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IFRS Technical Update
Preparing for 2018: Getting comfortable with IFRS 9 and 15
By Caroline Aggestam Pontoppidan
IASeminars Faculty Member
The IASB has issued several new and amended Standards and Interpretations which have not yet entered into force and consequently, in most cases, have not yet been applied. IFRS 9 Financial Instruments and IFRS 15 Revenue from Contracts with Customers are replacing IAS 39 and IAS 11/18 and four Interpretations for annual periods beginning on or after 1 January 2018.
IFRS 9 Financial Instruments
The changes from IAS 39, its predecessor, relate mainly to the classification and measurement of financial assets and liabilities, impairment of financial assets and hedge accounting. The changes respond to long-standing criticisms of IAS 39: too complex and too rule-based, not reflecting commercial substance. Banks and other financial institutions are most affected by the changes.
IFRS 9 reduces the number of categories of financial assets from four to three: amortised cost, fair value through profit or loss and fair value through other comprehensive income. The criteria for classifying financial assets are based on the business model within which they are held and the cash flow characteristics of the instruments themselves. The aim is to simplify the accounting treatment and to align it more closely with commercial reality.
IFRS 9 retains the same categories of financial liabilities as IAS 39: the main change here is the requirement to recognise fair value changes in financial liabilities due to an issuer’s own credit risk in other comprehensive income, rather than in profit or loss, when the fair value option has been chosen.
The approach to measuring impairment of financial assets is completely new. Out goes the ‘incurred loss’ model which only permits an impairment allowance to be charged when there is a past event that provides objective evidence of impairment. IAS 39 does not take into account forward-looking assessments. During the financial crisis of 2008 this led to recognising losses ‘too little and too late’. The new approach in IFRS 9, the ‘expected loss’ model, is more forward-looking: introducing this approach is a major challenge, particularly for banks, but should provide users with more relevant information about performance and credit risk.
IAS 39’s hedge accounting was believed to be flawed. It applied a rules-based approach which could result in hedge accounting not being permitted even where the entity was managing risk through hedging. IFRS 9 retains IAS 39’s three hedge accounting techniques but extends the range of valid hedged items and hedging instruments: this will increase the availability of hedge accounting. The Board has also relaxed the regime for assessing and testing hedge effectiveness: IAS 39 set quantitative tests of the degree of offsetting achieved, both retrospectively and prospectively: this excluded some hedging relationships from using hedge accounting. IFRS 9 replaces the quantitative test with a qualitative one and reduces the frequency of testing. The aim is to enable the financial statements to reflect the true nature and extent of an entity’s risk management strategy.
IFRS 15 Revenue from Contracts with Customers
IFRS 15 represents a single systematic approach to recognising revenue. It replaces IAS 11 Construction Contracts and IAS 18 Revenue and four Interpretations. These standards were principles-based but lacked enough effective application guidance. Some sectors will not find the changes onerous, although all will be required to meet significantly enhanced disclosure requirements and some changes in presentation. Companies in the telecoms, construction, real estate and software industries are likely to be significantly affected. Many of them enter into contracts with multiple elements stretching over more than one reporting period.
IAS 18, the main revenue standard, prescribed different models for sale of goods, rendering services and the use of assets by others. Revenue from the sale of goods is recognised when there has been a transfer of the significant risks and rewards of ownership to a buyer. Revenue from rendering services is recognised by reference to the stage of completion of the transaction.
IFRS 15 sets out a single model for recognising revenue, irrespective of whether it comes from selling goods or providing services. This is based on the transfer of control over the promised goods or services from the seller to the buyer/customer. Control is defined as the ability to direct the use of and obtain substantially all of the remaining benefits from the asset.
The IFRS 15 model is systematic and provides extensive application guidance. It involves five steps:
- Identify a valid contract with a customer.
- Identify within that contract the separate performance obligations - these are the units of accounting.
- Determine the transaction price, which is the amount of consideration to which the seller expects to become entitled.
- Allocate the transaction price to each performance obligation, based on relative standalone selling prices.
- Recognise revenue when the customer obtains control of the goods or services, which may be either over time or at a point in time.
IFRS 15 also sets out special rules for capitalising direct costs of obtaining contracts and costs of fulfilling contracts. In addition, the standard addresses presentation issues and introduces more useful disclosure requirements.
All in all, IFRS 9 and IFRS 15, while involving significant work in implementation for some preparers, are likely to make financial statements for relevant and reliable for users.
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