## IRR How to calculate

The Internal Rate of Return (IRR) is the discount rate that makes the net present value (NPV) of a project zero. In other words, it is the expected compound annual rate of return that will be earned on a project or investment.

When calculating IRR, expected cash flows for a project or investment are given and the NPV equals zero. Put another way, the initial cash investment for the beginning period will be equal to the present value of the future cash flows of that investment. (Cost paid = present value of future cash flows, and hence, the net present value = 0).

Once the internal rate of return is determined, it is typically compared to a company’s hurdle rate or cost of capital. If the IRR is greater than or equal to the cost of capital, the company would accept the project as a good investment. (That is, of course, assuming this is the sole basis for the decision).

In reality, there are many other quantitative and qualitative factors that are considered in an investment decision). If the IRR is lower than the hurdle rate, then it would be rejected, if IRR is the only investment consideration.

Under IFRS 16 ‘Leases’, a similar calculation is used to calculate discount rates are used to determine the present value of the lease payments used to measure a lessee’s lease liability. Discount rates are also used to determine lease classification for a lessor and to measure a lessor’s net investment in a lease.

For lessees, the lease payments are required to be discounted using:

For lessors, the discount rate will always be the interest rate implicit in the lease.

The interest rate implicit in the lease is defined in IFRS 16 as ‘the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.’

The lessee’s incremental borrowing rate is defined in IFRS 16 as ‘the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment’.

The incremental borrowing rate is determined on the commencement date of the lease. As a result, it will incorporate the impact of significant economic events and other changes in circumstances arising between lease inception and commencement.

## Disclosure non-financial assets and liabilities example

The guidance for this disclosure example is provided here.

### 8 Non-financial assets and liabilities

This note provides information about the group’s non-financial assets and liabilities, including:

• specific information about each type of non-financial asset and non-financial liability
• property, plant and equipment (note 8(a))
• leases (note 8(b))
• investment properties (note 8(c))
• intangible assets (note 8(d))
• deferred tax balances (note 8(e))
• inventories (note 8(f))
• other assets, including assets classified as held for sale (note 8(g))
• employee benefit obligations (note 8(h))
• provisions (note 8(i))
• accounting policies
• information about determining the fair value of the assets and liabilities, including judgements and estimation uncertainty involved (note 8(j)).

#### 8(a) Property, plant and equipment

 Amounts in CU’000 Freehold land Buildings Furniture, fittings and equipment Machinery and vehicles Assets under construction Total At 1 January 2019 Cost or fair value 11,350 28,050 27,510 70,860 – 137,770 Accumulated depreciation – – -7,600 -37,025 – -44,625 11,350 28,050 19,910 33,835 – 93,145 Movements in 2019 Exchange differences – – -43 -150 – -193 Revaluation surplus 2,700 3,140 – – – 5,840 Additions 2,874 1,490 2,940 4,198 3,100 14,602 Assets classified as held for sale and other disposals -424 – -525 -2,215 – 3,164 Depreciation charge – -1,540 -2,030 -4,580 – 8,150 Closing net carrying amount 16,500 31,140 20,252 31,088 3,100 102,080 At 31 December 2019 Cost or fair value 16,500 31,140 29,882 72,693 3,100 153,315 Accumulated depreciation – – -9,630 -41,605 – -51,235 16,500 31,140 20,252 31,088 3,100 102,080 Movements in 2020 Exchange differences – – -230 -570 – -800 Revaluation surplus 3,320 3,923 – – – 7,243 800 3,400 1,890 5,720 – 11,810 Additions 2,500 2,682 5,313 11,972 3,450 25,917 Assets classified as held for sale and other disposals -550 – -5,985 -1,680 – -8,215 Transfers – – 950 2,150 -3,100 – Depreciation charge – -1,750 -2,340 -4,380 – -8,470 Impairment loss (ii) – -465 -30 -180 – -675 Closing net carrying amount 22,570 38,930 19,820 44,120 3,450 128,890 At 31 December 2020 Cost or fair value 22,570 38,930 31,790 90,285 3,450 187,025 Accumulated depreciation – – -11,970 -46,165 – -58,135 22,570 38,930 19,820 44,120 3,450 128,890
##### (i) Non-current assets pledged as security

Refer to note 24 for information on non-current assets pledged as security by the group.

##### (ii) Impairment loss and compensation

The impairment loss relates to assets that were damaged by a fire – refer to note 4(b) for details. The whole amount was recognised as administrative expense in profit or loss, as there was no amount included in the asset revaluation surplus relating to the relevant assets. [IAS 36.130(a)]

## Example Disclosure financial instruments

The guidance for this example disclosure financial instruments is found here.

### 7 Financial assets and financial liabilities

This note provides information about the group’s financial instruments, including:

• an overview of all financial instruments held by the group
• specific information about each type of financial instrument
• accounting policies
• information about determining the fair value of the instruments, including judgements and estimation uncertainty involved.

The group holds the following financial instruments: [IFRS 7.8]

 Amounts in CU’000 Notes 2020 2019 Financial assets Financial assets at amortised cost – Trade receivables 7(a) 15,662 8,220 – Other financial assets at amortised cost 7(b) 4,598 3,471 – Cash and cash equivalents 7(e) 55,083 30,299 Financial assets at fair value through other comprehensive income (FVOCI) 7(c) 6,782 7,148 Financial assets at fair value through profit or loss (FVPL) 7(d) 13,690 11,895 Derivative financial instruments – Used for hedging 12(a) 2,162 2,129 97,975 63,162 Example Disclosure financial instruments Financial liabilities Liabilities at amortised cost – Trade and other payables1 7(f) 13,700 10,281 – Borrowings 7(g) 97,515 84,595 – Lease liabilities 8(b) 11,501 11,291 Derivative financial instruments – Used for hedging 12(a) 766 777 12(a) 610 621 124,092 107,565

The group’s exposure to various risks associated with the financial instruments is discussed in note 12. The maximum exposure to credit risk at the end of the reporting period is the carrying amount of each class of financial assets mentioned above. [IFRS 7.36(a), IFRS 7.31, IFRS 7.34(c)]

## Measurement of remaining coverage

Measurement of remaining coverage – An entity measures the liability for remaining coverage on initial recognition of a group of insurance contracts eligible for the premium allocation approach (PAA) that are not onerous, as follows (IFRS 17 55]:

Minus Measurement of remaining coverage
• Any insurance acquisition cash flows at that date, unless the entity is eligible and chooses to recognise the payments as an expense (coverage period of a year or less)
Plus or minus Measurement of remaining coverage
• Any amount arising from the derecognition at that date, the asset or liability recognised for insurance acquisition cash flows that the entity pays or receives before the group of insurance contracts

## Venture capital valuation method

With the estimation challenges that analysts face in valuing young companies, it should come as no surprise that they look for solutions that seem to, at least on the surface, offer them a way out. Many of these solutions, though, are the source of the valuation errors we see in young company valuations. In this section, we will look at the most common manifestations of what we view as the dark side in young company valuations, and how they play out in the venture capital valuation method.

1. Top line and bottom line, no detail: It is difficult to estimate the details on cash flow and reinvestment for young companies. Consequently, many valuations of young companies focus on the top line (revenues) and the bottom line (earnings, and usually equity earnings), with little or no attention paid to either the intermediate items (that separate earnings from revenues) or the reinvestment requirements (that separate earnings from cash flows)
2. Focus on the short term, rather than the long term: The uncertainty we feel about the estimates that we make for young companies become greater as we go further out in time. Many analysts use this as a rationale for cutting short the estimation period, using only three to five years of forecasts in the valuation. “It is too difficult to forecast out beyond that point in time” is the justification that they offer for this short time horizon.
3. Mixing relative with intrinsic valuation: To deal with the inability to estimate cash flows beyond short time periods, analysts who value young companies use relative valuation as a crutch. Thus, the value at then end of the forecast period (three to five years) is often estimated by applying an exit multiple to the expected revenues or earnings in that year and the value of that multiple is itself estimated by looking at what publicly traded companies in the business trade at right now.
4. Discount rate as the vehicle for all uncertainty: The risks associated with investing in a young company include not only the traditional factors – earnings volatility and sensitivity to macroeconomic conditions, for example – but also the likelihood that the firm will not survive to make a run at commercial success. When valuing private businesses, analysts often hike up discount rates to reflect all of the concerns that they have about the firm, including the likelihood that the firm will not make it.
5. Ad hoc and arbitrary adjustments for differences in equity claims: As we noted in the last section, equity claims in young businesses can have different rights when it comes to cash flow and control and have varying degrees of illiquidity. When asked to make judgments on the value of prior claims on cash flows, superior control rights or lack of liquidity, many analysts use rules of thumb that are either arbitrary or based upon dubious statistical samples.

All five of these practices come into play in the most common approach used to value young firms, which is the venture capital approach. This approach has four steps to it:

## Determining a leases discount rate

The definition of the lessee’s incremental borrowing rate states that the rate should represent what the lessee ‘would have to pay to borrow over a similar term and with similar security, the funds necessary to obtain an asset of similar value to the right-of-use asset in a similar economic environment.’ In applying the concept of ‘similar security’, a lessee uses the right-of-use asset granted by the lease and not the fair value of the underlying asset.

This is because the rate should represent the amount that would be charged to acquire an asset of similar value for a similar period. For example, in determining the incremental borrowing rate on a 5 year lease of a property, the security for the portion of the asset being leased (i.e. the 5 year portion of its useful life) would be likely to vary significantly from the outright ownership of the property, as outright ownership would confer rights over a period of time that would typically be significantly greater than the 5-year right-of-use asset contained in the lease.

In practice, judgement may be needed to estimate an incremental borrowing rate in the context of a right-of-use asset, especially when the value of the underlying asset differs significantly from the value of the right-of-use asset.

An entity’s weighted-average cost of capital (‘WACC’) is not appropriate to use as a proxy for the incremental borrowing rate because it is not representative of the rate an entity would pay on borrowings. WACC incorporates the cost of equity-based capital, which is unsecured and ranks behind other creditors and will therefore be a higher rate than that paid on borrowings.

## A Basic Guide to Cash Flow Forecasting

Nobody wants their business to fail. Although it’s impossible to predict the future with 100% accuracy, a cash flow forecast is a tool that will help you prepare for different possible scenarios in the future.

In a nutshell, cash flow forecasting involves estimating how much cash will be coming in and out of your business within a certain period and gives you a clearer picture of your business’ financial health

### What is Cash Flow Forecasting?

Cash flow forecasting is the process of estimating how much cash you’ll have and ensuring you have a sufficient amount to meet your obligations. By focusing on the revenue you expect to generate and the expenses you need to pay, cash flow forecasting can help you better manage your working capital and plan for various positive or difficult scenarios.

A cash flow forecast is composed of three key elements: beginning cash balance, cash inflows (e.g., cash sales, receivables collections), and cash outflows (e.g., expenses for utilities, rent, loan payments, payroll).

#### Building Out Cash Flow Scenario Models

It’s always good to create best case, worst-case and moderate financial scenarios. Through cash flow forecasting, you’ll be able to see the impact of these three scenarios and implement the suitable course of action. You can use the models to predict what needs to happen especially during difficult and uncertain times.

In situations where variables shift quickly such as during a recession, it is highly recommended to review and update your cash flow forecasts regularly on a monthly or even weekly basis. By monitoring your cash flow forecast closely, you’ll be able to identify warning signs such as declining revenue or increasing expenses.

## Disclosure financial assets and liabilities

– 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:

1. prepayments made (right to receive future good or service, not cash or a financial asset)
2. tax receivables and payables and similar items (statutory rights or obligations, not contractual), or
3. 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.

## The best 1 in overview – IFRS 9 Impairment requirements

IFRS 9 Impairment requirements

forward-looking information to recognise expected credit losses for all debt-type financial assets

Under IFRS 9 Impairment requirements, recognition of impairment no longer depends on a reporting entity first identifying a credit loss event.

IFRS 9 instead uses more forward-looking information to recognise expected credit losses for all debt-type financial assets that are not measured at fair value through profit or loss.

IFRS 9 requires an entity to recognise a loss allowance for expected credit losses on:

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

## IFRS vs US GAAP Employee benefits

IFRS vs US GAAP Employee benefits

The following discussion captures a number of the more significant GAAP differences under both the impairment standards. It is important to note that the discussion is not inclusive of all GAAP differences in this area.

The significant differences and similarities between U.S. GAAP and IFRS related to accounting for investment property are summarized in the following tables.

Standards Reference

 US GAAP IFRS IAS 19 Employee Benefits

Introduction

The guidance under US GAAP and IFRS as it relates to employee benefits contains some significant differences with potentially far-reaching implications.

This narrative deals with employee benefits provided under formal plans and agreements between an entity and its employees, under legislation or through industry arrangements, including those provided under informal practices that give rise to constructive obligations.