The key objective of IFRS 16 is to ensure that lessees recognise assets and liabilities for their major leases.
1. Lessee accounting model
A lessee applies a single lease accounting model under which it recognises all leases on-balance sheet, unless it elects to apply the recognition exemptions (see recognition exemptions for lessees in the link). A lessee recognises a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make payments. [IFRS 16.22]
Disclosure financial risk management provides the guidance on the need for disclosure of the management policies, procedures and measurement practices in place at the operations within the reporting entity’s group of companies and an actual example of disclosures for financial risk management.
Disclosure Financial risk management guidance
Classes of financial instruments
Where IFRS 7 requires disclosures by class of financial instrument, the entity shall group its financial instruments into classes that are appropriate to the nature of the information disclosed and that take into account the characteristics of those financial instruments. The classes are determined by the entity and are therefore distinct from the categories of financial instruments specified in IFRS 9. Disclosure Financial risk management
As a minimum, the entity should distinguish between financial instruments measured at amortised cost and those measured at fair value, and treat as separate class any financial instruments outside the scope of IFRS 9. The entity shall provide sufficient information to permit reconciliation to the line items presented in the balance sheet. Guidance on classes of financial instruments and the level of required disclosures is provided in Appendix B to IFRS 7. [IFRS 7.6, IFRS 7.B1-B3]
– provides a narrative providing guidance on users of financial statements’ needs to present financial disclosures in the notes to the financial statements grouped in more logical orders. But there is and never will be a one-size fits all.
Here it has been decided to separately disclose financial assets and liabilities and non-financial assets and liabilities, because of the distinct different nature of these classes of assets and liabilities and the resulting different types of disclosures, risks and tabulations.
Disclosure financial assets and liabilities guidance
Disclosing financial assets and liabilities (financial instruments) in one note
Users of financial reports have indicated that they would like to be able to quickly access all of the information about the entity’s financial assets and liabilities in one location in the financial report. The notes are therefore structured such that financial items and non-financial items are discussed separately. However, this is not a mandatory requirement in the accounting standards.
Accounting policies, estimates and judgements
For readers of Financial Statements it is helpful if information about accounting policies that are specific to the entityand about significant estimates and judgements is disclosed with the relevant line items, rather than in separate notes. However, this format is also not mandatory. For general commentary regarding the disclosures of accounting policies refer to note 25. Commentary about the disclosure of significant estimates and judgements is provided in note 11.
Scope of accounting standard for disclosure of financial instruments
IFRS 7 does not apply to the following items as they are not financial instruments as defined in paragraph 11 of IAS 32:
prepayments made (right to receive future good or service, not cash or a financial asset)
tax receivables and payables and similar items (statutory rights or obligations, not contractual), or
contract liabilities (obligation to deliver good or service, not cash or financial asset).
While contract assets are also not financial assets, they are explicitly included in the scope of IFRS 7 for the purpose of the credit risk disclosures. Liabilities for sales returns and volume discounts (see note 7(f)) may be considered financial liabilities on the basis that they require payments to the customer. However, they should be excluded from financial liabilities if the arrangement is executory. the Reporting entity Plc determined this to be the case. [IFRS 7.5A]
Classification of preference shares
Preference shares must be analysed carefully to determine if they contain features that cause the instrument not to meet the definition of an equity instrument. If such shares meet the definition of equity, the entity may elect to carry them at FVOCI without recycling to profit or loss if not held for trading.
IFRS 7 Complete Maturity analysis disclosure – IFRS 7 requires certain disclosures to be presented by category of an instrument based on the IFRS 9 recognition and measurement categories of financial instruments.
Certain other disclosures are required by class of financial instrument. For those disclosures an entity must group its financial instruments into classes of similar instruments as appropriate to the nature of the information presented. [IFRS 7 6]
The two main categories of disclosures required by IFRS 7 are:
information about the significance of financial instruments [IFRS 7 7 – 30]
information about the nature and extent of risks arising from financial instruments [IFRS 7 31 – 42]
– determines which entities are consolidated in a parent’s financial statements and therefore affects a group’s reported results, cash flows and financial position – and the activities that are ‘on’ and ‘off’ the group’s balance sheet. Under IFRS, this control assessment is accounted for in accordance with IFRS 10 ‘Consolidated financial statements’.
Some of the challenges of applying the IFRS 10 Special control approach include:
identifying the investee’s returns, which in turn involves identifying its assets and liabilities. This may appear straightforward but complications arise when the legal ownership of assets diverges from the accounting depiction (for example, in financial asset transfers that ‘fail’ de-recognition, and in finance leases). In general, the assessment of the investee’s assets and returns should be consistent with the accounting depiction in accordance with IFRS
it may not always be clear whether contracts and other arrangements between an investor and an investee
create rights or exposure to a variable return from the investee’s performance for the investor; or
transfer risk or variability from the investor to the investee IFRS 10 Special control approach
the relevant activities of an SPE may not be obvious, especially when its activities have been narrowly specified in its purpose and design IFRS 10 Special control approach
the rights to direct those activities might also be difficult to identify, because for example, they arise only in particular circumstances or from contracts that are outside the legal boundary of the SPE (but closely related to its activities).
IFRS 10 Special control approach sets out requirements for how to apply the control principle in less straight forward circumstances, which are detailed below: IFRS 10 Special control approach
when voting rights or similar rights give an investor power, including situations where the investor holds less than a majority of voting rights and in circumstances involving potential voting rights
when an investee is designed so that voting rights are not the dominant factor in deciding who controls the investee, such as when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements IFRS 10 Special control approach
involving agency relationships IFRS 10 Special control approach
when the investor has control only over specified assets of an investee
In December 2015, the Basel Committee on Banking Supervision (‘the Committee’) issued its Guidance on credit risk and accounting for expected credit losses (‘Basel Committee IFRS 9 Guidance’). The Guidance sets out supervisory guidance on sound credit risk practices associated with the implementation and ongoing application of expected credit loss (ECL) accounting frameworks, such as that introduced in IFRS 9, Financial Instruments.
The Committee expects a disciplined, high-quality approach to assessing and measuring ECL by banks. The Basel Committee IFRS 9 Guidance emphasises the inclusion of a wide range of relevant, reasonable and supportable forward looking information, including macroeconomic data, in a bank’s accounting measure of ECL. In particular, banks should not ignore future events simply because they have a low probability of occurring or on the grounds of increased cost or subjectivity.
In addition, the Basel Committee IFRS 9 Guidance notes the Committee’s view that that the use of the practical expedients in IFRS 9 should be limited for internationally active banks. This includes the use of the ‘low credit risk’ exemption and the ‘more than 30 days past due’ rebuttable presumption in relation to assessing significant increases in credit risk.
Obviously, banks keep in continued talks to their local regulator about the extent to which their regulator expects the (below) Banking IFRS 9 Guidance to apply to them.
Principles underlying the Banking IFRS 9 Guidance – in Summary
Supervisory guidance for credit risk and accounting for expected credit losses
A bank’s board of directors and senior management are responsible for ensuring appropriate credit risk practices, including an effective system of internal control, to consistently determine adequate allowances.
The measurement of allowances should build upon robust methodologies to address policies, procedures and controls for assessing and measuring credit risk
Banks should clearly document the definition of key terms and criteria to duly consider the impact of forward-looking information including macro-economic factors, different potential scenarios and define accounting policies for restructurings
Credit Risk Rating
A bank should have a credit risk rating process in place to appropriately group lending exposures on the basis of shared credit risk characteristics
A bank’s aggregate amount of allowances should be adequate and consistent with the objectives of the applicable accounting framework
Banks must ensure that the assessment approach (individual or collective) does not result in delayed recognition of ECL, e.g. by incorporating forward-looking information incl. macroeconomic factors on collective basis for individually assessed loans
Validation of models
A bank should have policies and procedures in place to appropriately validate models used to assess and measure expected credit losses
Experienced credit judgment
Experienced credit judgment in particular with regards to forward looking information and macroeconomic factors is essential
Consideration of forward looking information should not be avoided on the basis that banks consider costs as excessive or information too uncertain if this information contributes to a high quality implementation
A bank should have a sound credit risk assessment and measurement process that provides it with a strong basis for common systems, tools and data
A bank’s public disclosures should promote transparency and comparability by providing timely, relevant, and decision-useful information
Assessment of Credit Risk Management
Banking supervisors should periodically evaluate the effectiveness of a bank’s credit risk practices
Approval of Models
Supervisors should be satisfied that the methods employed by a bank to determine accounting allowances lead to an appropriate measurement of expected credit losses
Assessment of Capital Adequacy
Banking supervisors should consider a bank’s credit risk practices when assessing a bank’s capital adequacy
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.
financial guarantee contracts (except those accounted for as insurance contracts).
IFRS 9 requires an expected loss allowance to be estimated for each of these types of asset or exposure. However, the Standard specifies three different approaches depending on the type of asset or exposure:
* optional application to trade receivables and contract assets with a significant financing component, and to lease receivables
If an entity enters into a non-monetary exchange with a customer as part of its ordinary activities, then generally it applies the guidance on non-cash consideration in the IFRS 15 Revenue standard. Non-monetary transactions IFRS 15
Non-monetary exchanges with non-customers do not give rise to revenue. If a non-monetary exchange of assets with a non-customer has commercial substance, then the transaction gives rise to a gain or loss. The cost of the asset acquired is generally the fair value of the asset surrendered, adjusted for any cash transferred. Non-monetary transactions IFRS 15
Simple bartering involves no cost as this involves exchanging goods and/or services of the same value.
A barter exchange operates as a broker and bank in which each participating member has an account that is debited when purchases are made, and credited when sales are made. Compared to one-to-one bartering, concerns over unequal exchanges are reduced in a barter exchange.
The exchange plays an important role because it provides the record-keeping, brokering expertise and monthly statements to each member. Commercial exchanges make money by charging a commission on each transaction on either the buy or sell side, or a combination of both. Non-monetary transactions IFRS 15
In general, one requirement remains in tact in non-monetary transactions, revenue cannot be recognised if the amount of revenue is not reliably measurable. Non-monetary transactions IFRS 15