The Minimum Indications have to be considered in assessing IMPAIRMENT of Non Financial Assets

IAS 36 regulates the impairment of Non Financial Assets.

An asset is impaired when its carrying amount exceeds its recoverable amount. Paragraphs 12-14 of IAS 36 describe some indications that an impairment loss may have occurred. If any of those indications is present, an entity is required to make a FORMAL ESTIMATE OF RECOVERABLE AMOUNT. Except as described in paragraph 10, IAS 36 does not require an entity to make a formal estimate of recoverable amount if no indication of an impairment loss is present.

Paragraph 9 states that an entity shall assess at the end of each reporting period whether there is any indication  that an asset may be impaired. If any such indication exists, the entity shall estimate the recoverable amount of the asset.

As stated in paragraph 12, in assessing whether there is any indication that an asset may be impaired, an entity shall consider, as a minimum, the following indications :

EXTERNAL SOURCES OF INFORMATION

1. during the period, an asset’s market value has declined significantly more than would be expected as a result of the passage of time or normal use;
2. significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates or in the market to which an asset is dedicated;
3. market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially;
4. the carrying amount of the net assets of the entity is more than its market capitalisation

INTERNAL SOURCES OF INFORMATION

1. evidence is available of obsolescence or physical damage of an asset;
2. significant changes with an adverse effect on the entity have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include the asset becoming idle, plans to discontinue or restructure the operation to which an asset belongs, plans to dispose of an asset before the previously expected date, and reassessing the useful life of an asset as finite rather than indefinite;
3. evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected

DIVIDEND FROM A SUBSIDIARY, JOINTLY CONTROLLED ENTITY OR ASSOCIATE

1. for an investment in a subsidiary, jointly controlled entity or associate, the investor recognises a dividend from the investment and evidence is available that :

• the carrying amount of the investment in the separate financial statements exceeds the carrying amounts in the consolidated financial statements of the investee’s net assets, including associated goodwill; or
• the dividend exceeds the total comprehensive income of the subsidiary, jointly controlled entity or associate in the period the dividend is declared.

Further, paragraph 13 states that the list in paragraph 12 is not exhaustive. An entity may identify other indications that an asset may be impaired and these would also require the entity to determine the asset’s recoverable amount or, in the case of goodwill, perform an impairment test in accordance with paragraph 80-99 of IAS 36.

Evidence from internal reporting that indicates that an asset may be impaired, as stated within paragraph 14, includes the existence of :

1. cash flows for acquiring the asset, or subsequent cash needs for operating or maintaining it, that are significantly higher than those originally budgeted;
2. actual net cash flows or operating profit or loss flowing from the asset that are significantly worse than those budgeted;
3. a significant decline in budgeted net cash flows or operating profit, or a significant increase in budgeted loss, flowing from the asset; or
4. operating losses or net cash outflows for the asset, when current period amounts are aggregated with budgeted amounts for the future

As indicated in paragraph 10, IAS 36 requires an intangible asset with an indefinite useful life or not yet available for use and goodwill to be tested for impairment, at least annually (HRD).

Translation to the Presentation Currency from the Functional Currency

IAS 21, The Effect of Changes in Foreign Exchange Rates defines Presentation Currency as the currency in which the financial statements are presented. While the Functional Currency was defined as the currency of the primary economic environment in which the entity operates.

As stated in para.38 of IAS 21, an entity may present its financial statements in any currency. If the presentation currency differs from the entity’s functional currency, it translates its results and financial position into the presentation currency.

If the financial statements of the entity are not in the functional currency of a hyperinflationary economy, then the results and financial position shall be translated into a different presentation currency using the following procedures :

1. assets and liabilities for each statement of financial position presented (ie including comparatives) shall be translated at the closing rate at the date of the statement of financial position;
2. income and expenses for each statement of comprehensive income or separate income statement presented (ie including comparatives) shall be translated at exchange rates at the dates of the transactions; and
3. all resulting exchange differences shall be recognised in other comprehensive income.

The exchange differences as stated above which result from :

• translating income and expenses at the exchange rates at the dates of the transactions and assets and liabilities at the closing rate;
• translating the opening net assets at a closing rate that differs from the previous closing rate

Such exchange differences are not recognised in profit or loss because the changes in exchange rates have little or no direct effect on the present and future cash flows from operations. The cumulative amount of the exchange differences is presented in a separate component of equity until disposal of the foreign operation. When the exchange differences relate to a foreign operation that is consolidated but not wholly-owned, accumulated exchange differences arising from translation and attributable to non-controlling interest are allocated to, and recognised as part of non-controlling interests in the consolidated statement of financial position (para.41 of IAS 21).

Further, para. 42 of IAS 21 states that the results and financial position of an entity whose functional currency is the currency of a hyperinflationary economy shall be translated into a different presentation currency using the following procedures :

1. all amounts (ie assets, liabilities, equity items, income and expenses, including comparatives) shall be translated at the closing rate at the date of the most recent statement of financial position, except that
2. when amounts are translated into the currency of a non-hyperinflationary economy, comparative amounts shall be those that were presented as current year amounts in the relevant prior year financial statements (ie not adjusted for subsequent changes in the price level or subsequent changes in exchange rates).

When there is a change in an entity’s functional currency, the entity shall apply the translation procedures applicable to the new functional currency prospectively from the date of the change (para.35 of IAS 21) (Hrd).

Recognition of PROVISIONS

IAS 37 regarding Provision, Contingent Liabilities and Contingent Assets defines PROVISIONS as liabilities of uncertain timing or amount.

Provisions can be distinguished from other liabilities such as trade payables and accruals because there is UNCERTAINTY about the timing or amount of the future expenditure required in settlement.

By contrast :

(a)  trade payables are liabilities to pay for goods or services that have been received or supplied  and have been invoiced or formally agreed with the supplier; and

(b)  accruals are liabilities to pay for goods or services that have been received or supplied but have not been paid, invoiced or formally agreed with the supplier, including amounts due to employees (for example, amounts relating to accrued vacation pay). Although it is sometimes necessary to estimate the amount or timing of accruals, the uncertainty is generally much less than for provisions.

Accruals are often reported as part of trade and other payables, whereas provisions are reported separately.

A PROVISION shall be recognised when :

1. an entity has a present obligation (could be either legal obligation or constructive obligation) as a result of a past event;
2. it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
3. a reliable estimate can be made of the amount of the obligation

If these conditions are not met, no provision shall be recognised.

A legal obligation is an obligation that could :

1. be contractual; or
2. arise due to a legislation; or
3. result from other operation of law

A constructive obligation, however, is an obligation that results from an entity’s actions where :

1. by an established pattern of past practice, published policies, or a sufficiently specific current statement, the entity has indicated to other (third) parties that it will accept certain responsibilities; and
2. as a result, the entity has created a valid expectation in the minds of those parties that it will discharge those responsibilities.

In a general sense, all provisions are contingent because they are uncertain in timing or amount. However, within the scope of IAS 37 the term ‘contingent’ is used for liabilities and assets that are not recognised because their existence will be confirmed only by the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity (HRD).

Capitalisation of Exchange Differences, permissible or not ?

IAS 21, The Effect of Changes in Foreign Exchange Rates requires recognition of foreign exchange differences as income or expense in the period in which they arise.

Previously, there had been an allowed alternative treatment for certain losses incurred due to effects of exchange rate changes in foreign-denominated obligations associated with asset acquisition. This allowed alternative treatment resulted in capitalization of the loss.

Revised IAS 21 removes the limited option in the previous version of IAS 21 to capitalise exchange differences resulting from a severe devaluation or depreciation of a currency against which there is no means of hedging. Under IAS 21, such exchange differences are now recognised in profit or loss. Consequently, SIC-11, which outlined restricted circumstances in which such exchange differences may be capitalised, has been superseded since capitalisation of such exchange differences is no longer permitted in any circumstances (IAS 21 Paragraph IN10).

Following are further explanation to removed the previously allowed alternative treatment of capitalisation of exchange differences as stated in Basic for Conclusions on IAS 21 :

BC24 - The previous version of IAS 21 allowed a limited choice of accounting for exchange differences that arise ‘from a severe devaluation or depreciation of a currency against which there is no practical means of hedging and that effects liabilities which cannot be settled and which arise directly on the recent acquisition of an asset’. The benchmark treatment was to recognise such exchange differences in profit or loss. The allowed alternative was to recognise them as an asset.

BC25 – The Board noted that the allowed alternative (of recognition as an asset) was not in accordance with the Framework for the Preparation and Presentation of Financial Statements because exchange losses do not meet the definition of an asset. Moreover, recognition of exchange losses as an asset is neither allowed nor required by any liaison standard-setter, so its deletion would improve convergence. Finally, in many cases when the conditions for recognition as an asset are met, the asset would be restated in accordance with IAS 29 Financial Reporting in Hyperinflationary Economies. Thus, to the extent that an exchange loss reflects hyperinflation, this effect is taken into account by IAS 29. For all of these reasons, the Board removed the allowed alternative treatment and the related SIC Interpretation is superseded.

WATCH OUT!

According to IAS 23, Borrowing Costs, an entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. Borrowing costs may include exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.

The above image was taken from : Microsoft Office Website

The Concept of Significant Influence

Based on IAS 24 : Related Party Disclosures, entities are considered to be related parties when one of them either :

1. has the ability to control the other entity
2. can exercise significant influence over the other entity in making financial and operating decisions
3. has joint control over the other
4. is a joint venture in which the other entity is a joint venturer
5. functions as key management personnel of the other entity
6. is a close family member of any individual having the ability to control or influence the entity or is a key management member thereof

Significant Influence

The existence of the ability to exercise significant influence is an important concept in relation to this standard. It is one of the two criteria stipulated in the definition of a related party, which when present would, for the purposes of this standard, make one party related to another. In other words, for the purposes of this standard, if one party is considered to have the ability to exercise significant influence over another, then the two parties are considered to be related.

The existence of the ability to exercise significant influence may be evidenced in one or more of the following ways :

1. By representation on the board of directors of the other entity;
2. By participation in the policy-making process of the other entity;
3. By having material intercompany transactions between two entities;
4. By interchange of managerial personnel between two entities; or
5. By dependence on another entity for technical information

Significant influence may be gained through agreement, by statute, or by means of share ownership. Under the provisions of IAS 24, similar to the presumption of significant influence under IAS 28, an entity is deemed to possess the ability to exercise significant influence if it directly or indirectly through subsidiaries  holds 20% or more of the voting power of another entity (unless it can be clearly demonstrated that despite holding such voting power the investor does not have the ability to exercise significant influence over the investee).

Conversely, if an entity, directly or indirectly through subsidiaries, owns less than 20% of the voting power of another entity, it is presumed that the investor does not possess the ability to exercise significant influence (unless it can be clearly demonstrated that the investor does have such an ability despite holding less than 20% of the voting power).

Further, while explaining the concept of significant influence, IAS 28 also clarifies that “a substantial or majority ownership by another investor does not necessarily preclude an investor from having significant influence” (emphasis added).

Source of this article : WILEY – 2010 Interpretation and Application of International Financial Reporting Standards, by Barry J.Epstein and Eva K.Jermakowicz

Purpose of Related Party Disclosures

IAS 24 : Related Party Disclosures defines a related party as a person or entity that is related to the entity that is preparing its financial statements (reporting entity).

(a) A person or a close member of that person’s family is related to a reporting entity if that person :

1. has control or joint control over the reporting entity;
2. has significant influence over the reporting entity; or
3. is a member of the key management personnel of the reporting entity or of a parent of the reporting entity

(b) An entity is related to a reporting entity if any of the following conditions applies:

1. The entity and the reporting entity are members of the same group (which means that each parent, subsidiary and fellow subsidiary is related to the others)
2. One entity is an associate or joint venture of the other entity (or an associate or joint venture of a member of a group of which the other entity is a member)
3. Both entities are joint ventures of the same third party
4. One entity is a joint venture of a third entity and the other entity is an associate of the third entity
5. The entity is a post-employment benefit plan for the benefit of employees of either the reporting entity or an entity related to the reporting entity. If the reporting entity is itself such a plan, the sponsoring employers are also related to the reporting entity
6. The entity is controlled or jointly controlled by a person identified in (a)
7. A person identified in (a)(1) has significant influence over the entity or is a member of the key management personnel of the entity (or of a parent of the entity).

Related party relationships are a normal feature of commerce and business. For example, entities frequently carry on parts of their activities through subsidiaries, joint ventures and associates. In those circumstances, the entity has the ability to affect the financial and operating policies of the investee through the presence of control, joint control or significant influence.

A related party relationship could have an effect on the profit or loss and financial position of an entity. Related parties may enter into transactions that unrelated parties would not. For example, an entity that sells goods to its parent at cost might not sell on those terms to another customer. Also, transactions between related parties may not be made at the same amounts as between unrelated parties.

The profit or loss and financial position of an entity may be affected by a related party relationship even if related party transactions do not occur. The mere existence of the relationship may be sufficient to affect the transactions of the entity with other parties. For example, a subsidiary may terminate relations with a trading partner on acquisition by the parent of a fellow subsidiary engaged in the same activity as the former trading partner. Alternatively, one party may refrain from acting because of the significant influence of another – for example, a subsidiary may be instructed by its parent not to engage in research and development.

For these reasons, knowledge of an entity’s transactions, outstanding balances, including commitments, and relationships with related parties may affect assessments of its operations by users of financial statements, including assessments of the risks and opportunities facing the entity (Hrd).

The latest update of Financial Instruments, Insurance Contracts, Leases and Revenue Recognition discussions

Following is the report from IASB latest meeting on 12 April to 15 April, 2011 which was dropped into my inbox mail on April 20, 2011.

The IASB met in London from Tuesday 12 April to Friday 15 April. The sessions on Tuesday and Wednesday and on Thursday morning were held jointly with the US-based FASB.

The joint discussions focused on four projects: revenue recognition, leases, insurance contracts, and impairment of financial assets. The IASB-only sessions focused on hedge accounting (which the FASB joined by video) and an update of activities of the IFRS Interpretations Committee.

The boards discussed uncertain consideration in relation to revenue recognition and leases. The revenue recognition sessions also focused on allocating the transaction price, licences and rights to use, fulfilment costs, and sale and repurchase agreements. The leases sessions also focused on the definition of a lease and whether there should be one or two accounting approaches for leases.

The session on insurance focused on the use of a 'top-down approach' to determine a discount rate.

The impairment sessions included consideration of feedback from the outreach activities and comment letters on the joint supplementary document Financial Instruments: Impairment, interest income recognition and the definition of amortised cost and whether to discount a loss estimate.

In the sessions on hedge accounting the IASB began its redeliberations on the exposure draft Hedge Accounting and discussed the objective of hedge accounting and accounting for 'funding swaps', designating risk components of financial instruments that bear interest below a benchmark rate (the 'sub-LIBOR' issue), the eligibility of non-derivative financial instruments as hedging instruments (including the interaction with the fair value option) and macro hedge accounting.

During board week Sir David Tweedie, Chairman of the IASB, and Leslie Seidman, Chairman of the FASB, recorded an interview in which they review the achievements of the convergence programme so far and the time line for completing the remaining elements of the programme. To listen to the interview and read a transcript, please click here : Interview with Sir David Tweedie and Leslie Seidman regarding the timeline for completing the convergence programme

The topics discussed at the joint IASB/FASB board meeting were:

• Financial instruments: impairment
• Insurance contracts
• Leases
• Revenue recognition

The topics discussed at the IASB Board meeting were:

• Financial instruments: hedge accounting
• IFRS Interpretations Committee - update from last meeting

Using the With-and-without Method in Presenting the Compound Instruments in the Financial Statements

Sometimes issued nonderivative financial instruments contain both liability and equity elements. In other words, one component of the instruments meets the definition of a financial liability and another component of the instrument meets the definition of an equity instrument. Such instruments are referred to as compound instruments.

A common form of compound financial instrument is a debt instrument with an embedded conversion option, such as a bond convertible into ordinary shares of the issuer, and without any other embedded derivative features.

Para. 28 of IAS 32 Financial Instruments : Presentation states that the issuer of a non-derivative financial instrument shall evaluate the terms of the financial instrument to determine whether it contains both a liability and an equity component. Such components shall be classified separately as financial liabilities, financial assets or equity instruments, as follows :

1. The issuer’s obligation to make scheduled payments of interest and principal is a financial liability that exists as long as the instrument is not converted. On initial recognition, the fair value of the liability component is the present value of the contractually determined stream of future cash flows discounted at the rate of interest applied at the time by the market to instruments of comparable credit status and providing substantially the same cash flows, on the same terms, but without the conversion option.
2. The equity instrument is an embedded option to convert the liability into equity of the issuer. The fair value of the option comprises its time value and its intrinsic value, if any. This option has value on initial recognition even when it is out of the money.

How to recognize the initial carrying amounts of the liability and equity components of the compound instrument ?

As stated in the : IFRS – Practical Implementation Guide and Workbook, by Abbas Ali Mirza, Magnus Orrell and Graham J.Holt, to determine the initial carrying amounts of the liability and equity components, entities apply the so-called with-and-without method. The fair value of the instrument is determined first including the equity component. The fair value of the instrument as a whole generally equals the proceeds (consideration) received in issuing the instrument. The liability component is then measured separately without the equity component. The equity component is assigned the residual amount after deducting from the fair value of the compound instrument as a whole the amount separately determined for the liability component.

Example :

Entity A issues a bond with a principal amount of $100,000. The holder of the bond has the right to convert the bond into ordinary shares of Entity A. On issuance, Entity A receives proceeds of $100,000. By discounting the principal and interest cash flows of the bond using interest rates for similar bonds without an equity component, Entity A determines that the fair value of a similar bond without any equity component would have been $91,000. Therefore, the initial carrying amount of the liability component is $91,000. The initial carrying amount of the equity component is computed as the difference between the total proceeds (fair value) of $100,000 and the initial carrying amount of the liability component of $91,000. Thus the initial carrying amount of the equity component is $90,000. Entity A makes this journal entry :

Cash	100,000
Financial Liability		91,000
Equity		9,000

Source of this article :

1. IFRS – Practical Implementation Guide and Workbook, by Abbas Ali Mirza, Magnus Orrell and Graham J.Holt (2nd Edition)
2. IAS 32 Financial Instruments : Presentation

A Practical Guide to New IFRSs 2011 (PwC IFRS Publications)

In March 2011, one of the Big 4 accounting firm PricewaterhouseCoopers published its IFRS implementation guidance “A Practical Guide to New IFRSs for 2011”.

Within the 24-page guide book in Q & A format, it provides a high-level outline of the key requirements of new IFRS standards and interpretations that come into effect in 2011. Significant changes to IFRS are due to be published in 2011, but there is a relatively small number of changes that come into effect for 2011 year ends.

One of the significant changes was the IFRS 9, Financial Instruments which was reissued in 2010 to include guidance on financial liabilities and derecognition of financial instruments. This material was relocated from IAS 39, Financial Instruments : Recognition and Measurement, without change, except for financial liabilities that are designated at fair value through profit or loss. The rules on the classification and measurement of financial assets were previously published in the earlier version of IFRS 9. The standard is being added to as the IASB endorses different phases of the project to replace IAS 39. The reissued IFRS 9 applies to 2013 year ends but can be adopted with immediate effect.

Another changes was regarding IFRIC 19, Extinguishing Financial Liabilities with Equity Instruments which comes into effect in 2011.

Two further amendments that have effective dates in 2010 and will impact 2011 year ends. Amendments to IAS 32, Financial Instruments : Presentation, on classification of right issues and amendment to IFRS 1, First-time Adoption of IFRS, on financial instrument disclosures. Amendments that apply from 1 January 2011 include an amendment to IAS 24, Related Party Disclosures, and an amendment to IFRIC 14, IAS 19 – The limit on a defined benefit asset, minimum funding requirements and their interaction.

Download the publication directly from here : A Practical Guide to New IFRSs for 2011

Considering an entity’s Functional Currency

When a reporting entity prepares financial statements, IAS 21, The Effects of Changes in Foreign Exchange Rates, requires each individual entity included in the reporting entity – whether it is a stand-alone entity, an entity with foreign operations (such as a parent) or a foreign operation (such as a subsidiary or branch) – to determine its functional currency and measure its results and financial position in that currency.

The concept of functional currency is key to understanding translation of foreign currency financial statements.

Functional currency is defined as being the currency of the primary economic environment in which an entity operates. This is normally, but not necessarily, the currency in which that entity principally generates and expends cash.

An entity considers the following factors in determining its functional currency :

1. the currency that mainly influences sales prices for goods and services (this will often be the currency in which sales prices for its goods and services are denominated and settled); and
2. the currency of the country whose competitive forces and regulations mainly determine the sales prices of its goods and services
3. the currency that mainly influences labor, material and other costs of providing goods or services (this will often be the currency in which such costs are denominated and settled
4. the currency in which funds from financing activities (ie issuing debt and equity instruments) are generated
5. the currency in which receipts from operating activities are usually retained

The first three items are generally considered to be the most influential in deciding the functional currency.

The entity’s functional currency reflects the underlying transactions, events, and conditions under which the entity conducts its business. Accordingly, once determined, the functional currency is not changed unless there is a change in those underlying transactions, events and conditions.

If the functional currency is the currency of a hyperinflationary economy, the entity’s financial statements are restated in accordance with IAS 29, Financial Reporting in Hyperinflationary Economies.

Where there is a change in the functional currency, it should be applied from the date of change. A change must be linked to a change in the nature of the underlying transactions. For example, a change in the major market may lead to a change in the currency that influences sales prices. The change is accounted for prospectively, not retrospectively (HRD).

The Objective and Scope of IAS 21

OBJECTIVES - The purpose of IAS 21, The Effects of Changes in Foreign Exchange Rates, is to set out how to account for transactions in foreign currencies and foreign operations. The Standard also shows how to translate financial statements into a presentation currency. The presentation currency is the currency in which the financial statements are presented. The key issues are the exchange rate(s) that should be used and where the effects of changes in exchange rates are reported in the financial statements.

SCOPE – As stated in paragraph 3 of IAS 21, the Standard shall be applied :

(a) in accounting for transactions and balances in foreign currencies, except for those derivative transactions and balances that are within the scope of IAS 39, Financial Instruments : Recognition and Measurement and IFRS 9, Financial Instruments;

(b) in translating the results and financial position of foreign operations that are included in the financial statements of the entity by consolidation, proportionate consolidation or the equity method; and

(c) in translating an entity’s results and financial position into a presentation currency.

Further, paragraph 4 of IAS 21 states that IFRS 9 and IAS 39 apply to many foreign currency derivatives and, accordingly, these are excluded from the scope of this Standard. However, those foreign currency derivatives that are not within the scope of IFRS 9 and IAS 39 (e.g., some foreign currency derivatives that are embedded in other contracts) are within the scope of this Standard.

In addition, this Standard applies when an entity translates amounts relating to derivatives from its functional currency to its presentation currency.

This Standard does not apply to hedge accounting for foreign currency items, including the hedging of a net investment in a foreign operation. IAS 39 applies to hedge accounting.

This Standard applies to the presentation of an entity’s financial statements in a foreign currency and sets out requirements for the resulting financial statements to be described as complying with IFRSs. For translations of financial information into a foreign currency that do not meet these requirements, this Standard specifies information to be disclosed.

This Standard does not apply to the presentation in a statement of cash flows of the cash flows arising from transactions in a foreign currency, or to the translation of cash flows of a foreign operation, which are within the scope of IAS 7, Statement of Cash Flows (Hrd).

IFRS Practice Statement on Management Commentary – A Framework for Presentation

As dropped into my email INBOX on December 8, 2010, the IASB announced the publication of IFRS Practice Statement Management Commentary, a broad, non-binding framework for the presentation of narrative reporting to accompany financial statements prepared in accordance with IFRSs.

The Practice Statement is not an IFRS. Consequently, entities applying IFRSs are not required to comply with the Practice Statement, unless specifically required by their jurisdiction. Furthermore, non-compliance with the Practice Statement will not prevent an entity’s financial statements from complying with IFRSs, if they otherwise do so.

What is Management Commentary ?

Management commentary is a narrative report that provides a context within which to interpret the financial position, financial performance and cash flows of an entity. It also provides management with an opportunity to explain its objectives and its strategies for achieving those objectives. Users routinely use the type of information provided in management commentary to help them evaluate an entity’s prospects and its general risks, as well as the success of management’s strategies for achieving its stated objectives. For many entities, management commentary is already an important element of their communication with the capital markets, supplementing as well as complementing the financial statements.

Management commentary is within the scope of the Conceptual Framework for Financial Reporting, therefore it should be read in the context of the Conceptual Framework.

When management commentary relates to financial statements, an entity should either make the financial statements available with the commentary or identify in the commentary the financial statements to which it relates.

Management should identify clearly what it is presenting as management commentary and distinguish it from other information.

When management commentary is presented, management should explain the extent to which the Practice Statement has been followed. An assertion that management commentary complies with the Practice Statement can be made only if it complies with the Statements in its entirety.

Management should determine the information to include in management commentary considering the needs of the primary users of financial reports. Those users are existing and potential investors, lenders and other creditors.

An entity may apply this Practice Statement to Management Commentary presented prospectively from 8 December 2010.

For the complete exposition, please download the softcopy : IFRS Practice Statement - Management Commentary

Recognition and Measurement of Biological Asset and Agricultural Produce

The main objective of IAS 41, Agriculture is to prescribe the accounting treatment and disclosures related to agricultural activity. This Standard applies to biological assets, agricultural produce at the point of harvest, and government grants. The Standard does not apply to land related to agricultural activity, which is covered by  IAS 16, Property, Plant and Equipment, and IAS 40, Investment Property, or to intangible assets related to agricultural activity, which are covered by IAS 38, Intangible Assets.

IAS 41 defines Agricultural Activity as the management by an entity of the biological transformation and harvest of biological assets for sale or for conversion into agricultural produce or into additional biological assets. It covers a diverse range of activities, for example : raising livestock, forestry, annual or perennial cropping, cultivating orchards and plantations, floriculture and aquaculture (including fish farming).

Agricultural Produce is the harvested product of the entity’s biological assets. A Biological Asset is a living animal or plant. For examples, Sheep is the biological assets and wool is the agricultural produce. Trees in a plantation forest and plants are biological assets, while felled trees, cotton, harvested cane are the agricultural produce. Dairy cattle is a biological assets, and milk is the agricultural produce.

An entity shall recognize a biological asset or agricultural produce when, and only when :

1. the entity controls the asset as as result of past events;
2. it is probable that future economic benefits associated with the asset will flow to the entity; and
3. the fair value or cost of the asset can be measured reliably.

A biological asset shall be measured on initial recognition and at the end of each reporting period at its FAIR VALUE LESS COSTS TO SELL. The only exception to this requirement is where the fair value cannot be measured reliably. While agricultural produce harvested from an entity’s biological assets shall be measured at its FAIR VALUE LESS COSTS TO SELL AT THE POINT OF HARVEST. Unlike a biological asset, there is no exception in case in which fair value cannot be measured reliably. According to IAS 41, agricultural produce can always be measured reliably.

IAS 41 defines Cost to Sell as the incremental costs directly attributable to the disposal of an asset, excluding finance costs and income taxes. And Harvest is the detachment of produce from a biological asset or the cessation of a biological asset’s life processes.

Entities often enter into contracts to sell their biological assets or agricultural produce at a future date. Contract prices are not necessarily relevant in determining fair value, because fair value reflects the current market in which a willing buyer and seller would enter into a transaction. As a result, the fair value of a biological asset or agricultural produce is not adjusted because of the existence of a contract.

A gain or loss arising on initial recognition of a biological asset and agricultural produce at fair value less costs to sell and also from a change in fair value less costs to sell of a biological asset shall be included in profit or loss for the period in which it arises (Hrd).

The publication of 2011 IFRS (Blue Book) Consolidated without early application

Dropped into my email inbox on last Saturday, November 20, 2010, below was the announcement of the publication of 2011 IFRS Blue Book.

The IFRS Foundation is pleased to announce that the 2011 IFRS (Blue Book) Consolidated without early application will be published in December 2010.

International Financial Reporting Standards (IFRSs). Official pronouncements applicable on 1 January 2011. Does not include IFRSs with an effective date after 1 January 2011.

This single volume presents the International Financial Reporting Standards (IFRSs), including International Accounting Standards (IASs), IFRIC and SIC Interpretations, and the accompanying documents - illustrative examples, implementation guidance, bases for conclusions and dissenting opinions - as issued by the IASB and with an effective date no later than 1 January 2011.

This edition does not consolidate those IFRSs or changes to IFRSs with an effective date after 1 January 2011. Readers seeking the consolidated text of IFRSs issued at 1 January 2011 (including IFRSs with an effective date after 1 January 2011) should refer to the two-part 2011 IFRS Red Book, which is being published in parallel with this edition, expected March 2011.

Copies are priced at £60 each, plus shipping. Discounts are available for:

• academics/students
• middle income and low income countries
• multiple orders.

The 2011 IFRSs (Blue Book) Consolidated without early application Bound Volume (978-1-907026-85-0) (Product code7) is priced at £60 per copy, plus shipping. Further information can be found on IFRS Foundation web shop. Please register your interest in this product if you wish to be notified of its publication.

In the Absence of an IFRS, where to turn to ?

The IASB publishes its standards in a series of pronouncements called International Financial Reporting Standards (IFRSs). The term ‘International Financial Reporting Standards’ includes IFRSs, IASs and Interpretation developed by the IFRIC or its predecessor, the former SIC.

The Interpretation of IFRSs are prepared by the IFRIC to give authoritative guidance on issues that are likely to receive divergent or unacceptable treatment, in the absence of such guidance.

As stated in paragraph 9 of IAS 8, Accounting Policies, Changes in Accounting Estimates, and Errors that IFRS are accompanied by guidance to assist entities in applying their requirements. All such guidance states whether it is an integral part of IFRS. Guidance that is an integral part of the IFRSs is mandatory. Guidance that is not an integral part of the IFRSs does not contain requirements for financial statements.

Further, paragraph 10 states that in the absence of an IFRS that specifically applies to a transaction, other event or condition, management shall use its judgement in developing and applying an accounting policy that results in information that is :

(1)  relevant to the economic decision-making needs for users; and

(2)  reliable, in that the financial statements :

1. represent faithfully the financial position, financial performance and cash flows of the entity;
2. reflect the economic substance of transactions, other events and conditions, and not merely the legal form;
3. are neutral, ie. free from bias;
4. are prudent; and
5. are complete in all material respects

Following, paragraph 11 states that in making the judgement described in paragraph 10, management shall refer to, and consider the applicability of, the following sources in descending order :

1. the requirements in IFRSs dealing with similar and related issues; and
2. the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses in the Framework.

Paragraph 12 states that in making the judgement described in paragraph 10, management may also consider the most recent pronouncements of other standard-setting bodies that use a similar concept framework to develop accounting standards, other accounting literature and accepted industry practices, to the extent that these do not conflict with the sources in paragraph 11 (HRD).

Revenue Recognition from Rendering of Services

In general, IAS 18, Revenue states that revenue is recognized when it is probable that future economic benefits will flow to the entity and these benefits can be measured reliably.

How this standard regulates the revenue recognition particularly from rendering of services ?

Paragraph 20 of IAS 18 states that when the outcome of a transaction involving the rendering of services can be estimated reliably, revenue associated with the transaction shall be recognized by reference to the stage of completion of the transaction at the end of the reporting period.

The outcome of a transaction can be estimated reliably when all the following conditions are satisfied :

1. the amount of revenue can be measured reliably;
2. it is probable that the economic benefits associated with the transaction will flow to the entity;
3. the stage of completion of the transaction at the end of the reporting period can be measured reliably; and
4. the costs incurred for the transaction and the costs to complete the transaction can be measured reliably

The recognition of revenue by reference to the stage of completion of a transaction is often referred to as the percentage of completion method. Under this method, revenue is recognized in the accounting periods in which the services are rendered. The recognition of revenue on this basis provides useful information on the extent of service activity and performance during a period.

While, paragraph 22 states that revenue is recognized only when it is probable that the economic benefits associated with the transaction will flow to the entity. However, when an uncertainty arises about the collectibility of an amount already included in revenue, the uncollectible amount, or the amount in respect of which recovery has ceased to be probable, is recognized as an expense, rather than as an adjustment of the amount of revenue originally recognized.

Regarding the requirement of the existence of reliable estimation as stated in para. 20, further, para. 23 states that an entity is generally able to make reliable estimates after it has agreed to the following with the other parties to the transaction :

1. each party’s enforceable rights regarding the service to be provided and received by the parties;
2. the consideration to be exchanged; and
3. the manner and terms of settlement

The stage of completion of a transaction may be determined by a variety of methods. An entity uses the method that measures reliably the services performed. Depending on the nature of the transaction, the methods may include :

1. surveys of work performed;
2. services performed to date as a percentage of total services to be performed; or
3. the proportion that costs incurred to date bear to the estimated total costs of the transaction.

For practical purposes, when services are performed by an indeterminate number of acts over a specified period of time, revenue is recognized on a straight-line basis over the specified period unless there is evidence that some other method better represents the stage of completion. When a specific act is much more significant than any other acts, the recognition of revenue is postponed until the significant act is executed (Hrd).

The IFRS Framework

As described in the Introduction section of IFRS 2010 (Part A), the IASB has a Framework for the Preparation and Presentation of Financial Statements.

The FIRS Framework deals with the :

• objective of financial reporting
• qualitative characteristics of useful financial information
• reporting entity
• definition, recognition and measurement of the elements from which financial statements are constructed
• concepts of capital and capital maintenance

The intention of the Framework is to assist the IASB :

1. in the development of future IFRSs and in its review of existing IFRSs; and
2. in promoting the harmonisation of regulations, accounting standards and procedures relating to the presentation of financial statements by providing a basis for reducing the number of alternative accounting treatments permitted by IFRSs.

In addition, the Framework may assist :

1. preparers of financial statements in applying IFRSs and in dealing with topics that have yet to form the subject of a standard or an interpretation
2. auditors in forming an opinion on whether financial statements conform with IFRSs
3. users of financial statements in interpreting the information contained in financial statements prepared in conformity with IFRSs
4. those who are interested in the work of the IASB, providing them with information about its approach to the formulation of accounting standards

The Framework is not an IFRS. However, when developing an accounting policy in the absence of a standard or an Interpretation that specifically applies to an item, an entity’s management is required to refer to, and consider the applicability of, the concepts in the Framework.

In a limited number of cases there may be a conflict between the Framework and a requirement within a standard or an Interpretation. In those cases where there is a conflict, the requirements of the standard or Interpretation prevail over those of the Framework.

Current Development of the IFRS Framework

In October 2004, the FASB and IASB added to their agendas a joint project to develop an improved, common conceptual framework that builds on their existing frameworks (that is, the IASB’s Framework for the Preparation and Presentation of Financial Statements and the FASB’s Statements of Financial Accounting Concepts).

As noted in the FASB website (read further : Conceptual Framework—Joint Project of the IASB and FASB), the objective of the conceptual framework project, a joint project of the FASB and IASB, is to develop an improved common conceptual framework that provides a sound foundation for developing future accounting standards. Such a framework is essential to fulfilling the Boards’ goal of developing standards that are principles-based, internally consistent, and internationally converged and that lead to financial reporting that provides the information capital providers need to make decisions in their capacity as capital providers. The new framework, which will deal with a wide range of issues, will build on the existing IASB and FASB frameworks and consider developments subsequent to the issuance of those frameworks.

The project is being undertaken in eight phases :

1. Phase A – Objectives and Qualitative Characteristics
2. Phase B – Elements and Recognition
3. Phase C – Measurement
4. Phase D – Reporting Entity
5. Phase E – Presentation and Dislosure, including Financial Reporting Boundaries
6. Phase F – Framework Purpose and Status in GAAP Hierarchy
7. Phase G – Applicability to the Not-for-Profit Sector
8. Phase H – Entire Framework

On 28 September 2010, the IASB and the FASB announced the completion of the first phase of this joint project to develop an improved conceptual framework for IFRSs and GAAP. Click here for more information.

Another references :

1. ICAEW - The Conceptual Framework for Financial Reporting
2. IFRS - Conceptual Framework

Revenue recognition while an entity is acting as a Principal or as an Agent

Based on IAS 18, Revenue, in general term, revenue is recognized only when it is probable that the economic benefits associated with the transaction will flow to the entity and these benefits can be measured reliably.

Para. 8 of IAS 18 states that revenue includes only the gross inflows of economic benefits received and receivable by the entity on its own account. Amounts collected on behalf of third parties such as sales taxes, goods and services taxes and value added taxes are not economic benefits which flow to the entity and do not result in increases in equity. Therefore, they are excluded from revenue. Similarly, in an AGENCY relationship, the gross inflows of economic benefits include amounts collected on behalf of the PRINCIPAL and which do not result in increases in equity for the entity. The amounts collected on behalf of the principal are not revenue. Instead, revenue is the amount of commission.

Further, para. 21 of the Illustrative Examples of IAS 18 IE (Part B of IFRS 2010) provides guidance in determining whether an entity is acting as a PRINCIPAL or as an AGENT (as amended in IFRS 2009).

Such guidance states that determining whether an entity is acting as a principal or as an agent requires judgment and consideration of all relevant facts and circumstances.

An entity is acting as a PRINCIPAL when it has exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. Features that indicate that an entity is acting as a principal include :

1. the entity has the primary responsibility for providing the goods or services to the customer or for fulfilling the order, for example by being responsible for the acceptability of the products or services ordered or purchased by the customer;
2. the entity has inventory risk before or after the customer order, during shipping or on return;
3. the entity has latitude in establishing prices, either directly or indirectly, for example by providing additional goods or services; and
4. the entity bears the customer’s credit risk for the amount receivable from the customer.

An entity is acting as an AGENT when it does not have exposure to the significant risks and rewards associated with the sale of goods or the rendering of services. One feature indicating that an entity is acting as an agent is that the amount the entity earns is predetermined, being either a fixed fee per transaction or a stated percentage of the amount billed to the customer.

Read also : FASB EITF Issue No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent

The Requirements to classify an asset as HELD FOR SALE

IFRS 5, Non-current Assets Held for Sale and Discontinued Operations issued by the IASB in March 2004 replacing IAS 35, deals with the measurement and presentation in the statement of financial position of non-current assets (and disposal groups) held for sale. It also covers the presentation of discontinued operations in the statement of comprehensive income.

As stated in ‘Objective’, in particular, the IFRS requires :

1. assets that meet the criteria to be classified as held for sale to be measured at the lower of carrying amount and fair value less costs to sell, and depreciation on such assets to cease; and
2. assets that meet the criteria to be classified as held for sale to be presented separately in the statement of financial position and the results of discontinued operations to be presented separately in the statement of comprehensive income.

The overall principle of IFRS 5 as stated in paragraph 5 of IFRS 5 is that an entity shall classify a non-current asset (or disposal group) as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use.

The Standard specifies certain requirements and conditions that must be met for a non-current asset (or disposal group) to be classified as held for sale.

The two general requirements are as stated in paragraph 7 of IFRS 5 :

1. the asset (or disposal group) must be available for immediate sale in its present condition subject only to terms that are usual and customary for sales of such assets (or disposal groups); and
2. its sale must be highly probable

Appendix A of IFRS 5 defines “highly probable’ as significantly more likely than probable, where ‘probable’ means more likely than not.

Based on paragraph 8 of IFRS 5, several specific conditions must be satisfied for the sale of a non-current asset (or disposal group) to qualify as highly probable :

1. the appropriate level of management must be committed to a plan to sell the asset (or disposal group);
2. an active programme to locate a buyer and complete the plan must have been initiated;
3. the asset (or disposal group) must be actively marketed for sale at a price that is reasonable in relation to its current fair value;
4. except as permitted by paragraph 9, the sale should be expected to qualify for recognition as a completed sale within one year from the date of classification, and actions required to complete the plan should indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.

Paragraph 9 of IFRS 5 explains that events or circumstances may extend the period to complete the sale beyond one year. An extension of the period required to complete a sale does not preclude an asset (or disposal group) from being classified as held for sale if the delay is caused by events or circumstances beyond the entity’s control and there is sufficient evidence that the entity remains committed to its plan to sell the asset (or disposal group).

If an entity has classified an asset (or disposal group) as held for sale, but the criteria in paragraphs 7-9 are no longer met, the entity shall cease to classify the asset (or disposal group) as held for sale (paragraph 26 of IFRS 5) (Hrd).

Learning IFRS for SMEs from PwC Publications

On July 9, 2009 the IASB published the International Financial Reporting Standard for Small and Medium-size Entities (IFRS for SMEs). The IFRS for SMEs applies to all entities that do not have public accountability. An entity has public accountability if it files its financial statements with a securities commission or other regulatory organisation for the purpose of issuing any class of instrument in a public market, or if it holds assets in a fiduciary capacity for a broad group of outsiders – for example, a bank, insurance entity, pension fund, securities broker/dealer.

The definition of an SME is therefore based on the nature of an entity rather than on its size.

The IASB developed this standard in recognition of the difficulty and cost to private companies of preparing full compliant IFRS information. It also recognised that users of private entity financial statements have a different focus from those interested in publically listed companies. IFRS for SMEs attempts to meet the user’s needs while balancing the costs and benefits to preparers.

IFRS for SMEs is a stand-alone standard; it does not require preparers of private entity financial statements to cross-refer to full IFRS.

One of the big four accounting firms, PricewaterhouseCoopers (PWC) has published several materials to help familiarise accounting practices with the requirement of this standards.

There are four downloadable IFRS for SMEs publications as listed below. Just click the link to download directly from the source pages :

1. Similarities and Differences : A Comparison of 'Full IFRS' and IFRS for SMEs 
2. IFRS for SMEs : Pocket Guide 2009
3. IFRS for SMEs - Illustrative Consolidated Financial Statements 2010
4. IFRS for SMEs: A Less Taxing Standard ?

Source : PwC - IFRS for SMEs