When the entities NEED To and NEED NOT To present Consolidated Financial Statements ?

IAS 27, Consolidated and Separate Financial Statements shall be applied in the preparation and presentation of consolidated financial statements for a group of entities under the control of a parent. This standard shall also be applied in accounting for investments in subsidiaries, jointly controlled entities and associates when an entity elects, or is required by local regulations, to present separate financial statements. But this standard does not deal with methods of accounting for business combinations and their effects on consolidation, including goodwill arising on a business combination (refer to IFRS 3 Business Combinations).

As stated in para. 9 of IAS 27, a parent entity must present consolidated financial statements in which it consolidates its investments in subsidiaries [the standard defines a subsidiary as an entity, including an unincorporated entity such as a partnership, that is controlled by another entity (known as the parent)].

Following, para. 10 states that a parent need not present consolidated financial statements if all the following conditions apply :

(a) the parent is itself a wholly-owned subsidiary, or is a partially-owned subsidiary of another entity and its other owners, including those not otherwise entitled to vote, have been informed about, and do not object to, the parent not presenting consolidated financial statements;

(b) the parent's debt or equity instruments are not traded in a public market (a domestic or foreign stock exchange or an over-the-counter market, including local and regional markets);

(c) the parent did not file, nor is it in the process of filing, its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instruments in a public market; and

(d) the ultimate or any intermediate parent of the parent produces consolidated financial statements available for public use that comply with International Financial Reporting Standards.

Under the provisions of IAS 27, when the above conditions are all satisfied and as a consequence the parent entity chooses not to present consolidated financial statements, but to instead present separate financial statements, then all investments in its subsidiaries, jointly controlled entities and associates that are consolidated, proportionally consolidated or accounted for under the equity method in consolidated financial statements prepared in accordance with the requirements of IAS 27 or in financial statements prepared in accordance with the requirements of IAS 31 Interest in Joint Ventures or IAS 28 Investments in Associates, must be accounted for either at cost, or as available-for-sale financial assets in accordance with IAS 39 Financial Instruments : Recognition and Measurement. The same method must be applied for each category of investments. In other words, if consolidated financial reporting if foregone, then equity method accounting or proportional consolidation is also precluded.

As stated in para. 38 of IAS 27, when an entity prepares separate financial statements, it shall account for investments in subsidiaries, jointly controlled entities and associates either : (a) at cost, or (b) in accordance with IFRS 9 Financial Instruments and IAS 39 Financial Instruments : Recognition and Measurement.

Further, it states that the entity shall apply the same accounting for each category of investments. Investments accounted for at cost shall be accounted for in accordance with IFRS 5 Non-current Assets Held for Sale and Discontinued Operations when they are classified as held for sale (or included in a disposal group that is classified as held for sale) in accordance with IFRS 5. The accounting for investments in accordance with IFRS 9 and IAS 39 is not changed in such circumstances (HRD).

The shocking overhaul lease accounting standard

As I mentioned before in here : Exposure Draft of IAS 17 Leases, a new approach to lease accounting, on 17 August 2010, the global accounting standard-setter of IASB and the U.S accounting standard-setter of FASB have published for public comment a joint proposal to improve the financial reporting of lease contracts.

Soon after the publication, such ED becomes a hot topic of discussion and commenting amongst the accounting practices.

The proposal would require that all lease obligations be recorded on the balance sheet at the present value of the expected lease payment, along with an asset representing the right to use the leased asset. While the current accounting standard recognizes the capital (which places the lessee's asset and liability on the balance sheet) and operating lease (which goes off the balance sheet) method.

Before the publication of such ED, Reuters on August 15, 2010 published an article titled “Rulemakers plan global overhaul of lease accounting.” 

"Operating leases have long been considered one of the major off-balance sheet obligations, so there was this view that in an operating lease, the lessee has incurred an obligation and that it should be reflected on the balance sheet," said JanetPegg, an accounting analyst at UBS Investment Bank as reported by Reuter in the article.

Further, it reported that "while some investors may welcome the change to lease accounting because it will provide more clarity, many companies are fearful that the change will force their balance sheets to balloon overnight, and change all sorts of leverage and debt ratios, forcing them to renegotiate covenants with their lenders."

The Economist on August 19, 2010 in an article titled ”Shocking new accounting rules - You gonna buy that?” reported among others that "today, companies can opt either for a “capital lease”, which goes on the balance-sheet, or an “operating lease”, which does not. This distinction makes a certain sense. But the IASB and FASB think it is open to abuse. By labeling leases as “operating”, firms can appear less indebted than they really are. The new rules would put the right to use the leased item in the assets column. The obligation to pay for it would go in the debit column."

Leslie Seidman, FASB board member told WebCPA as reported in the article “Accounting Boards Propose Leasing Standards”  published on August 17, 2010 that "This proposal would put an asset on the books and amortize it, sort of like a depreciation expense, and then put a liability up and record interest expense related to it. First you’ve changed what you’re calling these P&L items, and then you’re changing the pattern of it because the asset will be amortized ratably and then interest expense will be recognized based on a declining liability amount. The pattern is just different from before, but again it’s intended to simulate the accounting if you were to buy it and finance it.”

Another related articles :

1. New lease accounting standard criticised for complexity (Accountancy Magazine)
2. New Accounting Rules Will Shatter The High Corporate Cash Mirage (Business Insider)
3. IASB and FASB propose to overhaul lease accounting
4. New leasing rules could hit bank lending (AccountancyAge)
5. Businesses await new standard for lease accounting (AccountingWeb)
6. FASB, IASB Ink Proposal to Put Leases on Balance Sheets (ComplianceWeek)

Exposure Draft of IAS 17 Leases, a new approach to lease accounting

On 17 August 2010, The IASB and US FASB published for public comment joint proposals to improve the financial reporting of lease contracts. As mentioned in the press release, the proposals are one of the main project included in the board's MoU. The proposals, if adopted, will greatly improve the financial reporting information available to investors about the financial effects of lease contracts. The proposed requirements would supersede IAS 17 Leases in IFRSs and the guidance in Topic 840 on leases in US GAAP.

The exposure draft (ED) is open for public comment until 15 December 2010.

In the ED, the boards propose to define a lease as a contract in which the right to use a specified asset is conveyed, for a period of time, in exchange for consideration. In the boards' view, this definition retains the principle in the definition of a lease in both IFRSs and US GAAP.

Current IAS 17 Leases defines a lease as an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments the right to use an asset for a agreed period of time. A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset. Title may or may not eventually be transferred. An operating lease is a lease other than a finance lease.

IFRSs and US GAAP classify leases into two categories : finance leases (called capital leases under US GAAP) and operating leases. Categorisation is based on various factors. If a lease is classified as a finance lease, assets and liabilities are shown on the lessee's balance sheet. However, for an operating lease the lessee does not show any assets or liabilities on the balance sheet. The lessee simply accounts for the lease payments as an expense over the lease term. Hence, investors have to estimate the effect of operating leases on financial leverage and earnings, and routinely have to adjust the financial statements of lessees for the effects of operating leases. Such adjustments are either arbitrary or based on estimates.

As the solution, the proposed model of lease accounting would reflect assets and liabilities arising from all lease contracts. All leases have to be recorded on the balance sheet. So, investors would no longer need to adjust the amounts presented in the balance sheet and the income statement to reflect the assets, liabilities and finance costs arising from lessees' operating leases.

In the ED, the boards also proposing a 'right-of-use' model in accounting for all leases (including leases of right-of-use assets in a sublease) where both lessees and lessors record assets and liabilities arising from lease contract. The assets and liabilities are recorded at the present value of the lease payments, and subsequently measured using a cost-based method.

In conjunction with revaluation issue, the ED proposes the approaches to the revaluation of right-of-use assets as follows :

(a) lessees using IFRSs would have the option to revalue right-of-use assets

(b) lessees using US GAAP would not be permitted to revalue right-of-use assets unless required to do so to recognise an impairment loss.

The ED proposes that if an entity applying IFRSs revalues a right-of-use asset, it should revalue the entire class of asset (ie the entire class of assets comprising all owned and leased assets) to which the underlying asset belongs.

The IASB Press Release and Exposure Draft are available to download in here : Exposure Draft and Comment Letter

Read also (updated December 2, 2010) :

1. Proposal Would Require Most Leases to Appear on the Balance Sheet (Journal of Accountancy)
2. Taking the "Ease" Out of "Lease"?

Changes to the Presentation of Other Comprehensive Income

At present, entities have an option in IAS 1 Presentation of Financial Statements to present either a statement of comprehensive income or two separate statements of profit or loss and other comprehensive income.

As prescribes in para. 81 of IAS 1 : an entity shall present all items of income and expense recognised in a period : (a) in a single statement of comprehensive income, or (b) in two statements : a statement displaying components of profit or loss (separate income statement) and a second statement beginning with profit or loss and displaying components of other comprehensive income (statement of comprehensive income).

On 27 May 2010, the International Accounting Standards Board (IASB) published for public comment proposals to improve the consistency of how items of Other Comprehensive Income (OCI) are presented.

This exposure draft proposes to require a statement of profit or loss and OCI containing two distinct sections - profit or loss and other comprehensive income.

It also proposes a new presentation approach for items of OCI. With recent decisions in other projects, more items will be presented in OCI. IFRS 9 and the proposed amendments to IAS 19 have introduced new items that will be presented in OCI.

The IASB is proposing to require that items that will never be recognised in profit or loss should be presented separately from those that are subject to subsequent reclassification (recycling).

The Board invites comments on the proposals in this ED, particularly on the questions set out in the ED. For instance, in Question 1 : the board proposes to change the title of the statement of comprehensive income to 'statement of profit or loss and other comprehensive income' when referred to in IFRSs and its other publications. Do you agree ? Why or why not ? What alternative do you propose ?

The exposure draft is open for comment until 30 September 2010.

Link to the IASB publications :

1. Presentation of Items of Other Comprehensive Income
2. IASB proposes improvements to the presentation of items of Other Comprehensive Income

Computer Software Cost, Capitalized or Expensed ?

Based on IAS 38 Intangible Assets, paragraph 4 which explains that some intangible assets may be contained in or on a physical substance such as a compact disc (in the case of computer software), legal documentation (in the case of license or patent) or film. In determining whether an asset that incorporates both intangible and tangible elements should be treated under IAS 16 Property, Plant and Equipment or as an intangible asset under IAS 38, an entity uses judgment to assess which element is more significant.

For example, computer software for a computer-controlled machine tool that cannot operate without that specific software is an integral part of the related hardware and it is treated as property, plant and equipment. The same applies to the operating system of a computer. When the software is not an integral part of the related hardware, computer software is treated as an intangible asset.

In connection with the accounting approach for the recognition of computer software costs, several questions may come up :

1. In the case of a company developing software programs for sale, should the costs incurred in developing the software be expensed, or should the costs be capitalized and amortized ?
2. If the developing software programs to be used for in-house applications only, how is the treatment ?
3. In the case of purchased software, should the cost of the software be capitalized as a tangible asset or as an intangible asset, or should it be expensed fully and immediately ?

Referring to the provision of IAS 38, the above questions can be clarified as follows :

(1) In the case of a software-developing company, the costs incurred in the development of software programs are research and development costs. Accordingly, as regulates in para. 54 of IAS 38, all expenses incurred in the research phase would be expensed. That is, all expenses incurred before technological feasibility for the product has been established should be expensed. The reporting entity would have to demonstrate both technological feasibility and a probability of its commercial success.

Technological feasibility would be established if the entity has completed a detailed program design or working model. The entity should have completed the planning, designing, coding, and testing activities and established that the product can be successfully produced.

Apart from being capable of production, the entity should demonstrate that it has the intention and ability to use or sell the program. Action taken to obtain control over the program in the form of copyrights or patents would support capitalization of these costs. At this stage the software program would be able to meet the criteria of identifiability, control, and future economic benefits, and can thus be capitalized and amortized as an intangible asset.

(2) In the case of software internally developed for in-house use – for example, a computerized payroll program developed by the reporting entity itself – the accounting approach would be different. While the program developed may have some utility to the entity itself, it would be difficult to demonstrate how the program would generate future economic benefits to the entity. Also, in the absence of any legal rights to control the program or to prevent others from using it, the recognition criteria would not be met. Further, the cost proposed to be capitalized should be recoverable. In view of the impairment test prescribed by the standard, the carrying amount of the asset may not be recoverable and would accordingly have to be adjusted. Considering the above facts, such costs may need to be expensed.

(3) In the case of purchased software, the treatment could differ and would need to be evaluated on a case-by-case basis. Software purchased for sale would be treated as inventory. However, software held for licensing or rental to others should be recognized as an intangible asset. On the other hand, cost of software purchased by an entity for its own use and which is integral to the hardware (because without that software the equipment cannot operate), would be treated as part of cost of the hardware and capitalized as property, plant, or equipment. Thus, the cost of an operating system purchased for an in-house computer, or cost of software purchased for computer-controlled machine tool, are treated as part of the related hardware.

The cost of other software programs should be treated as intangible assets (as opposed to being capitalized along with the related hardware), as they are not an integral part of the hardware. For example, the cost of payroll or inventory software (purchased) may be treated as an intangible asset provided it meets the capitalization criteria under IAS 38.

Source : IAS 38 Intangible Assets and Wiley – Interpretation and Application of IFRS, Barry J. Epstein and Eva K. Jermakowicz

The Death of LIFO Accounting ?

IAS 2 Inventories does not permit the use of the last-in, first-out (LIFO) formula to measure the cost of inventories of a company. This regulation has left the first-in, first-out (FIFO) and the weighted-average methods as the only two acceptable costing methods under IFRS.

In connection with the prohibition of LIFO formula, CFO.com on July 15, 2010 published an article titled “Sucking the LIFO Out of Inventory”. Written by Marie Leone, Senior Editor of CFO.com, this article described why companies still prefer LIFO method to measure the cost of inventories.

Here is the quotation from the article,

LIFO allows companies to calculate the cost of goods sold based on the price of the most recently purchased (“last-in”) inventory, rather than inventory that was purchased more cheaply in the past and has been sitting on the shelf. That boosts the cost of goods sold, which lowers profits – and, thus, taxable income. LIFO is particularly important to companies that have slow-moving inventory. Read further

The LIFO method has long been acceptable in the US for tax purposes, and, within the condition of rising prices, LIFO costing method resulted in lower reportable income and therefore in lower taxes.

Read also : Method of Inventory Costing under IAS 2