Excellent Study IFRS 9 Eligible Hedged items

IFRS 9 Eligible Hedged items

the insured items of business risk exposures

Although the popular definition of hedging is an investment taken out to limit the risk of another investment, insurance is an example of a real-world hedge.

Every entity is exposed to business risks from its daily operations. Many of those risks have an impact on the cash flows or the value of assets and liabilities, and therefore, ultimately affect profit or loss. In order to manage these risk exposures, companies often enter into derivative contracts (or, less commonly, other financial instruments) to hedge them. Hedging can, therefore, be seen as a risk management activity in order to change an entity’s risk profile.

The idea of hedge accounting is to reduce (insure) this mismatch by changing either the measurement or (in the case of certain firm commitments) FRS 9 Eligible Hedged itemsrecognition of the hedged exposure, or the accounting for the hedging instrument.

The definition of a Hedged item

A hedged item is an asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that

  1. exposes the entity to risk of changes in fair value or future cash flows and
  2. is designated as being hedged

The hedge item can be:

Only assets, liabilities, firm commitments and forecast transactions with an external party qualify for hedge accounting. As an exception, a hedge of the foreign currency risk of an intragroup monetary item qualifies for hedge accounting if that foreign currency risk affects consolidated profit or loss. In addition, the foreign currency risk of a highly probable forecast intragroup transaction would also qualify as a hedged item if that transaction affects consolidated profit or loss. These requirements are unchanged from IAS 39.

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Accounting Policies to First IFRS FS

Accounting Policies to First IFRS FS – An entity must use the same accounting policies in its opening IFRS statement of financial position and throughout all periods presented in its first IFRS financial statements. Those accounting policies must comply with each IFRSs effective at the end of its first IFRS reporting period, unless there is a mandatory exception to retrospective application or an optional exemption from the requirements of IFRSs.

[IFRS 1, paras 7 – 9]Accounting Policies to First IFRS FS

Note that:

  • An entity may apply a new IFRS that is not yet mandatory if that IFRSs permits early application.
  • The transitional provisions in IFRSs do not apply to a first-time adopter’s transition to IFRSs.

Mandatory Exceptions to Retrospective Application and Optional Exemptions from Read more

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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Operating cash flows under IAS 7

Operating cash flows

Cash flows must be analysed between operating, investing and financing activities.

For operating cash flows, the direct method of presentation is preferred, but the indirect method is acceptable.

Here are the differences and similarities between the direct and indirect method. Note the subtotals for operating, investing and financing activities are the same amount in both methods!

Indirect method cash flow statement

Direct method cash flow statement

Starts with:

Starts with:

  • Profit before tax
  • Adjustment for:
    • non-cash items
    • depreciation/amortization (add back to profit)
    • gain on disposal of NCA (deduct)
    • loss in disposal of NCA (add back)
    • remove impact of accruals
    • Interest expense (add back)
    • Interest income (deduct and relocate to Investing activities)
  • Movement on working capital items
    • Receivables (deduct increase, add decrease)
    • Payables (add increase, deduct decrease)
    • Inventory (deduct increase, add decrease)
    • Interest paid (deduct)
    • Taxation (including deferred tax movements) (deduct).
  • Acquisition cash flows
  • Receipts from customers
  • Less Payments to:
    • suppliers
    • employees
    • other operating expenses
    • interest charges
    • taxation

Operating cash flows

Cash Flows from Operating activities

Cash Flows from Operating activities

  • purchase of non-current assets
  • sale/disposal of non-current assets
  • acquisition cash flows
  • interest received/dividend received on investment.

Cash Flows from Investing activities

Cash Flows from Investing activities

  • purchase of (treasure) shares
  • cash from shares issued
  • dividend payments to owners
  • take loan/issue bonds
  • acquisition cash flows
  • payments under lease agreements

Cash Flows from Financing activities

Cash Flows from Financing activities

Common cash flow classification errors in practice

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Lessee accounting under IFRS 16

Lessee accounting under IFRS 16

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]

[IFRS 16.47, IFRS 16.49]

IFRS 16 Balance sheet Profit or loss

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IFRS 16 Lessor accounting

IFRS 16 Lessor accounting

Lessors continue to classify leases as finance or operating leases.

1. Lessor accounting model

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. The lessor accounting models are also essentially unchanged from IAS 17 Leases. [IFRS 16.B53, IFRS 16.BC289]

Are the lessee and lessor accounting models consistent?

No. A key consequence of the decision to retain the IAS 17 dual accounting model for lessors is a lack of consistency with the new lessee accounting model. This can be seen in the case Lease classification below:

  • the lessee applies the right-of-use model and recognises a right-of-use asset and a liability for its obligation to make lease payments; whereas
  • the lessor continues to recognise the underlying asset and does not recognise a financial asset for its right to receive lease payments.

There are also more detailed differences. For example, lessees and lessors use the same guidance for determining the lease term and assessing whether renewal and purchase options are reasonably certain to be exercised, and termination options not reasonably certain to be exercised. However, unlike lessees, lessors do not reassess their initial assessments of lease term and whether renewal and purchase options are reasonably certain to be exercised, and termination options not reasonably certain to be exercised (see changes in the lease term in the link).

Other differences are more subtle. For example, although the definition of lease payments is similar for lessors and lessees (see lease payments in the link), the difference is the amount of residual value guarantee included in the lease payments.

  • The lessor includes the full amount (regardless of the likelihood that payment will be due) of any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.
  • The lessee includes only any amounts expected to be payable to the lessor under a residual value guarantee.

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Better Communication in Financial Reporting

Better Communication in Financial Reporting

Better Communication in Financial Reporting is an IFRS.org initiative to focus financial reporting on users. There is a general view that financial reports have become too complex and difficult to read and that financial reporting tends to focus more on compliance than communication. See also narrative reporting as a discussion on alternative ways of reporting.

At the same time, users’ tolerance for sifting through information to find what they need continues to decline.

This has implications for the reputation of companies who fail to keep pace. A global study confirmed this trend, with the majority of analysts stating that the quality of reporting directly influenced their opinion of the quality of management.

To demonstrate what companies could do to make their financial report more relevant, there are several suggestions to ‘streamline’ the financial statements to reflect some of the best practices that have been emerging globally over the past few years. In particular:

  • Information is organized to clearly tell the story of financial performance and make critical information more prominent and easier to find.
  • Additional information is included where it is important for an understanding of the performance of the company. For example, we have included a summary of significant transactions and events as the first note to the financial statements even though this is not a required disclosure.

Improving disclosure effectiveness

Terms such as ’disclosure overload’ and ‘cutting the clutter’, and more precisely ‘disclosure effectiveness’, describe a problem in financial reporting that has become a priority issue for the International Accounting Standards Board (IASB or Board), local standard setters, and regulatory bodies. The growth and complexity of financial statement disclosure is also drawing significant attention from financial statement preparers, and more importantly, the users of financial statements.

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Leveraged buyout IFRS 3 best reporting

Leveraged buyout IFRS 3 best reporting – In corporate finance, a leveraged buyout (LBO) is a transaction where a company is acquired using debt as the main source of consideration. These transactions typically occur when a private equity (PE) firm borrows as much as they can from a variety of lenders (up to 70 or 80 percent of the purchase price) and funds the balance with their own equity. Leveraged buyout IFRS 3 best reporting

1 The process and business reason

The use of leverage (debt) enhances expected returns to the private equity firm. By putting in as little of their own money as possible, PE firms can achieve a large return on equity (ROE) and internal rate of return … Read more

IFRS 7 Financial instruments Disclosures High level summary

Scope IFRS 7 Financial instruments Disclosures High level summary

IFRS 7 applies to all recognised and unrecognised financial instruments (including contracts to buy or sell non-financial assets) except:

  • Interests in subsidiaries, associates or joint ventures, where IAS 27/28 or IFRS 10/11 permit accounting in accordance with IAS 39/IFRS 9
  • Assets and liabilities resulting from IAS 19
  • Insurance contracts in accordance with IFRS 4 (excluding embedded derivatives in these contracts if IAS 39/IFRS 9 require separate accounting)
  • Financial instruments, contracts and obligations under IFRS 2, except contracts within the scope of IAS 39/IFRS 9
  • Puttable instruments (IAS 32.16A-D).

Disclosure requirements: Significance of financial instruments in terms of the financial position and performance

Statement of financial position

Statement of

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Components of Financial Statements

Components of Financial Statements – The following comprise a complete set of financial statements:

  • a statement of financial position,
  • a statement of profit or loss and other comprehensive income, presented either:
    • in a single statement that included all components of profit or loss and other comprehensive income, or
    • in the form of two separate statements:
      • one displaying components of profit or loss,
      • immediately preceding another statement beginning with profit or loss and displaying components of other comprehensive income,
  • a statement of changes in equity,
  • a statement of cash flows,
  • notes to the financial statements, comprising significant accounting policies and other explanatory information,
  • a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following:
    • a change in accounting policy,
    • a correction of an error, or
    • a reclassification of items in the financial statements, and
    • comparative information in respect of the preceding period.

Components of Financial Statements Components of Financial Statements

Components of Financial Statements

a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following

a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following a (third) statement of financial position as at the beginning of the preceding period where an entity restates comparative information following

Components of Financial Statements