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.

The IASB issued the amendments to IAS 16 Property, Plant and Equipment and IAS 41 Agriculture on 30 June 2014. They are effective for annual periods beginning on or after 1 January 2016, with earlier application being permitted.

The updated report indicates that final endorsement of the amendments is currently expected in Q1 2015.

The endorsement status report, dated 23 July 2014, is available here.

The amendments follow consultation on the proposals set out in both Financial Reporting Exposure Draft (FRED) 51 Draft amendments to FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland: Hedge Accounting and FRED 54 Draft amendments to FRS 102 – Basic financial instruments. 

Basic financial instruments 

Under FRS 102, a debt instrument must be regarded as ‘basic’ in order for it to be measured at amortised cost. The amendments revise the criteria that determine whether a debt instrument is ‘basic’ and is intended to reduce the need for entities to measure debt instruments at fair value. 

The amendments permit amortised cost measurement for a broader range of debt instruments where it adequately captures the risk associated with those financial instruments. 

Examples illustrating the application of the revised requirements are included within the amendments.  In particular, under the revised FRS 102 some inflation-linked debt instruments, which would not have met previously the definition of basic financial instruments under FRS 102, would now be classified as basic.  

Hedge Accounting 

Under FRS 102, derivatives such as interest rate swaps, forward contracts and option contracts would not be ‘basic’ financial instruments and would be measured at fair value through profit and loss (FVPL). Hedge accounting allows the matching of gains or losses on those instruments with the recognition of losses or gains on items hedged.   

The amendments replace the restrictive hedge accounting requirements previously in FRS 102 with a set of hedge accounting principles based on the IFRS 9 Financial Instruments hedge accounting model.  As a result of the amendments, there will be more opportunities for entities to apply hedge accounting. 

In addition to broadening the eligibility criteria, the amendments also remove the requirement that an entity must expect the hedging instrument to be highly effective in offsetting the hedged risk in order to apply hedge accounting.  Instead the amendments require there to be “an economic relationship between the hedged item and the hedging instrument”. 

These are the final amendments to FRS 102 for financial instruments before its mandatory effective date (1 January 2015), enabling FRS 102 reporters to make an informed decision about which recognition and measurement rules to apply (i.e. those of Sections 11 and 12, IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9). 

The amendments include flexible transition provisions allowing retrospective designation of hedge relationships irrespective of which recognition and measurement rules are applied.

Alongside the amendments the FRC has also issued an Impact Assessment and Feedback Statement that summarises the feedback received in relation to FRED 51 and FRED 54.

Click for:

• Press release (link to FRC website.
• Amendments to FRS 102 Basic financial instruments and Hedge accounting (link to FRC website).
• Impact Assessment and Feedback Statement - Amendments to FRS 102: The Financial Reporting Standard applicable in the UK and Republic of Ireland (link to FRC website).
• UK Accounting Plus news item on FRED 51.
• UK Accounting Plus news item on FRED 54.
• UK Accounting Plus project page on FRED 51.
• UK Accounting Plus project page on FRED 54.
• 'Need to know' publication on the amendments

FRS 101 was originally published in November 2012 as part of the FRC's project to replace current UK GAAP with a new suite of standards, which also includes FRS 100 Application of Financial Reporting Requirements, FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland and FRS 103 Insurance Contracts.

FRS 101 was published in recognition of the fact that many UK groups prepare their consolidated financial statements in accordance with IFRSs rather than UK GAAP. For subsidiary entities, application of IFRSs is attractive because it would produce numbers consistent with those used to prepare the group accounts. However, many companies are put off using IFRSs for their subsidiaries by the extensive disclosure requirements.  In recognition of this, the FRC identified a number of disclosures that were, in their view, of limited usefulness in a set of subsidiary accounts. FRS 101 allows entities, in their entity only accounts, to apply the recognition and measurement requirements of IFRSs but take advantage of exemptions from these disclosures.

When FRS 101 was originally published, the FRC committed to review the standard on an annual basis and update it to ensure that it maintains consistency with IFRS and remains cost-effective for groups. The amendments published today represent the first of these annual updates.

The amendments to FRS 101 and its appendices, which follow consultation on the Exposure Draft FRED 53:

• simplify the new disclosure requirements of IAS 36 Impairment of Assets in relation to fair value measurements used in impairment reviews; and
• clarify how entities applying FRS 101 can adopt the new international accounting practice for investment entities (set out in IFRS 10 Investment Entities and its consequential amendments to IAS 27 Separate Financial Statements), whilst still complying with legal requirements.

A number of editorial amendments have also been made to clarify the legal requirements applicable to companies applying FRS 101 that hold financial instruments at fair value subject to paragraph 36(4) of Schedule 1 to the Regulations.

The amendments would have the same effective date as the existing standard i.e. periods commencing on or after 1 January 2015.

Alongside the amendments the FRC has also issued an Impact Assessment and Feedback Statement that summarises the feedback received in relation to FRED 53.

Click for:

• Press release (link to FRC website).
• Amendments to FRS 101 Reduced Disclosure Framework (2013/14 cycle) (link to FRC website).
• Impact Assessment and Feedback Statement: Amendments to FRS 101 Reduced Disclosure Framework (2013/14 cycle) (link to FRC website).
• UK Accounting Plus news item on the Exposure Draft of amendments to FRS 101 – FRED 53.
• UK Accounting Plus project page on FRED 53.

The amendments to IAS 16 and IAS 41, issued by the International Accounting Standards Board (IASB) on 30 June 2014 bring bearer plants, which no longer undergo significant biological transformation, into the scope of IAS 16 so that they are accounted for in the same way as property, plant and equipment.  The amendments also clarify that produce growing on bearer plants continues to be accounted for under IAS 41 and that government grants related to bearer plants no longer fall into the scope of IAS 41 but need to be accounted for under IAS 20 Accounting for Government Grants and Disclosure of Government Assistance.  The amendments are effective for annual periods beginning on or after 1 January 2016, with earlier application being permitted.

EFRAG supports the adoption of the amendments to IAS 16 and IAS 41 and recommends their endorsement.  EFRAG’s initial assessment is that the amendments to IAS 16 and IAS 41 meet the technical requirements of the Regulation (EC) No 1606/2002 of the European Parliament and of the Council on the application of international accounting standards.     

EFRAG’s conclusion is supported by an Effects Study Report which considers the costs and benefits of implementing the amendments to IAS 16 and IAS 41. EFRAG’s assessment is that the benefits for preparers and users in implementing the amendments to IAS 16 and IAS 41 outweigh the costs.

Comments are requested by 5 September 2014. 

Click for (all links to EFRAG website):

• Press release
• Draft endorsement advice and effects study report