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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Employee benefits accounting policies

Employee benefits accounting policies

This is a separated part of the example accounting policies, it is separated because of the size of this note and the specific nature of employee benefits.

Example accounting policies – Introduction

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. Here is a section providing guidance on what the requirements are, below a comprehensive example is provided, easy to tailor to the specific needs of your company.

Employee benefits Guidance

Presentation and measurement of annual leave obligations

RePort Plc has presented its obligation for accrued annual leave within current employee benefit obligations. However, it may be equally appropriate to present these amounts either as provisions (if the timing and/or amount of the future payments is uncertain, such that they satisfy the definition of ‘provision’ in IAS 37) or as other payables.

For measurement purposes, we have assumed that RePort Plc has both annual leave obligations that are classified as Employee benefits accounting policiesshort-term benefits and those that are classified as other long-term benefits under the principles in IAS 19. The appropriate treatment will depend on the individual facts and circumstances and the employment regulations in the respective countries.(IAS19(8),(BC16)-(BC21))

To be classified and measured as short-term benefits, the obligations must be expected to be settled wholly within 12 months after the end of the annual reporting period in which the employee has rendered the related services. The IASB has clarified that this must be assessed for the annual leave obligation as a whole and not on an employee-by-employee basis.

Share-based payments – expense recognition and grant date

Share-based payment expenses should be recognised over the period during which the employees provide the relevant services. This period may commence prior to the grant date. In this situation, the entity estimates the grant date fair value of the equity instruments for the purposes of recognising the services received during the period between service commencement date and grant date.(IFRS2(IG4))

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Disclosure equity

Disclosure equity

Get the requirements for properly disclosing equity as the owners’ balance of assets less liabilities 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.

Disclosure equity guidance

Share premium

IAS 1 requires disclosure of the par RePort of shares (if any), but does not prescribe a particular form of presentation for the share premium. RePorting Co. is disclosing the share premium in the notes. However, local company laws may have specific rules. For example, they may require separate presentation in the balance sheet. [IAS 1.79(a)]

Treasury shares

IAS 32 states that treasury shares must be deducted from equity and that no gain or loss shall be recognised on the Disclosure equitypurchase, sale, issue or cancellation of such shares. However, the standard does not specify where in equity the treasury shares should be presented. RePorting Co. has elected to present the shares in ‘other equity’, but they may also be disclosed as a separate line item in the balance sheet, deducted from retained earnings or presented in a specific reserve. Depending on local company law, the company may have the right to resell the treasury shares. [IAS 32.33]

Other reserves

An entity shall present, either in the statement of changes in equity or in the notes, for each accumulated balance of each class of other comprehensive income a reconciliation between the carrying amount at the beginning and the end of the period, separately disclosing each item of other comprehensive income and transactions with owners. See also commentary paragraphs 2 and 3 to the statement of changes in equity. [IAS 1.106(d)]

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Acquisitions and mergers as per IFRS 3

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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Accounting for mergers – Best 2 Read

Accounting for mergers

Mergers and acquisitions (business combinations) can have a fundamental impact on the acquirer’s operations, resources and strategies. For most entities such transactions are infrequent, and each is unique. IFRS 3 ‘Business Combinations’ contains the requirements for accounting for mergers, which are challenging in practice.

This narrative provides a high-level overview of IFRS 3 and explains the key steps in accounting for business combinations in accordance with this Standard. It also highlights some practical application issues dealing with:

  • how to avoid unintended accounting consequences when bringing two businesses together, and
  • deal terms and what effect they can have on accounting for business combinations.

The acquisition method in accounting for mergers

IFRS 3 establishes the accounting and reporting requirements (known as ‘the acquisition method’) for the acquirer in a business combination. The key steps in applying the acquisition method are summarised below:

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Fair value employee share options in IFRS 2

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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Option valuation models

Option valuation models

Option valuation models use mathematical techniques to identify a range of possible future share prices at the exercise date. From these possible future share prices, the pay-off of an option can be calculated. These intrinsic values at exercise are then probability-weighted and discounted to their present value to estimate the fair value of the option at the grant date.

This narrative is part of the IFRS 2 series, look here.

Model selection

There are three main models used to value options:

  • closed-form models: e.g. the BSM model;
  • lattice models; and
  • simulation models: e.g. Monte Carlo models.

These models generally result in very similar values if the same assumptions are used. However, certain models may be more restrictive than others – e.g. in terms of the different pay-offs that can be considered or assumptions that can be incorporated.

For example, a BSM model incorporates early exercise behaviour by using an expected term assumption that is shorter than the contractual life, whereas a lattice model or Monte Carlo model can incorporate more complex early exercise behaviour.

Simple model explanation

The approach followed in, for example, a lattice model illustrates the principles used in an option valuation model in a simplified manner.

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Modifications of employee share-based payment IFRS 2

Modifications of employee share-based payment transactions

  • The accounting for a modification depends on whether the modification changes the classification of the arrangement and whether the changes are beneficial to the employee.
  • As a minimum, the original grant-date fair value of the equity instruments granted is recognised under modification accounting.
  • Modifications that increase the fair value of the grant result in recognition of the incremental fair value measured at the date of modification.
  • Modifications that increase the number of equity instruments granted result in recognition of the fair value of the additional equity instruments, measured at the date of modification.
  • Other beneficial modifications – e.g. changes to service conditions or non-market performance conditions – are taken into account in applying the modified grant-date method.
  • Modifications that are not beneficial for the employee do not affect the total share-based payment cost.
  • Cancellations by the employee or by the entity result in accelerated vesting.
  • Compensation payments made for cancellations by the employer are recognised as a repurchase of equity interests. To the extent that a compensation payment exceeds the fair value of the equity instruments granted at the repurchase date, it is recognised as an expense.
  • Replacement awards need to be identified as such by the employer at the date when the new award is granted.
  • Replacement awards are accounted for by applying the principles of modification accounting, rather than as a separate new award and cancellation of the unvested old award.

This narrative contains guidance on modifications of share-based payment transactions with employees. There are no specific requirements for cash-settled share-based payments that are modified or cancelled because cash-settled share-based payments are remeasured to the ultimate cash payment

The modification requirements also apply to share-based payment transactions with parties other than employees that are measured indirectly – i.e. with reference to the fair value of the equity instruments granted. In this case, any reference to grant date is read as a reference to the applicable measurement date under those transactions – i.e. the date when the goods or services are received.

As a basic principle, IFRS 2 requires an entity to recognise, as a minimum, the original grant-date fair value of the equity instruments granted unless those equity instruments do not vest because of failure to meet any service and non-market performance conditions under the original terms and conditions. (IFRS 2.27)

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Employee share purchase plans

Employee share purchase plans

In an ESPP, the employees are usually entitled to buy shares at a discounted price. The terms and conditions can vary significantly and some ESPPs include option features. (IFRS 2.IG17)

In my view, the predominant feature of the share-based payment arrangement determines the accounting for the entire fair value of the grant. That is, depending on the predominant features, a share purchase plan is either a true ESPP or an option plan.

All of the terms and conditions of the arrangement should be considered when determining the type of equity instruments granted and judgement is required. The determination is important because the measurement and some aspects of the accounting for each are different (see below).

Options are characterised by the right, but not the obligation, to buy a share at a fixed price. An option has a value (i.e. the option premium), because the option holder has the benefit of any future gains and has none of the risks of loss beyond any option premium paid. The value of an option is determined in part by its duration and by the expected volatility of the share price during the term of the option.

In my view, the principal characteristic of an ESPP is the right to buy shares at a discount to current market prices. ESPPs that grant short-term fixed purchase prices do not have significant option characteristics because they do not allow the grant holder to benefit from volatility. I believe that ESPPs that provide a longer-term option to buy shares at a specified price are, in substance, option plans, and should be accounted for as such. (IFRS 2.B4-B41)

Examples of other option features that may be found in ESPPs are: (IFRS 2.IG17)

  • ESPPs with look-back features, whereby the employees are able to buy shares at a discount, and choose whether the discount is applied to the entity’s share price at the date of the grant or its share price at the date of purchase;
  • ESPPs in which the employees are allowed to decide after a significant period of time whether to participate in the plan; and
  • ESPPs in which employees are permitted to cancel their participation before or at the end of a specified period and obtain a refund of any amounts paid into the plan.

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Determination of grant date in IFRS 2

Determination of grant date

The determination of grant date is important because this is the date on which the fair value of equity instruments granted is measured. Usually, grant date is also the date on which recognition of the employee cost begins. However, this is not always the case (Service commencement date and grant date in Determination of the vesting period).

Grant date’ is the date at which the entity and the employee agree to a share-based payment arrangement, and requires that the entity and the employee have a shared understanding of the terms and conditions of the arrangement. (IFRS 2.A)

In order for the employer and the employee to ‘agree’ to a share-based payment transaction, there needs to be both an offer and an acceptance of that offer. (IFRS 2.IG2)

Approval and communication by the employer

If the agreement is subject to an approval process, then the grant date cannot be before the date on which that approval is obtained. If a grant is made subject to approval – e.g. by a board of directors – then the grant date is normally when that approval is obtained.

The arrangement also needs to be communicated to the employees to achieve grant date.

In a broad-based unilateral grant of a share-based payment, there is often a period of time between board approval and communication of the terms of the award to individual employees. In some entities, the terms and conditions of the awards are communicated to each employee by their direct supervisor. Because of the varying schedules of employees and employers, it is possible that different employees may be informed of their awards on different dates.

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