IFRS Update Nov 24 2016

1Audit | Tax | Advisory
IFRS Update
By Paul Rhodes
November 24, 2016

Tour of the following estimation & judgmental issues
 Functional currency (IAS 21)
 Strategic investments:
 Subsidiaries (IFRS 10)
 Joint operations (IFRS 11
 Joint venture (IFRS 11 & IAS 28)
 Associate (IAS 28)
 Financial instrument assets (IAS 39/IFRS 9)
 Business combinations (IFRS 3)
 Impairments of:
 Financial instrument assets – current rules (IAS 39)
 Financial instrument assets – new rules (IFRS 9)
 Other debits – IAS 36
 Going concern (IAS 1)

Functional currency (IAS 21)
 The functional currency is the currency of the primary economic environment in
which the entity operates, which is the environment in which it generates and
expends cash (8 & 9)
 The functional currency must be determined for all entities and foreign
operations in a group. Foreign operations may be subsidiaries, branches,
associates or joint arrangements.
 Deciding which is an entity’s functional currency, requires considering the
currency:
 that mainly influences sales prices (often the currency in which sales prices for goods
and services are denominated and settled);
 of the country whose competitive forces and regulations mainly determine the sales
prices of its goods and services; and
 that mainly influences labour, material and other costs of providing goods and services
(often the currency in which such costs are denominated and settled) (9)

 The following factors are also considered: the currency:
 In which funds from financing activities (both debt and equity) are generated; and
 In which receipts from operating activities are usually retained (10)
 Where an entity has foreign operations, the following factors are also considered,
in addition to those listed above:
 Whether the activities of the foreign operation are carried out as an extension of the
reporting entity, rather than with a significant degree of autonomy
 For example, when the foreign operation only sells goods imported from the reporting entity and
remits the proceeds to it; or whether the foreign operation accumulates cash, incurs expenses,
generates income and arranges borrowings in its local currency.
 Whether transactions with the reporting entity are a significant proportion of the foreign
entity’s transactions
 Whether cash flows from the foreign operation’s activities directly affect the cash flows
of the reporting entity and are readily available for remittance to the reporting entity
 Whether the foreign operation is dependent on funds provided from the reporting entity
or has sufficient funds from its own operations to finance normal operations (11)

 In cases where the indicators are mixed and the functional currency is not
obvious, judgment is required; the factors listed in paragraph 9 are given more
weight in making the determination because they are linked to the economic
environment of the reporting entity. (12 & BC9)
 Once the functional currency is determined it is not changed unless there is a
change in the underlying transactions, events and conditions. (13)

Example 1
 A group operates in one segment: equipment financing for small and medium
sized businesses in both Canada and the US. Operations are carried out by a
subsidiary in each country.
 The parent company issues shares and debentures to the public, both of which
are traded on the TSX.
 Two other operating segments were sold during the year ended December 31,
2015: a car dealership and company financing HVAC equipment to residential
purchasers. Both these businesses operated in Canada only.
 Based on the second quarter ended June 30, 2016, the US equipment financing
business accounted for 86.2% of consolidated net income and 59.7% of
consolidated assets.

 Finance margins earned in the US market are higher than margins in Canada
and the market for equipment financing in the US dwarfs the equivalent market in
Canada.
 The company’s projections suggest that by 2019, the US business will account
for 93.9% of consolidated net income.
 Both the parent company and US subsidiary have borrowing facilities from banks
that are denominated in US dollars. On a consolidated basis, total bank debt was
78.4% of total consolidated liabilities, and the parent company’s bank debt was
48.6% of total consolidated liabilities.
 The US dollar interest is the biggest expense on the non-consolidated income
statement of the parent company.
What is the Group’s functional currency for 2016?

Strategic investments

Interaction between IAS 39/IFRS 9, 10, 11, 12 and IAS 28
Control alone?
Consolidation in
accordance with IFRS 10
Disclosures in accordance
with IFRS 12
Joint control?
Define type of joint
arrangement in accordance
with IFRS 11
Significant
influence?
Account for share of assets,
liabilities, revenue and
expenses
with IFRS 12
Equity account for the
investment in accordance with
IAS 28
with IFRS 12
IAS 39/IFRS 9
yes no
yes no
Joint Operation Joint Venture yes no
Disclosures in
accordance
with IFRS 7

Control
 Prior to IFRS 10 the principle of consolidation was based on control:
 The pre-2011 version of IAS 27 defined control as ‘the power to govern the financial
and operating policies of an entity so as to obtain benefits from its activities.’
 SIC 12, Consolidation–Special Purpose Entities dealt with cases where an entity
controlled another entity but does not hold a majority of the voting interests.
 Special purpose entity is the IFRS equivalent of Variable Interest Entities from
old (pre-ASPE) Canadian GAAP. The ASPE accounting used to be in AcG 15
and EIC 157.
 While that guidance has been withdrawn, the hierarchy requires (or allows)
reference to IFRS, so IFRS could be applied in the private GAAP world.

Control
 IFRS 10 was intended to fix inconsistency in the application of the previous
standards, especially where an entity controls but holds less than a majority of
votes.
 IFRS 10 provides a single consolidation model with a single clear definition of
control for any circumstance

Control
 Exceptions to the consolidation requirement include:
 Scope exception:
 Parent need not present consolidated financial statements if it meets all of the following
conditions:
 wholly-owned subsidiary of another entity (or partially owned subsidiary and other owners have been informed
and also do not object)
 debt/equity not traded in public market
 financial statements not filed with regulatory bodies for the purpose of issuing instruments in a public market;
and
 Its ultimate or intermediate parent produces consolidated financial statements in which subsidiaries are
consolidated or measured at fair value.
 If the scope exception is applied, it can elect to prepare non-consolidated financial statements as
the entity’s only general purpose financial statements as per IAS 27, Separate Financial
Statements.
 Investments in subsidiaries, joint ventures and associates can be accounted for at cost or per
IFRS 9 or equity accounted. The same accounting must be applied for each category of
investments.

Control
 Investment entity exception
 An entity that:
 Obtains funds from one or more investors for the purpose of providing those investors with
investment management services;
 Commits to its investors that its business purpose is to invest solely for returns from capital
appreciation, investment income, or both; and
 Measures and evaluates the performance of substantially all of its investments on a fair value
basis
 Measures investments in subsidiaries at fair value through profit and loss in accordance
with IFRS 9.
 Subsidiaries that provide services related to the investment entities activities are still
consolidated.

Control
 Definition
 An investor controls an investee if, and only if, all the following are present:
 Power over investee
 Exposure/rights to variable returns
 Ability to use its power to affect amount of returns
 To make the determination, have to consider all facts and circumstances. This may
require significant judgement and disclosure.
 To be reassessed when facts or circumstances indicate there are changes to one or
more of the three elements of control (IFRS 10.B80-85). For example:
 A change from decision-making based on voting rights to decision-making based on agreement
 An increase in power due to the lapse of another investor’s decision-making power

Control
 Presumption when an investor owns > 50% voting power that it has control
 Although still must have the power to direct relevant activities
 Consider legal rights
 Control also exists if parent owns  50% voting power
 Power over > 50% of voting rights by agreement
 More voting rights than other parties
 Voting rights sufficient to direct relevant activities
 Other arrangements

Control
 Power
 An investor has power when it has existing rights that give it the current ability to direct the relevant
activities (being the activities that significantly affect the investee’s returns).
 Power arises from rights. Examples of rights other than voting rights include:
 Rights to appoint or remove key management
 Rights to appoint or remove another entity that directs the relevant activities
 Decision-making rights specified in a management contract
 Where rights arise from one or more contractual arrangements the determination can be complex.
 The current ability to direct means the entity has power even if its rights to direct have yet to be
exercised.
 Evidence that the investor has been exercising its rights may help in determining that it has power,
but such evidence is not in itself conclusive that power exists!
 Power means the power to the exclusion of others. However, where two investors each have
existing rights to unilaterally direct different relevant activities, it is the investor that directs the
activities that most significantly affect returns that has power over the investee.
 An investor can have power over an investee even when another investor has significant influence
over it.

Control
 Power (continued)
 What are the relevant activities? (IFRS 10.B11-B13)
 Only substantive rights are considered (‘substantive’ – having a firm basis in reality and therefore
important, meaningful or considerable) (IFRS 10.B22-25) and not protective rights. (B26-28)
 Determining whether rights give an investor the current ability to direct the relevant activities can be
difficult when rights are determined by contract.
 The following are considered:
 Purpose and design of the investee (IFRS 10.B5-8 & B51-54)
 More weight is given to whether the investor has the practical ability to unilaterally direct the relevant activities
(IFRS 10.B18 &21), for example:
 The investee’s key management are related parties of the investor (same individual is CEO of both)
 The investee can, without the contractual right to do so, direct the investee to enter into, or veto changes to,
significant transactions to benefit the investor
 Whether the investor has more than a passive interest in the investee (IFRS 10.B19), for example:
 The investee depends on the investor to fund operations
 Significant investee activities are conducted on behalf of the investor
 An investor with a large exposure to variable returns indicates that the investor may have power (IFRS 10.B20)

Control
 Example 2
 Investor A holds 40% of the voting rights of investee. Twelve other investors each hold
5% of the votes.
 A shareholder agreement grants investor A the right to appoint, remove and set the
remuneration of management responsible for directing the relevant activities.
 To date the investor has not exercised this right, and it seems likely that this right will not be
exercised in the near term
 To change the agreement, a two-thirds majority vote of the shareholders is required.
 Does entity A control the investee?

Control
 Returns
 An investor is exposed, or has rights, to variable returns from its involvement when the
investor’s returns have the potential to vary with the investee’s performance.
 Variable returns, by definition, are not fixed and have the potential to vary.
 The substance of the arrangement determines the variability. For example, a bond with
fixed interest payments provides variable returns due to default risk and exposure to
credit risk of the investee.
 All forms of return are considered, examples being:
 Dividends and changes in the value of the investee
 Remuneration for servicing an investee’s assets or liabilities or other fees
 Residual interests
 Tax benefits
 Returns that are not available to other investors (cost savings, economies of scale, access to
proprietary knowledge)
 Only one party can control the investee, but more than one party can share in the
returns.

Control
 Link between power and returns
 The investor has to be able to use its power to affect the returns it earns from the
investee.
 Therefore an investor with decision making rights has to determine if it is a
principal or agent. An investor acting as an agent does not control the investee
when it is exercising decision making rights delegated to it. (IFRS 10.B58-72)

Joint Control
 If an investee is not controlled by one investor, the next question is: whether it is
jointly controlled by all of the investors or a group of them.
 To be within the scope of IFRS 11, a joint arrangement must exist, which has the
following characteristics:
 The parties are bound by a contractual arrangement (IFRS 10.B2-4); and
 two or more of those parties have joint control of the arrangement (IFRS 11.B5-11)
 Joint control has to be in relation to the relevant activities determined by IFRS 10.
 Similar to IFRS 10, a party with only protective rights does not have joint control.
 If facts and circumstances change, the investor has to determine whether it still has
joint control.

Joint Control
 In circumstances where decisions may be made by more than one combination
of the investors agreeing together, joint control only exists if the contractual
arrangement specifies which parties are required to agree.
 Joint control means that one party that shares joint control can prevent another
party that shares control from making decisions.
 Example 3
 A and B are investors in an arrangement each with 35% of the voting rights over the
relevant activities. The remaining 30% are widely held.
 Decisions about the relevant activities require a simple majority.
 Do A and B jointly control the arrangement?

Joint Control
 Having determined that a joint arrangement exists, the entity shall determine its
classification as a joint operation or joint venture.
 If the parties with joint control have direct rights to assets and obligations for the
liabilities of the joint arrangement then the arrangement is a joint operation and the
parties are joint operators
 If the parties with joint control have rights to the net assets of the arrangement the
arrangement is a joint venture and they are joint venturers.
 The intention is that the accounting mirror the economics.

Joint Control
 The key to determining the classification is the structure of the joint arrangement.
Structure of the joint
arrangement
Not structured through a
separate vehicle
Joint operation Joint venture
Structured through a
separate vehicle
Consider:
(i) The legal form of the separate vehicle;
(ii) The terms of the contractual arrangement;
and
(iii) When relevant, other factors and
circumstances
Recognize share of assets, liabilities, revenue
and expenses
Accounted for using equity
method

Joint Control
 Examples of arrangements not structured through a separate vehicle include:
 The parties agree to manufacture a product together, whereby each is responsible for
specific tasks one using its intellectual property and the other its manufacturing
expertise. The contractual arrangement may specify how the common revenues and
costs are allocated to each party.
 The same would apply to an asset that is shared and operated jointly

Joint Control
 Where the arrangement is in a separate vehicle, the arrangement could be either
a joint operation or a joint venture.
 To decide which, need to look at the:
 contractual agreement (IFRS 11.B25-28)
 legal form of the vehicle (B22-24)
 And other factors, if any (B29-33)

Joint control
Legal form of
separate vehicle
Terms of
contractual
arrangement
Other facts and
circumstances
Does the legal form of the separate vehicle give the parties rights to the
assets, and obligations for the liabilities, relating to the arrangement?
Do the terms of the contractual arrangement specify that the parties have
rights to the assets, and obligations for the liabilities, relating to the
arrangement?
Have the parties designed the arrangement so that:
(a) Its activities primarily aim to provide the parties with an output (the
parties have rights to substantially all of the economic benefits of the
assets held in the separate vehicle) and
(b) it depends on the parties on a continuous basis for settling the liabilities
relating to the activity conducted through the arrangement?
J
o
i
n
t
o
p
e
r
a
t
i
o
n
Joint venture
No
No
No
Yes

Joint Control
 Example 4
 Two parties structure a joint arrangement in a corporation (Opco), each with 50%
ownership. The purpose of the arrangement is to manufacture materials required by the
parties for their own manufacturing processes. The parties’ own quantity and quality
specifications are used in the operation of the joint facility.
 The contractual agreement between the parties does not specify that the parties have
rights to the assets or obligations for the liabilities of Opco.
 The parties agree to purchase all output produced by Opco within the range of 60:40 to
40:60
 Opco cannot sell any of its output to third parties unless approved by both parties. Such
sales are expected to be rare.
 The purchase price to the parties is set at a level to recover the production and other
expenses of Opco.
 Is the arrangement a joint operation or a joint venture?

Investments in Associates and Joint Ventures
 IAS 28 applies to the following
 Joint ventures determined under IFRS 11 and
 Associates, which is an entity over which the investor has significant influence
 If the investor holds 20% of the voting power of the investee it is presumed to
have significant influence and vice versa
 A controlling interest held by another investor does not preclude others from
having significant influence

Investments in Associates
 Significant influence may also be through:
 Representation on the board of directors
 Participation in policy making processes (for example over dividends)
 Material transactions between the investor and investee
 Interchange of managerial personnel
 Provision of essential technical information

Business combinations (IFRS 3)
 A purchase transaction is either accounted for as a business combination under
IFRS 3 or in accordance with the appropriate standard for an asset acquisition
(IAS 16, IAS 40, IAS 38)
 Significant question because in a business combination:
 Goodwill or a gain on bargain purchase is recognized
 Assets acquired and liabilities assumed are accounted for at fair value (vs being
recognized at their relative fair values)
 Directly attributable acquisition costs are expensed (vs capitalized)
 Deferred tax assets and liabilities are recognized
 IFRS 2, Share-based Payment, does not apply
 IFRS provides guidance on recognizing contingent consideration (vs a lack of guidance
in the standards applicable to an asset purchase)
 Disclosures are considerable, and the same disclosure applies to acquisitions made in
the subsequent period
 Accounting differences continue in future periods, such as impairment,
depreciation/amortization

 What constitutes a business?
 Entity needs to determine whether the assets acquired and liabilities assumed
constitute a business (3)
 A business consists of inputs and processes applied to those inputs that have the ability
to create outputs. Therefore outputs are not required.
 Input: are economic resources, such as intellectual property, access to necessary materials,
employees and non-current assets such as intangible assets or the rights to use non-current
assets
 Process: is any system, standard, protocol, convention or rule, such as strategic management
processes, operational or resource management processes. Administrative processes are
specifically excluded.
 Output: is a return in the form of dividends, lower costs or other economic benefits

 Comments on the application of the definition
 If the transaction does not include both inputs and processes then it is not a business
combination
 Some processes must be included in the transaction, but all processes used by the
vendor need not be included. Some necessary processes may be provided by the
acquirer on integrating the business with their own.
 A business need not have liabilities
 The set of assets and activities has to be capable of being conducted and managed as
a business by a market participant. Whether the seller operated the set as a business
and whether the acquirer intends to operate it as a business is not relevant.

 There is a rebuttable presumption that an asset that includes goodwill is a business
 The elements of a business vary by industry and structure of an entity.
 New businesses often have few inputs and processes and only one (or no) outputs.
Other factors must be considered, including whether the set:
 Has begun planned principal activities
 Is pursuing a plan to produce outputs
 Will be able to obtain access to customers to purchase those outputs
 This is not a checklist and is not a comprehensive list
 This is a judgement call that has to be disclosed

 Example 5
 A company is in the process of developing a motor speedway.
 A copy of the balance sheet, income statement and certain notes is attached
 To date the company has purchased 219 acres of the land required for the speedway.
 At the balance sheet date there were purchase agreements for 359 acres, which
contained options to extend the closing date to June 17, 2016. A further 26 acres were
being negotiated at the balance sheet date.
 All of this land (totaling 604 acres) is required for the construction of the speedway,
including the speedway itself, parking, amenities and a buffer surrounding the site
based on a noise study.
 The development to date has included: all the required studies (environmental, traffic,
noise, economic), economic valuations for the speedway and rates of return on the
investment.

 The company has obtained commitments from different levels of government for tax
concessions and for cash contributions to the overall development (such as the cost of
road construction).
 Subsequent to the balance sheet date the purchase agreements covering the 359 acres
were not closed and therefore expired.
 If a purchaser bought all of the company’s assets and contracts, how would the
transaction be accounted for?

Financial instrument assets – current rules (IAS 39)
 Measurement
 When a financial asset (or liability) is initially recognized it is measured at its fair
value plus, for instruments not at fair value through P&L (FVP&L), transaction
costs that are directly attributable to its acquisition (or issue). (43)

 Subsequent accounting depends on the classification, which may be:
 Financial assets at FVP&L: includes assets held for trading; contingent consideration of
an acquirer in a business combination; it is designated as such on initial recognition.
 Held-to-maturity investments: non-derivative financial instruments with fixed or
determinable payments and fixed maturity that an entity has the positive intention and
ability to hold to maturity (but excluding those designated as FVP&L; those designated
as available-for-sale; and those that meet the definition of loans and receivables)
 Loans and receivables: non-derivative financial assets with fixed or determinable
payments that are not quoted in an active market (but excluding those intended to be
sold in the near term; those designated as at FVP&L; those designated as available-for-
sale; and those for which the holder may not recover all of its initial investment)
 Available-for-sale: non-derivative financial assets that are designated as available-for-
sale or are not classified as loans and receivables, held to maturity investments or
FVP&L.

 To be held for trading an asset needs to be:
i. Acquired for the purpose of sale in the near term; and
ii. Part of a portfolio of identified financial instruments that are managed together and for
which there is evidence of a recent pattern of short-term profit taking; or
iii. It is a derivative (except for a derivative that is a financial guarantee contract or a
designated and effective hedging instrument). (9)
 An instrument can be designated as at FVP&L if, for eg, it results in more
relevant information, because:
i. Eliminates or significantly reduces a measurement or recognition inconsistency that
would otherwise arise from measuring assets and liabilities on different bases.

 Subsequent measurement
 Loans and receivables and held-to-maturity investments are measured at
amortized cost using the effective interest method.
 Investments in equity instruments that do not have a quoted price in an active
market and for which fair value cannot be reliably measured and derivatives that
are linked to and must be settled by delivery of such equity instruments, are
measured at cost.
 All other financial assets are measured at FVP&L. (46)

 Impairment test
 All financial assets, except those at FVP&L, are subject to impairment test.
 All assets subject to credit exposure are considered for impairment not only
those that have the lowest credit rating or that have shown a deterioration in
credit quality. (AG85)
 A financial asset is impaired if, and only if, there is objective evidence of
impairment as a result of one or more events that occurred after initial
recognition of the asset and that loss event has an impact on the estimated
future cash flows that can be reliably estimated. The loss may be caused by the
combined effect of several events.
 Losses expected as a result of future events, no matter how likely, are not
recognized.

 Objective evidence of impairment includes:
 Significant financial difficulty of the borrower
 Default or delinquency in interest or principal payments
 The probable bankruptcy of the borrower
 For a group of financial assets: adverse changes in the payment status of borrowers in
the group (increased number of borrowers reaching their credit limit) or national or local
economic conditions that correlate with defaults on the assets in the group (for example
unemployment rate or a decrease in property prices)
 The disappearance of an active market; a downgrade of an entity’s credit rating;
or a decline in the fair value of a financial asset below its amortized cost are not,
of themselves, evidence of impairment. (60)

 The amount of the impairment loss is measured as the difference between:
 The assets carrying amount at the reporting date and
 The present value of estimated future cash flows (excluding future credit losses that
have not been incurred) discounted at the financial asset’s original effective interest
rate. Using the current market rate would impose fair value measurement on an asset
that is measured at amortized cost.
 The amount of the loss and reversals are recognized in P&L. (63 & 65)
 An impairment loss may be either a single amount or a range. If a range is
determined the best estimate is used. (AG86)
 The impairment test is first carried out individually for significant assets, and
individually or collectively for assets that are not individually significant. Assets
are grouped on the basis of similar credit risk characteristics, which may include
credit grading, industry, geographical location, type of collateral, past-due status.

 If the entity determines that there is no objective evidence of impairment for an
asset that is assessed individually, the asset is then considered for impairment
as part of a group. (63 & 64 & AG87)
 Once an impairment loss is recognized, interest income is recognized using the
original effective interest rate of the asset. (AG93)
 An impairment loss on a financial asset carried at cost is not reversed.
 Declines in the fair value of available-for-sale financial assets are recognized in
OCI. Where there is objective evidence that the asset is impaired, the cumulative
loss that was previously recognized in OCI is reclassified from equity to P&L.
(67)

 Example 6
 Lender A has concerns that some of its borrowers will not be able to make all
principal and interest payments due under their borrowing agreement in a timely
manner. Therefore it negotiates a restructuring of these loans.
 Lender A believes that each borrower will be able to meet their obligations under
the restructured terms.
Would Lender A recognize an impairment loss in each of the following restructured
loans:
a) Customer V will pay the full amount of the principal of the original loan five years after
the original due date, but none of the interest under the original terms.

 Example 6 Cntd.
b) Customer W will pay the full principal amount of the original loan on the original due
date, but none of the interest due under the original terms.
c) Customer X will pay the full principal amount of the original loan on the original due
date with interest only at a lower interest rate than the interest rate inherent in the
original loan.
d) Customer Y will pay the full principal amount of the original loan five years after the
original due date and all interest accrued during the original loan term, but no interest
for the extended term.
e) Customer Z will pay the full amount of the original loan five years after the original due
date and all interest, including interest for both the original term of the loan and the
extended term.

Financial instrument assets
– new rules (IFRS 9)

Financial instrument assets – new rules (IFRS 9)
 Measurement
 Financial assets (and liabilities) are initially recognized at their fair value plus or
minus, for instruments not at FVP&L, transaction costs that are directly
attributable to their acquisition or issue (5.1.1).
 Subsequent measurement may be either amortized cost, fair value through OCI
(FVOCI) or FVP&L (4.1.1) depending on the assets’ classification which itself
depends on the business model and the contractual cash flow characteristics.

 The business model:
 The determination is made at the level of groups of financial assets. An entity may have
more than one model for managing different groups of instrument: one portfolio of loans
may be managed to collect contractual cash flows and another may be managed to
trade and realize fair value gains. The determination need not be made at the reporting
entity level.
 The management scenarios for portfolios of assets must be reasonably expected to
occur. The intention to sell a particular portfolio only in a stress case scenario does not
affect the assessment of the business model. Similarly realizing cash flows in a way that
is different from expectations when the business model was assessed does not give
rise to a prior period error and does not change the classification of the remaining
financial assets in that business model.

 An entity’s business model is typically observable through actions taken to achieve
objectives. An entity has to use all available evidence, such as:
 how performance is evaluated and reported;
 the risks that affect the performance and how those risks are managed; and
 how management is compensated
 Judgement is required. (B4.1.2 to 2B)

 Amortized cost is used if the objective of the business model is to collect
contractual cash flows and the terms of the asset only give rise to payments of
principal and interest on the principal outstanding, on specified dates (4.1.2(a) &
9B))
 If the business model allows for the collection of contractual cash flows and the
sale of the financial asset, then they are measured at fair value through OCI
(4.1.2A)
 Principal means the fair value of the financial asset on initial recognition. Interest
is the consideration for the time value of money taking into account credit risk,
other risks and costs and a profit margin. (4.1.3)

 Examples that would result in contractual cash flows not representing a basic
lending arrangement, so contractual cash flows are not solely payments of
principal and interest, include:
 Contractual terms that introduce exposure to other risks or volatility, such as exposure
to changes in equity or commodity prices, including an interest rate that is reset to a
higher rate if an equity index reaches a particular level. (B.1.7A & B4.1.10)
 An imperfect relationship between the element of interest that represents consideration
for the time value of money, such as an interest rate that is reset monthly to a one-year
interest rate. A quantitative assessment of how different the contractual cash flows are
from the unmodified time value of money element of interest may be required.
(4.1.9B&C)
 A financial instrument that includes a clause allowing early settlement, and the
prepayment amount includes an unreasonable amount of additional compensation
(such as a fixed amount of compensation regardless of the timing of the early
termination) for the early termination of the contract. (B4.1.11(b))
 The instruments’ contractual cash flows represent an investment in an underlying asset
or cash flows, for example where cash flows are linked to sales. (B4.1.16)

 Measurement at fair value through P&L is the default for instruments that do not
fall into the amortized cost or FVOCI buckets, including when the principal and
interest criterion is not met.
 Irrevocable elections are available at initial recognition:
 For particular equity instruments that would otherwise be measured at FVP&L to
present subsequent changes in fair value in OCI (4.1.4).
 To designate a financial asset at FVP&L to avoid an accounting mismatch from
accounting for assets and liabilities on different bases. (4.1.5)

 Scope of the impairment rules
 An expected credit loss allowance is recognized for financial instrument assets
measured at amortized cost or at FVOCI in accordance with IFRS 9, plus the
following, some of which are otherwise outside the outside the scope of the
standard:
 Lease receivables (IAS 17)
 Contract assets (IFRS 15)
 Loan commitments and
 Financial guarantee contracts (IAS 4)
 The standard is effective for annual periods beginning on or after January 1,
2018. Earlier adoption is permitted.
 The standard is applied retrospectively. Prior periods are only restated if
restatement is possible without the use of hindsight.

 An allowance on a financial asset at FVOCI is recognized in OCI but does not
reduce the carrying amount of the asset in the statement of financial position.
(5.5.2)
 If at the reporting date there has not been any significant increase in credit risk
since initial recognition, the loss allowance is recognized at an amount equal to
the 12-month expected credit loss. (5.5.5)

 If the credit risk of a financial instrument increases significantly since initial
recognition then the loss allowance recognized is equal to the lifetime expected
credit loss. The assessment can be made individually or collectively. (5.5.3 & 4)
 The assessment is
 based on the change in the risk of a default occurring over the expected life of the
financial instrument
 must consider all reasonable and supportable information
 including forward looking information,
 that is available without undue cost or effort and
 that is indicative of significant increases in credit risk (5.5.9)

 If reasonable and supportable information is available, an entity cannot rely
solely on past due information, and vice versa. There is a rebuttable presumption
that the credit risk has increased significantly when contractual payments are
more than 30 days past due. This can be rebutted with reasonable and
supportable information that proves otherwise. (5.5.11)
 The changes in credit loss allowance is recognized in P&L as an impairment gain
or loss. (5.5.8)

 Example 7
 Company C is the holding company of a group that operates in a cyclical
industry. Bank B provides a loan to Company C. At that time prospects for the
industry were positive, even though input prices were volatile and a potential
decrease in sales is anticipated given the point in the cycle.
 In the past Company C has focused on external growth, acquiring investments in
companies in related sectors, making the group structure complex and reducing
the ability to forecast the cash that will be available at the holding company level.
 When the loan was advanced leverage was at an acceptable level, but there was
concern over Company C’s ability to refinance due to the short remaining life
until maturity, and over the ability to service the debt using dividends from
operating subsidiaries.

 Example 7 continued
 Company C’s leverage was in line with other customers of Bank B with similar
credit risk. Based on projections over the expected life of the loan the remaining
capacity on its coverage ratios was high. When the loan was advanced Bank B
determines there is significant credit risk and that uncertainties affecting cash
availability could lead to default. The loan is not considered to be originated
credit-impaired.
 Subsequent to recognition, three of Company C’s five key subsidiaries had a
significant reduction in sales due to market conditions, but sales are expected to
improve with the industry cycle. Sales in the other two subsidiaries are stable.
Company C has announced a restructuring to increase the flexibility for
refinancing existing debt and for payment of dividends.
 Has there been a significant increase in credit risk since initial recognition?

 Example 8
 Company H owns a real estate asset financed with a 5 year loan from Bank Z.
The loan is secured by a first mortgage over the real estate and has a loan-to-
value ratio of 50%. The Bank does not consider the loan to be credit-impaired at
initial recognition.
 Subsequent to initial recognition, revenues and operating profits of Company H
have decreased due to an economic recession, and the effects could be
significant and ongoing.
 Company H’s free cash flow is expected to decline to the point that coverage of
loan payments could become tight. Bank Z estimates that a further deterioration
in cash flows may result in Company H missing a contractual payment and the
loan becoming past due.
 An updated appraisal indicates a current loan-to-value ratio of 70%.
 Has the credit risk increased significantly?
 What effect does the collateral have?

 The measurement of expected credit losses must reflect:
 An unbiased probability weighted amount by evaluating a range of possible outcomes.
At a minimum the assessment should consider the possibility that a credit loss occurs
and the possibility that no credit loss occurs.
 The time value of money
 Reasonable and supportable information that is available without undue cost and effort
at the reporting date about
 Past events
 Current conditions and
 Forecasts of future economic conditions (5.5.17 & 18)
 The maximum period to consider is the maximum contractual period over which the
entity is exposed. The entity’s ability to demand repayment and cancel any undrawn
commitment does not limit the exposure to credit losses to the contractual notice period.
 The expected credit loss is measured over the period that the entity is exposed to credit
risk and expected credit losses would not be mitigated by credit risk management
actions. (5.5.20)

 For renegotiated or modified financial instruments that have not been
derecognized the change in credit risk at the reporting date is assessed by
comparing the risk of default based on the modified contractual terms with the
risk of default at initial recognition based on the original contractual terms.
(5.5.12)
 If a financial instrument was assessed as having low credit risk at initial
recognition then the entity may presume that credit risk has not increased
significantly. (5.5.10)
 If at a subsequent reporting date the entity concludes that the significant
increase in credit risk condition is no longer met, then the loss allowance is
measured at the 12-month expected credit loss at that date. (5.5.7)

 Example 9
 MIC M originates 2,000 loans with gross carrying amount of $500,000. The
portfolio can be split into two groups based on the credit risk characteristics of
each. Group X comprises 1,000 loans with gross carrying amount of $200 each,
and Group Y comprises 1,000 loans with gross carrying amount of $300 each.
There are no transaction costs or options.
 MIC M measures expected credit losses based on a loss rate approach for each
group, using samples of historical default and loss experience plus forward
looking information for forecast economic conditions.
 Historically loss rates are 0.3% based on four defaults for Group X and 0.15%
based on two defaults for Group Y. The portfolio can be described as:

Example 9 Continued
Group
Number
of
clients
in
Group
Estimated
Per loan
gross
carrying
amount
Total
estimated
gross
carrying
amount at
default
Historic
defaults
per
annum
Estimated
total gross
carrying
amount at
default
Present
value of
observed
loss
Loss rate
A B C = A x B D E = B x D F G = F ÷ C
X 1,000 $200 $200,000 4 $800 $600 0.3%
Y 1,000 $300 $300,000 2 $600 $450 0.15%
Expected credit losses should be discounted using the effective interest rate. The
present value of the observed loss is assumed.

Example 9 Continued
 At the reporting date MIC M expects an increase in defaults over the next 12
months: five in Group X and three in Group Y. The present value of the observed
loss per loan is estimated to remain consistent with historical losses. The
expected increase in defaults is not considered to represent a significant
increase in credit risk.
What are the present values of the loss allowance and the loss rates for each
group?

Other debits (IAS 36)
 Scope of IAS 36 Impairment of Assets
 The standard applies to all assets except:
 Inventories
 Contract assets (IFRS 15)
 Deferred tax assets
 Assets arising from employee benefits
 Financial assets within the scope of IAS 39/IFRS 9
 Investment property measured at fair value
 Biological assets measured at fair value less cost to sell
 Various debits arising under IFRS 4 Insurance Contracts
 Non-current assets classified as held for sale
 The following excludes issues related to goodwill, corporate assets, impairment
losses for CGUs, impairment loss reversals.

 Timing of impairment tests
 An entity shall perform an annual impairment test on:
 intangible assets with indefinite useful lives
 Intangible assets not yet available for use and
 Goodwill acquired in a business combination
 Testing intangible assets as above, can be performed at any time during an
annual period, provided it is performed at the same time each year. If an
intangible asset was recognized during the current year, a test must be
performed before the end of the current year. (10)

 The recoverability of other assets is tested when there is an indication of
impairment, based on consideration of:
 External sources:
 Adverse changes in the technological, market, economic or legal environment
 Market interest rates or other market rates of return have increased and those increase are likely
to have an effect on the discount rate used in calculating value in use
 The carrying amount of the assets is greater than the market capitalization
 Internal sources
 Evidence of obsolescence or physical damage
 Changes in the manner in which the asset is used, such as plans to discontinue use of the asset,
changes to the useful life of the asset, or plans to dispose of the asset earlier than expected
 A decline in actual performance compared to budget, a decline in budgeted net cash flows from
the asset, or higher cash flows needed to maintain the asset
 For investments in subsidiary, joint venture or associate
 Receiving a distribution from the investee where: the carrying amount of the investment in the
non-consolidated financial statements exceeds the net assets and goodwill picked up on
consolidation; or the dividend exceeds the income for the period. (9 & 12)

 Measuring recoverable amount
 Recoverable amount is the higher of
 fair value less costs of disposal and
 value in use.
 The recoverable amount is calculated for an individual asset, unless the asset
does not generate cash inflows that are largely independent of those from other
assets or groups of assets. In this case, recoverability is assessed for the cash
generating unit (CGU), unless fair value less cost of disposal can be measured
and either:
 The asset’s fair value less costs of disposal is greater than the carrying amount; or
 The asset’s value in use can be estimated to be close to its fair value less costs of
disposal. (22)

 A CGU is the smallest group of assets that generates cash inflows that are
largely independent of the cash inflows of other assets or groups of assets.
 If an external market exists for the output produced by an asset or group of
assets, then that asset or group of assets is the CGU even if all the output is
used internally. If internal transfer pricing is used then management must use its
best estimate of prices for arm’s length transactions.
 Judgement is required.

 Example 10
 A company owns a retail store chain. Store X makes all its retail purchases
through the company’s purchasing centre and the company makes all pricing,
marketing, advertising and human resource policies (except for hiring X’s
cashiers and sales staff).
 The company owns five other stores in the same city as X and 20 stores in other
cities. Each store probably has its own customer base. All stores in the chain are
managed the same way as X.
 X was purchased five years ago, along with four other stores. Ignore goodwill.
 What is the CGU for X?

 Practical application
 Estimates, averages and computational short-cuts can be applied if they provide
reasonable approximations of the detailed calculations illustrated in the standard
for determining recoverable amount. (23)
 The most recent detailed calculation of recoverable amount for an intangible
asset with indefinite life made in a preceding period can be used in the
impairment test for the current period, if all of the following criteria are met:
 For an intangible asset that is tested for impairment as part of a CGU, the assets and
liabilities making up the unit have not changed significantly since the detailed
calculation;
 The most recent recoverable amount calculated showed a substantial excess over the
asset’s carrying amount; and
 The likelihood that recoverable amount is below carrying amount is remote based on
events and circumstances since the last detailed calculation. (24)

 Fair value less costs of disposal
 Fair value reflects assumptions market participants would use when pricing the
asset, and so includes factors that would apply to entities in general. Therefore
fair value is not the same as value in use. (53A) Value in use is the more
common basis for measuring recoverable amount.
 In some cases it is not possible to determine fair value less costs of disposal
because there is no basis for making a reliable estimate of the price at which an
orderly transaction would take place. (20)
 Guidance on fair value is provided in IFRS 13.

 Value in use
 The calculation of value in use should reflect:
 An estimate of future cash flows derived from the asset;
 Expectations of possible variations in the amount or timing of those cash flows;
 The time value of money, represented by the current market risk free rate of interest;
 The price for bearing the uncertainty inherent in the asset; and
 Other factors that market participants would reflect in pricing future cash flows.
 The variations in cash flows, price for bearing uncertainty and other factors
(future price increases) can either be reflected in the cash flows used or in the
discount rate. (30 & 32 and Appendix A)
 A pretax discount rate is used. (51)

 The discount rate is the return an investor would require from an investment that
generates cash flows of amounts, timing and risk profile equivalent to those
derived from the asset. Often an asset specific market discount rate is not
available so a rate must be estimated (56, 57 and Appendix A)

 Cash flow projections shall be based on reasonable and supportable
assumptions using management’s best estimate of economic conditions that
may exist over the life of the asset. The most recent budgets/forecasts should
exclude the effects of future restructurings.
 Reasonableness of assumptions should be tested against past actual results.
 Cash flows beyond the period covered by projections (typically five years or less)
should be extrapolated using a steady or declining growth rate. The rate used
should not exceed the average rate for the industry, product or country, unless
the higher rate can be justified. (33)

 Cash outflows for servicing the asset and for replacing, assets with shorter
economic lives are included, but those for improving the assets performance are
not (unless the entity is committed to the restructuring in accordance with IAS
37). (41, 44 & 49)
 Cash flows to improve or enhance the performance of the asset, or cash flows
related to financing or income tax are excluded. (44 & 50)

 Example 11
 Separate attachment

Going concern (IAS 1)
 Financial statements are normally prepared on the basis that the entity is a going
concern and will continue in operation for the foreseeable future.
 Management is responsible for assessing whether an entity is able to continue
as a going concern. An entity is not a going concern if “management either
intends to liquidate the entity or to cease trading, or has no realistic alternative
but to do so”.
 In making the assessment, if management is aware “of material uncertainties
relating to events or conditions that may cast significant doubt upon the entity’s
ability to continue as a going concern” those uncertainties should be disclosed
(25).

Going concern (IAS 1)
 Management considers “all available information about the future, which is at
least, but not limited to, twelve months from the end of the reporting period”. (26)
Deterioration in operating results and financial position after the reporting period
may indicate a need to consider the going concern assumption. (15)
 Where the entity has a history of profits and access to financial resources, a
detailed analysis is not required. Where the ability to continue as a going
concern is questionable, management would consider “expected profitability,
debt repayment schedules and potential sources of replacement financing”. (26)

Resources
 In no particular order:
 Knowing the table of contents of standards
 Scope and definitions of each standard
 Application guidance and illustrative examples
 Green book, a guide through
 EY, especially the Index of standards for specific paragraphs
 Wiley subscription

IFRS Update Nov 24 2016

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IFRS Update Nov 24 2016