The Directive on disclosure of non-financial and diversity information by large companies and groups addressing environmental, social, and governance (ESG) issues was published in the Official Journal of the EU on 15 November 2014. EU Member States should transpose the rules on non-financial reporting into national legislation by 6 December 2016. In this context, the European Commission is organising transposition workshops to assist national authorities and prepares non-binding guidelines on the methodology for reporting non-financial information by end-2016.

Please click to access the consultation page on the European Commission website.

The 45-minute web presentation provided an overview of the new requirements and allowed participants to ask questions. Please click to access the recording and the slides here on the IASB website. Note that there is no charge to listen to the web presentation but a registration is required.

The report indicates that compliance with the UK Corporate Governance Code “remains high” and that the quality of explanations for non-compliance with the UK Corporate Governance Code’s provisions has improved – the FRC sees this as a “more thoughtful approach to governance”.  However 2015 provided a “mixed picture of progress” regarding the Stewardship Code with reporting against the principles of the Stewardship Code of “inconsistent quality”.

Key findings from the report, which is based upon a number of reports and surveys, are as follows:

Governance, reporting and audit

• 90 per cent of FTSE 350 companies comply with all, or all but one or two, of the UK Corporate Governance Code’s 54 provisions.  This is a slight fall from 94% in the prior year.
• Code provision B.1.2 which states that at least half the board (excluding the chairman) should be independent, remains the area of most non-compliance amongst FTSE 350 companies.
• There has been a “notable rise” in the quality of explanations for non-compliance with provisions of the UK Corporate Governance Code.  It was highlighted that “explanations were better where companies depart from the Code due to force of circumstances – such as directors leaving the board at short notice”.
• Disclosures on external audit appointments improved including “better clarity on company policy and more detailed insight into the processes by which auditor effectiveness and independence are assessed”.  However “fewer companies disclosed the expected timing of their next audit tender” - the FRC expects this to increase next year.
• The 2012 edition of the UK Corporate Governance Code introduced requirements for audit committees to provide more detail on the work they do.  Overall disclosures on the work in this area have improved – 72 per cent of FTSE 350 companies now give more detailed descriptions of the work they do versus 65 per cent in 2014.  However, there is still room for companies to improve their audit committee reporting.
• The 2012 edition of the UK Corporate Governance Code brought in an expectation that companies should set out their policies on boardroom diversity and report on the progress against any measureable objectives they had set themselves.  The report highlights that there has been an increase in the number of FTSE 100 companies that provide details on their gender diversity policy.  Nevertheless, some still made no reference at all in both the FTSE 100 and FTSE 250.  Additionally, the report indicates that “there remain a disappointing number of companies (including 24 in the FTSE 100) who despite recognition of a broader concept of diversity in the Code, still make no reference to this subject”.
• Only a “small number of companies” have decided to early adopt the requirements of the 2014 version of the UK Corporate Governance Code.  With respect to the revised Principle D.1, there has been an increase from 37 per cent to 51 per cent of FTSE 100 companies having longer share retention periods with regards to remuneration.  The FRC has indicated that it will continue to see how market practice develops in relation to the 2014 Code requirements.

Stewardship and engagement

• The FRC highlights that it has “been pleased to see improvements in the quality and quantity of investor monitoring and engagement”.  However it also indicates that more is required “to promote best practice”.
• The quality of signatory statements has seen to “vary considerably”.  The FRC wants to improve this and in December 2015 announced that it is to introduce a public tiering of signatories to the Stewardship Code in order to improve reporting against the Code and to assist investors.
• Investor feedback in 2015 was positive on engagement between companies and investors with many indicating that companies were being more responsive.
• Concerns were expressed in 2014 about the role of proxy advisors.  The FRC will continue to promote best practice in this area.
• 2015 saw an increase in voting activities at companies meetings with 73 per cent voter turnout in the UK.

The report indicates that in 2016 the FRC will “continue to promote corporate governance and corporate cultures that support the long-term success of companies”.  It will also “encourage effective investor stewardship and engagement between companies and investors”.  Specifically the FRC will:

Analyse the responses to the Succession Planning Discussion Document and consider whether any further action is necessary.

Continue to monitor adoption of 2014 UK Corporate Governance Code provisions.

Complete [its] market-led review about how boards can most effectively establish company culture and practices that embed good corporate behaviour.

Introduce the limited changes to the UK Corporate Governance Code linked to the implementation of the EU Audit Regulation and Directive (ARD) in 2016, but otherwise avoid revising the UK Corporate Governance Code over the three year strategy period.

Promote effective investor stewardship by evaluating Stewardship Code signatories’ statements and making public our assessment, promoting stewardship and engagement activities and initiating implementation of the Shareholder Rights Directive. 

Click for:

• Press release (link to FRC website).
• Full report (link to FRC website). 

Check out the summaries for the forthcoming discussions on insurance contracts, discount rates, fair value measurements, and revenue. We have added them to our meeting note page and will supplement them with our popular meeting notes after the meeting.

The report states that the International Financial Reporting Standards (IFRS) are "essential for the efficient functioning of the internal market and of the capital markets", are considered a European "public good", and "strengthen accountability by reducing the information gap between investors and companies, protecting investment and bringing transparency through enhancing the international comparability and quality of financial information and enabling investors and other market participants to make informed economic decisions, and therefore influence the behaviour of actors in financial markets and impact the stability of these markets".

Of the individual points made in the report, especially the following deserve to be mentioned.

If the motion gets passed by Parliament, the President will be asked forward the resolution to the Council and the Commission. Please click to access the full draft report on the Parliament's website.

Removing the leases project from the work plan and adding IFRS 16 Leases under completed standards is the only obvious change the Board notes. As always, in all other projects the next project steps may or may not have been pushed back by one month since the last work plan update. The revised IASB work plan is available on the IASB's website.

IPSAS 25 is based on IAS 19 Employee Benefits, which was later revised. The main changes that the IPSASB has proposed to IPSAS 25, so that convergence with IAS 19 is maintained to the extent appropriate, are:

• Remove an option that allows an entity to defer the recognition of changes in the net defined benefit liability (the “corridor approach”);
• Introduce the net interest approach for defined benefit plans;
• Amend certain disclosure requirements for defined benefit plans and multi-employer plans; and
• Simplify the requirements for contributions from employees or third parties to a defined benefit plan when those contributions are applied to a simple contributory plan that is linked to service.

Please click to access the press release and ED 59 on the IPSASB website. Comments are requested by 30 April 2016.

Leasing has been a long haul of a flight. It was first on the agenda in the early days of the IASB and since then has been through many stages: a joint project with the US standard-setters, FASB, followed by a joint discussion paper, and two joint exposure drafts. And it has been hit, through all that time, by vociferous and determined opposition. But, after a few twists and turns, the IASB has come to an answer and we have a standard. IFRS 16 is finally open for business and comes into force for reporting periods beginning on or after 1 January 2019. And the IASB is happy. Chatting with its Chairman, Hans Hoogervorst, the other day he told me that by their reckoning 85% of leases are held off-balance sheet at present. And, once IFRS 16 comes into force, that figure will drop, as he put it, ‘to zero’.

In the short term there are going to have to be some tricky decisions to be made. There will be more judgment and a steep learning curve, though there are three years of lead-in. And there are peculiarities. For example, the way in which the standard-setters have extricated themselves from the potentially time-consuming and cost-consuming issue of what should be done about small-ticket items, like office furniture, has been described by Hoogervorst as ‘not conceptually very beautiful’. The USD 5,000 indicative threshold is arbitrary but useful. Certainly it will bring the cost of implementing the standard down.

But the whole issue of leases, as ever, is riddled with complexities and quirks. The issue of leases versus contracts for services is a good example. If a construction company hires another company to dig out a building site using the provider’s equipment then that is a service. If the company hired the equipment and then used its own team to do it that would be a lease. The whole area of what is a lease and what is a contract for services may prove to be the most challenging of the practical aspects of the standard.

But overall the standard gets the work done and for the standard-setters the important thing is achieving something that provides greater transparency and comparability. Some airlines own most of their fleet. Some lease most of their fleet. IFRS 16 will take away the difference. Balance sheets will show the assets. Investors and analysts will no longer have to make their own basic adjustments. The standard will do it for them.

Hoogervorst also thinks that the changes which the standard brings about will be ‘eye-opening’ for management and that CEOs may be surprised at how many leases they have on the balance sheet and the knock-on effect that has in terms of finance. It certainly means they will also have to take a look at any contracts they have which rely on IFRS statements. And they will then have to make plans to explain to the people concerned, like lenders, how the financial statements will change when the new leases requirements take effect. The risks will not have grown, but they may, on paper, appear to have done so.

There is, as ever, much to be done, not only in understanding but also communicating the impacts. But the final result should be clearer for both preparers and, in particular, investors since a very obvious part of financing will become explicit rather than remaining implicit or hidden in the notes as before.

Background

In July 2006 a project to revise lease accounting was added to the IASB’s agenda. The project was undertaken as a joint project with the US Financial Accounting Standards Board (FASB), with both standard-setters looking to develop an approach requiring lessees to recognise assets and liabilities for the rights and obligations arising under leases. In the years that followed, a discussion paper and two exposure drafts were published, with both boards undertaking significant outreach activities. The IASB has now issued a final standard with a single lessee accounting model, whereas the FASB has decided to have a dual lessee accounting model in their forthcoming standard – both however require assets and liabilities to be recognised (with limited exceptions)

Identifying a lease

A contract is, or contains, a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Control is conveyed where the customer has both the right to direct the identified asset’s use and to obtain substantially all the economic benefits from that use.

Overview of the new accounting model in IFRS 16

Under IFRS 16 a lessee recognises a right-of-use asset and a lease liability. The right-of-use asset is treated similarly to other non-financial assets and depreciated accordingly and the liability accrues interest. This will typically produce a front-loaded expense profile (whereas operating leases under IAS 17 would typically have had straight-line expenses) as an assumed linear depreciation of the right-of-use asset and the decreasing interest on the liability will lead to an overall decrease of expense over the reporting period.

The lease liability is initially measured at the present value of the lease payments payable over the lease term, discounted at the rate implicit in the lease if that can be readily determined. If that rate cannot be readily determined, the lessee shall use their incremental borrowing rate.

As with IFRS 16’s predecessor, IAS 17, lessors classify leases as operating or finance in nature. A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership of an underlying asset. Otherwise a lease is classified as an operating lease.

For finance leases a lessor recognises finance income over the lease term, based on a pattern reflecting a constant periodic rate of return on the net investment. A lessor recognises operating lease payments as income on a straight-line basis or, if more representative of the pattern in which benefit from use of the underlying asset is diminished, another systematic basis.

Recognition exemptions

Instead of applying the recognition requirements of IFRS 16 described above, a lessee may elect to account for lease payments as an expense on a straight-line basis over the lease term or another systematic basis for the following two types of leases:

• leases with a lease term of 12 months or less and containing no purchase options – this election is made by class of underlying asset; and
• leases where the underlying asset has a low value when new (such as personal computers or small items of office furniture) – this election can be made on a lease-by-lease basis.

Effective date

IFRS 16 is effective for annual reporting periods beginning on or after 1 January 2019 (subject to EU endorsement). Earlier application is permitted if IFRS 15 Revenue from Contracts with Customers has also been applied.

Additional information

IASB website

• Press release
• Project summary and feedback statement
• Fact sheet — IFRS 16 Leases
• Access to the standard, the illustrative examples, and the basis for conclusions on eIFRS (eIFRS subsription required)
• Effects analysis
  
• Interview with Hans Hoogervorst introducing the standard
• Recording of web presentation on the new standard

UK Accounting Plus

• Need to know newsletter summarising the new standard
• Overview of the project history
• Summary of IFRS 16 Leases
• Interview with Hans Hoogervorst and Veronica Poole
• The Bruce Column – Bringing clarity to leases: The new standard

Specifically, participants and a panel consisting of representatives from national standard-setters, the European Parliament, users of financial statements, the IASB, EFRAG, and academics discussed the IASB's proposed Conceptual Framework and the results of an academic study, sponsored by EFRAG and the ICAS, on professional investors’ financial information usage. The press release on the EFRAG's website offers a summary of the main observations and access to the full report.