The proposed Framework is split into four sections:

1. Identification of the purpose and scope.
2. Explanation of concepts in the IESs.
3. Description of the nature of the IESs and related IAESB publications.
4. Role of IFAC members related to the IESs.

The proposal is part of the IAESB’s initiative to improve the relevancy, clarity, and consistency of its standards by redrafting all eight IESs in accordance with its new drafting conventions. To date, IESs 1 to 6, as well as the redrafting of IES 7, have been completed. The IES 8 revision is expected in the fourth quarter of 2014.

Comments are requested by 27 October 2014.

For more information, see the press release and the revised framework on the IFAC’s website.

Both companies (16) and institutional investors (19) took part in the project.  Further input was received from “over 200” retail investors. 

The project report; ‘Accounting policies and integration of related financial information’ is part of the Financial Reporting Council’s (FRC’s) programme  of work to support clear and concise reporting; a project which began with the publication of ‘Guidance on the Strategic Report’, in June 2014.

The project report provides a number of observations in the areas of accounting policies, notes to the financial statements and integration of financial review:

Accounting policies

The project report highlights a number of “clear messages” for companies in relation to improving the placement of significant accounting policies and enhancing the quality of their disclosures.  It highlights that institutional investors “consider that policies that are not significant are clutter” and were more concerned with the quality of disclosures rather than their placement. 

The project report notes that investors are “generally happy” for companies to make their own judgements as to what their significant accounting policies are.  However investors identified a number of attributes that, if taken alone or together, may indicate that a significant accounting policy would need to be disclosed:

materiality of transactions classes and amounts, and importance to the nature of the business;

policies for all distinct revenue streams;

where there is choice of policy under IFRS, or significant judgement in selecting the policy; and

where there is need for management to apply significant levels of estimation or judgement in applying the policy. 

The project report also identifies what “good quality” looks like for investors in relation to policy disclosures and highlights that “accounting policy disclosure should be company-specific” and avoid “boiler-plate” disclosures.

Investors identified that policies should:

be written using plain, understandable language;

describe any judgements made in selecting the policy applied, and the rationale for them;

describe the company’s application of accounting policies (not summarise the IFRS standard), including the estimation/judgements made and their significance to reported amounts; and

describe new IFRS requirements only if they significantly, or are likely to significantly, impact the financial statements; and present the impact of changes in tabular format.

Many companies currently disclose additional accounting policies (beyond those that are significant) and the project report indicates that there are “diverse views” among investors with “some” retail investors preferring a complete list of policies to be disclosed in the annual report and others, such as institutional investors, preferring that only significant accounting policies are disclosed.

Notes to the financial statements

The project report highlights that, among other things, consistency of note order across companies and time is “highly valued” by investors.  

Integration of financial review

The project report indicates that most investors “prefer the traditional approach of placing management commentary and financial statement information in separate sections of the annual report”.

A number of examples are provided in the project report of current good practice in these areas.

The press release and the full project report are available from the FRC website. A slide deck summarising the key findings of the report is also available to download from the FRC website.

In both cases, the EFRAG supports the adoption of the amendments and recommends that the European Commission endorses the amendments because it believes implementation that the benefits for preparers and users implementing the amendments outweigh the costs.

Concurrently, EFRAG has updated its report showing the status of endorsement to reflect the final EFRAG endorsement advices.

Click for the following information on the EFRAG website:

Current status

The revised time table for the major projects is now as follows:

Click for the IASB work plan dated 24 July 2014 (link to IASB website). We have updated our project pages to reflect the updated work plan and other known developments.

In October 2013, the Competition Commission (the predecessor of the CMA) announced a final package of remedies to increase competition within the provision of statutory audit services to FTSE 350 companies in the UK.  Among other things, the proposals required that all FTSE 350 companies put their statutory audit engagement out to tender at least every ten years. 

Subsequent to the release of the Competition Commission proposals members of the Council of Ministers adopted a new framework for EU audit reform in the form of a Directive amending the Statutory Audit Directive (Directive 2006/43/EC) (link to Europa website) and a Regulation on specific requirements regarding the statutory audit of public-interest entities (PIEs).  

In light of the EU rules, which the UK must adopt by 2016, the Competition Commission announced that it would review its draft Orders to consider the implications that the EU legislation would have.

The draft Order ‘The Statutory Audit Services for Large Companies Market Investigation (Mandatory use of competitive tender processes and Audit Committee responsibilities) Order 2014’ (“the draft Order”), published for consultation today, seeks to put into force some of the changes proposed by the Competition Commission including requiring that FTSE 350 companies put their statutory audit out to tender at least every ten years.  The draft Order proposes that if a FTSE 350 company has not retendered within five years, the Audit Committee must, in the Audit Committee Report covering the fifth financial year, state the financial year in which it intends to complete a competitive tender process and why this period is in the best interests of the members.  This process must be repeated in consecutive years until retendering is required in the tenth year.  The draft Order also implements measures designed to strengthen the influence of the company’s Audit Committee over the provision of audit services.

The CMA has announced that they do not plan to make an order implementing the Competition Commission’s original proposal regarding auditor clauses in loan arrangements.  EU legislation will, from 17 June 2017, prohibit the use of restrictive clauses in contracts which limit a company’s choice of auditor “in order to promote market diversity” and the CMA considers that the EU measures “are more extensive than its proposed remedy…..and therefore sufficiently address concerns identified in its report in this regard”.

In its Plan and Budget, the Financial Reporting Council (FRC) announced that it would address the consequences of the Competition Commission’s other proposed remedies including introduction of a programme to review FTSE 350 audits on average every five years, increased reporting of the work of the Audit Quality Review, and a change to the UK Corporate Governance Code to require an advisory vote on the Audit Committee Report.

Comments on the draft Order are invited in writing until 24 August 2014.

Click for:

• Press release (link to CMA website).
• Draft Order (link to CMA website).
• Notice of intention to make the Order (link to CMA website).
• Explanatory note accompanying the draft Order and Notice (link to CMA website).
• Our previous UK Accounting Plus news item on EU audit reform
• Governance in brief publication

The Standard supersedes all previous versions of IFRS 9 and is effective for periods beginning on or after 1 January 2018. The updated report does not indicate when a final endorsement of the standard can be expected.

The endorsement status report, dated 24 July 2014, is available here.

Background

The IASB has had the project to replace IAS 39 on its active agenda since 2008 and has undertaken the project in phases. The IASB first issued IFRS 9 in 2009 with a new classification and measurement model for financial assets followed by requirements for financial liabilities and derecognition added in 2010. Subsequently, IFRS 9 was amended in 2013 to add the new general hedge accounting requirements.

This final version of IFRS 9 adds a new expected loss impairment model and amends the classification and measurement model for financial assets by adding a new fair value through other comprehensive income (FVTOCI) category for certain debt instruments and additional guidance on how to apply the business model and contractual cash flow characteristics test.

Summary of key requirements

Expected loss impairment model

The impairment model in IFRS 9 is based on the concept of providing for expected losses at inception of a contract, except in the case of purchased or originated credit-impaired financial assets, where expected credit losses are incorporated into the effective interest rate.

Scope

The impairment requirements of IFRS 9 apply to:

• Financial assets measured at amortised cost;
• Financial assets mandatorily measured at FVTOCI (see below);
• Loan commitments when there is a present obligation to extend credit (except where these are measured at FVTPL);
• Financial guarantee contracts to which IFRS 9 is applied (except those measured at FVTPL);
• Lease receivables within the scope of IAS 17 Leases; and
• Contract assets within the scope of IFRS 15 Revenue from Contracts with Customers (i.e. rights to consideration following transfer of goods or services).

General Approach

With the exception of purchased or originated credit impaired financial assets (see below), expected credit losses are required to be measured through a loss allowance at an amount equal to:

• the 12-month expected credit losses (expected credit losses that result from those default events on the financial instrument that are possible within 12 months after the reporting date); or
• full lifetime expected credit losses (expected credit losses that result from all possible default events over the life of the financial instrument).

A loss allowance for full lifetime expected credit losses is required for a financial instrument if the credit risk of that financial instrument has increased significantly since initial recognition, as well as to contract assets or trade receivables that do not constitute a financing transaction in accordance with IFRS 15.

Additionally, entities can elect an accounting policy to recognise full lifetime expected losses for all contract assets and/or all trade receivables that do constitute a financing transaction in accordance with IFRS 15. The same election is also separately permitted for lease receivables.

For all other financial instruments, expected credit losses are measured at an amount equal to the 12-month expected credit losses.

Significant increase in credit risk

With the exception of purchased or originated credit-impaired financial assets (see below), the loss allowance for financial instruments is measured at an amount equal to lifetime expected losses if the credit risk of a financial instrument has increased significantly since initial recognition, unless the credit risk of the financial instrument is low (e.g. investment grade) at the reporting date in which case it can be assumed that credit risk on the financial instrument has not increased significantly since initial recognition.

The assessment of whether there has been a significant increase in credit risk is based on an increase in the probability of a default occurring since initial recognition.

The requirements also contain a rebuttable presumption that the credit risk has increased significantly when contractual payments are more than 30 days past due. IFRS 9 also requires that (other than for purchased or originated credit impaired financial instruments) if a significant increase in credit risk that had taken place since initial recognition and has reversed by a subsequent reporting period (i.e., cumulatively credit risk is not significantly higher than at initial recognition) then the expected credit losses on the financial instrument revert to being measured based on an amount equal to the 12-month expected credit losses. [IFRS 9 paragraph 5.5.11]

Purchased or originated credit-impaired financial assets

Purchased or originated credit-impaired financial assets are treated differently because the asset is credit-impaired at initial recognition. For these assets, the estimated cash flows used to calculate the (credit-adjusted) effective interest rate at initial recognition incorporate lifetime expected credit losses. Subsequently, any changes in expected losses are recognised as a loss allowance with a corresponding gain or loss recognised in profit or loss.

Credit-impaired financial asset

Under IFRS 9, a "financial asset is credit-impaired when one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include[s] observable data about the following events:

(a) significant financial difficulty of the issuer or the borrower;

(b) a breach of contract, such as a default or past due event;

(c) the lender(s) of the borrower, for economic or contractual reasons relating to the borrower’s financial difficulty, having granted to the borrower a concession(s) that the lender(s) would not otherwise consider;

(d) it is becoming probable that the borrower will enter bankruptcy or other financial reorganisation;

(e) the disappearance of an active market for that financial asset because of financial difficulties; or

(f) the purchase or origination of a financial asset at a deep discount that reflects the incurred credit losses.”

Basis for estimating expected credit losses

Any measurement of expected credit losses under IFRS 9 shall reflect an unbiased and probability-weighted amount that is determined by evaluating the range of possible outcomes as well as incorporating the time value of money. Also, the entity should consider reasonable and supportable information about past events, current conditions and reasonable and supportable forecasts of future economic conditions when measuring expected credit losses.

To reflect time value, expected losses should be discounted to the reporting date using the effective interest rate of the asset (or an approximation thereof) that was determined at initial recognition. A “credit-adjusted effective interest” rate should be used for expected credit losses of purchased or originated credit-impaired financial assets.  In contrast to the “effective interest rate” (calculated using expected cash flows that ignore expected credit losses), the credit-adjusted effective interest rate reflects expected credit losses of the financial asset.

Presentation

Whilst interest revenue is always required to be presented as a separate line item, it is calculated differently according to the status of the asset with regard to credit impairment. In the case of a financial asset that is not a purchased or originated credit-impaired financial asset and for which there is no objective evidence of impairment at the reporting date, interest revenue is calculated by applying the effective interest rate method to the gross carrying amount.

In the case of a financial asset that is not a purchased or originated credit-impaired financial asset but subsequently has become credit-impaired, interest revenue is calculated by applying the effective interest rate to the amortised cost balance, which comprises the gross carrying amount adjusted for any loss allowance.

In the case of purchased or originated credit-impaired financial assets, interest revenue is always recognised by applying the credit-adjusted effective interest rate to the amortised cost carrying amount.

Limited amendments to classification and measurement of financial assets

Fair value through other comprehensive income (FVTOCI) category

The final version of IFRS 9 introduces a new classification and measurement category of FVTOCI for debt instruments that meet the following two conditions:

• Business model test: The financial asset is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets.
• Cash flow characteristics test: The contractual terms of the financial asset give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding.

When an asset meets both of these conditions it is required to be measured at FVTOCI unless, on initial recognition, it is designated at fair value through profit or loss to address an accounting mismatch.

For such assets, interest revenue, foreign exchange gains and losses and impairment gains and losses are recognised in profit or loss with other gains or losses (i.e., the difference between those items and the total change in fair value) recognised in other comprehensive income (OCI). Any cumulative gain or loss recorded in OCI would be reclassified to profit and loss on derecognition or dealt with in accordance with specific guidance in the case of reclassifications.

Interest income and impairment gains and losses are recognised and measured in the same manner as for assets measured at amortised cost such that the amounts in OCI represents the difference between the amortised cost value and fair value. This results in the same information in profit of loss as if the asset was measured at amortised cost, yet the statement of financial position reflects the instrument’s fair value.

Additional guidance

The final Standard also adds guidance on how to determine whether financial assets are held under a business model that is ‘hold to collect’ or ‘hold to collect and sell’ with examples and explanations of the types and levels of sales that are acceptable for such business models.

In addition to guidance on the business model test, the Standard adds guidance on the contractual cash flow characteristics test to clarify that in basic lending arrangements the most significant elements of interest are consideration for the time value of money and credit risk. If the time value of money element is modified (e.g. interest rate resets every month to a one-year rate), an entity is required to assess the modified element against new criteria introduced by the amendment.

The application guidance also introduces an additional exception that allows certain additional prepayment features to meet the contractual cash flow characteristics requirements to qualify for amortised cost or FVTOCI measurement.

Effective date

The Standard has a mandatory effective date for annual periods beginning on or after 1 January 2018, with earlier application permitted (subject to local endorsement requirements). The Standard is applied retrospectively with some exceptions (for example most of the hedge accounting requirements apply prospectively) but entities need not restate prior periods in relation to classification and measurement (including impairment).

The final version of IFRS 9 supersedes all previous versions of the Standard. However, for annual periods beginning before 1 January 2018, an entity may elect to apply those earlier versions of IFRS 9 if the entity’s relevant date of initial application is before 1 February 2015.

Additional information

IASB website

• Press release
• Project Summary
• Investor Perspective: IFRS 9: A Complete Package for Investors

IAS Plus

• Robert Bruce interviews:
  • IFRS 9 'Financial Instruments' (overview)
  • Impact of IFRS 9 on the banking industry
• Need to know - IASB finalises IFRS 9 which changes the classifcation and measurement of financial assets and introduces an expected loss impairment model
• Overview of the project history
• Summary of IFRS 9 Financial Instruments

In November the government expressed their support for the removal of mandatory quarterly reporting requirements which were one of the recommendations of Professor Kay in his review of the UK Equity market in 2012 (the “Kay Review”) (link to BIS website).  The Kay Review sought to address the issue of short-termism in the equity market.  

The removal of mandatory quarterly reporting has been agreed at a European Union level as part of the amendments to the Transparency Directive and must be transposed into UK law by November 2015.  However, as part of the government’s autumn statement, they announced that they would bring forward this change in advance of the November 2015 deadline and adopted enabling secondary legislation in June 2014 allowing the FCA to implement this change.

The FCA proposes to:

• Remove the requirements in DTR 4.3 completely
• Remove DTR 4.4.6R and DTR 6.3.5R(3)(C) which will become obsolete
• Consequential amendments to others rules in the DTR that refer to interim management statements.

Comments are invited in writing until 4 September 2014.

Click for:

• Press release (link to FCA website).
• Full consultation paper ‘CP14/12: Removing the Transparency Directive’s requirement to publish interim management statements’ (link to FRC website).
• UK Accounting Plus news item on the government proposals.