Reclassification adjustments

Reclassification adjustments are amounts reclassified to profit or loss in the current period that were recognised in other comprehensive income in the current or previous periods.[IAS 1 92]

Recycling (the reclassification from equity (through other comprehensive income) to profit or loss)
Recycling is the process where gains or losses are reclassified from equity to profit or loss as an accounting adjustment. In other words gains or losses are first recognised in other comprehensive income and then in a later accounting period also recognised in the profit or loss. In this way the gain or loss is reported in the total comprehensive income of two accounting periods and in colloquial terms is said to be recycled as it is recognised twice. Reclassification adjustments

At present it is down to individual accounting standards to direct when gains and losses are to be reclassified from equity to profit or loss as a reclassification adjustment. So rather than have a clear principles based approach on recycling what we currently have is a rules based appr oach to this issue. Reclassification adjustments

For example, IAS 21 The Effects of Changes in Foreign Exchange Rates (IAS 21), is one example of a standard that requires gains and losses to be reclassified from equity to profit or loss as a reclassification adjustment. When a group has an overseas subsidiary a group exchange difference will arise on the re-translation of the subsidiary’s goodwill and net assets.

In accordance with IAS 21 such exchange differences are recognised in other comprehensive income and so accumulate in the FX translation reserve. On the disposal of the subsidiary, IAS 21 requires that the net cumulative balance of group exchange differences be reclassified from equity to P&L as a reclassification adjustment – ie the balance of the group exchange differences in the FX translation reserve is transferred to profit or loss to form part of the profit on disposal. Reclassification adjustments Reclassification adjustments

Alternatively, IAS 16 PPE is an example of a standard that prohibits gains and losses to be reclassified from equity to profit or loss as a reclassification adjustment. If we consider land that cost $10m which is treated in accordance with IAS 16 PPE. If the land is subsequently revalued to $12m, then the gain of $2m is recognised in a revaluation reserve and will be taken to revaluation reserve. When in a later period the asset is sold for $13m, Reclassification adjustments

IAS 16 PPE specifically requires that the profit on disposal recognised in the profit or loss is $1m – ie the difference between the sale proceeds of $13m and the carrying amount of $12m. The previously recognised gain of $2m is not recycled/reclassified back to profit or loss as part of the gain on disposal. However the $2m balance in the revaluation surplus is now redundant as the asset has been sold and the profit is realised. Accordingly, there will be a transfer in the Statement of Changes in Equity, from the revaluation reserve of $2m into RE.


The following reporting lines are items included in Other comprehensive income, the reclassification adjustments are marked.Reclassification adjustments

 

IFRS link

Financial reporting line

IAS 1 82A(a)(ii)

Items that are or may be reclassified subsequently to profit or loss

IAS 21 52(b)

Foreign operations – foreign currency translation differences

IAS 1 85

Net investment hedge – net loss

IAS 1 82A(b)(ii)

Equity-accounted investees – share of other comprehensive income

IAS 1 92

Reclassification of foreign currency differences on loss of significant influence

IFRS 7 24C(b)(i)

Cash flow hedges – effective portion of changes in fair value

IFRS 7.24C(b)(iv)

IAS 1 92

Cash flow hedges – reclassified to profit or loss1

Example presentation in the statement of cash flows

Cash flow hedges: 20×7 20×6
Gains (losses) arising during the year -4,667 -4,000
Less: Reclassification adjustments for gains (losses) included in profit or loss 4,000
-667 -4,000

IAS 1 85

Cost of hedging reserve – changes in fair value

IAS 1 92

Cost of hedging reserve – reclassified to profit or loss2

IFRS 7 20(a)(viii)

Debt investments at fair value through other comprehensive income – net change in fair value

IFRS 7 20(a)(viii)

IAS 1 92

Debt investments at fair value through other comprehensive income – reclassified to profit or loss3

IAS 1 91(b)

Related tax (income) expense4

 

Note: With an increase in the use of fair value measurement in the financial position, there was a need to separate realised gains and losses from unrealised gains and loss. Realised gains and losses (using accrual accounting) are include in profit or loss. Unrealised gains and losses in other comprehensive income. Using this concept other comprehensive income became a sort of sub-statement for equity, it specifies movements with an unrealised gain or loss effect that would show either: Reclassification adjustments

  • directly in profit or loss, Reclassification adjustments
  • directly in equity, or Reclassification adjustments
  • directly in equity with reclassification to profit or loss upon realisation, Reclassification adjustments

if the statement of other comprehensive income would not be in use. Reclassification adjustments

Reclassification adjustments arise on disposal of foreign operation, derecognition on available-for-sale financial assets and when a hedged transaction affects profit or loss (IAS 1 95). Adjustments do not arise on revaluation surplus or actuarial gains or losses on defined benefit plans (IAS 1 96).

The purpose of the statement of profit or loss and other comprehensive income (other comprehensive income) is to show an entity’s financial performance in a way that is useful to a wide range of users so that they may attempt to assess the future net cash inflows of an entity.

The statement should be classified and aggregated in a manner that makes it understandable and comparable. International Financial Reporting Standards (IFRS) currently require the statement to be presented as either one statement, being a combined statement of profit or loss and other comprehensive income or two statements, being the statement of profit or loss and the statement of profit or loss and other comprehensive income. Reclassification adjustments

An entity has to show separately in other comprehensive income, those items which would be reclassified (recycled) to profit or loss and those items which would never be reclassified (recycled) to profit or loss. The related tax effects have to be allocated to these sections. Reclassification adjustments

Profit or loss includes all items of income or expense (including reclassification adjustments) except those items of income or expense that are recognised in other comprehensive income as required or permitted by IFRS standards. Reclassification adjustments are amounts recycled to profit or loss in the current period that were recognised in other comprehensive income in the current or previous periods.

An example of items recognised in other comprehensive income that may be reclassified to profit or loss are foreign currency gains on the disposal of a foreign operation and realised gains or losses on cash flow hedges. Those items that may not be reclassified are changes in a revaluation surplus under IAS 16, Property, Plant and Equipment, and actuarial gains and losses on a defined benefit plan under IAS 19, Employee Benefits. Reclassification adjustments

However, there is a general lack of agreement about which items should be presented in profit or loss and in other comprehensive income. The interaction between profit or loss and other comprehensive income is unclear, especially the notion of reclassification and when or which other comprehensive income items should be reclassified. A common misunderstanding is that the distinction is based upon realised versus unrealised gains.

This lack of a consistent basis for determining how items should be presented has led to an inconsistent use of other comprehensive income in IFRS standards. It may be difficult to deal with other comprehensive income on a conceptual level since the International Accounting Standards Board (the Board) are finding it difficult to find a sound conceptual basis. However, there is urgent need for some guidance around this issue.

Opinions vary but there is a feeling that other comprehensive income has become a ‘dumping ground’ for anything controversial because of a lack of clear definition of what should be included in the statement. Many users are thought to ignore other comprehensive income as the changes reported are not caused by the operating flows used for predictive purposes.

Financial performance is not defined in the Conceptual Framework for Financial Reporting® but could be viewed as reflecting the value the entity has generated in the period and this can be assessed from other elements of the financial statements and not just the statement of profit or loss and other comprehensive income. Reclassification adjustments

Examples would be the statement of cash flows and disclosures relating to operating segments. The presentation in profit or loss and other comprehensive income should allow a user to depict financial performance including the amount, timing and uncertainty of the entity’s future net cash inflows and how efficiently and effectively the entity’s management have discharged their duties regarding the resources of the entity. Reclassification adjustments

See also: Conceptual Framework 2018

Reclassification adjustments

Reclassification adjustments

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