www.pwc.com/ifrs IFRS news – February 2012
IFRS news – February 2012 1
It
Eurozone and 2011 financial
reporting: not just about the banks
Mary Dolson, partner in PwC’s Global Accounting Consulting Services, provides an
overview of the impact of the current economic climate on 2011 financial
statements of entities outside the banking and financial services sector (guidance
on issues affecting financial services entities is available in our ‘practical guide’).
There continue to be significant concerns
about the economies of some European
countries. Austerity programmes and rescue
packages have not eliminated the possibility
of default on sovereign debt, and the
broader economic news remains gloomy.
All entities doing business in the eurozone
need to consider the impact of the current
economic climate on their 2011 financial
statements. Entities in some industries are
directly exposed to the government as a
customer. Banks and other financial
institutions are the most exposed to
sovereign debt. Many entities in a variety of
industries are exposed to macro-economic
trends, such as reduced consumer spending
and downward pricing pressure.
Going concern
The current environment might result in
reduced availability of credit and declining
business performance. Financial
institutions might impose stringent
requirements over new or existing
borrowings. This could cast doubt on the
going concern assumption.
Conditions or events that might cast doubt
on the going concern assumption include:
squeezed financing and indications of
withdrawal of financial support by
lenders;
adverse key financial ratios; and
significant deterioration in the value of
non-financial assets.
You should assess the appropriateness of
the going concern assumption and disclose
any material uncertainties.
Accounts receivable and revenue
recognition
Many entities continue to do business with
governments in the troubled eurozone
countries, despite long delays in payment,
mandatory restructuring of older unpaid
debtors, significant discounts on factoring
receivables where factoring is possible and
downward pricing pressure on goods and
services. If these are your circumstances,
you should consider what issues might
arise around the valuation of accounts
receivable and recognising revenue.
Valuation of new and
outstanding trade receivables
You should also consider for impairment
all existing and new trade receivables from
governmental bodies in troubled eurozone
countries. An impairment loss is calculated
based on revised expected cash flows,
discounted at the receivables’ original
effective interest rate. Any impairment
IFRS news
In this issue:
1
Economic conditions
and 2011 year ends
4
Interview
IASB chairman Hans
Hoogervorst
6
IFRS quiz
Debt versus equity
9
Contacts
www.pwc.com/ifrs
IFRS news – February 2012 2
charge is recorded as a current-period bad-
debt expense.
You should consider discounting, on initial
recognition, any receivables that are not
expected to be collected immediately. There
is no ‘grace period’ in the revenue standard
for receivables that are collected within one
year or any other specific period. You should
discount accounts receivable at initial
recognition, with a consequential reduction
in revenue, if the effect of discounting is
expected to be material.
Discounting requires estimating the date of
collection and the actual amounts that will
be collected, and determining an
appropriate interest rate to use.
When estimating the date of collection, you
should use the most recent data available
on day-sales outstanding, adjusted for any
recent developments.
The appropriate discount rate is the rate at
which the customer could otherwise
borrow on similar terms. For a government
body, a reasonable starting point for
estimation is the most recent rate at which
the relevant government body has been
able to borrow.
Some receivables may be interest-bearing
by statute; however, this does not remove
the requirement to consider discounting.
The rate of interest that government bodies
are paying is unlikely to be the same as the
rate at which receivables should be
discounted.
Revenue recognition
You also need to determine whether
revenue should be recognised for current
sales, and the amount of revenue to be
recognised. You have to meet all five
revenue recognition criteria in IAS 18,
‘Revenue’, in order to recognise revenue.
The criteria that are most under stress in
the current environment are that:
revenue can be measured reliably; and
it is probable that economic benefits
will flow to the entity.
You should first determine if it is probable
that you will be paid for the goods you have
received. Slow payment does not, on its
own, preclude revenue recognition.
However, slow payment may well reduce
the amount of revenue, because the
corresponding receivable will be
discounted.
Revenue recognised might be further
reduced by an estimate of discounts,
clawbacks and future allowances that
governments might demand.
You should not recognised revenue if you
don’t expect to receive payment, or if you
expect discounts and allowances to be
material but cannot estimate them.
Non-financial asset impairment
Current economic difficulties will impact
the expected future cash flows to be
generated by long-term, non-financial
assets such as goodwill, PPE and intangible
assets. If your business has significant non-
financial assets relating to, located in or
selling into any of the troubled eurozone
economies, you should consider the impact
when measuring the recoverable amount of
non-financial assets.
The effects of the economic downturn could
impact impairment calculations in several
different ways, notably: triggering
impairment reviews; affecting key
assumptions underlying management’s cash
flow forecasts (growth, discount rates); and
requiring more sensitivity disclosures.
You should determine an impairment loss,
if any, after calculating the recoverable
amount. You also need to be alert to the use
of over-optimistic assumptions in
impairment cash flow models in the
current environment.
Employee benefits
Long-term employee benefit liabilities,
including defined benefit pension
obligations, are discounted using a rate
based on market yields at the balance sheet
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IFRS news – February 2012 3
date on high-quality corporate bonds of
equivalent currency and term. The bond
should be rated at least AA to be
considered ‘high quality’. Use market yields
(at the balance sheet date) on government
bonds of equivalent currency and term if
there is no deep market in high-quality
corporate bonds. Discount rates and other
assumptions are coming under more
scrutiny in the current environment.
Entities in the eurozone have a policy
choice to consider discount rates either at
the level of the eurozone or the individual
country. You should apply the policy
consistently from year to year, and any
change is a change in an accounting policy.
A change from a eurozone corporate bond
rate to a country government bond rate is
unlikely to provide more reliable and
relevant information.
Many entities use actuaries to help derive
appropriate assumptions; actuaries use
different approaches to develop their
advice. Where an actuary uses a different
methodology from that used in prior
periods, you should bear in mind
consistency and applicability. A change in
methodology should lead to a ‘better’
estimate of the appropriate discount rate,
and should reflect available data about
market yields and the benefit plan’s
expected cash flows.
Provisions
IAS 37, ‘Provisions’, requires provisions to
be discounted, typically starting with a
risk-free rate. The sovereign debt crisis
raises the question of whether a
downgraded government credit ratings
means that government bond yields no
longer provide a risk-free rate.
There are some countries for which all the
ratings agencies have acted to downgrade
government bonds. The yield on these
bonds is unlikely to be a risk-free rate; you
will need to make some risk adjustment to
establish a risk-free rate. Judgement is
needed to determine whether government
bonds remain risk free.
Taxes
You should scrutinise the recoverability of
deferred tax assets, particularly when
current and expected future profits are
adversely affected by market conditions.
Deferred tax assets are recognised only to
the extent it is probable that future taxable
profit will be available against which the
assets can be utilised.
Consider future reversals of existing
deferred tax liabilities, future taxable profits
and tax planning opportunities when
evaluating deferred tax assets. You should
give particular attention to the assumptions
underlying expected taxable profits in future
periods and to the requirement to have
convincing evidence of future profits when
the entity has a history of losses.
Disclosures
Additional disclosures may well be required
in the current economic environment;
several regulators have already issued
guidance about their expectations in this
area. IFRS 7, ‘Financial instruments:
Disclosures’, is particularly relevant; take
care to ensure the objectives set out in the
standard are met. Further disclosures are
required by IAS 1, ‘Presentation of financial
statements’. It may be necessary to make
broader disclosures about the impact of the
European economic environment on your
business, financial instruments,
concentration of risk and future.
Subsequent events
Events may unfold quickly; you should
consider carefully whether you need to
reflect events occurring between the balance
sheet date and the date of authorisation in
the financial statements. Events are either
adjusting or non-adjusting; many non-
adjusting events will still require disclosure.
You can find our guidance on economic
pressures in the current environment from
the topic summary: ‘Impacts of the current
market conditions’. Click this link or visit
pwc.com/ifrs, ‘Additional PwC guidance’.
www.pwc.com/ifrs
IFRS news – February 2012 4
Raising standards
IASB chairman Hans Hoogervorst tells IFRS news about his approach to standard-
setting and the challenges around the convergence agenda.
What is the IASB’s overall
strategy?
It’s pretty simple really. Our job is to
develop a single set of globally consistent
financial reporting standards that deliver
high-quality information to investors. At
the same time, we are working with
national and regional public authorities, as
well as other international organisations, to
encourage global adoption of these
standards.
In practice, that means completing our
current work programme with the US
FASB to the highest possible standard. It
means consulting on our future agenda and
continuing to strengthen the institutional
relationships between the IASB and our
stakeholders.
What is the biggest challenge
you face over the short term?
There are two primary challenges. The first
challenge is for the IASB and the FASB to
complete jointly the remaining convergence
projects of revenue recognition, leasing and
financial instruments. The second is to
encourage the remaining major economies
to come on board.
On the first challenge, we are pretty far
advanced in our work to deliver
improvements to the revenue recognition
and leasing accounting standards. Given
the importance of this work, we are re-
exposing for public comment both sets of
proposals. At the same time, we are
conducting an unprecedented amount of
outreach activities on these projects to
ensure we fully understand all of the issues
and, as far as possible, we have avoided any
unintended consequences.
The remaining convergence project is
financial instruments. I’m pretty hopeful
that we will get very close to a converged
solution in many areas of the financial
instruments project. It’s a difficult task, as
the boards have been pulled in different
directions. We’ve each tried to respond as
best we can, but this has made achieving
convergence very challenging.
What are the criteria for a good
accounting standard?
In my view, a good accounting standard is
one that delivers high-quality, comparable
information to investors, but that does so
in a way that minimises the burden on
preparers. The standards need to be
applicable across developed and emerging
economies, auditable, enforceable and not
lead to diversity in practice. It’s a tall order,
but one that we take very seriously.
There are various ways we achieve this. We
have a geographically and professionally
diverse board of talented individuals. Our
work benefits from a thorough, robust and
comprehensive due process. We welcome
broad participation in the standard-setting
process, and we debate the different
viewpoints in a very transparent manner.
We take the time to explain what we heard,
how we responded and the rationale for the
decisions we have taken. And then we
revisit the standard a few years after it has
come into effect, just to make sure it is
working as designed. That’s about as much
as anyone could expect.
What is the greatest obstacle to
every country in the world one
day reporting under IFRS? Will
it happen?
Yes, I believe it will happen. The question is
when and how. Global accounting
standards are an inevitable consequence of
globally interconnected financial markets.
The greatest obstacle is political will, and
Hans Hoogervorst
Taurae
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IFRS news – February 2012 5
that is largely contained through the
recommendations of the G20 Leaders and
others. Even in the US, support for global
accounting standards is SEC policy and the
policy of the US Government. However, the
SEC is an independent agency and will go
through its own independent decision-
making process.
How do you measure an IASB
chairman’s success?
One of the most important things is respect
for the organisation and its work. Have we
sought broad input throughout the
standard-setting process, given careful
consideration to the issues, developed the
best possible standards, made sure they
can be applied around the world and
sought to avoid unintended consequences?
Not everyone will like the outcome, but
respect for the way we have gone about our
work, as an independent standard-setter, is
in my opinion the measure of our success.
What are your thoughts on the
recent SEC release of the two
papers on IFRS?
They are both very good assessments of the
current state of play.
The first paper looks at how well IFRSs are
being applied where they are required for
use. The SEC staff concluded that the
financial statements analysed generally
complied with IFRSs, but there were
inconsistencies observed – mainly due to a
lack of disclosure of accounting policies
and how individual standards had been
applied.
Consistent application of the standards is a
major challenge for standard-setters,
securities regulators and market
supervisors around the world. This is
something that our trustees have
encouraged us to look at. However, it is
also important to note that this problem is
not unique to IFRSs. The Wall Street
Journal noted that the findings were
similar to an earlier SEC study of Fortune
500 companies using US GAAP. The
problem of inconsistent application exists
whether companies use IFRSs or US GAAP.
However, the important point is this: you
can only work towards consistent
application if you have one single language,
and IFRS is the only candidate.
The second paper looked at the differences
between IFRSs and US GAAP and contains
no major surprises. The paper recognises
the tremendous progress that the boards
have made in bringing IFRSs and US GAAP
into alignment. However, the paper also
shows how quite a few differences remain,
particularly in the detail.
Many of these differences are not very
important. But getting rid of them through a
process of convergence could take up many,
many years. That is why I am even more
convinced that it is not in the best interests
of investors in the US or anywhere else in
the world to spend another 10 years seeking
to eliminate ever-smaller differences, which
entail significant costs for change without
much incremental benefit. That is also why
the time is right for a positive decision on
the incorporation of IFRSs into the US
financial reporting regime.
Should the IASB abandon
convergence if the SEC doesn’t
make a positive statement on
IFRS? When would you ‘call
time’ on the US prevarication?
Leslie Seidman, Chair of the FASB, and I
agree that we should ‘call time’ on the
convergence programme once these few
remaining projects have been completed.
The convergence programme has provided
a very useful mechanism to improve and
align IFRSs and US GAAP. However, we
that it is now time to look to the future. A
positive SEC decision will see the FASB
continuing to play a very active role in the
development of IFRSs.
What are you enjoying most
about the job?
I get to work with an enthusiastic, young,
talented group of people who are
“We should ‘call time’
on the convergence
programme once these
few remaining projects
have been completed”
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IFRS news – February 2012 6
passionate about what we do and are
working hard to help the organisation
achieve its goals. It is enjoyable to work in
an organisation with a very strong public-
interest ethic. I also enjoy the opportunity
to travel to some very interesting parts of
the world and meet people with
involvement in the work that we do.
The technical details of the standards can
be challenging, but I have found that being
a relative newcomer to accounting
standard-setting has helped me to offer a
fresh perspective to many of our
discussions.
Where will the next group of
board members come from?
Board members are selected by the trustees
following an international public search for
candidates. The primary criterion for
selection is their practical experience with
IFRSs. The trustees also consider
geographical criteria, and it is their
objective to increase the size of the Board
to 16 members by July 2012.
The trustees have just renewed the
appointment of our Chinese board member
Wei-Guo Zhang and Stephen Cooper from
the UK for another five-year term. Paul
Pacter has also agreed to stay on for a
further six months, until the Trustees
appoint his successor.
That leaves three appointments to cover
existing and forthcoming vacancies. Elke
König stepped down from the IASB at the
end of December 2012 to take up an
appointment as President of the German
Federal Financial Supervisory Authority,
while John Smith steps down this June
2011. A further board position is available
due to the constitutional amendment to
expand membership of the IASB to 16
members by July 2012
Quick-fire questions
Coffee or tea? Coffee
Restaurant or home cooking?
Home cooking
Balance sheet or income statement?
Income statement
IFRS quiz: debt or equity
So you think you know your debt from your equity? Test yourself against PwC’s
financial instruments specialist, Tina Farington, with this IFRS quiz (the first in a
series) about how to classify financial instruments from the perspective of the
issuer. Please note, this is not for amateurs!
Classification of capital as debt or equity
keeps the CFO awake at night, and getting it
wrong has severe consequences for
measurement. The guidance to classify such
instruments is addressed in IAS 32,
‘Financial instruments: Presentation’.
The IASB and FASB have been working on a
project to replace their respective
classification models. However, the project
to define debt versus equity has been placed
on hold and a converged solution seems a
long way off. Practitioners are going to live
and breathe the current classification model
for at least a few more years. S0, here are a
few questions to test your knowledge of the
current model under IFRS.
Q1: Which statement is true in the
definition of a financial liability?
(a) The key component to the definition is
that it is based on a written contract.
(b) It includes a contractual obligation to
deliver cash or other financial asset.
(c) It includes instruments that
economically obligate one entity to
deliver cash or other financial asset to
another entity.
(d) It does not include instruments that can
be settled only using the entity’s own
equity shares.
Tina Farington
www.pwc.com/ifrs
IFRS news – February 2012 7
Q2: Which of the following would preclude
the classification of an instrument as
equity?
(a) The entity’s ability to make distributions.
(b) The entity's history of making
distributions in prior years.
(c) Cash payments are not at the discretion
of the entity.
(d) The liquidation ranking (for example,
preferred share versus ordinary share).
Q3: Which instrument would be classified
as equity under IFRS?
(a) A preferred share that is redeemable only
if there is a change in control of the entity.
(b) A warrant where the issuer can decide to
settle either in cash or by delivering own
shares.
(c) A warrant giving the counterparty a right
to acquire a fixed number of the entity’s
shares for a fixed amount of cash.
(d) A contract where the amount of cash
that will be delivered is based on
changes in the market price of the
entity’s own equity.
Q4: A company has issued non-cumulative,
non-redeemable 5% preference shares
where the payment of the dividend is solely
at the discretion of the board of directors.
How should the instrument be classified?
(a) As equity, because the shares are non-
redeemable and dividends are solely at
the issuer’s discretion.
(b) It depends on the legal form of the
instrument.
(c) As a liability, because of the stated
dividend percentage and the intention of
the company to pay them.
(d) As mezzanine or ‘temporary’ equity,
because the preference shares have
characteristics of both a liability and
equity.
Q5: Which of the following is the best
example of a ‘compound’ instrument (that
is, has both a liability component and an
equity component) based on the facts
provided?
(a) A non-redeemable preference share that
converts into a fixed number of equity
shares anytime at the option of the
holder.
(b) A preference share that is redeemable
for cash in 10 years and pays
discretionary dividends.
(c) A convertible bond that may be
converted into a variable number of
equity shares in three years and has
cumulative mandatory coupon.
(d) Not applicable − instruments should not
be split into different components.
Q6: A puttable instrument is one that
requires the issuer to repurchase or redeem
the instrument for cash or other financial
asset on exercise of the put. The ‘puttables
amendment’ was issued in 2008. Which of
the following statements is true about the
amendment?
(a) It is an exception whereby all puttable
instruments may be classified as equity.
(b) It requires the put to be accounted for as
a derivative and the rest of the
instrument (that is, the share) to be
classified as equity.
(c) The puttable instrument can be
classified in equity if the issuer is only
required to redeem the instrument
based on a contingent event that is very
remote.
(d) One of the criteria for a puttable
instrument to be classified in equity is
that it is the most subordinate
instrument.
Q7: When evaluating a bond that is
convertible into equity shares, which of the
following features would result in the
conversion option being classified as
equity?
(a) The convertible bond is denominated in
a foreign currency.
(b) An adjustment is made to the number of
shares converted that entitles the
instrument holder to additional benefits
over that of the shareholder.
(c) Cash settlement alternatives at the
discretion of either the issuer or the
holder.
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IFRS news – February 2012 8
(d) Gross physical settlement for a fixed
amount of cash in exchange for a fixed
amount of shares (that is, considered to
be fixed for fixed).
Q8: On 1 December 2011, an entity enters
into a contract to purchase 10 million
shares of its common stock after one year
at C2 per share. The contract can only be
settled 'gross' in shares (physical delivery)
in exchange for a fixed amount of cash (C2
per share). Which statement describes the
most appropriate accounting?
(a) Liability for the present value of the
redemption amount (that is, the
proceeds to be paid upon settlement),
with the offsetting entry to equity.
(b) Derivative based on the fair value of the
forward contract.
(c) Equity only.
(d) Liability only.
Q9: Other than financial liabilities
measured at fair value through profit and
loss, how are financial liabilities
subsequently measured under IFRS?
(a) The amount of undiscounted cash that
would be required to settle the
obligation at the reporting date.
(b) Amortised cost using the effective
interest rate method.
(c) Amortised cost using the stated interest
rate of the debt.
(d) Either fair value or amortised cost at the
choice of the issuer.
Q10: Where should interest payments on a
financial liability be recognised?
(a) Equity.
(b) Profit or loss.
(c) It is management’s policy choice.
(d) It depends on the facts and
circumstances (for example, whether the
instrument is subsequently convertible).
Answers
Question 1: B – A contractual obligation to
deliver cash is a key component of the
definition of a liability. Economic compulsion
alone would not result in a financial liability.
Furthermore, though there is a contractual
obligation that forms part of the definition
under IFRS, it is not required for this to be only
in the form of a written contract.
Question 2: C – The entity must have
discretion to avoid cash payment to be classified
as equity. The entity's historical trend or ability
to make distributions is not considered as part
of the analysis.
Question 3: C –This warrant meets the
definition of equity as it meets the ‘fixed for
fixed’ rule (that is, the holder can exchange a
fixed amount of cash for a fixed number of
shares). Derivative contracts that can be settled
through any method other than gross physical
exchange (for example, net cash or net share
settlement) fails the definition of equity in
accordance with IAS 32.26, regardless of who
controls the decision. Finally, simply because an
event is contingent (for example, there is a
change in control), does not negate a
contractual obligation.
Question 4: A – When preferred shares are
non-redeemable, the appropriate classification
is determined by the other rights that may
attach to them under IFRS. Distributions to
holders of the preferred shares that are at the
discretion of the issuer would meet the
definition of equity as the entity does not have a
contractual obligation to pay cash. The legal
form of an instrument and economic
compulsion by the entity does not impact
classification of the instrument.
Question 5: B – There is a concept of a
compound instrument in IFRS. The preference
shares are redeemable for cash at a future date,
so this represents the liability component.
However, the discretionary dividends until the
instrument is redeemed represent an equity
component.
A convertible bond to convert into a variable
number of shares results in a liability with an
embedded derivative; and a preference share
that converts into a fixed number of shares or
www.pwc.com/ifrs
IFRS news – February 2012 9
otherwise non-redeemable is equity in its
entirety. Finally, there is no concept of
‘mezzanine’ equity under IFRS.
Question 6: D – The IASB issued a very
narrow amendment in 2008, whereby certain
instruments that would otherwise meet the
definition of a liability (because of the
obligation to redeem the instrument at the
option of the holder) could be classified as
equity if very strict criteria are met. One of
those criteria in IAS 32.16A-B is that the
puttable share is the most subordinate
instrument.
Question 7: D – Only instruments that are
gross physically settled by exchanging a fixed
amount of cash for a fixed amount of equity
may be classified as equity. A foreign currency
bond will result in a variable amount of cash in
settlement. Furthermore: (1) cash settlement
alternatives (even those at discretion of the
issuer) and (2) adjustments to the conversion
ratio where the rights and relative ownership of
the shareholder as compared to the instrument
holder are not maintained violate the fixed-for-
fixed rule.
Question 8: A – The forward contract
itself is equity (that is, it meets the fixed for
fixed rule), but IAS 32.23 requires that a
financial liability be set up for the present
value of the forward purchase price (the
present value of C20m). This amount is
reclassified from equity to liability. This
forward is not accounted for as a typical
derivative because of the explicit guidance in
this area.
Question 9: B – The instrument is carried
at amortised cost; the effective interest rate
method is the correct method of calculating
the amortised cost of a financial liability.
The stated rate is not appropriate.
Furthermore, all financial liabilities not
classified at fair value through profit and
loss at initial recognition are subsequently
measured at amortised cost.
Question 10: B – IFRS guidance is clear
that interest payments on a liability should
be recorded in profit and loss. This is not a
policy choice.
We have more guidance on these issues. A
good place to start is our topic summary on
financial instruments. Click this link or visit
or visit pwc.com/ifrs, ‘Additional PwC
guidance’.
For further help on IFRS technical issues contact:
Business combinations and adoption of IFRS
[email protected]: Tel: + 44 (0)20 7804 2930
[email protected]: Tel: +44 (0)20 7804 7392
Financial instruments and financial services
[email protected]: Tel: + 44 (0)20 7213 1175
[email protected]: Tel: + 44 (0)20 7212 5700
Liabilities, revenue recognition and other areas
[email protected]: Tel: +44 (0)20 7213 5336
IFRS news editor
[email protected]: Tel: +44 (0)20 7804 9377
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