Malta: Year-End Accounting Reminders – IFRS, December 2012

Introduction

This publication relates to reporting requirements as at 31 December 2012. It highlights the topical issues to consider and the new standards and interpretations that apply at this date.

Topical issues at 31 December 2012

This section summarises some accounting hot topics that may impact December 2012 year ends.

Impact of adopting IAS 19 revised

IAS 8 para 30 requires that when an entity has not applied a new IFRS that has been issued but is not yet effective, that the entity discloses this fact and known or reasonably estimable information relevant to assessing the possible impact on the entity's financial statements. We expect that such disclosure would include both the quantitative and qualitative impact of adoption.

Non-controlling interests and cash flow statements

Where there are non-controlling interests in a subsidiary that is consolidated as part of a group, the treatment of the non-controlling interest in the consolidated cash flow statements should be consistent with the overall approach to non-controlling interests.

Changes in ownership interests in a subsidiary that do not result in a loss of control, such as the purchase or sale by a parent of a subsidiary's equity instruments, are now accounted for as equity transactions under IAS 27. IAS 7 was therefore amended by IAS 27 so that the resulting cash flows are classified in the same way as other transactions with owners − that is, as cash flows from financing activities in the consolidated cash flow statement. See the guidance in paragraph 30.108 onwards in the 'IFR Manual of accounting'.

Breaches of banking covenants and presentation of borrowings

An entity classifies a borrowing as current under IAS 1 if it does not have an unconditional right at the balance sheet date to defer settlement for at least 12 months after the end of the reporting period. Where an entity is in breach of banking covenants at the period end and the breach causes the entity to lose the unconditional right to avoid settling within 12 months, the whole borrowing is a current liability at the balance sheet date if the breach has not been waived by the lender before the period end. Even where covenant waivers are subsequently received from the lender, and where borrowings have been restructured in the following year, the financial statements should present the borrowings based on their contractual maturity at the period end. A post-period end waiver is a non-adjusting post balance sheet event under IAS 10.

IFRS 3 disclosure reminders

One of the disclosures required in the business combinations standard that can often be overlooked is the requirement to provide a qualitative description of the items that make up goodwill. For example, this may include expected synergies resulting from the combination or intangible assets that do not meet the criteria for separate recognition. The omission of this disclosure has been specifically noted by regulators (for instance, in the UK FRRP's annual report for 2011). An acquirer is also required to disclose specific information for transactions that are recognised separately from the business combination. This includes a description of the transaction, the accounting treatment and the line item in the financial statements in which each item is recognised. Examples of such transactions include settlement of pre-existing relationships and acquisition related costs. Furthermore, the amount and recognition basis of any issue costs not recognised as an expense must also be disclosed.

Debt-for-debt renegotiations

Entities sometimes negotiate with lenders to restructure their existing debt obligations. Such restructuring may result in either a modification or an exchange of debt instruments. Different accounting applies for each. Under IAS 39, a restructuring is accounted for as an extinguishment if either the renegotiated debt instrument is on substantially different terms from the existing instrument, or the renegotiated instrument is with a different lender (including when the new lender is connected with the previous lender – for example, two groups under the common control of the same individual). In this case, the existing debt instrument is derecognised, and the new or revised debt instrument is initially recognised at fair value. The difference between the fair value of the renegotiated instrument and the carrying amount of the old instrument is recognised in the income statement. See paragraph 6.6.158 of the IFRS Manual of accounting for further information. If the renegotiated debt is with the same lender (including a member of the same group) and not on substantially different terms, the restructuring is accounted for as a modification. The existing debt instrument is not extinguished but continues to be recognised at amortised cost. The difference between the previous carrying amount and the present value of the revised estimated cash flows discounted at the original effective interest rate should either be recognised immediately as a gain or loss in the income statement or should adjust the effective interest rate of the liability (that is, it should be recognised in the income statement over the remaining life of the instrument). The appropriate treatment depends on the facts and circumstances.

Control under IFRS 10

IFRS 10, 'Consolidated financial statements', replaces all of the guidance on control and consolidation in IAS 27, 'Consolidated and separate financial statements', and SIC-12, 'Consolidation – special purpose entities'.

IAS 27 defines control as: '. . .the power to govern the financial and operating policies of an entity so as to obtain benefits from its activities...'. IFRS 10 defines control differently as: '... an investor controls an investee when the investor is exposed or has rights, to variable returns from its involvement with the investee and has the ability to affect those returns through its power over the investee...' .

The definition of control under IFRS 10 is not based solely on legal ownership. It encompasses three distinct principles, which if present identify the existence of control by an investor over an investee.

These principles are:

• power over the investee;
• exposure, or rights, to variable returns from its involvement with the investee; and
• the ability to use its power over the investee to affect the amount of the investor's returns.

In assessing control over an investee, these three factors cannot be considered in isolation; all three must be present for an investor to conclude whether it has control.

The main distinction between the old and new definition of control is that, under IFRS 10, there is a clear requirement to link power and returns (that is, benefits) and an investor's ability to affect those returns.

All entities will need to consider the impact of the new definition, as it may result in some entities consolidating investments that they previously did not, and deconsolidating entities that do not meet the control definition under IFRS 10. IFRS 10 is effective for annual periods beginning on or after 1 January 2013, with earlier application permitted. However it was endorsed by the EU at the end of December with an effective date for annual periods beginning on or after 1 January 2014, with early adoption permitted.

An amendment to IFRS 10 was issued on October 2012. The amendment exempts 'Investment entities' from the requirements to consolidate controlled investees. The amendment apply for annual periods beginning on or after 1 January 2014 with earlier application permitted. However, this is still subject to EU endorsement. The amendment will primarily impact investment funds and similar entities which will be exempted from consolidating controlled investees under the amendment.

Accounting for joint arrangements under IFRS 11

Proportionate consolidation

One of the key changes brought in by IFRS 11 is the elimination of the accounting policy choice when accounting for investments in joint ventures. Previously, when a venture had an interest in a jointly controlled entity, it was allowed to report the assets and liabilities using either proportionate consolidation (gross accounting) or the equity method of accounting (net accounting). For those used to reporting gross – typically in the oil and gas, property development and telecommunication industries – the new standard will bring significant changes by reducing the size of balance sheets and income statements unless action is taken now. (see below). All entities will need to consider the impact of the standard in their financial statements. IFRS 11 is effective for annual periods beginning on or after 1 January 2013, with earlier application permitted. However it was endorsed by the EU at the end of December with an effective date for annual periods beginning on or after 1 January 2014, with early adoption permitted.

Retaining gross reporting

Jointly controlled entities (JCEs) might not meet the definition of joint ventures under the new standard. By moving away from the importance of an investment's legal structure, some JCEs might be classified as joint operations in future.

Segment reporting under IFRS 8

The following are some areas that could require further consideration at year ends based on experiences to date under IFRS 8.

Operating segments and segment disclosures are presented based on the information the chief operating decisionmaker (CODM) receives and uses to make decisions. Therefore, the first step in applying IFRS 8 is to determine the identity of the CODM. Identification of operating segments, reportable segments and segment disclosures will then follow.

The CODM is the individual or group of individuals who perform the function of allocating resources to operating segments and assessing their performance. A committee of nonexecutive directors is unlikely to be the CODM given that their function is more one of governance rather than management. Therefore, a supervisory board of executive directors is more likely to be the CODM. Identification of the CODM should consider the key operating decisions made in running the business and who makes these decisions.

Disclosures in respect of operating segments should consider:

• How are the entity's activities reported in the information used by management to review performance and make resource allocation decisions?
• Is any proposed aggregation of operating segments into one reportable segment supported by the aggregation criteria in the standard, including consistency with the core principle (that is, enabling users to evaluate the nature and financial effects of the entity's business activities and economic environments)?
• Is the information about reportable segments based on IFRS measures or on an alternative basis?
• Have the reported segment amounts been reconciled to the IFRS aggregate amounts?
• Is the operating analysis set out in the narrative report consistent with the operating segments in the financial statements?

At every reporting date the entity should reconsider whether their current operating segment disclosure remains appropriate. Changes in the identity or formation of the CODM and the information reviewed by the CODM could lead to changes in the segment disclosures provided. This consideration is especially important where there has been a restructuring of the organisation.

Discount rates and provisions

The risk-free rate is an important element in various calculations and assumptions, as it provides a base to determine an appropriate discount rate. The proxy for such a risk-free rate is in many cases the government bond 'yield' rate for the country where the entity operates. However, due to the recent economic turmoil, the credit rating of government debt has been downgraded in a number of countries, reflecting a market view that the debt (and related yield) is no longer free of risk.

Where this has occurred in a country (country A) for which the entity wishes to apply a risk-free discount rate, an acceptable approach would be to use a government bond 'yield' rate of a AAA-rated country (country B), with appropriate adjustment for the differences in inflation between the two countries.

Disclosure of significant estimation uncertainties – discount rates

The application of an appropriate discount rate to determine the present value of an accounting balance is a common requirement under a number of IFRS accounting standards. Methods for determining an appropriate discount rate vary but often have regard to risk-free rates, or in particular, under IAS 19, to corporate bond rates or government bond rates. In the current economic environment, the selection of an appropriate discount rate is highly judgemental and can have a material impact on financial statements. Management should therefore consider disclosing discount rates as a significant source of estimation uncertainty, in accordance with IAS 1 para 125.

Out-of-the money share-based payments – cancellations and modifications

Many employee share awards are no longer favourable in the current economic conditions. If non-market vesting conditions have been affected, some of these awards now result in only a relatively small charge being recognised in the income statement.

Many entities are considering cancelling such awards where employees will not meet non-market performance conditions. Management should consider this approach carefully; by cancelling an award ahead of time, it will be treated as a cancellation under IFRS 2. This means that the entity needs to account for the award as an acceleration of vesting. It will therefore recognise immediately the amount that otherwise would have been recognised for services received over the remainder of the vesting period (see further paragraph 12.138 of the 'IFRS Manual of accounting').

As an alternative to cancelling an award, the entity might consider modifying the award to re-incentivise employees – for example, by repricing the awards and perhaps reducing the number of awards or adding new vesting conditions. IFRS 2 requires any incremental fair value awarded as a result of modifications to be recognised over the remaining vesting period. It may be possible to modify the award such that it has no incremental fair value but provides a better incentive to employees.

Externally imposed capital requirements, including covenants

As part of capital management disclosures, IAS 1 requires an entity to disclose whether during the period it complied with any externally imposed capital requirements to which it is subject and, if not, the consequences of such non-compliance. This includes capital requirements/limits established through contractual relationships – for example, with banks. Therefore, where loans are included in an entity's definition of capital, the disclosure in respect of externally imposed capital requirements will apply to covenants attached to the loans. This is discussed in paragraph 23.117 of the IFRS Manual of Accounting. In the past, the FRRP has noted that capital management disclosure is a significant area of information for users, particularly when assessing going concern considerations, so we expect it will continue to be an area of focus by regulators.

Standards and IFRICs applicable to 31 December 2012 year ends

Standards and IFRICs newly applicable for companies with December

2012 year ends are set out below.

Amendments

Amendments to IFRS 7, 'Financial instruments: Disclosures' on transfers of assets (effective 1 July 2011). Theseamendments arise from the IASB'sreview of off-balance-sheet activities. Theamendments will promote transparencyin the reporting of transfer transactionsand improve users' understanding of therisk exposures relating to transfers offinancial assets and the effect of thoserisks on an entity's financial position,particularly those involving securitisationof financial assets. Earlier applicationsubject to EU endorsement is permitted.For further details see Straight away 32.

Amendment to IFRS 1, 'First time adoption', on fixed dates and hyperinflation (effective 1 July 2011).These amendments include two changesto IFRS 1, 'First-time adoption of IFRS'.The first replaces references to a fixeddate of 1 January 2004 with 'the dateof transition to IFRSs', thus eliminatingthe need for entities adopting IFRSs forthe first time to restate derecognitiontransactions that occurred before thedate of transition to IFRSs. The secondamendment provides guidance on howan entity should resume presentingfinancial statements in accordance with IFRSs after a period when the entity was unable to comply with IFRSs because itsfunctional currency was subject to severehyperinflation. For further details see Straight away 38.

Amendment to IAS 12, 'Income taxes', on deferred tax (effective 1 January2012). IAS 12, 'Income taxes', currentlyrequires an entity to measure the deferredtax relating to an asset depending onwhether the entity expects to recover thecarrying amount of the asset through useor sale. It can be difficult and subjective toassess whether recovery will be throughuse or through sale when the asset ismeasured using the fair value modelin IAS 40, 'Investment property'. This amendment therefore introduces anexception to the existing principle for themeasurement of deferred tax assets orliabilities arising on investment propertymeasured at fair value. As a result of theamendments, SIC-21, 'Income taxes −recovery of revalued non-depreciableassets', will no longer apply to investmentproperties carried at fair value. Theamendments also incorporate into IAS12 the remaining guidance previouslycontained in SIC-21, which is withdrawn.For further details see Straight away 37.

New IFRS standards effective after 1 January 2013

Under paragraph 30 of IAS 8, entities need to disclose any new IFRSs that are issued but not yet effective and that are likely to impact the entity. This summary includes all new standards and amendments issued before 31 December 2012 with an effective date after 1 January 2013. These standards can generally be adopted early, subject to EU endorsement in some countries.

New IFRICs effective after 1 January 2013

These IFRICs can generally be adopted early, subject to EU endorsement in some countries.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.