Accounting News Deloitte Czech Republic. January 2017

Transcription

1 Accounting News Deloitte Czech Republic January 2017

2 (No) Change in the Valuation of Inventory? 2 9 endorsed for use in the EU Updated guidance on the topic We bring you a summary of the amendment to the accounting legislation regarding the valuation of internally produced inventory and its practical impacts The amendment to accounting legislation that has been effective since 1 January 2016 has brought, aside from the categorisation of reporting entities and groups of reporting entities, changes in the structure of statements, disclosure requirements and other news that have already been discussed, changes in the definition of own costs for the purposes of valuation of internally produced inventory. This article will outline the effects of this change in relation to other legislative changes, whether it is actually a change at all and if so, which reporting entities it will impact. We will also have a look at how the change in valuation methodology should be reflected in the financial statements for 2016, including the impact on the comparative period. 01 First of all, it is necessary to mention that the definition of the purpose of keeping the accounting records, which now emphasises the user: Entities are obliged to keep their accounting records so that the financial statements are prepared on their basis in a comprehensible manner and give a true and fair view of the entity s assets, liabilities and financial position to ensure that the user of this information could make economic decisions on its basis. The definition of material information has also been made more precise, again emphasising the user: Information is treated as material if it can be assumed that the failure to present it or its incorrect statement may impact the judgement of the user, and the materiality of individual information is assessed in relation to other similar information. The new definition of own costs of inventory (from the Act on Accounting) reads as follows: Own costs of internally produced inventory include direct costs incurred for the production or other activities, or allocable indirect costs that relate to the production or other activities; direct costs include the cost of material and other consumed products or other expenses that arise in direct relation to the production or other activities. And the regulation adds: Own costs include direct costs and can also include a proportionate part of variable and fixed indirect costs, causally allocable to a particular production task and related to the period

3 3 9 endorsed for use in the EU of activity ; The entity will select the valuation method with respect to the obligations set by the law, especially the principle of materiality and the true and fair view of assets. Sources close to the policy makers indicate that the reason for the change in the definition is the attempt to limit the opportunity for selecting the valuation level as offered by the previous regulation; as a secondary positive effect, the change also brings the legislation closer to international standards for inventory measurement, e.g. IAS 2. In order to assess these reasons, let us review the previous definitions (until the end of 2015). As for the definition from the Act on Accounting, we can see that the provision valid since 2016 renders the allocation of direct costs more precisely: Own costs of inventory include direct costs incurred for the production or other activities, or part of indirect costs that relates to production or other activities. The definition valid until 2015 was more complicated depending of the nature of the production, and it can be neatly summarised in the following text and table: Own costs include either the actual amount of costs, or the amount of costs based on the method of production calculation set by the reporting entity. Updated guidance on the topic In addition, the regulation stated: Reporting entities can use a different method to value internally produced inventory such as work in progress, finished and semi-finished products Work in progress Finished or semi-finished products in production with a short-term non-stop cycle only direct material costs direct material and payroll costs in mass and large-scale serial production in small-scale serial, piece or custom production and in production with a long-term cycle only direct costs, which include costs of direct material, semi-finished products, direct wages and other direct costs direct costs, production overheads and, if the production cycle is longer than 12 months, in exceptional cases also administrative overheads

4 4 9 endorsed for use in the EU Updated guidance on the topic 02 It is time to remember the categories of direct and indirect costs from management accounting and their relation to the production volume (variable, fixed). Aside from that, costs can also be viewed in relation to the production unit and divided into unit and overhead costs. Direct costs include costs that are directly related to a specific type of production task but they do not always have to be proportional to the production volume. They can for example include basic material, the work of a production worker on a specific task including social security and health insurance contributions, depreciation of specialised equipment for this production task, subcontract cooperation on a particular task etc. On the other hand, indirect costs are not related to a particular type of production task and ensure the running of the business process in a wider context. Indirect costs are usually divided among the individual production types (and units) using suitable methods. They would, for example, include costs common for several production tasks, e.g. the salary of the production director including contributions, production maintenance costs, depreciation of multipurpose equipment common for several production lines (conveyors before and after a particular production line), costs related to warehouse overheads for material, etc. If it makes sense i.e. taking into account the significance and practicality of managerial decisions such costs can be allocated to the individual production types using suitable techniques, including the use of activity-based management. 03 If we have a look at the traditional calculation formula and its individual items, we will notice a difference more or less only starting from the level of indirect production overheads and administrative overheads. Especially for production overheads, it will be necessary to consider whether the allocation to production tasks and therefore the inclusion in valuation will improve the view of inventory valuation. Let us imagine a situation of a production company for example in the automotive industry, i.e. usually the just in time regime (according to the previous definition, it would probably be a mass and large-scale serial production) in this case, it would probably not make sense to allocate common indirect production costs to the individual production tasks. The current valuation methodology will therefore continue to apply.

5 5 9 endorsed for use in the EU Updated guidance on the topic The legislation no longer allows for the inclusion of administrative overheads in inventory valuation. In practice, the impact of (non)inclusion of administrative overheads in inventory valuation will particularly impact construction and development companies and project companies that build, for example, extensive investment units (projects lasting several years). But if we consider the parallel with the present approach to interest expenses, where the letter of the law forbids the capitalisation of interest expenses or loan expenses in general in the valuation of internally produced inventory, but development companies (through independent entities, SPVs ) do capitalise such expenses, e.g. in often genuine situations where they work only on a single project, since there can be no doubt about the causal link of these expenses to the production then we can also relativise the ban on including administrative overheads in inventory valuation. Unlike previous provisions, however, it will be a truly exceptional approach applicable only to certain industries. In the case of construction companies, valuation of work in progress (uninvoiced projects) will be allowed to include only a fraction of the previous administrative costs as most of them will not be defensible under the new definition or there will be no adequate methods for dividing such indirect administrative costs among various projects (by a defined percentage to the production volume of the particular project). Paradoxically, this fact could in practice lead construction or project companies to seek ways to allocate administrative tasks directly to projects (time record-keeping, targeting of marketing costs etc.) which could ultimately lead to financial savings subject to these costs being reviewed for legitimacy.

6 6 9 endorsed for use in the EU Updated guidance on the topic The above can be neatly summarised in the following table: Calculation formula item Unit overhead Until 2015 (*based on the nature of production) From 2016 Direct material incl. semi-finished products x x yes yes Direct payroll costs incl. social security and health insurance x x yes yes Other direct costs direct overheads x yes* yes Production overheads indirect x yes* yes Administrative overheads x yes* mostly not Costs of sale x x no no Calculated profit x no no If, despite the above, the entity decides to change the policy of valuation of internally produced inventory, it will have to take into account the impact on the comparative period. In practice, it can be expected that the reporting entity will only change the methodology if it leads to material effects. Which automatically means that it is necessary to change the information for the comparative period, i.e. as if the new policy had been valid from the beginning of the previous reporting period. This usually has different effects on the individual statements balance sheet, profit and loss account, and statement of changes in equity. In order to reflect the changes in valuation as of the beginning of the comparative, i.e. previous period including tax effects on tax payable or deferred (!), the category Other profit or loss from prior years will be used. The change in the methodology also means that it will be necessary to file an additional tax return.

7 7 9 endorsed for use in the EU Updated guidance on the topic When dealing with such a situation, practical help can be found, for example, in the Interpretations of the National Accounting Council, specifically in I-29 Corrections of Misstatements, Changes in Accounting Estimates and Changes in Accounting Policies, and in I-30 Comparability of Information for the Current and Previous Period in Individual Financial Statements of Businesses. The new interpretation I-35 Valuation of Internally Produced Inventory (the final version is yet to be published on the Council s website) also deals with the principles of economy and purposefulness of the costs incurred, the links between valuation and use of capacity, the necessity to compare previously set costs with actual normalised costs etc., which have so far been lacking in accounting legislation and they were usually dealt with intuitively in practice, using the knowledge of the international framework or the help of an auditor, if at all. Illustration of the change in valuation method on an example Background: Production company ABC has decided to include the valuation of finished products in production overheads (including payroll costs of production workers) starting from 1 January Production overheads represent a 30% mark-up on the valuation of finished products in direct material costs. The value of inventory of finished products amounted to CZK 7 million as of 31 December 2015 and to CZK 5 million as of 31 December As of 31 December 2016, the value of inventory of products amounts to CZK 10 million using the new valuation including production overheads. How will the change in the method of inventory valuation be reflected in the financial statements for 2016? Solution: It represents a material impact, the preparation of the financial statements for 2016 will therefore require restating the information for the previous period, as if the same method of valuation applied from 1 January 2015.

8 8 9 endorsed for use in the EU Updated guidance on the topic The introductory table shows the necessary calculations: Calculation formula item (CZK 000) Balance at 31 Dec 2014 Finished products in direct material costs 5,000 7,000 Production overheads mark-up 30% 30% Revised valuation of finished products 6,500 9,100 Difference to be taken into account 1,500 2,100 Cumulative effect on profit/loss before tax in the relevant year Total cumulative effect on profit/loss before tax x 2,100 Tax impact (unchanged rate of 19%). in the relevant year Total cumulative tax impact x 399 Balance at 31 Dec 2015 Note 1, Impact to be reflected in the profit and loss account Impact to be reflected in the profit and loss account Net impact in the relevant year 1, Impact to be reflected in Other profit or loss from prior years Total net impact x 1,701 Total net effect for prior years

9 9 9 endorsed for use in the EU Updated guidance on the topic The individual statements follow let us start with the statement of changes in equity. Please pay attention to the highlighted figures (net impact in the individual years). In brief, it can be said that naturally only the change in valuation as of 31 December 2015 (in the amount of 2,100) has an impact in 2016, but its total effect after tax (i.e. in the amount of 1,701) is divided between equity as of January 2015 (the amount of 1,215 in the example) and the balance sheet for 2015 (in the amount of 486). The preparation of financial statements for 2016 has to reflect the impact of the higher valuation from 2015 in the change in internally produced inventory. Practical recognition of the retrospective impact will occur in 2016 on accounts no. 42x Other profit or loss from prior years, 341 Income taxation, 58 Change in internally produced inventory and 591 Income taxation.

10 10 9 endorsed for use in the EU Updated guidance on the topic Statement of Changes in Equity (CZK 000) Change description Other profit or loss from prior years Profit or loss for the current period Balance as of 31 Dec 2014 original Original values Correction change in valuation method +1,215 Adjusted information Balance as of 31 Dec 2014 corrected +1,215 Sum of the original values and adjusted information Division of profit/loss Original values Correction transfer +1,215-1,215 Profit or loss for the current period original Original values Profit or loss for the current period change in method +486 Adjusted information Balance as of 31 Dec 2015 corrected 1, Sum of the original values and adjusted information Division of profit/loss Original values Correction transfer Profit or loss for the current period -1,701 Sum of the original values and adjusted information "-1,701" Balance as of 31 Dec ,701-1,701 Note

11 11 9 endorsed for use in the EU Updated guidance on the topic The balance sheet and profit and loss account then show the following: Selected items of the financial statements for 2016 (CZK 000) Balance Sheet 31 Dec 2016 (net) 31 Dec 2015 (net) Note Assets C.I.3.1. Products 10,000 9,100 Value Liabilities A.IV.3. Other profit or loss from prior years 1,701 1,215 Value A.V. Profit or loss for the current period +486 Adjusted information C.II.8.5 State tax payables and subsidies +399 Adjusted information (also decrease in tax for 2016) Profit and loss account Note B. Change in internally produced inventory -2, Adjusted information L.1. Income tax payable Adjusted information ** Profit/loss after tax -1, Adjusted information

12 9 endorsed for use in the EU 12 9 endorsed for use in the EU Updated guidance on the topic On 22 November 2016, 9 Financial Instruments was endorsed by the European Commission for use in the European Union. 9 is the IASB s replacement of IAS 39 Financial Instruments: Recognition and Measurement. The EU effective date is the same as the IASB s effective date (annual periods beginning on or after 1 January 2018 with earlier application permitted). The Standard includes requirements for recognition and measurement, impairment, derecognition and general hedge accounting. 9 was being issued in several phases from We provided detailed updates on individual phases in our Accounting News: 1. New classification and measurement model for financial assets (see our Accounting Newsletter from December 2009 for more information). 2. Requirements for financial liabilities and derecognition were added in 2010 (see our Accounting Newsletter from November 2010 for more information). 3. New general hedge accounting requirements (see our Accounting Newsletter from January 2014 for more information). 4. Final version of 9 issued in July 2014 (see our Accounting Newsletter from September 2014 for more information) supersedes all previous versions of 9 and: a. adds a new expected loss impairment model; and b. amends the classification and measurement model for financial assets. In this article we will provide a high-level overview of the 9 requirements, focusing on the areas which are different from IAS 39: classification and measurement of financial assets; classification and measurement of financial liabilities; impairment; and hedge accounting. The derecognition model in 9 is carried over unchanged from IAS 39 and is therefore not considered further in this article. Classification and measurement of financial assets With respect to the classification and measurement, the number of categories

13 13 9 endorsed for use in the EU Updated guidance on the topic of financial assets under 9 has been reduced; all recognised financial assets that are currently within the scope of IAS 39 Financial Instruments: Recognition and Measurement will be subsequently measured at either amortised cost or fair value under 9. Specifically: A debt instrument that (i) is held within a business model whose objective is to collect the contractual cash flows and (ii) has contractual cash flows that are solely payments of principal and interest on the principal amount outstanding must be measured at amortised cost (net of any write down for impairment), unless the asset is designated at fair value through profit or loss (FVTPL) under the fair value option. A debt instrument that (i) is held within a business model whose objective is achieved both by collecting contractual cash flows and selling financial assets and (ii) has contractual terms of the financial asset that give rise on specified dates to cash flows that are solely payments of principal and interest on the principal amount outstanding, must be measured at FVTOCI, unless the asset is designated at FVTPL under the fair value option. All other debt instruments must be measured at fair value through profit or loss (FVTPL). All equity investments are to be measured in the statement of financial position at fair value, with gains and losses recognised in profit or loss except that if an equity investment is not held for trading, an irrevocable election can be made at initial recognition to measure the investment at fair value through other comprehensive income (FVTOCI), with dividend income recognised in profit or loss. Classification and measurement of financial liabilities 9 also contains requirements for the classification and measurement of financial liabilities. One major change from IAS 39 relates to the presentation of changes in the fair value of a financial liability designated as at FVTPL attributable to changes in the credit risk of that liability. Under 9, such changes are presented in other comprehensive income, unless the presentation of the effect of the change in the liability s credit risk in other comprehensive income would create or enlarge an accounting mismatch in profit or loss. Changes in fair value attributable to a financial liability s credit risk are not subsequently reclassified to profit or loss. Under IAS 39, the entire amount of the change in the fair value of the financial liability designated as FVTPL is presented in profit or loss.

14 14 9 endorsed for use in the EU Updated guidance on the topic Impairment methodology The impairment model under 9 reflects expected credit losses, as opposed to incurred credit losses under IAS 39. Under the impairment approach in 9, it is no longer necessary for a credit event to have occurred before credit losses are recognised. Instead, an entity always accounts for expected credit losses and changes in those expected credit losses. The amount of expected credit losses should be updated at each reporting date to reflect changes in credit risk since initial recognition. Hedge accounting The general hedge accounting requirements of 9 retain the three types of hedge accounting mechanisms in IAS 39. However, greater flexibility has been introduced to the types of transactions eligible for hedge accounting, specifically broadening the types of instruments that qualify as hedging instruments and the types of risk components of non-financial items that are eligible for hedge accounting. In addition, the effectiveness test has been overhauled and replaced with the principle of an economic relationship. Retrospective assessment of hedge effectiveness is no longer required. Far more disclosure requirements about an entity s risk management activities have been introduced. Transitional provisions 9 is effective for annual periods beginning on or after 1 January 2018 with earlier application permitted (subject to certain conditions set out in the standard). 9 contains specific transitional provisions for i) classification and measurement of financial assets; ii) impairment of financial assets; and iii) hedge accounting. Other information Additional details on the requirements of 9 can be found: Directly in 9 Financial Instruments the English version of this standard is here At In the previous issues of Accounting News. Given the complexity of 9, we will also deal with individual parts in our next issues of Accounting News.

15 New Interpretation IFRIC 22 on foreign currency transactions and advance 15 9 endorsed for use in the EU Updated guidance on the topic On 8 December 2016, the International Accounting Standards Board (IASB) published IFRIC 22 Foreign Currency Transactions and Advance Consideration developed by the Interpretations Committee to clarify the accounting for transactions that include the receipt or payment of advance in a foreign currency. Background The Interpretations Committee observed some diversity in practice regarding the exchange rate used when reporting transactions that are denominated in a foreign currency in accordance with IAS 21 The Effects of Changes in Foreign Exchange Rates in circumstances in which is received or paid in advance of the recognition of the related asset, expense or income. As a consequence, the Interpretations Committee decided to develop an interpretation. Scope of the interpretation The interpretation addresses foreign currency transactions or parts of transactions where there is that is denominated or priced in a foreign currency; the entity recognises a prepayment asset or a deferred income liability in respect of that, in advance of the recognition of the related asset, expense or income; and the prepayment asset or deferred income liability is non-monetary. Consensus The Interpretations Committee came to the following conclusion: The date of the transaction, for the purpose of determining the exchange rate, is the date of initial recognition of the non-monetary prepayment asset or deferred income liability. If there are multiple payments or receipts in advance, a date of transaction is established for each payment or receipt. Effective date IFRIC 22 is effective for annual reporting periods beginning on or after 1 January Earlier application is permitted. Transition On initial application, entities apply the interpretation either: retrospectively in accordance with IAS 8; or prospectively to all foreign currency assets, expenses and income in the scope of the interpretation initially recognised on or after the beginning of the reporting period an entity first applies the interpretation in or the beginning of a prior reporting period presented as comparative information.

16 IASB issued amendments to IAS 40 regarding transfers of investment 16 9 endorsed for use in the EU Updated guidance on the topic On 8 December 2016, the International Accounting Standards Board (IASB) published Transfers of Investment Property (Amendments to IAS 40) to clarify transfers of to, or from, investment. Background The IASB received a request for clarification of the application of paragraph 57 of IAS 40 Investment Property, which provides guidance on transfers to, or from, investment properties. More specifically, the question was whether a under construction or development that was previously classified as inventory could be transferred to investment when there was an evident change in use. Changes The amendments in Transfers of Investment Property (Amendments to IAS 40) are: Paragraph 57 has been amended to state that an entity shall transfer a to, or from, investment when, and only when, there is evidence of a change in use. A change of use occurs if meets, or ceases to meet, the definition of investment. A change in management s intentions for the use of a by itself does not constitute evidence of a change in use. The list of evidence in paragraph 57(a) (d) was designated as a non-exhaustive list of examples instead of the previous exhaustive list. Effective date and transition requirements The amendments are effective for periods beginning on or after 1 January Earlier application is permitted. An entity applies the amendments to changes in use that occur on or after the beginning of the annual reporting period in which the entity first applies the amendments. Retrospective application is also permitted if that is possible without the use of hindsight.

17 9 endorsed for use in the EU Updated guidance on the topic IASB concluded the annual On 8 December 2016, the IASB issued Annual Improvements to Standards Cycle. The pronouncement contains amendments to three International Financial Reporting Standards (s) as a result of the IASB s annual improvements project. Annual Improvements to Standards Cycle makes amendments to the following standards: Subject of amendment Effective date 1 First-time Adoption of s 12 Disclosure of Interests in Other Entities IAS 28 Investments in Associates and Joint Ventures Deleted the short-term exemptions in paragraphs E3 E7 of 1, because they have now served their intended purpose. Clarified the scope of the standard by specifying that the disclosure requirements in the standard, except for those in paragraphs B10 B16, apply to an entity s interests listed in paragraph 5 that are classified as held for sale, as held for distribution or as discontinued operations in accordance with 5 Non-current Assets Held for Sale and Discontinued Operations. Clarified that the election to measure at fair value through profit or loss an investment in an associate or a joint venture that is held by an entity that is a venture capital organisation, or other qualifying entity, is available for each investment in an associate or joint venture on an investment-by-investment basis, upon initial recognition. Annual periods beginning on or after 1 January 2018 Annual periods beginning on or after 1 January 2017 Annual periods beginning on or after 1 January

18 EU Endorsement Process 18 9 endorsed for use in the EU Updated guidance on the topic The European Financial Reporting Advisory Group (EFRAG) updated its report showing the status of endorsement of each, including standards, interpretations, and amendments, most recently on 14 December As of 21 December 2016, the following IASB pronouncements are awaiting European Commission endorsement for use in the EU: Standards 14 Regulatory Deferral Accounts (issued in January 2014) the European Commission has decided not to launch the endorsement process of this interim standard and to wait for the final standard 16 Leases (issued in January 2016) Amendments Amendments to 2 Classification and Measurement of Share-based Payment Transactions (issued in June 2016) Amendments to 4 Applying 9 Financial Instruments with 4 Insurance Contracts (issued in September 2016) Amendments to 10 and IAS 28 Sale or Contribution of Assets between an Investor and its Associate or Joint Venture (issued in September 2014) Amendments to 15 Clarifications to 15 (issued in April 2016) Amendments to IAS 7 Disclosure Initiative (issued in January 2016) Amendments to IAS 12 Recognition of Deferred Tax Assets for Unrealised Losses (issued in January 2016) Amendments to IAS 40 Transfers of Investment Property (issued in December 2016) Annual Improvements to Standards Cycle (issued in December 2016) Interpretation IFRIC 22 Foreign Currency Transactions and Advance Consideration (issued in December 2016) Click here for the Endorsement Status Report

19 Updated guidance on the topic 19 9 endorsed for use in the EU Updated guidance on the topic In November 2016, based on the consensus reached by EITF, the FASB issued Accounting Standard Update ASU Restricted Cash. The Update recently issued as ASU Restricted Cash changes current US GAAP guidance in section ASC 230 Statement of Cash Flows (FAS 95). The Update changes the requirements of how to present restricted cash or cash equivalents in the Statement of Cash Flows. Currently the guidance is not specific as to where the restricted cash and cash equivalents should be presented. The practice has shown a wide diversity as companies present transfers between cash account and restricted cash accounts either as operating, investing or financing activity or even as a combination of those. Also there is a diversity in presentation of direct cash receipts to or cash payments from restricted cash accounts, which are currently presented as either as cash inflow and outflow or as noncash investing or financing activity. In order to achieve consistent and comparable figures, the Update requires that the companies must present the restricted cash or cash equivalents balances as part of cash and cash equivalents in the statement of cash flows. Respectively, transfers between restricted and non-restricted cash balances shall not be presented as cash flow activity (whether operating, investing or financing) in the statement of cash flow. The reconciliation between the cash and cash equivalents figure in the statement of cash flow and the same figure in the statement of financial position needs to be disclosed. Disclosures on material balances of restricted cash or cash equivalents shall be provided to disclose related accounting policies, nature of the restrictions. The Update does not provide any definition of restricted cash or cash equivalents, but still for many entities it will significantly change how the statement of cash flows looks. This Update is applicable to all entities that have restricted cash or cash equivalents and becomes effective for public business entities for fiscal years beginning after 15 December 2017, for all other entities one year later with early adoption permitted to all entities.

20 Contact If you have any questions regarding any of the articles in this publication, please contact one of the following audit experts: 9 endorsed for use in the EU IASB concluded the annual Czech Accounting Jarmila Rázková jrazkova@deloittece.com and Martin Tesař Soňa Plachá Gabriela Jindřišková mtesar@deloittece.com splacha@deloittece.com gjindriskova@deloittece.com Updated guidance on the topic Deloitte Advisory s.r.o. Nile House, Karolinská 654/2, Praha 8 - Karlín, Czech Republic Tel.: Subscribe to dreport and other newsletters and invitations here Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a more detailed description of DTTL and its member firms. Deloitte provides audit, tax, consulting, financial advisory and legal services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 150 countries and territories, Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they need to address their most complex business challenges. Deloitte s more than 225,000 professionals are committed to becoming the standard of excellence Deloitte Czech Republic