A Guide through IFRS July 2010

The IFRS Foundation will shortly publish an updated version of "A Guide through IFRSs July 2010".

This 2010 edition is presented in two volume parts (Part A and B), sold together as a set. This new guide will include :

• All IFRSs and IASs as approved by the IASB at 1 July 2010
• The Complete and up-to-date consolidated text, with extensive cross-references and other annotations, of IFRSs, including IASs and IFRIC and SIC Interpretations.
• IASB-issued supporting documents, illustrative examples, implementation guidance.
• Bases for conclusions and dissenting opinions as approved at 1 July 2010.

This edition does not contain documents that are being replaced or superseded but remain applicable of the reporting entity chooses not to adopt the newer version early.

The main changes in this collection, since the 2009 edition, are the inclusion of :

• one new standard – IFRS 9
• one revised standard – IAS 24
• amendments to IFRSs that were issued as separate documents
• amendments to IFRSs issued in the third annual improvements project
• amendments to other IFRSs resulting from those revised or amended standards
• one new Interpretation – IFRIC 19

The arrangement of the contents in this edition differs from that in previous editions. In recognition of the growing size of the contents this edition of the Bound Volume is published in two parts. Part A presents the Framework and the unaccompanied IFRSs and their introductions and explanatory rubrics. Part B contains the accompanying documents, such as bases for conclusions, implementation guidance and illustrative examples. This partition therefore distinguishes the Framework and the requirements of IFRSs (in Part A) from the non-mandatory accompanying material (in Part B), and enables them to be read side by side.

How to purchase this publication ?

A Guide through IFRS July 2010 - (ISBN 978-1-907026-82-9 Set of two volume parts A & B), can be purchased for £90 each set (plus shipping). Discounts are available for bookshops/agents, multiple copies, students/academics and residents of middle and low income countries.
You can find further information about this publication and register your interest at the web shop.

Proposed amendments to IAS 12 Deferred Tax : Recovery of Underlying Assets

On 10 September 2010, the IASB published for public comment an exposure draft (ED) of Deferred Tax : Recovery of Underlying Assets.

The proposal would amend one aspect of IAS 12 Income Taxes. Under IAS 12, the measurement of deferred tax liabilities and deferred tax assets depends on whether an entity expects to recover an asset by using the asset or by selling the asset. In some cases, it is difficult and subjective to assess whether recovery will be through use or through sale.

To provide a practical approach in such cases, the proposed amendments state that, in specified circumstances, the measurement of deferred tax liabilities and deferred tax assets should reflect a rebuttable presumption that the carrying amount of the underlying asset will be recovered entirely by sale.

The specified circumstances are that the deferred tax liability or deferred tax asset arises from :

1. investment property, when an entity applies the fair value model in IAS 40 Investment Property; or
2. property, plant and equipment or intangible assets, when an entity applies the revaluation model in IAS 16 Property, Plant and Equipment or IAS 38 Intangible Assets.

The presumption is rebutted only when an entity has clear evidence that it will consume the asset’s economic benefits throughout its economic life.

Overall, the proposed amendments are intended to provide a practical approach for measuring deferred tax liabilities and deferred tax assets when it would be difficult and subjective to determine the expected manner of recovery.

The ED is open for comment until 9 November 2010.

The Press Release and the Exposure Draft are available from the IASB website : IASB proposes to amend one aspect of accounting for deferred tax

Effect of Operating and Finance Leases on Lessee Financial Statements and Key Financial Ratios

As stated in IAS 17 : Leases, there are two classifications of lease transaction that applicable in the financial statements of the lessee : (1) Operating leases and (2) Finance leases.

Followings are the effect of operating and finance leases on lessee financial statements and key financial ratios which was taken from : International Financial Reporting Standards - A Practical Guide by Hennie van Greuning.

(1) Balance Sheet

Operating Lease - Non effect because no assets or liabilities are created under the operating method

Finance Lease - A leased asset (equipment) and a lease obligation are created when the lease is recorded. Over the life of the lease, both are written off, but the asset is usually written down faster, creating a net liability during the life of the lease

(2) Income Statement

Operating Lease – The lease payment is recorded as an expense. These payments are often constant over the life of the lease.

Finance Lease – Both interest expense and depreciation expense are created. In the early years of the lease, they combine to produce a higher expense than is reported under the operating method. However, over the life of the lease, the interest expense declines, causing the total expense trend to decline. This produces a positive trend in earnings. In the later years, earnings are higher under the finance lease method than under the operating method. Over the entire term of the lease, the total lease expenses are the same under both methods.

(3) Statement of Cash Flows

Operating Lease – The entire cash outflow paid on the lease is recorded as an operating cash outflow

Finance Lease – The cash outflow from the lease payments is allocated partly to an operating or financing cash outflow (interest expense) and partly to a financing cash outflow (repayment of the lease obligation principal). The depreciation of the leased asset is not a cash expense and, therefore, is not a cash flow item.

(4) Profit Margin

Operating Lease – Higher in the early years because the rental expense is normally less than the total expense reported under the finance lease method. However, in later years, it will be lower than under the finance lease method.

Finance Lease – Lower in the early years because the total reported expense under the finance lease method is normally higher than the lease payment. However, the profit margin will rend upward over time, so in the later years it will exceed that of the operating method.

(5) Asset Turnover

Operating Lease – Higher because there are no leased assets recorded under the operating method

Finance Lease – Lower because of the leased asset (equipment) that is created under the finance lease method. The ratio rises over time as the asset is depreciated.

(6) Current Ratio

Operating Lease – Higher because no short-term debt is added to the balance sheet by the operating method.

Finance Lease – Lower because the current portion of the lease obligation created under the finance lease method is a current liability. The current ratio falls farther over time as the current portion of the lease obligation rises.

(7) Debt to Equity Ratio

Operating Lease – Lower because the operating method creates no debt

Finance Lease – Higher because the finance lease method creates a lease obligation liability (which is higher than the leased asset in the early years). However, the debt-to-equity ratio decreases over time as the lease obligation decreases

(8) Return on Assets

Operating Lease – Higher in the early years because profits are higher and assets are lower

Finance Lease – Lower in the early years because earnings are lower and assets are higher. However, the return on asset ratio rises over time because the earnings trend is positive and the assets decline as they are depreciated.

(9) Return on Equity

Operating Lease – Higher in the early years because earnings are higher

Finance Lease – Lower in the early years because earnings are lower. However, the return on equity rises over time because of a positive earnings trend.

(10) Interest Coverage

Operating Lease – Higher because no interest expense occurs under the operating method

Finance Lease – Lower because interest expense is created by the finance lease method. However, the interest coverage ratio rises over time because the interest expense declines over time.

How is the treatment of Land and Buildings lease transaction ?

Formerly, based on IAS 17 Leases (2003 amendment) para. 14, leases of land and buildings are classified as operating or finance leases in the same way as leases of other assets (read also my previous post regarding the criteria which one of them a lease agreement has to meet to be classified as a finance lease in the financial statements of the lessee : The right way to classify a lease). However, a characteristic of land is that normally has an indefinite economic life and, if title is not expected to pass to the lessee by the end of the lease term, the lessee normally does not receive substantially all of the risks and rewards incidental to ownership, in which case the lease of land will be an operating lease. A payment made on entering into or acquiring a leasehold that is accounted for as an operating lease represents prepaid lease payments that are amortised over the lease term in accordance with the pattern of benefits provided.

Para. 15 stated that the land and buildings elements of a lease of land and buildings are considered separately for the purpose of lease classification. if title to both elements is expected to pass to the lessee by the end of the lease term, both elements are classified as a finance lease, whether analysed as one lease or as two leased, unless it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership of one or both elements. When the land has an indefinite economic life, the land element is normally classified as an operating lease unless title is expected to pass to the lessee by the end of the lease term, in accordance with paragraph 14. The buildings element is classified as a finance or operating lease in accordance with paragraphs 7-13.

However, based on IAS 17 Leases (2009 amendment), both para. 14 and para. 15 of IAS 17 (2003 amendment) were eliminated, replaced with para. 15A which states that when a lease includes both land and buildings elements, an entity assesses the classification of each element as a finance or an operating lease separately in accordance with paragraphs 7-13. In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life.

Why para. 14 and para. 15 of IAS 17 (2003 amendment) was eliminated ?

As prescribed in the Basic for Conclusions on IAS 17 Leases, para. BC8A (IFRS 2010 as at 1 Januari 2010 Part B) that as part of its annual improvements project in 2007, the Board reconsidered the decisions it made in 2003, specifically the perceived inconsistency between the general lease classification guidance in para. 7-13 and the specific lease classification guidance in para. 14 and 15 related to long-term leases of land and buildings. The Board concluded that the guidance in para. 14 and 15 might lead to a conclusion on the classification of land leases that does not reflect the substance of the transaction.

For example, consider a 999-year lease of land and buildings. In this situation, significant risks and rewards associated with the land during the lease term would have been transferred to the lessee despite there being  no transfer of title.

The Board noted that the lessee in leases of this type will typically be in a position economically similar to an entity that purchased the land and buildings. The present value of the residual value of the property in a lease with a term of several decades would be negligible. The Board concluded that the accounting for the land element as a finance lease in such circumstances would be consistent with the economic position of the lessee.

Further, as explained in para. BC8D, the Board noted that this amendment reversed the decision it made in amending IAS 17 in December 2003. The Board also noted that the amendment differed from the International Financial Reporting Interpretations Committee's agenda decision in March 2006 based on the IAS 17 guidance that such long-term leases of land would be classified as an operating lease unless title or significant risks and rewards of ownership passed to the lessee, irrespective of the term of the lease. However, the Board believed that this change improves the accounting for leases by removing a rule and an exception to the general principles applicable to the classification of leases.

Some respondents to the exposure draft proposing this amendment agreed with the direction of this proposal but suggested that it should be incorporated into the Board's project on leases. The Board acknowledged that the project on leases is expected to produce a standard in 2011. However, the Board decided to issue the amendment now because of the improvement in accounting for leases that would result and the significance of this issue in countries in which property rights are obtained under long-term leases. Therefore, the Board decided to remove this potential inconsistency by deleting the guidance in paragraphs 14 and 15  (Hrd).