Investments

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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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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Example accounting policies

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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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Startup valuation

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Startup valuation

If every business starts with an idea, young companies can range the spectrum. Some are unformed, at least in a commercial sense, where the owner of the business has an idea that he or she thinks can fill an unfilled need among consumers.

Others have inched a little further up the scale and have converted the idea into a commercial product, albeit with little to show in terms of revenues or earnings. Still others have moved even further down the road to commercial success, and have a market for their product or service, with revenues and the potential, at least, for some profits.

Startup valuationSince young companies tend to be small, they represent only a small part of the overall economy. However, they tend to have a disproportionately large impact on the economy for several reasons.

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The Statement of Cash Flows

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Statement of Cash Flows

IAS 7.10 requires an entity to analyse its cash inflows and outflows into three categories:

  • Operating;
  • Investing; and
  • Financing.

IAS 7.6 defines these as follows:

‘Operating activities are the principal revenue producing activities of the entity and other activities that are not investing or financing activities.’

‘Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.’

‘Financing activities are activities that result in changes in the size and composition of the contributed equity and borrowings of the entity.’

1. Operating activities

It is often assumed that this category includes only those cash flows that arise from an entity’s principal revenue producing activities.

However, because cash flows arising from operating activities represents a residual category, which includes any cashStatement of cash flows flows that do not qualify to be recorded within either investing or financing activities, these can include cash flows that may initially not appear to be ‘operating’ in nature.

For example, the acquisition of land would typically be viewed as an investing activity, as land is a long-term asset. However, this classification is dependent on the nature of the entity’s operations and business practices. For example, an entity that acquires land regularly to develop residential housing to be sold would classify land acquisitions as an operating activity, as such cash flows relate to its principal revenue producing activities and therefore meet the definition of an operating cash flow.

2. Investing activities

An entity’s investing activities typically include the purchase and disposal of its intangible assets, property, plant and equipment, and interests in other entities that are not held for trading purposes. However, in an entity’s consolidated financial statements, cash flows from investing activities do not include those arising from changes in ownership interest of subsidiaries that do not result in a change in control, which are classified as arising from financing activities.

It should be noted that cash flows related to the sale of leased assets (when the entity is the lessor) may be classified as operating or investing activities depending on the specific facts and circumstances.

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Acquisitions and mergers as per IFRS 3

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Acquisitions and mergers

Acquisitions and mergers are becoming more and more common as entities aim to achieve their growth objectives. IFRS 3 ‘Business Combinations’ contains the requirements for these transactions, which are challenging in practice.

This narrative sets out how an entity should determine if the transaction is a business combination, and whether it is within the scope of IFRS 3.

Identifying a business combination

IFRS 3 refers to a ‘business combination’ rather than more commonly used phrases such as takeover, acquisition or Acquisitions and mergersmerger because the objective is to encompass all the transactions in which an acquirer obtains control over an acquiree no matter how the transaction is structured. A business combination is defined as a transaction or other event in which an acquirer (an investor entity) obtains control of one or more businesses.

An entity’s purchase of a controlling interest in another unrelated operating entity will usually be a business combination (see case below).

Case – Straightforward business combination

Entity T is a clothing manufacturer and has traded for a number of years. Entity T is deemed to be a business.

On 1 January 2020, Entity A pays CU 2,000 to acquire 100% of the ordinary voting shares of Entity T. No other type of shares has been issued by Entity T. On the same day, the three main executive directors of Entity A take on the same roles in Entity T.

Consider this…..

Entity A obtains control on 1 January 2020 by acquiring 100% of the voting rights. As Entity T is a business, this is a business combination in accordance with IFRS 3.

However, a business combination may be structured, and an entity may obtain control of that structure, in a variety of ways.

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Fair value employee share options in IFRS 2

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Fair value employee share options

Share options give the holder the right to buy the underlying shares at a set price, called the ‘exercise price’, over or at the end of an agreed period. If the share price exceeds the option’s exercise price when the option is exercised, then the holder of the option profits by the amount of the excess of the share price over the exercise price. Benefit is derived from the right under the option to buy a share for less than its value.

The holder’s cost is the exercise price, whereas the value is the share price. It is not necessary for the holder to sell the share for this profit to exist. Sale only results in realisation of the profit. Because an option holder’s profit increases as the underlying share price increases, share options are used to incentivise employees to contribute to an increase in the price of the underlying shares.

Employee options are typically call options, which give holders the right but not the obligation to buy shares. However, other types of options are also traded in markets. For example, put options give holders the right to sell the underlying shares at an agreed price for a set period.

Given that holders of put options profit when share prices fall below the exercise price, such options are not viewed as aligning the interests of employees and shareholders. All references in this section to ‘share options’ are to employee call options.

Share options granted by entities often cannot be valued with reference to market prices. Many entities, even those whose shares are quoted publicly, do not have options traded on their shares. Options that trade on recognised exchanges such as the Chicago Board Options Exchange are created by market participants and are not issued by entities directly.

Even when there are exchange-traded options on an entity’s shares for which prices are available, the terms and conditions of these options are generally different from the terms and conditions of options issued by entities in share-based payments and, as a result, the prices of such traded options cannot be used directly to value share options issued in a share-based payment.

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Equity – 2 understand it all at best

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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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