IASB Projects A pocketbook guide As at 31 December 2011 In this edition ... Introduction 2 Timeline 3 IASB projects 4 • Consolidation 4 • Financial instruments 7 • Leases 13 • Revenue recognition 15 • Insurance contracts 17 • Annual improvements 19 • Amendments to IFRS 1 20 • Agenda consultation 21 • Post implementation reviews 22 1 IASB Projects Introduction Ernst & Young’s pocketbook guide summarises the key features of active The IASB updated its work plan on 20 December 2011 to reflect the projects of the International Accounting Standards Board (IASB or the amended timetable for its projects. Highlights of the current IASB’s work Board) . This publication also includes potential financial and business plan are provided in this publication. In addition to re-exposing the revenue implications of the proposed standards, along with our views on the recognition proposal, the IASB and FASB also decided to formally expose respective projects that have been shared with the Board. their joint lease proposal for a second time because they have made significant changes to the model they proposed last year. A second exposure We hope you have found the previous editions of this pocketbook guide draft is expected in the first half of 2012. The decision to re-expose helpful. In previous editions, we highlighted a number of standards and the leases and revenue recognition proposals will allow constituents an amendments that the IASB finalised in 2010 and 2011. Details of these opportunity to provide further feedback. new and amended standards can be found in our publication, IFRS Update for the financial year ending 31 December 2011. We also refer you to our Joint Project Watch — IASB/FASB joint projects from an IFRS perspective for additional details of projects discussed in this This edition of the pocketbook guide provides updates on the IASB’s pocketbook guide that have been undertaken jointly by the Boards. active projects, incorporating activities and tentative decisions made up to 31 December 2011. We highlight the Board’s proposals for consolidation We trust that you will find this guide, as well as the Joint Project Watch, of investment entities and the re-exposure of the proposal on revenue useful. recognition. Other significant updates from our June 2011 edition include tentative decisions on significant aspects of the leases, financial Yours sincerely, instruments and insurance contracts projects. Ruth Picker Global Leader — IFRS Services Global Professional Practice December 2011 IASB Projects 2 Project timeline 2011 2012 Ongoing projects First half Second half First half Second half Consolidation Transitional guidance for IFRS 10 Investment entities Financial Instruments1 Impairment SD General hedge accounting RD2, Macro hedge accounting Asset and liability offsetting Leases Revenue recognition Insurance contracts 3 Annual improvements 2009-2011 4 4 5 Amendments to IFRS 1 Agenda consultation Agenda decision Post implementation reviews IFRS 8 Operating Segments IR TC IFRS 3 Business Combinations IR Exposure draft (including re-exposure) Roundtable discussions Final standard SD Supplementary document RD Review draft IR Initiate review TC Target Completion 1 The IASB addressed this project in stages. Final IFRSs for classification and measurement-assets and liabilities were issued in Q4 2009 and Q4 2010, respectively. 2 An RD of the general hedge accounting proposals is expected to be made available on the IASB website for a period of 90 days. 3 Re-exposure or RD. 4 Annual improvements 2009-2011 is expected to be completed in the first half of 2012; separate EDs on annual improvements 2010-2012 and 2011-2013 are expected to be issued in Q1 and Q3 2012, respectively. 5 The Board will decide whether to proceed with the amendments based on comments received on the ED. 3 IASB Projects Project Key developments to date Implications Consolidation — overview Background: • Splitting the project into parts allowed the IASB to Consolidation publish IFRS 10, while allowing time for due process • IFRS 10 Consolidated Financial Statements was regarding the proposed changes in the accounting by published in Q2 2011 and replaces portions of IAS investment entities. 27 Consolidated and Separate Financial Statements and the interpretation SIC-12 Consolidation — Special Purpose Entities. • In December 2011, the IASB issued an ED that proposed clarifications to the transitional guidance in IFRS 10. The proposals are aimed at addressing constituent concerns that the transitional provisions of IFRS 10 were more burdensome than originally intended by the IASB. Comments on the ED are due 21 March 2012 and a final IFRS is targeted for Q2 2012. Investment entities • A separate ED of proposed amendments to consolidation requirements for investment entities was issued in Q3 2011. IASB Projects 4 Project Key developments to date Implications Consolidation — Background: The IASB issued a new consolidation • This would be a significant change for investment investment entities standard in May 2011 that establishes a single control entities, which are currently required to consolidate Joint project model applicable to all entities. The IASB, jointly with investees that they control. the US Financial Accounting Standards Board (FASB), is (ED issued August 2011) continuing to consider issues relating to consolidation accounting for investment entities. Scope: The proposals would be applicable to all controlled investments held by a reporting entity that meet the definition of an investment entity. Key features: • To qualify as an investment entity, an entity would be required to meet several criteria. • An investment entity would be prohibited from consolidating investments in entities that it controls, and could not account for joint ventures or associates using the equity method. Instead, an investment entity would measure those investments at fair value. • A parent of an investment entity that is not an ‘investment entity’ itself would be required to consolidate any controlled investees held by the investment entity (i.e., fair value is not allowed at the parent entity level). 5 IASB Projects Project Key developments to date Implications Consolidation - • Entities that do not meet the criteria to be an ➢ Some constituents (including the FASB) consider it investment entities cont’d investment entity would be prohibited from appropriate that an entity should be able to retain, in its measuring investments in joint ventures and consolidated financial statements, the fair value associates at fair value. This is currently permitted, accounting applied by its subsidiary in the parent’s but not required, for certain entities, such as consolidated financial statements. investment-linked insurance funds. Proponents of this view generally believe that Transition: if fair value provides the most decision-useful • If an entity meets the definition of an ‘investment information in the financial statements of the entity’, an adjustment to opening retained earnings investment entity, it also provides the most decision- would be made. The adjustment would be for the useful information in the group’s financial statements. difference between the previous carrying amount of the net assets of the controlled investee and the fair value of the investee as of the date of first applying the proposed amendment. • An effective date of 1 January 2013 was proposed ➢ during deliberations, which coincides with the effective date of IFRS 10 Consolidated Financial Statements. IASB Projects 6 Project Key developments to date Implications Financial instruments (IAS 39 Background: The IASB separated the financial • The IASB and FASB have divergent views on several replacement) - overview instruments project into several phases: areas, particularly on the extent of use of fair value. Classification and measurement • The limited scope review of IFRS 9 creates • IFRS 9 Financial Instruments for financial assets was uncertainty as to what IFRS 9, if amended, will first published in November 2009 and updated in require. This could be of concern to entities that have October 2010 for financial liabilities. Refer to IFRS already adopted IFRS 9. Update for the financial year ending 31 December 2011 for details of the new requirements of IFRS 9. • Amendments issued in December 2011 revised the effective date of IFRS 9 to annual periods beginning on or after 1 January 2015. Further, these amendments no longer require entities to restate comparative figures. Instead, entities would either be required or permitted to provide additional disclosures on the basis of the entity’s date of transition. • The IASB tentatively decided at its November 2011 meetings to initiate a limited scope review of IFRS 9 and, in particular, to consider the interaction with the insurance contracts project and the differences with US GAAP. 7 IASB Projects Project Key developments to date Implications Financial instruments (IAS 39 Balance sheet offsetting We fully support the deferral of the effective date of replacement) - overview cont’d • Amendments to IFRS 7 Financial Instruments: IFRS 9. We also fully support the IASB’s decision to Disclosures and IAS 32 Financial Instruments: continue to permit earlier application of IFRS 9, Presentation were issued in December 2011. particularly as it would allow first-time adopters to apply only one set of financial instruments requirements. Hedge accounting Relief from restating comparatives addresses • A final standard is expected to be issued in the first constituents’ concerns about the original IFRS 9 half of 2012 on general hedge accounting. requirements. • Proposals on macro hedge accounting are being considered separately and an ED is expected in the first half of 2012. Impairment of financial assets • The IASB and FASB (the Boards) are jointly working on an approach for impairment of financial assets. This approach is based on variations of proposals that were previously issued in 2009 and 2011 and is expected to take into account constituents’ feedback received on the previous proposals. An ED is expected in the first half of 2012. IASB Projects 8 Project Key developments to date Implications Financial instruments — Scope: The proposals are applicable to all financial We support the Boards’ efforts to arrive at a converged impairment assets recorded at amortised cost under IFRS 9 (e.g., solution to accounting for credit impairment under IFRS Joint project loans held by financial institutions and investments in and US GAAP. debt securities). (Re-exposure expected first half 2012) Key features: • The Boards have agreed to pursue a ‘three-bucket approach’. Under this approach, all financial assets are initially placed into Bucket 1 and subsequently moved to Bucket 2 and 3 as credit deteriorates. • An impairment allowance would be recorded based on the lifetime expected losses for the portion of assets expected to move to Buckets 2 or 3 over the next 12 months. • Assets would move into Bucket 2 when (1) there has been a “more than insignificant” deterioration in credit quality and (2) the likelihood of default is such that it is at least reasonably possible that the contractual cash flows may not be recoverable. • The Boards agreed to avoid bright lines indicating when lifetime expected losses should be recorded when applying the three-bucket approach to debt securities and consumer and commercial loans. • The Boards have yet to discuss the disclosure requirements and application of the new impairment approach to purchased financial assets, trade receivables and lease receivables. Transition: The expected effective date for IFRS 9 impairment is 1 January 2015, unless there are further delays in the impairment project. 9 IASB Projects Project Key developments to date Implications Financial instruments — Scope: The amendments are applicable to offsetting • Although a fully converged framework for balance asset and liability offsetting financial assets and financial liabilities. sheet offsetting between IFRS and US GAAP has Key features: not been achieved by these changes to IFRS, the (Amendments to IFRS issued amendments to IFRS 7 will enable a reconciliation of December 2011 • IFRS 7 amendments require additional disclosures the effect of the IFRS and US GAAP difference. for financial instruments entered into under an • The amendments will not have a major effect on enforceable master netting agreement (or other accounting practice, but the new disclosure similar agreement). requirements may result in system modification. • IAS 32 amendments provide application guidance for offsetting financial instruments in the statement of financial position as follows: • The right of set-off must be legally enforceable in both the normal course of business and in the event of default, bankruptcy and insolvency of either of the counterparties • Only gross settlement systems with certain features would be considered equivalent to net settlement Transition: The amendments to IAS 32 are applied retrospectively to annual and interim periods beginning on or after 1 January 2014. The new disclosures in IFRS 7 are applied retrospectively and are effective for annual and interim periods beginning on or after 1 January 2013. Earlier application is permitted. IASB Projects 10 Project Key developments to date Implications Financial instruments — general Scope: An entity may choose to designate a hedging • A principles-based approach is proposed, which is hedge accounting relationship between a ‘hedging instrument’ and a consistent with the IASB’s objective to reduce ‘hedged item’ as defined in the proposed standard. complexity. Under the propsed model, there would be (IFRS expected first half of a better link between an entity’s risk management 2012) Key features: strategy, the rationale for hedging and the impact of • Hedge accounting would be permitted for risk hedging on the financial statements. components of financial and, for the first time, • For entities that already apply IFRS, it is expected non-financial items, provided the risk components that almost all of the previous hedge accounting can be separately identified and reliably measured. relationships under IAS 39 would still qualify under • There would be no arbitrary bright line tests for the proposed standard. hedge effectiveness assessment. Instead, there must • The proposals are likely to have a significant impact be an economic relationship between the hedged on entities that use economic hedging practices, but item and the hedging instrument, and the effect of are currently unable to reflect this in their financial credit risk must not dominate the value changes that statments. would result from that relationship. Qualitative testing would be possible, when appropriate. 11 IASB Projects Project Key developments to date Implications Financial instruments — general • A hedge relationship would be rebalanced after • The most significant benefit may be for non-financial hedge accounting cont’d inception when the hedge ratio is adjusted for risk services entities, because hedge accounting would be management purposes, rather than being de- permitted for risk components of non-financial items. designated and re-designated as currently required under IAS 39. Transition: The proposals are expected to be applicable prospectively for annual periods beginning on or after 1 January 2015. Early application would be permitted, but only if the hedge accounting proposals are adopted together with all other IFRS 9 requirements that have been previously finalised. IASB Projects 12 Project Key developments to date Implications Leases Background: Based on feedback from constituents on • This would be a significant change from existing Joint project the ED (issued in August 2010), the Boards identified a IFRS. The classification of leases as either finance or number of issues that continue to be discussed during operating would cease and be replaced with a right of (Re-exposure expected first half the ongoing redeliberations. use approach. As a result, key ratios (e.g., gearing, of 2012) EBITDA and interest coverage), bank covenants and Scope: Generally, leases of property, plant and other key performance metrics are likely to be equipment. impacted. Key features: • Initial and ongoing estimation would require new Lessee model processes and changes to information systems to • Lessees would recognise an asset for the right to use capture information required by the proposed the leased item and a corresponding obligation to standard (e.g., lease term, lease and non-lease pay rentals. Current operating lease accounting components). would be eliminated except for certain short-term • Entities would need to focus on separating services ➢ leases (i.e., leases with maximum term of 12 months). and executory payments from existing operating • Amortisation of the right-to-use asset and interest on leases. Previously these costs may have been split the lease obligation would be recognised in profit or out as the accounting treatment for such payments loss. was often the same as operating lease payments • Reassessment of certain key considerations (e.g., under existing IFRS. lease term, variable lease payments that depend on an index or rate) would be required throughout the life of the lease. 13 IASB Projects Project Key developments to date Implications Leases cont’d Lessor model ➢ We support the Boards’ decision to re-expose and • Lessors would apply a single approach, the receivable strongly encourage companies to re-evaluate the and residual approach, to all leases, except short- proposed revised model and provide feedback to the term leases and leases of investment property. Boards. Lessors would apply current operating lease accounting to short-term leases and leases of investment property. • Under the receivable and residual approach, the lessor would recognise a lease receivable, allocate the carrying value of the underlying asset being leased between the right of use granted to the lessee and the portion retained by the lessor (‘residual asset’), and recognise profit at the commencement of the lease. • Over the term of the lease, the lessor would recognise income related to interest on the receivable and accretion of the residual asset. Transition: Lessees and lessors could transition following either a full retrospective approach or a modified retrospective approach (i.e., an approach that allows certain types of relief that the Boards designed to reduce transition costs). The Boards have not concluded on the effective date. IASB Projects 14 Project Key developments to date Implications Revenue recognition – Background: The Boards exposed their joint revenue • Accounting for multiple-element deliverables in Joint project recognition proposal for a second time in November a contract may impact the timing of revenue 2011 as a result of significant changes made to their recognition. (Re-exposure November 2011) original proposals. • The notion of ’transfer of control’ would have a significant impact on revenue recognition, mainly in Scope: The proposal would apply to revenue arising long-term contracts. This would need to be taken into from contracts with customers and the sale of some consideration in existing and forthcoming contracts. non-financial assets that are not an output of the No significant impact is expected for normal sales entity’s ordinary activities (i.e., sale of property, contracts. plant and equipment or intangibles). Lease contracts, insurance contracts, financial instruments and certain • Revenue and its related key performance indicators non-monetary transactions are outside the scope of the may change. For example, the presentation of bad proposal. debts expense as a separate line item adjacent to the revenue line instead of part of operating expenses Key features: would result in a lower gross margin amount. • The proposed model is based on the following five • Among other changes, the proposal would require steps: additional disaggregated disclosures of revenue, 1. Identify the contract with a customer — Contracts reconciliations of contract asset and liability account can be written, verbal or implied. Contracts could balances between periods, and disclosure of key be combined, but would not be required to be estimates. These changes may require significant segmented. modifications to existing internal data gathering 2. Identify the separate performance obligations in efforts and processes. the contract — A good or service would be distinct (i.e., a separate performance obligation) if either: (i) the entity regularly sells the good or service separately; or (ii) the customer can benefit from the good or service on its own or together with other readily available resources. 15 IASB Projects Project Key developments to date Implications Revenue recognition cont’d 3. Determine the transaction price — The transaction Many of the changes will have a significant impact on price would be the amount of consideration that an entities and may require significant cost to implement. entity expects to be entitled to in exchange for Accordingly, we strongly support the Boards’ decision to transferring promised goods or services to a give constituents a chance to formally comment on the customer. The transaction price would exclude revised proposal. credit risk. 4. Allocate the transaction price to the separate performance obligations — Estimated transaction prices would be allocated based on the stand-alone selling prices. A residual technique could be used for performance obligations with highly variable prices (e.g., software licences). 5. Recognise revenue when (or as) the entity satisfies a performance obligation — An entity would satisfy a performance obligation by transferring control of a promised good or service to the customer, which could occur over time or at a point in time. The amount of revenue recognised may be constrained (i.e., limited because of variable consideration and rights of return). • An entity would recognise a liability and a corresponding expense if a performance obligation satisfied over time becomes onerous provided the performance obligation is satisfied over more than one year. Transition: Full retrospective application, with some relief, is proposed and early adoption would be permitted under IFRS. The Boards have not yet proposed an effective date, but have indicated that it would not be before 1 January 2015. IASB Projects 16 Project Key developments to date Implications Insurance contracts Background: Although a number of tentative decisions • The Board’s proposals are far-reaching and may have Joint project have been made since redeliberations began in a significant impact on insurers (e.g., estimating February 2011, the Board continues to actively discuss all future cash flows arising from the fulfilment (Re-exposure or review draft this project. The IASB tentatively decided at its of an insurance contract on a probability-weighted expected first half 2012) November 2011 meetings to initiate a limited scope basis, accounting for acquisition costs incurred by review of IFRS 9 and, in particular, to consider the insurers to secure contracts with policyholders). interaction with the insurance contracts project. This would have a related impact on key processes and internal controls. Scope: Applies to all types of insurance contracts • The proposed model would result in a significant (life, non-life, direct insurance and reinsurance). change to a number of financial metrics and may Key features: also result in an increase in volatility of profit or loss. • The proposed approach for the measurement of • The tentative decisions made by the IASB differ insurance contracts is based on the following building from the FASB decisions in some important areas blocks: (e.g., margins and acquisition costs). As a result, • Expected present value of future cash flows there is a risk that the Boards may not reach a • A risk adjustment converged solution. • A residual margin that eliminates any gain at inception of the contract, but will be adjusted subsequently for changes in estimates of cash flows • The discount rate used to measure insurance contracts would be a current rate updated at the end of each reporting period (i.e., the discount rate would not be ‘locked in’ at inception of the contract). Rather than a prescribed rate, the proposed approach would include the principle that the rate should reflect the characteristics of the liability. 17 IASB Projects Project Key developments to date Implications Insurance contracts cont’d • Initial recognition of insurance contracts would In our comment letter, we expressed concerns about ordinarily be the date coverage becomes effective. some of the features of the measurement model • The measurement of the insurance contract would proposed in the ED. We believe these must be resolved include the direct acquisition costs that the insurer before a standard on insurance contracts can be incurs when acquiring the contracts in a portfolio, finalised. We also proposed a number of changes to without making a distinction between successful and aspects of the model. unsuccessful efforts. We are closely monitoring the impact of the Board’s • Reinsurance would substantially follow the overall recent decisions on our concerns and convergence with concepts proposed with a few modifications to reflect the FASB. In particular, the Board’s decisions on the topic the nature of reinsurance arrangements. of asset and liability mismatch will be a critical aspect of • A modified approach based on a premium allocation finalising the model. model would be applied to the liability for remaining coverage for some types of contracts (e.g., contracts with a coverage period of one year or less). Transition: A limited retrospective approach was proposed in the original ED. However, the Board has not concluded on the transition method or the effective date. IASB Projects 18 Project Key developments to date Implications Annual improvements Background: The Improvements to IFRS project is an • Amendments made as part of annual improvements 2009-2011 annual process that the IASB has adopted to deal with are generally intended to clarify requirements rather non-urgent, but necessary, amendments to IFRS (the than result in substantive changes to current (Final amendments expected annual improvements). The IASB issued an ED in 2011 practice. However, management may need to first half 2012) and is expected to issue two additional EDs in 2012 on re-evaluate existing policies, procedures or disclosure annual improvements 2010-2012 and 2011-2013). practices. Scope: The June 2011 ED proposes seven amendments to five standards. Key features: • Proposed clarification that income tax relating to both a distribution to holders of an equity instrument and to transaction costs of an equity transaction would be recognised in accordance with IAS 12 Income Taxes. • Other clarifications are proposed for IFRS 1 First-time Adoption of International Financial Reporting Standards, IAS 1 Presentation of Financial Statements, IAS 16 Property, Plant & Equipment and IAS 36 Impairment of Assets. Transition: The amendments are expected to be effective for annual periods beginning on or after 1 January 2013. 19 IASB Projects Project Key developments to date Implications Amendments to IFRS 1 Background: The IASB proposed limited scope • The proposed amendments are expected to be amendments to IFRS 1 in October 2011. The Board will applicable to jurisdictions where below-market (ED issued October 2011) decide whether to proceed with the amendments based interest rate loans from governments are available on comments received on the ED. to entities. This would provide relief to first-time adopters with such government loans that were Scope: The amendments would provide an exception accounted for at cost under previous GAAP. to first-time adopters with government loans that have below market interest rates that were entered into prior to the transition to IFRS. Key features: The proposed exception requires first-time adopters to apply paragraph 10A of IAS 20 Accounting for Government Grants and Disclosure of Government Assistance prospectively to government loans with a below-market rate of interest entered into on or after the date of transition to IFRS. An entity may only apply the requirement of paragraph 10A of IAS 20 to earlier transactions if the necessary information required was obtained at the time of initially accounting for that loan. Transition: The amendments would be effective for annual periods beginning on or after 1 January 2013. Earlier application would be permitted. IASB Projects 20 Project Key developments to date Implications Agenda consultation Background: As the IASB moves closer to finalising the The IASB has the unique ability at this point in time to remaining projects from its current work plan, the Board step back and re-assess the strategic direction of IFRS as (Agenda decision expected is looking forward to the next three years of standard a valuable tool for financial reporting. 2012) setting. As part of this process, in July 2011, the IASB To achieve this, we believe the IASB’s agenda should issued a Request for Views on the strategic direction include a long-term project on the future of performance and overall balance of its future agenda. Constituents’ reporting. This project would focus on the decision responses will be considered when setting the future usefulness of IFRS and consider IFRS financial agenda in 2012. statements as a whole. This will help to enhance Key features: confidence in the relevance of IFRS financial statements • The IASB has proposed that the following three for both users and preparers. aspects should be reflected in the strategic approach for setting its future agenda: • A more diverse IFRS community potentially leading to new issues • A more complex market environment creating new challenges in financial reporting • A number of new and amended IFRS have been issued or are expected to be issued in 2012 placing pressure on preparers to implement these changes and users to understand the key differences • The Request for Views also highlights that the strategy of the future agenda should not only focus on the development of new IFRS, but should also emphasise the need to maintain existing IFRS. This includes completion of the conceptual framework project as a strategic priority and initiating the post-implementation reviews project. 21 IASB Projects Project Key developments to date Implications Post implementation reviews – Background: The IFRS Due Process Handbook • One outcome of these reviews could be proposals for IFRS 8 and IFRS 3 establishes that a post-implementation review revisions to IFRS 8 and IFRS 3. is normally carried out two years after the new requirements have become mandatory and been implemented. Such reviews are normally limited to important issues identified as contentious during the development of the pronouncement and consideration of any unexpected costs or implementation problems encountered. Key features: • A review of IFRS 8 Operating Segments, applicable for annual periods beginning on or after 1 January 2009, has been initiated and is expected to be completed in 2012. • A review of IFRS 3 Business Combinations, applicable for annual periods beginning on or after 1 January 2010, is expected to be initiated in 2012. IASB Projects 22 Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 152,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve their potential. Ernst & Young refers to the global organization of member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. 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