NHF Finance Forums 2012

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1 NHF Finance Forums 2012 SORP and IFRS (or new UK GAAP) Alphabet Soup! Plans for the session Part 1 Part 2 Part 3 Introduction, background, taking stock Implications for housing sector Where do you go from here? 2 1

2 Part 1 Introduction, background, taking stock 3 Introduction and background Plans for convergence of UK GAAP with international standards talked about for a number of years Many sectors have already adopted IFRS - Listed companies - Health bodies - Central and local government There has been significant (long!) debate concerning adoption of IFRS in the housing sector 4 2

3 Introduction and background August 2009 ASB consultation on Future of UK GAAP Autumn 2010 updated consultation, large housing response January 2012 The FRS consultation released ASB recognised impact of previous FRSME on housing sector Proposed accounting regime Tier 1 EU Adopted IFRS Tier 2 The FRS (new UK GAAP) Previous Tier structure EU-listed entities AIM entities Other publicly accountable entities Non publicly accountable entities Current proposals (January 2012) EU-listed entities AIM entities Other entities If required by Company Law Housing Associations Tier 3 FRSSE Small non publicly accountable entities Small entities (as defined by Company Law) 5 The IFRS transition timetable for the housing sector latest position 2014/15 IFRS Comparatives 2015/16 First year of reporting Transition date Opening IFRS balance sheet (1 April 14 for March year ends) Comparative IFRS year end 2014/15 comparatives First IFRS year end 2015/16 Annual report (and 2014/15 comparatives) 6 3

4 Introduction and background Role for Statement of Recommended Practices (SORPs ) - SORPs would still be needed - Provide supplementary (and sector specific guidance) e.g. accounting treatment for: - Leases (Low Cost Home Ownership / shared ownership) - Treatment of grant - Pensions (SHPS) - No transition to IFRS/new UK GAAP allowed for housing until new SORP published Accounts Directions still have same legal status 7 Part 2 Implications for housing sector 8 4

5 Introduction and background Key areas of change The FRS Statement Format Borrowing costs Valuation of property, plant and equipment (including housing properties) Grants Leasing Defined Benefit Pension schemes (SHPS) Financial Instruments (IFRS 9) 9 Statement Format Balance Sheet = Statement of Financial Position I&E/P&L = Statement of Comprehensive Income Statement of Changes in Equity Cash flow Statement = Statement of Cash Flows 10 5

6 Statement of Financial Position Follow Companies Act format - except to the extent that these requirements are not permitted by any statutory framework under which non-company entities report (e.g. Accounts Direction?) Liabilities should be shown as current unless there is an unconditional right to defer settlement for 12 months or more 11 Statement of Comprehensive Income Can show down to profit or loss in a separate income statement Other comprehensive income (OCI) = STRGL equivalent No exceptional items 12 6

7 Statement of Changes in Equity Contain: - total comprehensive income (split into P&L* and OCI) - retrospective restatements for policy changes or error corrections* - dividend payments* - other distributions - issues of shares If an entity has no OCI, and only the *items, it can add these to P&L as a statement of income and retained earnings 13 Statement of Cash Flows Presents changes in cash and cash equivalents Three main headings (operating, investing, financing) 14 7

8 Presentation Fairness Financial statements shall present fairly the financial position, financial performance and cash flows The Companies Act true and fair view Fair presentation = true and fair view Estimates, Errors Estimates corrected prospectively Errors corrected retrospectively 15 Capitalisation of borrowing costs Previous proposals did not allow capitalisation. The FRS now allows capitalisation. Accounting policy choice must be applied consistently. 16 8

9 Tangible fixed assets housing properties Previous proposals did not allow valuation The FRS allows valuation accounting policy choice. Must be applied consistently. What about the Valuation basis? - needs to be an income based model - EUV-SH meets the definition - is EUV-SH still the best model? 17 Property, plant or equipment or investment properties? Will housing properties meet the definition of investment properties under IFRS? Some types of tenure will...which ones? The draft FRS considers concept of held for social benefit - if yes then property, plant or equipment - if no then investment property 18 9

10 Property, plant or equipment or investment properties? Tenure types under consideration? - general needs - shared ownership - market rent - intermediate rent - affordable rents - shared equity - key worker, student accommodation - rent to Homebuy - others? 19 Property, plant or equipment or investment properties? Investment properties - accounted for at valuation - changes in valuation recognised in profit and loss - hold at cost if undue cost or effort in obtaining valuation Current position SORP working party has assessed tenure types against guidance and will consult on its proposals 20 10

11 Grants Current treatment held against asset, depreciate net asset. The FRS allows choice of 2 options: Performance model grant with no conditions is recognised in income when grant is receivable. grant with conditions is recognised in income when grant conditions are met Accruals model classified as either capital or revenue capital grants recognised in income over life of asset revenue grant recognised in income over related costs for grants intended use deferred grant is held as liability and shall not offset the assets 21 Grants FRS 102 gives option to use either performance or accruals method for SHG. Key question - Should an option be given to use either performance or accruals method? Some examples

12 Grants How would performance method apply to SHG? The two proposed approaches to accounting for SHG are either : 1) Take the view that all SHG conditions met and book to I&E as revenue. 2) Conclude that conditions never met so hold all grant as liability until repaid. If assume conditions never met then the higher depreciation charge mentioned previously will not be offset by income from grant amortisation. Consequently there would be a negative impact on the I&E. 23 Example 1: Performance method (all conditions met) Cost 100 (land 30) Grant 50 UEL 100 years Dr Non-current asset cost 100 Cr Cash 100 Dr Cash 50 Cr Grant income 50 Dr Depreciation expense (100-30)/100 = 0.7 Cr Accumulated Depreciation 0.7 Year 1 I&E impact is surplus of (50-0.7) = 49.3 Year 2 I&E impact is deficit of

13 Example 2: Performance method (conditions not met) Cost 100 (land 30) Grant 50 UEL 100 years Dr Non-current asset cost 100 Cr Cash 100 Dr Cash 50 Cr Deferred Income 50 Dr Depreciation expense 0.7 Cr Accumulated Depreciation 0.7 Year 1 I&E impact is deficit of 0.7 Year 2 I&E impact is deficit of Grants How would accruals method apply to SHG? Grant should be accounted for as relating to revenue or grant related to an asset. Where relates to an asset then recognise in I&E over life of asset. Where relates to revenue recognise in I&E over period corresponding to the related costs. Where grant is deferred then recognise as deferred income, not net against value of asset. Accruals method will result in amortisation of grant to I&E over life of asset thereby offsetting (in part) the increased depreciation charge on the asset mentioned previously

14 Example 3: Accruals method Cost 100 (land 30) Grant 50 UEL 100 years Dr Non-current asset cost 100 Cr Case 100 Dr Cash 50 Cr Deferred Income 50 Dr Depreciation expense 0.7 Cr Accumulated Depreciation 0.7 Dr Deferred Income (50/100) = 0.5 Cr Grant income 0.5 Year 1 I&E impact is deficit of ( ) = 0.2 Year 2 I&E impact is deficit of Grants (continued) Current position Sector had 35billion of grant as at 31 March 2011 Transitional treatment not stipulated in FRS. Considering impact on Valuation accounting What about RCGF? What about timing of grant payments? 28 14

15 Pensions Multi-employer scheme e.g. Social Housing Pension Scheme (SHPS) Multi employer exemption still holds... However, liability linked to past service will require recognition Current position SORP working party will consult on outcome 29 Leases Lease standards changing but not yet included in the FRS Finance lease v operating lease - current leases need to be assessed - classification based on who owns risks and rewards? - 90% test removed now a balance of factors - leasing future developments direction of travel is on balance sheet Current position Not a SORP consultation issue as financial impact deemed to be low (although experience is that resource impact is high)

16 Financial Instruments Very complicated and changing... Current position Changes to financial instruments standards on the way IFRS 9, timing very uncertain as content still under review 31 Main impact on sector Valuation of loans and derivatives that have mark-to-market exposure Any embedded derivatives in loan / swap agreements, leases, other complex contracts (for example, rental guarantee agreements) Impairment of financial assets (rent arrears cannot be based on general provisions) Disclosure requirements, onerous and lengthy 32 16

17 What are categories of hedges Fixed rate assets/liabilities Variable rate assets/liabilities Assets/liabilities in foreign currencies Firm commitments Fair Value Hedge Cash Flow Hedge Highly probable forecast transactions Assets / Liabilities / Firm Commitments in foreign currencies Net investments in foreign operations Net investment Hedge Common hedges for housing sector 33 Simply, what is a cash-flow hedge Measure hedging instrument at fair value Effective portion Cash flow hedge reserve Strict rules to prove effectiveness Requires mature systems and documentation Ineffective portion Profit or loss 34 17

18 Part 3 Where do we go from here? 35 Conclusions and what next? Conclusions (at this stage!)... Issue Borrowing Costs Valuation Investment properties Position Choice allowed Choice allowed Tenure types consultation on which ones qualify as IPS Grant Accounting policy change what s the impact? Pensions Leases Financial Instruments Past service cost recognition Detailed exercise but low impact Changing, volatile waiting for IFRS

19 Conclusions and what next? What next? Final FRS planned to be published January 2013 IFRS 9 timing uncertain SORP consultation planned for February 2013 Republished IFRS/new UK GAAP SORP March Practical challenges that arise under IFRS include: Practical Implications of IFRS conversion PROCESS SYSTEMS PEOPLE Accounting policies & procedures Updated & new controls New valuations Impairment modelling Increase data collection Management reporting Budgeting process Accounting and consolidation systems enhancement Data gaps New systems required Update chart of accounts New procedures Training Communication strategy Training strategy Project Management support Resource / skills to manage the change Corporate governance Embedding knowledge new policies and processes 38 19

20 A successful conversion model Phase 1 Phase 2 Phase 3 Impact Assessment 2.1 Project Set-Up 2.2 Component Evaluation & Issues Resolution 2.3 Initial Conversion Embed Change Financial and Accounting Operations and Resources Systems 39 Phase 1: Impact assessment Phase 1 Impact assessment Phase 1.1 Phase 1.2 Phase 1.3 Conduct desktop review High level diagnostic sessions Report findings & develop implementation plan Objectives Identify the principal issues, created by transition to IFRS, which require further investigation; Identify the broad implications of such issues these may be grouped into impact on financial results, processes, systems and people; and Formulate a high level IFRS implementation plan for the next stage of the overall project

Next steps Establish if there is a training need? Get an impact assessment. Produce a detailed implementation plan. Make decisions on appropriate project governance.

pwc.com 07590 352 454 This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice.

21 Next steps Establish if there is a training need? Get an impact assessment. Produce a detailed implementation plan. Make decisions on appropriate project governance. Allocate appropriate resource to the team Communicate : - Internally and - Externally 41 Contacts Phil Cliftlands Director philip.d.cliftlands@uk.pwc.com Guy Flynn Senior Manager guy.w.flynn@uk.pwc.com This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP UK its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP UK. All rights reserved. In this document, refers to PricewaterhouseCoopers LLP UK which is a member firm of PricewaterhouseCoopers International Limited, each member firm of which is a separate legal entity. 21

22 Jargon buster financial instruments Terminology Amortised cost Swap (basic) Cash flow hedge Derivative financial instrument Effective interest method Financial asset Financial liability Meaning = Initial recognition amount - principal payments +/- discounted amortisation - any impairment (financial asset) Interest payments exchanged are based on two different floating rate indices. A hedge of the exposure to variability in cash flows that: - is attributable to a particular risk of asset or liability (e.g. future interest payments on variable rate debt) or a highly probable forecast transaction; and - could affect profit or loss. Swaps, futures, forwards, which create rights and obligations that have the effect of transferring between the parties to the instrument, one or more of the financial risks inherent in an underlying primary financial instrument. Method of calculating the amortised cost of a financial asset or a financial liability (or group of financial assets or financial liabilities) and of allocating the interest income or expense over the relevant period. Any asset that is cash, or contractual right to receive cash (eg, rental debtors) Any liability that is cash (loan), or contractual right to exchange or settle obligations with financial assets. 43 Jargon buster financial instruments Terminology Embedded derivative Closely related Mark-to-Market Callable instrument Meaning Derivative instrument that is embedded in another contract the host contract. The host contract might be a debt or equity instrument, a lease, an insurance contract or a sales or purchase contract. Embedded derivative is part of a host contract (a clause or section) which causes the cash flows from that contract to be modified, based on a specified variable such as interest rate, security price, commodity price, foreign exchange rate, index of prices or rates or other variable. Embedded derivatives will have to be identified, separated and marked-tomarket through the income statement where the economic risks and characteristics of the embedded derivatives are not closely related to those of the host contract. An embedded derivative that modifies a contracts inherent risk (such as a fixed or floating interest rate swap) would be considered closely related. Conversely, an embedded derivative that changes the nature of the risks of a contract is not closely related. Closely related: Inflation linked contracts if not leveraged. Not closely related: Option to extend the remaining term of a debt instrument at a fixed rate. Refers to the valuation of positions or exposure at current market value as opposed to cost. In the detail, mark-to-market is the daily adjustment of open positions to reflect profits and losses resulting from price movements occurring. An instrument that gives the issuer the right to call it back from the holder (that is, to terminate the instrument)

Supporting Older People Conference

Supporting Older People Conference Speakers: Active chair: SP1: The housing SORP but not as we know it! Mei Ashelford Project Director, Accounting and Reporting Policy Team, Financial Reporting Council