Malta: Year-End Accounting Reminders - IFRS, September 2012

INTRODUCTION

This publication relates to reporting requirements as at 30 September 2012. It highlights the topical issues to consider and the new standards and interpretations that apply at this date.

TOPICAL ISSUES AT 30 SEPTEMBER 2012

This section summarises some accounting hot topics that may impact September 2012 year ends.

'Commitments' to related parties – IAS 24 amendment

IAS 24 was amended in November 2009 and applies to financial years ending on and after December 2011. One of the amendments was the insertion of a requirement to disclose commitments with related parties, including key management. 'Commitments' includes commitments to do something if a particular event occurs or does not occur in the future, including executory contracts (recognised and unrecognised).

What types of arrangement might now need to be disclosed? An entity's commitments to members of key management, such as long-term incentive schemes or commitments to provide loans, would need to be disclosed. Arrangements between an entity and a related party to purchase an asset from the entity would also need to be disclosed, even if the purchase has not yet occurred. Such commitments were often not disclosed in the past, as they were not seen as 'transactions' because there was no accounting impact until the event occurred. See also IFRS news, March 2012.

Non-controlling interests and cash flow statements

Where there are non-controlling interests in a subsidiary that is consolidated as part of a group, the treatment of the non-controlling interest in the consolidated cash flow statements should be consistent with the overall approach to non-controlling interests. Changes in ownership interests in a subsidiary that do not result in a loss of control, such as the purchase or sale by a parent of a subsidiary's equity instruments, are now accounted for as equity transactions under IAS 27. IAS 7 was therefore amended by IAS 27 so that the resulting cash flows are classified in the same way as other transactions with owners − that is, as cash flows from financing activities in the consolidated cash flow statement. See the guidance in paragraph 30.108 onwards in the 'IFRS Manual of accounting'.

Breaches of banking covenants and presentation of borrowings

An entity classifies a borrowing as current under IAS 1 if it does not have an unconditional right at the balance sheet date to defer settlement for at least 12 months after the end of the reporting period. Where an entity is in breach of banking covenants at the period end and the breach causes the entity to lose the unconditional right to avoid settling within 12 months, the whole borrowing is a current liability at the balance sheet date if the breach has not been waived by the lender before the period end. Even where covenant waivers are subsequently received from the lender, and where borrowings have been restructured in the following year, the financial statements should present the borrowings based on their contractual maturity at the period end. A post-period-end waiver is a non-adjusting post balance sheet event under IAS 10.

IFRS 3 disclosure reminders

One of the disclosures required in the business combinations standard that can often be overlooked is the requirement to provide a qualitative description of the items that make up goodwill. For example, this may include expected synergies resulting from the combination or intangible assets that do not meet the criteria for separate recognition. The omission of this disclosure has been specifically noted by regulators (for instance, in the UK FRRP's annual report for 2011). An acquirer is also required to disclose specific information for transactions that are recognised separately from the business combination. This includes a description of the transaction, the accounting treatment and the line item in the financial statements in which each item is recognised. Examples of such transactions include settlement of pre-existing relationships and acquisition-related costs. Furthermore, the amount and recognition basis of any issue costs not recognised as an expense must also be disclosed.

Debt-for-debt renegotiations

Entities sometimes negotiate with lenders to restructure their existing debt obligations. Such restructuring may result in either a modification or an exchange of debt instruments. Different accounting applies for each.

Under IAS 39, a restructuring is accounted for as an extinguishment if either the renegotiated debt instrument is on substantially different terms from the existing instrument, or the renegotiated instrument is with a different lender (including when the new lender is connected with the previous lender – for example, two groups under the common control of the same individual). In this case, the existing debt instrument is derecognised, and the new or revised debt instrument is initially recognised at fair value. The difference between the fair value of the renegotiated instrument and the carrying amount of the old instrument is recognised in the income statement. See paragraph 8.158 of the 'IFRS Manual of accounting – Financial instruments' for further information. If the renegotiated debt is with the same lender (including a member of the same group) and not on substantially different terms, the restructuring is accounted for as a modification. The existing debt instrument is not extinguished but continues to be recognised at amortised cost. The difference between the previous carrying amount and the present value of the revised estimated cash flows discounted at the original effective interest rate should either be recognised immediately as a gain or loss in the income statement or should adjust the effective interest rate of the liability (that is, it should be recognised in the income statement over the remaining life of the instrument). The appropriate treatment depends on the facts and circumstances.

Control under IFRS 10

IFRS 10, 'Consolidated financial statements', replaces all of the guidance on control and consolidation in IAS 27, 'Consolidated and separate financial statements', and SIC-12, 'Consolidation – special purpose entities'.

IAS 27 defines control as: '. . .the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities...'.

IFRS 10 defines control differently as: '...an investor controls an investee when the investor is exposed or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee...' .

The definition of control under IFRS 10 is not based solely on legal ownership. It encompasses three distinct principles, which if present identify the existence of control by an investor over an investee. These principles are:

• power over the investee;
• exposure, or rights, to variable returns from its involvement with the investee; and
• the ability to use its power over the investee to affect the amount of the investor's returns.

In assessing control over an investee, these three factors cannot be considered in isolation; all three must be present for an investor to conclude whether it has control.

The main distinction between the old and new definition of control is that, under IFRS 10, there is a clear requirement to link power and returns (that is, benefits) and an investor's ability to affect those returns.

All entities will need to consider the impact of the new definition, as it may result in some entities consolidating investments that they previously did not, and deconsolidating entities that do not meet the control definition under IFRS 10. IFRS 10 is effective for annual periods beginning on or after 1 January 2013, with earlier application permitted. For entities applying IFRS as adopted by the EU, EU endorsement is expected in late 2012. However, endorsement is proposed with an effective date for annual periods beginning on or after 1 January 2014, with early adoption permitted.

Accounting for joint arrangements under IFRS 11

Proportionate consolidation

One of the key changes brought in by IFRS 11 is the elimination of the accounting policy choice when accounting for investments in joint ventures. Previously, when a venturer had an interest in a jointly controlled entity, it was allowed to report the assets and liabilities using either proportionate consolidation (gross accounting) or the equity method of accounting (net accounting). For those used to reporting gross – typically in the oil and gas, property development and telecommunication industries – the new standard will bring significant changes by reducing the size of balance sheets and income statements unless action is taken now. (see below). All entities will need to consider the impact of the standard in their financial statements. IFRS 11 is effective for annual periods beginning on or after 1 January 2013, with earlier application permitted. For entities applying IFRS as adopted by the EU, EU endorsement is expected in late 2012. However, endorsement is proposed with an effective date for annual periods beginning on or after 1 January 2014, with early adoption permitted.

Retaining gross reporting

Jointly controlled entities (JCEs) might not meet the definition of joint ventures under the new standard. By moving away from the importance of an investment's legal structure, some JCEs might be classified as joint operations in future.

Segment reporting under IFRS 8

The following are some areas that could require further consideration at year ends based on experiences to date under IFRS 8.

Operating segments and segment disclosures are presented based on the information the chief operating decision-maker (CODM) receives and uses to make decisions. Therefore, the first step in applying IFRS 8 is to determine the identity of the CODM. Identification of operating segments, reportable segments and segment disclosures will then follow.

The CODM is the individual or group of individuals who perform the function of allocating resources to operating segments and assessing their performance. A committee of nonexecutive directors is unlikely to be the CODM given that their function is more one of governance rather than management. Therefore, a supervisory board of executive directors is more likely to be the CODM. Identification of the CODM should consider the key operating decisions made in running the business and who makes these decisions. Disclosures in respect of operating segments should consider:

• How are the entity's activities reported in the information used by management to review performance and make resource allocation decisions?
• Is any proposed aggregation of operating segments into one reportable segment supported by the aggregation criteria in the standard, including consistency with the core principle (that is, enabling users to evaluate the nature and financial effects of the entity's business activities and economic environments)?
• Is the information about reportable segments based on IFRS measures or on an alternative basis?
• Have the reported segment amounts been reconciled to the IFRS aggregate amounts?
• Is the operating analysis set out in the narrative report consistent with the operating segments in the financial statements?

At every reporting date the entity should reconsider whether their current operating segment disclosure remains appropriate. Changes in the identity or formation of the CODM and the information reviewed by the CODM could lead to changes in the segment disclosures provided. This consideration is especially important where there has been a restructuring of the organisation.

Discount rates and provisions

The risk-free rate is an important element in various calculations and assumptions, as it provides a base to determine an appropriate discount rate. The proxy for such a risk-free rate is in many cases the government bond 'yield' rate for the country where the entity operates. However, due to the recent economic turmoil, the credit rating of government debt has been downgraded in a number of countries, reflecting a market view that the debt (and related yield) is no longer free of risk.

Where this has occurred in a country (country A) for which the entity wishes to apply a risk-free discount rate, an acceptable approach would be to use a government bond 'yield' rate of a AAA-rated country (country B), with appropriate adjustment for the differences in inflation between the two countries.

Disclosure of significant estimation uncertainties – discount rates

The application of an appropriate discount rate to determine the present value of an accounting balance is a common requirement under a number of IFRS accounting standards. Methods for determining an appropriate discount rate vary but often have regard to risk-free rates, or in particular, corporate bond rates or government bond rates are applied under IAS 19. In the current economic environment, the selection of an appropriate discount rate is highly judgemental and can have a material impact on financial statements. Management should therefore consider disclosing discount rates as a significant source of estimation uncertainty, in accordance with IAS 1 para 125.

Out-of-the money share-based payments – cancellations and modifications

Many employee share awards are no longer favourable in the current economic conditions. If non-market vesting conditions have been affected, some of these awards now result in only a relatively small charge being recognised in the income statement.

Many entities are considering cancelling such awards where employees will not meet non-market performance conditions. Management should consider this approach carefully; by cancelling an award ahead of time, it will be treated as a cancellation under IFRS 2. This means that the entity needs to account for the award as an acceleration of vesting. It will therefore recognise immediately the amount that otherwise would have been recognised for services received over the remainder of the vesting period (see further paragraph 12.138 of the 'IFRS Manual of accounting').

As an alternative to cancelling an award, the entity might consider modifying the award to re-incentivise employees − for example, by repricing the awards and perhaps reducing the number of awards or adding new vesting conditions. IFRS 2 requires any incremental fair value awarded as a result of modifications to be recognised over the remaining vesting period. It may be possible to modify the award such that it has no incremental fair value but provides a better incentive to employees.

Externally imposed capital requirements, including covenants

As part of capital management disclosures, IAS 1 requires an entity to disclose whether during the period it complied with any externally imposed capital requirements to which it is subject and, if not, the consequences of such non-compliance. This includes capital requirements/limits established through contractual relationships – for example, with banks. Therefore, where loans are included in an entity's definition of capital, the disclosure in respect of externally imposed capital requirements will apply to covenants attached to the loans. This is discussed in paragraph 23.117 of the IFRS Manual of Accounting. In the past, the FRRP has noted that capital management disclosure is a significant area of information for users, particularly when assessing going concern considerations, so we expect it will continue to be an area of focus by regulators.

STANDARDS AND IFRICs APPLICABLE TO 30 SEPTEMBER 2012 YEAR ENDS

Standards and IFRICs newly applicable for companies with September 2012 year ends are set out below.

Amendments

IAS 24 (revised), 'Related party disclosures' (effective 1 January 2011). This revised standard removes the requirement for government related entities to disclose details of all transactions with the government and other government-related entities and it clarifies and simplifies the definition of a related party. This is further discussed in Straight away 05.

Amendments to IFRS 7, 'Financial instruments: Disclosures' on transfers of assets (effective 1 July 2011). These amendments arise from the IASB's review of off-balance-sheet activities. The amendments will promote transparency in the reporting of transfer transactions and improve users' understanding of the risk exposures relating to transfers of financial assets and the effect of those risks on an entity's financial position, particularly those involving securitisation of financial assets. Earlier application subject to EU endorsement is permitted. For further details see Straight away 32.

Amendment to IFRS 1, 'First time adoption', on fixed dates and hyperinflation (effective 1 July 2011). These amendments include two changes to IFRS 1, 'First-time adoption of IFRS'. The first replaces references to a fixed date of 1 January 2004 with 'the date of transition to IFRSs', thus eliminating the need for entities adopting IFRSs for the first time to restate derecognition transactions that occurred before the date of transition to IFRSs. The second amendment provides guidance on how an entity should resume presenting financial statements in accordance with IFRSs after a period when the entity was unable to comply with IFRSs because its functional currency was subject to severe hyperinflation. For further details see Straight away 38.

Annual improvements to IFRSs 2010 (effective 1 January 2011). This set of amendments includes changes to six standards and one IFRIC:

• IFRS 1, 'First time adoption'.
• IFRS 3, 'Business combinations'.
• IFRS 7, 'Financial instruments; Disclosures'.
• IAS 1, 'Presentation of financial statements'.
• IAS 27, 'Separate financial statements'.
• IAS 34, 'Interim financial reporting'.
• IFRIC 13, 'Customer loyalty programmes'.

Straight away alert 17 discusses the implications of this set of amendments.

New IFRICs

Amendment to IFRIC 14, 'Prepayments of a minimum funding requirement' (effective 1 January 2011). This amendment will have a limited impact, as it applies only to entities that are required to make minimum funding contributions to a defined benefit pension plan. It removes an unintended consequence of IFRIC 14, 'IAS 19 – The limit on a defined benefit asset, minimum funding requirements and their interaction', relating to voluntary pension pre-payments when there is a minimum funding requirement. There is further guidance on the impact of this amendment in Straight away 10.

NEW IFRS STANDARDS EFFECTIVE AFTER 1 OCTOBER 2012

Under paragraph 30 of IAS 8, entities need to disclose any new IFRSs that are issued but not yet effective and that are likely to impact the entity. This summary includes all new standards and amendments issued before 30 September 2012 with an effective date after 1 October 2012. These standards can generally be adopted early, subject to EU endorsement in some countries.

NEW IFRICs EFFECTIVE AFTER 1 OCTOBER 2012

These IFRICs can generally be adopted early, subject to EU endorsement in some countries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.