IFRS 15 Retail – the finest perfect examples

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IFRS 15 Retail revenue – finest perfect examples

Retail is the process of selling consumer goods or services to customers through multiple channels of distribution to earn a profit. Retailers satisfy demand identified through a supply chain. The term “retailer” is typically applied where a service provider fills the small orders of many individuals, who are end-users, rather than large orders of a small number of wholesale, corporate or government clientele. (Source: Wikipedia)

So what is the IFRS 15 guidance for retail?

Here are the cases covering the most significant accounting topics for retail in IFRS 15.

Case – Customer incentives Buy three, get coupon for one free

Death By Chocolate Ltd, a high street chain, is offering a promotion whereby a customer who purchases three boxes of chocolates at €20 per box in a single transaction in a store receives an offer for one free box of chocolates if the customer fills out a request form and mails it to them before a set expiration date.

Death By Chocolate estimates, based on recent experience with similar promotions, that 80% of the customers will complete the mail in rebate required to receive the free box of chocolates.

How is a ‘buy three, get one free’ transaction accounted for and presented by Death By Chocolate?

The rules

IFRS 15.22 states: “At contract inception, an entity shall assess the goods or services promised in a contract with a customer and shall identify as a performance obligation each promise to transfer to the customer either:IFRS 15 Retail

  1. a good or service (or a bundle of goods or services) that is distinct; or
  2. a series of distinct goods or services that are substantially the same and that have the same pattern of transfer to the customer (see paragraph 23).”

IFRS 15.26 provides examples of distinct goods and services, including “granting options to purchase additional goods or services (when those options provide a customer with a material right, as described in paragraphs B39-B43)”.

IFRS 15.B40: “If , in a contract, an entity grants a customer the option to acquire additional goods or services, that option gives rise to a performance obligation in the contract only if the option provides a material right to the customer that it would not receive without entering into that contract (for example, a discount that is incremental to the range of discounts typically given for those goods or services to that class of customer in that geographical area or market).

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IFRS 15 Real estate Revenue complete and accurate recognition

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IFRS 15 Real estate

Under IFRS 15 real estate entities recognize revenue over the construction period if certain conditions are met.

Key points

  • An entity must judge whether the different elements of a contract can be separated from each other based on the distinct criteria. A more complex judgment exists for real estate developers that provide services or deliver common properties or amenities in addition to the property being sold.
  • Contract modifications are common in the real estate development industry. Contract modifications might needIFRS 15 Real estate to be accounted for as a new contract, or combined and accounted for together with an existing contract.
  • Real estate managers may structure their arrangements such that services and fees are in different contracts. These contracts may meet the requirements to be accounted for as a combined contract when applying IFRS 15.
  • Real estate management entities are often entitled to several different fees. IFRS 15 will require a manager to consider whether the services should be viewed as a single performance obligation, or whether some of these services are ‘distinct’ and should therefore be treated as separate performance obligations.
  • Variable consideration for entities in the real estate industry may come in the form of claims, awards and incentive payments, discounts, rebates, refunds, credits, price concessions, performance bonuses, penalties or other similar items.
  • Real estate developers will need to consider whether they meet any of the three criteria necessary for recognition of revenue over time.

IFRS 15 core principle

The core principle of IFRS 15 is that revenue reflects the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

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EBITDA – 1 Best complete read

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EBITDA – Earnings before interest taxes depreciation and amortisation

– is a measure of a company’s overall financial performance and is used as an alternative to simple earnings or net income in some circumstances. Earnings before interest, taxes, depreciation and amortisation, however, can be misleading because it strips out the cost of capital investments like property, plant, and equipment.

This metric also excludes expenses associated with debt by adding back interest expense and taxes to earnings. Nonetheless, it is a more precise measure of corporate performance since it is able to show earnings before the influence of accounting and financial deductions.EBITDA

Simply put, Earnings before interest, taxes, depreciation and amortisation is a measure of profitability. While there is no legal requirement for companies to disclose their EBITDA (here also written as EBIT-DA), according to the U.S. generally accepted accounting principles (US GAAP) or International Financial Reporting Standards (IFRS), it can be worked out and reported using information found in a company’s financial statements.

The earnings, tax, and interest figures are found on the income statement, while the depreciation and amortisation figures are normally found in the notes to operating profit or on the cash flow statement. The usual shortcut to calculate EBITDA is to start with operating profit, also called earnings before interest and tax (EBIT) and then add back depreciation and amortisation.

https://www.merriam-webster.com/dictionary/EBITDA

Origins of EBITDA

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IFRS 2022 update – IAS 8 Definition of Accounting Estimates – Your best read

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IFRS 2022 update – IAS 8 Definition of Accounting Estimates

Effective for annual periods beginning on or after 1 January 2023.

On 12 February 2021, the International Accounting Standards Board (the IASB or the Board) issued amendments to IAS 8 Accounting Policies, Changes to Accounting Estimates and Errors, in which it introduces a new definition of ‘accounting estimates’. The amendments are designed to clarify the distinction between changes in accounting estimates and changes in accounting policies and the correction of errors.

Definition of an accounting estimate

The current version of IAS 8 does not provide a definition of accounting estimates. Accounting policies, however, are defined. Furthermore, the standard defines the concept of a “change in accounting estimates”. A mixture of a definition of one item with a definition of changes in another has resulted in difficulty in drawing the distinction between accounting policies and accounting estimates in many instances. In the amended standard, accounting estimates are now defined as, “monetary amounts in financial statements that are subject to measurement uncertainty”.

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IFRS 2022 update – IFRS 16 Lease Liability in a Sale and Leaseback – Best read

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IFRS 2022 update – IFRS 16 Lease Liability in a Sale and Leaseback

Effective for annual periods beginning on or after 1 January 2024.

Key requirements

On 22 September 2022, the International Accounting Standards Board (the IASB or Board) issued Lease Liability in a Sale and Leaseback (Amendments to IFRS 16) (the amendment). The amendment to IFRS 16 Leases specifies the requirements that a seller-lessee uses in measuring the lease liability arising in a sale and leaseback transaction, to ensure the seller-lessee does not recognise any amount of the gain or loss that relates to the right of use it retains.

A sale and leaseback transaction involves the transfer of an asset by an entity (the seller-lessee) to another entity (the buyer-lessor) and the leaseback of the same asset by the seller-lessee.

The amendment is intended to improve the requirements for sale and leaseback transactions in IFRS 16. It does not change the accounting for leases unrelated to sale and leaseback transactions.IFRS 16 Lease Liability in a Sale and Leaseback

Background

In a sale and leaseback transaction, the seller-lessee assesses whether the transfer of the asset satisfies the requirements in IFRS 15 Revenue from Contracts with Customers to be accounted for as a sale. If it is accounted for as a sale, paragraph 100(a) of IFRS 16 requires the seller-lessee to measure the right-of-use asset arising from the leaseback at the proportion of the previous carrying amount of the asset that relates to the right of use retained by the seller-lessee.

However, IFRS 16 did not specify the measurement of the liability that arises in a sale and leaseback transaction. This has been addressed in the amendment.

Amendment to IFRS 16

After the commencement date in a sale and leaseback transaction, the seller-lessee applies paragraphs 29 to 35 of IFRS 16 to the right-of-use asset arising from the leaseback and paragraphs 36 to 46 of IFRS 16 to the lease liability arising from the leaseback. In applying paragraphs 36 to 46, the seller-lessee determines ‘lease payments’ or ‘revised lease payments’ in such a way that the seller-lessee would not recognise any amount of the gain or loss that relates to the right of use retained by the seller-lessee. Applying these requirements does not prevent the seller-lessee from recognising, in profit or loss, any gain or loss relating to the partial or full termination of a lease, as required by paragraph 46(a) of IFRS 16.

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IFRS 2022 update – Classification of non-current liabilities with covenants – Best read

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Overview – IFRS 2022 update – Classification of non-current liabilities with covenants

In October 2022, the IASB issued amendments that clarify that only covenants with which an entity must comply on or before the reporting date will affect a liability’s classification as current or non-current. IFRS 2022 update – Classification of non-current liabilities with covenants

Additional disclosures are required for non-current liabilities arising from loan arrangements that are subject to covenants to be complied with within twelve months after the reporting period.

The amendments will be effective for annual reporting periods beginning on or after 1 January 2024, with early application permitted. IFRS 2022 update – Classification of non-current liabilities with covenants

Why this change?

In January 2020, the IASB issued amendments to paragraphs 69 to 76 of IAS 1 (the 2020 amendments) to specify the requirements for classifying liabilities as current or non-current. A key requirement of the 2020 amendments was that entities with liabilities that are subject to covenants to be complied with at a date subsequent to the reporting period (“future covenants”) do not have the right to defer settlement of the liabilities at the end of the reporting period if they do not comply with the covenants at that date. IFRS 2022 update – Classification of non-current liabilities with covenants

Stakeholders were concerned about the impact of this proposal and, as a result, the IFRS Interpretations Committee (the Committee) published a tentative agenda decision (TAD) in December 2020 explaining how to apply the proposal to three fact patterns. The Committee agreed with the concerns raised in comment letters responding to the TAD about the consequences of the 2020 amendments for certain scenarios and reported them to the Board. On that basis, the Board proposed amendments in November 2021, which, after further adjustments, resulted in the amendments issued in October 2022 (the 2022 amendments). IFRS 2022 update – Classification of non-current liabilities with covenants

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IFRS 9 Best long-read SPPI Test

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The SPPI Test

If an asset is in a hold-to-collect or hold-to-collect or sell business model, an entity assesses whether the cash flows from the financial asset meet the ‘solely payments of principal and interest’ (SPPI Test) benchmark – i.e. whether the contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest.

  • ‘Principal’ is the fair value of the financial asset on initial recognition. The principal may change over time – e.g. if there are repayments of principal.
  • ‘Interest’ is consideration for the time value of money and credit risk. Interest can also include consideration for other basic lending risks and costs, and a profit margin.

A financial asset that does not meet the SPPI Test is always measured at FVPL, unless it is a non-trading equity instrument and the entity makes an irrevocable election to measure it at FVOCI. Here is the decision tree to put the narrative in context:

SPPI Test

Contractual cash flows that meet the SPPI Test are consistent with a basic lending arrangement in the banking industry.

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Low credit risk operational simplification

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Low credit risk operational simplification

IFRS 9 contains an important simplification that, if a financial instrument has low credit risk, then an entity is allowed to assume at the reporting date that no significant increases in credit risk have occurred. The low credit risk concept was intended, by the IASB, to provide relief for entities from tracking changes in the credit risk of high quality financial instruments. Therefore, this simplification is only optional and the low credit risk simplification can be elected on an instrument-by-instrument basis.

This is a change from the 2013 ED, in which a low risk exposure was deemed not to have suffered significant deterioration in credit risk. The amendment to make the simplification optional was made in response to requests from constituents, including regulators. It is expected that the Basel Committee SCRAVL consultation document will propose that sophisticated banks should only use this simplification rarely for their loan portfolios.

For low risk instruments, the entity would recognise an allowance based on 12-month ECLs. However, if a financial instrument is not considered to have low credit risk at the reporting date, it does not follow that the entity is required to recognise lifetime ECLs. In such instances, the entity has to assess whether there has been a significant increase in credit risk since initial recognition that requires the recognition of lifetime ECLs.

The standard states that a financial instrument is considered to have low credit risk if: [IFRS 9.B5.22]

  • The financial instrument has a low risk of default
  • The borrower has a strong capacity to meet its contractual cash flow obligations in the near term
  • Adverse changes in economic and business conditions in the longer term may, but will not necessarily, reduce the ability of the borrower to fulfil its contractual cash flow obligations Low credit risk operational simplification

A financial instrument is not considered to have low credit risk simply because it has a low risk of loss (e.g., for a collateralised loan, if the value of the collateral is more than the amount lent (see collateral) or it has lower risk of default compared with the entity’s other financial instruments or relative to the credit risk of the jurisdiction within which the entity operates.

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Payment holidays on loans

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Payment holidays on loans under IFRS 9

Governments and banks have introduced payment deferral programs to support borrowers affected by Covid-19. But deferred payments are not forgiven and must be repaid in the future, raising prospective risks to the banking system. Thus, they should be designed to balance near-term economic relief benefits with longer-term financial stability considerations.

The Basel Committee on Banking Supervision (BCBS) and several prudential authorities have issued statements clarifying how payment deferrals should be considered in assessing credit risk under applicable accounting frameworks. These measures aim to encourage banks to continue lending, to avert an even deeper recession.

Prudential authorities are caught “between a rock and a hard place” as they encourage banks – through various relief measures – to provide credit to solvent, but cash-strapped borrowers, while keeping in mind the longer-term implications of these measures for the health of banks and national banking systems.

In navigating these tensions, banks and supervisors face a daunting task as borrowers that may be granted payment holidays have varying risk profiles. Distinguishing between illiquid and insolvent borrowers – amidst an uncertain outlook – should help guide banks’ efforts to support viable borrowers, while preserving the integrity of their reported financial metrics.

What is this all about?

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IFRS 16 Leases presentation in cash flows – Complete easy read

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IFRS 16 Leases presentation in cash flows

Most changes from IAS 17/IFRIC 4 to IFRS 16 relate to lessees, the companies renting a car, office or warehouse.

At first, IFRS 16 has affected balance sheet and balance sheet-related ratios such as the debt/equity ratio. Aside from this, IFRS 16 also influenced the income statement, because an entity now has to recognise interest expense on the lease liability (obligation to make lease payments) and depreciation on the ‘right-of-use’ asset (that is, the asset that reflects the right to use the leased asset).

Due to this, for lease contracts previously classified as operating leases the total amount of expenses at the beginning of the lease period will be higher than under IAS 17. Another consequence of the changes in presentation is that EBIT and EBITDA will be higher for companies that have material operating leases.

IFRS 16 also changes the cash flow statement. Lease payments that relate to contracts that have previously been classified as operating leases are no longer presented as operating cash flows in full. Only the part of the lease payments that reflects interest on the lease liability can be presented as an operating cash flow (depending on the entity’s accounting policy regarding interest payments).

Cash payments for the principal portion of the lease liability are classified within financing activities. Payments for short-term leases, leases of low-value assets and variable lease payments not included in the measurement of the lease liability remain presented within operating activities.

Presentation and disclosures

In the statement of cash flows, lease payments are classified consistently with payments on other financial liabilities:

  • The part of the lease payment that represents cash payments for the principal portion of the lease liability is presented as a cash flow resulting from financing activities.
  • The part of the lease payment that represents interest portion of the lease liability is presented either as an operating cash flow or a cash flow resulting from financing activities (in accordance with the entity’s accounting policy regarding the presentation of interest payments).
  • Payments on short-term leases, for leases of low-value assets and variable lease payments not included in the measurement of the lease liability are presented as an operating cash flow.

A simple example to classify the movements in Right-of-use assets is as follows:

IFRS 16 Leases presentation in cash flows

A simple example to classify the movements in Lease liabilities is as follows:

IFRS 16 Leases presentation in cash flows

On the balance sheet, the right-of-use asset can be presented either separately or in the same line item in which the underlying asset would be presented. The lease liability can be presented either as a separate line item or together with other financial liabilities. If the right-of-use asset and the lease liability are not presented as separate line items, an entity discloses in the notes the carrying amount of those items and the line item in which they are included.

In the statement of profit or loss and other comprehensive income, the depreciation charge of the right-of-use asset is presented in the same line item/items in which similar expenses (such as depreciation of property, plant and equipment) are shown. The interest expense on the lease liability is presented as part of finance costs. However, the amount of interest expense on lease liabilities has to be disclosed in the notes.

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IFRS 16 Leases presentation in cash flows