IFRS

The IASB has published IFRS 9 – Financial Instruments – which will be effective for periods commencing on or after 1 January 2018. This replaces the notoriously complex requirements of IAS 39 Financial Instruments: Recognition and Measurement.

Whilst the changes will significantly impact financial institutions, all entities will need to consider whether the changes affect their financial instruments, and hence their financial statements.

So how will it impact entities that are not financial institutions?

• Financial assets may need to be measured differently, as they will be classified on the basis of the cash flows associated with the asset and the entity’s business model instead of whether they meet defined criteria for different categories of financial asset, as they are currently.
• Fair value gains and losses arising on the re-measurement of certain financial assets previously classified as 'available-for-sale' under IAS 39 (eg some investments in debt instruments) will be recognised in profit or loss rather than in other comprehensive income.
• There is no longer the requirement to separate out derivatives embedded in financial assets from host contracts. Instead it is likely that the host contract will be measured at fair value with movements recognised in profit or loss.
• Impairment losses will be recognised earlier due to the implementation of a new impairment loss model, which is based on expected rather than incurred losses.
• The new hedging requirements are easier to interpret and are more closely aligned with the risk management objectives and strategies of the business. Specifically, there is more flexibility to apply hedge accounting to groups of items, including net positions, so you can adopt hedging accounting on a more ‘entity wide’ basis. This could make hedge accounting a more accessible and worthwhile approach for some businesses.
• There will be no impact on the recognition and measurement of financial liabilities unless a liability has been designated as fair value through profit or loss in which case changes in the fair value of the liability attributable to changes in credit risk of the borrower are presented in other comprehensive income.

What action do you need to take?

• Identify the financial instruments that you currently have and note how each one is measured.
• For financial assets that were in the scope of IAS 39, identify the nature of the cash flows associated with them and the business reasons for holding them, as this will impact on their measurement.
• Earlier recognition of impairment losses may impact on key performance indicators and covenant breaches so it is important to identify how the new model will impact these.
• Consider whether the new hedge accounting requirements could be applied.
• Look at the transitional arrangements and options available and how they should be applied.

How we can help

RSM has the experience and the expertise to help:

• assess the impact of the new standard on your financial statements, tax cash flows and distributable profits;
• assess the available options for the presentation of fair value gains or losses, the impact these will have and the actions that will need to be taken;
• value your financial instruments; and
• assess whether hedge accounting could be applied and if so develop procedures for measuring hedge effectiveness.

For more information on IFRS 9, please get in touch with your usual RSM contact.

IFRS 15, which replaces IAS 18 Revenue, IAS 11 Construction Contracts and their associated interpretations, comes into effect for periods commencing on or after 1 January 2018. Earlier adoption is permitted.

Although the standard was originally published in May 2014, implementation issues were highlighted, so on 12 April 2016, the IASB published amendments to IFRS 15 to clarify some of its requirements and provide additional transitional relief.

What does this mean for you?

IFRS 15 sets out a single framework for revenue recognition. Its core principle is that an entity recognises revenue to depict 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. 

This might sound as though your sales will be exactly as they are now, but in fact the new standard might change the amount of revenue you recognise, which period it is booked into and the classification of the income by type. This is particularly relevant where a transaction is paid for over time, because the time value of money is now accounted for not only when you provide a significant financing benefit to a customer but also when you receive such a benefit (by recognising an interest expense).

In addition, the allocation of the contract price between different elements of the contract may change, because the standard now has detailed guidance on how to allocate the contract price, including any discounts or other variable amounts. This may be different from the accounting policy you developed under IAS 18 or IAS 11.

Finally, the timing of recognition of revenue might change, since the sale point will be the moment that control passes to the customer rather than when the significant risks and rewards of ownership have transferred.

How will it impact you?

• Entities may wish to reconsider their current contract terms and business practice.

• Revenue may be accelerated or deferred, particularly for those:
  
  • entities that provide a bundle of goods and services (eg mobile phone providers);
  • provide licenses (eg software distributors); and 
  • whom consideration receivable is variable in nature (eg because of discounts), rebates and other price concessions, incentives and performance bonuses, penalties or other similar items.
• The timing of revenue recognition may change even when there is only one performance obligation, particularly for those involved in providing services. Entities will need to determine whether revenue should be recognised over time or at a point in time.
• The amount of revenue recognised may change if an entity receives a significant financing benefit.
• Existing accounting software may need to be adapted or replaced to ensure it is capable of capturing data to deal with the new accounting requirements; particularly for use in making estimates, establishing standalone selling prices, or supporting the extensive disclosure requirements.
• Estimates and judgements made under the existing standards may need to be revised to comply with the specific guidance in IFRS 15.

What action do you need to take?

IFRS 15 sets out five key steps:

• Step 1: identify the contract(s) with a customer
• Step 2: identify the performance obligations in the contract
• Step 3: determine the transaction price
• Step 4: allocate the transaction price to the performance obligations in the contract
• Step 5: recognise revenue when (or as) the entity satisfies a performance obligation

You should consider whether this new model based on control rather than risks and rewards, changes your revenue recognition policies by fully understanding the specific guidance and rules contained in the new standard. Carefully consider the impact of the available transitional options and practical expedients to understand the impact they may have on reported profit, taxation liabilities, covenant arrangements, dividend policy, performance related remuneration and narrative reporting. 

How we can help

RSM has the experience and expertise to:

• guide you through IFRS 15, highlighting where key judgements will be required and making you aware of practical alternatives (eg valuing customer options);
• compare and contrast the requirements of IFRS 15 with existing accounting policies;
• develop an implementation plan that will ensure a smooth and cost effective transition and, if required, assist in project managing the implementation;
• support you in the data capture of your contracts, processing and presentation of the results;
• explain the transition methods and practical expedients available when implementing IFRS 15, together with their comparative advantages and disadvantages and the disclosure implications;
• assist in reviewing material prepared for communication with stakeholders about the impact of implementing IFRS 15, including the costs of the implementation process; and
• if you have already started the implementation process, we can help you to determine whether the recent clarifications change the impact of IFRS 15 on your entity and therefore change your choices for transition.

For more information on IFRS 15, please get in touch with your usual RSM contact.

The IASB has published the leasing standard IFRS 16 which comes into effect for periods commencing on or after 1 January 2019. It may be adopted early, however only if IFRS 15 - Revenue from contracts with customers is adopted at the same time.

Every company that uses leasing, hire purchase or rental arrangements as a financing solution will be affected by the new standard.

What does this mean for you?

Simply put, the new standard eliminates off balance sheet accounting by lessees in respect of their operating leases. In most cases, this results in the recognition of a lease liability on the balance sheet (which reflects the present value of the future rental payments) and a corresponding asset which is referred to in the standard as a 'right of use' asset. It does however provide an exemption for assets that are low value when new and those with lease terms of less than one year.

After initial recognition, the lease liability will need to be adjusted for the effective interest included in the rental payments and the 'right of use asset' will need to be depreciated. In other words, straightforward operating leases will now be treated in a very similar way to HP agreements, with the main difference being that the initial debit is the right to use the specified asset for a period of time rather than the actual asset itself.

How will it impact you?

• Due to a higher initial interest charge and constant depreciation rate, the cost of renting the asset is accelerated in the earlier years compared to the cost that would have been recognised under the old operating lease accounting rules.
• Key performance ratios such as EBITDA, interest cover, gearing levels, asset turnover, operating profit, earnings per share, return on capital employed and operating cash flows could be affected.
• Transition could affect the cost of financing, covenants and credit ratings.
• Lease agreements may need to be revisited to understand and assess the impact and potentially restructured.
• Software may need to be adapted or replaced to deal with the new accounting requirements.

What action do you need to take?

Louise Ward reveals the key steps to a successful IFRS16 implementation in this video:

• Identify which key performance ratios will be affected.
• Communicate with lenders well in advance of the changes taking effect.
• Assess whether your accounting software is fit for purpose.
• Assess whether you have the right information and reporting tools to ensure that you can comply with the new disclosure requirements.

How we can help

Our team has the experience and expertise to: 

• assess the impact of the new standard on your key performance measures, loan and employee agreements;
• help you understand the impact of implementation on your financial statements and your business; and
• identify, collate and analyse the data required to help you determine what financing decisions, if any, you need to make.

We can also:

• develop an implementation plan to ensure a smooth and cost-effective transition and project manage the implementation process;
• assess whether your existing systems will be able to cope with the implementation of the new standard and advise on a selection of software vendors;
• establish an appropriate business process and system of internal control; and
• assess the impact of any modifications to the lease terms and how they will be accounted for.     

For more information on IFRS 16, please get in touch with your usual RSM contact.