Low credit risk operational simplification

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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IRR How to calculate

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.

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Natural disasters IFRS accounting

Natural disasters IFRS accounting

In the wake of the recent and devastating flood events in Queensland and Victoria, the destruction caused by Cyclone Yasi in Far North Queensland and the fires that have raged in Western Australia, attention for business has now turned from crisis management and clean up to addressing the longer term financial and business implications.

Business Continuity and Crisis Management

In the immediate aftermath of a disaster, the focus should be on stabilising your business.

Factors to consider include:

  • Cash flow – consider your short term cash flow requirements and evaluate how these needs might be met. This could include sourcing government grant assistance, taking advantage of concessions offered by government agencies to disaster affected business (eg ATO lodgement and payment deferrals), discussing short term financing needs with your bankers, discussions with stakeholders such as shareholders, deferring or re-prioritising (where possible) major items of expenditure and reviewing your commitments to your customers and suppliers.
  • People – employees may have been directly or indirectly impacted by the disasters, and support for staff at this time can be critical to the recovery of your business. Consideration should be given to ensuring staff are able to take an appropriate time off work (both when directly affected and also to participate in voluntary clean-up activities where appropriate), providing support services such as Employee Assistance Programs, and ensuring premises and work sites are safe. Other factors to consider include actively managing your workforce to preserve working capital, ensuring employees are focused on tasks that provide the biggest benefit to your business, and being mindful of potential legal obligations and responsibilities to employees. Above all, it is extremely important to communicate effectively with employees at times of crisis, to ensure that they remain focused on the things that matter to your business, and to ensure that a lack of information is not filled by counter-productive speculation and rumour.
  • Customers and suppliers – businesses should focus on discussing how the disasters have impacted key customers and suppliers, as disruptions to the supply-chain or sales pipeline may have significant adverse impacts on cash flow. Consideration should not just be given to those suppliers and customers directly impacted, but also to the indirect impacts (e.g. suppliers to your supplier / customers of your customer etc).

In the longer term, many businesses will need to consider and perhaps recreate their business continuity plans/crisis management strategies moving forward. Despite many businesses having these plans in place, the “acid test” of true crisis has highlighted that many businesses were not as well prepared as they thought. Many plans had never been properly tested in the past.

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Going concern and pandemics

Going concern and pandemics

IAS 1 Presentation of Financial Statements requires management, when preparing financial statements, to make an assessment of an entity’s ability to continue as a going concern, and whether the going concern assumption is appropriate.

Furthermore, disclosures are required when the going concern basis is not used or when management is aware, in making their assessment, of material uncertainties related to events or conditions that may cast significant doubt upon the entity’s ability to continue as a going concern.

Disclosure of significant judgement is also required where the assessment of the existence of a material uncertainty is a significant judgement.

In assessing whether the going concern assumption is appropriate, the standard requires that all available information about the future, which is at least, but not limited to, twelve months from the end of the reporting period, should be taken into account.

This assessment needs to be performed up to the date on which the financial statements are issued.

Refer to ‘Current vulnerability due to concentration and liquidity risks‘ below for further discussion on the current vulnerability entities are facing due to concentration and liquidity risks.

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Landlord accounting model – IFRS 16 best replacement for IAS 40

Landlord accounting model

Landlords continue to classify leases as finance or operating leases, and continue to classify many real estate leases as operating leases.

1 Overview

The lessor follows a dual accounting approach for lease accounting. The accounting is based on whether significant risks and rewards incidental to ownership of an underlying asset are transferred to the lessee, in which case the lease is classified as a finance lease. This is similar to the previous lease accounting requirements that applied to lessors.

What are the impacts of IFRS 16 on lessors?

Much of the guidance in IFRS 16 on lessor accounting is a ‘carry forward’ from IAS 17 Leases – literally a cut-and-paste. This reflects feedback from financial statement users and other stakeholders that lessor accounting was not ‘broken’.

However, there are a number of changes in the details of lessor accounting. For example, lessors apply the new:

  • definition of a lease (see this page);
  • guidance on separating components of a contract (see this page);
  • guidance on lease term (see this page);
  • guidance on lease modifications (see this page);
  • guidance on sub-lease (see this page); and
  • guidance on sale-and-leaseback (see this page).

The same definition of ‘lease term’ applies to both lessees and lessors. IFRS 16 includes guidance on when extension options and termination options are taken into consideration when determining the lease term. Additional guidance has been issued about determining the lease term – an estimate that could significantly impact the overall lease accounting.

In addition, IFRS 16 includes specific guidance on separating the components of a contract and accounting for lease modifications by lessors.

The new guidance may significantly impact the accounting for sub-leases and sale-and-leaseback transactions.

2 Lease classification

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Amortised cost and the effective interest method

Amortised cost and the effective interest method

This narrative explores the factors that an entity needs to consider in calculating the amortised cost of a financial asset or financial liability and recognising interest revenue and expense based on the effective interest rate (EIR).

Calculating amortised cost

The amortised cost of a financial asset or financial liability is calculated in the same way as under IAS 39, although IFRS 9 introduces the concept of ‘gross carrying amount’ for financial assets. The gross carrying amount is the amortised cost grossed up for the impairment allowance. The elements of amortised cost are illustrated below.

Financial assets

Financial liabilities

Fair value at initial recognition

At recognition a loan receivable or payable is recognised at fair value measured as the present value of all future cash receipts discounted using the prevailing market rate(s) of interest for a similar instrument (currency, term, etc.) with a similar credit rating.

MINUS

Principal redemptions/repayments

ADD

Periodical interest income based on the effective interest method

Periodical interest expense based on the effective interest method

MINUS

Gross carrying amount

N/A

Loss allowance

= Amortised costs

= Amortised costs

(no adjustment for loss allowance)

Calculating the EIR

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Example accounting policies

Example accounting policies

Get the requirements for properly disclosing the accounting policies to provide the users of your financial statements with useful financial data, in the common language prescribed in the world’s most widely used standards for financial reporting, the IFRS Standards. First there is a section providing guidance on what the requirements are, followed by a comprehensive example, easy to tailor to the specific needs of your company.Example accounting policies

Example accounting policies guidance

Whether to disclose an accounting policy

1. In deciding whether a particular accounting policy should be disclosed, management considers whether disclosure would assist users in understanding how transactions, other events and conditions are reflected in the reported financial performance and financial position. Disclosure of particular accounting policies is especially useful to users where those policies are selected from alternatives allowed in IFRS. [IAS 1.119]

2. Some IFRSs specifically require disclosure of particular accounting policies, including choices made by management between different policies they allow. For example, IAS 16 Property, Plant and Equipment requires disclosure of the measurement bases used for classes of property, plant and equipment and IFRS 3 Business Combinations requires disclosure of the measurement basis used for non-controlling interest acquired during the period.

3. In this guidance, policies are disclosed that are specific to the entity and relevant for an understanding of individual line items in the financial statements, together with the notes for those line items. Other, more general policies are disclosed in the note 25 in the example below. Where permitted by local requirements, entities could consider moving these non-entity-specific policies into an Appendix.

Change in accounting policy – new and revised accounting standards

4. Where an entity has changed any of its accounting policies, either as a result of a new or revised accounting standard or voluntarily, it must explain the change in its notes. Additional disclosures are required where a policy is changed retrospectively, see note 26 for further information. [IAS 8.28]

5. New or revised accounting standards and interpretations only need to be disclosed if they resulted in a change in accounting policy which had an impact in the current year or could impact on future periods. There is no need to disclose pronouncements that did not have any impact on the entity’s accounting policies and amounts recognised in the financial statements. [IAS 8.28]

6. For the purpose of this edition, it is assumed that RePort Co. PLC did not have to make any changes to its accounting policies, as it is not affected by the interest rate benchmark reforms, and the other amendments summarised in Appendix D are only clarifications that did not require any changes. However, this assumption will not necessarily apply to all entities. Where there has been a change in policy, this will need to be explained, see note 26 for further information.

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Capitalisation of expenditure – 1 Complete answer

Capitalisation of expenditure

Capitalisation of expenditure is only possible when one of the following situations occur:

  • Capital expenditure (including equipment repairs and maintenance)
  • Recording lease contracts – Right-of-Use Assets
  • Capitalisation of borrowing costs
  • Capitalisation of cloud computing costs
  • Capitalisation of intangible assets
  • Capitalisation of internally capitalized intangible assets
  • Research & development costs
  • Prepaid expenses

Capital expenditure (including equipment repairs and maintenance)

The cost of an item of property, plant and equipment under IAS 16 Property, plant and equipment shall be recognised as an asset if, and only if:

  • it is probable that future economic benefits associated with the item will flow to the entity; and
  • the cost of the item can be measured reliably. (IAS 16.7)

Investment property

Certain properties which are used on rental are classified as an investment property in which case IAS 40 Investment property will apply. Only tangible items which have a useful life of more than one period are classified as property, plant and equipment as per IAS 16. But refer to the words “more than one period” as more than one accounting period of 12 months.

Also, an entity shall determine a threshold limit commensurate to its size for recognizing a tangible item as property, plant and equipment. For example, a tangible item of insignificant amount although satisfying the definition of property, plant and equipment may be expensed.

Initial recognition of indirect costs

Items of property, plant and equipment may be acquired for safety or environmental reasons. The acquisition of such property plant and equipment, although not directly increasing the future economic benefits of any particular existing item of property, plant and equipment, may be necessary for an entity to obtain the future economic benefits from its other assets.

Such items of property plant and equipment qualify for recognition as assets because they enable an entity to derive future economic benefits from related assets in excess of what could be derived had those items not been acquired.

Subsequent recognition of indirect costs

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Equity – 2 understand it all at best

Equity

There are, at least, two ways to discuss equity:

  • Equity is the residual interest in the assets of the entity after deducting all its liabilities, or
  • An equity instrument is any contract that evidences a residual interest in the assets of an entity after deducting all of its liabilities.

But also:

1. Equity the residual interest in the assets of the entity after deducting all its liabilities

1. Statement of Financial Position

Assets

Equity and liabilities

1. Non-current assets

2. Current assets

Help

Help

A – TOTAL ASSETS [1 + 2] = B

3. Non-current liabilities (including Provisions)

4. Current liabilities (including Provisions)

5. Equity [1 + 2 -/- 3 -/- 4]

Help

B – TOTAL EQUITY AND LIABILITIES [3 + 4 + 5] = A

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Disclosure non-financial assets and liabilities example

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

Net carrying amount

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

Net carrying amount

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

Acquisition of subsidiary

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

Net carrying amount

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)]

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