December Deloitte Czech Republic. Accounting news Czech Accounting, IFRS and US GAAP. Tax news Direct, indirect and other taxation

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1 Accounting news Czech Accounting, IFRS and US GAAP Tax news Direct, indirect and other taxation Legal news Newly proposed legislative changes Real Estate News Offices the End or a New Beginning? Deloitte Czech Republic

2 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 Accounting news Deloitte Czech Republic US GAAP Simplifying the Measurement of Inventory under US GAAP

3 Accounting news Ten Presentation Issues Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP I have sat down with a bottle of white wine to write an article on presentation in statutory financial statements. This topic may be appreciated by accountants and financial directors in spring when financial statements are prepared. Therefore, I have selected 10 presentation issues I repeatedly encounter in delivering audit and advisory services. In addition to questions related to the balance sheet and profit and loss account, I would also like to focus on the cash flow statement, which is often overlooked. In fact, presentation misstatements to which auditors typically refer as reclassifications are usually less significant than misstatements affecting the results of operations. On the other hand, such misstatements are rather frequent, with some of them being important discussion topics for financial department employees and auditors to clarify their views. Balance Sheet Let us start with the balance sheet. There are two key questions: long-term or short-term characteristics and the identification of assets and liabilities. 1. Presenting long-term and short-term loans We will start at a brisk pace. This really is a burning issue for financial directors of companies that have not met all the covenants set out in a loan agreement with the bank as of the balance sheet date. In this situation, the company is obliged to report the entire loan as a shortterm payable. The only way of avoiding this is to obtain a written confirmation from the bank demonstrating that the bank will not seek immediate repayment of the loan. Czech Accounting Standards require such a declaration to be obtained by the date of preparing the statutory financial statements. International Financial Reporting Standards (IFRS) specify more stringent criteria requiring the bank s declaration issued prior to the balance sheet date. 2. Long-term receivables and payables Common companies analyse the aging structure of receivables and payables in order to focus on past-due items. Items with a future due date are sometimes omitted. Receivables and payables due for more than 12 months after the balance sheet date should be reported as long-term items in the balance sheet. A practical example is the reporting of longterm retention fees, which is a common practice mainly in the construction industry. For instance, 5% of each individual invoice payable in more than a year may not be obvious at first sight if the company does not divide invoices into two parts (commonly payable, retentions). 3. Negative items in balance accounts There are different reasons for negative items in the balance accounts of receivables and payables. From our experience, these usually include credit notes/debit notes, cancellations, unmatched payments or overpayments. When deciding which negative items belong to the balance account and which should be reclassified to the other side of the balance sheet, it is necessary to use the matching principle, ie as to whether it is possible to definitely match a negative item with another item on the balance account. For example, if one is unsure which receivable the unmatched payment relates to, such received payment should be presented as a payable. 2

4 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP 4. Presenting various liabilities The structure of assets is easily comprehensible. On the other hand, the classification of liabilities is more varied, covering liabilities, estimated payables and reserves; therefore, the presentation of liabilities in the above categories may be inaccurate. In some cases, corrections of assets (provisions) are recognised as liabilities, which is of course incorrect. The following table summarises selected examples of liability-related dilemmas: Dilemma Example 1 Example 2 Liabilities vs. Estimates Management bonuses Received invoice, not processed in the system Estimates vs. Reserves Reserves vs. Liabilities Reserve for warranty repairs Judicial judgement, payment order Reserve for outstanding vacation Income tax reserve Profit and Loss Account For the majority of companies, the most frequently monitored indicators in the profit and loss account include sales and the result of operations. Therefore, it is necessary to focus on revenues at first in order to ensure the reliable presentation in the profit and loss account. 5. Income from principal activities or other operating income Companies may report operating income in two sections. Income from principal activities is the most important and, therefore, it should be presented on the first lines of the profit and loss account. Other operating income that does not represent the principal economic activity is recognised in the middle of the profit and loss account, close to the income from the sale of assets and inventory. Typical examples of other operating income include the sale of receivables as well as income from and costs of non-core business activities. The situation is specific in each company and it is, therefore, necessary to pay maximum attention to the most suitable matching of relating costs and income for individual profit or loss lines to have the appropriate informative value. 6. When it is possible to report extraordinary income and expenses Extraordinary income and expenses present transactions that are clearly distinct from the ordinary activities of the company as well as income or expenses from events or transactions that are not expected to recur frequently or regularly. The category of extraordinary income and expenses is not permitted under IFRS and, in our opinion, it should be used only rarely and in exceptional cases in the financial statements prepared in line with Czech Accounting Standards. The inappropriate recognition of items under extraordinary expenses or income may be related to the term materiality. This concept may be perceived differently by the chief accountant, financial director and auditor. A general review of the profit and loss account by the financial director may often reveal an extraordinary transaction that, in fact, is not material and should be reclassified under ordinary operating income. 7. Each line Change in should agree to the balance sheet By applying this simple rule, it is possible to gain simple points for reviewing the correctness of the profit and loss account. Nevertheless, the absence of agreement of the lines Change in reserves and provisions and Change in internally produced inventory with the balance sheet frequently occurs in practice. 3

5 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Cash Flow Statement One step in the preparation of the cash flow statement is completely different from preparing a balance sheet and profit and loss account. Cash flow statements cannot be prepared by pressing a button; it is often manual work, the royal discipline in the area of accounting performed by the chief accountant. The preparation of cash flow statements is discussed in detail in an article by David Batal in the Accounting News from May and June 2014, which I can highly recommend. In this article, I would like to emphasise three areas that I find interesting: 8. Definition of cash and cash equivalents This seemingly simple question becomes interesting in companies that work with an overdraft account, participate in group cash pooling, or have a portion of cash deposited with a notary or otherwise temporarily frozen. In any case, it seems correct to start with the definition of cash and cash equivalents set forth under Section 40 of Regulation No. 500/2002 Coll. Cash equivalents include current liquid assets easily convertible into cash in an amount agreed in advance. Cash equivalents include, for instance, long-term cash deposits with no more than a three-month notice period. It is appropriate to record the company s position and stance on every situation in writing in the form of an internal rule which will guarantee clear justification of the selected solution. 9. Identification of all non-cash items The first and the last number in the cash flow statements are clear now and it is only necessary to address presentation transfers. It is critical to correctly assess operating cash flow, which may be achieved by the successful identification and determination of all non-cash items, predominantly in the area of investments and financing. In the cash flow statement, almost every accountant reports correctly provisions for receivables, inventory or write-offs of receivables representing a transfer within the operating cash flow. However, they sometimes disregard the impact of subsidies on the acquisition of assets or unrealised exchange rate differences from a foreign-currency loan that affect the operating cash flow. 10. Correct presentation of payables from financing Line C.1. Change in payables from financing and stating its correct value is the basis for the successful preparation of cash flow statements. It is desirable to see the results as a true cash flow on this line received and repaid loans between the company and financing institutions. The first step in completing this line involves identifying those payables in the company s balance sheet that the company considers, based on its judgement, payables from financing. The difference between these payables at the end and at the beginning of the reporting period does not provide us with the desired value. It is also necessary to take into account, for example, the impacts of exchange rate differences, capitalisation of payables or outstanding interest allocated to a principal. 4

6 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting Conclusion I am sure that each of you has encountered some of the above topics in practice and that you are able to handle them. If you have a few more minutes, please try to summarise your experience from the reading of this article by completing the following table with Yes or No. If there are any No answers on line C, please do not hesitate to contact me (vmosa@deloittece.com). I will be pleased to get in touch with you and give you my advice. IFRS IFRS Tips A. This topic is relevant for me IFRS EU Endorsement Process B. I can manage Invitation to a Seminar IFRS News 2014 C. Is it true that A=B? US GAAP Simplifying the Measurement of Inventory under US GAAP

7 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 Invitation to a Seminar News in Czech Accounting Prague, Ostrava, Pilsen We would like to invite you to Deloitte s traditional autumn seminar on the news in Czech accounting providing a summary on accounting legislation and legal and tax news having an impact on companies financial statements. The seminar is predominantly intended for accountants, economists and financial managers preparing or involved in the preparation of financial statements under Czech accounting legislation and the related tax and legal regulations and for all of you who want to learn more about Czech accounting and the latest tax and legal developments. Seminars will be held in Czech in November and December in Prague, Pilsen and Ostrava and will be delivered by our professionals. Timing Prague: 10 and 5 Ostrava: 11 Pilsen: 4 More information on: 6 US GAAP Simplifying the Measurement of Inventory under US GAAP

8 Accounting news IFRS Tips Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process In this issue of our IFRS Tips we will focus on our clients inquiries relating to IFRS 13 Fair Value Measurement, which is effective for annual periods beginning on or after 1 January This standard was discussed in greater detail in our Accounting News from September We would like to start with a summary of the major points of the standard. IFRS 13 defines fair value, sets out in a single IFRS a framework for measuring fair value and introduces consistent requirements for fair value measurement disclosures. IFRS 13 does not specify situations in which the fair value measurement is required but stipulates the manner of measuring the fair value if required by another standard. IFRS 13 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The below graph summarises the steps that are necessary for the appropriate fair value measurement under IFRS Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP

9 Accounting news Fair value measurement framework 1. Identity unit of account Czech Accounting Ten Presentation Issues 2. Differentiate between: Invitation to a Seminar News in Czech Accounting 2a. Non-financial assets 2b. Financial assets and financial liabilities 2c. Liabilities and equity instruments IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 Identify highest and best use and valuation premise (i.e. whether value is maximised through standalone use or in combination with other assets and/or liabilities. Consider whether financial assets are grouped with financial liabilities and managed on the basis of net exposure to a market risk (or risks) or counterparty credit risk. Assume measurement-date transfer, and look to measurement data $ related to the instrument held as an asset if quoted prices are not available for transfers. 8 US GAAP 3. Identify principal (or most advantageous) market Simplifying the Measurement of Inventory under US GAAP 4. Identify market participants and the assumptions participants make in determining fair value 5. Select an appropriate valuation technique or techniques and related inputs to determine fair value Market approach Income approach Cost approach 6. If applicable, allocate fair value measures attributable to multiple units of account to the unit of account that is the subject of the fair value measurement. 7. Determine hierarchy classification and prepare disclosures Level 1 Level 2 Level 3

10 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Questions below relate to the points 3 and 4 from the graph above. Identifying the Principal (or Most Advantageous) Market According to IFRS 13.16, for the purposes of measuring the fair value of an asset or liability, the transaction to sell the asset or transfer the liability is assumed to take place either: in the principal market for the asset or liability; or in the absence of a principal market, in the most advantageous market for the asset or liability. The principal market is defined as the market with the greatest volume and level of activity for the asset or liability. [IFRS 13 - Appendix A]. The most advantageous market is defined as the market that maximises the amount that would be received to sell the asset or minimises the amount that would be paid to transfer the liability, after taking into account transaction costs and transport costs. [IFRS 13 - Appendix A]. Question How should an entity identify the principal (or most advantageous) market for an asset or a liability? Answer When identifying the principal or most advantageous market, an entity is required to take into account all information that is reasonably available but it is not required to undertake an exhaustive search of all possible markets. In the absence of evidence to the contrary, the market in which an entity would normally enter into a transaction to sell the asset or to transfer the liability is presumed to be the principal market (or most advantageous market). [IFRS 13.17] Therefore, an entity is permitted to use the price in the market in which it normally enters into transactions unless there is evidence that the principal market and that market are not the same. [IFRS 13.BC53] If there is a principal market for the asset or liability, the fair value measurement should reflect the price in that market, even if the price in a different market is potentially more advantageous at the measurement date. [IFRS 13.18] A principal market may not exist, for example, when the volume or level of activity for the asset or liability is the same in two different markets to which the entity has access, or when there is no observable market for the asset or liability. In such circumstances, an entity needs to identify the most advantageous market or develop assumptions from the perspective of a market participant in a hypothetical most advantageous market. 9

11 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting If there is evidence that the market in which an entity would normally transact is not the principal (or most advantageous) market, the principal (or most advantageous) market should be identified by: firstly, identifying other markets to which the entity has access; and secondly, when relevant, assessing which of two or more accessible markets is the principal (or most advantageous) market. Nevertheless, if the entity has access to the principal market at that date, the entity could measure the asset s fair value using observed prices for sales of similar (but unrestricted) assets in that market. If the restriction is a characteristic of the asset (i.e. it would transfer with the asset in a hypothetical sale), an entity should make an adjustment to observed market prices for similar (but unrestricted) assets to reflect the restriction. IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Each of these aspects is considered further below. Access to the market A market cannot be identified as the principal (or most advantageous) market unless the entity has access to that market at the measurement date. Different entities (and businesses within those entities) with different activities may have access to different markets; consequently, the principal (or most advantageous) market for the same asset or liability might be different for different entities (and businesses within those entities). [IFRS 13.19] Example 7 accompanying IFRS 13 illustrates a scenario in which two entities (retail counterparty and dealer) measure the same instrument (interest rate swap) differently because each identifies its principal market on the basis of the market to which it has access (from the perspective of the retail counterparty, the retail market is the principal market; from the perspective of the dealer, the dealer market is the principal market). Identifying the principal (or most advantageous) market The principal market should be identified on the basis of the volume or level of activity for the asset or liability rather than the volume or level of activity of the reporting entity s transactions in a particular market. [IFRS 13.BC52] Therefore, the assessment as to which of two or more accessible markets is the principal market is made from the perspective of market participants rather than the entity. Equally, in the absence of a principal market, the most advantageous market is identified using the assumptions that market participants would use. Even when there is no observable market for the asset or liability at the measurement date, IFRS requires that a fair value measurement shall assume that a transaction takes place at that date, considered from the perspective of a market participant that holds the asset or owes the liability. 10 Although an entity must be able to access the market, the entity does not need to be able to sell the particular asset or transfer the particular liability on the measurement date to be able to measure fair value on the basis of the price in that market. [IFRS 13.20] For example, as illustrated in Example 8 accompanying IFRS 13, an entity may be restricted from selling a particular asset (e.g. equity instrument) at the measurement date.

12 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Identifying Market Participants when no Apparent Exit Market Exists IFRS requires that, even when there is no observable market to provide pricing information about the sale of an asset or the transfer of a liability at the measurement date, a fair value measurement should assume that a transaction takes place at that date, considered from the perspective of a market participant that holds the asset or owes the liability. That assumed transaction establishes a basis for estimating the price to sell the asset or to transfer the liability. Question How should an entity identify market participants when no apparent exit market exists? Answer When an observable market for an asset or a liability does not exist, an entity must assume a hypothetical transaction at the measurement date. This is consistent with the fair value objective in IFRS 13. When an entity develops a fair value measurement that is based on a hypothetical transaction at the measurement date, the entity is not required to identify specific market participants. Instead, the entity should consider the characteristics of potential market participants who would purchase the asset or accept a transfer of the liability being measured. In addition, the entity should identify the assumptions that such market participants would make in a transaction that maximises the amount received to sell an asset or minimises the amount paid to transfer a liability. Potential market participants include the following (the list is not exhaustive). For non-financial assets, groups of non-financial assets or groups of non- -financial assets and liabilities in a business or cash-generating unit: -- strategic buyers these buyers have related assets and the asset being measured would enhance the value of the business unit within which the buyer would use the asset. Examples of strategic buyers are direct competitors or others with characteristics similar to those of the entity; and -- financial buyers these buyers do not have related or substitute assets. Examples of financial buyers are financial institutional investors and private equity and venture capital investors. For financial instruments: counterparties to a derivative instrument, investors maximising return, investors trying to establish a strategic relationship with an investee or a range of other participants with a specific objective. When identifying a potential market participant, care should be taken to ensure that the unit of account from the perspective of the market participant is consistent with the unit of account of the item being measured. See the next question for a discussion of how to develop assumptions that market participants would use when no apparent exit market exists. 11

13 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Developing Market Participant Assumptions when no Apparent Market Exists Question How should an entity develop the assumptions that market participants would use when no apparent exit market exists? Answer When an observable market for an asset or a liability does not exist, an entity must assume a hypothetical transaction at the measurement date. When developing assumptions that market participants would use in such a hypothetical transaction, an entity may start with its own assumptions and make adjustments for factors specific to the asset or liability being measured, including (the list is not exhaustive): transportation costs necessary to transfer an asset from its current location to the hypothetical market (if location is a characteristic of the asset); conversion costs to transform a non-financial asset from its current condition to its highest and best use from the perspective of potential market participants; synergies that are specific to the entity and not available to market participants and thus would not be taken into account in the hypothetical transaction (e.g. cost savings from synergies related to other groups of assets held by the entity); Market participant assumptions that are developed when no apparent market exists may be based on unobservable inputs or adjustments. An entity needs to evaluate the significance of these inputs or adjustments when determining the appropriate level in the fair value hierarchy within which the measurement should be categorised. [IFRS 13.73] Use of Assumptions that Market Participants would use Entity F uses a discounted cash flow model to measure the fair value of a financial asset. Entity F has obtained information about the assumptions that market participants would use to measure the fair value of the asset. However, Entity F believes that some of those assumptions are not appropriate. Question Is Entity F permitted to rely on its own internal data rather than use the assumptions that market participants would use? Answer No. A fair value measurement is a market-based measurement and not entity-specific. IFRS requires that the fair value of an asset or a liability should be measured using the assumptions that market participants would use when pricing the asset or liability, assuming that market participants act in their economic best interest. 12 growth rates and risk adjustments to reflect market participant assumptions; and performance and risk indicators (e.g. delinquencies, defaults, prepayment speeds and interest rates).

14 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP When using a discounted cash flow model, Entity F should incorporate relevant observable inputs whenever available. Any unobservable inputs used in the fair value measure (e.g. estimated future cash flows or risk adjustments incorporated into the discount rate) should be based on management s estimate of assumptions that market participants would use in pricing the asset in a current transaction at the measurement date. If market data from transactions involving comparable assets indicate, for example, that a significant liquidity discount applies at the measurement date to compensate for the difficulty in selling assets under current market conditions, Entity F should incorporate that information in its cash flow model (e.g. through an adjustment to the discount rate) even if management s internal data would not result in such a liquidity adjustment. Example Entity F uses a discounted cash flows model as a valuation technique to measure the fair value of its investment in the debt securities of Entity X. No quoted price for identical securities is available. Entity F s valuation technique requires assumptions about default rates as inputs. Default rate assumptions can be readily derived from current relevant observable market data for example, actively traded credit default swaps on publicly traded bonds of Entity X, asset swap spreads (the differential between the bond yield and the LIBOR curve expressed in basis points) or issuer spreads on the basis of recent notes issuances. In applying its valuation technique to measure fair value, Entity F should maximise the use of relevant observable inputs. Therefore, Entity F cannot rely solely on its own historical default data for issuers with a credit quality similar to that of Entity X or on its own default assumptions, even if the default assumptions are stressed (e.g. by changing the inputs to other reasonably possible alternative assumptions). Instead, Entity F should use the relevant default rate assumptions that are observable in the market. 13

15 Accounting news IFRS EU Endorsement Process Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 The European Financial Reporting Advisory Group (EFRAG) updated its report showing the status of endorsement of each IFRS, including standards, interpretations, and amendments, most recently on 24 October As of 19 November 2014, the following IASB pronouncements are awaiting European Commission endorsement for use in the EU: Standards IFRS 9 Financial Instruments (issued in July 2014) IFRS 14 Regulatory Deferral Accounts (issued in January 2014) IFRS 15 Revenue from Contracts with Customers (issued in May 2014) Amendments Amendments to IFRS 10 and IAS 28 Sale or Contribution of Assets between an Investor and its Associate or Joint Venture (issued in September 2014) Amendments to IFRS 11 Accounting for Acquisitions of Interests in Joint Operation (issued in May 2014) Amendments to IAS 16 and IAS 38 Clarification of Acceptable Methods of Depreciation and Amortisation (issued in May 2014) Amendments to IAS 16 and IAS 41 Bearer plants (issued in June 2014) Amendments to IAS 19 Defined Benefit Plans: Employee Contributions (issued in December 2013) Amendments to IAS 27 Equity Method in Separate Financial Statements (issued in August 2014) 14 US GAAP Annual Improvements to IFRSs Cycle (issued in December 2013) Simplifying the Measurement of Inventory under US GAAP Annual Improvements to IFRSs Cycle (issued in December 2013) Annual Improvements to IFRSs Cycle (issued in September 2014) Click here for the Endorsement Status Report

16 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 Invitation to a Seminar IFRS News 2014 Prague Dear All, We would like to invite you to Deloitte s traditional autumn seminar on International Financial Reporting Standards (IFRS). You will have the opportunity to learn which new standards, amendments and interpretations will have to be taken into account in preparing financial statements for 2014 and which in the following periods. We will introduce new rules which are either already effective or will become effective in the near future and will show their practical application on a number of examples. The seminar is predominantly intended for accountants, economists and financial managers of projects relating to IFRS and for all who want to know more about IFRS. Seminars will be held in Prague in Czech and will be delivered by our professionals. Timing Prague: 25 November 2014 and 3 More information on: 15 US GAAP Simplifying the Measurement of Inventory under US GAAP

17 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Simplifying the Measurement of Inventory under US GAAP In our Accounting News issued in September 2014 we informed you about a list of new projects run by the US Financial Accounting Standards Board (FASB). One of them was an exposure draft *) on the subsequent measurement of inventory, which was issued in July 2014 with the expected effective date of December As inventory is a topic relevant for many of our clients, it has been chosen as the subject of this article. How Do the Main Provisions Differ from Current U.S. Generally Accepted Accounting Principles (GAAP) and What is the Aim of the Exposure Draft? The main aim of the exposure draft is to simplify the current standard on inventory, which is presented in the FASB Accounting Standards Codification in Topic 330. The current guidance on the measurement of inventory is seen to be unnecessarily complex, because there are several potential outcomes. It currently requires a reporting entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realisable value, or net realisable value less an approximately normal profit margin. To simplify the measurement of inventory, the Board proposes that inventory be measured at the lower of cost and net realisable value, which is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments would eliminate the guidance in Topic 330 that requires a reporting entity also to consider the replacement cost of inventory and the net realisable value of inventory, less an approximately normal profit margin. The proposed Update would also more closely align the measurement of inventory in US GAAP with the measurement of inventory in International Financial Reporting Standards (IAS 2, Inventories). Subsequent Measurement under the Exposure Draft The methods of estimating the cost of inventory under US GAAP (for example average cost, first-in first-out) would not be changed by this proposed update. A departure from the cost basis of pricing inventory is required when the cost of inventory exceeds its net realisable value. Where there is evidence that the net realisable value of inventory is less than cost, whether due to physical deterioration, obsolescence, changes in price levels, or other causes, the difference shall be recognised as a loss in earnings in the period in which it occurs. This is generally accomplished by measuring inventory at the lower of cost and net realisable value. The previous wording of the standard was referring to departure from the cost basis when the utility of the goods is no longer as great as their cost and stating such goods at a lower level commonly designated as market. The proposed wording of the standard seems to be less complex and more easily understandable by the stakeholders. The Board chose net realisable value over market (fair) value because reporting entities understand how to determine the net realisable value of inventory and it should be less costly to apply than the market value, which could have several outcomes. The application of the lower of cost and net realisable value guidance shall consider the form, content, and composition of the inventory. *) Exposure draft is a document released by the Financial Accounting Standards Board (FASB) for public commentary on proposed new accounting standards. The FASB is able to revise the proposed standards based on the information it receives from comment letters (usually sent by practicing accountants who are familiar with the practical impact than new standards would have based on their experience in dealing with similar issues at their firms or with their clients) before it issues a formal pronouncement to implement the new standards. 16

18 Accounting news Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Depending on the character and composition of the inventory, the rule of lower of cost and net realisable value or market may properly be applied either directly to each item or to the total of the inventory (or, in some cases, to the total of the components of each major category). The method shall be that which most clearly reflects periodic income. For example, if an entity uses three components to produce a finished good, it may conclude that it is the most useful to apply the lower of cost and net realisable value guidance to the total cost of inventory related to that finished good. The net realisable value of one of those individual components, on a standalone basis, may decline below its cost. However, if the amount that is expected to be recovered upon sale of the related finished good is in excess of the total cost of inventory related to that finished good, no adjustment is required, provided the guidance is applied consistently from year to year. To the extent, however, that certain goods or materials are excessive in relation to others, the lower of cost and net realisable value guidance shall be applied to the individual items constituting the excess. Unless an effective method of classifying the categories of inventory not constituting the excess is practicable, the guidance shall be applied to each item in the inventory. Changes in Relevant Disclosures Substantial and unusual losses from the application of the lower of cost and net realisable value guidance should be disclosed in the financial statements. No other changes in disclosures are considered in the Exposure draft. Amendments of other subtopics Some of the other guidance in Topic 330 Inventory is being amended to more clearly articulate the requirements for the measurement and disclosure of inventory. Other than the change in the subsequent measurement guidance from the lower of cost or market to the lower of cost and net realisable value, there would be no other changes to the guidance in measuring inventory. The methods of estimating the cost of inventory under US GAAP (for example, average cost; first-in, first-out; last-in, first-out; and the retail inventory method) would not be changed by the amendments in this proposed Update. When Will the Amendments Be Effective and what is the Transition Requirement? The expected effective date of the amendments is for annual periods, and interim periods within those annual periods, beginning after 15 December 2015, with early adoption permitted. The final effective date will depend on feedback from stakeholders on the proposed Update and the issuance date of any final Accounting Standards Update. An entity should apply the proposed guidance prospectively to the measurement of inventory after the date of adoption, the only disclosures required at transition would be the nature of and reason for the change in accounting principle. How Do the Provisions Compare with International Financial Reporting Standards (IFRS)? The proposed Update would also more closely align the measurement of inventory in US GAAP with the measurement of inventory in International Financial Reporting Standards. IAS 2, Inventories, requires inventory to be measured at the lower of cost and net realisable value. The term net realisable value is defined in IAS 2 as the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale, which is similar to the definition in US GAAP. Source: FASB 17

19 Accounting news Contact If you have any questions regarding any of the articles in this publication, please contact one of the following audit experts: Czech Accounting Ten Presentation Issues Invitation to a Seminar News in Czech Accounting IFRS IFRS Tips IFRS EU Endorsement Process Czech Accounting Stanislav Staněk Vratislav Moša IFRS and US GAAP Martin Tesař Soňa Plachá Lenka Neuvirtová sstanek@deloittece.com vmosa@deloittece.com mtesar@deloittece.com splacha@deloittece.com lneuvirtova@deloittece.com Deloitte Advisory s.r.o. Nile House Karolinská 654/ Prague 8 - Karlín Czech Republic Tel.: Fax: Invitation to a Seminar IFRS News 2014 US GAAP Simplifying the Measurement of Inventory under US GAAP Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee ( DTTL ), its network of member firms, and their related entities. DTTL and each of its member firms are legally separate and independent entities. DTTL (also referred to as Deloitte Global ) does not provide services to clients. Please see for a more detailed description of DTTL and its member firms. Deloitte provides audit, tax, consulting, financial advisory and legal services to public and private clients spanning multiple industries. With a globally connected network of member firms in more than 150 countries and territories, Deloitte brings world-class capabilities and high-quality service to clients, delivering the insights they need to address their most complex business challenges. Deloitte s more than 200,000 professionals are committed to becoming the standard of excellence Deloitte Czech Republic

20 Tax news Direct Taxes Changes to Income Taxes Effective from Tax Administration Puts Greater Emphasis on Transfer Pricing Proving the Origin of Assets Amendment to the Act on Investment Incentives BEPS Action 7: Preventing Artificial Avoidance of the Permanent Establishment Status Sanctions against Negligent Tax Administrators The Global Era of Exchanging Information on Financial Accounts: CRS Implementation Tax news Deloitte Czech Republic Indirect Taxes Amendments to the VAT Act Governmental Decree on the Reverse Charge Mechanism Ruling of the Supreme Administrative Court Afs 86/ Appendix Tax liabilities for and Grants & Incentives news SK - Grants New Operational Programme Quality of Environment was approved by EC

21 Tax news Direct Taxes Changes to Income Taxes Effective from Tax Administration Puts Greater Emphasis on Transfer Pricing Proving the Origin of Assets Amendment to the Act on Investment Incentives BEPS Action 7: Preventing Artificial Avoidance of the Permanent Establishment Status Sanctions against Negligent Tax Administrators The Global Era of Exchanging Information on Financial Accounts: CRS Implementation Indirect Taxes Amendments to the VAT Act Governmental Decree on the Reverse Charge Mechanism Ruling of the Supreme Administrative Court Afs 86/ Appendix Tax liabilities for and Grants & Incentives news SK - Grants New Operational Programme Quality of Environment was approved by EC Changes to Income Taxes Effective from The amendment to the Income Tax Act has been passed by the Parliament, signed by the President and will soon be published in the Collection of Acts. We have been informing you of the proposed changes that should impact corporate and personal income tax from the beginning of next year. They are changes based on comments made to some of the amendments that were passed within the recodification of private law last year, the cancellation of the provisions relating to the single collection point, and other changes. Here is the most important news: A positive change is the possibility of the unlimited claiming of taxdeductible items (such as tax losses, R&D tax relief, or gifts) in an additional tax return up until now, it was only possible to claim tax-deductible items against additional income so that the tax base in the additional tax return would be at least CZK 1,000 higher than the original tax base declared in the regular tax return. However, if these tax-deductible items are taken into account by the tax administrator during the tax inspection, they will not be taken into consideration in penalty calculations. Tax-advantageous investment funds will be significantly reduced. Only basic investment funds, which will basically include only publicly accessible funds, will be permitted to use the 5% income tax rate, others (such as the current funds of qualified investors) will be subject to the standard taxation treatment of 19%, like regular business corporations. Refunded share premiums, additional contributions outside the share capital or other similar payments will be subject to the same taxation treatment as, for example, settlement shares or liquidation balance shares (ie the difference between the refund and the tax acquisition price will be subject to a withholding tax of 15% / 35 %). The payments of reserve funds, originally consisting of profits, will be subject to the same tax treatment as decreases of issued capital consisting of profits (in the case of meeting the standard conditions of the relationship between a parent company and a subsidiary, they will be exempt from the withholding tax as profit shares). The income of an investor from paid-out revenues in the case of hybrid instruments, ie Tier 1 additional capital investment tools (defined in Regulation (EU) No. 575/2013), will be subject to the same withholding tax as profit shares. Many taxpayers might find the adjustment to Section 24 (2), letter zc) unpleasant. In line with this change, it will only be possible to consider directly rebilled costs as tax-deductible (ie only such costs for which a specific related income exists). Taxpayers who receive supplies from a related entity for a price other than the arm s length price must increase their tax base by the difference between the transfer prices (unless this difference had already been settled by the related party). In connection with the standard three-year period determining the statute of limitations for receivables, the new Civil Code shortens the period for creating a 100% tax deductible provision against receivables from 36 to 30 months. The shorter period will also be applied to the obligation of additional taxation of past-due payables. A new tax-deductible expense is the write-off of a receivable that was not accounted for as income when it was created, but was recorded in the balance sheet as a result of correcting the previous mistakes, and then was subject to regular income tax. Gratuitous property benefit from a loan for use, a gratuitous bailment or a loan for consumption will be subject to tax, but will be possible to exempt (a limit of up to CZK 100 thousand from one person within the taxation period). However, based on the statement of reasons, the provisions regarding gratuitous property benefit will not apply, for example, to loans for the use of machines, devices, templates and moulds intended for ensuring supplies for the borrower, as these cases do not represent gratuitous income. 2

22 Tax news Direct Taxes Changes to Income Taxes Effective from Tax Administration Puts Greater Emphasis on Transfer Pricing Proving the Origin of Assets Amendment to the Act on Investment Incentives BEPS Action 7: Preventing Artificial Avoidance of the Permanent Establishment Status Sanctions against Negligent Tax Administrators The Global Era of Exchanging Information on Financial Accounts: CRS Implementation Indirect Taxes Amendments to the VAT Act Governmental Decree on the Reverse Charge Mechanism Ruling of the Supreme Administrative Court Afs 86/ Appendix Tax liabilities for and Grants & Incentives news SK - Grants New Operational Programme Quality of Environment was approved by EC In multiple transfers of a business enterprise, ie in its mergers or spin-offs, it will be possible to transfer tax losses. A new definition of finance lease will be introduced, reflecting its economic substance (in accordance with the existing rulings of the Supreme Administrative Court). The possibility of applying a tax exemption in the relationship between a parent company and its subsidiary will be broader and will also apply to the legal statuses of a European company or a cooperative. Discrimination should also be eliminated from the approach to foreign companies with their real management in the Czech Republic, through the application of the EU directive on the common taxation of parent companies and subsidiaries. Thanks to the conclusion of a treaty for the avoidance of double taxation with Liechtenstein, it will also be possible to apply the benefits of the Income Tax Act (exemptions, tax deductions) for the relationships with/taxpayers from the Principality of Liechtenstein. Individuals will have to report to the tax administrator any tax-exempt income of over CZK 5 million. Non-compliance with this obligation will be subject to sanctions. The manner of personal income taxation remains the same (ie the super gross salary remains the tax base for employment income), and so does the calculation of the social security and health insurance (for example the statutory severance payment will still not be subject to insurance). The maximum basis of assessment will only apply to social security premium (CZK 1,277,328 being the limit for 2015); health insurance will not be capped. Also the tax exemption of employee benefits will remain the same, covering healthcare, sport, educational, cultural and leisure facilities: the limit for the exemption of taxes and insurance will only apply to leisure facilities, as previously (CZK 20 thousand), and others will not be limited. Private life insurance will be subject to tax relief if the insurance contract does not enable the surrender of funds before reaching 60 years of age (and not earlier than 60 months from concluding the contract). In contrast to the previous proposals, however, a breach of conditions will only bring obligations for the employee consisting of additional tax in the tax return (without insurance contributions); the employer will not have to correct the tax records retrospectively. In the case of interest-free loans provided to employees with a principal of over CZK 300 thousand, the taxable income (subject to insurance) will be the arm s length interest. Old-age pensioners will once again have the possibility of claiming the basic tax relief (CZK 24,840), and families with more than one child will be able to claim a higher tax relief for the second child and subsequent children (an increase of CZK 2,400 and 3,600 per year). In addition, parents will have the opportunity to claim a tax relief equal to the expenses incurred for placing the child in a kindergarten or another pre-school care institution, up to the amount of the minimum salary. The obligation to file a tax return will not apply to employees who have achieved an income that is subject to a solidary tax increase only in some months of the year (for pre-payments made), and not during the whole year. Employers will be able to prepare the annual reconciliation for these employees already for the year 2014 (provided other conditions are also met). 3