GT IFRS Top 20 Tracker 2012 Edition

2012 EDITION

IFRS Top 20 Tracker

Important Disclaimer:This document has been developed as an information resource. It is intended as a guide only and the application of its contents to specific situations will depend on the particularcircumstances involved. While every care has been taken in its presentation, personnel whouse this document to assist in evaluating compliance with International Financial ReportingStandards should have sufficient training and experience to do so. No person should actspecifically on the basis of the material contained herein without considering and takingprofessional advice. Neither Grant Thornton International Ltd, nor any of its personnel nor any of its member firms or their partners or employees, accept any responsibility for anyerrors it might contain, whether caused by negligence or otherwise, or any loss, howsoevercaused, incurred by any person as a result of utilising or otherwise placing any reliance upon this document.

Contents

Executive s ummary 1

1 Being consistent 2

2 Economic conditions and public spending cuts 3

3 Eurozone sovereign debt crisis 5

4 Going concern 8

5 Presentation of financial statements 10

6 Revenue recognition 12

7 The statement of cash flows 14

8 Business combinations 16

9 Impairment testing and disclosure 18

10 Asset disposals and discontinued operations 20

11 Share-based payment arrangements 22

12 Debt or equity? Identifying financial liabilities 24

13 Financial instruments disclosures 26

14 Capital management disclosures 28

15 Hedge accounting 30

16 The cutting clutter challenge 32

17 Detail counts… 34

18 What's on the way for 2012? 36

19 What's on the way for 2013? 37

20 What's on the horizon? 39

IFRS Top 20 Tracker 1

Key themesKey themes driving selection of the issues in the2012 edition are:• the need for a company’s management

commentary and financial statements tocomplement and be consistent with each other

• the effect that adverse economic conditions mayhave on a company’s financial statements, withparticular emphasis on issues related to theEurozone sovereign debt crisis

• key areas of interest for regulators• challenging areas of accounting • recent and forthcoming changes in financial

reporting.

The IFRS Top 20 Tracker is not of course intendedto be a comprehensive list of issues that companiesmay face during this financial reporting season. It isintended to highlight areas that we expect to beparticularly significant for many Grant Thorntonclients, and in turn to assist management inprioritisation and review.

Grant Thornton International LtdFebruary 2012

IntroductionThe 2012 edition of the IFRS Top 20 Trackercontinues to take management through the top 20disclosure and accounting issues identified byGrant Thornton International Ltd (GrantThornton International) as potential challenges forIFRS preparers.

The member firms within Grant ThorntonInternational – one of the world’s leadingorganisations of independently owned andmanaged accounting and consulting firms – haveextensive experience in the application of IFRS.Grant Thornton International, through its IFRSteam, develops general guidance that supports itsmember firms’ commitment to high quality,consistent application of IFRS.

This edition is based on IFRS applicable for accounting periods commencing on or after1 January 2011.

Executive summary

2 IFRS Top 20 Tracker

Regulators continue to focus on revenuerecognition in general, with accounting policies forrevenue recognition coming under intense scrutiny.It is important that a company’s revenuerecognition policies are consistent with informationgiven about the nature of its business model in itsmanagement commentary.

Other areas where regulators have been knownto question apparent inconsistency betweenmanagement commentary and the financialstatements, include impairment, going concern andoperating segment disclosures.

Points to consider We set out below some points to help managementin achieving consistency in the managementcommentary and the financial statements:• are a company’s segment disclosures under

IFRS 8 ‘Operating Segments’ consistent withthe way it describes its business and itsmanagement in the management commentary?

• are non-IFRS measures properly reconciled toIFRS disclosures where appropriate?

• are the assumptions used in an entity’simpairment testing (for example estimates offuture growth rates in estimating future cashflows) consistent with information disclosed inthe management commentary?

• do the company’s accounting policies cover thekey types of revenue and other transactioninformation discussed in the managementcommentary and are they clear, relevant andcomplete?

• is the discussion of events after the reportingperiod in the management commentaryconsistent with the disclosures in the financialstatements under IAS 10 ‘Events after theReporting Period’?

The financial statements as a wholeMany companies that prepare their financialstatements in accordance with IFRS are alsorequired to prepare an accompanying managementcommentary (also described using other titles suchas Management’s Discussion and Analysis,Operating and Financial Review, and Directors’Report). The IASB has published its own non-mandatory Practice Statement in this area. In manycountries local law and stock exchange regulationalso set out narrative reporting and disclosurerequirements that go beyond IFRS.

Complying with each of these requirementsrequires complete and accurate accountinginformation. The different requirements cannot beconsidered in isolation however. It is important thatthe management commentary and financialstatements are considered as a whole, in order toensure that they both complement and areconsistent with each other.

The importance of consistency coversmanagement commentary, the primary statements,the accounting policies and the notes to the financialstatements. Where the different sections of themanagement commentary and financial statementsare prepared by different people, or at differenttimes, particular care will be needed to make surethat all of these elements fit together as a cohesivewhole, avoiding repetition as far as possible.

Regulators question inconsistenciesRegulators will look for inconsistencies betweeninformation given in different parts of a company’smanagement commentary and its financialstatements. For example, is information given aboutthe future outlook for the business consistent withdisclosure about why the company is considered tobe a going concern? (More information about thedisclosure of going concern is given in Section 4.)

1 Being consistent


Impact on management commentaryManagement will need to assess the impact thatthese wider economic factors will have on thefuture outlook for their business. These assessmentswill affect the forward-looking components ofmanagement commentary. This will be a key part ofmaking sure that management commentary and thefinancial statements complement and are consistentwith each other, as discussed in Section 1.

Impact on areas of financial reportingThere are a number of areas of the financialstatements that may be impacted where an entity isaffected by adverse economic conditions andspending cuts, some of which are highlightedbelow. The areas impacted will vary dependingupon the nature of the business concerned and thesector or industry in which it operates.

Going concernWhere a company is impacted adversely byeconomic uncertainty or by public spending cuts,this will need to be taken into account bymanagement in assessing whether the business is agoing concern. The assessment made should also bereflected in the disclosure about going concernmade in the financial statements (discussed furtherin Section 4).

For example, a company that has significantbalances outstanding, or business relationships,with the public sector in a country facing financialstress should probably disclose that fact andindicate the future events that could impact onamounts outstanding and future trading volumes.In such instances, consideration will also need to begiven to additional going concern disclosures suchas the key assumptions made by management aspart of the going concern assessment.

BackgroundBusinesses in many parts of the world continue tofeel the impact of subdued global economic activity.The crisis in the Eurozone has in particular exerteda negative impact on growth, with companies (bothin Europe and more widely) seeing revenue andprofit growth weakening.

Economic conditionsThe final quarter of 2011 saw a slowdown ingrowth in many European countries and talk of areturn to recession in some.

There continues to be uncertainty over theprospects for economic recovery throughout theEurozone and further afield, including majoreconomies such as the USA. Economic growthremains slow and market conditions are challengingfor many companies. As a result, the outlook formany businesses is uncertain, with pressure onmargins and financing as well as weak demand forproducts and services.

Austerity measuresMany European governments have announced orare implementing austerity programmes. Thesemeasures have a direct impact on businesses’ tradewith the public sector and also affect widereconomic drivers such as consumer confidence. Forcompanies that do business with the public sectorin affected countries, significant cuts will have animpact as the public sector seeks to find efficienciesin the provision of its services. Even companies thatdo not trade directly with the public sector maynevertheless be affected by the cuts, as they may, forexample, be part of the supply chain.

2 Economic conditions and publicspending cuts


The requirements of IFRS 7 ‘FinancialInstruments: Disclosures’ are extensive and includedisclosures about financial instruments at fair valueand about hedge accounting.

Consequences of restructuringA downturn in business may necessitaterestructuring. Where a decision is made to sell orterminate part of the business, IFRS 5 ‘Non-currentAssets Held for Sale and Discontinued Operations’may become relevant. The requirements of IFRS 5are discussed in Section 10.

Management will also need to consider whethera provision is required under IAS 37 ‘Provisions,Contingent Liabilities and Contingent Assets’ as aresult of a decision to restructure the business. Aprovision may only be made where managementhas a constructive obligation to restructure; intentalone is not sufficient. A constructive obligationarises when there is a detailed formal plan in placefor the restructuring and a valid expectation hasbeen raised in those affected that the restructuringwill be carried out. A restructuring may alsoinclude termination benefits, which are covered byslightly different rules in IAS 19 ‘EmployeeBenefits’.

As well as any impact on expected futurerevenues which will need to be considered inassessing going concern, other factors such as theavailability of finance will need to be taken intoaccount, in particular where facilities are due forrenewal within 12 months of issue of the financialstatements.

ImpairmentSignificant adverse changes in the economicenvironment or market in which a companyoperates are indicators of potential assetimpairments. As a result, impairment testing will berequired under IAS 36 ‘Impairment of Assets’, andimpairment charges may result. Impairment testingis discussed in more detail in Section 9.

Fluctuations in foreign exchange rates maypresent issues in impairment testing, particularly forcompanies that trade with countries in theEurozone. In calculating value in use under IAS 36,future cash flows should be included in thecurrency in which they will be generated and thendiscounted using an appropriate discount rate forthat currency. The present value is then translatedusing the spot rate at the date of the value in usecalculation.

Inventory write-downs may also be requiredunder IAS 2 ‘Inventories’.

Use of derivatives to reduce exposure to marketvolatilityManagement may seek to mitigate exposure tomarket volatility through the use of instrumentssuch as forward contracts or interest rate swaps.Such instruments are derivatives in the scope of IAS 39 ‘Financial Instruments: Recognition andMeasurement’, which requires recognition at fairvalue with movements taken to profit or loss. Whilethe use of derivatives may reduce real exposure torisk, they may introduce income statementvolatility.

There may be scope to apply hedge accountingunder IAS 39. However, there are strict conditionswhich must be met in order for hedge accounting tobe applied (Section 15). It is important to note thatthese conditions must be met at the outset, asformal designation and documentation of thehedging relationship needs to be in place at theinception of the hedge.

BackgroundIn addition to the general challenges discussed inSection 2, the crisis in Eurozone sovereign debtgives rise to various accounting issues relating tofinancial instruments.

Banks in particular may have significantsovereign debt exposure and increased liquidityrisks. However, banks are not the only entitiesaffected. Other entities will also face increasedcountry and currency risks. We summarise below anumber of IFRS requirements that may needparticular attention by management.

Eurozone sovereign debt holdingsSeveral European governments are experiencingfinancial difficulties, evidenced in some cases bybail-out actions and credit rating downgrades. Thisraises a question of whether sovereign debt issuedby such governments is impaired in the financialstatements of holders.

Put broadly, under IAS 39 ‘Financial Assets:Recognition and Measurement’, a financial asset ora group of financial assets is impaired if there isobjective evidence of impairment that reduces theestimated future cash flows.

In our view there is objective evidence ofimpairment of Greek Government Bonds (GGBs)at 31 December 2011 and at the date of writing thispublication. Accordingly, for GGBs classified asavailable-for-sale, impairment losses should reflectfair values at the period end. For GGBs classified asheld to maturity or loans and receivables,impairment should reflect the latest expectations ofa private sector contribution (or ‘haircut’). Newinformation as to the private sector involvement inrestructuring, and whether it will go ahead, mayimpact measurement of GGBs at amortised cost.


At the date of writing, we do not believeimpairment losses for other Eurozone sovereigndebt are needed. An important difference betweenGGBs and other sovereign debt is that, in the lattercase, there is no current expectation of a privatesector haircut. However, new information (eginformation about private sector involvement) mayemerge before the date of approval of an entity’sfinancial statements that may change thisconclusion. If so, impairment would be recognisedat that date.

Impairment of other financial assetsThe current economic environment will also affectfinancial asset impairment more generally.Impairment losses need to be determined on a caseby case basis reflecting the specific facts andcircumstances. Some specific points to considerinclude:• for debt type assets, objective evidence of

impairment includes financial difficulty of thedebtor, breaches of the terms of the instrumentand it becoming probable that the debtor willenter bankruptcy or financial reorganisation

• for investments in equities, a significant orprolonged decline in fair value to below cost isone type of objective evidence of impairment

• for available for sale assets, if objective evidenceof impairment exists the entire decline in fairvalue that has been recognised in othercomprehensive income is reclassified into profitor loss.

3 Eurozone sovereign debt crisis


Disclosure about risks and uncertaintiesIAS 1 ‘Presentation of Financial Statements’contains a disclosure requirement in relation to thesources of estimation uncertainty in the carryingamount of assets and liabilities (IAS 1.125). Thecurrent economic environment will lead to manyexamples of increased estimation uncertainty.Entities must disclose information aboutassumptions and other major sources of estimationuncertainty that have a significant risk of resultingin material adjustments in the following year. Forexample, impairment of sovereign debt from aparticular country with financial challenges maynot be required, but disclosure of the amountsoutstanding would be appropriate (IAS 1.125-133).

This disclosure will be influenced by theassessment of material country and/or currencyrisks faced by each entity, the underlyingassumptions about a reasonable range of potentialoutcomes, and how such different circumstancesmight affect the value of the relevant assets andliabilities.

IFRS 7 ‘Financial Instruments: Disclosures’requires extensive disclosure in relation to financialinstruments and related risks. Examples includedetailed disclosures about risk concentrations,credit risk, liquidity risk and other market risks andhow those risks are managed. Management needs toconsider the impact of economic conditions onsuch disclosures. For European banks meaningfulliquidity disclosures and information on capitalmanagement, funding requirements, contingenciesand stress tests are likely to be of particularimportance.

Effect of Eurozone sovereign debt crisis ondiscount ratesAs well as the effect on financial asset impairmentdiscussed above, the Eurozone sovereign debt crisismay affect companies more generally as a result ofits effect on discount rates.

Where an asset-specific rate is not directlyavailable, it is typical to estimate the discount rateby using the Capital Asset Pricing Model (CAPM)to calculate the entity’s weighted average cost ofcapital. Key components of the CAPM are a risk-free rate of return (usually estimated by reference toa government security), a market risk premium, anda Beta factor (representing sensitivity to marketmovements).

The Eurozone sovereign debt crisis hasincreased the yield on long-dated governmentbonds in what are perceived as the weaker countriesin the Eurozone, while decreasing the yields on thegovernment bonds of those countries that areperceived as being safe havens. Putting thisinformation into the CAPM may result in asignificant increase in the discount rate to be usedfor the impairment testing of some assets and cashgenerating units. This together with reducedexpectations of future cash flows may result inhigher levels of impairment for some companies.


Events after the reporting periodThe macro-economic situation in many countries,and the circumstances of specific companies, maychange rapidly in the current environment. Thiswill increase the prevalence of material events afterthe reporting period affecting companies’ financialstatements. IAS 10 ‘Events after the ReportingPeriod’ classifies events after the reporting periodinto those that provide evidence of conditions thatexisted at the end of the reporting period (adjustingevents) and those that do not (non-adjustingevents). Particular attention may need to be paid tothe identification and analysis of such events in thecurrent circumstances.

Going concern – Specific considerations forbanksIFRS also requires management to make anassessment of the entity’s ability to continue as agoing concern (see section 4). For banks,particularly in the Eurozone, a number of specificfactors will impact the going concern assessment.These factors include:• the general tightening of credit and liquidity

that has been observed in the Eurozone • the sovereign debt issues referred to above,

along with broader macro-economic matters,may affect fragile investor and depositorconfidence

• banks in the Eurozone are required to meethigher capital requirements by June 2012

• actions by central banks (including theEuropean Central Bank) and supervisoryauthorities to support the banking sector maybe uncertain.


The guidance may be relevant to managementoperating in those areas of the world that are facedby uncertain economic conditions when makingfinancial announcements, in particular on how toreflect uncertainties facing their business. Threecore principles can be drawn from the guidance: • management should undertake and document a

rigorous assessment of whether the company isa going concern when preparing annual andinterim financial statements. The process carriedout by management should be proportionate innature and depth depending upon the size, levelof financial risk and complexity of the companyand its operations

• management should consider all availableinformation about the future when concludingwhether the company is a going concern. Itsreview should cover a period of at least twelvemonths from the end of the reporting period

• management should make balanced,proportionate and clear disclosures about goingconcern for the financial statements to give a fairpresentation.

Going concern statusContinuing difficult economic conditions in certainareas of the world (see Sections 2 and 3) mean thatthe assumption that the business is a going concernmay not be clear-cut in some cases and managementmay need to make careful judgements relating togoing concern.

Management needs to ensure that it isreasonable for them to prepare the financialstatements on a going concern basis. IAS 1‘Presentation of Financial Statements’ (IAS 1.25)requires that where management is aware, inmaking its going concern assessment, of materialuncertainties related to events or conditions thatmay cast significant doubt upon an entity’s abilityto continue as a going concern, those uncertaintiesmust be disclosed in the financial statements.

FRC GuidanceThe UK’s Financial Reporting Council (FRC) hasproduced ‘Going Concern and Liquidity Risk:Guidance for Directors of UK Companies 2009’,which brings together all the guidance previouslyissued by that regulator in relation to going concernand continues to promote the awareness of theissues facing companies in the current environment.

4 Going concern

Part of being consistentThe going concern disclosures also need to beconsidered in the light of other information in thefinancial statements and any accompanyingmanagement commentary. Section 1 covers theimportance of the financial statements andmanagement commentary complementing andbeing consistent with each other as a whole, and thedisclosures explaining why the entity is consideredto be a going concern are an important part of that.

Management should consider whether there isinformation which suggests that there may beuncertainties over going concern, and ensure thatthis is addressed in the disclosures they give. Thismight include, for example, financial informationsuch as impairment losses, cash outflows ordisclosures showing significant debts due forrepayment within a year, as well as narrativedisclosures such as principal risks and uncertaintiesand financial risk management information. Theeffects of intercompany indebtedness and anyconcerns over the recoverability of intercompanybalances should also not be overlooked. The goingconcern disclosures are an opportunity formanagement to explain why such matters do notaffect the status of the entity as a going concern.

DisclosuresWhen preparing financial statements, managementis required to include statements about theassumptions it has made and in particular thosewhich are specific to its circumstances.

Management should address these reportingchallenges at an early stage in preparing thefinancial statements as this will help to avoid anylast-minute problems which could cause adverseinvestor reaction.

For financial reporting purposes, the assessmentof going concern is made on the date thatmanagement approves the financial statements.Management have three potential conclusions:• there are no material uncertainties and therefore

no significant doubt regarding the entity’sability to continue as a going concern.Disclosures sufficient to give a fair presentationare still required, meaning that managementneed to explain why it considers it appropriateto adopt the going concern basis, identify keyrisks and say how these have been addressed

• there are material uncertainties and thereforethere is significant doubt regarding the entity’sability to continue as a going concern, thusgiving rise to the need for additional disclosuresunder IAS 1.25

• the use of the going concern basis is notappropriate. In this case, additional disclosuresare required to explain the basis of accountingadopted.

Depending on which conclusion managementreaches, the disclosures can be complex and difficultto compose. If going concern might be an issue forthe company, management should allow extra timeto consider this.


When the revised IAS 1 was first issued, there wassome confusion as to the level of detail relating toother comprehensive income required in thestatement itself. The IASB addressed this byamending IAS 1 to clarify that the impact ofindividual items of other comprehensive income oneach component of equity may be disclosed in anote to the financial statements.

Additional comparative statement of financialposition IAS 1 requires an additional comparative Statementof Financial Position, together with related notes, tobe presented as at the beginning of the earliestcomparative period whenever a new accountingpolicy is applied retrospectively, or there is aretrospective restatement of items in the financialstatements, or when items in the financialstatements are reclassified. This includes, forexample, a voluntary change of accounting policyor presentation, as well as the retrospectiveapplication of a new or amended standard.

Disclosure of key judgements and estimatesRegulators continue to pay close attention todisclosures relating to judgements and estimates.Omissions may become apparent frommanagement commentary, which comment onmatters that are not then highlighted as areas ofsignificant judgement or estimation in the financialstatements.


Statement of comprehensive incomeUnder IAS 1 ‘’Presentation of FinancialStatements’, the statement of comprehensiveincome may be presented either as a singlestatement or as two statements (ie an incomestatement and statement of comprehensive income).In either case, the statement should contain onlyitems that form part of comprehensive income.Whilst this is normally straightforward forcomponents of profit or loss, identifying what ispart of other comprehensive income continues tobe a challenge for some companies.

Examples of other comprehensive incomeinclude the revaluation of property, plant andequipment, fair value movements for available-for-sale financial assets and exchange differences onretranslation of foreign operations. Othercomprehensive income does not include, forexample, dividends or new share capital as these aretransactions with owners in their capacity as such,rather than income or expenses. Hence, such itemsshould be shown in the statement of changes inequity not the statement of comprehensive income.

Statement of changes in equityThe statement of changes in equity must always bepresented as a primary statement. The key elementsof the statement are:• total comprehensive income (split between

parent and non-controlling interests)• for each component of equity, the effects of

retrospective application or retrospectiverestatements under IAS 8 ‘Accounting Policies,Changes in Accounting Estimates and Errors’

• transactions with owners in their capacity asowners, showing separately contributions byand distributions to owners

• a reconciliation between opening and closingbalances for each component of equity.

5 Presentation of financial statements

Key judgementsRegulators have noted that IFRS is aprinciples�based reporting framework whichrequires management judgement in its application.IAS 1 requires disclosure of the judgements thatmanagement has made in applying the entity’saccounting policies that have the most significanteffect on the assets and liabilities recognised in thefinancial statements. In effect, a significantjudgement is a view that management has taken inapplying an accounting policy (IAS 1.122).Regulators are likely to challenge companies thatdisclose no areas in which management hasexercised judgements that have had a significanteffect on amounts recognised in the financialstatements.

The disclosure given about significantjudgements should not simply list the areas of thefinancial statements affected, or repeat theaccounting policies for the relevant areas, butshould explain in what particular aspectmanagement has exercised its judgement. Whereapplication of a different judgement would havehad a material effect on the matter reported, thispoint should be addressed in the disclosures.

Key assumptions and sources of estimationuncertaintyIn addition to disclosing significant judgements,management is required to disclose keyassumptions concerning the future and other keysources of estimation uncertainty that have asignificant risk of causing a material adjustment tothe carrying amounts of assets and liabilities withinthe next financial year (IAS 1.125). Though thisdisclosure is often combined with key judgements,it is a separate disclosure requirement and one thatis often not well addressed.

In disclosing key areas of estimationuncertainty, an important aspect of good qualitydisclosure is providing sensitivity analysis ofcarrying amounts to the methods, assumptions orestimates supporting their calculation.

So what is key? When considering what judgements or estimatesshould be disclosed within the financial statements,management should consider what transactions orissues have led to significant discussions at Boardmeetings or have been areas of significant debatewith the auditor. The more complex issues mayhighlight areas that require significant judgementsimpacting on the financial statements, for exampleshould a subsidiary continue to be consolidatedfollowing a change in circumstances?



The primary issue when accounting for revenueis the determination of the point at which revenuemay be recognised, ie when goods or services aredelivered and when it is probable that futureeconomic benefits will flow to the entity and can bemeasured reliably. Examples of areas wherecompanies may be open to challenge regarding theirrevenue recognition policies include where:• the accounting policy suggests that revenue

might be recognised before the qualifyingcriteria have been satisfied, leading to anoverstatement of income

• the accounting policy indicates that revenue isrecognised on product delivery with noreference to customer acceptance or returns

• the company sells both goods and services andthe policy is unclear as to how the variouscomponents have been accounted for.

Regulators have challenged companies that includedetailed accounting policies which relate toapparently immaterial revenue streams. As noted inSection 16, unnecessary clutter such as immaterialor irrelevant accounting policies should beeliminated from a good set of financial statements.

Part of being consistentIn Section 1, we discussed the importance ofconsistency between the entity’s managementcommentary and the financial statements, andnarrative disclosures in general being consistentwith the amounts in the financial statements. Forexample where a company refers to several incomestreams in its management commentary orsegmental disclosures, it is essential that theaccounting policies on revenue address each of thekey revenue streams identified. Failure to do so isvery likely to lead to questions from regulators.

Revenue recognition policiesThe revenue recognition policy is often the mostimportant accounting policy in the financialstatements. Revenue recognition continues togenerate a significant number of questions fromregulators. The key points of concern remain that:• the accounting policy is not set out in sufficient

detail• it is not clear how the stage of completion is

determined with reference to sales of services• policies applied to the various revenue streams

that companies have are not described• areas of significant judgement are not explained.

None of these issues is new, yet it is evident thatcompanies continue to fail to live up to regulators’and investors’ expectations regarding disclosure ofrevenue recognition policies.

The revenue accounting policy must be clear asto how the principles of IAS 18 ‘Revenue’ havebeen applied to the specific business and itssignificant revenue streams and demonstrate clearlythe point at which revenue is recognised and thebasis on which it is measured, particularly wherethe stage of completion has to be identified.

6 Revenue recognition


Changes in the business modelA company’s business model will evolve over time.This may be through changes in strategy, organicgrowth, or as a result of acquisitions and disposals.Consequently, a company’s revenue streams willchange.

It is important that the revenue recognitionpolicies are updated regularly to reflect thesechanges. A common issue is that changes in thebusiness model are discussed in managementcommentary, in particular where these arise fromacquisitions the company has made, but the changesto revenue streams that result are not reflected inthe revenue recognition accounting policies.

DisclosuresIn addition to requirements for the recognition andmeasurement of revenue, IAS 18 sets out specificdisclosures that companies need to give. Thesedisclosures are easily overlooked, or it is assumedthat other disclosures included within thecompany’s accounts meet the requirements. Forexample, companies are required to disclose theamount of revenue generated from each significantcategory recognised during the period, includingthe sale of goods and the rendering of services. Fortransactions involving the rendering of services, theaccounting policy needs to include the methodsadopted to determine the stage of completion.

When writing the accounting policies,management should ask themselves “Does ourstated policy fit with management commentaryabout how we generate revenue?”. If the answer isno, then the policy needs to be improved. Thepolicy should reflect both the timing of therecognition and the measurement of revenue.Where companies have significant obligations inrespect of customer returns, their accountingpolicies should address this issue.

Multiple-element arrangements The aim of IAS 18 is to recognise revenue when,and to the extent that, goods have been delivered toa customer or services have been performed.However, a single transaction may contain anumber of different elements. Take, for example, acontract which includes the sale of a computer,related training and on-going support. Therecognition of revenue in this scenario may not bestraightforward. IAS 18 requires a company todetermine whether the contract should beaccounted for as a single contract or whether itcontains separately identifiable components thatshould be accounted for separately.

IAS 18 requires a company to apply its revenuerecognition criteria to each separately identifiablecomponent of a single transaction to reflect thetransaction’s substance. When identifyingcomponents of a contract, it is important to assessthe contract from the perspective of the customerand not the seller. The key is to understand whatthe customer believes they are purchasing.

Where the company’s bank balance often movesbetween a positive balance and an overdraftposition, this is evidence that the bank overdraft isan integral part of the management of cash in thebusiness. Where this is the case, the bank overdraftshould be included in cash and cash equivalents.

Longer term borrowings, such as bank loans,are not however part of cash and cash equivalents.Similarly, long term deposits are excluded from thedefinition. The inclusion of long term balances incash and cash equivalents obscures the true short-term position. Regulators have challengedcompanies where such items are included in cashand cash equivalents.

Identification and classification of cash flowsIt is important that all cash flow items are identifiedand appropriately included in the statement of cashflows. The consistency of managementcommentary and the financial statements as a wholeshould be considered in this regard. For example, ifthere is discussion of the disposals of assets oroperations, or the issue or repurchase of shares inmanagement commentary, then the relevant cashflows should be appropriately presented in thestatement of cash flows.

Under IAS 7 ‘Statement of Cash Flows’, thereare three types of cash flows, being cash flows fromoperating activities, investing activities andfinancing activities. Cash flows reported must beclassified under these headings. Regulators havechallenged companies which have not made thisclassification correctly. Each heading is explainedbelow.


The importance of the statement of cash flowsAll companies and groups reporting under IFRS arerequired to present a statement of cash flows. Thepurpose of this statement is to provide users offinancial statements with the information they needto make an assessment of the ability of thereporting entity to generate cash and cashequivalents, as well as the needs of the entity toutilise that cash.

A further benefit of the statement of cash flowsis that it enables comparisons to be made betweendifferent entities, because it is not impacted byfactors such as the selection of different accountingpolicies for similar transactions or events.

The ability of an entity to generate cash hasbecome even more important given the economicuncertainties existing in many areas of the world(see Section 2). It is possibly as a result of this thatthe statement of cash flows is coming underincreased scrutiny. We outline below a number ofareas where regulators have raised issues.

Cash and cash equivalentsAs stated above, the purpose of the statement ofcash flows is to provide information about how thereporting entity generates cash and cashequivalents. Cash includes both cash in hand anddemand deposits. Cash equivalents are short-term,highly liquid investments that are readilyconvertible to known amounts of cash and whichare subject to an insignificant risk of changes invalue. Therefore an investment normally qualifies asa cash equivalent only when it has a short maturityof, for example, three months or less from the dateof acquisition.

7 The statement of cash flows

Operating activitiesOperating activities are the main activities of theentity which generate revenue, as well as otheractivities which do not meet the definition ofinvesting or financing activities. This categorytherefore includes items such as receipts from thesale of goods and services, and payments tosuppliers.

The cash flows from operating activities may bepresented using either the direct method, in whichthe major classes of cash receipts and cash paymentsare disclosed, or the indirect method. Under theindirect method, profit or loss is adjusted for non-cash items, movements in working capital and anyincome or expense items associated with investingor financing cash flows in order to reconcile to thetotal cash flows from operating activities.

Investing activitiesInvesting activities include the acquisition anddisposal of long-term assets, such as property, plantand equipment, and the acquisition and disposal ofinvestments not included in cash equivalents.

Investing cash flows are of importance to usersof the financial statements because they representthe extent to which cash has been used to invest inresources which are intended to generate income inthe future. Only expenditure which results in arecognised asset in the statement of financialposition may be included in cash flows frominvesting activities. Accordingly, cash outflows inareas such as training or research (which might beviewed as investments in a broad sense) are not‘investing’ under IAS 7 because such costs arerequired to be expensed under IFRS.

Financing activitiesFinancing activities result in changes to the size orcomposition of the contributed equity orborrowings of the entity. Examples of financingcash flows include the proceeds from the issue ofshares and repayments of borrowings.

Cash flows arising from changes in ownershipinterests in subsidiaries which do not result in a lossof control are also classified as financing activities.This includes, for example, the purchase by theparent of a non-controlling interest in a subsidiary.

Foreign exchange differencesThe treatment of foreign exchange differences in thestatement of cash flows is a key area which causesproblems in practice. Regulators have challengedcompanies where foreign exchange differences arereported in the reconciliation between profit or lossand the cash flows from operating activities, as thisis an indicator that the reconciliation may not havebeen done correctly.

Where cash flows arise in a foreign currency,these should be recorded in the company’sfunctional currency by translating each cash flow atthe exchange rate on the date the cash flowoccurred. An average rate for the period may beused where this approximates to the actual rates.

Where a group has a foreign subsidiary, the cashflows of that subsidiary should be translated intothe group’s presentation currency using the actualexchange rates at the dates the cash flows occurred.Again, an average rate may be used where thisapproximates to the actual rates.

Unrealised gains and losses may arise fromchanges in exchange rates. Such gains and losses arenot cash flows. However, the effect of changes inexchange rates on cash and cash equivalentsdenominated in a foreign currency does need to bereported in the statement of cash flows in order toreconcile the opening and closing balances of cashand cash equivalents. This amount is presentedseparately from the cash flows from operating,investing and financing activities, and is typicallyshown at the foot of the statement of cash flows.



IFRS 3 Revised The revised IFRS 3 ‘Business Combinations’ wasissued in 2008 and became effective for businesscombinations occurring in annual periodsbeginning on or after 1 July 2009. The areas of IFRS 3 which cause practical problems inapplication of the requirements or which are oftenoverlooked are now becoming apparent. Some ofthese key areas are highlighted here.

Identifying a businessIFRS 3 defines a business as “an integrated set ofactivities and assets that is capable of beingconducted and managed for the purpose ofproviding a return in the form of dividends, lowercosts or other economic benefits directly toinvestors or other owners, members orparticipants”. Although the most commonapplication of IFRS 3 is to the situation where oneentity acquires another, the definition makes it clearthat a business need not be an entity, – it can be acollection of assets and activities. In addition, itfollows from the definition that the collection ofassets and activities does not have to be providingreturns right now, but must have the ability to do soin the future.

Consequently, difficulties can arise indetermining whether a collection of assets iscombined with activities such that it constitutes abusiness. Regulators have challenged companieswhere it appears that a transaction had been treatedas a purchase of a group of assets when in fact itshould have been treated as a business combination.An example of an indicator that a group of assets isa business is that employees are transferred with theacquired assets. Alternatively, it may be the types ofassets acquired that give rise to questions, forexample, assets arising from research anddevelopment.

Identifying the acquirerIn all business combinations in the scope of IFRS 3,one of the combining entities is required to beidentified as the acquirer. The acquirer is the entitythat obtains control of the acquiree. The acquirer isusually the entity that transfers cash or other assetsor incurs liabilities, or that issues equity instrumentsto effect the business combination. However, insome business combinations, the issuing entity (thelegal parent) is the acquiree for accountingpurposes. Such business combinations are known asreverse acquisitions. Regulators have approachedcompanies where there was a question overwhether the acquirer had been properly identifiedunder IFRS 3 and therefore whether the businesscombination was a reverse acquisition.

Relevant factors in determining which entity isthe acquirer include:• the relative voting rights in the combined entity

after the business combination• the existence of a large minority voting interest

in the combined entity if no other owner ororganised group of owners has a significantvoting interest

• the composition of the governing body of thecombined entity

• the composition of the senior management ofthe combined entity

• the terms of exchange of equity interests.

8 Business combinations


Contingent considerationIt is common for acquisition arrangements toinclude an amount of consideration for whichpayment is contingent on the occurrence of a futureevent, or where the amount to be paid in the futurevaries depending on, for example, the level of futureprofits of the acquiree. Any contingentconsideration in a business combination is included,at fair value, in the consideration transferred at theacquisition date.

Where contingent consideration gives rise to afinancial asset or liability within the scope ofIAS 39 ‘Financial Instruments: Recognition andMeasurement’, changes in fair value after theacquisition are recognised in profit or loss or inother comprehensive income in accordance withIAS 39. Where contingent consideration meets thedefinition of equity under IAS 32 ‘FinancialInstruments: Presentation’, there is no subsequentremeasurement. It is important that there isadequate disclosure in the accounting policies or inthe notes to explain how contingent considerationhas been accounted for. In particular, regulatorshave challenged companies that recognisedcontingent consideration liabilities but had notexplained how those liabilities were measured.

Requirement for future servicesWhere contingent consideration contains arequirement to provide future services, for example,in the case of former owners of the acquiree whobecome employees after the acquisition, then thatconsideration is not part of the considerationtransferred to obtain control of the business.Instead it relates to the services to be received andshould be recognised as a post-acquisition expense,rather than increasing goodwill.

Accounting for a reverse acquisitionIn a reverse acquisition, the accounting acquirerusually issues no consideration for the acquiree.Instead the accounting acquiree issues its equityshares to the owners of the accounting acquirer.However, in order to account for the businesscombination under IFRS 3, the considerationtransferred needs to be determined based on anequivalent amount the accounting acquirer wouldhave paid to effect the same combination.

Consolidated financial statements issuedfollowing a reverse acquisition will be in the nameof the legal parent (the accounting acquiree) but arepresented as a continuation of the legal subsidiary(the accounting acquirer). The exception to this isthat the financial statements, including thecomparatives, reflect the capital structure (that is,the legal share capital and share premium) of thelegal parent. Appendix B to IFRS 3 sets out how tocalculate the consideration as well as how theconsolidated financial statements are to bepresented following a reverse acquisition.

Intangible assets acquiredIFRS 3 requires the identifiable assets and liabilitiesacquired to be recognised at their acquisition datefair values. This includes identifiable intangibleassets of the acquiree, whether or not these wererecognised in the accounts of the acquiree. IFRS 3 isalso clear that all identifiable intangible assetsacquired in a business combination should becapable of reliable measurement.

Where a business combination is discussed in acompany’s management commentary, this maycover expected benefits of the acquisition such asthe use of brand names or access to customerrelationships. This should be consistent with theidentification of intangible assets acquired.Regulators have noted that it is often apparent thatnot all acquired intangibles have been recognisedbecause of inconsistency between the managementcommentary and the disclosures.

Where the acquirer is not intending to use anintangible asset acquired in a business combination,for example, where the acquiree has a brand namewhich is to be discontinued, the acquirer is stillrequired to recognise the asset at fair value. Thedecision not to use the asset may result in animpairment charge being recognised in post-acquisition profit or loss.


Identification of impairment indicatorsThe identification of impairment indicators is thethird step in the process, in order to determinewhich CGUs will be tested for impairment. CGUsto which goodwill or intangible assets withindefinite lives have been allocated, and intangibleassets not yet available for use, are tested forimpairment at least annually. Other CGUs aretested only when an indicator of impairment arises.

Calculation of recoverable amountThe recoverable amount of those CGUs that arerequired to be tested for impairment is thencalculated. Recoverable amount is the higher ofvalue in use and fair value less costs to sell. Value inuse is calculated using a discounted cash flowmodel, which requires key assumptions such as pre-tax discount rates and growth rates to be made foreach CGU.

Allocation of impairment lossesWhen the recoverable amount has been calculated,any impairment loss is allocated to the assets of theCGU. Impairment losses are first allocated togoodwill until goodwill is reduced to nil. Anyremaining impairment losses are then allocatedacross the other assets of the CGU on a pro ratabasis, although no individual asset should bereduced below its own recoverable amount.

Impairment testing and disclosureImpairment testing under IAS 36 ‘Impairment ofAssets’ continues to be an important issue for manybusinesses, whilst the disclosures about impairmenttesting in the financial statements are an area ofongoing scrutiny by regulators. The processfollowed in testing for impairment may be complexand involve significant judgement and thedisclosure requirements are extensive.

The impairment testing processIdentification of cash-generating unitsIf there are indicators that an individual asset isimpaired, it is tested for impairment. Morecommonly, cash-generating units (CGUs) aretested. A CGU is defined in IAS 36 as the smallestidentifiable group of assets that generates cashinflows that are largely independent of the cashinflows from other assets or groups of assets. Thefirst step in the impairment testing process is theidentification of the CGUs that make up thebusiness, as these CGUs will form the basis of theimpairment tests. In addition, IAS 36 requiresextensive disclosures to be made by CGU.

Allocation of assets to cash-generating unitsThe next step is that the assets of the business mustbe allocated to CGUs. This includes goodwill,which must be allocated to CGUs at least to thelevel of operating segments identified under IFRS 8,before any aggregation of operating segments intoreportable segments. The allocation of assets toCGUs gives the carrying value which will becompared to recoverable amount to determine theamount of any impairment.

9 Impairment testing and disclosure


those should be used for the impairment test, withthe cash flows then extrapolated beyond thatperiod. IAS 36 does not require management toprepare a five year forecast for the purpose of theimpairment test.

Assumptions should be disclosed for both theperiod covered by approved budgets and beyondthis period. The growth rate used to extrapolatebeyond the period covered by approved budgets isalso required to be stated, and justification will beneeded where this is higher than the long-termaverage growth rate for the products, industry orcountry in which the CGU operates. High growthrates will be difficult to justify in the long term,because, when high growth is available in aparticular market, competitors are likely to enterthat market and therefore restrict the growthavailable to companies already in that market.

Sensitivity disclosuresWhere there is no impairment loss for a CGU, butthe impairment test shows that there is littleheadroom such that a reasonably possible change ina key assumption would result in an impairment,IAS 36 requires additional disclosures to be made.These include the amount of headroom on theimpairment test for that CGU, the value assigned tothe key assumption and the amount by which thatassumption would need to change in order for therecoverable amount to be equal to the carryingamount of the CGU.

Events or circumstances leading to animpairmentRegulators have highlighted IAS 36’s requirementto disclose the events or circumstances leading to amaterial impairment loss or the reversal of animpairment loss. Discussion of such events inmanagement commentary that precedes thefinancial statements will not meet the requirementsof IAS 36 unless a cross-reference is given from theimpairment disclosures within the audited financialstatements. Where the disclosure is given separately,it is important to ensure consistency withmanagement commentary.

Disclosure requirements of IAS 36IAS 36 requires extensive disclosure of informationrelating to different stages of the impairmentprocess to be given for each CGU to whichsignificant goodwill is allocated or which hassuffered an impairment. In addition, there are likelyto be significant judgements or key sources ofestimation uncertainty arising from the impairmenttesting, which should be disclosed under IAS 1 ‘Presentation of Financial Statements’ (see Section 5). Regulators have challengedcompanies where no significant judgements wereidentified in the impairment testing process.

Discount rates and growth ratesThe discount rates and growth rates used incalculating the recoverable amount of each CGUshould be disclosed. The rates should be specific tothe risks of each CGU. Where the same discountrates or growth rates are used for two or moreCGUs, this may give rise to questions, in particularwhere those CGUs have performed differentlyhistorically or have different risk profiles, forexample because they are in different geographiclocations. Significant changes in the discount ratesor growth rates used compared to previous yearsshould also be explained in the financial statements.

Regulators have been known to challengecompanies where the discount rates applied todifferent CGUs is unclear, or where the same rate isapplied to a number of CGUs with disparateactivities.

Approach to determining key assumptionsAs well as disclosing the assumptions themselves,an explanation should be given as to how these havebeen determined. This should include the extent towhich the assumptions reflect past experience or areconsistent with external sources of information.

Period covered by budgets and beyondThe period over which the projected cash flowsused in the impairment test are estimated (usingapproved budgets or forecasts) is required to bedisclosed, with an explanation given where thisexceeds five years. Although IAS 36 only requiresan explanation to be given where the periodcovered by approved budgets or forecasts exceedsfive years, this does not mean that a five year periodmust be used. If, for example, management onlyprepare approved budgets for a two year period,


In some cases, events beyond the control of thecompany may extend the time taken to completethe sale beyond one year. Where this happens butthere is sufficient evidence that management remaincommitted to their plan to sell the asset or disposalgroup, classification as held for sale may still beappropriate.

What is a disposal group?IFRS 5 defines a disposal group as a group of assetsto be disposed of in a single transaction, togetherwith liabilities directly associated with those assetswhich will be transferred in the same transaction.Where the disposal group is either a cash-generatingunit (CGU) to which goodwill has been allocated(see Section 9), or an operation which is part ofsuch a CGU, then the disposal group will includethe associated goodwill.

Measurement of non-current assets held forsaleNon-current assets within the scope of themeasurement requirements of IFRS 5 are requiredto be measured at the lower of their carryingamount and fair value less costs to sell. Where fairvalue less costs to sell is lower, this will result in animpairment charge being recognised when the assetor disposal group is classified initially as held forsale. If fair value less costs to sell subsequentlyincreases, this is recognised to the extent that itreverses a previous impairment loss.

Disposals of assets or operationsDifficult trading conditions mean that manycompanies are seeking to restructure theirbusinesses. In some cases, this leads to disposals ofassets or operations, in which case IFRS 5 ‘Non-current Assets Held for Sale and DiscontinuedOperations’ will be relevant.

Where a subsidiary is disposed of, therequirements of IAS 27 ‘Consolidated andSeparate Financial Statements’ will also apply tothe calculation of the gain or loss on disposal in theconsolidated accounts. However, the discussionhere focuses on the requirements of IFRS 5.

Classification as held for saleA non-current asset or disposal group should beclassified as held for sale if its carrying amount willbe recovered principally through a sale transactionrather than through continuing use. Thisclassification is appropriate under IFRS 5 onlywhere the sale is highly probable and the asset, ordisposal group, is available for sale immediately inits present condition, subject only to terms that arecustomary for sales of such assets.

Consequently, an intention to sell will not besufficient to meet the held-for-sale classificationunder IFRS 5. The following criteria must be met:• management are committed to a plan to sell the

asset or disposal group• an active programme to locate a buyer and

complete the plan to sell is in place• the asset, or disposal group, is being actively

marketed for sale at a reasonable price inrelation to its fair value

• the sale is expected to be complete within oneyear from the date of classification as held forsale.

10 Asset disposals and discontinuedoperations


A discontinued operation is a component of anentity which is either classified as held for sale orhas been disposed and meets one of the followingthree conditions:• it represents a separate major line of business or

geographical area of operations• it is part of a single co-ordinated plan to dispose

of a separate major line of business orgeographical area of operations

• it is a subsidiary acquired exclusively with aview to resale

A component of an entity has both operations andcash flows and can be clearly distinguished from therest of the entity. It will have been either a CGU ora group of CGUs while being held for use.

Presentation of discontinued operationsThe statement of comprehensive income (orseparate income statement, if presented) is requiredto show a single amount comprising the total of thepost-tax profit or loss of discontinued operationsand the post-tax gain or loss on remeasurement tofair value less costs to sell of the assets or disposalgroups which make up the discontinued operation.

Further analysis of this single amount isrequired, either in the statement of comprehensiveincome or in the notes. This analysis is required toshow:• the revenue, expenses and pre-tax profit or loss

of discontinued operations• the gain or loss recognised on the measurement

to fair value less costs to sell or on disposal ofthe assets or disposal groups which make up thediscontinued operation

• the related income tax expense associated witheach of the above.

The net cash flows attributable to the operating,investing and financing activities of discontinuedoperations should also be disclosed.

Exceptions to the measurement provisions ofIFRS 5Certain assets are specifically excluded from themeasurement requirements of IFRS 5. As a result,when these assets are classified as held for sale, theycontinue to be measured in accordance with therelevant standard. Examples include investmentproperty carried at fair value under IAS 40‘Investment Property’ and deferred tax assets in thescope of IAS 12 ‘Income Taxes’.

Presentation and disclosurePresentation of non-current assets held for saleIn the statement of financial position, non-currentassets held for sale, or the assets of a disposal groupclassified as held for sale, are required to bepresented separately from other assets. Thisrequirement is typically met by giving a sub-totalfor current assets followed by a line item ‘Non-current assets classified as held for sale’ and then afurther total. Similarly, the liabilities of a disposalgroup should be presented separately from otherliabilities. The assets and liabilities of a disposalgroup must not be offset.

Disclosure of non-current assets held for saleIFRS 5 also requires information to be givenincluding a description of non-current assets ordisposal groups which have either been classified asheld for sale or sold, together with a description ofthe facts and circumstances of the sale or expectedsale and the expected manner and timing of thatsale.

The gain or loss recognised on measurement atfair value less costs to sell is also required to bedisclosed, as is the reportable segment in which thenon-current asset, or disposal group, is presentedunder IFRS 8 ‘Operating Segments’.

Discontinued operationsA non-current asset or a disposal group that meetsthe criteria to be classified as held for sale underIFRS 5 may also be a discontinued operation underIFRS 5, although this is not necessarily the case.


The entity has the choice of settlementWhere the entity has the choice as to how thearrangement is settled, management must considerwhether there is a present obligation to settle incash. This will be the case if the option to settle inequity has no commercial substance, or the entityhas a past practice or stated policy of settling incash, or the entity generally settles in cash whenrequested to do so by the counterparty. Where theentity has a present obligation to settle in cash, thearrangement is accounted for as a cash-settledshare-based payment. Where there is no suchobligation, the arrangement is accounted for as anequity-settled share-based payment.

Conditions associated with a share-basedpaymentA share-based payment may have a number ofconditions which need to be met in order for theemployees to be entitled to receive the award. It isimportant that all such conditions are identified andthen classified appropriately under IFRS 2, as thetreatment of the award differs according to the typeof condition.

Non-vesting conditions are conditions whichdo not determine whether the entity receives theservices that entitle the counterparty to receive theaward. This means that if a non-vesting condition isnot met, it does not impact on the services theentity receives.

An example is the requirement for an employeeto save in a Save As You Earn (SAYE) scheme. In atypical SAYE scheme, employees are given theopportunity to subscribe for shares (often at adiscount to the market price) if they save a regularamount. The savings are usually made by adeduction from the employees’ wages and areapplied to cover the exercise price of the optionsupon exercise. Employees can stop contributing

Share-based payment arrangementsShare-based payments such as share option schemesare an increasingly popular way for companies toincentivise and remunerate their employees.Management may look for innovative ways tostructure such arrangements in order for these to betax-efficient. The accounting requirements for suchawards are found in IFRS 2 ‘Share-basedPayment’. This section discusses some key areaswhich cause problems in practice.

The impact of a settlement choiceIFRS 2 defines both equity-settled and cash-settledshare-based payment arrangements. However,some arrangements provide either the entity or thecounterparty with the choice of how the award willbe settled. Where this is the case, the accountingtreatment must be considered carefully.

The counterparty has the choice of settlementWhere the counterparty (eg the employee) canchoose whether they receive cash or equityinstruments under a share-based paymentarrangement, the entity granting the award hasgranted a compound financial instrument, whichincludes a debt component and an equity component.

For transactions with employees, the fair valueof the compound financial instrument is determinedat the grant date by first measuring the fair value ofthe debt component and then the fair value of theequity component. The fair value of the equitycomponent will take into account the fact that theemployee must forfeit the right to receive cash inorder to receive the equity instrument. The sum ofthese is the fair value of the compound financialinstrument. Where the arrangement is structuredsuch that the fair value of the two settlementalternatives is the same, the fair value of the equitycomponent will be nil.

11 Share-based payment arrangements


and obtain a refund of their contributions at anytime, but forfeit their entitlement to exercise theiroptions if they do so. An employee’s decision tostop saving does not change the fact that he or shecontinues to provide the company with serviceshowever. Under IFRS 2 an employee’s decision tostop saving is treated as a cancellation of the share-based payment (see below).

Vesting conditions are the conditions whichdetermine whether the entity receives the servicesthat entitle the counterparty to receive the award.They can be service conditions, which require onlya specified period of service to be completed, orperformance conditions, which require certainperformance targets to be met in addition to aperiod of service. Performance conditions aremarket conditions if they are related to the entity’sshare price.

Impact on selecting a valuation modelBoth non-vesting and market performanceconditions are required to be taken into account indetermining the grant date fair value of a share-based payment. As a result, the types of valuationmodel that can be used are limited where suchconditions exist. For example, the Black-Scholesformula is not suitable where there are marketconditions.

Modifications to share-based paymentsCompanies that set up share-based paymentschemes some years ago may find that they nolonger provide the incentive to employees that wasoriginally intended, for example because fallingshare prices have resulted in share options being outof the money. In this situation, management maydecide to modify the terms of the arrangement, andthis will have accounting consequences.

Where the terms of a share-based payment aremodified, the incremental fair value at the date ofthe modification must be calculated. This is theexcess of the fair value of the modified award overthe fair value of the original award, both calculatedat the date of the modification. If, for example, ashare option scheme is modified and the onlychange is to reduce the exercise price of the options,this means that there must be an incremental fairvalue at the date of the modification.

The incremental fair value is then spread over theremainder of the vesting period in addition to theshare-based payment charge based on the grant datefair value of the original award. If the incremental fairvalue is negative, there is no change to the accountingand the charge continues to be based on the grantdate fair value of the original award.

Cancellations and replacement awardsWhere a share-based payment award is cancelled byeither the entity or the counterparty, the companyis required to recognise immediately the amountthat otherwise would have been recognised over theremainder of the vesting period. If, however, thecompany grants a new award and, on the date thatit is granted, identifies it as a replacement for thecancelled award, then this is accounted for as amodification.

Group situationsIt is common for one group entity, typically theparent company, to grant share-based paymentawards to the employees of another group entity,typically a subsidiary. Where this occurs, theaccounting treatment needs to be considered in theindividual accounts of each entity involved, as wellas in the consolidated accounts.

The entity receiving the services accounts forthe scheme as equity-settled if it is settled in its ownequity instruments or if another entity will settlethe obligation (whether in cash or shares).Otherwise it accounts for the award as a cash-settled share-based payment.

The entity settling the award but not receivingservices recognises the award as an equity-settledshare-based payment only if it is settled in thatentity’s own equity instruments. Otherwise theaward is accounted for as a cash-settled share-basedpayment. The entity settling the award also needs toconsider where the debit entry goes if it is notreceiving the services under the arrangement. In thetypical case of a parent company which has grantedawards to employees of a subsidiary, the debit entryis usually made to cost of investment in subsidiary.


Convertible bond exampleWhat if a company has issued a convertible bondwhich the holder can convert into ordinary sharesof the entity? The fixed-for-fixed test determineshow the conversion option is accounted for.

If the conversion option passes the fixed-for-fixed test, then it is an equity component. However,there is also a liability component, being theobligation to pay cash, and therefore the bond is acompound financial instrument. The fair value ofthe liability component on inception would beequal to the cash outflows discounted by a marketrate for a straight (non-convertible) bond. Theequity component is simply the residual amountafter deducting the debt component from the fairvalue of the instrument as a whole. The equitycomponent would not then be remeasuredsubsequently, so changes in the fair value of theconversion right would not normally affect profits.

If the conversion option fails the fixed-for-fixedtest, the company must account for the entireinstrument as a liability. That liability is effectively ahost debt contract with an embedded derivative.Under IAS 39 ‘Financial Instruments: Recognitionand Measurement’, in most cases, the companywould be required to separate the embeddedderivative from the host debt contract and carry thisembedded derivative at fair value through profit orloss. To value this conversion option would requirethe use of valuation experts, which can be costlyand time consuming. The changes in value of theembedded derivative, which reflect the fair valuemovements of the conversion right, would affectprofit or loss.

IntroductionApplying the fixed-for fixed test in IAS 32‘Financial Instrument: Presentation’ to determinewhether financial instruments such as convertibledebt, warrants or preference shares are debt orequity has been a recurring theme for some yearsnow. In addition, difficulties arise in determiningwhether payments to be made on the occurrence ofuncertain future events give rise to financialliabilities under IAS 32. As companies look to raisefinance, new types of capital instrument continue toemerge. Although IAS 32 has been in place for anumber of years it remains topical as companiesconsider how it applies to these new instruments.

What is the fixed-for-fixed test?The definition of a financial liability in IAS 32.11has two elements. The first covers the situationwhere an entity has a contractual obligation todeliver cash or to exchange financial instruments ina way which is potentially unfavourable. Thesecond element relates to contracts which may besettled in an entity’s own equity instruments. Somecontracts which may be settled in an entity’s ownequity instruments are financial liabilities (debt),some are equity and some have both debt andequity components. This classification is dependenton the fixed-for-fixed test. The fixed-for-fixed testmay seem straightforward at first glance, butexperience shows that this is rarely the case.

Essentially, a contract is classified as equity if itwill, or may, be settled by the exchange of a fixedamount of cash or another financial asset for a fixednumber of the entity’s own equity instruments.Where this is the case, the fixed-for-fixed test ispassed. Otherwise, the instrument fails the test andthe entity has a financial liability. An importantpoint is that a contract is not necessarily itself anequity item simply because it is paid or settled usingthe entity’s own shares.

12 Debt or equity? Identifyingfinancial liabilities


Variation clausesInstruments such as convertible bonds, warrants orpreference shares which can be converted toordinary shares often include variation clauseswhich alter the conversion ratio. These are oftendescribed as anti-dilution clauses, and may beincluded in the contract with the intention ofpreserving the rights of the holders of theconvertible instruments relative to other equityholders.

Where such variation clauses simply preservethe rights of all equity holders relative to each other,they will not cause the fixed-for-fixed test to fail ifthe original conversion terms before the variationclause passed the fixed-for-fixed test. However,clauses described as anti-dilution often go beyondthis, in which case they cause the fixed-for-fixed testto fail, and as a result the conversion option must betreated as a financial liability.

Foreign currencyAnother practical problem arises where theconversion price or option exercise price isdenominated in a currency other than thefunctional currency of the issuer. Where this is thecase, the conversion terms might be such that afixed amount in a foreign currency converts to afixed number of shares. However, the fixed-for-fixed test is failed because a fixed amount of foreigncurrency is not a fixed amount of cash in the issuingentity’s functional currency.

Contracts to purchase own sharesSpecial rules apply to contracts that might result inthe issuing entity having to purchase its own sharesfor cash (eg written put options). This type ofcontract creates a liability, even when the ‘fixed-forfixed’ test is met. The liability is recognised as thepresent value of the exercise purchase price, and thedebit is recorded in equity (IAS 32.23). Interest isaccrued on this liability as the discount unwindsover time.

If the contract is an option and the option lapsesunexercised, the liability is transferred to equity.

Contingent settlement provisionsContingent settlement provisions relate to contractswhere the issuer is required to make a paymentbased on uncertain future events. In broad terms, ifa payment is required based on an uncertain futureevent that is controlled neither by the issuer nor theholder of the instrument, then that contingentpayment represents a financial liability.

There are two exceptions to this. The first iswhere the contingent event is a liquidation,provided that liquidation itself is neither pre-planned nor at the discretion of one of the financialinstrument holders. The second exception is wherethe obligation is not genuine. However, this isdefined very narrowly, such that ‘not genuine’means the event that would give rise to thecontingent payment is extremely rare, highlyabnormal and very unlikely to occur.

Two types of contingent settlement provisionthat are particularly common and that causeproblems in applying the requirements of IAS 32are obligations based on a percentage of profit andobligations arising from a change of control.

Payments of a percentage of profitsA common issue arises from requirements to pay apercentage of profits as dividends on shares. Thesecontingent dividends are a financial liability becausefuture revenue and profits are not in the control ofthe issuer.

Payments contingent on change in controlWhere there is an obligation to pay cash on achange of control, such as to redeem preferenceshares, the definition of a financial liability willnormally be met. This is because managementcannot prevent shareholders from selling theirshares.

However, in certain limited circumstances, suchas when change in control can only be sanctioned ina general meeting via normal simple majorityvoting, such that the shareholders are essentiallypart of management when making the decision, itmay be possible to argue that a payment to be madeon change of control is not a financial liability. Thisis likely to be a significant judgement which shouldbe disclosed in the financial statements.


Financial instruments disclosuresIFRS 7 ‘Financial Instruments: Disclosures’ sets outextensive disclosure requirements in relation tofinancial instruments. Although IFRS 7 has beeneffective since 2007, it has been amended several timessince. Financial instrument disclosures are oftenhighly significant to users of the financial statements.Given the continued economic uncertainties, theyhave an even greater significance at present. Some ofthe key disclosures are covered here.

Categories of financial instrumentOne of the key disclosures in IFRS 7 is that entitiesare required to disclose the carrying amounts oftheir financial assets and liabilities analysed by thecategories defined in IAS 39 ‘Financial Instruments:Recognition and Measurement’. These categoriesare:• financial assets at fair value through profit or

loss• held-to-maturity investments• loans and receivables• available-for-sale financial assets• financial liabilities at fair value through profit or

loss• financial liabilities measured at amortised cost.

Impairment of financial assetsIFRS 7 requires disclosure of the impairment lossrecognised on each class of financial assets. Inaddition, when financial assets are impaired bycredit losses and the impairment is recorded in aseparate account rather than directly reducing thecarrying amount of the assets, a reconciliation ofmovements in that allowance account should bepresented for each class of financial assets. Theserequirements are among the most commondisclosure requirements raised with companies byregulators.

Financial assets past due but not impairedIFRS 7 requires an entity to disclose financial assetsthat are past due but not impaired. ‘Past due’ meansa financial asset where the counterparty has failed tomake payment when contractually due. Thiswould, for example, include slow-paying tradereceivables. Entities are required to disclose anageing of financial assets past due at the reportingdate but not impaired. This disclosure is not thesame as an analysis of ageing of receivables (whichwould also include those not past due).

Maturity analysis (financial liabilities)For the maturity analysis, IFRS 7 requires an entityto disclose:a a maturity analysis for non-derivative financial

liabilities that shows the remaining contractualmaturities

b a maturity analysis for derivative financialliabilities. The maturity analysis shall includethe remaining contractual maturities for thosederivative financial liabilities for whichcontractual maturities are essential for anunderstanding of the timing of the cash flows

c a description of how the entity manages theliquidity risk inherent in (a) and (b).

Liquidity risk is defined as the risk that an entitywill encounter difficulty in meeting obligationsassociated with financial liabilities that are settledby delivering cash or another financial asset.

13 Financial instruments disclosures


The maturity analysis should cover all non-derivative financial liabilities (including tradepayables), derivative financial liabilities that areessential to an understanding of the timing of cashflows and items outside the scope of IAS 39 butwithin the scope of IFRS 7 (eg finance leases). Theamounts included in the analysis should be thecontracted, undiscounted cash flows. Hence, thefigures often will not equal those in the Statementof Financial Position, which will either be fairvalues or, more commonly, amortised cost.

IFRS 7 requires qualitative disclosures to begiven about the risks arising from financialinstruments. It is important that the liquidity riskdisclosures are tailored to the entity’scircumstances, for example, an explanation of thefuture obligations should be given, together with anexplanation of funding facilities available. Theliquidity risk disclosures interact with the goingconcern disclosures, discussed in Section 4.

Sensitivity analysisIFRS 7.40 requires that a sensitivity analysis bedisclosed for each type of market risk (interest raterisk, foreign exchange risk and other price risks, forexample commodity price risk). The sensitivityanalysis needs to show separately both the effect onprofit and on equity of a reasonably possiblechange in the underlying index. This disclosurerequires comparatives. It is important that themethods and assumptions used in performing thesensitivity analysis are also disclosed.

The fair value hierarchyIFRS 7 requires entities to classify financial assetsand financial liabilities carried at fair value into ahierarchy based on the inputs into the measurementof their fair value. The fair value hierarchy consistsof the following three levels:• Level 1 – quoted prices (unadjusted) in active

markets for identical assets or liabilities• Level 2 – inputs other than quoted prices

included within Level 1 that are observable forthe asset or liability, either directly (ie as prices)or indirectly (ie derived from prices)

• Level 3 – inputs for the asset or liability that arenot based on observable market data(unobservable inputs)

This disclosure requirement applies to all financialinstruments carried at fair value. This includesavailable-for-sale financial assets measured at fairvalue as well as financial assets and financialliabilities at fair value through profit or loss. Theextent of disclosure required depends on the inputsto the fair value measurement. At its simplest, fairvalue is measured directly using a quoted marketprice. However, it might be measured using avaluation model with various inputs, depending onthe financial instrument in question. The moredetailed disclosure is required for instrumentswhere the inputs to the fair value measurement arenot based on observable market data.

Hedge accounting disclosuresIFRS 7 includes specific disclosure requirements inrelation to hedge accounting. Entities that applyhedge accounting are required to give a descriptionof each type of hedge, the nature of the risks beinghedged and a description of each financialinstrument designated as a hedging instrument.These disclosures will help users of the financialstatements to understand the risks the entity isexposed to and how they are managed.

In addition, there are a number of specificdisclosures for cash flow hedges. Entities arerequired to disclose the period in which the cashflows are expected to occur and when those cashflows are expected to affect profit or loss. Anyamounts reclassified from equity to profit or loss inthe period are also required to be disclosed. Theserequirements are among the most commondisclosure requirements raised with companies byregulators.


ASB report In response to regulator concern, the UKAccounting Standards Board (ASB) carried out atargeted review of capital management disclosures,the findings of which were published in December2010. Although the report focuses on UKcompanies, its findings may be of interest tocompanies outside the UK. The key points raised intheir report are discussed below.

Stakeholder interest in disclosuresThe ASB found that, for all companies, investorsand other stakeholders want to be able tounderstand what the company views as capital andits strategy for management of that capital, and donot believe that this is just a matter for banks andinsurers subject to prudential regulation.

Management of different companies mayapproach capital management in very differentways. Similarly, investors will have differentinterests with regard to the management of capital.Some focus on historical invested capital, others onaccounting capital and others on marketcapitalisation. Some investors consider capital inpurely equity capital terms, while others includelonger term debt.

While investors have a keen interest in capital,the ASB found that they do not currently make useof the disclosures given. The disclosures often donot meet the needs of investors because they are notgiven in an informative way and do not allowcomparability between companies.

IntroductionIAS 1 ‘Presentation of Financial Statements’requires disclosure of information that enables usersof the financial statements to evaluate the entity’sobjectives, policies and processes for managingcapital (IAS 1.134-136). Regulators have raisedconcerns over inadequate compliance with theserequirements, and we expect them to continue tofocus on this area in the future.

Meaningful disclosure regarding capitalmanagement is particularly important in thedifficult economic conditions which are beingexperienced in many countries. Many companiesmay have had to act to manage their capital base,for example by suspending dividends or issuingnew shares. Such actions should be reflected in thecapital management disclosures.

The key requirementsIAS 1 requires both qualitative and quantitativedisclosures about the management of capital, withthe aim of enabling users of the financial statementsto understand and evaluate an entity’s objectives,policies and processes for managing capital.

In order to meet this aim, the disclosure givenshould include a description of what the entitymanages as capital as well as summary quantitativedata about what the entity manages as capital. Anychanges in what is managed as capital also need tobe explained.

Where there are externally imposed capitalrequirements, the nature of those requirementsshould be explained, together with informationabout how they are incorporated into themanagement of capital. Where applicable, entitiesalso should state whether they have complied withexternally imposed capital requirements during theperiod and, if not, the consequences of non-compliance.

14 Capital management disclosures


Issued identified with disclosuresThe ASB found that only a minority of companieswhose capital management disclosures theyreviewed provided an enlightened analysis thatexplained their financial capital resources and howit related to their strategy. The majority ofcompanies omitted disclosures or provided largelyboilerplate information about financial capital, suchthat the disclosures did not convey meaningfullyhow those companies assess capital or how theymanage it over the medium to long term.

What do good capital disclosures look like?The ASB report also highlights examples of goodpractice in several areas, as discussed below.

Objectives and policies for the management ofcapitalThe more informative disclosures about an entity’sobjectives and policies for the management ofcapital included the process for capital management,how often policies were revisited and howperformance was assessed, together with discussionof objectives such as:• maintaining an investment grade credit rating• managing gearing to balance higher leverage

with the advantages of a strong credit profile• having enough capital to sustain future product

development• maintaining an optimal capital structure to

balance financial flexibility and cost of capital• reducing the cost of capital consistent with the

entity’s risk appetite.

Quantitative disclosuresGood examples of the quantitative disclosuresabout capital required by IAS 1 provided ananalysis of capital linked to the amounts reported inthe Statement of Financial Position, including a listof the various types of capital managed.


• the effectiveness of the hedge can be reliablymeasured

• the hedge is assessed on an ongoing basis anddetermined actually to have been highlyeffective.

If one of these criteria is no longer met, hedgeaccounting must be discontinued.

Hedging documentation Formal documentation is required at the inceptionof the hedge and cannot be backdated. If hedgedocumentation is not in place, hedge accounting isnot permitted under IAS 39. The documentation isrequired to set out the following:• a clear description of the hedged item and

hedging instrument• the risk management objective for carrying out

the hedge• the nature of the risk being hedged• the methods to be used in assessing

effectiveness, including frequency of the tests.

Hedge effectivenessTo qualify for hedge accounting, a hedge must behighly effective in achieving offsetting changes infair value or cash flows attributable to the hedgedrisk during the period for which the hedge isdesignated. Effectiveness must be testedprospectively at inception and thereafter bothprospectively and retrospectively, at a minimum,each time an entity prepares its annual or interimfinancial statements. Where a hedge fails theeffectiveness test, hedge accounting should bediscontinued from the date effectiveness was lastdemonstrated.

Introduction Hedge accounting under IAS 39 ‘FinancialInstruments: Recognition and Measurement’ ispurely optional but is permitted only wherestringent conditions are met.

The objective of hedge accounting is to ensurethat the gain or loss on the hedging instrument isrecognised in profit or loss in the same period whenthe item being hedged affects profit or loss.

Hedge accounting departs from IAS 39’s defaultprinciples in order to do this. This sectionhighlights the conditions which need to be met inorder to use hedge accounting, and sets out whenhedge accounting must be discontinued.

Conditions applying to use of hedge accountingSpecific rules limit what can be considered as ahedging instrument, and what can be considered asa hedged item.

In summary, a hedging instrument can be aderivative financial instrument or, for hedges offoreign exchange risk only, a non-derivativefinancial instrument. Broadly speaking, the hedgeditem must be an identified hedged item or group ofitems that could affect profit or loss.

Furthermore, in order to be able to use hedgeaccounting, all of the following conditions must bemet:• at the inception of the hedge there is formal

designation and documentation of the hedgingrelationship and the entity’s risk managementobjective and strategy for undertaking the hedge

• the hedge is expected to be highly effective • for cash flow hedges, a forecast transaction that

is the subject of the hedge must be highlyprobable and must present an exposure tovariations in cash flows that could ultimatelyaffect profit or loss.

15 Hedge accounting


IAS 39 does not prescribe particular methods ofassessing effectiveness. However, as noted below,the testing methods to be used must be set out inthe formal documentation supporting the hedgeaccounting designation. The actual results of thehedge effectiveness testing need to demonstrate thatthe gain or loss on the hedging instrument is withina range of 80% to 125% of the corresponding lossor gain on the hedged item.

Even if the hedge is highly effective, theineffective element must always be recognised inprofit or loss. It is not correct to assume that thehedge is always 100% effective just because criticalterms match. There are many ways in whichineffectiveness arises. For example:• if the hedged items are highly probable sales,

then it is unrealistic to assume that the customerwill always pay on exactly the same day as therelated hedging instrument matures

• if the hedge relationship commenced after thederivative hedging instrument had been enteredinto, then this would create ineffectiveness

• at inception of a cash flow hedge, an interestswap (pay fixed/receive variable) will often haveexactly matching terms to a variable rate loan(the hedged item). However, if at any time in thefuture the terms no longer match (eg throughloan repayment) this may create ineffectiveness.

Discontinuance of hedge accounting Hedge accounting should be discontinuedprospectively if one of the following occurs:• the hedging instrument expires or is sold,

terminated or exercised• the hedge no longer meets the criteria for hedge

accounting (for example the hedge no longermeets effectiveness requirements)

• the forecast transaction is no longer expected tooccur

• the entity revokes the designation.

The effect of discontinuance of hedge accounting isthat future fair value changes of the hedged itemand any hedging instruments are accounted for asthey would be without hedge accounting. However,a revised effective interest rate is calculated whenfair value hedge accounting ceases for a debtinstrument.

On a discontinuance of a cash flow hedge:• the cumulative gain or loss on the hedging

instrument that had been recognised in othercomprehensive income from the period whenthe hedge was effective remains in equity untilthe forecast transaction occurs

• if the transaction is no longer expected to occur,the cumulative gain or loss that had beenrecognised in other comprehensive income isreclassified immediately from equity to profit orloss as a reclassification adjustment.


Clutter in financial statementsThe disclosures required in IFRS continue toincrease. In addition, public authorities in manyjurisdictions have added reporting requirements inareas such as risk, governance, remuneration andsustainability. Unsurprisingly, recent years haveseen a substantial increase in the average length ofcompanies’ financial statements in many parts ofthe world. Against this background, manycompanies, users and other stakeholders have beenasking whether we are reaching ‘informationoverload’ – the point where the sheer volume ofinformation starts to detract from its practicalusefulness.

Standard-setters and regulators are mindful ofthis concern. Several bodies have launchedconsultations and studies aimed at finding a way totackle clutter and thereby focus on the informationthat matters. Examples inlcude:• the IASB, in its Agenda Consultation, has asked

about whether it should develop a disclosureframework. This could lead to a less prescriptiveand more principle-based approach todisclosure over time

• EFRAG and the FASB are collaborating inorder to develop new thinking on how toensure disclosures are relevant

• the Institute of Chartered Accountants ofScotland and the New Zealand Institute ofChartered Accountants have undertaken a jointproject, ‘Losing the Excess Baggage’, resultingin specific recommendations to reduce thevolume of disclosure.

These and other initiatives may point the way tolonger-term solutions. But in the meantime cancompanies do anything to reduce the length of theirreport while complying with all the requiredstandards? The UK Accounting Standards Board(ASB) believes they can. In 2011 the ASB published‘Cutting Clutter – Combatting clutter in annualreports’. This followed a discussion paper ‘Louderthan Words: Principles and actions for makingcorporate reports less complex and more relevant’that was published by the UK’s Financial ReportingCouncil (FRC) in 2009.

What is clutter?The ASB report explains the term clutter ascomprising two problems:• immaterial disclosures that inhibit the ability to

identify and understand relevant information,and

• explanatory information that remainsunchanged from year to year.

Immaterial disclosures can often be found wheredetailed notes are given in support of line items inthe accounts which are small. A specific examplegiven in the ASB report is share-based payment. Anexample of explanatory information that oftenremains unchanged, or largely unchanged, fromyear to year is the accounting policies note.

16 The cutting clutter challenge


Remove immaterial disclosureIAS 1 ‘Presentation of Financial Statements’ statesclearly that a specific disclosure required by anIFRS need not be provided if the information is notmaterial (IAS 1.31). Materiality is judgemental, andthis is an area where there is a tendency to err onthe side of caution, perhaps to avoid questionsarising from regulators if the disclosure were notincluded. However, this is an area wheremanagement can cut clutter in financial statementsby giving careful consideration to whether or notdisclosures are material.

Clarity of expressionOne aim of cutting clutter is to increase the clarityof the financial statements for users. An element ofthis is looking at the clarity of expression and thelanguage used in the financial statements, in orderto assess whether complicated information iscommunicated in a clear way that users will be ableto understand.

The future of the debate The ASB report makes three calls for actionconsidered necessary to remove some of theexisting barriers. They are:• continue to encourage debate about what

materiality means from a disclosure perspective• investigate the possibility and potential benefits

of separating explanatory information, eitherwithin or outside the financial statements

• engage with other stakeholders regarding theirinformation requests.

Both the FRC and ASB have called for the debateon cutting clutter to continue, but recognise thatchange will only happen if all those involved incorporate reporting make a concerted effort.

The barriers to cutting clutterThe ASB report identifies behavioural issues as akey barrier to cutting clutter in financial statements.They are not referring only to the behaviour ofpreparers, but also regulators, standard setters,auditors and institutes. All of these parties mayhave a tendency to err on the side of caution, byincluding each and every disclosure requirement inthe financial statements. However, because thebarrier is behavioural, some change can be achievedto cut clutter without changing standards orguidance.

Actions to takeBoth the FRC discussion paper and ASB report aimto provide guidance to preparers of financialstatements. The FRC discussion paper providesfour guiding principles for communication to be:• focused• open and honest• clear and understandable• interesting and engaging.

The ASB report provides disclosure aids for threeareas of financial statements which often containclutter, being governance disclosures, accountingpolicies and share-based payment disclosures.

Four actions that all companies can take areconsidered below.

Accounting policiesAccounting policies should be specific to thecircumstances of the reporting entity. Managementshould review and assess the accounting policiesgiven in the financial statements. Where accountingpolicies are not relevant to an entity’s business, theyare irrelevant and add clutter, and should be deleted.

Eliminate duplicationInformation is often duplicated within financialstatements, particularly where managementcommentary is given. This duplication ofinformation creates clutter. Management shouldseek to minimise such duplication, and, forexample, make use of cross references whereappropriate.


Related party disclosuresIssues over related party disclosures and compliancewith IAS 24 ‘Related Party Disclosures’ continue toarise and draw comment from regulators. Whilstthese issues do not affect reported profits, relatedparty disclosures are often significant to readers ofthe financial statements, and thus should not beoverlooked.

Revision of IAS 24 Related Party DisclosuresA revised version of IAS 24 was issued inNovember 2009 and is effective for periodsbeginning on or after 1 January 2011. The two mainchanges brought in by the revised standard are:• the introduction of an exemption from IAS 24’s

disclosures for transactions with: (a) agovernment that has control, joint control orsignificant influence over the reporting entity;and (b) ‘government-related entities’ (entitiescontrolled, jointly controlled or significantlyinfluenced by that same government)

If a reporting entity applies this exemption, it isrequired to disclose the name of the government inconcern and the nature of its relationship with thereporting entity. It is also required to discloseinformation on the nature and amount of eachindividually significant transaction with thegovernment or government-related entity. Forother transactions that are collectively, but notindividually, significant, a qualitative or quantitativeindication of their extent is required to be disclosed.

• a change to the definition of related parties. Thedefinition now explicitly includes as relatedparties of one another:– two joint ventures of the same third party– a joint venture and an associate of the same

third party (but not two associates).

Key management personnel compensationIAS 24.17 requires disclosure of key managementpersonnel compensation in total, split between:• short-term employee benefits• post-employment benefits• other long-term benefits• termination benefits• share-based payment.

Key management personnel may include personssuch as leaders of key divisions within the group aswell as the more obvious boardroomrepresentatives of the parent company.

The IAS 24 disclosures focus on the costrecognised by the reporting entity rather than thebenefit to the director or employee. This means thefigures disclosed may not be the same as thoseprovided in compliance with statutoryremuneration disclosures for management underlocal legislation.

17 Detail counts…


Onerous operating leasesIAS 37 ‘Provisions, Contingent Liabilities andContingent Assets’ defines an onerous contract as acontract in which the unavoidable costs of meetingthe obligations under the contract exceed theeconomic benefits expected to be received under it.The continuing difficult economic conditions beingexperienced in many areas of the world increase thepotential for operating leases to become onerous,such that a provision is required to be recognised inthe financial statements in accordance with IAS 37.

Situations that increase the likelihood that alease is onerous include the following:• the leased asset is abandoned, partly abandoned

or under-utilised• the leased asset is used in a loss-making

operation• the rentals payable under the lease are above

current market rates

The presence of one or more of these factorsincreases the likelihood that a lease is onerous, butdoes not necessarily mean that this is the case. Inorder to determine whether a lease is an onerouscontract and a provision is needed, managementwill need to compare the unavoidable costs of alease and expected economic benefits to be receivedon a case-by-case basis.

The impact of tax rate changesWhere there have been changes to the rate of tax,the accounting for current tax will need to beconsidered, in particular where a company’saccounting period straddles the date at which a newtax rate becomes effective. The effective tax rate forsuch a period will need to be calculated byweighting the tax rates applicable before and afterthe change.

The main impact, however, is in the accountingfor deferred tax. IAS 12 ‘Income Taxes’ requiresdeferred tax assets and liabilities to be calculatedusing the tax rates expected to apply to the periodthat the asset is realised or the liability settled, basedon tax rates that have been enacted or substantivelyenacted at the reporting period date. Companieswill therefore need to estimate the period in whichdeferred tax assets are expected to be realised andliabilities settled and apply the tax rates for therelevant periods based on the rates that have beenenacted by the end of the reporting period.


Amendments to IAS 12Amendments have been made to IAS 12 ‘IncomeTaxes’ which are effective for periods beginning onor after 1 January 2012. However these amendmentsare limited in scope and will apply only to companiesthat have investment property measured at fairvalue under IAS 40 ‘Investment Property’. Theamendments introduce a rebuttable presumptionthat in such circumstances, an investment propertyis recovered entirely through sale.

Guidance in SIC 21 ‘Income Taxes – Recoveryof Revalued Non-Depreciable Assets’ addressingsimilar issues involving non-depreciable assetsmeasured using the revaluation model in IAS 16 ‘Property, Plant and Equipment’ has alsobeen incorporated into IAS 12 and SIC 21 iswithdrawn.

Presentation of other comprehensive incomeThe IASB has issued an amendment to IAS 1 entitled‘Presentation of Items of Other ComprehensiveIncome’. The amendment is effective for periodsbeginning on or after 1 July 2012.

The amendment does not change which itemsare presented in other comprehensive income, butdoes change the structure of their presentation. Themain change is a requirement for entities to groupitems presented in other comprehensive incomeinto those that, in accordance with other IFRSs:• will not be reclassified subsequently to profit or

loss• will be reclassified subsequently to profit or loss

when specific conditions are met.

The IASB has backed away from its previousproposals to require a single statement ofcomprehensive income, so presentation in twoconsecutive statements, being an income statementand a statement of comprehensive income, willcontinue to be permitted.

IFRS changes for 2012As for 2011, there are no major new IFRSs with amandatory effective date in 2012. Therefore manycompanies will have the advantage of relativestability when preparing their financial statements.However, there are some smaller changes whichtake effect and have the potential to impact on 2012financial statements in certain situations. These areoutlined below.

Amendments to IFRS 7IFRS 7 ‘Financial Instruments: Disclosure’ has beenamended with effect for periods beginning on orafter 1 July 2011. For companies with Decemberyear-ends, this means that the first year to beimpacted will be the year ending 31 December 2012.

The amendments to IFRS 7 will mainly impactfinancial institutions. As a result of theamendments, additional disclosures are requiredwhere financial assets are derecognised but there iscontinuing involvement. The new disclosures aredesigned to provide information that enables users:• to understand the relationship between

transferred financial assets that are notderecognised in their entirety and the associatedliabilities; and

• to evaluate the nature of, and risks associatedwith, any continuing involvement of thereporting entity in financial assets that arederecognised in their entirety.

The approach to derecognition set out in IAS 39 ‘Financial Instruments: Recognition andMeasurement’ is not changed by the amendments.

18 What’s on the way for 2012?


IFRS 10 Consolidated Financial StatementsIFRS 10 provides a revised framework to assesswhen one entity controls another, which will applyboth to more conventional subsidiaries and tospecial purpose vehicles. In most cases, conclusionsas to what should be consolidated are likely to beunchanged. However, ‘borderline’ consolidationdecisions taken under IAS 27 will need to bereassessed and some will need to be revised.

Significant judgement will be needed inapplying the definition of control in certainsituations. For example, this will be the case wherean entity holds potential voting rights over anotherentity. In addition, IFRS 10 is clear that control canexist where a minority of voting rights are held butthe remaining voting rights are held by a largenumber of widely dispersed shareholders.

IFRS 11 Joint ArrangementsIFRS 11 defines two types of joint arrangement,being joint operations and joint ventures. Thiscontrasts with the three classifications in IAS 31,which is replaced by IFRS 11. As a result, entitieswith interests in joint arrangements will need toassess the classification of the arrangement underIFRS 11.

In most cases, jointly controlled entities underIAS 31 will be joint ventures under IFRS 11.However, IFRS 11 does not allow proportionateconsolidation for joint ventures. Instead, equityaccounting under IAS 28 must be applied. This willlead to a significant change for many companies.

IFRS changes for 2013In contrast to 2012, there are a number of new and amended standards with an effective date of 1 January 2013 which will impact IFRS preparers.These include new standards on consolidation, jointarrangements and fair value measurement, as well asamendments to the accounting for defined benefitpension schemes.

With the exception of fair value measurement,the main changes are applied retrospectively, givinga transition date of 1 January 2012 for companieswith a 31 December period end. Althoughtransitional reliefs may be available in certaincircumstances, this means that these changes needto be thought about now.

Interests in other entitiesIn May 2011 the IASB issued a package of newstandards covering the accounting for interests inother entities, as well as new disclosurerequirements. The new standards are:• IFRS 10 ‘Consolidated Financial Statements’

which supersedes IAS 27 ‘Consolidated andSeparate Financial Statements’ and SIC 12‘Consolidation – Special Purpose Entities’

• IFRS 11 ‘Joint Arrangements’ whichsupersedes IAS 31 ‘Interests in Joint Ventures’

• IFRS 12 ‘Disclosure of Interests in OtherEntities’

• IAS 27 (Revised) ‘Separate FinancialStatements’, and

• IAS 28 (Revised) ‘Investments in Associatesand Joint Ventures’.

Companies with investments in other entities, inparticular subsidiaries and joint ventures, will needto reassess the accounting treatment they apply. Thekey points of IFRSs 10, 11 and 12 are coveredbriefly below.

19 What’s on the way for 2013?


IFRS 12 Disclosure of Interests in Other EntitiesIFRS 12 is designed to complement the other newstandards. It sets out consistent disclosurerequirements for subsidiaries, joint ventures andassociates, as well as unconsolidated structuredentities. The disclosure requirements are extensiveand will result in significant amounts of newdisclosures for some companies.

Structured entities were previously referred toin SIC 12 as special purpose entities. Thedisclosures required by IFRS 12 aim to providetransparency about the risks a company is exposedto through its interests in structured entities.

Fair value measurementIFRS 13 ‘Fair Value Measurement’ was also issuedin May 2011. The new standard does not specifywhich items must be measured at fair value.However, where fair value measurement is requiredby another standard, IFRS 13 sets out how fairvalue should be measured and gives requirementsfor the disclosure of fair value information. Therequirements of IFRS 13 are to be appliedprospectively as of the beginning of the annualperiod in which it is initially applied.

IFRS 13 defines fair value as the price thatwould be received to sell an asset or paid to transfera liability in an orderly transaction between marketparticipants at the measurement date. It clarifiesthat fair value is based on a transaction taking placein the principal market for the asset or liability or, inthe absence of a principal market, the mostadvantageous market. The principal market is themarket with the greatest volume and level ofactivity for the asset or liability.

The disclosure requirements of IFRS 13 willresult in significant amounts of additionaldisclosure for some companies, for example whereinvestment property is measured at fair value. IFRS 13 extends the use of the fair value disclosuresrequired by IFRS 7 ‘Financial Instruments:Disclosures’ to non-financial items measured at fairvalue, and also requires disclosures about the fairvalue of certain items not measured at fair value.

Accounting for pension schemesIAS 19 ‘Employee Benefits’ has been amended forperiods beginning on or after 1 January 2013. Thiswill mainly impact the accounting for definedbenefit pension schemes.

The corridor approach for the recognition ofactuarial gains and losses has been removed, as hasthe option to recognise actuarial gains and losses inprofit or loss. The impact of this is that all actuarialgains and losses will be recognised in othercomprehensive income in the period in which theyarise.

In addition, the calculation of net interest costhas changed. There will no longer be separatecalculations of the expected return on plan assetsand the interest cost of funding the defined benefitobligation. Instead, a single rate is applied to the netof the defined benefit obligation and plan assets.This will impact on profit or loss, with the majorityof companies seeing a reduction in profits as aresult.


IFRS continues to changeThe IASB has a heavy work programme to revampmajor areas of IFRS over the next few years,including revenue, leasing and financialinstruments. An update on these projects is givenbelow. Although the impact may seem some wayoff, these major changes will need to be consideredwell in advance.

Revenue The IASB and the US standard setter, the FASB,have a joint project to develop a new standard on revenue recognition, which will replace IAS 18 ‘Revenue’, IAS 11 ‘Construction Contracts’and several IFRS Interpretations Committeeinterpretations for IFRS preparers. An ExposureDraft (ED) of a proposed standard ‘Revenue fromContracts with Customers’ was issued in June2010. Following the comment period, in which over900 comment letters were sent, the IASB and FASBhave made changes to the proposals. As a result anew ED was published in November 2011 with acomment period ending on 13 March 2012. Thefinal standard could be issued in the second half of2012 and the effective date proposed in the ED isannual periods beginning on or after 1 January 2015.Application is expected to be retrospective, withrestatement of comparatives. This means that anyexisting contracts in place at the start of thecomparative period will be affected.

As the title indicates, the contract is central tohow revenue will be accounted for once the finalnew standard is in place. The central principle isthat revenue will be recognised not based on asupplier’s activity but on the transfer of control of agood or service to the customer.

Many respondents to the proposals in the EDwere concerned that revenue from the rendering ofservices would be recognised much later than iscurrently the case under IAS 18, with recognition atthe end of the contract in many cases. This area hasbeen reconsidered and the new ED clarifies thattransfer of control of services to a customer mayhappen continuously when certain criteria are met.

LeasesIn August 2010, the IASB and FASB issued theirlong-awaited joint ED ‘Leases’. When issued as anIFRS, this will replace the present standard, IAS 17.The new standard will cover both lessees andlessors. As for revenue, a large number of commentletters were received and the proposals for leases aregoing to be re-exposed, as significant changes havebeen proposed to the original ED. The new ED isexpected in the second quarter of 2012 and theeffective date of the new standard is expected to beyears beginning on or after 1 January 2015.

For lessees, the existing operating lease versusfinance lease distinction will be removed andreplaced by a single model based on rights of use.All leases will be included in the Statement ofFinancial Position, as the lessee will recognise aright-of-use asset and a corresponding liability forthe obligation to pay rentals. The IASB isproposing some transitional reliefs but manyexisting leases will nevertheless need to be restated.

For lessors, the 2010 ED proposed twoapproaches depending on the exposure of the lessorto the risks and benefits of the underlying asset.However, it appears likely that the proposals forlessors will change in the new ED.

20 What’s on the horizon?


IFRS 9 Financial InstrumentsIFRS 9 ‘Financial Instruments’ will replace IAS 39 ‘Financial Instruments: Recognition andMeasurement’, and is currently being developed instages by the IASB. The original intention was thatIFRS 9 would be effective for periods beginning onor after 1 January 2013, however the IASB has nowdecided to delay implementation until periodsbeginning on or after 1 January 2015. Earlyapplication of the standard’s requirements ispermitted (subject to any constraints imposed bylocal jurisdiction).

Phase 1: Classification and measurementThe requirements for classification andmeasurement of financial assets and liabilities havebeen issued. IFRS 9 has only two categories for theclassification of financial assets, compared to thefour categories in IAS 39. For financial liabilities,most requirements from IAS 39 have been carriedforward into IFRS 9, although some changes havebeen made to the fair value option for financialliabilities to address issues on own credit risk.Although this part of IFRS 9 had been consideredfinal, the IASB have recently decided to re-open theproject to address application issues, includingspecific concerns for insurance companies, and toexplore opportunities to reduce differences with USGAAP.

Phase 2: Impairment methodologyFollowing the issue of the ED in 2009 and asupplementary document early in 2011, the IASB iscurrently re-deliberating the proposals on theimpairment of financial assets. The broad theme isto replace IAS 39’s current ‘incurred loss’ approachwith an expected loss approach. The proposals todate have been criticised as very complex toimplement, and a further exposure draft is expectedin the first half of 2012.

Phase 3: Hedge accountingThe IASB has the objective of improving theusefulness of financial statements by fundamentallyreconsidering the hedge accounting requirements of IAS 39. An exposure draft was issued inDecember 2010 covering general hedge accounting.This phase of the project is nearing completion, and a near-final ‘staff draft’ is expected to be issuedsoon. The IASB is continuing to debate itsproposals on macro, or portfolio, hedge accounting.

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GT IFRS Top 20 Tracker 2012 Edition

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