Audit Committee Institute Sponsored by KPMG. Horizon. A briefing for audit committee members and finance directors - Issue 6.

Transcription

1 Audit Committee Institute Horizon A briefing for audit committee members and finance directors - Issue 6 March 2009

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3 Audit Committee Institute Contents Introduction 1 1 Financial reporting issues Regulators Financial reporting Other issues 19 2 Tax and people issues 21 3 US matters 23 4 Sustainability 24

4 1 Audit Committee Institute Introduction Welcome to the sixth edition of Horizon: a briefing paper for audit committee members and finance directors. The pace of change in financial reporting, regulation, company law, tax and pensions has increased dramatically in recent years and is set to continue. It is a huge challenge to keep abreast of these developments and to find the necessary time to influence their direction. This publication is forward looking so as to help you monitor the likely changes and their potential effect on your company and where appropriate participate in shaping the future. If you would like to discuss any of these developments in more detail please call your usual KPMG contact who can assist you further.

5 Audit Committee Institute 2 1 Financial reporting issues 1.1 Regulators Mutual recognition and equivalence of US GAAP and IFRSs US Developments On 14 November 2008, the SEC published its proposed roadmap which could lead to the mandatory use of IFRS by US issuers from These developments are discussed in more detail in section 3. As part of the SEC s plan, about 110 of the largest US companies would become eligible to adopt IFRS on a voluntary basis from the end of In 2011, the SEC would perform a cost benefit analysis based on the early adopters and decide whether to approve a mandatory requirement for companies to adopt IFRS. Its decision will be based on whether the adoption of IFRS is in the public interest and would benefit investors, together with the achievement of several milestones. A mandatory requirement could start in 2014 with the possibility of a staged rollout if various milestones are achieved. The comment period on the SEC s proposals has been extended and now closes on 20 April EU equivalence mechanism As reported in the last issue of Horizon, on 21 December 2007 the EU adopted a regulation detailing the equivalence mechanism in relation to the acceptability of third country GAAP s within the EU. Since then, the Commission has been developing proposals on which third country GAAPs should be accepted as equivalent. On 12 December 2008, the Commission announced that it had determined that the GAAPs of US and Japan are considered to be equivalent to EU adopted IFRSs. In addition, the GAAPs of China, Canada, South Korea and India may continue to be used by third country issuers on EU regulated markets pending a further review of these GAAPs by the Commission by The Commission will also regularly monitor the ongoing status of equivalence and report to Member States and Parliament where necessary. We strongly support the progress being made globally and particularly in the EU and US to move towards one global set of high quality accounting standards given the increased benefits and reduced cost that this could bring in respect of access to capital markets.

6 3 Audit Committee Institute IASCF Governance Constitutional Review On 8 December 2008, the International Accounting Standards Foundation (IASCF) published a discussion document on the second part of its five-yearly Constitutional review. The purpose of the discussion document is to seek comment on the full range of constitutional issues that were not addressed in the first part of the review, such as the possible need for emergency due process procedures, funding arrangements and the IASB s agenda-setting procedures. Comments are due by 31 March 2009 with changes expected to take effect from 1 January We support the continued improvement of the openness, transparency, and governance of the IASCF. Over the past months, the IASB has been asked to address perceived problems in the global financial markets urgently through a fast-track procedure for issuing new requirements. Whilst we believe that the IASB should do all it can to address concerns and that due process could be fast tracked to some extent, in our view, effective consultation with preparers and users of financial statements is an important element of the governance framework within which standard setters must operate. FRC launches complexity project In July 2008, the Financial Reporting Council (FRC) announced that it had launched a project to review the complexity and relevance of current company reporting requirements. The project is intended to consider the risk that reporting requirements and related guidance are contributing to the increasing complexity of reports without making them more useful or understandable. The scope of the project includes requirements relating to financial statements, accompanying management commentary and other reports. As a first goal, the FRC would like to understand the causes of complexity in corporate reporting and start a debate about how to reduce complexity. The project is being supported by a Complexity Advisory Panel a group of senior executives experienced in the world of preparing, communicating and analysing corporate information which met four times in The panel is due to meet to consider a draft consultation document in early The increasing length and complexity of financial reports has been the subject of a number of recent press reports. We support initiatives to reduce the complexity of financial reports where this has the benefit of improving usefulness to users or of reducing the cost burden whilst not reducing usefulness. We encourage readers to respond to the Consultation Document once issued.

7 Audit Committee Institute 4 EU endorsement status There remains a substantial pipeline of Standards and Interpretations which need to be considered for endorsement, most of which are expected to be endorsed early in As part of the endorsement process, EFRAG continues to ask for comments in respect of its initial assessments. A number of such requests have recently closed and more can be expected over the coming months. We believe that differences between EU endorsed IFRS and IFRS as issued by the IASB should be kept to an absolute minimum. The European Commission, the Council of Ministers and the Parliament have all acknowledged the importance of ensuring that standards and interpretations are adopted in a timely manner. To facilitate swift endorsement, the IASB should also work to ensure that standards are widely acceptable before being issued. 1.2 Financial reporting IASB Standard setting activities In January 2009 the IASB updated its Technical Plan to reflect changes in the timing of its projects since October A summary of the International Accounting Standards Board s (IASB) current work program and estimated timetable for consultations can be found at: Current+Projects/IASB+Projects/IASB+Work+Plan.htm In September 2008, the IASB and US Financial Accounting Standards Board (FASB) published an update on progress towards convergence of IFRS and US GAAP further to the 2006 Memorandum of Understanding (MOU) between those bodies. As part of the proposed roadmap (see section 3), the SEC has now announced that continued convergence will form part of its assessment in 2011 of whether to require US domestic issuers to apply IFRS. Consequently, the FASB and IASB have set a goal of completing their remaining major convergence projects by As a result, convergence will continue to be an important element of the IASB s agenda over the next couple of years. In response to a number of requests from high profile bodies including the G20, Financial Stability Forum (FSF) and European Commission, the IASB have also committed to a number of actions in relation to the credit crunch. This has resulted in the IASB announcing a number of short-term actions to address specific concerns (for example, issuing its amendments to IAS 39 and IFRS 7 in respect of the reclassification of financial assets), the acceleration of a number of projects (for example, consolidation) and the formation of a Financial Crisis Advisory Group.

8 5 Audit Committee Institute The IASB s work program has also increasingly started to focus on the early stages of projects which are designed to modernise or replace IFRSs, for example, the work on the conceptual framework and new standards for financial instruments, liabilities and equity. Additionally, a number of projects are now underway which are designed to fill perceived gaps in standards in respect of specific topics or industries, for example, projects on extractive industries, insurance, and emission rights. We expect to see further developments in these areas over the coming 12 months. We support the balance of the agenda continuing to focus on improving IFRSs either in the short-term (e.g., the Annual Improvements amendments) or through long-term IASB projects. Whilst we agree that the IASB should work to consider how accounting standards have interacted with the current financial crisis and address any short-comings in standards that arise, it is important that the IASB maintains its independence and due process to ensure that the resulting standards continue to be of a high-quality and meet users needs. Recently closed comment periods There are a number of documents which have been issued by the IASB for comment for which the comment period has recently expired. Examples include: earnings per share (comment period ended 5 December 2008); annual improvements 2008 (comment period ended 7 November 2008); first time adoption of IFRSs (IFRS 1): additional exemptions (comment period closed 23 January 2009); non current assets held for sale and discontinued operations (comment period ended 23 January 2009); financial Instruments: enhanced disclosures (IFRS 7) (comment period ended 15 December 2008); and financial instruments with characteristics of equity (comment period ended 5 September 2008). In addition, some earlier Exposure Drafts continue to be discussed by the IASB, notably IAS 37, in respect of which a final standard is expected in the second half of As the IASB considers the comments that it has received, further developments can be expected in respect of these projects over the coming months. Our detailed comments on each of these can be found at com/pubs/pub_other.cfm

9 Audit Committee Institute 6 While the comment periods of these documents are closed, we encourage companies to monitor progress in these projects and be ready to respond to future developments or to contact the IASB directly if they have questions or concerns regarding these proposals. Consolidation On 18 December 2008, the IASB published ED 10 Consolidated Financial Statements. The ED contains proposals intended to strengthen and improve the requirements for identifying which entities a company controls by replacing the existing definition of control in SIC 12 and IAS 27 with a unified definition which can be applied to all entities (including both SPEs and other entities). The proposals also include expanded disclosure requirements that are intended to enable investors to assess the extent to which a reporting entity has been involved in setting up special structures and the risks to which these special structures expose the entity. The proposals form part of the IASB s comprehensive review of off balance sheet activities and address an area that the G20 and Financial Stability Forum asked it to consider as part of its response to the financial crisis. The proposed definition of control is, on the face of it, similar to the definition of control in IAS 27. It is based on a notion of power to direct activities to generate returns. However, the guidance in the ED in respect of power to direct, what constitutes activities and what are returns is different to the guidance in IAS 27 and SIC 12 in a number of key respects. In addition, a number of new concepts are introduced such as agency and some existing requirements, most notably the risks and rewards test in SIC12, have changed or been removed. Comments are due on the proposals by 20 March Whilst we are still considering the implications of the ED and our response to it, we have significant concerns that it may not meet its objectives. In particular, we have concerns that the proposed wording may not improve financial reporting because it does not make clear how the principle of control should operate. We are also concerned that the lack of clarity around control may result in more diversity in practice as well as increased opportunities for structuring to avoid consolidation. The new definition may also require a number of entities to undertake significant projects to assess its impact. We are therefore concerned that the current draft proposals may not be operational in practice. We believe that the IASB could meet the requirements of the Financial Stability Forum by integrating SIC 12 into IAS 27, enhancing the disclosure of off-balance sheet arrangements and including some specific additional guidance in IAS 27 (for example guidance on de facto control, reassessing control and the use of agents). The IASB could then, as part of a separate long-term project, develop a properly considered control model.

10 7 Audit Committee Institute We encourage all entities to review the draft standard published on the IASB website and to become involved in the discussions on this important topic. In addition to considering the impact of the definition of control on consolidation, we encourage entities to review the disclosure requirements in the Exposure Draft which may necessitate significant additional disclosure in some cases. Derecognition In April 2005, the IASB and the U.S. Financial Accounting Standards Board (FASB) began a research project to develop an approach to derecognition. The project will initially focus on financial assets and is intended to result in an improvement to both IAS 39 and SFAS 140. At the same time, the Boards decided to consider the feasibility of developing a broader derecognition standard that would apply to all types of assets. At their joint Board meeting in April 2008, the IASB and FASB affirmed that the derecognition project is a high priority and, in July 2008, decided to move the project from its research agenda to its active agenda. Since then, The IASB has developed two different approaches to the derecognition of financial assets. Under both approaches, an entity would derecognise an asset that it had transferred if it had no continuing involvement in the asset and the transferee had the practical ability to transfer the asset to a third party for its own benefit and could exercise that practical ability unilaterally and without needing to impose additional restrictions on the transfer. In addition, under the first approach, the transferor would derecognise the asset only if the transferee had present access to the economic benefits underlying the asset. In February, the IASB decided to propose the second approach in its exposure draft but to include a detailed description of Approach 1 as an alternative. An Exposure Draft is expected to be issued in the first half of 2009 with a final amendment of the derecognition guidance in IAS 39 expected by the middle of Derecognition is an issue which affects many entities and transactions and the rules set out in IAS 39 can be complex. In light of this and current experience, it would seem appropriate to review the approach in the standard to determine whether the current guidance may be improved. Given the wide range of transactions that may be affected by such a project, we suggest that all interested parties review the Exposure Draft when issued and be prepared to comment.

11 Audit Committee Institute 8 Joint IASB and FASB project to establish a common standard on financial statement presentation Phase A of the project was completed with the publication in September 2007 of the amended IAS 1 Presentation of Financial Statements. However, phase A dealt only with relatively minor issues such as the titles of primary statements. On 16 October 2008, the IASB published a Discussion Paper in respect of phase B of the project. If adopted, the proposals in the Discussion Paper would see the statement of financial position, statement of cash flows and statement of comprehensive income split into sections based on business activities (operating and investing), financing, income taxes, discontinued operations, equity, and, in the statement of comprehensive income, other comprehensive income. In addition, the proposals in the Discussion Paper would mandate the use of the direct method of presenting operating cash flows. They would also specify principles for the aggregation of information as well as what totals and subtotals would be required in each financial statement. However, as decided by the IASB in July 2008, the Discussion Paper does not reconsider the requirements in respect of which items are presented in other comprehensive income and which are presented in profit or loss or the requirements relating to the reclassification of items of other comprehensive income to profit or loss (i.e., recycling). Phase C - which has not yet begun, will address presentation and display of interim financial information in U.S. GAAP. The IASB may reconsider the requirements in IAS 34, Interim Financial Reporting. The comment period in respect of the Discussion Paper for phase B closes on 14 April The next step of the project is expected to be an Exposure Draft which is expected in In our view, the project is key to the effective communication of financial performance under IFRS. Issues such as recycling between equity and the income statement (e.g., for cash flow hedges) mean that the presentation of performance is inevitably linked to important recognition and measurement issues. It is disappointing that the IASB has now reduced the scope of the project and does not plan to address these issues. More generally, we note that the proposed changes may have a significant impact on current practice and the IASB should consider fully whether the costs of preparing the additional information needed to comply with the proposals in the Discussion Paper (for example, to prepare the cash flow statement using the direct method ) may exceed the benefits. With that in mind, we urge preparers and users of financial statements to respond to the IASB s Phase B Discussion Paper with their views on this important topic.

12 9 Audit Committee Institute Revenue Recognition On 19 December 2008, the IASB published a Discussion Paper, Preliminary Views on Revenue Recognition in Contracts with Customers, setting out a joint approach to the recognition of revenue. The Discussion Paper is the first step in the IASB and FASB s joint project to develop concepts for revenue recognition and a general revenue recognition standard based on those concepts. The general standard would replace the existing standards on revenue recognition, IAS 11 Construction Contracts and IAS 18 Revenue. The Discussion Paper proposes a model for recognising revenue that would apply to all contracts with customers although the IASB will re-consider whether it is appropriate for contracts such as leases, financial instruments, and insurance contracts after they have received comments. At that time, they will also consider its implications for entities that recognise revenue in the absence of a contract (for example, gains arising from fair value movements in accordance with IAS 41 Agriculture). The paper proposes a contract-based revenue recognition model under which revenue is recognised as an entity increases the net of its rights and obligations under a contract. In this model, revenue is recognised when a contract asset increases or a contract liability decreases (or some combination of the two). That occurs when an entity performs by satisfying an obligation in the contract, for example when it transfers a promised asset (such as a good or a service) to the customer. In the case of the sale of a good that typically occurs when the customer takes physical possession of the good. In the case of a service that occurs when the customer has received the promised service. Rights and performance obligations in a contract would be measured initially based on the transaction price (i.e., the contractual consideration). If a contract comprises more than one performance obligation, the transaction price would be allocated to performance obligations based on the relative stand-alone selling prices of the goods and services underlying those performance obligations. The IASB believes that, for many contracts (particularly for commonplace retail transactions), the proposed revenue recognition model would cause little, if any, change. However, in some circumstances, applying the boards proposed model would change present practice. For example: Entities would disaggregate contracts into more components (performance obligations) than might have been the case using existing standards. Entities that at present recognise revenue for construction-type contracts would recognise revenue during construction only if the customer controls the item as it is constructed.

13 Audit Committee Institute 10 Entities that at present account for warranties or other post-delivery services as cost accruals would account for those obligations as performance obligations and would recognise revenue only as they are satisfied. Entities that have previously deferred the recognition of revenue or recognised it on a straight line basis because revenue relating to goods or services to be delivered cannot be reliably measured would estimate the stand-alone selling prices of the undelivered goods and services and recognise revenue as gods and services are delivered to the customer. In the proposed model, costs of obtaining contracts (for example, commissions paid to a salesperson) would be capitalised only if they qualify for capitalisation in accordance with other standards. As a result, an entity would generally recognise such costs as expenses as incurred which may not be the same period in which revenue is recognised. The Discussion Paper is open for public comment until 19 June 2009 with an Exposure Draft expected to be published early in Developing a consistent principle which can be applied to the many different types of revenue arrangement that exist is a significant challenge. In our view, this project could have a substantial and wide-ranging impact on revenue recognition. Whilst the project has not yet reached the Exposure Draft stage, we would encourage all companies to consider the proposals and respond to the IASB Discussion Paper at an early stage to ensure that their views and specific revenue recognition issues are considered by the IASB in developing an ED.

14 11 Audit Committee Institute Income taxes As discussed in previous editions of Horizon, the IASB s Income Taxes project is intended to reduce the differences between IAS 12 Income Taxes and the US standard, SFAS 109 Accounting for Income Taxes. It is being conducted as a joint IASB and FASB project. The underlying approach in both standards is based on the balance sheet liability approach (i.e., temporary differences). However, both Standards include numerous (and different) exceptions to the basic principle which the project is seeking to eliminate. For example, the project is proposing to remove the exemption from reflecting deferred tax on assets acquired with no tax base i.e., an asset acquired for 100 that has nil tax base would be measured on initial recognition at 142, together with a deferred tax liability of 42 assuming a 30 percent tax rate. The timetable for the project has been slipping and an Exposure Draft is now expected to be issued early in 2009 with a final standard expected in In our view, the elimination of exceptions may highlight the principles but the results may be seen by some as introducing unnecessary complexity into the accounting (for example for assets that have a nil tax base) and may produce pre-tax results that are more difficult to explain. Companies will need to be ready to respond to the proposals when they are issued early in Fair value measurement The use of fair value in financial statements has continued to make headlines particularly in respect of the valuation of certain financial instruments in current market conditions. Over recent months, the IASB has published a number of documents intended to address some of these issues including guidance on the application of fair value measurement when markets become inactive and a revision to IAS 39 in respect of reclassifying financial instruments measured at fair value. The IASB continues its work on a number of projects considering when and how to measure fair value. In respect of how to measure fair value, in 2006, the IASB issued a Discussion Paper based on SFAS 157 Fair Value Measurement issued by the FASB. Since then, the IASB staff have been conducting a standard by standard review and considering the comments that were received in response to its Discussion Paper. Following round-table discussions with interested parties during the fourth quarter of 2008 the IASB currently plans to publish an ED on fair value measurement in the first quarter of 2009 and then hold Round Table meetings later in the year.

15 Audit Committee Institute 12 In respect of when to use fair value, the IASB issued on 19 March 2008 a Discussion Paper Reducing Complexity in Reporting Financial Instruments. The Discussion Paper puts forward arguments for and against a possible longterm approach that would use fair value measurement for all types of financial instruments in the scope of a financial instruments standard. The IASB sought views on both the possible long-term and intermediate approaches as well as possible alternatives on how it should proceed in developing new standards for reporting financial instruments that are principle-based and less complex. The comment period in respect of this Discussion Paper closed in September An agenda decision on the next steps in respect of this project is expected early in Assuming that the project is taken onto the IASB agenda, an advisory group is expected to be set up during More generally, further developments in this area are likely to occur through the joint IASB/FASB project on the conceptual framework (see Conceptual framework section). In our view, current market conditions including volatility and limited liquidity have made the determination of fair value complex and pose a significant challenge for companies. We support the prioritisation of these issues by the IASB and FASB to deliver internationally consistent guidance where appropriate. These issues are of great importance to companies and users alike. Management commentary On 27 October 2005, the IASB published a Discussion Paper Management Commentary that assessed the role the IASB could play in improving the quality of the management commentary that accompanies financial statements. In this project, the IASB are developing the principles and essential content necessary to make management commentary reporting useful to investors. The output of the project will be a non-mandatory guidance document. The management commentary Exposure Draft is scheduled for publication in the second quarter of In our view, management commentary provides an excellent opportunity for management to provide additional information to shareholders much of which could not be provided by a set of financial statements alone. We therefore support the IASB in its attempts to provide high quality guidance for management reporting. However, we urge caution that any such guidance must be capable of being applied in different jurisdictions applying different legal frameworks.

16 13 Audit Committee Institute Leases The IASB s long term lease accounting project is expected to result in a fundamental change in accounting for leases. The project will cover leases of real estate as well as equipment leases. The primary objective of the project is to develop a new model for the recognition of assets and liabilities arising under lease contracts. At its meeting in July 2008, the IASB decided to focus on lessee accounting and defer the development of a new accounting model for lessors. The Board also decided on an overall approach based on applying the existing finance lease model to all leases. Leasing is a major international industry, and a very important source of finance for a wide range of entities. The IASB and FASB have therefore established a joint working group for this project. The first working group meeting was held in February A Discussion Paper is expected to be issued jointly by the FASB and the IASB early in In our view, changes to expand the existing finance lease model to include all leases would represent a significant change to current accounting practice and may have a significant impact on the balance sheets of a wide range of entities. We therefore urge all companies that may be affected to monitor developments in this area and participate in the discussion of this significant issue. Extractive industries The ultimate objective of this project is to develop an International Financial Reporting Standard (IFRS) on accounting for extractive activities. This IFRS will supersede IFRS 6 Exploration for and Evaluation of Mineral Resources. Work is currently being undertaken by a project team comprising representatives from the national standard setters of Australia, Canada, Norway and South Africa with a view to publishing a Discussion Paper in early The Discussion Paper will be published as an IASB document but will contain only the project team s views. After publication of the Discussion Paper, the IASB will make a decision about adding the project to its active agenda. This Discussion Paper forms the starting point of a project to deliver a more comprehensive standard than currently exists. We strongly support the IASB in its efforts to develop consistent guidance in this area.

17 Audit Committee Institute 14 Post-employment benefits (including pensions) In July 2006, the IASB commenced a long-term project involving a fundamental review of all aspects of post-employment benefit accounting. The UK Accounting Standards Board (ASB) and the Pro-Active Accounting Activities in Europe (PAAinE) group issued a Discussion Paper in January 2008 on the Financial Reporting of Pensions which is intended to be a first step towards informing that debate. In addition to its longer term review of accounting for post employment benefits the IASB is considering more immediate amendments to IAS 19 as part of its general convergence project and, in this regard, issued a Discussion Paper Preliminary Views on Amendments to IAS 19 Employee Benefits. The Discussion Paper proposed amendments to IAS 19 to address issues such as presentation and disclosure, the definition of defined benefit and defined contribution arrangements, smoothing and deferral mechanisms (i.e., the corridor approach) and the treatment of settlements and curtailments. The IASB s preliminary views include the removal of the option to use the corridor approach. In addition, benefit promises would be split between contribution-based promises and defined benefit promises. The measurement of contribution-based promises would be at fair value assuming the terms of the benefit promise do not change. In January 2009, the IASB tentatively agreed to defer its work in respect of contribution-based promises. These are now expected to form part of a separate exposure draft, potentially as part of its comprehensive review of pension accounting. The comment period for the Discussion Paper closed in September The IASB plans to redeliberate the issues and publish an Exposure Draft of proposed amendments to IAS 19 in the second half of 2009, with a view to issuing a revised standard by We support the IASB s objective of improving the accounting for postemployment benefits. In the previous edition of Horizon, we questioned the scope of the IASB s short-term project and commented that we believed that contribution-based promises should form part of a wider review of the accounting for all employee benefits rather than being part of the short-term project. We therefore welcome the IASB s tentative decision in January 2009 to defer the consideration of contribution-based promises. Companies are now aware changes in pension accounting can have a significant impact on reported results. We therefore encourage all companies to monitor the development of the IASB ED and amended pensions standard as a result of this project.

18 Audit Committee Institute 15 Insurance contracts In May 2007, the IASB issued a Discussion Paper Preliminary views on Insurance contracts. The comment period is now closed. This project is the second phase in the IASB s development of standards covering insurance activities and will eventually provide guidance for both insurers and policyholders. The FASB issued the same paper with an invitation to comment (comment period now closed). The FASB also asked for views on whether the scope of its project should include accounting by policyholders. In October 2008, the FASB decided to participate in the development of the standard as a joint project between the IASB and FASB. The IASB is now undertaking its review of responses to the Discussion Paper. It has decided not to hold public round-table meetings at this stage of the project, noting that members of its Insurance Working Group supply input from a wide range of perspectives. The IASB expects to issue an Exposure Draft in the second half of We welcome progress towards a comprehensive global solution to insurance contract accounting and urge all interested parties to be ready to comment on the Exposure Draft when issued. In addition to this project, interested parties should review the Revenue Recognition Discussion Paper (see above) which includes further considerations likely to affect the accounting for insurance contracts.

19 Audit Committee Institute 16 Liabilities and equity As part of the MOU, the IASB and FASB are working towards developing a converged standard on the distinction between liabilities and equity as a replacement for IAS 32. The FASB led the research stage of the project and published a Preliminary Views document Financial Instruments with Characteristics of Equity in November The IASB did not deliberate the proposals in the FASB document but in February 2008, issued a Discussion Paper to solicit views on whether the proposals in the FASB document were a suitable starting point for the IASB s deliberations. The FASB document describes three approaches for distinguishing equity from non-equity instruments; basic ownership, ownership-settlement and reassessed expected outcomes. All three approaches use the definition of a basic ownership instrument and conclude that they are equity. Under the ownership-settlement approach other perpetual instruments and some derivative instruments that are indexed to and settled with the entity s basic ownership instruments also would be classified as equity. In January 2008 EFRAG published a Discussion Paper Distinguishing between Liabilities and Equity on behalf of PAAinE. That paper describes a further approach: the loss absorption approach which classifies instruments or components of instruments as equity if the instrument s claim on net assets is reduced if the entity incurs a loss. The deadline for comments in respect of the IASB paper ended in September The deadline for comments on the PAAinE paper ended in July The FASB and the IASB now intend to work together towards issuing an Exposure Draft in the second half of 2009 with a final standard expected in The classification of financial instruments under IAS 32 Financial Instruments: Disclosure between Liabilities and Equity has been an area which has given rise to some controversy and practical difficulties in implementation. Any future changes are likely to have wide ranging effects. We would encourage companies to monitor this project and respond to the Exposure Draft when published so that implementation problems associated with IAS 32 are not repeated.

20 17 Audit Committee Institute Emissions trading schemes In June 2004, the IFRIC issued an interpretation on the accounting for emission trading schemes. In June 2005, the IASB decided to withdraw this interpretation and, in September 2005, added a project on emission trading schemes to its agenda. The objective of the IASB s project is to develop comprehensive guidance on the accounting for emissions trading schemes, considering (but not limited to): whether emissions allowances are assets and, if so, what is the nature of those assets? how emission allowances should be measured and whether the way allowances are acquired affects their recognition or measurement? how to account for allowances received free of charge from a government and whether an associated liability exists? the subsequent accounting for allowances and any related liabilities. what the overall financial reporting effects are of the above decisions? An Exposure Draft in respect of emissions trading schemes is expected to be issued in the second half of 2009 with a final standard due in There has been little or no formal guidance in this area in the past and divergence has developed. We therefore support the IASB in its efforts to develop authoritative literature on the accounting for emission allowances to reduce the existing divergence and develop a common accounting framework. Given the controversial nature of this project in the past and its widening applicability, we urge constituents to review and comment on the Exposure Draft when issued.

21 Audit Committee Institute 18 Conceptual framework The IASB and FASB are developing a single converged framework for developing future accounting standards. An Exposure Draft on the first of eight phases (Phase A) was published in May 2008 (concerning the objectives and qualitative characteristics of financial reporting) and roundtables held. The Exposure Draft reaffirmed the IASB s position that the primary user group for accounts will be those who have a claim (or potentially may have a claim) on the entity s resources its present and potential equity and other capital providers. Other potential users may benefit from financial reporting information, but they are not its focus. The comment period in respect of this phase closed in September 2008 and the chapters are expected to be issued in final form in the second quarter of At the same time, the IASB and FASB jointly published a Discussion Paper on the reporting entity (Phase D). The Discussion Paper considers a number of issues relating to the reporting entity concept including: whether a precise definition of reporting entity is necessary and whether a reporting entity must be a legal entity; how to circumscribe the area of business activity of interest to equity investors, lenders, and other capital providers in the context of a group of entities; when two entities should be considered as a single unit (including a discussion of the meaning of control); different approaches to determining the composition of a group reporting entity; and issues related to the general purpose financial reports of a parent entity (including whether parent-only financial statements meet the objective of financial reporting). The comment period in respect of phase D closed in September 2008 and an ED is expected in the second half of Discussion Papers on Phases B and C of the Project ( Elements and Recognition and Measurement ) are currently scheduled for the first half of 2010 and the second half of 2009 respectively. In our view it is difficult to overstate the importance of this project, the outcome of which should influence standard setting for many years. Given the project s importance we would like to see it being given greater priority by the IASB and FASB, so that proposals are developed more quickly. A satisfactory outcome requires that companies engage with investors and other users internationally to assess the potential impact of the proposals being made in the conceptual framework project and to present considered solutions to the IASB and FASB that meet all needs in an appropriate manner.

22 19 Audit Committee Institute Intangible assets In October 2008, the Australian Accounting Standards Board (AASB) published a Discussion Paper that analyses the issues involved in accounting for internally generated intangible assets. The paper challenges some of the accounting requirements in existing standards with the intention of encouraging international debate and contributing to improvements in the IASB s standards on intangible assets. The Discussion Paper has been authored by staff of the AASB with the encouragement and support of the group of National Standard Setters (NSS), a global group of representatives of national accounting standard setters and related organisations whose main role is to assist the IASB, primarily through research and commentary on project priorities. EFRAG and has also drawn attention to the paper in order to further the global debate. The AASB is inviting comments on this paper by 15 May Whilst the AASB paper is not directly part of the standard setting process, it does present the opportunity to influence the debate about intangible assets at an early stage. Such assets increasingly form a significant part of an entity s value and so are increasingly important in understanding an entity s financial performance. The AASB paper admits that its approach may not be practical or cost effective for preparers but intends to encourage debate amongst preparers and users about how a practical approach may be developed. In our view, it is increasingly important to influence the debate about new standards early in the process and this paper represents an opportunity to do just that. Given the fundamental changes that may arise if some of its proposals are put into practice and the burden that they may place on companies, we recommend that entities respond to this paper by May Other issues UK GAAP Convergence The UK Accounting Standards Board responsible for setting UK GAAP has for a number of years pursued a policy of convergence between UK GAAP and IFRS. UK GAAP remains the main accounting framework used by most UK companies, including many UK subsidiaries of listed companies that now apply IFRS as adopted by the EU.

23 Audit Committee Institute 20 In May 2006, the ASB asked for comments on the future of financial reporting requirements in the UK. In particular, it sought views on the convergence of UK GAAP and IFRS and the possible scope of full IFRS and the IASB s planned IFRS for Private Entities (formerly the IFRS for Small and Medium Sized Entities). Since then, the ASB has been awaiting the outcome of the IASB s IFRS for Nonpublicly Accountable Entities project. As that project nears completion a final standard is now expected first half of 2009 we expect that the UK ASB will consider and expose for comment revised proposals on the future of UK GAAP, in particular the extent to which UK GAAP and IFRSs should further converge. In our view, there may be significant benefits from the further convergence of UK GAAP with IFRS for preparers, users and auditors. However, it is important that UK GAAP continues to find a balance of cost-benefit and complexity that is appropriate to the entities to which it applies. Companies are encouraged to consider and respond to any proposals for change as they are exposed for comment in the coming months.

24 Audit Committee Institute 21 2 Tax and people issues VAT Changes On 1 January 2010 there will be a sea change in the rules for VAT accounting on services. It is no exaggeration to say that this is the biggest change since the Single Market changes 16 years ago which changed the way VAT was accounted for on cross border supplies of goods within the EU. The place of supply of many services will change and greater statistical reporting requirements with tight compliance deadlines will affect most taxpayers. The 2010 changes are merely phase 1 with further changes due in 2011 (relating to cultural services) and 2013 (long term hire of means of transport) and 2015 (telecoms, electronically supplied services and broadcasting). There is a useful summary of the main changes and effective dates at the end of the consultation document. The place of supply of some services remains the same as now. Although this is an EU initiative clearly UK law will have to change to reflect the new rules. The draft version of the new UK legislation has now been released for comment. The draft can be found at: Current position Currently the default rule for services is to tax them where the supplier belongs. From 1 January 2010 the default rule for business to business supplies of services (B2B) will be the customer s place of belonging. The default rule for business to consumer (B2C) services (supplier s establishment) remains unchanged. The possibility of a wider application of the use and enjoyment concept to all services covered by the general rules is also available although the UK will continue to apply use and enjoyment only to the hire of equipment, telecoms services, broadcasting services, B2B electronic services and the hire of means of transport. The changes in brief and their impact In order to avoid the need for the supplier to have to register in the customer s country the customer (taxable person) will account for VAT under the reverse charge rules. The supplier will have to record these cross border B2B supplies of services that are subject to reverse charge on EC Sales Lists, (similar to the ones currently completed for B2B cross border intra EU supplies of goods) and HMRC estimate that up to 200,000 businesses will be affected by the EC

25 Audit Committee Institute 22 Sales List changes. Apart from the systems changes needed to capture the information for EC Sales Lists, a potential problem is the lack of harmony on liability within the EU. A supply that might be taxable in the UK for instance, could be exempt in the customer s country and hence not subject to the reverse charge. The extension of the reverse charge is likely to cause increased costs for banks and insurance companies which will find offshore services that are currently treated as supplied outside the EU suddenly becoming liable to largely irrecoverable reverse charge VAT. Another major change envisaged by the VAT package is that UK VAT registered entities who also have non business activities will have to account for reverse charge VAT on services received from an overseas supplier for a non business purpose, that is to say they will be regarded as a taxable person for all such supplies. This VAT will then be irrecoverable as it will not be used for business purposes. This will affect many charities, including universities with non business research activities. The changes should reduce the amount of foreign VAT incurred on the purchase of services in other EU countries. The changes should also reduce the number of registrations required for foreign suppliers. This will generate both cash flow and administrative savings. For example for those countries that treat warranty recharges for work on goods as supplies, these will no longer be treated as domestic supplies under the new rules. The systems and compliance costs of adapting to the new regime may be substantial. The perennial problem with reverse charge services, (that of identifying exactly where the customer belongs where customers are multi national) will be increased substantially as more services become subject to this regime. This is a particular problem with global contracts. There are also issues around the meaning of what is a B2B supply (in situations where the customer has no VAT number but purports to be in business). There are proposed changes to the time at which reverse charge VAT is declared, to ensure parity between the supplier s EC Sales List and the customer s VAT return, which could cause practical problems as the payment date will cease to be the tax point is not far away. All affected businesses should study the draft legislation, assess the impact of the new rules on them, and plan to be ready for the changes. Any concerns can be fed back to HMRC as part of the consultation process.

26 Audit Committee Institute 23 3 US matters SEC proposed Roadmap for the Potential Use Financial Statements Prepared in accordance with IFRS for U.S. Issuers In the last edition of Horizon we reported the imminent release by the SEC of a proposed Roadmap on the use of IFRSs by U.S. Issuers. On 14 November 2008, the US Securities and Exchange Commission published for comment its proposed Roadmap for the Potential Use of Financial Statements Prepared in Accordance with International Financial Reporting Standards by US Issuers. Comments on the 165-page proposal were originally due in mid-february, but the SEC has now extended the deadline to 20 April 2009 to allow interested parties additional time to analyse the issues and to respond with comments. The Roadmap and comments received to date can be found on the SEC s web site at The integration of the world s capital markets and the use of different GAAP (dependent on the exchanges) has highlighted the need for a single set of high quality globally accounting standards which would provide greater comparability of financial information across borders and increase investor confidence in the quality of the information. International Financial Reporting Standards has expanded significantly over the last few years whereby more than 100 countries around the world either require or permit IFRS. The proposed roadmap identifies milestones of progress that will be monitored between now and 2011, when the SEC plans to consider requiring all U.S. public companies to file their financial statements using IFRS. It also includes a proposed rule that would, if adopted, permit certain large U.S. public companies in industries composed mainly of IFRS-reporting entities to use IFRS as soon as in their 2009 financial statements for calendar-year companies. We support the introduction of a transition plan and a timeline to permit a short optional transition period prior to mandatory adoption of IFRS for all U.S. domestic issuers, with the ultimate goal of a single set of high quality, globally accepted accounting standards based on IFRS at a set date in the future. The proposed roadmap is a significant step in responding to that goal. The change in U.S. administration and the appointment of a new SEC Chairman increases the importance of interested parties responding to this consultation so as to influence the direction of future policy in this area.

27 Audit Committee Institute 24 4 Sustainability Corporate Sustainability: Value creation in the Financial Downturn A range of significant business challenges and broader social issues have resulted from the recent downturn, including increasing unemployment, volatile pricing and supply of commodities such as oil and steel and rising food prices. Prior to the financial downturn, many global organisations made pledges to invest in Sustainability by cutting their greenhouse gas emissions and reducing their environmental impact. What will happen to these commitments when businesses are currently fighting to stay afloat? Concerns over Corporate Sustainability have probably not been at the forefront of most CEOs and board members minds in recent months and while management teams are worried about whether their businesses are sustainable economically, the question of whether they are sustainable from a green perspective seems much less important. Corporate Responsibility and the economy Issues such as climate change, environmental degradation, health & safety, human rights and corruption do not vanish because the economy is not growing and are just as important in an economic downturn. The downturn demonstrates that global financial markets are inextricably linked, a crisis in one part of the world can quickly spread to other regions. In the same way, many social and economic challenges such as climate change are international challenges. The environment has clearly been overshadowed by the economy in recent months, but it has not dropped off the radar. Corporate Sustainability is no longer a sideline issue - it is part of mainstream business, affecting the longterm value of any organisation. Current political dialogue on issues such as human rights and climate change is fuelling shareholder and consumer pressure to deliver on Corporate Sustainability related promises. Enhanced media coverage of the role of business in solving environmental and social problems makes Corporate Sustainability difficult to overlook as an emerging issue requiring attention by business across all sectors.

28 25 Audit Committee Institute Regulation Regulation is gradually increasing for Sustainability. Recent and forthcoming regulation includes: The new Groundwater Regulations, which are currently coming into force in February 2009, the revised Hazardous Waste (England and Wales) Regulations 2005, which have been amended and will come into force in April The Batteries and Accumulators (Placing on the Market) Regulations 2008 also came into effect on 26 September 2008, restricting the use of cadmium and mercury in new batteries and requiring that batteries can be removed easily from products. Wider Climate Change related legislation includes: The UK Climate Change Bill ( the Carbon Reduction Commitment ( climatechange/uk/business/crc/index.htm The Government plans to issue a third detailed consultation asking for feedback on the draft carbon reduction commitment regulations in February 2009); and the EU Energy and Climate package. In light of these changes, there is likely to be more focus on carbon accounting, reporting and compliance. For example parts of the aviation sector will be included within the EU Emissions Trading Scheme (ETS gov.uk/environment/climatechange/trading/). All intra-eu flights will be covered from 2011 and all flights to/from an EU airport will be covered from There is also debate currently ongoing as to the inclusion of shipping within the EU ETS. A global or regional maritime solution would see significant worldwide implications on (among others) shipping lines, owners, operators, exporters, importers and insurers, and would focus international trade s attention on carbon risk. The commitment of the Government to integrate the Sustainability agenda into policy making for planning, sustainable communities, green construction, regeneration and major projects, for example, demonstrates how important key decision makers feel the role sustainability is in helping the economy recover from the financial crisis. The Government has also signalled that the downturn could be used as a mechanism to stimulate jobs in the green sector. Corporate Sustainability value creation Corporate Sustainability can contribute to improving the financial performance of business. A commitment to corporate responsibility can lead to competitive and ethical differentiation compared with competitors, which can be especially relevant in economic downturns. Many companies realise that there are substantial cost savings to be made from having a sustainability policy in place. Some simple yet impactful changes that can be made from e.g., double-sided printing, switching lights to movement sensitive lighting, investing in micro-generation, cutting down on the wasteful use of energy, increasing recycling and economising with other materials are but a few examples.

29 Audit Committee Institute 26 Organisations can improve their business processes by examining their carbon dioxide emissions and carbon liabilities in their supply chains. By investing in renewable energy, developing environmentally sustainable products & technologies, investing in micro-generation and increasing energy efficiency, organisations can save money and diversify their portfolios. The embedding of environmental, social and governance (ESG) issues into corporate management and operations may be essential to the longterm value and success of an organisation in today s inter-connected global economy. Restoring confidence and trust can be enhanced through long-term sustainable value creation, where Corporate Sustainability is an integral part of ethical business.

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