Background

This was a new issue.

The IC received a request to clarify whether revenue from the sale of pre-completion residential units in a multi-unit condominium (‘off-plan sales’) should be recognised over time or at a point in time.

The submitter provided the following specific fact pattern which takes into account the common contractual terms and legislative framework applicable to the submitter’s jurisdiction regarding off-plan sales:

• a) The entity, being a real estate developer, and the customer enter into a contract for the sale and purchase of a real estate unit before the entity constructs the unit.
• b) On signing the contract, the entity is obliged to deliver the completed unit as specified in the contract—it cannot change or substitute the unit agreed to in the contract. The entity retains legal title to the unit (and any land attributed to it) until construction is complete.
• c) The customer generally pays 20%-30% of the purchase price of the unit as it is being constructed, and pays the remainder of the purchase price to the entity after construction is complete.
• d) The customer may resell or pledge the unit while it is being constructed. However, the customer cannot change the structural design of the unit or cancel the contract, except as noted in (f) below.
• e) If the entity is in breach of its obligations under the contract, the buyers of the units of the condominium have the right, as a group, to decide to remove the entity and hire another real estate developer to complete the construction of the property.
• f) Although the contract is irrevocable under local law, the courts have accepted requests to cancel a contract in specific circumstances, mainly when it has been proven that the customer is not financially able to fulfil the terms of the contract. In this situation, the customer can cancel the contract and is entitled to receive most, but not all, of the payments it has already made to the entity. The remainder is retained by the entity as a termination penalty. The entity may also auction off the unit if the customer defaults on payments.

Staff analysis

The Staff believed that revenue from the sale of off-plan units, based on specific fact pattern as described in the submission, should be recognised at a point in time because none of the IFRS 15.35 criteria for recognition of revenue over time is met. The Staff focused their analysis on the application of paragraphs 35(b) and 35(c) of IFRS 15.

Paragraph 35(b) specifies that to recognise revenue over time, the customer must control the asset as it is created or enhanced. Control refers to the ability to direct the use of, and obtain substantially all of the benefits from, the asset. The Staff observed that although the customer can resell or pledge the unit under construction and is exposed to market value changes of the unit, it does not have legal title to the unit, nor does it have any ability to direct the construction or structural design of the unit as the unit is being constructed. Furthermore, the customer’s legal right to replace the entity in the event of the entity’s failure to perform as promised is protective in nature and is not indicative of control.

Paragraph 35(c) specifies that to recognise revenue over time, the asset created by an entity’s performance must not have an alternative use to the entity and the entity must have an enforceable right to payment for performance completed to date. The Staff observed that in this case, even though the entity is contractually restricted from directing the partly constructed unit for another use, the entity does not have an enforceable right to payment for performance completed to date upon termination.

Staff recommendation

The Staff recommended that the IC not add this issue to its agenda on grounds that the requirements in IFRS 15 provide an adequate basis for an entity to determine whether to recognise revenue over time or at a point in time for the fact pattern described in the submission.

Letter from the Brazilian Securities and Futures Commission

The Brazilian SFC sent a letter to the IC commenting on the Staff analysis. The letter observed that the Staff analysis was based on an ‘inadequate understanding of the nature of the contract’ under review, which ‘distorts all the conclusions made’ in the Staff paper.

Discussion

The IC agreed with the Staff’s technical analysis and agreed not to add the issue onto its agenda. The few IC members who referred to the Brazilian SFC letter observed that it did not contain any additional points that would influence the technical analysis.

The IC members generally agreed on the following three points:

1. When assessing under IFRS 15.35(b) whether a customer controls an asset as it is being created, it is important to identify clearly what the asset under consideration is. In this case, the asset that the customer has while the apartment block is under construction is the sale and purchase contract, including the right to sell or pledge that contract, as opposed to the physical unit itself.
2. No single factor is determinative of the control assessment. In this case, the question about whether title of the land passes to the customer is powerful, but it is not in itself conclusive of whether control of the asset has passed to the customer. All relevant facts and circumstances should be considered with appropriate weights given to each.
3. When assessing under IFRS 15.35(c) whether the entity has a right to payment for performance completed to date, especially in the case of contract termination, one should focus on the existence of the right to terminate and not on the probability or frequency of that right’s being exercised. As long as the right to terminate is determined to be enforceable, if upon termination the entity would not be entitled to an amount that compensates it for work performed to date, then the contract fails the paragraph 35(c) criterion regardless of how infrequently the termination right has historically been, or is expected to be, exercised.

A lot of time was spent discussing how the tentative agenda decision (TAD) should be worded. It was agreed that the TAD should specify that the conclusion reached by the IC is based on a very specific fact pattern and that slight changes in contractual terms, the applicable laws and other facts and circumstances could lead to a different outcome. The TAD would also shift the focus from giving a conclusive response to setting out how the IFRS 15 guidance should be applied to the case at hand.

Background

This was a new issue.

The IC received a request to consider amending IAS 41 to remove the requirement of using pre-tax cash flows when measuring the fair value of a biological asset.

In 2008, the Board amended IAS 41 to remove the requirement to use a pre-tax discount rate when determining the fair value of a biological asset. However, the requirement to use pre-tax cash flows in paragraph 22 survived this amendment for no apparent reason. When IFRS 13 was issued in 2011, the Board consequentially amended IAS 41 to remove all the fair value measurement guidance except for paragraph 22, which contains specific requirements for the fair value measurement of biological assets.

The submitter noted that using pre-tax cash flows is inconsistent with the requirements of IFRS 13, which requires the fair value to be determined based on how a market participant would value the asset, which could be pre-tax or post-tax, depending on facts and circumstances and as long as the assumptions are internally consistent.

Staff analysis

Outreach conducted by the Staff indicated support for amending IAS 41 to fix this oversight.

Staff recommendation

The Staff recommended that the Board:

1. propose to amend IAS 41.22 to remove the requirement to use pre-tax cash flows when measuring the fair value of a biological asset; and
2. include this proposed amendment in its next annual improvements cycle.

Discussion

The IC approved the Staff recommendation without any significant discussion.

Background

This was a new issue.

The IC received a request to clarify how an entity accounts for a transaction in which it contributes property, plant and equipment (PPE) to a newly-formed associate in exchange for shares in that associate.

In the submission, three entities under common control set up an associate. The PPE contributed by the investors are not a business as defined, the contribution is considered to have commercial substance and the transaction is carried out at market terms.

The submitter asked three questions:

• a) whether IFRSs provide a general exemption from applying the requirements of a particular Standard to common control transactions;
• b) Do ‘unrelated investors’ in IAS 28.28 (which requires an investor to recognise gains and losses from upstream and downstream transactions only to the extent of unrelated investors’ interests in the associate) refer to:
  • (i) any investor other than the reporting entity, or
  • (ii) investors that do not meet the definition of a related party in IAS 24? and
• Should the investor determine the gain or loss on contributing PPE to the associate and the cost of its investment in the associate based on:
  • (i) the fair value of the PPE contributed, or
  • (ii) the fair value of the acquired interest in the associate?

Staff analysis

Question A

This question was discussed by the IC in its June 2017 meeting (see AP 8 to that meeting). At that meeting, the IC concluded that unless a Standard specifically excludes common control transactions from its scope, an entity applies the requirements in the relevant Standard to common control transactions. An entity should not apply the scope exception in IFRS 3.2(c) with regard to business combinations under common control by analogy to other common control transactions.

Question B

The Staff observed that the term ‘unrelated investors’ refers to investors other than the entity (including its consolidated subsidiaries). This is consistent with the requirements of SIC 3 Elimination of Unrealised Profits and Losses on Transactions with Associates, which was withdrawn in 2003 and had its requirements incorporated into IAS 28, principle unchanged, albeit reworded. In addition, this interpretation is consistent with the premise that financial statements are prepared from the perspective of the reporting entity, and not, for example, from the perspective of the parent of the reporting entity.

Question C

The Staff believed that in an arm’s length transaction, it would be relatively rare for the fair value of the PPE contributed to differ significantly from the fair value of acquired interest. If there is any initial indication of such a difference, the investor should understand the reason for the difference (e.g. whether other items have been exchanged as part of the transaction, in which case those other items should be accounted for applying the relevant Standards) and assess whether it has determined fair value appropriately, including any potential impairment of the PPE contributed or of the acquired interest.

Be that as it may, the Staff used a numerical example to illustrate how to account for the difference if it did exist. The net result of the example reflects a determination of the cost of the investment and the resulting gain/loss on the PPE contributed based on IAS 28.32. In other words, they are determined based on the higher of the fair value of the PPE given up (being the deemed purchase price of the investment) and the investor’s share of the fair value of the net assets of the associate. Both these ‘fair values’ have been determined after eliminating the investor’s share of the gain on contribution of PPE to the associate.

Staff recommendation

The Staff recommended that the IC not add this issue to its agenda on grounds that the requirements in the existing Standards provide an adequate basis for an entity to account for such transactions.

Discussion

The IC agreed with the Staff recommendation. There was no significant discussion on questions A and B.

On question C, the IC was generally comfortable with the outcome of the Staff analysis. The IC emphasised that it is important to understand the reason for any potential difference in fair value between the PPE given up and the associate acquired, and to reassess the fair values as appropriate. A few members observed that there is an inconsistency between IAS 16.71 on the calculation of the gain on disposal of PPE and IAS 28.32 on the determination of the cost of the investment in associate. IAS 16.71 requires the gain on disposal of PPE to be determined using the net proceeds on disposal (essentially the fair value of the associate acquired); whereas IAS 28.32 requires the investment in associate to be measured at cost (essentially the fair value of the PPE given up). Given the conflict in literature, the Staff’s analysis may not be the only appropriate solution. In determining the appropriate accounting treatment, the IC reiterate that an entity will have to apply judgement in determining which fair value is more reliable depending on facts and circumstances.

The IC also debated on how to draft the tentative agenda decision to include the points raised by the IC above.

Background

In May 2017, the IC discussed whether a financial instrument, classified as equity by the issuer in accordance with IAS 32.16A-16D, is eligible for FVTOCI classification in terms of IFRS 9.4.1.4. The IC concluded that it is clear from the requirements of IFRS 9 and IAS 32 that such financial instruments are financial liabilities and are not equity instruments as defined. Accordingly, they are not eligible for FVTOCI classification in terms of IFRS 9.4.1.4. The IC decided not to take the issue onto its agenda.

Staff analysis of comment letters received

Three comment letters were received in which all the respondents agreed with the IC’s decision. No significant comments were raised.

Staff recommendation

The Staff recommended that the IC finalise the agenda decision.

Discussion

The IC approved the Staff recommendation without discussion.

Background

In March 2017, the IC discussed whether it should add a project onto its agenda regarding how income tax-related interests and penalties should be accounted for. The research performed by the Staff then did not indicate widespread diversity in how such interests and penalties are accounted for, nor that it has a material effect on the amounts reported by entities. The IC concluded that it was not a high priority project and decided not to add this project onto its agenda.

Staff analysis on comment letters received

Five comment letters were received: three agreed with not adding the issue onto the IC’s agenda and two disagreed. Those who disagreed believed that the IC should address the diversity in practice. A few respondents also suggested that the IC provide guidance on assessing whether such an interest or penalty is an income tax that falls within the scope of IAS 12 (failing which such items would be accounted for under IAS 37), especially in instances when a single amount including tax, interest and/or penalty is agreed as a lump sum with the tax authorities and it is difficult to split them into the different components.

The Staff conducted further research and concluded that there was not sufficient evidence of a widespread diversity in practice, nor that the amounts recognised for these balances were material enough to warrant standard-setting activities. The Staff also noted that based on the feedback received from the 2015 Agenda Consultation, the Board decided not to add any project on IAS 12 onto its agenda (narrow-scope or a wider project) because it was not considered a high priority compared to other more pressing issues. The Staff also believed that adding any guidance on the assessment of whether such interests and penalties are income taxes would be beyond the scope of an agenda decision.

Staff recommendation

In light of the above, the Staff recommended that the IC not add a project onto its agenda regarding the accounting of income tax-related interests and penalties, and to finalise the agenda decision.

Discussion

The IC agreed to finalise the agenda decision, subject to following more pertinent drafting changes:

• To make an explicit statement that whether the interest or penalty is accounted for in accordance with IAS 12 or IAS 37 is not an accounting policy choice;
• To refer to previous agenda decisions on discussions of what is an income tax; and
• To clarify that the reference of this not being a high priority project is assessed in terms of the significance and pervasiveness of the matter to stakeholders, and not in terms of the availability of resources of the IC or the Board.

On the first point, one IC member noted that in the absence of any guidance on how an entity should assess whether a tax-related interest or penalty is an income tax, there would be no consistency in how such an assessment is made. This loophole could be exploited by entities as an accounting policy choice. However, the IC generally believed that the outcome of the assessment is highly dependent on local tax laws and that no generic guidance could capture the specific facts and circumstances of each case. The Staff also acknowledged that it is difficult to make this assessment and previous submissions have indicated the same problem.

Background

In March 2017, the IC discussed whether a subsidiary that becomes a first-time adopter of IFRS later than its parent may apply IFRS 1.D16 to recognise cumulative translation differences (CTD) at the amount that would be included in the parent’s consolidated financial statements, based on the parent’s date of transition to IFRS.

IFRS 1.D16 permits such a subsidiary to measure its assets and liabilities, but not components of equity, based on the parent’s date of transition to IFRS. Furthermore, IFRS 1.D18 prohibits an entity from applying any of the exemptions in IFRS 1 by analogy. Accordingly, the IC concluded that IFRS 1 provides an adequate basis for a first-time adopter to determine how to account for CTD and decided not to add the issue onto its agenda.

Staff analysis on comment letters received

Three of the four respondents agreed with the IC’s technical conclusion. However, all the respondents asked the Board to consider amending IFRS 1 to extend the exemption in paragraph D16 to CTD.

The Staff conducted some analysis and agreed that it would be relatively easy to propose a narrow-scope amendment to extend the exemption of paragraph D16 to CTD. Such an amendment would have little risk of unintended consequences, would be in line with the intention of the paragraph D16 exemption of not having to keep two sets of books, and would potentially benefit many first-time adopters. However, the Staff believed that any potential standard-setting activities should consider more than just CTD (i.e. they would need to consider other components of equity as well), which would be more complex than suggested by the respondents. On balance, the Staff believed that the benefits of an amendment to IFRS 1 would not justify the costs of developing it and thus did not recommend such an amendment.

Staff recommendation

The Staff recommended that the IC finalise the agenda decision.

Discussion

The IC agreed to finalise the agenda decision to confirm that the IFRS 1.D16 exemption cannot be applied to components of equity. However, they also agreed to perform additional research to help define the scope of a potential amendment to IFRS 1 in relation to this matter, i.e. whether it should be a narrow-scope amendment dealing with CTA only, or whether the scope should be broadened to cover all OCI, including a possibility of dealing only with OCI that will be subsequently recycled to profit or loss.

The IC members had mixed views about whether or not to amend IFRS 1 for the same reasons given by the Staff. The IC spent most of the session debating this issue.

Background

In June 2017, the IC discussed what costs an entity should consider when assessing whether a contract is onerous in terms of IAS 37. The IC concluded that there are two reasonable interpretations of what constitutes ‘unavoidable costs’:

• All costs that are necessary to complete a contract. This would include a share of costs that would have been incurred even without the contract, e.g. depreciation on assets used in other contracts and common overheads.
• Costs that an entity would not incur if it did not have the contract (often referred to as incremental costs).

The IC also concluded that it would not be wise to amend some of the requirements on onerous contracts (i.e. considering what constitutes unavoidable costs only) without conducting a comprehensive review of all of those requirements. However, that would be beyond the ambit of the IC and so it decided not to add the matter onto its agenda.

Feedback from comment letters received

Eleven comment letters were received, ten of which suggested standard-setting activities are necessary to clarify the onerous contract requirements in IAS 37.68 in order to reduce diversity in practice. Such diversity is expected to increase once IFRS 15 becomes effective as IFRS 15 requires an entity to apply IAS 37 when assessing whether a contract with a customer is onerous, including those that were previously assessed based on the requirements of IAS 11. Most of these respondents believe that a narrow-scope amendment to clarify what constitutes unavoidable costs could help achieve consistency in interpretation.

No significant comments were raised with regard to the two interpretations of unavoidable costs provided by the IC. Some respondents suggested other interpretations that they think were appropriate.

Staff analysis

For the reasons given by the IC in its June 2017 meeting, the Staff continued to believe that it would not be feasible to develop a narrow-scope amendment to IAS 37 with regard to unavoidable costs separately from a wider project on onerous contracts, or even on IAS 37 as a whole.

Staff recommendation

The Staff recommended that the IC:

• finalise the agenda decision subject to drafting changes, and
• ask the Board to consider adding a narrow-scope research project on onerous contracts to its work plan.

Discussion

The IC did not vote on this paper but decided not to finalise the agenda decision. Instead, in light of the feedback received, the IC has asked the Staff to research into the possible scope of a project on onerous contracts for discussion at a future meeting. The Staff will notify the Board of this decision and will update them on the progress of the project to make sure it ties in with the Board’s wider project plan on IAS 37 that is in the research pipeline. The Staff will also consider the possibility of producing educational material regarding what is meant by ‘unavoidable costs’ in the meantime.

Most of the IC members saw the need for standard-setting given the feedback received. In addition to undertaking further research, a few members were in favour of finalising the agenda decision in order to limit the diversity in practice to the two views in the tentative agenda decision. They acknowledged that although this may not the best solution, it is better than having no guidance at all. However, some other members were concerned that such a limitation may have unintended consequences given that they had not considered the other possible interpretations raised by the respondents in their comment letters.

One IC member suggested limiting the scope of the project to contracts within the scope of IFRS 15 (particularly those onerous contracts that are currently accounted for under IAS 11) because this would have the least disturbance on onerous contracts that are already accounted for under IAS 37. The other IC members did not support this idea because they thought that any analysis on onerous contracts would inevitably touch on areas beyond IFRS 15. Also, it is too late to try to fix IFRS 15 issues now with implementation only a few months away.

Background

In June 2017, the IC discussed how an entity accounts for goods (e.g. watches, fridges, cars) that it purchases for onward distribution to potential customers for promotional purposes. The IC concluded that an entity should recognise the promotional goods acquired as an expense when it has a right to access the goods, regardless of when it distributes the goods. The IC believed that the requirements of IAS 38 are clear in this regard and decided not to add this issue onto its agenda.

Feedback from comment letters received

Six comment letters were received. Two respondents disagreed with the IC’s technical conclusion. The other respondents did not raise any significant comments.

The respondents who disagreed with the IC’s technical analysis argued that the promotional goods under consideration have significant tangible value and can be legitimately used for other purposes. IAS 38.4 requires an entity to assess whether the tangible or intangible aspect of an item is more significant when determining whether the item is within the scope of IAS 38. In this case, the tangible value of the goods may be argued to be more significant than the intangible value of the goods (i.e. the car, fridge or watch is able to function as such without losing any of its inherent value even without the entity’s branding). This indicates that the goods are not within the scope of IAS 38. These respondents believe that a more appropriate assessment would be whether there is an alternative means (other than for promotional purposes) by which value could be generated from the goods. If so, the goods should be accounted for under the relevant Standard.

Staff analysis

The Staff pointed out that in the submission, the goods are used solely for promotional purposes. Accordingly, the costs incurred are an ‘expenditure on advertising’ which is specifically included within the scope of IAS 38 (IAS 38.5). The Staff believed that an entity should not consider the significance of the tangible versus intangible elements (IAS 38.4) when it has been determined that an expenditure is incurred for advertising or promotional purposes.

Furthermore, the Staff believed that IAS 38.BC46B to BC46C clearly require that an entity consider the purpose for which it has acquired the goods. If an entity acquires the goods solely for promotional purposes, the entity should not recognise an asset simply because it could derive benefits from other potential uses.

In light of the above, the Staff continued to agree with the IC’s technical conclusion.

Staff recommendation

The Staff recommended that the IC finalise the agenda decision subject to drafting changes.

Discussion

The IC agreed to finalise the agenda decision.

Two IC members disagreed with the technical conclusion for the same reasons given by the dissenting respondents set out above and those given in the June 2017 IC meeting. However, all other eleven IC members concurred with the Staff’s analysis and believed that the intention of the entity to use the goods for promotional purposes is of paramount importance and that intention trumps the physical attributes or functionality of the goods. They also noted that the revised agenda decision has added the word ‘solely’ in its explanation: ‘if an entity acquires the goods solely for promotional purposes’, it is clear that those goods have no other purpose than to undertake those activities and so they fall squarely within the scope of IAS 38.BC46B.

Nonetheless, the two members who objected were unconvinced on grounds that IAS 38.BC5 indicates that the intention with which management holds an asset is not relevant to its classification as an intangible asset. Furthermore, intention is not the same as commitment. Given that there is no commitment to distribute the goods for promotional purposes and management’s intention can change subsequently for valid reasons, it is not appropriate to expense the goods at the outset. One of the IC members also questioned whether it would be appropriate for an entity to expense its own inventories as soon as a decision is taken to distribute those stock for promotional purposes, instead of waiting till the actual distribution. No one responded.

Background

In June 2017, the IC discussed how an entity accounts for the acquisition of an interest in an associate or joint venture from an entity under common control. The IC concluded that an entity applies IAS 28 to such transactions and should not apply the BCUCC scope exception in IFRS 3 by analogy. The IC believed that the scope of IAS 28 is clear in this regard and decided not to add this matter onto its agenda.

Staff analysis of comment letters received

Eleven comment letters were received and the responses were mixed: five agreed with the IC, five disagreed and one had mixed views.

Those who disagreed with the IC’s technical conclusion noted that it is inconsistent with the agenda decision published in May 2013 on the same issue, which explicitly acknowledged a lack of clarity in how to account for such transactions. They questioned what led the IC to change their view from 2013. In response, the Staff did not believe that there is any inconsistency between the two agenda decisions. They observed that the 2013 agenda decision did not provide any technical conclusion on the matter and merely set out the basis for diversity in practice.

Some respondents repeated some of the issues already considered by the IC in their June 2017 meeting without any new arguments. The Staff continued to agree with the IC’s decision on those issues.

More than half of the respondents also disagreed that the cost of the investment in an associate or joint venture should always be adjusted for the effects of a transaction with owners. The Staff acknowledged their concern and recommended removing that reference.

The Staff rejected suggestions of postponing the finalisation of the agenda decision until completion of the BCUCC project as that would unnecessarily perpetuate the diversity in practice.

Staff recommendation

The Staff recommended that the IC finalise the agenda decision subject to drafting changes.

Discussion

The IC did not vote on this paper. The Chair of the IC will report back to the Board and discuss the potential next steps with them.

There was significant re-debate of this issue. Some members were happy to finalise the agenda decision while others disagreed with the technical conclusion reached in the tentative agenda decision. Both sides re-iterated the comments made in the previous meeting (see June 2017 agenda paper 8). Those who disagreed believed that IAS 28.26 could reasonably be read to mean that the IFRS 3 BCUCC exemption applies to an associate acquired under common control. In addition, these IC members believed that it is not intuitive to have an exemption for subsidiaries but not for associates when an entity controls a subsidiary (and have all the fair value information at hand on the date of acquisition) but not an associate. Furthermore, they believed that finalising the agenda decision would lead to significant operational and practical issues for entities that have previously applied predecessor accounting to account for associates acquired under common control. This is because these entities would have to go back to all such transactions, perhaps many years ago, and apply fair value accounting. The availability of information and the use of hindsight are just some of the potential practical issues resulting from such a change. Without any transition provisions, using an agenda decision to conclude on this matter is simply not workable.

The Chair of the IC and the Staff had wanted to finalise the agenda decision because they believed that it was clear that IAS 28 applies to such a transaction (which was supported by a majority of the IC members in the June 2017 meeting). This was also in response to criticisms that the IC had tended to postpone finalising agenda decisions pending the outcome of the Board’s research projects, thus not reigning in diversity in practice in a timely manner. However, they conceded to the dissenting opinions and decided to hold back on finalising the agenda decision.

The Staff will present their analysis on the feedback received on the following tentative agenda decision at a future meeting:

• IFRS 3 Business Combinations—Acquisition of a group of assets that does not constitute a business

The Staff are currently in the process of analysing the following matter:

• IFRS 9: Dual currency bonds – whether a dual currency bond meets the solely payments of principal and interest condition in IFRS 9

Discussion

There was no discussion on this paper.