IFRS FOR SMEs 2017 SEMINAR

Transcription

1 1 IFRS FOR SMEs 2017 SEMINAR Presented by: Anton van Wyk M. Com CA (SA) 2

2 Presenter details Anton van Wyk M. Com CA (SA) Cell: Please feel free to add me on LinkedIn for further communication and course information Welcome and agenda for the morning Welcome to the 2017 IFRS for SMEs seminar Agenda for the half-day seminar Estimated duration Provisions and contingencies (S21) 1 hour Financial instruments (S11, S12 & S22) 1.5 hours Foreign currency translation (S30) 30 mins Accounting policies, estimates and errors (S10) 30 mins Events after the end of the reporting period (S32) 15 mins Related party disclosures (S33) 15 mins 4

3 Provisions and contingencies Section 21 of the IFRS for SMEs What is a liability? A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits A present obligation exists when an entity has no realistic alternative but to settle the obligation Present obligations can be Legal Binding contract/agreement Statutory requirements (laws/acts) Constructive Derives from an entity s actions ACTION REACTION

4 Restructuring provisions Separate rules exist! A restructuring is a programme that is planned and controlled by management and materially changes either the scope of a business undertaken by an entity or the manner in which that business is conducted. An entity recognises a restructuring provision ONLY when it has a legal or constructive obligation at the reporting date, to carry out the restructuring. A constructive obligation for restructuring only arises when an entity: Has a detailed formal plan for the restructuring identifying at least: The business or part of business concerned; The principal locations affected; The location, function and approximate number of employees who will be compensated for terminating their services; The expenditures that will be undertaken; and When the plan will be implemented; AND Has raised a valid expectation in those affected that it will carry out the restructuring by starting to implement that plan or announcing its main features to those affected by it. Case study 1 On 22 February 2017, Mr. Jones, an employee of ABC (Pty) Ltd, slipped on a wet floor and broke his leg while at work. He instituted a legal claim against ABC (Pty) Ltd for R to cover alleged medical costs on 15 March 2017, two weeks after the financial year-end of the company. On 20 March 2017, ABC (Pty) Ltd instituted a counterclaim for R against Cleaning (Pty) Ltd, the cleaning company responsible for cleaning the premises of ABC (Pty) Ltd, alleging that they had not put up proper signage indicating that the floor was wet, resulting in the fall of Mr. Jones. The financial statements were authorised for issue on 30 April 2017, at which time the legal claim was still unresolved. Accident Year-end Jones claim ABC claim AFS issued 22/2/17 28/2/17 15/3/17 20/3/17 30/4/17

5 Does a present obligation exist? Present Obligation? YES NO UNCERTAIN Apply recognition Disclose CL or leave Does a deemed criteria: present obligation Probable that benefits will flow out? exist? Probable? Amount can be reliably measured? NO YES Both YES? Both not YES? Recognise liab/provision Disclose CL or leave Application to case study 1 It is clear that there is uncertainty about whether a present obligation exists for ABC (Pty) Ltd. ABC (Pty) Ltd considers whether a deemed present obligation exists by consulting their legal advisers. If the legal advisers are of the opinion that it is probable (i.e. more likely than not) that ABC (Pty) Ltd has a present obligation to Mr. Jones, ABC (Pty) Ltd has a deemed present obligation and will continue to assess the recognition criteria: Is it probable that money will flow from ABC (Pty) Ltd remember: not all parties with present obligations are found guilty in court Can the amount of the claim be reliably measured or estimated by the legal advisers? If the legal advisers do not hold the opinion that ABC (Pty) Ltd has a deemed present obligation, a contingent liability is disclosed in the notes to the financial statements at 28 February Assume the legal advisers professional opinion to be that ABC (Pty) Ltd: Has a deemed present obligation (i.e. they should have ensured that a sign was put up); Will be found guilty by the judge; and Will have to pay an amount of R to Mr. Jones to reimburse him for his actual medical costs. RESULT: ABC (Pty) Ltd will recognise a provision for legal claim to the amount of R at their financial year-end (28 February 2017). The addressed uncertainty relates to the amount of the claim.

6 Application to case study 1 (cont d) Counterclaim? Represents an asset to ABC (Pty) Ltd, and is therefore not dealt with in terms of Section 21 of IFRS for SME s Assets are recognised when they meet the recognition criteria: Probable that future economic benefits will flow to the entity; and The amount can be measured/estimated reliably. HOWEVER: Assets arising out of uncertainty (i.e. contingent assets), can only be recognised (i.e. become assets) when it is VIRTUALLY certain that future economic benefits will flow to the entity (e.g. when an insurance company acknowledges a claim and states that it intends to settle, or when prior case law dictates how a judge is most likely to rule in terms of a court case etc.). RESULT: ABC (Pty) Ltd will disclose the counterclaim in their financial statements (notes) at 28 February 2017, until such time that payment of their claim becomes virtually certain, at which stage a debtor will be recognised. Case study 2 Company X (Pty) Ltd pollutes the environment by means of smoke released by their factories chimneys. During the current financial year, legislation became effective that all air-polluting entities must fit smoke filters to their factories with immediate effect. The cost of such filters for X (Pty) Ltd will be R5 million. The legislation determines that companies in breach of law will be fined R1 million when identified. By 28 February 2017, the financial year-end of X (Pty) Ltd, the company had not fitted smoke filters and have not been fined for their neglect either. The company s luck unfortunately ran out and they were found and fined R1 million for air pollution on 20 March The financial statements were authorised for issue on 30 April Will a liability/provision be recognised, or a contingent liability disclosed or nothing be done in the financial statements of X (Pty) Ltd as at 28 February 2017?

7 Avoidance test Only those obligations that exist INDEPENDENTLY from the future actions of an entity, may be recognised as liabilities Therefore: CAN THE OBLIGATION BE AVOIDED by the entity acting in a certain way, or not acting in a certain way, as at a specified date (usually year-end)? If the obligation cannot be avoided in any realistic way, the entity is presently obligated If the obligation can be avoided in a realistic way, the entity is not (yet) presently obligated Statutory obligations are often a good example of the risk of incorrect recognition Application to case study 2 At financial year-end of X (Pty) Ltd, the company can avoid the settlement of the following statutory obligations, as follows: The obligation to fit smoke filters of R5 million X (Pty) Ltd can stop polluting the air by changing their activities X (Pty) Ltd can sell their factory X (Pty) Ltd can close their business entirely The obligation to pay a fine of R1 million X (Pty) Ltd can fit smoke filters before getting fined X (Pty) Ltd can stop polluting the air by changing their activities X (Pty) Ltd can sell their factory X (Pty) Ltd can close their business entirely It is therefore clear that X (Pty) Ltd has no present obligation in respect of the above two statutory obligations and will not recognise any amount as a liability or a provision X (Pty) Ltd is technically required to disclose a contingent liability in respect of the above two statutory obligations in the notes to the financial statements Prejudicial disclosure? Non-compliance with legislation is an audit issue?

8 Case study 3 Mr. X purchases a ticket for R1 800 from South African Airways (SAA) on 21 August 2017 to fly from OR Tambo International Airport to Cape Town International Airport on 22 December He pays for the ticket with his credit card. The terms and conditions on the ticket clearly state that the ticket is nonrefundable. A similar ticket, if purchased on the date of the flight, would have cost Mr. X R Ignore VAT. Required: How and when should SAA recognise and measure the above sales transaction in their financial accounting records on the relevant dates? IFRS 15 Revenue from Contracts with Customers IFRS 15 released by IASB Effective date 1 January 2017, but earlier adoption permitted Moves away from earnings process, and follows an asset/liability approach Definition of liability therefore very important for revenue recognition Revenue only recognised to the extent that liability is extinguished Steps per IFRS: Identify the contract that will generate the revenue Determine the relevant underlying performance obligations in the contract Determine the contract price Assign the contract price to each performance obligation based on fair value As the performance obligation is extinguished, the revenue is recognised

9 Application to case study 3 When the ticket is sold, SAA has a performance obligation to fly Mr. X to Cape Town from Johannesburg on 22 December They have however been paid and therefore the cash payment was received in advance. SAA will only be able to recognise the money received as revenue once the flight has been completed. What about the terms and conditions stating that the ticket is non-refundable? Journal entries for SAA: 21 August 2017 Dr Bank Cr Income received in advance (F/P) December 2017 Dr Income received in advance (F/P) Dr Interest expense (P/L) 400 Cr Revenue (P/L) Provisions and contingencies Section 21 of the IFRS for SME s Scope Applies to all provisions, contingent liabilities and contingent assets Including: Provisions relating to leases (only in respect of operating leases that have become onerous) Provisions relating to construction contracts Provisions relating to employee benefit obligations Provisions relating to income tax The liability elements of the above 4 items are dealt with in own sections in the IFRS for SME s

10 3 Tiers of Liabilities Outright liabilities RECOGNISED No uncertainty in respect of present obligation No uncertainty in respect of timing or amount Provisions RECOGNISED No uncertainty in respect of present obligation (Addressed) uncertainty in respect of timing or amount Contingent liabilities DISCLOSED OR LEFT, NEVER RECOGNISED Uncertainty in respect of present obligation (Unaddressed) uncertainty in respect of timing or amount Provisions A provision is a liability of (addressed) uncertain timing or amount Recognised only when: Entity has an obligation at the reporting date as a result of a past event; It is probable (i.e. more likely than not) that the entity will be required to transfer economic benefits in settlement; and The amount of the obligation can be estimated reliably. Changes in this amount are therefore regarded changes in estimates"!

11 Case study 4 Company A Ltd is a public non-listed entity. Their annual audit takes place within two months after their year-end. No interim audit is performed. The annual audit fee increases only by inflation (6% per annum) and was R1 million for the previous year. The chief financial officer (CFO) of Y Ltd has asked your opinion on whether a provision for audit fees should actually be recognised by the company at year-end seeing that none of the audit work has been performed by the auditors by yearend. Required: Provide your opinion on the abovementioned question of the CFO of Y Ltd. Assume Y (Pty) Ltd is a private company instead, with a public interest score of 68 and is owner-managed. Would your answer in respect of the above, differ? And if so, how? Past (obligating) event Very important to search for the correct obligation-creating event for each liability and provision Which event creates the obligation for the entity? Is the event a PAST event? What does that mean? Past events versus events after the end of the reporting period ( post-balance sheet events )

12 Application to case study 4 Y Ltd is a public non-listed entity that has to be audited in terms of the Companies Act of 2008 (i.e. legal obligation) The company has no realistic alternative but to be audited and to settle the fee of the audit The past obligating event of the company is the trading of the company which necessitates (triggers) the audit The provision for audit fees survives the avoidance test, as the company will have to be audited and there is nothing that can be done to avoid that (even in liquidation, an audit will be performed) = legal obligation It would be appropriate for Y Ltd to recognise a provision for audit fees Application to case study 4 (cont d) Y (Pty) Ltd is a private company that is owner-managed with a PIS of less than 100 The Companies Act of 2008 does not require for such a company to be audited there is therefore no legal obligation to be audited How to decide? Does the MOI require an audit? Yes: A provision for audit fees should be recognised No: No provision for audit fees should be recognised A case can be made that Y (Pty) Ltd has a constructive obligation to be audited based on the fact that their past behaviour (i.e. electing to be audited since 2008) has created a valid expectation in those affected (the auditors) that the company will act in a certain way (i.e. be audited and pay for the audit) Should such a liability be a provision, or an outright liability? Where is the uncertainty? What about the matching concept? Shouldn t the cost of an audit be matched to the income statement of the period being audited instead of in the next financial year? Some argue that the provision is recognised based on the principle of an onerous contract

13 Case study 5 Company G (Pty) Ltd applies the IFRS for SME s in their annual financial statements. The company leases its head office building in terms of an operating lease at R per month. The company decided on 28 February 2017 (their financial year-end) to vacate the current building and move their head office to another building in a better location. The lease contract can be cancelled, which would incur G (Pty) Ltd a cancellation penalty of R1 million, or G (Pty) Ltd can sublease the building to another tenant at R per month for the remainder of the operating lease contract. There are 36 months left on the lease contract as at the financial year-end of the company. Required: What would the journal entries be in terms of the above information to comply with the requirements of the IFRS for SME s as at 28 February 2017? Assume a nominal post-tax discount rate of 7.2% per annum Onerous contracts An onerous contract is a contract in which the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received under it. If an entity has a contract that is onerous, the present obligation under the contract shall be recognised and measured as a provision. Many contracts (for example, some routine purchase orders) can be cancelled without paying compensation to the other party, and therefore there is no obligation. Other contracts establish both rights and obligations for each of the contracting parties. Where events make such a contract onerous, the contract falls within the scope of this Standard and a liability exists which is recognised. Executory contracts that are not onerous fall outside the scope of this Standard. The unavoidable costs under a contract reflect the least net cost of exiting from the contract, which is the lower of the cost of fulfilling it and any compensation or penalties arising from failure to fulfil it. Before a separate provision for an onerous contract is established, an entity recognises any impairment loss that has occurred on assets dedicated to that contract.

14 Application to case study 5 The least net cost of exiting the contract needs to be calculated: Cost of fulfilment: R R = R per month excess Discounted at 10% per annum for 36 months PV = R Cancellation penalty: R1 million Least net cost of exiting the contract shall be provided, i.e. R Application to case study 5 (cont d) Journal entries at 28 February 2017 Dr Operating lease expense (P/L) Cr Provision for onerous contract (F/P) Journal entries at 28 February 2018 (assume building is sub-leased) Dr Operating lease expense (P/L) Cr Bank Dr Bank Cr Rental income (P/L) Dr Interest on onerous contract (P/L) Cr Provision for onerous contract (F/P) Dr Provision for onerous contract (F/P) Cr Operating lease expense (P/L)

15 Executory contracts What is an executory contract? Both parties have not performed at all OR both parties have performed to the same extent Executory contracts do not contain liability elements Examples: Operating lease instalments not in arrears = executory contract (both parties have performed to the same extent) Operating lease instalments in arrears = non-executory contract (one party (lessor) has outperformed the other (lessee) and lessee therefore incurs liability Valuable test in practice! Measurement of provisions Initial measurement PV of expected future cost of settling the obligation (if effect of time value of money is material) Gains from the expected disposal of assets must be excluded from the measurement of a provision Reimbursement from third parties, for settling the provision Disclosed as contingent liability in notes to AFS Recognised as asset only when virtually certain to occur Amount recognised for reimbursement is limited to amount of provision SoFP: Asset and provision presented separately! SoCI: Expense and reimbursement may be offset and presented net Debit side of provision is an expense, unless an asset is more appropriate (e.g. IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities)

16 Case study 6 Company X (Pty) Ltd owns plant with a cost price of R50 million (excl. VAT). The expected future cost to dismantle the plant after 20 years is R10 million (excl. VAT). An appropriate nominal pre-tax discount rate is 10% per annum. The plant is depreciated over 20 years and there is no residual value. Plant is not revalued in terms of the IFRS for SME s. Calculations: PV of R10 million at 10% p.a. for 20 years = R Journal to recognise plant at initial recognition: Dr Plant Cr Bank/Creditors/LTL Dr Plant Cr Provision for dismantling (F/P) Case study 6 (cont d) Assume that for year 1, the estimates remain unchanged. Journal entries: Dr Interest expense (P/L) Cr Provision for dismantling (F/P) Assume for year 2, that the discount rate changes from 10% p.a. to 9% p.a. on the first day of the year. New PV = R Journal entries: 1 st day of Year 2 Dr Plant (R R ) Cr Provision for dismantling (F/P) End of Year 2 Dr Interest expense (P/L) Cr Provision for dismantling (F/P)

17 Measurement of provisions (cont d) Subsequent measurement Only those expenditures for which the provision was originally recognised, may be charged against a provision Provisions are estimates, and are therefore reviewed at each reporting date Changes in estimates are recognised in profit or loss, unless capitalised to assets per IFRIC 1 Where provisions are measured at present value, the unwinding of the effect of discounting shall be recognised as finance cost in profit or loss Disclosures relating to provisions For each class of provision, the following is disclosed in the notes to the AFS: A reconciliation showing: The CA at the beginning and end of the period Additions during the period (including adjustments due to changes in estimates) Amounts charged against the provision during the period Unused amounts reversed during the period Brief description of the nature of the obligation and the expected amount and timing of any resulting payments Indication of the uncertainties about the amount or timing of those outflows The amount of any expected reimbursement (stating which amount has been recognised as an asset for that reimbursement) Comparative information for prior periods is not required.

18 Disclosure of contingent liabilities Only is the possibility of outflow of resources is not remote For each class of contingent liability, the following: A brief description of the nature of the contingent liability An estimate of its financial effect (if practicable) An indication of the uncertainties relating to the amount or timing of the outflow (if practicable) The possibility of any reimbursement (if possible) Where disclosure is ever impracticable, that fact must be disclosed in the notes to the AFS as well Disclosure of contingent assets Where assets arise out of uncertainty and likelihood of inflow of economic benefits is less than virtually certain, the following is disclosed: A description of the nature of the contingent assets at the end of the reporting period An estimate of the financial effect (only if practicable without undue cost or effort) Where disclosure is ever impracticable, that fact must be disclosed in the notes to the AFS as well

19 Financial instruments Sections 11, 12 and 22 of the IFRS for SMEs Sections in the IFRS for SMEs Section 11: Basic financial instruments Section 12: Other financial instruments issues Section 22: Liabilities and equity

20 Overview of main areas in s11 Scope Section 11 versus section 12? Accounting policy choice (IFRS for SMEs versus full IFRSs (IAS 39)) Basic financial instruments Initial recognition Initial measurement Subsequent measurement Amortised cost and effective interest method Impairment of financial instruments measured at cost or amortised cost Recognition Measurement Reversal Fair value Valuation technique Derecognition of financial assets and financial liabilities Disclosures Examples of financial instruments WITHIN THE SCOPE OF SECTION 11 OF THE IFRS FOR SMEs Cash Demand and fixed term deposits (entity is the depositor) Commercial paper and commercial bills held Accounts receivable Accounts payable Loans receivable Loans payable Bonds and similar debt instruments Investments in non-convertible preference shares Investments in non-puttable ordinary shares and preference shares Commitments to receive a loan, where the commitment cannot be settled net in cash

21 Scope of Sections 11 and 12 S11 and s12 together deal with recognition (including derecognition), measurement and disclosure of financial instruments SECTION 11 SECTION 12 Basic financial instruments More complex financial instruments Relevant to ALL entities with financial instruments Must be considered to ensure correct inclusion or exclusion from scope Accounting policy choice An entity with financial instruments, shall CHOOSE to apply either: Sections 11 and 12 in IFRS for SMEs in FULL; or IAS 39 Financial Instruments: Recognition and Measurement (in full IFRSs) plus the disclosure requirements of Sections 11 and 12 of IFRS for SMEs The above choice is an accounting policy choice! Section 10 Accounting Policies, Estimates and Errors in IFRS for SMEs will apply to changes in accounting policies! Make sure a change made qualifies as a change in accounting policy!

22 Specific scope exclusions The following do not fall within the scope of section 11: Investments in subsidiaries, associates and joint ventures Financial instruments that meet the definition of equity (i.e. entity s own equity) Leases Derecognition per s11 will apply to lease receivables and lease payables S12 may also apply to some leases Employers rights and obligations under employee benefit plans What are basic FI s? Section 11! (a) Cash (b) A debt instrument that meets the prescribed conditions (see next slide) (c) A commitment to receive a loan that: (i) cannot be settled NET in cash; and (ii) when the commitment is executed, is expected to meet the prescribed conditions (d) An investment in non-convertible preference shares and non-puttable ordinary shares or preference shares

23 What are the prescribed conditions? A debt instrument that satisfies (a) to (d) below, shall be accounted for i.t.o. s11: (a) Returns to the holder are (i) a fixed amount (ii) a fixed rate of return over the life of the instrument (iii) a variable return that, throughout the life of the instrument, is equal to a single referenced quoted and observable interest rate (such as LIBOR or prime) (iv) A combination of (ii) and (iii), provided that both rates are positive (b) No contractual provision that determines that the holder can lose the principal amount or any interest attributable to current/prior periods (subordination agreement of debt instrument is not an example of this) (c) Contractual provisions that permit issuer to prepay or holder to put back before maturity are not contingent on future events (d) No conditional returns or repayment provisions except for the variable rate return in (a) (iii) and prepayment provisions in (c) above. Examples satisfy Debt instruments that normally satisfy the prescribed conditions: Trade receivables/trade payables Loans from banks and other 3 rd parties Accounts payable in foreign currency Loans to/from subsidiaries and associates that are due on demand A debt instrument that would become immediately receivable if the issuer defaults on an interest or principal payment

24 Examples don t satisfy Debt instruments that normally don t satisfy the prescribed conditions: An investment in another entity s equity instruments other than non-convertible preference shares or non-puttable ordinary or preference shares Interest rate swap that returns a cash flow that is positive or negative Forward commitment to purchase a commodity or financial instrument that is capable of being cash-settled and that, on settlement, could have positive or negative cash flow (positive and negative cash flows not acceptable) Options and forward contracts (returns not fixed) Investments in convertible debt (return to the holder can vary with price of issuer s equity shares) Loan receivable from 3 rd party that gives the 3 rd party the right or obligation to prepay IF the applicable tax/accounting requirements change (contingent on future events) What is a financial instrument (FI)? A contract (NB) That gives rise to a financial asset of one entity and A financial liability or equity instrument of another entity

25 Initial recognition when? Financial assets (FA s) or financial liabilities (FL s) shall be initially recognised ONLY when the entity becomes a party to the contractual provisions of the instrument Legal form prevails Initial measurement When a FA or FL is recognised initially (i.e. at FIRST recognition), the entity shall measure the FI at its transaction price Transaction costs are usually included in the transaction price If the FA or FL is subsequently measured at fair value through profit or loss, the transaction costs are expensed at initial recognition through profit or loss If the arrangement/agreement, in effect, constitutes a financing transaction, the FA or FL shall be measured at the present value of the future payments discounted at a market rate of interest for similar debt This is normally evident in: Interest-free financing Financing below market-related terms

26 Thoughts on initial measurement Initial measurement is EXTREMELY interesting Goal is to ensure initial measurement at an appropriate amount which is marketrelated If transaction is based on arm s length terms, the transaction price will approximate the fair value of the financial instrument (FA or FL) Therefore always compare transaction terms with market terms!! Possibility 1: Sales/purchase transactions with implicit financing element Possibility 2: Other debt instruments interest below market-related rates Examples of initial recognition Company GHI (Pty) Ltd obtains a long-term loan from ZZZ Bank of R3 million. Interest of 9.5% per annum (nominal and pre-tax) is compounded and paid annually. The loan s capital will be paid back at the end of the 5 year term of the agreement. Similar loans bear interest at 9.5% per annum, nominal and pre-tax It is evident that there is no sign of: An implicit financing element (this is not a sales/purchase transaction) Interest below market-related rates The loan will therefore be initially measured by GHI (Pty) Ltd at the transaction price of R3 million (Test: Discounting future cash flows (interest and capital) will return a present value of R3 million, as the loan s terms are the same as the market-related terms)

27 Examples of initial measurement (2) Parent A grants a loan of R2 million to subsidiary B. The loan is repayable at the end of 5 years and bears nominal interest of 5% per annum, pre-tax. Interest is compounded and paid annually. Loans to entities with a similar risk profile to that of entity B bear market-related interest at 10% per annum, nominal and pre-tax It is evident that there is an effective financing transaction present as the subsidiary and the parent are related parties and the interest rate on the loan is 5% below the market interest rate The loan will be initially measured at the present value of the expected cash flows, as it constitutes an effective financing arrangement FV = R2 million (redemption amount) Pmt = 5% x R2 million = R interest paid annually I/Yr = 10% (market-related) N = 5 (term of loan in years) P/Yr = 1 (compounded annually) Thus PV = R (rounded) The loan will be initially measured at R Examples of initial measurement (3) Purchase or sales transaction = risk of implicit financing element! Company A sells goods to the value of R (excluding VAT) to customer X on credit. Customer X is granted 90 days, which is the standard credit period for all customers, to settle the debt. The prime rate of interest is 10% per annum, nominal and pre-tax The debtor (financial asset) that is recognised by company A is measured initially at the transaction price. As the debt is within the normal credit terms of the company and also short-term (3 months), the amount will be left undiscounted. There is no evidence of an implicit financing element present The trade debtor will be initially measured at R (including VAT) this is the transaction price!

28 Examples of initial measurement (4) Purchase or sales transaction = risk of implicit financing element! Company B sells goods to Customer Z for R2 million on credit and charges no interest. Customer Z is granted 12 months to settle the debt. The credit terms exceed the normal credit terms of company B. The applicable interest rate is 10% per annum, nominal and pre-tax in respect of similar customers The debtor (financial asset) that is recognised by company B is measured initially at the present value of the expected cash flows as it constitutes an effective financing arrangement (there is an implicit financing element present) The trade debtor will be initially measured at the current cash price of the item, or if that price is not available, the present value of the future cash flows discounted at a market-related interest rate (e.g. 10% per annum) Initial measurement summary FI terms market-related? YES NO Measure Implicit financing Other initially element in sales/ debt at transaction purchase transaction instrument price Measure at cash price If not available: Measure initially at PV of future cash flows using I% of similar debt

29 Subsequent measurement of FI s Debt instruments that satisfy prescribed conditions Amortised cost, using the effective interest method Debt instruments classified as current assets or current liabilities Undiscounted amount of cash or other consideration expected to be paid or received, net of impairment where appropriate Unless the arrangement constitutes a financing transaction: PV of future payments discounted at a market-related interest rate for similar debt instrument Commitments to receive a loan: at cost, which could be zero Investments in non-convertible preference shares or non-puttable ordinary or preference shares: If traded publicly or fair value can be reliably Otherwise at cost less impairment Effective interest method? Affected by discounts, premiums and transaction costs The nominal interest rate is not (necessarily) the interest recognised in profit or loss Effective interest takes into account ALLOCATION of items such as transaction costs, discounts/premiums at acquisition, discounts/premiums at redemption and effectively smoothes them over the term of the instrument This is also why the prescribed conditions are important in respect of limiting uncertainty and contingencies and fixing returns (rates and amounts)

30 Example: amortised cost Company DEF (Pty) Ltd issues bonds and receives R2 million in cash on 1/1/2014. The bonds bear interest at 12% per annum (nominal and pre-tax) and are redeemable at R2.2 million (i.e. R premium) at maturity date, being 31/12/2019 (i.e. 5 years). Interest receivable is compounded and received annually at the end of the year. Similar bonds in the market bear interest at 12% per annum, nominal and pre-tax. Transaction costs amount to R and are paid in cash on 1/1/2014. The bonds are debt instruments that satisfy prescribed conditions: Returns: fixed amount, fixed rate No contractual provision that determines that company DEF can lose principle or interest for any current or prior period(s) No contingent prepayment provisions for holder or issuer No conditional returns (not even interest rate is variable) Bond will be subsequently measured at amortised cost, using effective interest method Example (continued) The effective interest rate must be calculated first PV = R2 million less R transaction costs = R net inflow N = 5 years P/Yr = 1 (compounded once per annum) Pmt = (R ) (i.e. R2 million x 12%) FV = (R2.2 million) (redemption amount) Thus: effective I% = 14.24% Why not 12%? Transaction costs reduce net cash inflow by R Redemption premium not reflected in the 12% annual interest

31 Example (continued) Journal entries 1/1/2014 (initial recognition and measurement) Dr Bank Cr Bond liability (recognise bond issued) Dr Bond liability Cr Bank (capitalise transaction costs to bond) 31/12/2014 (subsequent measurement) Dr Interest expense (P/L) Cr Bank Cr Bond liability (bal. figure) (recognise interest at effective rate of 14.24% p.a. on R1.95 million) Example (continued) Journal entries 31/12/2015 Dr Interest expense (P/L) Cr Bank Cr Bond liability (bal. figure) (recognise interest at effective rate of 14.24% p.a.) 31/12/2016 Dr Interest expense (P/L) Cr Bank Cr Bond liability (bal. figure) (recognise interest at effective rate of 14.24% p.a.) 31/12/2017 Dr Interest expense (P/L) Cr Bank Cr Bond liability (bal. figure) (recognise interest at effective rate of 14.24% p.a.) 31/12/2018 Dr Interest expense (P/L) Cr Bank Cr Bond liability (bal. figure) (recognise interest at effective rate of 14.24% p.a.) Dr Bond liability Cr Bank (settlement of bond liability)

32 Impairment testing of FA s At end of each reporting period entity to assess whether objective evidence of impairment of FA s (measured at cost or amortised cost) exists If so, recognise impairment loss in profit or loss What is objective evidence of impairment? Significant financial difficulty or issuer or obligor Breach of contract, such as default in interest or principal payments The creditor (based on debtor s financial difficulty) granting concession to debtor that the creditor wouldn t otherwise consider When it becomes probable that debtor will enter bankruptcy or other financial reorganisation Observable data indicating measurable decrease in future cash flows from a group of FA s (even though decrease cannot as yet be allocated to individual FA s within the group) (e.g. adverse national or local economic conditions or adverse changes in industry conditions) Significant adverse changes in technological, market, economic or legal environment in which entity operates Impairment testing of FA s (2) FA s to be tested individually for impairment Investments in equity instruments of another entity Other FA s that are individually significant Remaining FA s to be tested either individually or grouped based on similar credit characteristics Professional judgement to be used

33 Impairment testing of FA s (3) How is the impairment loss measured? FA s measured at amortised cost: IL = CA of FA less PV of estimated cash flows discounted at the FA s original effective interest rate FA s measured at cost less impairment: IL = CA of FA less best estimate of amount receivable should the FA be sold at reporting date (amount is an approximation, could be zero) Impairment testing of FA s (4) Reversal of impairment loss is allowed/possible If the decrease in the impairment loss can be related objectively to an event occurring after the impairment was recognised (e.g. debtor s credit rating improves) The carrying amount of the FA (after reversal of IL) shall NOT exceed the CA of the FA that would have existed had there never been an impairment loss Journal entry: Dr Financial asset (F/P) XXX Cr Reversal of impairment loss (P/L) XXX Or Dr Allowance for impairment (F/P) XXX Cr Reversal of impairment loss (P/L) XXX

34 Example of impairment of FA s Company A (Pty) Ltd invested in bonds for R5 million with a term of 5 years. The bonds bear coupon interest at 10% p.a. (nominal and pre-tax). Similar bonds also bear coupon interest at 10% p.a. (nominal and pre-tax). The bonds will be redeemed at the end of 5 years (31/12/2016) at a premium of 10% on their par value of R5 million. Interest is calculated and paid annually. Step 1: Calculate effective rate of the FA PV = (R5m) cash outflow FV = R5.5m cash inflow at redemption N = 5 years P/Yr = 1 (compounded annually) Pmt = R (i.e. 10% x R5m) Thus I/Yr = % Example (continued) Step 2: Journalise the transaction in the records of Company A (Pty) Ltd 1/1/2014 Dr Investment in bonds Cr Bank /12/2014 Dr Bank Dr Investment in bonds (bal. figure) Cr Interest received (P/L) /12/2015 Dr Bank Dr Investment in bonds (bal. figure) Cr Interest received (P/L)

35 Example (continued) Assume at the end of year 2015, objective evidence exists that the holder of the bonds is experiencing financial difficulty and cannot make further coupon payments for two years (being 2016 and 2017). The coupon payments will then be made at R for the years ending 2018, 2019 and The bonds will now be redeemed at R5 million + 10% on their par value on 31/12/2020. What is the impairment loss on the bonds? Step 1: Calculate the PV of the expected future cash flows as at 31/12/2015 CF1 and CF2 = 0 CF3 and CF4 = R CF5 = R6.1 million (being R5.5 million + R ) I/Yr = % (the original effective interest rate!!) Thus new PV = R Example (continued) Step 2: Calculate the CA of the FA as at 31/12/2015 R5m (Jnl 1) + R (Jnl 2) + R (Jnl 3) = R Step 3: Compare CA (step 2) to recoverable amount (step 1) R R = R (impairment loss) Journal entry: Dr Impairment loss (P/L) Cr Investment in bonds (F/P) Or Cr Allowance for impairment (F/P) (recognise impairment loss on FA measured at amortised cost)

36 Example (continued) Journal entries for 2016 to 2020 (with revised cash flows) 31/12/2016 (no cash payment of interest by holder) Dr Investment in bonds Cr Interest received (P/L) /12/2017 (no cash payment of interest by holder) Dr Investment in bonds Cr Interest received (P/L) /12/2018 (cash interest payments commence by holder) Dr Bank Dr Investment in bonds Cr Interest received (P/L) /12/2019 Dr Bank Dr Investment in bonds Cr Interest received (P/L) /12/2020 Dr Bank Dr Investment in bonds Cr Interest received (P/L) Dr Bank Cr Investment in bonds Example (continued) Assume on 31/12/2018, objective evidence indicates that the credit rating of the holder of the bonds has improved and the holder can make payment of R interest for 2019 and 2020 and settle the bonds at a premium of 10% on par value on 31/12/2020. This represents a possible reversal of the impairment loss. Step 1: What is the new PV of future cash flows as at 31/12/2018? Pmt = R (given) FV = R5.5 million (given) I/Yr = % (the original effective interest rate!!) N = 2 (i.e and 2020) P/Yr = 1 (compounded annually) Thus PV = R (rounded)

37 Example (continued) Step 2: What is the CA of the FA at 31/12/2018? R (previous PV of cash flow) + R (2016) + R (2017) + R (2018) = R Step 3: What would the CA of the FA have been, had there never been an IL? As at 31/12/2018, the CA of the investment in bonds would have been zero (bonds would have been settled). The reversal of the impairment loss may therefore not be recognised. If it is assumed that the CA of the investment in bonds exceeded R at the date of the reversal of the impairment loss, the reversal of the impairment loss would be done as follows: R R = R (reversal of impairment loss) Journal entry: 31/12/2018 Dr Investment in bonds Or Dr Allowance for impairment Cr Reversal of impairment loss (P/L) FA s measured at fair value Investments in ordinary (equity) shares or preference shares must be measured at fair value, if they are publicly traded or their fair values can be measured reliably Fair value hierarchy, to determine fair value, is as follows: Quoted price for an identical asset in an active market (usually the current bid price) If quoted prices are unavailable, the price of recent transaction for an identical asset (as long as no significant changes have taken place in economic circumstances or no significant time lapse) If the market is not active and recent transactions of an identical asset are not a good estimate of fair value, the entity estimates fair value by using a valuation technique

38 FA s measured at fair value (2) What is a valuation technique? Recent arm s length market transactions for an identical asset between knowledgeable willing parties Reference to the fair value of another asset that is substantially the same as the asset being measured Discounted cash flow analysis Option pricing models Other techniques commonly used by market participants to price the asset and technique has been demonstrated to provide reliable estimates of prices obtained in actual market transactions, such techniques may be used Use market-inputs as far as possible, rather than entity-inputs FA s measured at fair value (3) What if fair value can no longer be reliably measured/estimated? At the date that the fair value can no longer be measured/estimated reliably, its carrying amount (as at the last date the asset was reliably measured at fair value) becomes its new cost The FA will be measured at cost less impairment, until a reliably measured fair value becomes available again

39 Derecognition of FA s FA s shall be derecognised only when: The contractual rights to the cash flows from the FA expire or are settled; or The entity transfers to another party substantially all of the risks and rewards of ownership of the FA; or The entity, despite having retained some significant risks and rewards of ownership, has transferred control of the FA to another party and the other party has the practical ability to sell the FA in its entirety to an unrelated 3 rd party and is able to exercise that ability unilaterally and without needing to impose additional restrictions on the transfer. In this case, the entity shall: Derecognise the FA; and Recognise separately any rights and obligations retained or created in the transfer Derecognition of FA s (2) If a transfer does NOT result in derecognition of a FA because the entity has retained the significant risks and rewards of ownership of the transferred FA, the entity shall continue to recognise the transferred FA in its entirety, and shall recognise a financial liability for the consideration transferred The FA and FL shall NOT be offset In subsequent periods, the entity shall recognise any income received on the transferred asset and any expense incurred on the financial liability

40 Derecognition of FA s (3) If the transferor provides non-cash collateral (e.g. debt or equity instruments) to the transferee, the accounting for the collateral by the two parties depends on whether the transferee has the right to sell or re-pledge the collateral and on whether the transferor has defaulted Accounting is as follows: Transferee has right to sell/re-pledge: transferor reclassifies the FA in the SoFP (e.g. as loaned asset, pledged equity instruments etc.) separately from other assets Transferee sells collateral pledged to it: recognise the proceeds from sale, and a liability measured at fair value for its obligation to return the collateral Transferor defaults and no longer entitled to redeem collateral: derecognise collateral and transferee recognises collateral as its own asset initially at fair value, or if it has already sold the collateral, derecognises its obligation to return the collateral Thus: transferor continues to recognise the collateral and transferee does NOT recognise collateral UNLESS there is default as in previous point Derecognition of FL s An entity shall derecognise a FL (or a part of a FL) only when it is extinguished (when the obligation specified in the contract has been discharged, cancelled or expired) The entity shall recognise in profit or loss any difference between the CA of the FL (or part of a FL) extinguished or transferred to another party and the consideration paid (including non-cash items transferred or liabilities assumed)

41 Example: derecognition appropriate An entity sells a group of its accounts receivable to a bank at less than their face amount. The entity continues to handle collections from the debtors on behalf of the bank, including sending monthly statements, and the bank pays the entity a market-rate fee for servicing the receivables. The entity is obliged to remit promptly to the bank any and all amounts collected, but it has no obligation to the bank for slow payment or non-payment by the debtors. In this case, the entity has transferred to the bank substantially all of the risks and rewards of ownership of the receivables. Accordingly, it removes the receivables from its statement of financial position (derecognises them), and it shows no liability in respect of the proceeds received from the bank. The entity recognises a loss calculated as the difference between the carrying amount of the receivables at the time of sale and the proceeds received from the bank. The entity recognises a liability to the extent that it has collected funds from the debtors but has not yet remitted them to the bank. Example: derecognition inappropriate The facts are the same as the preceding example except that the entity has agreed to buy back from the bank any receivables for which the debtor is in arrears as to principal or interest for more than 120 days. In this case, the entity has retained the risk of slow payment or non-payment by the debtors a significant risk with respect to receivables. Accordingly, the entity does not treat the receivables as having been sold to the bank, and it does not derecognise them. Instead, it treats the proceeds from the bank as a loan secured by the receivables. The entity continues to recognise the receivables as an asset until they are collected or written off as uncollectible.

42 Disclosures IFRS for SMEs (par to 11.48) apply Disclosures required in respect of: Accounting policies for FI s 6 categories of FA s and FL s and their amounts (notes or in SoFP) Derecognition (i.r.o. transferred FA s that don t qualify for derecognition) Collateral (when FA s have been pledged as collateral for liabilities/contingent liabilities) Defaults and breaches on loans payable (details, if not remedied) Items of income, expense, gains or losses on FI s (details, amounts etc.) Section 11: Basic Financial Instruments UPDATES MAY 2015 The accounting policy choice to account for basic financial instruments in terms of the IFRS for SMEs or IAS 39 (in full IFRSs), is retained Even when IAS 39 is finally superseded by IFRS 9 in full IFRSs, a final version of IAS 39 will be retained for reference i.t.o. the IFRS for SMEs Addition of an undue cost or effort exemption from the measurement requirements of investments in equity instruments measured at fair value through profit or loss Clarification of the scope of section 11 and its interaction with other sections of the IFRS for SMEs (specific scope exclusions clarified) Clarification that a bank loan that permits the borrower to terminate the arrangement early, even though the borrower may be required to pay a penalty to compensate the bank for its costs of the borrower terminating the arrangement early would still enable the loan agreement to be treated as a basic financial instrument, given that all the other conditions are still satisfied (this was interpreted before as NOT satisfying the relevant requirement and was included in examples of transactions that would NOT satisfy the requirements to be treated as basic financial instruments)

43 Section 11: Basic Financial Instruments UPDATES MAY 2015 Clarification (by means of examples) what effectively constitutes a financing transaction Payment is deferred beyond normal terms, e.g. providing interest-free credit to a buyer for the sale of goods Financed at a rate of interest that is not a market rate, e.g. an interest-free or below market interest rate loan to an employee Clarification when measuring fair value (the fair value hierarchy) in a binding sale agreement (i.e. level 2 of the hierarchy), that this is an arm s length transaction between knowledgeable, willing parties (old definition of fair value i.t.o. full IFRSs is retained here) Overview of main areas in s12 Scope Section 11 versus section 12? Accounting policy choice (IFRS for SMEs versus full IFRSs (IAS 39)) More complex financial instruments Initial recognition Initial measurement Subsequent measurement Fair value through profit or loss Impairment of financial instruments measured at cost or amortised cost Derecognition of financial assets and financial liabilities Hedge accounting Disclosures

44 Examples of financial instruments WITHIN THE SCOPE OF SECTION 12 OF THE IFRS FOR SMEs Asset-backed securities (e.g. securitised receivables) Options Rights Warrants Futures and forward contracts Interest rate swaps that can be settled net in cash Designated and qualifying hedging instruments Commitments to make a loan to another entity Commitments to receive a loan where the commitment can be settled net in cash Specific scope exclusions (s12) Similar to Section 11 Interests in subsidiaries, associates and joint ventures Employers rights and obligations under employee benefit plans Leases FI s that meet the definition of an entity s own equity instruments Unique to Section 12 FI s covered by Section 11 Rights under insurance contracts Contracts for contingent consideration in a business combination

45 Unique scope considerations (NB) Basic principle: contracts to buy or sell a non-financial item (such as PP&E, a commodity, inventory, intangible asset etc.) are EXCLUDED from section 12 as the contracts are not financial instruments Exception: Contracts to buy or sell a non-financial item will be INCLUDED in section 12 if the contract can be settled: Net in cash or another financial instrument; or By exchanging financial instruments as if the contracts were financial instruments; Except for: contracts that were entered into and continue to be held for the purpose of the physical receipt or delivery of the non-financial item in accordance with the entity s expected purchase, sale or usage requirements = these contracts shall be excluded from the scope of section 12 Unique scope considerations (2) Example Company A (Pty) Ltd is the holder of an option to acquire a machine from Company B (Pty) Ltd at R The option contract is NOT within the scope of section 12 as it is not a financial instrument (reason: machine = PP&E = non-financial item) If the option can be settled net in cash (i.e. company A (Pty) Ltd can demand payment of the difference between the market value of the machine and R at maturity date of the option), the option contract IS within the scope of section 12 as it is now a speculative instrument If the option can be settled net in cash, but company A (Pty) Ltd entered into the option and continues to hold the option for the purpose of the physical delivery of the machine in terms of company A (Pty) Ltd s expected purchase, sale or usage requirements, the option contract is NOT within the scope of section 12 (reason: its purpose is not speculation)

46 Unique scope considerations (3) Section 12 applies to all contracts that impose risks on the buyer or seller that are not typical of contracts to buy or sell tangible items For example: this section applies to contracts that could result in a loss to the buyer or seller as a result of contractual terms that are unrelated to changes in the price of the non-financial item, changes in foreign exchange rates or a default by one of the counterparties Crux: Be on the lookout for unusual contract terms that can cause unusual losses to the buyer/seller of the non-financial item Initial recognition Same as section 11

47 Initial measurement FA s or FL s shall be initially measured at its fair value, which is normally the transaction price Section 11: measure initially at transaction price (look out for unusual interest arrangements, then at PV of future cash flows) Section 12: Transaction costs shall NOT be included in the initial measurement of FI s, as the subsequent measurement is at FVTPL If payment for an asset is deferred or is financed at a rate of interest that is not a market rate, the entity shall initially measure the asset at the present value of the future payments discounted at a market rate of interest Subsequent measurement At the end of each reporting period, an entity shall measure all FI s within the scope of section 12 at fair value and recognise changes in fair value in profit or loss, except as follows: Equity instruments that are not publicly traded and whose fair values cannot be reliably measured (and all contracts linked to such instruments that, if exercised, will result in delivery of such instruments), shall be measured at cost less impairment Amortised cost does not feature within section 12 At the date that the fair value can no longer be measured/estimated reliably, its carrying amount (as at the last date the asset was reliably measured at fair value) becomes its new cost The FA will be measured at cost less impairment, until a reliably measured fair value becomes available again

48 Impairment of FI s (at cost) Same as section 11 Derecognition of FA s and FL s Same as section 11

49 Hedge accounting Special set of rules to account for designated hedging instruments and their hedged items Certain requirements have to be met before hedge accounting can take place Hedge accounting permits the gain or loss on the hedging instrument and on the hedged item to be recognised in profit or loss at the same time Requirements for hedge accounting ALL of the following criteria must be complied with: The entity designates and documents the hedging relationship (risk being hedged, hedged item, hedging instrument is clearly identified) The hedged risk is a qualifying hedged risk specified in the IFRS for SMEs The hedging instrument is a specified hedging instrument specified in the IFRS for SMEs The entity expects the hedging instrument to be highly effective in offsetting the designated hedged risk ( hedge effectiveness is the degree to which changes in fair value or cash flows of the hedged item that are attributable to the hedged risk, are offset by changes in fair value or cash flows of the hedging instrument)

50 Qualifying hedged risks Interest rate risk of a debt instrument measured at amortised cost (not foreign exchange risk: forex gains or losses on hedged item already in P/L (s30) and forex gains or losses on hedging instrument too = therefore effect of hedge accounting is immaterial) Foreign exchange risk OR interest rate risk in a firm commitment or a highly probable forecast transaction Price risk of a commodity it holds, or in a firm commitment or highly probable forecast transaction to purchase or sell a commodity Foreign exchange risk in a net investment in a foreign operation Qualifying hedging instruments Interest rate swap, foreign currency swap, foreign currency FEC, commodity FEC that is expected to be highly effective in offsetting a qualifying risk that is designated as the hedged risk It involves a party external to the reporting entity (i.e. external to the group, segment or individual entity being reported on) Its notional amount is equal to the designated amount of the principal/notional amount of the hedged item It has a specified maturity date, not later than: The maturity date of the hedged item; The expected settlement of the commodity purchase or sale commitment; or The occurrence of the highly probably forecast transaction being hedged. It has no prepayment, early termination or extension features

51 Hedge type 1: fair value hedge Fair value hedge hedges the risk of changes in the fair value of: recognised financial instruments (e.g. interest rate risk on fixed interest rate loans) or commodities held (price risk) Examples of hedging instrument used to hedge designated hedged item s risk: Interest rate swap (swap fixed rate for variable interest rate) Acquisition of put ( sell ) option on commodities Hedge type 1: fair value hedge (2) Changes in the fair value of FAIR VALUE hedges (hedging instrument), are accounted for in profit or loss and the hedging instrument (e.g. interest rate swap or put option) as an asset or liability in the statement of financial position The changes in the fair value of the hedged item are also recognised in profit or loss and an adjustment is made to the carrying amount of the hedged item If hedge accounting is discontinued and the hedged item is an asset or liability carried at amortised cost and has not been recognised, any fair value adjustments (gains/losses) recognised as adjustments to the CA of the hedged item are amortised into profit or loss using the effective interest method over the remaining life of the hedged item

52 Hedge type 1: fair value hedge (3) Hedge accounting is discontinued if: The hedging instrument expires or is sold or terminated; The hedge no longer meets the requirements of hedge accounting; or The entity revokes the designation Hedge type 2: cash flow hedge Cash flow hedge hedges the risk of changes in the cash flows of: recognised financial instruments (e.g. interest rate risk on variable interest rate loans) or firm commitments/highly probable forecast transactions (price risk or foreign exchange risk) net investments in a foreign operation (foreign exchange risk) Examples of hedging instrument used to hedge designated hedged item s risk: Interest rate swap (swap variable rate for fixed interest rate) Foreign currency FEC (on foreign firm commitment or foreign highly probable forecast transactions) to hedge foreign exchange risk Commodity FEC (on foreign firm commitment or highly probable forecast transaction) to hedge price risk Foreign long-term loan obtained (to hedge forex risk on net investment in foreign operation)

53 Hedge type 2: cash flow hedge (2) Changes in the cash flows of CASH FLOW hedges (hedging instrument), are accounted for in other comprehensive income (OCI) and the hedging instrument (e.g. interest rate swap or forex FEC or commodity FEC) as an asset or liability in the statement of financial position only the effective portion! The ineffective portion is recognised in profit or loss The hedging gain/loss recognised in other comprehensive income shall be reclassified ( recycled ) to profit or loss when the hedged item is recognised in profit or loss or when the hedging relationship ends Hedge type 2: cash flow hedge (3) Hedge accounting is discontinued if: The hedging instrument expires or is sold or terminated; The hedge no longer meets the requirements of hedge accounting; or The entity revokes the designation The forecast transaction (which is the hedged item) is no longer highly probable

54 Examples of hedge accounting Example 1: Foreign firm commitment hedged by fair value hedge Company A (Pty) Ltd places a non-cancellable order for inventory on 20 January 2015 to the value of $ The inventory is delivered on 28 February Company A s reporting date is 31 March 2015, at which date the foreign creditor is still unsettled and 40% of the inventory acquired in this transaction had been sold. The foreign creditor is settled at 30 April Company A (Pty) Ltd took out a hedge (foreign exchange FEC) on 20 January 2015 to cover the payment of the creditor on 30 April 2015 at S1 = R9.80. Company A (Pty) Ltd complies with all hedging criteria, except that hedge effectiveness must be assessed on an ongoing basis. The spot rates and FEC rates for similar FEC s than Company A (Pty) Ltd s FEC, are as follows: Spot rate FEC rate 20 January 2015 $1 = R9.50 $1 = R February 2015 $1 = R9.75 $1 = R March 2015 $1 = R9.90 $1 = R April 2015 $1 = R9.98 $1 = R10.30 Examples of hedge accounting (2) Solution 20 Jan 2015 no journal entries as no transaction date and hedge fair value = 0 28 Feb 2015 Effectiveness assessment Gain on hedge: $ x (R10.00 R9.80) = R Loss on transaction: $ x (R9.75 R9.50) = R = 80% = effective Journal entries Dr Forex loss (P/L) Cr FC Liability Dr FEC Asset Cr Hedging gain (P/L) Dr Inventory ($100k x R9.75) Cr Foreign creditor Dr FC Liability Cr Inventory

55 Examples of hedge accounting (3) 31 March 2015 (year-end) Effectiveness assessment Gain on hedge: $ x (R10.22 R9.80) = R Loss on transaction: $ x (R9.90 R9.50) = R = 105% = effective Journal entries Dr Forex loss (P/L) (R R before) Cr Foreign creditor Dr FEC Asset (R R before) Cr Hedging gain (P/L) Dr Cost of sales (40% x (R R25 000)) Cr Inventory Examples of hedge accounting (4) 30 April 2015 (settlement date) Effectiveness assessment Gain on hedge: $ x (R9.98 R9.80) = R Loss on transaction: $ x (R9.98 R9.50) = R = 37.5% = ineffective Journal entries Dr Forex loss (P/L) (R R R25 000) Cr Foreign creditor Dr For. creditor (R975k + R15k + R8k) or ($100k x R9.98) Cr Bank Dr Fair value loss (P/L) (R R R20 000) Cr FEC Asset Dr Bank (R20k + R22k R24k) or ($100k x (R9.98 R9.80)) Cr FEC Asset

56 Examples of hedge accounting (5) Example 2: Foreign highly probable forecast transaction hedged by cash flow hedge Company A (Pty) Ltd places a cancellable order for inventory on 20 January 2015 to the value of $ The inventory is delivered on 28 February Company A s reporting date is 31 March 2015, at which date the foreign creditor is still unsettled and 40% of the inventory acquired in this transaction had been sold. By 30 April 2015 the remainder of the inventory had been sold. The foreign creditor is settled at 30 April Company A (Pty) Ltd took out a hedge (foreign exchange FEC) on 20 January 2015 to cover the payment of the creditor on 30 April 2015 at $1 = R9.80. Company A (Pty) Ltd complies with all hedging criteria, except that hedge effectiveness must be assessed on an ongoing basis. The spot rates and FEC rates for similar FEC s than Company A (Pty) Ltd s FEC, are as follows: Spot rate FEC rate 20 January 2015 $1 = R9.50 $1 = R February 2015 $1 = R9.75 $1 = R March 2015 $1 = R9.90 $1 = R April 2015 $1 = R9.98 $1 = R10.30 Examples of hedge accounting (6) Solution 20 Jan 2015 no journal entries as no transaction date and hedge fair value = 0 28 Feb 2015 Effectiveness assessment Gain on hedge: $ x (R10.00 R9.80) = R Loss on transaction: $ x (R9.75 R9.50) = R = 80% = effective Journal entries Dr FEC Asset Cr Hedging gain (OCI) Dr Inventory ($100k x R9.75) Cr Foreign creditor

57 Examples of hedge accounting (7) 31 March 2015 (year-end) Effectiveness assessment Gain on hedge: $ x (R10.22 R9.80) = R Loss on transaction: $ x (R9.90 R9.50) = R = 105% = effective Journal entries Dr Hedging gain (OCI) Cr Cost of sales (R20k x 40%) Dr Forex loss (P/L) (R R before) Cr Foreign creditor Dr FEC Asset (R R before) Cr Hedging gain (P/L) Dr Cost of sales (40% x R ) Cr Inventory Examples of hedge accounting (8) 30 April 2015 (settlement date) Effectiveness assessment Gain on hedge: $ x (R9.98 R9.80) = R Loss on transaction: $ x (R9.98 R9.50) = R = 37.5% = ineffective Journal entries Dr Forex loss (P/L) (R R R25 000) Cr Foreign creditor Dr For. creditor (R975k + R15k + R8k) or ($100k x R9.98) Cr Bank Dr Fair value loss (P/L) (R R R20 000) Cr FEC Asset Dr Bank (R20k + R22k R24k) or ($100k x (R9.98 R9.80)) Cr FEC Asset Dr Hedging gain (OCI) (R20k x 60%) Cr Cost of sales Dr Cost of sales (R975k x 60%) Cr Inventory

58 Disclosures IFRS for SMEs (par to 12.29) apply Disclosures required in respect of: All disclosures as required in s11, adapted to include FI s as per s12 Disclosures relating to fair value hedges and cash flow hedges Section 12: Other Financial Instruments Issues UPDATES MAY 2015 Clarification of the scope of section 12 and its interaction with other sections of the IFRS for SMEs (specific scope exclusions clarified) Similar adjustments as to section 11 Basic Financial Instruments Consequential adjustments to references to measurement of investments in equity instruments relating to undue cost or effort exemption, as discussed earlier Clarification that hedges measured at fair value that meet the specified requirements (i.e. cash flow hedges) are recognised in other comprehensive income (OCI) Further clarification that the cumulative amount deferred in OCI on a cash flow hedge, is restricted and that the excess above the restriction is recognised in P/L (hedge ineffectiveness is also separately disclosed in the notes) Emphasis that hedge effectiveness is tested cumulatively since inception of the hedge Clarification that amounts deferred in OCI are reclassified to P/L when the hedged item affects P/L (e.g. cost of sales, depreciation, amortised cost model etc.) Clarification that the cumulative amount of exchange differences relating to a hedge of a net investment in a foreign operation deferred in OCI shall NOT be reclassified to P/L upon disposal or partial disposal of the foreign operation Clarification that hedge accounting is discontinued prospectively

59 Overview of main areas in s22 Scope Classification of an instrument as liability or equity Original issue of shares or other equity instruments Sale of options, rights and warrants Capitalisation issues, bonus issues and share splits Convertible debt or similar compound financial instruments Treasury shares Distributions to owners Non-controlling interest and transactions in shares of a consolidated subsidiary Scope Section 22 assists in classification of FI s as either liabilities, or equity Also, how to account for the issue of equity instruments to investors/owners Share-based payment dealt with in section 26 of IFRS for SMEs Entity receives goods/services from its employees as consideration for its equity instruments (e.g. shares and share options) Entity receives goods/services from vendors of goods services in consideration for its equity instruments Specific EXCLUSIONS from the scope Investments in subsidiaries, associates and joint ventures Employers rights and obligations under employee benefit plans Contracts for contingent consideration (from acquirer s perspective) FI s, contracts and obligations under share-based payment transactions (share buy-backs are within the scope of section 22)

60 Classification of FI s as Equity or FL Equity = A L (i.e. E = residual interest, a balancing figure) Includes investments by the owners of the entity PLUS: additions to those investments earned through profitable operations and retained in the entity for use in the entity s operations MINUS: reductions to those investments as a result of unprofitable operations and distributions to owners Liability = present obligation of entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying future economic benefits Liability definition is stronger Summary: Equity vs FL Equity versus FL Does the entity have an unconditional right to avoid settling in cash or another FA? NO FL (fully/partially) YES How settled? Entity s own ordinary shares Other Variable # or Variable R Fixed # and Fixed R FL Equity Equity

61 Classification examples The entity issues debentures that bear interest at 10% per annum (annually compounded and payable in cash). The debentures are compulsorily redeemable in cash at maturity date at par value plus 20% premium. The debentures are initially classified as FL s in full The entity issues preference shares that bear preference dividends at 8% per annum (annually compounded and payable in cash). The preference shares are compulsorily convertible into ordinary shares of the entity at maturity date. The preference shares are initially classified as compound FI s (capital = equity; interest = FL) Classification examples (2) The entity issues preference shares that earn preference dividends at 10% per annum (compounded annually). The preference dividends are non-cumulative in nature, i.e. if not declared, they are forsaken. The preference shares are compulsorily convertible into ordinary shares of the entity at maturity date. The preference shares are initially classified as equity in full The entity issues bonds that bear coupon interest of 10% per annum (compounded annually and payable in cash). The bonds are compulsorily convertible into a number of ordinary shares of the entity equalling the nominal value of the bonds plus a premium of 5% on nominal value. The bonds are initially classified as FL s in full

62 Classification examples (3) The entity issues bonds that bear interest at 12% per annum (annually compounded and payable in cash). The bonds are convertible at the choice of the holder into ordinary shares of the entity at maturity date. If such conversion is not exercised, the bonds are redeemable in cash at par value. The bonds are initially classified as compound FI s (interest = FL, capital = FL, conversion option = equity) The entity issues preference shares that earn preference dividends at 10% per annum (compounded annually and payable in cash). Preference dividends are non-cumulative in nature. The preference shares are convertible at the choice of the issuer (i.e. the entity) into ordinary shares of the entity at maturity date. If such conversion is not exercised, the preference shares are redeemable in cash at par value. The preference shares are initially classified as equity in full Compound financial instruments The ISSUER of a compound financial instrument shall, at initial recognition, recognise separately the FL and equity components of the financial instrument The proceeds of the issue shall be allocated between FL and equity components Steps to follow with compound financial instruments: 1. Value the FL component first (= PV of all cash flows that cannot be unconditionally avoided, discounted at a market rate for a similar instrument without a conversion option, think of interest, dividends and capital!) 2. Allocate the PV (per step 1) to FL and the remainder of the proceeds to equity component (as a balancing figure) 3. Use the effective interest method to subsequently account for the FL 4. Equity is not re-measured

63 Example: compound FI s On 1/1/2014, the entity issues 500 convertible bonds. The bonds are issued at par with a face value of R100 per bond and are for a 5-year term, with no transaction costs. The total proceeds from the issue are R Interest is payable annually in arrears at a nominal interest rate of 4%, pre-tax. Each bond is convertible, at the holder s discretion, into 25 ordinary shares of the issuer at any time to maturity. At the time the bonds are issued, the market interest rate for similar debt that does not have a conversion option, is 6% per annum. Step 1: Value the FL component first. The settlement of the interest payments as well as capital of the bonds cannot be unconditionally avoided and are FL s. FV = R (redemption amount) Pmt = R2 000 (4% x R50 000) (interest payable annually) I/Yr = 6% (use MARKET-RELATED rate as debt is being VALUED) N = 5 P/Yr = 1 Thus PV = R (rounded) Example (continued) Step 2: Allocate the proceeds between FL and equity 1/1/2014 Dr Bank Cr Financial liability (bonds) Cr Equity (conversion option) Step 3: Account for effective interest on FL in subsequent periods 31/12/2014 Dr Interest expense (P/L) Cr Bank (R x 4%) Cr Financial liability (bonds) 747 (balancing figure)

64 Section 22: Liabilities and Equity UPDATES MAY 2015 Addition of clarifying guidance on classification of financial instruments as equity or a liability (focus on the unconditional right to avoid settlement in cash or another financial asset, without which the instrument meets the definition of a financial liability and is classified as such) Exemption from the initial measurement requirements (i.e. at fair value) for equity instruments issued as part of a business combination Clarification that income tax relating to distributions to holders of equity instruments (owners) and to transaction costs of an equity transaction should be accounted for in terms of section 29 Income Tax Modification to require that the liability element of a compound financial instrument is accounted for in the same way as a similar stand-alone financial liability Test the financial liability against the requirements provided in section 11 Basic Financial Instruments to determine whether the liability is to be accounted for i.t.o. section 11 (amortised cost) or section 12 (fair value) i.e. no automatic assumption of amortised cost for the liability element of the compound financial instrument Addition of an undue cost or effort exemption from the requirement to measure the liability to pay a non-cash distribution (dividend) at the fair value of the non-cash assets to be distributed and clarifying guidance on accounting for the settlement of the dividend payable (i.e. difference between dividend paid (i.e. non-cash assets transferred) and the dividend payable at date of settlement, is recognised in P/L) Disclose the fact that the exemption has been used, and the reasons for the undue cost or effort Foreign currency translation Section 30 of the IFRS for SMEs

65 Section 30 Deals with foreign currency translation Scope exclusions Determining the functional currency Foreign currency transactions reported in functional currency Change in functional currency Presentation currency different to functional currency Translation into the presentation currency Translation of foreign operation into the investor s presentation currency Disclosures required Scope of section 30 Two major sections covered: Translating foreign currency transactions and foreign operations into the functional currency of an SME; and Translating the functional currency financial statements into a different presentation currency Exclusions from scope: Accounting for financial instruments denominated in a foreign currency Hedge accounting of foreign currency items

66 How to determine functional currency Each entity must identify its functional currency Functional currency = currency of the primary economic environment in which the entity operates Primary economic environment = the one in which it primarily generates and expends cash Primary indicators (if absolutely conclusive: only these considered) The currency that mainly influences sales prices for goods and services (often the currency in which sales prices for goods/services are denominated and settled) The currency that mainly influences labour, material and other costs of providing goods or services (often the currency in which such costs are denominated and settled) Secondary indicators (if primary not conclusive, or primary indicators mainly conclusive) The currency in which funds from financing activities are generated (e.g. issuing debt and equity instruments) The currency in which receipts from operating activities are usually retained Example: functional currency A stand-alone entity extracts a mineral (commodity) from underground in South Africa. The currency of South Africa is the ZAR. Sales of the commodity are denominated in US Dollar (US$), the local currency of the United States of America. The US$ sales price of the mineral is affected by global supply and demand. The USA accounts for about 50% of global demand for the mineral. About 90% of the entity s costs are for expatriate staff salaries and imported chemicals and specialised machinery imported from the USA. These costs are denominated and settled in US$. The entity s other costs are incurred and settled in ZAR. Functional currency of the entity? The entity s functional currency is the US$ Market forces in the USA economy largely determine: The selling price of the entity s output (USA is major contributor to the global market demand and the entity s sales are denominated and settled in US$) The costs of the entity s inputs (competitive forces and regulations in the USA mainly determine the cost of the entity s inputs (about 90% of its costs are sourced from the USA and denominated and settled in US$

67 Example: functional currency (2) A stand-alone entity based in South Africa, manufactures a product for export to the Netherlands. Labour and raw materials for this product are relatively inexpensive in South Africa. The entity s sales prices are nearly always denominated in Euro (the local currency of the Netherlands) and established predominantly based on competitive forces in the Netherlands and by the Netherlands regulations. Customers settle in Euro and the entity holds it excess cash in Euro only converting sufficient Euro to ZAR to settle its operating costs as they fall due. The majority of the entity s borrowings are in Euro. Most costs are however paid in ZAR. Specialised machinery is purchased from suppliers in Botswana and are denominated in Pula (the local currency of Bostwana). Such costs are not significant when compared to the ZAR-denominated operating costs. Functional currency? Competitive forces in the Netherlands are the predominant influences on the sales prices of the entity s products, which indicates that Euro is its functional currency ZAR is also indicated as possibly being the functional currency because of the majority of raw material and labour costs being influenced by competitive forces in South Africa Economic forces in Botswana are not material because the cost of the machinery imported is not significant Primary indicators are therefore mixed, so secondary indicators are considered The entity generates funds from financing activities in Euro and holds the majority of its cash reserves in Euro Secondary indicators confirm Euro as the functional currency Management is still to apply professional judgement as to the final selection of the functional currency Functional currency: foreign operation? Reporting entity (who has the foreign subsidiary, associate, JV or branch), will consider the following factors to determine whether the functional currency of the foreign operation (FO) is the same as that of the reporting entity (RE): Whether activities of the FO are carried out as extension of the RE, rather than being carried out with a significant degree of autonomy (e.g. FO only sells goods imported from the RE and remits cash back to the RE) Whether transactions with the RE are a high or low proportion of the FO s activities (dependence) Whether cash flows from the FO s activities directly affect the cash flows of the RE and are readily available for remittance to the RE Whether cash flows from the FO s activities are sufficient to service existing and normally expected debt obligations without funds being made available by the RE

68 Example: functional currency (3) Parent company A (with a functional currency of ZAR) manufactures influenza remedies in South Africa. It has a subsidiary in Botswana. The subsidiary is predominantly financed by a loan in Pula (the local currency of Botswana). The subsidiary operates with significant autonomy from the parent. Management of the subsidiary determine, without interference from the parent, the prices of its products, which are mainly influenced by local competition and regulations. The subsidiary uses some of the parent s formulas under a licence agreement, but also develops and produces some of its own formulas to meet local preferences and local health and safety regulations. It manufactures its own products in Botswana with locally sourced raw materials and local labour. It also sells its products to customers in Botswana. Some specialised machinery is purchased from abroad but the cost of such equipment is insignificant in relation to other operating costs. Is the subsidiary autonomous or an extension of the parent company? Primary indicators indicate that Pula is the functional currency Pula is the currency in which sales prices are denominated and settled The prices are determined by competition and government regulation in Botswana Prices are not significantly influenced by international competition, regulations or changes in exchange rates between Pula and other currencies The most significant costs are denominated and settled in Pula The primary indicators all indicate Pula as the functional currency, and therefore any further indicators are not considered Foreign currency transactions A transaction that is denominated or requires settlement in a foreign currency Foreign currency = currency different from the functional currency Initial recognition: Foreign currency translated to functional currency at spot exchange rate at the transaction date Considerations? When is the transaction date? (see next slide for example) A rate that approximates the actual at the transaction date, is often used (e.g. average rate for a week or month etc.) As long as exchange rates do not fluctuate significantly

69 Example: transaction date An SME in Johannesburg (RSA) places a non-cancellable order to import inventories from the United States of America (USA) on 15 January 2015 to the value of $ The goods are shipped free-on-board by the USA supplier on 28 January The goods reach the Durban harbour on 7 February 2015 and clear customs on 9 February The goods are transported via road transport to Johannesburg and reach the SME on 11 February Spot exchange rates were: US$1 =? 15 January 2015 R January 2015 R February 2015 R February 2015 R February 2015 R11.56 Foreign currency transactions (2) Subsequent reporting periods: At the end of each reporting period, an entity shall: Translate foreign currency monetary items using the closing (spot) rate Translate non-monetary items that are measured in terms of historical cost in a foreign currency using the exchange rate at the date of the transaction (i.e. not restated) Translate non-monetary items that are measured at fair value in a foreign currency using the exchange rates at the date when the fair value was determined Exchange differences arising on the settlement or translation of monetary items at rates different to the initial recognition, are recognised in profit or loss when incurred When another section of the IFRS for SMEs requires a gain or loss on a non-monetary item to be recognised in other comprehensive income, an entity shall also recognise any exchange component of that gain or loss in other comprehensive income (the same applies for profit or loss)

70 Example 1: foreign currency transaction SME A (Pty) Ltd receives inventories free-on-board on 31 January 2015 (the order value was $ ). The amount will be settled in cash on 30 April The entity s reporting date is 28 February Spot exchange rates are as follows: $1 = R? 31 January 2015 R February 2015 R April 2015 R11.70 Journal entries? 31 January 2015 (transaction date) Dr Inventory (F/P) ($ x R11.00) R Cr Foreign payable (F/P) R February 2015 (reporting date) Dr Foreign exchange loss (P/L) R Cr Foreign payable (F/P) R ($ x (R11.40 R11.00)) 30 April 2015 (settlement date) Dr Foreign exchange loss (P/L) R Cr Foreign payable (F/P) R ($ x (R11.70 R11.40)) Dr Foreign payable (F/P) R Cr Bank ($ x R11.70) R Example 2: foreign currency loan payable SME B (Pty) Ltd obtained a two-year loan from a foreign bank on 1 January 2015 for FC The loan bears fixed interest at 8% per annum (market-related), payable on 31 December of each year. The FC5 000 capital is settled on 31 December The entity s functional currency is ZAR. FC is a foreign currency. Spot exchange rates are as follows: R1 = FC? 1 January Average exchange rate (2015) December Average exchange rate (2016) December Notes in terms of section 11 Interest is market-related, therefore the loan is accounted for at transaction price of FC5 000, translated into functional currency at spot rate at the date The effective interest rate (used for amortised cost model) is also 8% p.a.

71 Example 2 (continued) 1 January 2015 Dr Bank (FC5 000 / FC5) R1 000 Cr Foreign loan financial liability (F/P) R December 2015 Dr Interest expense (P/L) [(FC5 000 x 8%) / FC5.06] Cr Foreign loan financial liability (F/P) Dr Foreign loan financial liability (F/P) Cr Bank (FC400 / FC5.10) R79 R78 R79 R78 Dr Foreign loan financial liability (F/P) R21 Cr Forex gain (P/L) [(FC5 000 / FC5.10) R1 001] R21 (*) (*) consists of R1 gain on interest and R20 gain on capital Example 2 (continued) 31 December 2016 Dr Interest expense (P/L) [(FC5 000 x 8%) / FC4.90] Cr Foreign loan financial liability (F/P) Dr Foreign loan financial liability (F/P) Cr Bank (FC400 / FC4.80) Dr Forex loss (P/L) [(FC5 000 / FC4.80) R979] Cr Foreign loan financial liability (F/P) R82 R83 R63 R82 R83 R63 Dr Foreign loan financial liability (F/P) R1 042 Cr Bank (FC5 000 / FC4.80) R1 042

72 Change in functional currency The translation procedures applicable to the new functional currency shall be applied prospectively from the date of the change (similar to a change in estimate) Functional currency can only change if there is a change to the underlying transactions, events and conditions relevant to the entity, which are then reflected by another functional currency The entity translates all items into the new functional currency using the exchange rate at the date of the change of the functional currency The resulting translated amounts for non-monetary items are treated as their historical cost Translation into another P/C Presentation currency (PC) is a free choice for the SME AFS can therefore be presented in any currency/(ies) the entity chooses Translation procedures: Assets and liabilities shall be translated at the closing (spot) rate for that statement of financial position (also applies to comparative figures) Income and expenses for each statement of comprehensive income shall be translated at exchange rates at the dates of the transactions (also applied to comparative figures) All resulting exchange differences (i.e. balancing figure) shall be recognised in other comprehensive income (OCI) called a foreign currency translation reserve, or FCTR

73 Example: translation procedures The following trial balance resulted from ABC (Pty) Ltd, who prepared their financial statements in their functional currency of US$ for ABC (Pty) Ltd wishes to present their 2014 financial statements in ZAR for taxation purposes. US$ trial balance as at 31 December 2014: Share capital (contributed 1/1/2013) ($100) Retained earnings (as at 1/1/2014) (*) ($5 000) Property, plant and equipment $6 000 Inventories $1 900 Trade payables ($1 300) Revenue (*) ($7 000) Cost of sales (*) $4 000 Operating expenses (*) $1 000 Taxation (*) $500 (*) = evenly incurred Example: translation procedures (2) The following exchange rates applied: US$1 = R? 1 January 2013 R January 2014 R December 2014 R11.70 Average exchange rate (2014) R11.30 Average exchange rate (2013) R10.00 Prepare the post-translation trial balance as at 31 December 2014 in ZAR Share capital ($100 x R9.50) (R950) Retained earnings (1/1/2014) ($5 000 x R10.00) (R50 000) Property, plant and equipment ($6 000 x R11.70) R Inventories ($1 900 x R11.70) R Trade payables ($1 300 x R11.70) (R15 210) Revenue ($7 000 x R11.30) (R79 100) Cost of sales ($4 000 x R11.30) R Operating expenses ($1 000 x R11.30) R Taxation ($500 x R11.30) R5 650 Foreign currency translation reserve (FCTR) = OCI!! (R9 320)

74 Example: translation procedures (3) The US$ trial balance indicates the following as at 31 December 2015: Share capital (contributed 1/1/2013) ($100) Retained earnings (for 2013) (*) ($5 000) Retained earnings (for 2014) (*) ($1 500) Property, plant and equipment $8 000 Inventories $1 600 Trade payables ($1 400) Revenue (*) ($8 300) Cost of sales (*) $5 000 Operating expenses (*) $1 200 Taxation (*) $500 (*) = evenly incurred Example: translation procedures (4) The following exchange rates applied: US$1 = R? 1 January 2013 R January 2014 R December 2014 R December 2015 R11.50 Average exchange rate (2015) R11.20 Average exchange rate (2014) R11.30 Average exchange rate (2013) R10.00 Prepare the post-translation trial balance as at 31 December 2015 in ZAR Share capital ($100 x R9.50) (R950) Retained earnings (2013) ($5 000 x R10.00) (R50 000) Retained earnings (2014) ($1 500 x R11.30) (R16 950) Property, plant and equipment ($8 000 x R11.50) R Inventories ($1 600 x R11.50) R Trade payables ($1 400 x R11.50) (R16 100) Revenue ($8 300 x R11.20) (R92 960) Cost of sales ($5 000 x R11.20) R Operating expenses ($1 200 x R11.20) R Taxation ($500 x R11.20) R5 600 Foreign currency translation reserve (FCTR) = OCI!! (R8 480)

75 Example: translation procedures (5) Statement of financial position (ZAR) Property, plant and equipment Inventories Total assets Share capital Retained earnings Other comprehensive income Trade payables Total equity and liabilities Example: translation procedures (6) Statement of changes in equity (ZAR) R/E FCTR Opening balance (1 January 2015) Total comprehensive income for the year (840) Closing balance (31 December 2015) Note: the FCTR clearly decreased during 2015 due to the strengthening of the ZAR against the US$.

76 Translation of foreign operations Intragroup monetary assets/liabilities (e.g. intercompany loans) must be eliminated in consolidated financial statements, but resulting exchange differences will remain behind in the consolidated financial statements of the parent company Parent (ZAR) Subs (US$) Loan to S (denominated in US$) R Loan from P (denominated in US$) ($1 000) Spot exchange rate (2015): US$1 = R11.00 Spot exchange rate (2014): US$1 = R10.50 Consolidated AFS of parent (2015) Exchange gain on intragroup loan (P/L) = R500 = will not be eliminated Translation of foreign operations (2) Section 19 Business Combinations and Goodwill deals with the calculation of goodwill arising in a business combination transaction Section 30 determines that: Goodwill arising at the date of acquisition (i.t.o. s19); and Fair value adjustments to assets and liabilities at the acquisition date (i.t.o. s19) are to be regarded as assets and liabilities of the foreign operation They are therefore to be translated to the closing rate at the reporting date and will therefore contribute to the FCTR at reporting date

77 Accounting policies, accounting estimates and errors Section 21 of the IFRS for SMEs Section 10 Deals with accounting policies, changes in accounting estimates and correction of (material) errors in respect of the prior period Accounting policies Selection and application Consistency Changes in accounting policies Application Retrospective application Disclosure requirements Changes in accounting estimates Disclosure requirements Corrections of prior period errors Disclosure requirements

78 Accounting policies - selection Accounting policies = the specific principles, bases, conventions, rules and practices applied by an entity in preparing and presenting financial statements The IFRS for SMEs only applies to events/transactions that are material in the AFS IFRS for SMEs provides accounting treatment, then follow the treatment IFRS for SMEs does NOT provide accounting treatment, then SME s management must use professional judgement in developing and applying an accounting policy that results in information that is: Relevant; and VS Consistency Reliable Comparability Faithful representation Economic substance over legal form From one period to the next Neutral and free from bias and between entities Prudent and Complete in all material aspects If no existing IFRS? Assistance (approach) used to develop and apply own accounting policies by management of SME (hierarchy): Consult IFRS for SMEs for requirements and guidance dealing with similar and related issues; and then Consider the definitions, recognition criteria and measurement concepts for assets, liabilities, income and expenses (and the pervasive principles) in section 2 of the IFRS for SMEs; and then Consider the requirements and guidance in full IFRSs dealing with similar and related issues Select and apply accounting policies consistently for similar transactions, events and conditions unless IFRS for SMEs specifically permits categorisation of items for which different policies may be appropriate

79 Interesting to note Departure from the IFRS for SMEs to achieve a specific outcome (even for immaterial items) is NOT allowed Guidance to IFRS and IFRS for SMEs Integral part of the IFRS for SMEs = mandatory to apply Not integral part = non-mandatory, but highly recommended Changes in accounting policies An SME shall change an accounting policy ONLY if the change: (i) is required by changes made to the IFRS for SMEs (involuntary); OR (ii) results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity s financial position, financial performance or cash flows (voluntary)

80 What is NOT a change in AP? Application of an AP to transactions, events or conditions that differ in substance from those previously occurring Application of a new AP for transactions, events or conditions that did not occur previously (or were immaterial) A change to the cost model when a reliable measure of fair value is no longer available (or vice versa) for an asset that this IFRS for SMEs would otherwise require or permit to be measured at fair value (e.g. investment property) i.e. availability of the fair value of the asset causes a transfer between asset categories/changes in measurement (e.g. investment property to PP&E, or PP&E to investment property ; or an investment in shares of another entity measured at cost fair value through profit or loss and vice versa etc.) Important principle If the IFRS for SMEs allows a choice of accounting treatment (including the measurement basis) for a specified transaction, event or condition and an entity changes its previous choice: That is a change in accounting policy

81 How are changes in AP applied? Involuntary changes in AP Accounted for in terms of transitional provisions, if any, specified in the amendment of the IFRS for SMEs IFRS for SMEs allows IAS 39 to be followed for financial instruments, instead of section 11 and section 12 IAS 39 undergoing significant changes: thus when IAS 39 is amended, follow transitional provisions of the amendment All other changes in AP Retrospective application Apply the new AP to comparative information for prior periods to the earliest date for which it is practicable (as if new AP had always been applied) If impracticable to apply to one/more prior periods the entity shall apply the new AP to the CA s of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable (which may be the current period) Disclosure of change in AP Involuntary changes in AP Nature of the change in AP Current and each prior period presented, to the extent practicable, the amount of the adjustment for each financial statement line-item affected The amount of the adjustment relating to periods prior to those presented, to the extent practicable An explanation if it is impracticable to disclose the above information Voluntary changes in AP Nature of the change in AP The reason(s) why the new AP provides reliable and more relevant information Current and each prior period presented, to the extent practicable, the amount of the adjustment for each financial statement line-item affected The amount of the adjustment relating to periods prior to those presented, to the extent practicable An explanation if it is impracticable to disclose the above information

82 Examples: changes in AP s? SME ABC (Pty) Ltd decides to change the way that their inventory is measured from the first-infirst out (FIFO) basis, to the weighted average cost method. Is this a change in accounting policy? SME DEF (Pty) Ltd determines that the remaining useful life and residual value of a machine needs to be reduced to 5 years instead of 7 years. Is this a change in accounting policy? The IFRS for SMEs is currently being revised in certain areas and when approved, these amendments/improvements will require certain SMEs to amend the accounting treatment adopted for certain transactions. Is this a change in accounting policy? SME JKL (Pty) Ltd decides to measure investment property in terms of the fair value model through profit or loss as from the end of the current financial reporting period. The fair value has never before been reliably measurable for their investment property, but is now. Is this a change in accounting policy? What if the fair value had been reliably measurable before? Changes in accounting estimates Change in accounting estimate = an adjustment to the carrying amount of an asset or liability, or the amount of the periodic consumption of an asset, that results from the assessment of the PRESENT status of, and expected future benefits and obligations associated with, assets and liabilities Changes in AE s result from NEW information and developments Changes in AE s are not corrections of errors! When it is difficult to distinguish a change in accounting estimate from a change in accounting policy, the change is treated as a change in accounting estimate Examples Allowance for doubtful debt is amended Allowance for obsolete inventory is amended Changes in useful lives/residual values/depreciation methods of depreciable assets Warranty obligations and amendments to the carrying amounts of provisions

83 Application of changes in AE s The SME shall recognise the effect of a change in accounting estimate PROSPECTIVELY by including it in profit or loss in: The period of the change (if the change affects that period only); or The period of the change and future periods (if the change affects both) Disclosure of changes in AE s The nature of the change in an accounting estimate The effect of the change on assets, liabilities, income and expenses for the current period If practicable: the estimated effect of the change in one or more future periods

84 Corrections of prior period errors Prior period errors are omissions from, and misstatements in, the entity s financial statements for one or more prior periods arising from a failure to use, or misuse of, reliable information that: Was available when the AFS for those periods were authorised for issue; and Could reasonably be expected to have been obtained and taken into account in the preparation and presentation of those AFS Examples effects of mathematical mistakes, mistakes in applying accounting policies, oversights, misinterpretation of facts, fraud etc. Treatment of prior period errors To the extent practicable, an entity shall correct a material prior period error RETROSPECTIVELY in the first AFS authorised for issue after its discovery, by: Restating comparative amounts for the prior periods presented in which the error occurred; or If the error occurred before the earliest period presented, restating the opening balances of assets, liabilities and equity for the earliest period presented If impracticable to apply to one/more prior periods the entity shall apply the correction to the CA s of assets and liabilities as at the beginning of the earliest period for which retrospective application is practicable (which may be the current period)

85 Disclosure of prior period errors The nature of the prior period error For each period presented, to the extent practicable, the amount of the correction for each financial statement line-item affected To the extent practicable, the amount of the correction at the beginning of the earliest period presented An explanation if it is not practicable to determine the amounts required for the above disclosure items Impracticability considered Retrospective application will always seem impracticable Retrospective information must sometimes be estimated Estimates must reflect the circumstances that existed when the transaction, event or condition occurred Try to isolate information that: Provides evidence of circumstances that existed on the dates as at which the transaction, event or condition occurred and Would have been available when the AFS for that period were authorised for issue Hindsight accounting should be avoided at all cost retrospective application is not an opportunity to achieve a specific outcome or achieve more than one goal at a time!

86 Example SME ABC (Pty) Ltd holds an investment in the shares of another entity. The fair value of the share portfolio has now become readily available as the entity in which the shares are held, listed on the JSE Ltd. ABC (Pty) Ltd measured the investment in the share portfolio at cost (less impairment) as the fair value was not reliably determinable until listing on the JSE Ltd. In the current year, ABC (Pty) Ltd discovered a material error i.r.o. the calculation of the cost price of the share portfolio at initial recognition of the investment. The CFO of ABC (Pty) Ltd has indicated that he wishes to measure the shares at their estimated fair value from initial recognition as that information has now become readily available for the listed investment as part of retrospectively correcting the cost price. Change in accounting policy? Change in accounting estimate? Correction of material prior period error? What is the error? Approach i.r.o. impracticability Apply change in policy/correction of error retrospectively. If impracticable: Apply retrospectively as far back as possible. If impracticable: Use estimates, but not hindsight accounting, to apply retrospectively as far back as possible. If still impracticable: Accept as impracticable and deal with current period only

87 Events after the end of the reporting period Section 32 of the IFRS for SMEs Section 32 Deals with events after the end of the reporting period Defining events after the end of the reporting period (2 types) Recognition and measurement Adjusting events Non-adjusting events Dividends? Non-adjusting events affecting going concern? Disclosure requirements