable to be a comprehensive list of issues that companiesfor accounting periods commencing on or after may face during this financial reporting season. It is1 January 2011. intended to highlight areas that we expect to be particularly significant for many Grant Thornton clients, and in turn to assist management in prioritisation and review. Grant Thornton International Ltd February 2012 IFRS Top 20 Tracker 1
  4. 4. 1 Being consistentThe financial statements as a whole Regulators continue to focus on revenueMany companies that prepare their financial recognition in general, with accounting policies forstatements in accordance with IFRS are also revenue recognition coming under intense scrutiny.required to prepare an accompanying management It is important that a company’s revenuecommentary (also described using other titles such recognition policies are consistent with informationas Management’s Discussion and Analysis, given about the nature of its business model in itsOperating and Financial Review, and Directors’ management commentary.Report). The IASB has published its own non- Other areas where regulators have been knownmandatory Practice Statement in this area. In many to question apparent inconsistency betweencountries local law and stock exchange regulation management commentary and the financialalso set out narrative reporting and disclosure statements, include impairment, going concern andrequirements that go beyond IFRS. operating segment disclosures. Complying with each of these requirementsrequires complete and accurate accounting Points to considerinformation. The different requirements cannot be We set out below some points to help managementconsidered in isolation however. It is important that in achieving consistency in the managementthe management commentary and financial commentary and the financial statements:statements are considered as a whole, in order to • are a company’s segment disclosures underensure that they both complement and are IFRS 8 ‘Operating Segments’ consistent withconsistent with each other. the way it describes its business and its The importance of consistency covers management in the management commentary?management commentary, the primary statements, • are non-IFRS measures properly reconciled tothe accounting policies and the notes to the financial IFRS disclosures where appropriate?statements. Where the different sections of the • are the assumptions used in an entity’smanagement commentary and financial statements impairment testing (for example estimates ofare prepared by different people, or at different future growth rates in estimating future cashtimes, particular care will be needed to make sure flows) consistent with information disclosed inthat all of these elements fit together as a cohesive the management commentary?whole, avoiding repetition as far as possible. • do the company’s accounting policies cover the key types of revenue and other transactionRegulators question inconsistencies information discussed in the managementRegulators will look for inconsistencies between commentary and are they clear, relevant andinformation given in different parts of a company’s complete?management commentary and its financial • is the discussion of events after the reportingstatements. For example, is information given about period in the management commentarythe future outlook for the business consistent with consistent with the disclosures in the financialdisclosure about why the company is considered to statements under IAS 10 ‘Events after thebe a going concern? (More information about the Reporting Period’?disclosure of going concern is given in Section 4.)2 IFRS Top 20 Tracker
  5. 5. 2 Economic conditions and public spending cutsBackground Impact on management commentaryBusinesses in many parts of the world continue to Management will need to assess the impact thatfeel the impact of subdued global economic activity. these wider economic factors will have on theThe crisis in the Eurozone has in particular exerted future outlook for their business. These assessmentsa negative impact on growth, with companies (both will affect the forward-looking components ofin Europe and more widely) seeing revenue and management commentary. This will be a key part ofprofit growth weakening. making sure that management commentary and the financial statements complement and are consistentEconomic conditions with each other, as discussed in Section 1.The final quarter of 2011 saw a slowdown ingrowth in many European countries and talk of a Impact on areas of financial reportingreturn to recession in some. There are a number of areas of the financial There continues to be uncertainty over the statements that may be impacted where an entity isprospects for economic recovery throughout the affected by adverse economic conditions andEurozone and further afield, including major spending cuts, some of which are highlightedeconomies such as the USA. Economic growth below. The areas impacted will vary dependingremains slow and market conditions are challenging upon the nature of the business concerned and thefor many companies. As a result, the outlook for sector or industry in which it operates.many businesses is uncertain, with pressure onmargins and financing as well as weak demand for Going concernproducts and services. Where a company is impacted adversely by economic uncertainty or by public spending cuts,Austerity measures this will need to be taken into account byMany European governments have announced or management in assessing whether the business is aare implementing austerity programmes. These going concern. The assessment made should also bemeasures have a direct impact on businesses’ trade reflected in the disclosure about going concernwith the public sector and also affect wider made in the financial statements (discussed furthereconomic drivers such as consumer confidence. For in Section 4).companies that do business with the public sector For example, a company that has significantin affected countries, significant cuts will have an balances outstanding, or business relationships,impact as the public sector seeks to find efficiencies with the public sector in a country facing financialin the provision of its services. Even companies that stress should probably disclose that fact anddo not trade directly with the public sector may indicate the future events that could impact onnevertheless be affected by the cuts, as they may, for amounts outstanding and future trading volumes.example, be part of the supply chain. In such instances, consideration will also need to be given to additional going concern disclosures such as the key assumptions made by management as part of the going concern assessment. IFRS Top 20 Tracker 3
  6. 6. As well as any impact on expected future The requirements of IFRS 7 ‘Financialrevenues which will need to be considered in Instruments: Disclosures’ are extensive and includeassessing going concern, other factors such as the disclosures about financial instruments at fair valueavailability of finance will need to be taken into and about hedge accounting.account, in particular where facilities are due forrenewal within 12 months of issue of the financial Consequences of restructuringstatements. A downturn in business may necessitate restructuring. Where a decision is made to sell orImpairment terminate part of the business, IFRS 5 ‘Non-currentSignificant adverse changes in the economic Assets Held for Sale and Discontinued Operations’environment or market in which a company may become relevant. The requirements of IFRS 5operates are indicators of potential asset are discussed in Section 10.impairments. As a result, impairment testing will be Management will also need to consider whetherrequired under IAS 36 ‘Impairment of Assets’, and a provision is required under IAS 37 ‘Provisions,impairment charges may result. Impairment testing Contingent Liabilities and Contingent Assets’ as ais discussed in more detail in Section 9. result of a decision to restructure the business. A Fluctuations in foreign exchange rates may provision may only be made where managementpresent issues in impairment testing, particularly for has a constructive obligation to restructure; intentcompanies that trade with countries in the alone is not sufficient. A constructive obligationEurozone. In calculating value in use under IAS 36, arises when there is a detailed formal plan in placefuture cash flows should be included in the for the restructuring and a valid expectation hascurrency in which they will be generated and then been raised in those affected that the restructuringdiscounted using an appropriate discount rate for will be carried out. A restructuring may alsothat currency. The present value is then translated include termination benefits, which are covered byusing the spot rate at the date of the value in use slightly different rules in IAS 19 ‘Employeecalculation. Benefits’. Inventory write-downs may also be requiredunder IAS 2 ‘Inventories’.Use of derivatives to reduce exposure to marketvolatilityManagement may seek to mitigate exposure tomarket volatility through the use of instrumentssuch as forward contracts or interest rate swaps.Such instruments are derivatives in the scope ofIAS 39 ‘Financial Instruments: Recognition andMeasurement’, which requires recognition at fairvalue with movements taken to profit or loss. Whilethe use of derivatives may reduce real exposure torisk, they may introduce income statementvolatility. There may be scope to apply hedge accountingunder IAS 39. However, there are strict conditionswhich must be met in order for hedge accounting tobe applied (Section 15). It is important to note thatthese conditions must be met at the outset, asformal designation and documentation of thehedging relationship needs to be in place at theinception of the hedge.4 IFRS Top 20 Tracker
  7. 7. 3 Eurozone sovereign debt crisisBackground At the date of writing, we do not believeIn addition to the general challenges discussed in impairment losses for other Eurozone sovereignSection 2, the crisis in Eurozone sovereign debt debt are needed. An important difference betweengives rise to various accounting issues relating to GGBs and other sovereign debt is that, in the latterfinancial instruments. case, there is no current expectation of a private Banks in particular may have significant sector haircut. However, new information (egsovereign debt exposure and increased liquidity information about private sector involvement) mayrisks. However, banks are not the only entities emerge before the date of approval of an entity’saffected. Other entities will also face increased financial statements that may change thiscountry and currency risks. We summarise below a conclusion. If so, impairment would be recognisednumber of IFRS requirements that may need at that date.particular attention by management. Impairment of other financial assetsEurozone sovereign debt holdings The current economic environment will also affectSeveral European governments are experiencing financial asset impairment more generally.financial difficulties, evidenced in some cases by Impairment losses need to be determined on a casebail-out actions and credit rating downgrades. This by case basis reflecting the specific facts andraises a question of whether sovereign debt issued circumstances. Some specific points to considerby such governments is impaired in the financial include:statements of holders. • for debt type assets, objective evidence of Put broadly, under IAS 39 ‘Financial Assets: impairment includes financial difficulty of theRecognition and Measurement’, a financial asset or debtor, breaches of the terms of the instrumenta group of financial assets is impaired if there is and it becoming probable that the debtor willobjective evidence of impairment that reduces the enter bankruptcy or financial reorganisationestimated future cash flows. • for investments in equities, a significant or In our view there is objective evidence of prolonged decline in fair value to below cost isimpairment of Greek Government Bonds (GGBs) one type of objective evidence of impairmentat 31 December 2011 and at the date of writing this • for available for sale assets, if objective evidencepublication. Accordingly, for GGBs classified as of impairment exists the entire decline in fairavailable-for-sale, impairment losses should reflect value that has been recognised in otherfair values at the period end. For GGBs classified as comprehensive income is reclassified into profitheld to maturity or loans and receivables, or loss.impairment should reflect the latest expectations ofa private sector contribution (or ‘haircut’). Newinformation as to the private sector involvement inrestructuring, and whether it will go ahead, mayimpact measurement of GGBs at amortised cost. IFRS Top 20 Tracker 5
  8. 8. Effect of Eurozone sovereign debt crisis on Disclosure about risks and uncertaintiesdiscount rates IAS 1 ‘Presentation of Financial Statements’As well as the effect on financial asset impairment contains a disclosure requirement in relation to thediscussed above, the Eurozone sovereign debt crisis sources of estimation uncertainty in the carryingmay affect companies more generally as a result of amount of assets and liabilities (IAS 1.125). Theits effect on discount rates. current economic environment will lead to many Where an asset-specific rate is not directly examples of increased estimation uncertainty.available, it is typical to estimate the discount rate Entities must disclose information aboutby using the Capital Asset Pricing Model (CAPM) assumptions and other major sources of estimationto calculate the entity’s weighted average cost of uncertainty that have a significant risk of resultingcapital. Key components of the CAPM are a risk- in material adjustments in the following year. Forfree rate of return (usually estimated by reference to example, impairment of sovereign debt from aa government security), a market risk premium, and particular country with financial challenges maya Beta factor (representing sensitivity to market not be required, but disclosure of the amountsmovements). outstanding would be appropriate (IAS 1.125-133). The Eurozone sovereign debt crisis has This disclosure will be influenced by theincreased the yield on long-dated government assessment of material country and/or currencybonds in what are perceived as the weaker countries risks faced by each entity, the underlyingin the Eurozone, while decreasing the yields on the assumptions about a reasonable range of potentialgovernment bonds of those countries that are outcomes, and how such different circumstancesperceived as being safe havens. Putting this might affect the value of the relevant assets andinformation into the CAPM may result in a liabilities.significant increase in the discount rate to be used IFRS 7 ‘Financial Instruments: Disclosures’for the impairment testing of some assets and cash requires extensive disclosure in relation to financialgenerating units. This together with reduced instruments and related risks. Examples includeexpectations of future cash flows may result in detailed disclosures about risk concentrations,higher levels of impairment for some companies. credit risk, liquidity risk and other market risks and how those risks are managed. Management needs to consider the impact of economic conditions on such disclosures. For European banks meaningful liquidity disclosures and information on capital management, funding requirements, contingencies and stress tests are likely to be of particular importance.6 IFRS Top 20 Tracker
  9. 9. Events after the reporting period Going concern – Specific considerations forThe macro-economic situation in many countries, banksand the circumstances of specific companies, may IFRS also requires management to make anchange rapidly in the current environment. This assessment of the entity’s ability to continue as awill increase the prevalence of material events after going concern (see section 4). For banks,the reporting period affecting companies’ financial particularly in the Eurozone, a number of specificstatements. IAS 10 ‘Events after the Reporting factors will impact the going concern assessment.Period’ classifies events after the reporting period These factors include:into those that provide evidence of conditions that • the general tightening of credit and liquidityexisted at the end of the reporting period (adjusting that has been observed in the Eurozoneevents) and those that do not (non-adjusting • the sovereign debt issues referred to above,events). Particular attention may need to be paid to along with broader macro-economic matters,the identification and analysis of such events in the may affect fragile investor and depositorcurrent circumstances. confidence • banks in the Eurozone are required to meet higher capital requirements by June 2012 • actions by central banks (including the European Central Bank) and supervisory authorities to support the banking sector may be uncertain. IFRS Top 20 Tracker 7
  10. 10. 4 Going concernGoing concern status The guidance may be relevant to managementContinuing difficult economic conditions in certain operating in those areas of the world that are facedareas of the world (see Sections 2 and 3) mean that by uncertain economic conditions when makingthe assumption that the business is a going concern financial announcements, in particular on how tomay not be clear-cut in some cases and management reflect uncertainties facing their business. Threemay need to make careful judgements relating to core principles can be drawn from the guidance:going concern. • management should undertake and document a Management needs to ensure that it is rigorous assessment of whether the company isreasonable for them to prepare the financial a going concern when preparing annual andstatements on a going concern basis. IAS 1 interim financial statements. The process carried‘Presentation of Financial Statements’ (IAS 1.25) out by management should be proportionate inrequires that where management is aware, in nature and depth depending upon the size, levelmaking its going concern assessment, of material of financial risk and complexity of the companyuncertainties related to events or conditions that and its operationsmay cast significant doubt upon an entity’s ability • management should consider all availableto continue as a going concern, those uncertainties information about the future when concludingmust be disclosed in the financial statements. whether the company is a going concern. Its review should cover a period of at least twelveFRC Guidance months from the end of the reporting periodThe UK’s Financial Reporting Council (FRC) has • management should make balanced,produced ‘Going Concern and Liquidity Risk: proportionate and clear disclosures about goingGuidance for Directors of UK Companies 2009’, concern for the financial statements to give a fairwhich brings together all the guidance previously presentation.issued by that regulator in relation to going concernand continues to promote the awareness of theissues facing companies in the current environment.8 IFRS Top 20 Tracker
  11. 11. Disclosures Part of being consistentWhen preparing financial statements, management The going concern disclosures also need to beis required to include statements about the considered in the light of other information in theassumptions it has made and in particular those financial statements and any accompanyingwhich are specific to its circumstances. management commentary. Section 1 covers the Management should address these reporting importance of the financial statements andchallenges at an early stage in preparing the management commentary complementing andfinancial statements as this will help to avoid any being consistent with each other as a whole, and thelast-minute problems which could cause adverse disclosures explaining why the entity is consideredinvestor reaction. to be a going concern are an important part of that. For financial reporting purposes, the assessment Management should consider whether there isof going concern is made on the date that information which suggests that there may bemanagement approves the financial statements. uncertainties over going concern, and ensure thatManagement have three potential conclusions: this is addressed in the disclosures they give. This• there are no material uncertainties and therefore might include, for example, financial information no significant doubt regarding the entity’s such as impairment losses, cash outflows or ability to continue as a going concern. disclosures showing significant debts due for Disclosures sufficient to give a fair presentation repayment within a year, as well as narrative are still required, meaning that management disclosures such as principal risks and uncertainties need to explain why it considers it appropriate and financial risk management information. The to adopt the going concern basis, identify key effects of intercompany indebtedness and any risks and say how these have been addressed concerns over the recoverability of intercompany• there are material uncertainties and therefore balances should also not be overlooked. The going there is significant doubt regarding the entity’s concern disclosures are an opportunity for ability to continue as a going concern, thus management to explain why such matters do not giving rise to the need for additional disclosures affect the status of the entity as a going concern. under IAS 1.25• the use of the going concern basis is not appropriate. In this case, additional disclosures are required to explain the basis of accounting adopted.Depending on which conclusion managementreaches, the disclosures can be complex and difficultto compose. If going concern might be an issue forthe company, management should allow extra timeto consider this. IFRS Top 20 Tracker 9
  12. 12. 5 Presentation of financial statementsStatement of comprehensive income When the revised IAS 1 was first issued, there wasUnder IAS 1 ‘’Presentation of Financial some confusion as to the level of detail relating toStatements’, the statement of comprehensive other comprehensive income required in theincome may be presented either as a single statement itself. The IASB addressed this bystatement or as two statements (ie an income amending IAS 1 to clarify that the impact ofstatement and statement of comprehensive income). individual items of other comprehensive income onIn either case, the statement should contain only each component of equity may be disclosed in aitems that form part of comprehensive income. note to the financial statements.Whilst this is normally straightforward forcomponents of profit or loss, identifying what is Additional comparative statement of financialpart of other comprehensive income continues to positionbe a challenge for some companies. IAS 1 requires an additional comparative Statement Examples of other comprehensive income of Financial Position, together with related notes, toinclude the revaluation of property, plant and be presented as at the beginning of the earliestequipment, fair value movements for available-for- comparative period whenever a new accountingsale financial assets and exchange differences on policy is applied retrospectively, or there is aretranslation of foreign operations. Other retrospective restatement of items in the financialcomprehensive income does not include, for statements, or when items in the financialexample, dividends or new share capital as these are statements are reclassified. This includes, fortransactions with owners in their capacity as such, example, a voluntary change of accounting policyrather than income or expenses. Hence, such items or presentation, as well as the retrospectiveshould be shown in the statement of changes in application of a new or amended standard.equity not the statement of comprehensive income. Disclosure of key judgements and estimatesStatement of changes in equity Regulators continue to pay close attention toThe statement of changes in equity must always be disclosures relating to judgements and estimates.presented as a primary statement. The key elements Omissions may become apparent fromof the statement are: management commentary, which comment on• total comprehensive income (split between matters that are not then highlighted as areas of parent and non-controlling interests) significant judgement or estimation in the financial• for each component of equity, the effects of statements. retrospective application or retrospective restatements under IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’• transactions with owners in their capacity as owners, showing separately contributions by and distributions to owners• a reconciliation between opening and closing balances for each component of equity.10 IFRS Top 20 Tracker
  13. 13. Key judgements Key assumptions and sources of estimationRegulators have noted that IFRS is a uncertaintyprinciples based reporting framework which In addition to disclosing significant judgements,requires management judgement in its application. management is required to disclose keyIAS 1 requires disclosure of the judgements that assumptions concerning the future and other keymanagement has made in applying the entity’s sources of estimation uncertainty that have aaccounting policies that have the most significant significant risk of causing a material adjustment toeffect on the assets and liabilities recognised in the the carrying amounts of assets and liabilities withinfinancial statements. In effect, a significant the next financial year (IAS 1.125). Though thisjudgement is a view that management has taken in disclosure is often combined with key judgements,applying an accounting policy (IAS 1.122). it is a separate disclosure requirement and one thatRegulators are likely to challenge companies that is often not well addressed.disclose no areas in which management has In disclosing key areas of estimationexercised judgements that have had a significant uncertainty, an important aspect of good qualityeffect on amounts recognised in the financial disclosure is providing sensitivity analysis ofstatements. carrying amounts to the methods, assumptions or The disclosure given about significant estimates supporting their calculation.judgements should not simply list the areas of thefinancial statements affected, or repeat the So what is key?accounting policies for the relevant areas, but When considering what judgements or estimatesshould explain in what particular aspect should be disclosed within the financial statements,management has exercised its judgement. Where management should consider what transactions orapplication of a different judgement would have issues have led to significant discussions at Boardhad a material effect on the matter reported, this meetings or have been areas of significant debatepoint should be addressed in the disclosures. with the auditor. The more complex issues may highlight areas that require significant judgements impacting on the financial statements, for example should a subsidiary continue to be consolidated following a change in circumstances? IFRS Top 20 Tracker 11
  14. 14. 6 Revenue recognitionRevenue recognition policies The primary issue when accounting for revenueThe revenue recognition policy is often the most is the determination of the point at which revenueimportant accounting policy in the financial may be recognised, ie when goods or services arestatements. Revenue recognition continues to delivered and when it is probable that futuregenerate a significant number of questions from economic benefits will flow to the entity and can beregulators. The key points of concern remain that: measured reliably. Examples of areas where• the accounting policy is not set out in sufficient companies may be open to challenge regarding their detail revenue recognition policies include where:• it is not clear how the stage of completion is • the accounting policy suggests that revenue determined with reference to sales of services might be recognised before the qualifying• policies applied to the various revenue streams criteria have been satisfied, leading to an that companies have are not described overstatement of income• areas of significant judgement are not explained. • the accounting policy indicates that revenue is recognised on product delivery with noNone of these issues is new, yet it is evident that reference to customer acceptance or returnscompanies continue to fail to live up to regulators’ • the company sells both goods and services andand investors’ expectations regarding disclosure of the policy is unclear as to how the variousrevenue recognition policies. components have been accounted for. The revenue accounting policy must be clear asto how the principles of IAS 18 ‘Revenue’ have Regulators have challenged companies that includebeen applied to the specific business and its detailed accounting policies which relate tosignificant revenue streams and demonstrate clearly apparently immaterial revenue streams. As noted inthe point at which revenue is recognised and the Section 16, unnecessary clutter such as immaterialbasis on which it is measured, particularly where or irrelevant accounting policies should bethe stage of completion has to be identified. eliminated from a good set of financial statements. Part of being consistent In Section 1, we discussed the importance of consistency between the entity’s management commentary and the financial statements, and narrative disclosures in general being consistent with the amounts in the financial statements. For example where a company refers to several income streams in its management commentary or segmental disclosures, it is essential that the accounting policies on revenue address each of the key revenue streams identified. Failure to do so is very likely to lead to questions from regulators.12 IFRS Top 20 Tracker
  15. 15. When writing the accounting policies, Changes in the business modelmanagement should ask themselves “Does our A company’s business model will evolve over time.stated policy fit with management commentary This may be through changes in strategy, organicabout how we generate revenue?”. If the answer is growth, or as a result of acquisitions and disposals.no, then the policy needs to be improved. The Consequently, a company’s revenue streams willpolicy should reflect both the timing of the change.recognition and the measurement of revenue. It is important that the revenue recognitionWhere companies have significant obligations in policies are updated regularly to reflect theserespect of customer returns, their accounting changes. A common issue is that changes in thepolicies should address this issue. business model are discussed in management commentary, in particular where these arise fromMultiple-element arrangements acquisitions the company has made, but the changesThe aim of IAS 18 is to recognise revenue when, to revenue streams that result are not reflected inand to the extent that, goods have been delivered to the revenue recognition accounting policies.a customer or services have been performed.However, a single transaction may contain a Disclosuresnumber of different elements. Take, for example, a In addition to requirements for the recognition andcontract which includes the sale of a computer, measurement of revenue, IAS 18 sets out specificrelated training and on-going support. The disclosures that companies need to give. Theserecognition of revenue in this scenario may not be disclosures are easily overlooked, or it is assumedstraightforward. IAS 18 requires a company to that other disclosures included within thedetermine whether the contract should be company’s accounts meet the requirements. Foraccounted for as a single contract or whether it example, companies are required to disclose thecontains separately identifiable components that amount of revenue generated from each significantshould be accounted for separately. category recognised during the period, including IAS 18 requires a company to apply its revenue the sale of goods and the rendering of services. Forrecognition criteria to each separately identifiable transactions involving the rendering of services, thecomponent of a single transaction to reflect the accounting policy needs to include the methodstransaction’s substance. When identifying adopted to determine the stage of completion.components of a contract, it is important to assessthe contract from the perspective of the customerand not the seller. The key is to understand whatthe customer believes they are purchasing. IFRS Top 20 Tracker 13
  16. 16. 7 The statement of cash flowsThe importance of the statement of cash flows Where the company’s bank balance often movesAll companies and groups reporting under IFRS are between a positive balance and an overdraftrequired to present a statement of cash flows. The position, this is evidence that the bank overdraft ispurpose of this statement is to provide users of an integral part of the management of cash in thefinancial statements with the information they need business. Where this is the case, the bank overdraftto make an assessment of the ability of the should be included in cash and cash equivalents.reporting entity to generate cash and cash Longer term borrowings, such as bank loans,equivalents, as well as the needs of the entity to are not however part of cash and cash equivalents.utilise that cash. Similarly, long term deposits are excluded from the A further benefit of the statement of cash flows definition. The inclusion of long term balances inis that it enables comparisons to be made between cash and cash equivalents obscures the true short-different entities, because it is not impacted by term position. Regulators have challengedfactors such as the selection of different accounting companies where such items are included in cashpolicies for similar transactions or events. and cash equivalents. The ability of an entity to generate cash hasbecome even more important given the economic Identification and classification of cash flowsuncertainties existing in many areas of the world It is important that all cash flow items are identified(see Section 2). It is possibly as a result of this that and appropriately included in the statement of cashthe statement of cash flows is coming under flows. The consistency of managementincreased scrutiny. We outline below a number of commentary and the financial statements as a wholeareas where regulators have raised issues. should be considered in this regard. For example, if there is discussion of the disposals of assets orCash and cash equivalents operations, or the issue or repurchase of shares inAs stated above, the purpose of the statement of management commentary, then the relevant cashcash flows is to provide information about how the flows should be appropriately presented in thereporting entity generates cash and cash statement of cash flows.equivalents. Cash includes both cash in hand and Under IAS 7 ‘Statement of Cash Flows’, theredemand deposits. Cash equivalents are short-term, are three types of cash flows, being cash flows fromhighly liquid investments that are readily operating activities, investing activities andconvertible to known amounts of cash and which financing activities. Cash flows reported must beare subject to an insignificant risk of changes in classified under these headings. Regulators havevalue. Therefore an investment normally qualifies as challenged companies which have not made thisa cash equivalent only when it has a short maturity classification correctly. Each heading is explainedof, for example, three months or less from the date below.of acquisition.14 IFRS Top 20 Tracker
  17. 17. Operating activities Financing activitiesOperating activities are the main activities of the Financing activities result in changes to the size orentity which generate revenue, as well as other composition of the contributed equity oractivities which do not meet the definition of borrowings of the entity. Examples of financinginvesting or financing activities. This category cash flows include the proceeds from the issue oftherefore includes items such as receipts from the shares and repayments of borrowings.sale of goods and services, and payments to Cash flows arising from changes in ownershipsuppliers. interests in subsidiaries which do not result in a loss The cash flows from operating activities may be of control are also classified as financing activities.presented using either the direct method, in which This includes, for example, the purchase by thethe major classes of cash receipts and cash payments parent of a non-controlling interest in a subsidiary.are disclosed, or the indirect method. Under theindirect method, profit or loss is adjusted for non- Foreign exchange differencescash items, movements in working capital and any The treatment of foreign exchange differences in theincome or expense items associated with investing statement of cash flows is a key area which causesor financing cash flows in order to reconcile to the problems in practice. Regulators have challengedtotal cash flows from operating activities. companies where foreign exchange differences are reported in the reconciliation between profit or lossInvesting activities and the cash flows from operating activities, as thisInvesting activities include the acquisition and is an indicator that the reconciliation may not havedisposal of long-term assets, such as property, plant been done correctly.and equipment, and the acquisition and disposal of Where cash flows arise in a foreign currency,investments not included in cash equivalents. these should be recorded in the company’s Investing cash flows are of importance to users functional currency by translating each cash flow atof the financial statements because they represent the exchange rate on the date the cash flowthe extent to which cash has been used to invest in occurred. An average rate for the period may beresources which are intended to generate income in used where this approximates to the actual rates.the future. Only expenditure which results in a Where a group has a foreign subsidiary, the cashrecognised asset in the statement of financial flows of that subsidiary should be translated intoposition may be included in cash flows from the group’s presentation currency using the actualinvesting activities. Accordingly, cash outflows in exchange rates at the dates the cash flows occurred.areas such as training or research (which might be Again, an average rate may be used where thisviewed as investments in a broad sense) are not approximates to the actual rates.‘investing’ under IAS 7 because such costs are Unrealised gains and losses may arise fromrequired to be expensed under IFRS. changes in exchange rates. Such gains and losses are not cash flows. However, the effect of changes in exchange rates on cash and cash equivalents denominated in a foreign currency does need to be reported in the statement of cash flows in order to reconcile the opening and closing balances of cash and cash equivalents. This amount is presented separately from the cash flows from operating, investing and financing activities, and is typically shown at the foot of the statement of cash flows. IFRS Top 20 Tracker 15
  18. 18. 8 Business combinationsIFRS 3 Revised Identifying the acquirerThe revised IFRS 3 ‘Business Combinations’ was In all business combinations in the scope of IFRS 3,issued in 2008 and became effective for business one of the combining entities is required to becombinations occurring in annual periods identified as the acquirer. The acquirer is the entitybeginning on or after 1 July 2009. The areas of that obtains control of the acquiree. The acquirer isIFRS 3 which cause practical problems in usually the entity that transfers cash or other assetsapplication of the requirements or which are often or incurs liabilities, or that issues equity instrumentsoverlooked are now becoming apparent. Some of to effect the business combination. However, inthese key areas are highlighted here. some business combinations, the issuing entity (the legal parent) is the acquiree for accountingIdentifying a business purposes. Such business combinations are known asIFRS 3 defines a business as “an integrated set of reverse acquisitions. Regulators have approachedactivities and assets that is capable of being companies where there was a question overconducted and managed for the purpose of whether the acquirer had been properly identifiedproviding a return in the form of dividends, lower under IFRS 3 and therefore whether the businesscosts or other economic benefits directly to combination was a reverse acquisition.investors or other owners, members or Relevant factors in determining which entity isparticipants”. Although the most common the acquirer include:application of IFRS 3 is to the situation where one • the relative voting rights in the combined entityentity acquires another, the definition makes it clear after the business combinationthat a business need not be an entity, – it can be a • the existence of a large minority voting interestcollection of assets and activities. In addition, it in the combined entity if no other owner orfollows from the definition that the collection of organised group of owners has a significantassets and activities does not have to be providing voting interestreturns right now, but must have the ability to do so • the composition of the governing body of thein the future. combined entity Consequently, difficulties can arise in • the composition of the senior management ofdetermining whether a collection of assets is the combined entitycombined with activities such that it constitutes a • the terms of exchange of equity interests.business. Regulators have challenged companieswhere it appears that a transaction had been treatedas a purchase of a group of assets when in fact itshould have been treated as a business combination.An example of an indicator that a group of assets isa business is that employees are transferred with theacquired assets. Alternatively, it may be the types ofassets acquired that give rise to questions, forexample, assets arising from research anddevelopment.16 IFRS Top 20 Tracker
  19. 19. Accounting for a reverse acquisition Contingent considerationIn a reverse acquisition, the accounting acquirer It is common for acquisition arrangements tousually issues no consideration for the acquiree. include an amount of consideration for whichInstead the accounting acquiree issues its equity payment is contingent on the occurrence of a futureshares to the owners of the accounting acquirer. event, or where the amount to be paid in the futureHowever, in order to account for the business varies depending on, for example, the level of futurecombination under IFRS 3, the consideration profits of the acquiree. Any contingenttransferred needs to be determined based on an consideration in a business combination is included,equivalent amount the accounting acquirer would at fair value, in the consideration transferred at thehave paid to effect the same combination. acquisition date. Consolidated financial statements issued Where contingent consideration gives rise to afollowing a reverse acquisition will be in the name financial asset or liability within the scope ofof the legal parent (the accounting acquiree) but are IAS 39 ‘Financial Instruments: Recognition andpresented as a continuation of the legal subsidiary Measurement’, changes in fair value after the(the accounting acquirer). The exception to this is acquisition are recognised in profit or loss or inthat the financial statements, including the other comprehensive income in accordance withcomparatives, reflect the capital structure (that is, IAS 39. Where contingent consideration meets thethe legal share capital and share premium) of the definition of equity under IAS 32 ‘Financiallegal parent. Appendix B to IFRS 3 sets out how to Instruments: Presentation’, there is no subsequentcalculate the consideration as well as how the remeasurement. It is important that there isconsolidated financial statements are to be adequate disclosure in the accounting policies or inpresented following a reverse acquisition. the notes to explain how contingent consideration has been accounted for. In particular, regulatorsIntangible assets acquired have challenged companies that recognisedIFRS 3 requires the identifiable assets and liabilities contingent consideration liabilities but had notacquired to be recognised at their acquisition date explained how those liabilities were measured.fair values. This includes identifiable intangibleassets of the acquiree, whether or not these were Requirement for future servicesrecognised in the accounts of the acquiree. IFRS 3 is Where contingent consideration contains aalso clear that all identifiable intangible assets requirement to provide future services, for example,acquired in a business combination should be in the case of former owners of the acquiree whocapable of reliable measurement. become employees after the acquisition, then that Where a business combination is discussed in a consideration is not part of the considerationcompany’s management commentary, this may transferred to obtain control of the business.cover expected benefits of the acquisition such as Instead it relates to the services to be received andthe use of brand names or access to customer should be recognised as a post-acquisition expense,relationships. This should be consistent with the rather than increasing goodwill.identification of intangible assets acquired.Regulators have noted that it is often apparent thatnot all acquired intangibles have been recognisedbecause of inconsistency between the managementcommentary and the disclosures. Where the acquirer is not intending to use anintangible asset acquired in a business combination,for example, where the acquiree has a brand namewhich is to be discontinued, the acquirer is stillrequired to recognise the asset at fair value. Thedecision not to use the asset may result in animpairment charge being recognised in post-acquisition profit or loss. IFRS Top 20 Tracker 17
  20. 20. 9 Impairment testing and disclosureImpairment testing and disclosure Identification of impairment indicatorsImpairment testing under IAS 36 ‘Impairment of The identification of impairment indicators is theAssets’ continues to be an important issue for many third step in the process, in order to determinebusinesses, whilst the disclosures about impairment which CGUs will be tested for impairment. CGUstesting in the financial statements are an area of to which goodwill or intangible assets withongoing scrutiny by regulators. The process indefinite lives have been allocated, and intangiblefollowed in testing for impairment may be complex assets not yet available for use, are tested forand involve significant judgement and the impairment at least annually. Other CGUs aredisclosure requirements are extensive. tested only when an indicator of impairment arises.The impairment testing process Calculation of recoverable amountIdentification of cash-generating units The recoverable amount of those CGUs that areIf there are indicators that an individual asset is required to be tested for impairment is thenimpaired, it is tested for impairment. More calculated. Recoverable amount is the higher ofcommonly, cash-generating units (CGUs) are value in use and fair value less costs to sell. Value intested. A CGU is defined in IAS 36 as the smallest use is calculated using a discounted cash flowidentifiable group of assets that generates cash model, which requires key assumptions such as pre-inflows that are largely independent of the cash tax discount rates and growth rates to be made forinflows from other assets or groups of assets. The each CGU.first step in the impairment testing process is theidentification of the CGUs that make up the Allocation of impairment lossesbusiness, as these CGUs will form the basis of the When the recoverable amount has been calculated,impairment tests. In addition, IAS 36 requires any impairment loss is allocated to the assets of theextensive disclosures to be made by CGU. CGU. Impairment losses are first allocated to goodwill until goodwill is reduced to nil. AnyAllocation of assets to cash-generating units remaining impairment losses are then allocatedThe next step is that the assets of the business must across the other assets of the CGU on a pro ratabe allocated to CGUs. This includes goodwill, basis, although no individual asset should bewhich must be allocated to CGUs at least to the reduced below its own recoverable amount.level of operating segments identified under IFRS 8,before any aggregation of operating segments intoreportable segments. The allocation of assets toCGUs gives the carrying value which will becompared to recoverable amount to determine theamount of any impairment.18 IFRS Top 20 Tracker
  21. 21. Disclosure requirements of IAS 36 those should be used for the impairment test, withIAS 36 requires extensive disclosure of information the cash flows then extrapolated beyond thatrelating to different stages of the impairment period. IAS 36 does not require management toprocess to be given for each CGU to which prepare a five year forecast for the purpose of thesignificant goodwill is allocated or which has impairment test.suffered an impairment. In addition, there are likely Assumptions should be disclosed for both theto be significant judgements or key sources of period covered by approved budgets and beyondestimation uncertainty arising from the impairment this period. The growth rate used to extrapolatetesting, which should be disclosed under beyond the period covered by approved budgets isIAS 1 ‘Presentation of Financial Statements’ also required to be stated, and justification will be(see Section 5). Regulators have challenged needed where this is higher than the long-termcompanies where no significant judgements were average growth rate for the products, industry oridentified in the impairment testing process. country in which the CGU operates. High growth rates will be difficult to justify in the long term,Discount rates and growth rates because, when high growth is available in aThe discount rates and growth rates used in particular market, competitors are likely to entercalculating the recoverable amount of each CGU that market and therefore restrict the growthshould be disclosed. The rates should be specific to available to companies already in that market.the risks of each CGU. Where the same discountrates or growth rates are used for two or more Sensitivity disclosuresCGUs, this may give rise to questions, in particular Where there is no impairment loss for a CGU, butwhere those CGUs have performed differently the impairment test shows that there is littlehistorically or have different risk profiles, for headroom such that a reasonably possible change inexample because they are in different geographic a key assumption would result in an impairment,locations. Significant changes in the discount rates IAS 36 requires additional disclosures to be made.or growth rates used compared to previous years These include the amount of headroom on theshould also be explained in the financial statements. impairment test for that CGU, the value assigned to Regulators have been known to challenge the key assumption and the amount by which thatcompanies where the discount rates applied to assumption would need to change in order for thedifferent CGUs is unclear, or where the same rate is recoverable amount to be equal to the carryingapplied to a number of CGUs with disparate amount of the CGU.activities. Events or circumstances leading to anApproach to determining key assumptions impairmentAs well as disclosing the assumptions themselves, Regulators have highlighted IAS 36’s requirementan explanation should be given as to how these have to disclose the events or circumstances leading to abeen determined. This should include the extent to material impairment loss or the reversal of anwhich the assumptions reflect past experience or are impairment loss. Discussion of such events inconsistent with external sources of information. management commentary that precedes the financial statements will not meet the requirementsPeriod covered by budgets and beyond of IAS 36 unless a cross-reference is given from theThe period over which the projected cash flows impairment disclosures within the audited financialused in the impairment test are estimated (using statements. Where the disclosure is given separately,approved budgets or forecasts) is required to be it is important to ensure consistency withdisclosed, with an explanation given where this management commentary.exceeds five years. Although IAS 36 only requiresan explanation to be given where the periodcovered by approved budgets or forecasts exceedsfive years, this does not mean that a five year periodmust be used. If, for example, management onlyprepare approved budgets for a two year period, IFRS Top 20 Tracker 19
  22. 22. 10 Asset disposals and discontinued operationsDisposals of assets or operations In some cases, events beyond the control of theDifficult trading conditions mean that many company may extend the time taken to completecompanies are seeking to restructure their the sale beyond one year. Where this happens butbusinesses. In some cases, this leads to disposals of there is sufficient evidence that management remainassets or operations, in which case IFRS 5 ‘Non- committed to their plan to sell the asset or disposalcurrent Assets Held for Sale and Discontinued group, classification as held for sale may still beOperations’ will be relevant. appropriate. Where a subsidiary is disposed of, therequirements of IAS 27 ‘Consolidated and What is a disposal group?Separate Financial Statements’ will also apply to IFRS 5 defines a disposal group as a group of assetsthe calculation of the gain or loss on disposal in the to be disposed of in a single transaction, togetherconsolidated accounts. However, the discussion with liabilities directly associated with those assetshere focuses on the requirements of IFRS 5. which will be transferred in the same transaction. Where the disposal group is either a cash-generatingClassification as held for sale unit (CGU) to which goodwill has been allocatedA non-current asset or disposal group should be (see Section 9), or an operation which is part ofclassified as held for sale if its carrying amount will such a CGU, then the disposal group will includebe recovered principally through a sale transaction the associated goodwill.rather than through continuing use. Thisclassification is appropriate under IFRS 5 only Measurement of non-current assets held forwhere the sale is highly probable and the asset, or saledisposal group, is available for sale immediately in Non-current assets within the scope of theits present condition, subject only to terms that are measurement requirements of IFRS 5 are requiredcustomary for sales of such assets. to be measured at the lower of their carrying Consequently, an intention to sell will not be amount and fair value less costs to sell. Where fairsufficient to meet the held-for-sale classification value less costs to sell is lower, this will result in anunder IFRS 5. The following criteria must be met: impairment charge being recognised when the asset• management are committed to a plan to sell the or disposal group is classified initially as held for asset or disposal group sale. If fair value less costs to sell subsequently• an active programme to locate a buyer and increases, this is recognised to the extent that it complete the plan to sell is in place reverses a previous impairment loss.• the asset, or disposal group, is being actively marketed for sale at a reasonable price in relation to its fair value• the sale is expected to be complete within one year from the date of classification as held for sale.20 IFRS Top 20 Tracker
  23. 23. Exceptions to the measurement provisions of A discontinued operation is a component of anIFRS 5 entity which is either classified as held for sale orCertain assets are specifically excluded from the has been disposed and meets one of the followingmeasurement requirements of IFRS 5. As a result, three conditions:when these assets are classified as held for sale, they • it represents a separate major line of business orcontinue to be measured in accordance with the geographical area of operationsrelevant standard. Examples include investment • it is part of a single co-ordinated plan to disposeproperty carried at fair value under IAS 40 of a separate major line of business or‘Investment Property’ and deferred tax assets in the geographical area of operationsscope of IAS 12 ‘Income Taxes’. • it is a subsidiary acquired exclusively with a view to resalePresentation and disclosurePresentation of non-current assets held for sale A component of an entity has both operations andIn the statement of financial position, non-current cash flows and can be clearly distinguished from theassets held for sale, or the assets of a disposal group rest of the entity. It will have been either a CGU orclassified as held for sale, are required to be a group of CGUs while being held for use.presented separately from other assets. Thisrequirement is typically met by giving a sub-total Presentation of discontinued operationsfor current assets followed by a line item ‘Non- The statement of comprehensive income (orcurrent assets classified as held for sale’ and then a separate income statement, if presented) is requiredfurther total. Similarly, the liabilities of a disposal to show a single amount comprising the total of thegroup should be presented separately from other post-tax profit or loss of discontinued operationsliabilities. The assets and liabilities of a disposal and the post-tax gain or loss on remeasurement togroup must not be offset. fair value less costs to sell of the assets or disposal groups which make up the discontinued operation.Disclosure of non-current assets held for sale Further analysis of this single amount isIFRS 5 also requires information to be given required, either in the statement of comprehensiveincluding a description of non-current assets or income or in the notes. This analysis is required todisposal groups which have either been classified as show:held for sale or sold, together with a description of • the revenue, expenses and pre-tax profit or lossthe facts and circumstances of the sale or expected of discontinued operationssale and the expected manner and timing of that • the gain or loss recognised on the measurementsale. to fair value less costs to sell or on disposal of The gain or loss recognised on measurement at the assets or disposal groups which make up thefair value less costs to sell is also required to be discontinued operationdisclosed, as is the reportable segment in which the • the related income tax expense associated withnon-current asset, or disposal group, is presented each of the above.under IFRS 8 ‘Operating Segments’. The net cash flows attributable to the operating,Discontinued operations investing and financing activities of discontinuedA non-current asset or a disposal group that meets operations should also be disclosed.the criteria to be classified as held for sale underIFRS 5 may also be a discontinued operation underIFRS 5, although this is not necessarily the case. IFRS Top 20 Tracker 21
  24. 24. 11 Share-based payment arrangementsShare-based payment arrangements The entity has the choice of settlementShare-based payments such as share option schemes Where the entity has the choice as to how theare an increasingly popular way for companies to arrangement is settled, management must considerincentivise and remunerate their employees. whether there is a present obligation to settle inManagement may look for innovative ways to cash. This will be the case if the option to settle instructure such arrangements in order for these to be equity has no commercial substance, or the entitytax-efficient. The accounting requirements for such has a past practice or stated policy of settling inawards are found in IFRS 2 ‘Share-based cash, or the entity generally settles in cash whenPayment’. This section discusses some key areas requested to do so by the counterparty. Where thewhich cause problems in practice. entity has a present obligation to settle in cash, the arrangement is accounted for as a cash-settledThe impact of a settlement choice share-based payment. Where there is no suchIFRS 2 defines both equity-settled and cash-settled obligation, the arrangement is accounted for as anshare-based payment arrangements. However, equity-settled share-based payment.some arrangements provide either the entity or thecounterparty with the choice of how the award will Conditions associated with a share-basedbe settled. Where this is the case, the accounting paymenttreatment must be considered carefully. A share-based payment may have a number of conditions which need to be met in order for theThe counterparty has the choice of settlement employees to be entitled to receive the award. It isWhere the counterparty (eg the employee) can important that all such conditions are identified andchoose whether they receive cash or equity then classified appropriately under IFRS 2, as theinstruments under a share-based payment treatment of the award differs according to the typearrangement, the entity granting the award has of condition.granted a compound financial instrument, which Non-vesting conditions are conditions whichincludes a debt component and an equity component. do not determine whether the entity receives the For transactions with employees, the fair value services that entitle the counterparty to receive theof the compound financial instrument is determined award. This means that if a non-vesting condition isat the grant date by first measuring the fair value of not met, it does not impact on the services thethe debt component and then the fair value of the entity receives.equity component. The fair value of the equity An example is the requirement for an employeecomponent will take into account the fact that the to save in a Save As You Earn (SAYE) scheme. In aemployee must forfeit the right to receive cash in typical SAYE scheme, employees are given theorder to receive the equity instrument. The sum of opportunity to subscribe for shares (often at athese is the fair value of the compound financial discount to the market price) if they save a regularinstrument. Where the arrangement is structured amount. The savings are usually made by asuch that the fair value of the two settlement deduction from the employees’ wages and arealternatives is the same, the fair value of the equity applied to cover the exercise price of the optionscomponent will be nil. upon exercise. Employees can stop contributing22 IFRS Top 20 Tracker
  25. 25. and obtain a refund of their contributions at any The incremental fair value is then spread over thetime, but forfeit their entitlement to exercise their remainder of the vesting period in addition to theoptions if they do so. An employee’s decision to share-based payment charge based on the grant datestop saving does not change the fact that he or she fair value of the original award. If the incremental faircontinues to provide the company with services value is negative, there is no change to the accountinghowever. Under IFRS 2 an employee’s decision to and the charge continues to be based on the grantstop saving is treated as a cancellation of the share- date fair value of the original award.based payment (see below). Vesting conditions are the conditions which Cancellations and replacement awardsdetermine whether the entity receives the services Where a share-based payment award is cancelled bythat entitle the counterparty to receive the award. either the entity or the counterparty, the companyThey can be service conditions, which require only is required to recognise immediately the amounta specified period of service to be completed, or that otherwise would have been recognised over theperformance conditions, which require certain remainder of the vesting period. If, however, theperformance targets to be met in addition to a company grants a new award and, on the date thatperiod of service. Performance conditions are it is granted, identifies it as a replacement for themarket conditions if they are related to the entity’s cancelled award, then this is accounted for as ashare price. modification.Impact on selecting a valuation model Group situationsBoth non-vesting and market performance It is common for one group entity, typically theconditions are required to be taken into account in parent company, to grant share-based paymentdetermining the grant date fair value of a share- awards to the employees of another group entity,based payment. As a result, the types of valuation typically a subsidiary. Where this occurs, themodel that can be used are limited where such accounting treatment needs to be considered in theconditions exist. For example, the Black-Scholes individual accounts of each entity involved, as wellformula is not suitable where there are market as in the consolidated accounts.conditions. The entity receiving the services accounts for the scheme as equity-settled if it is settled in its ownModifications to share-based payments equity instruments or if another entity will settleCompanies that set up share-based payment the obligation (whether in cash or shares).schemes some years ago may find that they no Otherwise it accounts for the award as a cash-longer provide the incentive to employees that was settled share-based payment.originally intended, for example because falling The entity settling the award but not receivingshare prices have resulted in share options being out services recognises the award as an equity-settledof the money. In this situation, management may share-based payment only if it is settled in thatdecide to modify the terms of the arrangement, and entity’s own equity instruments. Otherwise thethis will have accounting consequences. award is accounted for as a cash-settled share-based Where the terms of a share-based payment are payment. The entity settling the award also needs tomodified, the incremental fair value at the date of consider where the debit entry goes if it is notthe modification must be calculated. This is the receiving the services under the arrangement. In theexcess of the fair value of the modified award over typical case of a parent company which has grantedthe fair value of the original award, both calculated awards to employees of a subsidiary, the debit entryat the date of the modification. If, for example, a is usually made to cost of investment in subsidiary.share option scheme is modified and the onlychange is to reduce the exercise price of the options,this means that there must be an incremental fairvalue at the date of the modification. IFRS Top 20 Tracker 23
  26. 26. 12 Debt or equity? Identifying financial liabilitiesIntroduction Convertible bond exampleApplying the fixed-for fixed test in IAS 32 What if a company has issued a convertible bond‘Financial Instrument: Presentation’ to determine which the holder can convert into ordinary shareswhether financial instruments such as convertible of the entity? The fixed-for-fixed test determinesdebt, warrants or preference shares are debt or how the conversion option is accounted for.equity has been a recurring theme for some years If the conversion option passes the fixed-for-now. In addition, difficulties arise in determining fixed test, then it is an equity component. However,whether payments to be made on the occurrence of there is also a liability component, being theuncertain future events give rise to financial obligation to pay cash, and therefore the bond is aliabilities under IAS 32. As companies look to raise compound financial instrument. The fair value offinance, new types of capital instrument continue to the liability component on inception would beemerge. Although IAS 32 has been in place for a equal to the cash outflows discounted by a marketnumber of years it remains topical as companies rate for a straight (non-convertible) bond. Theconsider how it applies to these new instruments. equity component is simply the residual amount after deducting the debt component from the fairWhat is the fixed-for-fixed test? value of the instrument as a whole. The equityThe definition of a financial liability in IAS 32.11 component would not then be remeasuredhas two elements. The first covers the situation subsequently, so changes in the fair value of thewhere an entity has a contractual obligation to conversion right would not normally affect profits.deliver cash or to exchange financial instruments in If the conversion option fails the fixed-for-fixeda way which is potentially unfavourable. The test, the company must account for the entiresecond element relates to contracts which may be instrument as a liability. That liability is effectively asettled in an entity’s own equity instruments. Some host debt contract with an embedded derivative.contracts which may be settled in an entity’s own Under IAS 39 ‘Financial Instruments: Recognitionequity instruments are financial liabilities (debt), and Measurement’, in most cases, the companysome are equity and some have both debt and would be required to separate the embeddedequity components. This classification is dependent derivative from the host debt contract and carry thison the fixed-for-fixed test. The fixed-for-fixed test embedded derivative at fair value through profit ormay seem straightforward at first glance, but loss. To value this conversion option would requireexperience shows that this is rarely the case. the use of valuation experts, which can be costly Essentially, a contract is classified as equity if it and time consuming. The changes in value of thewill, or may, be settled by the exchange of a fixed embedded derivative, which reflect the fair valueamount of cash or another financial asset for a fixed movements of the conversion right, would affectnumber of the entity’s own equity instruments. profit or loss.Where this is the case, the fixed-for-fixed test ispassed. Otherwise, the instrument fails the test andthe entity has a financial liability. An importantpoint is that a contract is not necessarily itself anequity item simply because it is paid or settled usingthe entity’s own shares.24 IFRS Top 20 Tracker
  27. 27. Variation clauses Contingent settlement provisionsInstruments such as convertible bonds, warrants or Contingent settlement provisions relate to contractspreference shares which can be converted to where the issuer is required to make a paymentordinary shares often include variation clauses based on uncertain future events. In broad terms, ifwhich alter the conversion ratio. These are often a payment is required based on an uncertain futuredescribed as anti-dilution clauses, and may be event that is controlled neither by the issuer nor theincluded in the contract with the intention of holder of the instrument, then that contingentpreserving the rights of the holders of the payment represents a financial liability.convertible instruments relative to other equity There are two exceptions to this. The first isholders. where the contingent event is a liquidation, Where such variation clauses simply preserve provided that liquidation itself is neither pre-the rights of all equity holders relative to each other, planned nor at the discretion of one of the financialthey will not cause the fixed-for-fixed test to fail if instrument holders. The second exception is wherethe original conversion terms before the variation the obligation is not genuine. However, this isclause passed the fixed-for-fixed test. However, defined very narrowly, such that ‘not genuine’clauses described as anti-dilution often go beyond means the event that would give rise to thethis, in which case they cause the fixed-for-fixed test contingent payment is extremely rare, highlyto fail, and as a result the conversion option must be abnormal and very unlikely to occur.treated as a financial liability. Two types of contingent settlement provision that are particularly common and that causeForeign currency problems in applying the requirements of IAS 32Another practical problem arises where the are obligations based on a percentage of profit andconversion price or option exercise price is obligations arising from a change of control.denominated in a currency other than thefunctional currency of the issuer. Where this is the Payments of a percentage of profitscase, the conversion terms might be such that a A common issue arises from requirements to pay afixed amount in a foreign currency converts to a percentage of profits as dividends on shares. Thesefixed number of shares. However, the fixed-for- contingent dividends are a financial liability becausefixed test is failed because a fixed amount of foreign future revenue and profits are not in the control ofcurrency is not a fixed amount of cash in the issuing the issuer.entity’s functional currency. Payments contingent on change in controlContracts to purchase own shares Where there is an obligation to pay cash on aSpecial rules apply to contracts that might result in change of control, such as to redeem preferencethe issuing entity having to purchase its own shares shares, the definition of a financial liability willfor cash (eg written put options). This type of normally be met. This is because managementcontract creates a liability, even when the ‘fixed-for cannot prevent shareholders from selling theirfixed’ test is met. The liability is recognised as the shares.present value of the exercise purchase price, and the However, in certain limited circumstances, suchdebit is recorded in equity (IAS 32.23). Interest is as when change in control can only be sanctioned inaccrued on this liability as the discount unwinds a general meeting via normal simple majorityover time. voting, such that the shareholders are essentially If the contract is an option and the option lapses part of management when making the decision, itunexercised, the liability is transferred to equity. may be possible to argue that a payment to be made on change of control is not a financial liability. This is likely to be a significant judgement which should be disclosed in the financial statements. IFRS Top 20 Tracker 25
  28. 28. 13 Financial instruments disclosuresFinancial instruments disclosures Financial assets past due but not impairedIFRS 7 ‘Financial Instruments: Disclosures’ sets out IFRS 7 requires an entity to disclose financial assetsextensive disclosure requirements in relation to that are past due but not impaired. ‘Past due’ meansfinancial instruments. Although IFRS 7 has been a financial asset where the counterparty has failed toeffective since 2007, it has been amended several times make payment when contractually due. Thissince. Financial instrument disclosures are often would, for example, include slow-paying tradehighly significant to users of the financial statements. receivables. Entities are required to disclose anGiven the continued economic uncertainties, they ageing of financial assets past due at the reportinghave an even greater significance at present. Some of date but not impaired. This disclosure is not thethe key disclosures are covered here. same as an analysis of ageing of receivables (which would also include those not past due).Categories of financial instrumentOne of the key disclosures in IFRS 7 is that entities Maturity analysis (financial liabilities)are required to disclose the carrying amounts of For the maturity analysis, IFRS 7 requires an entitytheir financial assets and liabilities analysed by the to disclose:categories defined in IAS 39 ‘Financial Instruments: a a maturity analysis for non-derivative financialRecognition and Measurement’. These categories liabilities that shows the remaining contractualare: maturities• financial assets at fair value through profit or b a maturity analysis for derivative financial loss liabilities. The maturity analysis shall include• held-to-maturity investments the remaining contractual maturities for those• loans and receivables derivative financial liabilities for which• available-for-sale financial assets contractual maturities are essential for an• financial liabilities at fair value through profit or understanding of the timing of the cash flows loss c a description of how the entity manages the• financial liabilities measured at amortised cost. liquidity risk inherent in (a) and (b).Impairment of financial assets Liquidity risk is defined as the risk that an entityIFRS 7 requires disclosure of the impairment loss will encounter difficulty in meeting obligationsrecognised on each class of financial assets. In associated with financial liabilities that are settledaddition, when financial assets are impaired by by delivering cash or another financial asset.credit losses and the impairment is recorded in aseparate account rather than directly reducing thecarrying amount of the assets, a reconciliation ofmovements in that allowance account should bepresented for each class of financial assets. Theserequirements are among the most commondisclosure requirements raised with companies byregulators.26 IFRS Top 20 Tracker