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22/01/2015
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Gavin Aspden FCA
Director, Qualifications. ICAEW
IFRS Update
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Today’s programme
• General direction
• Leasing project
• Revenue (IFRS 15)
• Financial instruments (IFRS 9)
• Fair values (IFRS 13)
• Group Accounting (IFRSs 10, 11 and 12)
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Convergence with US GAAP
“For issues of primary interest
to stakeholders in U. S. capital
markets, the FASB will set its
own agenda.”Quote from FASB website
Major projects:
Financial instruments
Leases
Revenue
Significant differences exist between some of the FASB and IASB ‘solutions’
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Leasing
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Recap...
How to do you determine if a lease is a finance lease or an operating lease under current IFRS (IAS17)?
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Lease Accounting –Proposals
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Why a leases project?
Lessee• Most assets and liabilities
are off-balance sheet• Limited information about
operating leases
Lessor• Lack of transparency
about residual values• Consistency with lessee
proposals and revenue proposals
7
$1.25 trillion of off-balance-sheet operating lease commitments for SEC registrants*
* Estimate according to the 2005 SEC report on off-balance-sheet
activities
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Lease Accounting – first proposal
Proposal - Single Accounting Model
IAS 17
Operating
lease
A lease other
than a finance
lease
Finance lease
Transfers
substantially all
the risks and
rewards of
ownership to the
lessee
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Lease Accounting – second proposal
Proposal - Dual Accounting Model recognising that all
leases are not the same, type A and type B leases
IAS 17
Operating
lease
A lease other
than a finance
lease
Finance lease
Transfers
substantially all
the risks and
rewards of
ownership to the
lessee
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Lease Accounting – third (and final?) proposal
Proposal - Single Accounting Model
IAS 17
Operating
lease
A lease other
than a finance
lease
Finance lease
Transfers
substantially all
the risks and
rewards of
ownership to the
lessee
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Comment letter sent into FASB Lyles & McCarty LLP – industry frustration
Let's cut to the meat of the issue:
1. a lease is a lease is a lease and should be accounted for as such;
2. the 300+ page proposal as written has been a waste of manpower, brainpower and paper. If this proposal cannot be condensed to one double-spaced sheet of paper, it should be thrown out entirely; and,
3. rather than waste more time on such issues, all previous pronouncements, edicts, white papers, regulations, etc. should be reviewed and also reduced to a single page each. If this cannot be done, they should also be thrown out.
Larry L Lyles
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Lessee accounting – identifying a lease
Where are we today? Where might we be?
A lease conveys the right to use a specific asset for a period of time.
A lease conveys the right to control the use of a specified asset for a period of time.
Right to control use
• direct use of asset; and
• obtain benefits from that use.
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Lease measurement
• Simplification
– Exclude variable payments
– Exclude most optional payments
– 12-month minimum duration
– Further discussions on going regarding small assets like laptops
and office furniture
Measure lease assets and liabilities at the present value of
future lease payments
(lease assets include costs directly related to entering into the lease)
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
ICAEW’s Formal Opinion
• Our formal response letter is available here
– (its only 11 pages if you are interested...)
• http://www.icaew.com/~/media/Files/Technical/Financial-reporting/IFRS/icaew-rep-117-13-no-signature.pdf
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
What next... From the IASB’s own report
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
IFRS 15Revenue Recognition
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Revenue recognition
Exposure draft Key concerns Redeliberations Second exposure draft
A single revenue
recognition model,
removing the current
distinction between goods
and services
Focus on when the
customer obtains control of
whatever is being supplied
Lack of clarity about how
and when revenue relating
to some services will be
recognised
Various matters of detail
Basic five step model
unchanged
More guidance on when
revenue can be recognised
over time
Lots of minor tweaks made
Issued November 2011
Final standard issued May
2014
Effective date of new
standard 1 January 2017
IFRS 15 Issued May 2014Effective 1 January 2017
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
A principles-based standards
IFRS 15 is a new principles-based revenue recognition standard
IFRS 15 is almost completely converged with US GAAP
IFRS 15 supersedes IAS 11, IAS 18, IFRIC 13, IFRIC 15, IFRIC 18 and SIC-31
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Who will be affected and to what extent?
For some entities – timing of revenue and profit recognition may be significantly affected
For most entities – need to consider impact on existing systems and processes
Don’t underestimate implementation / transition and disclosure challenges
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
The ‘five step’ approach
A company should recognise revenue to depict the transfer of promised goods or services to the customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or
services
Core principle
Steps in applying the core principle
Identify the
contract(s)
with
the customer
Identify the
performance
obligations in
the contract
Determine
the
transaction
price
Allocate the
transaction
price
Recognise
revenue when
or as a
performance
obligation is
satisfied
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Step 1 – Identify the contract(s) withthe customer
• A contract creates enforceable rights and obligations
• It may be written, verbal, or implied by customary business practice
• A contract must have commercial substance
• It must be more likely than not that an entity will collect consideration from the customer
• It may be necessary to combine two or more contracts entered into at or near the same time with the same customer and account for them as a single contract
• As a practical expedient, an entity may apply the standard to a portfolio of contracts with similar characteristics
• IFRS 15 also provides guidance on contract modifications
Identify the
contract(s)
with
the customer
Identify the
performance
obligations in
the contract
Determine
the
transaction
price
Allocate the
transaction
price
Recognise
revenue when
or as a
performance
obligation is
satisfied
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Step 2 – Identify the performance obligations in the contract
• A contract may contain one or more performance obligations ie, promises to transfer what are known as ‘distinct’ goods or services to a customer
• It is often necessary to break individual contracts down into a series of ‘distinct’ goods and services
• Goods and services are ‘distinct’ if:
– the customer can benefit from the good or service on its own or together with other resources
that are readily available to the customer ie, the goods or services are capable of being distinct;
and
– the entity’s promise to transfer the goods or services to the customer is separately identifiable
from other promises in the contract ie, the goods or services are distinct in the context of the
contract
Identify the
contract(s)
with
the customer
Identify the
performance
obligations in
the contract
Determine
the
transaction
price
Allocate the
transaction
price
Recognise
revenue when
or as a
performance
obligation is
satisfied
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Step 3 – Determine the transaction price
• An entity must consider the terms of the contract and its customary business practices to determine the transaction price
• In many cases it will simply be the price specified by the contract, excluding any amounts collected on behalf of third parties such as sales taxes
• While the transaction price will usually be easy to determine when it is a fixed amount at the time of sale, it will be more complicated in other cases, for example when the amount could vary in the future based on contract terms or if consideration is in forms other than cash
• The transaction price is adjusted for the time value of money when a contract contains a significant financing component
• The transaction price is not otherwise adjusted for collectability
Identify the
contract(s)
with
the customer
Identify the
performance
obligations in
the contract
Determine
the
transaction
price
Allocate the
transaction
price
Recognise
revenue when
or as a
performance
obligation is
satisfied
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Step 4 – Allocate the transaction price
• When a contract contains more than one performance obligation, it will be necessary to allocate the transaction price to each of these
• This is usually done in proportion to the stand-alone selling price of the goods or services underlying each performance obligation
• If a stand-alone selling price is not directly observable, it should be estimated by considering all information that is reasonably available
• The standard specifies that an entity should allocate a discount to all promised goods or services in the contract unless the entity has observable evidence that the discount relates to one or more, but not all, performance obligations in the contract
• The standard also contains guidance on whether variable consideration should be allocated to the entire contract or to specific parts thereof
Identify the
contract(s)
with
the customer
Identify the
performance
obligations in
the contract
Determine
the
transaction
price
Allocate the
transaction
price
Recognise
revenue when
or as a
performance
obligation is
satisfied
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Example
• An entity offers a 'free' phone with a standalone selling price of £200 to a customer who signs a two-year contract paying £30 a month or £720 in total over the life of the contract for telecoms services
• The standalone selling price of the telecoms services is estimated as £25 a month or £600 in total over the life of the contract
• Under its current practice the entity recognises no revenue upfront and simply recognises £30 a month over the life of the contract
• Under the new standard the entity would have to allocate the total revenue to the phone and the telecoms services in proportion to their stand-alone selling prices
Current practice IFRS 15
Phone £0 recognised upfront £180 recognised upfront ie, (200/(600+200))*£720
Telecoms services Recognise £30 a month over the life of the
contract
The remaining £540 is allocated to the telecoms services & recognised at £22.50 a month over the
life of the contract
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Step 5 – Recognise revenue when or as a performance obligation is satisfied
• Performance obligations are settled by transferring the goods or services to the customer
• This occurs when the customer obtains control of the goods or services ie, when the customer has the ability to direct the use of and obtain the benefits from the goods or services
• At the inception of the contract an entity will need to determine whether control is transferred – and revenue recognised – over time or at a point in time
Identify the
contract(s)
with
the customer
Identify the
performance
obligations in
the contract
Determine
the
transaction
price
Allocate the
transaction
price
Recognise
revenue when
or as a
performance
obligation is
satisfied
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Over time or at a point in time?
An entity recognises revenue over time if one or more of the following criteria is met
The customer simultaneously receives and consumes the benefits of the entity’s performance as the entity performs
The entity’s performance creates or enhances an asset that the customer
controls as the asset is created or enhanced
The entity’s performance does not create an asset with an alternative use to the entity and the entity has an enforceable right to
payment for the performance completed to date
Otherwise revenue is recognised at the point in
time when control is transferred to the customer
The entity has a present right to payment for the asset
The customer has legal title to the asset
The entity has transferred physical possession of the asset
The customer has the significant risks and rewards of ownership of the asset
The customer has accepted the asset
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Also provided
• Application Guidance (within the standard – appendix B)
– 17 pages
• Illustrative examples
– 83 pages (!)
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
IFRS 9Financial Instruments: recognition and measurement
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Financial instruments
Project phase Exposure draft Status / next steps
1a. Classification & measurement of financial assets
Jul 2009 IFRS 9 published in Nov 2009
Redeliberations on-going
1b. Classification &measurement of financial liabilities
May 2010 Added to IFRS 9 in Oct 2010
2. Impairment Original ED in Nov 2009
Supplement in Jan 2011
Second ED in Mar 2013
Finalised deliberations in Feb 2014
Added to IFRS 9 in July 2014
3a. General hedge accounting
Dec 2010 Added to IFRS 9 in Nov 2013
3b. Macro hedge accounting
De-coupled from IFRS 9 project in May 2012
Discussion paper issued in April 2014 (Comments by Oct 2014)
X
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Introduction
IAS 32
Presentation (1995)
Accounting for financial instruments
IAS 39
Recognition
and
measurement
(1998)
IFRS 7
Disclosures
(2005)
IFRS 9
Recognition
and
measurement
(2009-2018)
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Transition
• When does IFRS 9 become mandatory?
– Annual periods beginning on or after 1 January 2018
– Early adoption permitted but
– Cannot early adopt earlier editions of IFRS 9 after 1 February 2015
– After 1 February 2015 then all provisions of the standard must be adopted
– Full retrospective application on adoption but
– Restatement of comparatives is not required but is permitted if it can be done without the benefit of hindsight
– If comparatives are not restated the opening balance of its retained earnings should be adjusted
– Operational simplifications exist to ease retrospective application
– Applied at the date of initial application which must be the beginning of a reporting period after the standard is issued
– Due to phased implementation, this could result in more than one date of initial application
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Transition
• Entities that have applied IFRS 9 (2009), IFRS 9 (2010) or IFRS 9 (2013) early
– Apply transition rules at relevant date of initial application
– However the transitional provisions can only be applied once
– Ability to review designations of financial assets and liabilities to
FVTPL
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Held to maturity
Long-term
Fixed maturity
Positive intent & ability
At FV through P/L
Short-term
Held for trading
Available for sale
Medium to long-term
Sell as and when
Initial measurement
Subsequent measurement
Fair value
Include transaction costs
Fair value
Exclude transaction costs
Amortised cost
Fair value with gains & losses to OCI
Fair value with gains & losses to profit or loss
Loans & receivables
Fixed or determinable payments
Not quoted in an active market
IAS 39
Financial assets – a quick reminder
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Financial assets – new model summary
All other instrumentsEquities, derivatives & some hybrid contracts
+
No bifurcation
Reclassification required where business model changes
Fair value through P&L
Fair value option
Accounting mismatches only
Option to take gains & losses to OCI for equities
No recycling
Contractual cash flow characteristics
Business model test
+
Hold to
collect
Hold to
collect
and sell
Amortised
cost
Fair value
through
OCI
IFRS 9
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
• Factors to consider:
– The way assets are managed
– How performance is reported
– How management are compensated
– Frequency, timing and volume of
sales in prior periods
– Expectations of future sales activity
– Why past and future sales have or
will be made
• Sales in ‘stress case’ scenarios do not disqualify hold to collect
• Entity forced by regulator to routinely sell significant volumes to demonstrate liquidity of assets will fail hold to collect business model
Contractual cash flow
characteristics
Business model test
+
IFRS 9
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
• Principal
• Interest in principal outstanding
• Time value of money
• Credit risk
• Leverage / multiples
• Non-financial variables
• Conversion features
Contractual cash flow
characteristics
Business model test
+
Do contractual cash
flows represent solely
payments of principal
and interest (SPPI)?
4
44
45555
5555
5555
IFRS 9
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Equity instruments
All other instruments
Equities, derivatives & some hybrid contracts
Fair value through P&L
Option to take gains
& losses to OCI for equities
No recycling
Is the instrument held for trading?
Does the instrument meet the definition of equity in its entirety under IAS 32?
Has the entity
elected fair value through OCI
No
No
NoYes
Yes
Yes
• Election made at initial recognition
• Election is irrevocable
IFRS 9
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Financial liabilities
Retain IAS 39 measurement requirements
Held for trading
Vanilla liabilities
Hybrid instruments
Fair value through P&L
Amortised cost
Bifurcation
Maintain fair value option – but with one amendment regarding ‘own credit risk’
IFRS 9
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Impairment
Incurred loss model
• Currently used by IAS 39
• Credit losses are recognised only if an event has occurred that has a negative effect on future cash flows & that effect can be reliably estimated
• An entity is not permitted to consider the effects of future expected losses
The challenge
• ‘Financial meltdown’
• ‘Too big to fail’
• ‘Cliff effect’• ‘Risk taking’
• ‘Unrealised v realised profits’
• ‘Complex disclosures’
• ‘G20, Governments and politics’
• ‘Bonus culture’
Expected loss model
• Proposed way forwards
• Requires an entity to make an ongoing assessment of expected credit losses
• Will require earlier recognition of credit losses in many cases
IFRS 9
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BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Concerns from philosophy and psychology (!)
• Optimism/pessimism paradigm
– How do we feel v supportable estimation modelling
– Use of judgement
– Media impact - an understand (ability) problem
• Game theory
– Jump before they jump to market lead?
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
IASB’s approach v FASB’s approach
• Fundamental difference in views
• ‘Complexity v ‘Simplicity’
• ‘Prudence’ v ‘Reality’
• IASB fieldwork in 2013
– Portfolios excluding mortgages
– IAS 39 to IFRS 9 predicts increase in loss allowance of 25-60%
– IAS 39 to FASB model predicts increase in loss allowance of 50-140%
– Mortgage portfolios
– IAS 39 to IFRS 9 predicts increase in loss allowance of 30-250%
– IAS 39 to FASB model predicts increase in loss allowance of 130-730%
– Caveat – only 15 companies took part in the survey
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How will impairment provisions change?
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Expected loss model…
• On initial recognition • Interest revenue
calculated on gross carrying amount
• Lifetime losses from default inside 12 months weighted by probability of default in 12 months
Stage 1
• If more than insignificant deterioration in credit quality & likelihood of loss event reasonably possible
• Interest revenue calculated on gross carrying amount
• Lifetime expected loss allowance
Stage 2
• If deteriorate to credit-impaired
• Interest revenue calculated on net carrying amount
• Lifetime expected loss allowance
Stage 3
IFRS 9
Performing Underperforming Non-performing
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Scope exclusions
• Includes both originated and purchased credit-impaired assets
• Outside of scope of the above model
• Use credit adjusted effective interest rate
• No day 1 allowance balance
• No day 1 impairment loss recognised
• Allowance balance represents changes in lifetime loss expectations
• Consistent with IAS 39 (AG5)
Financial assets credit impaired on initial recognition
• Practical expedient to enable entities to calculate losses using certain current practices eg, group receivables by age and applying historical loss rates
• Implied application to non-financial services entities
• Recognition of full lifetime expected loss on a matrix model basis
Trade receivables without a significant financing
component
IFRS 9
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Low credit risk
• If the credit risk is determined to be low at the reporting date
– Impairment can be measured using 12-month ECL
– Presumption that no significant increase in credit risk has occurred
There is a low risk of default
Borrower has strong capacity to meet obligations in
the short term
Adverse changes in economic or
business conditions
in the longer term wont necessarily reduce ability to fulfil obligations
• Risk is evaluated without consideration of collateral
• Not considered low risk just through comparison to entity’s other instruments or the jurisdiction in which the entity operates
• Internal ratings are permitted providing consistent with a global rating
definition of ‘investment grade’
• If no longer ‘low risk’ it does not automatically move to Stage 2
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Stage 1 – clarity
• An entity calculates ‘12 month expected credit losses’ by multiplying the probability of a default occurring in the next 12 months by the total lifetime credit losses that would result from that default
• They are NOT the expected cash shortfalls over the next twelve months
• They are NOT the credit losses on instruments that are forecast to default in the next twelve months.
– If they are identified as such then they would either be stage 2 or 3
or would have been credit impaired on initial recognition
IFRS 9
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Stages 2 and 3 - clarity
• Stages 2 and 3 require lifetime expected credit losses to be recognised
• Stage 2 – no objective evidence of impairment and with interest revenue based on gross amount
– Viewed as underperforming
• Stage 3 – objective evidence of impairment and with interest revenue based on the net amount
– Viewed as non-performing
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Moving between stages - clarity
• Moving from stage 1 to stage 2 or 3
– Significant deterioration in the credit quality since initial recognition
considering the term of the asset and the original credit quality
– If above ‘investment grade’, credit risk determination is not
required
– ‘Simplification’ of initial approach but judgement still required
• Moving from stage 2 or 3 back to 1
– Permitted
– Originated and purchased non-credit-impaired would be moved
back up when the downward transfer notion is no longer satisfied
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Significant increase in credit risk
• Change in the risk of a default occurring over the expected life
• Compare risk of default at reporting date to risk of default at initial
recognition date
• If a probability of default method is used then it should be lifetime PD but a 12-month PD can be used if not expected to give a different result
– Consider payment obligation profile, payment holidays, credit related factors which only impact beyond 12 months
• Ignore impact of collateral when
making assessment of increasing risk
– However, include for calculation of loss
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Significant increase in credit risk
• Using reasonable and supportable information available without undue cost or effort
• A ‘principles based’ approach
– Multifactor and holistic approach
– Relevance and weight of any factor will be determined by:
– Product type
– Instrument characteristics
– Geographical region
• IASB confirmed throughout the development process that the information needed should include:
– Probabilities of default
– Pricing information
– Credit ratings and other qualitative inputs
IFRS 9
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Source of information for credit risk
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Significant increase in credit risk
• The following indicators were identified:
– Change in internal price indicators of credit risk
– Change in credit spread, rates, terms, collateral, guarantees or covenants if issued now
– Changes in market indicators of credit risk
– Change in credit spread, credit default swap price, fair values below amortised cost value, changes in the prices of borrowers other instruments
– Change in externally or internally derived credit rating of borrower
– Change in general economic or market conditions, regulatory or technology environment of the borrower
– Change in actual or expected performance of the borrower
– Values of underlying collateral
– Changes in guarantee quality
– Change in the loan documentation
– Change in credit risk management
Rebuttable PresumptionCredit risk has increased
significantly when contractual payments are more than 30
days past due
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Measurement of expected credit losses
Expected credit losses are a probability weighted estimate of the present value of all cash shortfalls
discounted at the original effective interest rate over
the expected life of the financial instrument
• An entity should measure in a way that reflects:
– An unbiased and probability weighted
amount that is determined by evaluating
a range of possible outcomes;
– The time value of money; and
– Reasonable and supportable information
that is available without undue cost or
effort at the reporting date about past
events, current conditions and forecasts
of future economic conditions
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Disclosures relating to ECL
• Qualitative
– Inputs, assumptions and
estimation techniques
used
– For estimating ECL
– To determine significant
increases in credit risk and
default
– To determine credit
impaired assets
– Write off policies, modification policies and collateral
• Quantitative
– Reconciliation of
opening to closing
amounts showing key
drivers of change
– Loss allowance
– Gross amounts
– Gross amounts by credit risk grade
– Write offs, recoveries and modifications
BUSINESS WITH CONFIDENCE icaew.com© ICAEW 2014
Challenges
Strategic
• Impact on Capital
• Impact on earnings stability and other KPIs
• Managing stakeholders’ and market expectations
Tactical
• Define indicators and thresholds for stage migration, especially between stages 1 and 2
• Define and identify key information to bridge current models to multi-year EL requirements
• Align with peer group
Operational
• Data availability
• Data quality
• Financial reporting
• Management reporting
• Regulatory reporting
• Impact on IT systems (model on model)
• Disclosure information
IFRS 9
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Hedging
Not linked to common risk management practices
Detailed rules make achieving hedge accounting impossible or very costly
IAS 39 Aligns hedge
accounting more closely with risk management
More principles-based
IFRS 9
��
IFRS 9
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Achieving, continuing & discontinuing hedge accounting
Achieving hedge accounting
Continuing hedge accounting
Discontinuing hedge accounting
• Quantitative hedge effectiveness assessment
• Must expect to be 80-125% effective
• Qualitative, forward-looking hedge effectiveness assessment
• No arbitrary ‘bright line’
• Retrospective effectiveness test
• Must be 80-125% effective
• No retrospective test• Hedging relationship may
need to be ‘rebalanced’
• Must discontinue if cease to meet qualifying criteria
• Voluntary termination allowed
• Must discontinue if cease to meet qualifying criteria
• Voluntary termination prohibited
IFRS 9
IAS 39 IFRS 9
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Hedging
Hedging instrument
Designated derivative or other financial asset or liability whose fair value or cash flows are expected to offset changes in the fair value of the designated hedged item
Most often a derivative
Hedged item
An asset, liability, firm commitment, highly probable forecast transaction or net investment in a foreign operation that exposes the entity to risks of changes in fair value or future cash flows and is designated as being hedged
Gains and losses on hedged items and hedged instruments can be accounted for under hedge accounting rules provided the hedging relationship is formally designated & documented and expected to be highly effective.
IAS 39 \ IFRS 9
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Fair Value Hedge Hedge of fair value of a recognised asset or liability
Hedging types
Cash Flow Hedge Hedge of cash flow volatility associated with a recognised asset or liability
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Fair Value Hedge Hedge of fair value of a recognised asset or liability or unrecognised firm commitment
Hedging types
Cash Flow Hedge Hedge of cash flow volatility associated with a recognised asset or liability or highly probable forecast transaction
IAS 39 \ IFRS 9
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Fair Value Hedge Hedge of fair value of a recognised asset or liability or unrecognised firm commitment
Hedged item & hedging instrument re-measured to fair value via profit or loss
Outcome is that gains & losses on hedged item and hedged instrument matched in P/L in same period
Hedging types
Cash Flow Hedge Hedge of cash flow volatility associated with a recognised asset or liability or highly probable forecast transaction
Effective gain or loss on hedging instrument to equity until hedged item affects profit or loss
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XYZ plc owns stocks of 28,000 gallons of oil which cost £500,000 on 1.12.20X3. In order to hedge the fluctuation in the market value of the oil the company signs a futures contract to deliver 28,000 gallons of oil on 31.3.20X4 at the futures price of £20 per gallon.The market price of oil on 31.12.20X3 is £21 per gallon and the futures price for 31.3.20X4 delivery is £23 per gallon.How would this be accounted for if the derivative did notqualify for hedge accounting?What if it did qualify for hedge accounting?
Hedging a recognised asset – fair value hedge
IAS 39 \ IFRS 9
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31.12.X3
Inventory – no hedge accounting
Derivative
Re-measure to fair value
Loss of 28,000 * (23-20) = £84,000
Measure at cost
Gain recognised when sold
Loss
Gain
Mismatch
Hedging a recognised asset – fair value hedge
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31.12.X3
Inventory – hedge accounting
Derivative
Re-measure to fair value
Loss of 28,000 * (23-20) = £84,000
Re-measure to fair value
Gain of (28,000 * 21) – 500,000 = £88,000
Loss
Net profit or loss impact is £4,000.
Gain
Hedging a recognised asset – fair value hedge
IAS 39 \ IFRS 9
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An entity expects to have to undertake repairs to a ship next year due to changing regulations. It is uncommitted to this transaction but it is highly probable that the work will be undertaken.The repair work will be undertaken in Singapore at a cost of S$60 million and therefore the entity is exposed to movements in the exchange rate. It therefore enters into a futures contract, buying forward S$60 million at a rate of £1 = S$3.
The futures price on 31.12.X3 (the company’s year end) is $3.25.
How would this be accounted for if the derivative did not qualify for hedge accounting?What if it did qualify for hedge accounting?
Hedging a highly probable forecast transaction – cash
flow hedge
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31.12.X3
Highly probable forecast transaction
Derivative
Re-measure to fair value
Loss of S$60m/3.00 - S$60m/3.25 = £1,538,462
Not on statement of financial position
Gain recognised when paid
Loss
Gain
Mismatch
Hedging a highly probable forecast transaction – cash
flow hedge
IAS 39 \ IFRS 9
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31.12.X3
Highly probable forecast transaction
Derivative – hedge accounting
Re-measure to fair value but gain or loss deferred in equity
Loss of S$60m/3.00 - S$60m/3.25 = £1,538,462
Not on balance sheet
Gain recognised when paid
Loss
Gain
Gain and loss
recognised in the same accounting period.
Hedging a highly probable forecast transaction – cash
flow hedge
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IFRS 7
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Financial instruments – disclosures
IFRS 7
• Detailed statement of financial position disclosures including
– For each category of financial asset & financial liability
– Carrying amount
– Related fair value
– Amount & reason for any reclassification
– Additional detailed risk disclosures if any loans & receivables or financial liabilities are measured at fair value through profit or loss
– Methods & assumptions used to determine fair values for different classes of financial asset & financial liability
– Derecognition
– Collateral
– Allowances for credit losses
– Compound instruments with multiple embedded derivatives
– Defaults and breaches
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Financial instruments – disclosures
IFRS 7
• Detailed profit or loss and equity disclosures including
– For each category of financial asset & financial liability
– Income, expenses, gains and losses
– Net gains and losses
– Amount of impairment loss
– Total interest income
– Fee income and expenditure
– Financial assets and liabilities not through profit or loss
– Trust and other fiduciary activities
– Interest income on impaired financial assets
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Financial instruments – disclosures
IFRS 7
• Detailed other disclosures including
– Details of accounting policies
– Hedge accounting
– Qualitative & quantitative risk disclosures (HSBC discloses 53 pages on this alone!)
– Credit risk
– Liquidity risk
– Market risk
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IFRS 13 Fair value measurement
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A new definition of fair value
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date
Based on exit price rather than entry price, regardless of whether the entity plans to hold or sell the asset
Principal or most advantageous marketHighest and best use
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A fair value hierarchy
The hierarchy categorises the inputs used in valuation techniques into
three levels
1. Quoted market prices for identical assets or liabilities in
active market
eg, unadjusted quoted market prices for traded securities
2. Directly or indirectly observable inputs other than market
prices within level 1
eg, quoted prices for similar assets or liabilities in active markets
3. Unobservable inputs
eg, use the best information available in the circumstances
Fair value measurement is categorised in its entirety in the level of the
lowest level input that is significant to the entire measurement
IFRS 13
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Determining fair value
• Consistent with unit of account
Identify asset or liability being
measured
• No adjustment for transaction costs
• Based on current market conditionsUse exit price
• Principal market is market with greatest volume and level of activity
• If no principal market use price in most advantageous market
Principal or most advantageous
market
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Valuation techniques
Maximise the use of relevant observable inputs and minimising the use
of unobservable inputs
market approach
cost approach
income approach
uses prices and other relevant information generated by market transactions involving identical or similar assets, liabilities or a group of assets and liabilities
reflects the amount that would be required currently to replace the service capacity of an asset i.e., current replacement cost
converts future amounts (eg, cash flows or income and expenses) to a single current amount reflecting current market expectations about those future amounts.
IFRS 13
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The package of “five” standards
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The IASB ‘consolidations’ project
All five standards must be adopted at the same time
IAS 27 Consolidated and separate financial statementsSIC 12 Consolidation – special purpose entities
IAS 28 Investments in associatesSIC 13 Jointly controlled entities –non-monetary contributions by venturers
IAS 31 Interests in joint ventures
IFRS 10 Consolidated financial statements
IAS 28 Investments in associates and joint ventures
IFRS 11 Joint arrangements
IAS 27 Separate financial statements
IFRS 12 Disclosure of interests in other entities
Before After
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IFRS 10 Consolidated Financial Statements
Out with the old…
IAS 27
SIC 12
Focus on control =Power to govern the financial and
operating policies+
Obtain benefits
Focus on risks and rewards =Majority of benefits or
majority of residual risks
IFRS 10
Focus on control =
1. Power from existing rights+
2. Exposure to variable returns+
3. Link between power and returns
Single basis applies to voting interests and SPEs
���� more judgement
…and in with the new
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Guidance on identifying ‘power’
• Activities that affect returns• Examples: operating/financing policies and
appointment/remuneration of key managementRelevant activities
• Practical ability to exercise rights• Distinguish substantive from protective rightsSubstantive rights
• Majority – as before• Minority – consider ‘de facto’ control
Existing rights from votes
• Practical ability to act unilaterally• Existence of special relationship
• Exposure to risk/reward
Existing rights from other than votes
IFRS 10
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Classification of joint arrangements
IFRS 11 focuses on economic rights and obligations…
Joint ventureJoint operation
A joint operation is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the assets, and obligations for the liabilities, relating to the arrangement.
A joint venture is a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
Assets xLiabilities x
Net assets x
Revenue xExpenses x
Net income x
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Accounting for joint ventures & joint operations
Not structured through a separate vehicle
Structured through a separate vehicle
Accounting for assets, liabilities, revenues and expenses in
accordance with the contractual arrangement
Equity method
Joint operation
No option
Joint venture
Consider the legal form, the terms of the contractual arrangement and, if
relevant, other facts and circumstances
IFRS 11
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Disclosure – IFRS 12
• Subsidiaries• Joint arrangements
• Associates• Unconsolidated structured entities
Scope
• How is ‘control’ decision based on evidence?
• Consolidated, but interest < 50%
• Not consolidated, but interest > 50%
More explanation of judgements
• Include if ‘sponsored’
• Extensive qualitative and quantitative disclosures
Unconsolidated structured
entities
IFRS 12
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