Narrow-scope amendments to Section
3856 Financial Instruments
June 7, 2017
The views expressed in this presentation are those of the presenter, not necessarily those of the Accounting Standards Board.
Background
• November 2014 – the AcSB launched a Post-implementation Review (PIR) of Section 3856 Financial Instruments
• The PIR was designed to allow the AcSB to assess:
– if the Section provides useful information;
– whether there are unexpected costs of applying the
Section; and
– whether there are areas of the Section that should be
changed.
Background - continued
• During the PIR, the AcSB talked to:
– 86 practitioners
– 21 financial statement users
– 2 financial statement preparers; and
– 1 academic
• A copy of the AcSB’s feedback statement on the
PIR is available here.
Background - continued
• The Board reviewed topics identified by respondents to the PIR and assessed whether they had merit of being added to its project plan
• As part of this process, the Board:
– Prioritized some narrow-scope issues and included
them in this project;
– Identified other larger projects that will be
considered in the context of its broader agenda.
Topics included in this project
• The following topics have been included in this
project:
– initial recognition of related party financial instruments;
– measurement of related party compound financial
instruments;
– classification of impairment and forgiveness of related party
loans;
– scope of accounting for modifications and extinguishments of
related party financial liabilities; and
– financial instrument disclosure (excluded from this
discussion)
The Board’s current thinking
• The Board is reviewing and evaluating different
alternatives to address the topics included in this
project
• The proposed alternatives included in this
presentation are preliminary and may change as
the result of additional outreach or the AcSB’s
due process activities
Purpose of this meeting
Obtain feedback regarding some of the alternatives being explored by the AcSB to address the narrow-scope issues included in this project, including:
– Any comments you may have on the alternatives discussed; and
– Your views on the effects of the alternatives being explored.
Topic #1 – Scope of accounting for
related party financial instruments
What we heard from respondents:
Confused as to whether related party financial instruments are in the scope of Section 3856 or Section 3840 after initial recognition
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
The AcSB heard the following from additional practitioner outreach:
This issue is more than just a navigation issue
- Entities struggle to apply the concepts in Section
3840 (carrying amount and exchange amount) to
financial instruments
Why?
The theoretical starting point for the standards is in
conflict
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Section 3856 Section 3840
Para. 3856.07
Financial instruments are initially measured at fair value
Para. 3840.10
Related parties are presumed to not be dealing at arm’s length. A transaction between related parties cannot be presumed to have been entered into at fair value.
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Potential alternative being considered
• Include initial measurement guidance for related party
financial instruments in Section 3856
• Related party financial instruments would be initially
measured at the:
– undiscounted cash flow(s) of the instrument (excluding interest and
dividend payments);
– cost of the instrument (if it does not have contractual cash flows); or
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Potential alternative being considered (cont’d)
– fair value (if the entity is required or intends to re-
measure the instrument at fair value after initial
recognition)
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Application of undiscounted cash flow alternative :
Scenario #1
Company A transfers land to Company B in a tax planning
arrangement and takes back redeemable preferred shares.
The carrying amount of the land is $90,000, its fair value is
$100,000. The redemption amount and fair value of the
redeemable preferred shares is $100,000. The redeemable
preferred shares do not meet the requirements of
paragraph 3856.23 and therefore have been classified as a
liability by the issuer.
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Transferor accounting:
Dr. Investment 100,000
Cr. Land 90,000
Cr. Contributed surplus 10,000
Transferee accounting:
Dr. Land 90,000
Dr. Equity 10,000
Cr. P/S liability 100,000
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Application of cost alternative:
Scenario #2
Company A transfers land to Company B and
takes back common shares (Company B is not
publicly traded). The carrying amount of the land
is $90,000, its fair value is $100,000.
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Topic #1 – Scope of accounting for related
party financial instruments (cont’d)
Transferor accounting:
Dr. Investment 90,000
Cr. Land 90,000
Transferee accounting:
Not in the scope of Section 3856 as this would be an equity
(common share) transaction for this entity.
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Topic #2 – Measurement of related party
compound financial instruments
What we heard from respondents:
Questioned whether guidance in Section 3856 para. 22 is available to compound financial instruments (i.e. measure the equity component as zero)
In practice, practitioners and preparers are
allocating a nominal amount of the proceeds from
these instruments to the equity component
(generally $0 or $1)
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Topic #2 – Measurement of related party
compound financial instruments
Potential alternative being considered
If always in Section 3856 (see discussion in topic 1) then
mitigates confusion regarding availability of
measurement options in Section 3856.
The Board may clarify that the initial measurement
guidance for related party financial instruments should
be applied to the instrument as a whole and that the
allocation of proceeds should be considered from the
context of paragraph 3856.20-22.
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Topic #3 – Classification of impairment
and forgiveness of related party loans
What the AcSB heard from respondents:
Accounting for the impairment and / or forgiveness of a related party loan is unclear
Should the impairment of a related party loan be
recorded in equity?
Should both the impairment and subsequent
forgiveness be accounted for together through
income or through equity?
Topic #3 – Classification of impairment
and forgiveness of related party loans
Key observations from lender users consulted:
Primarily concerned with “leakage”
Once the money has left the entity, the related party
loan has no value unless it is secured;
Generally have protective rights that would restrict
management from removing capital or assets from
the entity.
Users were less concerned with the nature of the
relationship (i.e. management or shareholder) and
more concerned with the original transaction.
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Topic #3 – Classification of impairment
and forgiveness of related party loans
Key observations from lender users consulted (cont’d):
If the original transaction was in the normal course
of operations the impairment and forgiveness
should be recognized through profit or loss;
If not, it should be recognized through equity.
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Topic #3 – Classification of impairment
and forgiveness of related party loans
Key observations from practitioners consulted:
In practice related party accounts often include a
mixture of transactions (normal course and not
normal course) and that it would be impracticable to
determine the nature of cash flows within these
accounts.
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Topic #3 – Classification of impairment
and forgiveness of related party loans
Potential alternatives being considered
a) Clarify that the impairment indicators in para.
3856.A15 are not exclusive to third party financial
assets;
b) Clarify that impairments, are recognized in income
as indicators arise;
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Topic #3 – Classification of impairment
and forgiveness of related party loans
c) Add guidance that the forgiveness of related party
financial assets should be recognized in:
• Income, if the original transaction that brought rise to
the asset was in the normal course of operations; or
• Equity if:
– The original transaction that brought rise to the asset was
not in the normal course of operations; or
– It is impracticable to determine whether the amount
forgiven originated in the normal or non-normal course of
operations.
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Topic #3 – Classification of impairment
and forgiveness of related party loans
Forgiveness of loans with an individual that is acting solely in capacity of senior management (i.e. is not also a shareholder) is compensation and should be recognized in income.
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Topic #4 – Scope of accounting for modifications
and extinguishments of related party loans
Key observations from practitioners consulted:
ASPE preparers struggle to apply the 10% test (for both
related and third party modifications)
Modification of related party loans is often done for tax
purposes (similar to forgiveness);
Para. 3856.28 requires the difference between the
carrying amount of the FL and consideration paid to be
recognized in accordance with Section 3840.
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Topic #4 – Scope of accounting for modifications
and extinguishments of related party loans
Potential alternative being considered
• All modifications or related party financial liabilities
are accounted for as an extinguishment with the
new instrument measured in accordance with the
initial measurement guidance alternative explored in
Topic #1.
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For more information, visit www.frascanada.ca
Contacts
Andrew White, CPA, CA Kelly Khalilieh, CPA, CA
Principal, AcSB Senior Principal, AcSB
Phone: +1 (416) 204-3487 +1 (416) 204-3453
Email: [email protected] [email protected]
June 7, 2017