On 15 September 2014, the President

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1 Editor s Note W elcome to our third edition of ICPAK Technical e-newsletter. As you may be aware the mission of ICPAK is to oversee the development of the accountancy profession in Kenya through: supporting the members professional and business needs, competencies and skills so that they are able to meet clients expectations and employers; protecting the public by ensuring that members adhere to recognised international standards of financial reporting and management; protecting the public interest and promoting the recognition of ICPAK members globally. Capital Gains Tax Accounting Implication on Current and Deferred Tax This edition gives technical updates from the IFRS Foundation, Boards of IFAC and project updates from the professional standards committee, practitioners development committee and the registration and quality assurance committee. Additionally, we provide a highlight of the impact of the reintroduction of capital gains tax on accounting for current and deferred tax on the financial statements. We also give a summary of the IPSASB conceptual framework which comes at an opportune time when the PSASB (K) has adopted IPSAS for public Sector entities. The Institute will continue providing technical support to the Board through capacity building initiatives and promotion of the FiRe Award. It is imperative to that PSASB has proposed to ensure that more than 400 public sector entities participate in 2015 FiRe Award edition. CPA Dr. Patrick Ngumi, PhD - Editor The Mighty Colosseum, an attractive tourist site in Rome was built between AD On 15 September 2014, the President assented to the Finance Bill 2014 (now Finance Act 2014). The Act, among other amendments, re-introduces, with effect from 1st January 2015, Capital Gains Tax (CGT) which was historically chargeable from 1975 until its suspension in The Eighth Schedule, paragraph 2 is amended by providing that income in respect of which CGT is taxable is the whole of a gain which accrues to a company or an individual on or after 1st January, 2015 on the transfer of property situated in Kenya, whether or not the property was acquired before 1st January, Capital gains tax will be chargeable as a final tax at the rate of 5%. The tax is applicable on transfer of properties - transactions in land and buildings, movable and immovable items of a capital nature and shares and marketable securities (with various exemptions). Current tax Because the rate of 5% is different from the current income tax rate of 30%, transactions related to the capital gains tax should be recorded at the capital gains tax at the rate of 5%. This will lead to additional disclosure in relation to the use of a different tax rate in the tax reconciliation required under both Standards. Deferred tax The recognition of deferred tax is the most significant accounting impact arising from the reintroduction of capital gains tax. Prior to the re-introduction of the tax, deferred tax was not recognised on fair value gains arising on financial assets, investments, freehold land and investment property measured at fair value. This was on the premise that any capital gains (note trading gains were always taxable) realized on the disposal of such assets was not taxable. With the re-introduction of capital gains tax, for temporary differences arising from properties carried at fair value, and which are not depreciated, deferred tax will be measured at the capital gains tax rate of 5% whereas for those measured at depreciated amounts or at cost, deferred tax on 1 2

2 financial instruments, thereby removing a source of complexity associated with previous accounting requirements. such temporary differences will be measured at the income tax rate. IAS 12p51 provides that the measurement of deferred tax liabilities and deferred tax assets shall reflect the tax consequences that would follow from the manner in which the entity expects, at the end of the reporting period, to recover or settle the carrying amount of its assets and liabilities. This implies that, any deferred tax on an asset being depreciated should still be measured at the income tax rate. This would include investment property measured using the cost model, but deferred tax on investment property measured at fair value would be at the capital gains rate. The deferred tax should be recognised in other comprehensive income or in profit or loss depending on where the related gain or loss is recognised. The professional standards committee is currently working on a guideline to address the accounting treatment of deferred tax arising from the reintroduction of capital gains tax. IASB Updates 1. Narrow scope amendments IFRS 10 and IAS 28 On 11 September 2014, the International Accounting Standards Board (IASB) issued narrow-scope amendments to IFRS 10 Consolidated Financial Statements and IAS 28 Investments in Associates and Joint Ventures (2011). The amendments address an acknowledged inconsistency between the requirements in IFRS 10 and those in IAS 28 (2011), in dealing with the sale or contribution of assets between an investor and its associate or joint venture. Full gain or loss will be recognised by the investor where the non-monetary assets constitute a business. If the assets do not meet the definition of a business, the gain or loss is recognised by the investor to the extent of the other investors interests. The amendments will only apply when an investor sells or contributes assets to its associate or joint venture. They are not intended to address accounting for the sale or contribution of assets by an investor in a joint operation. The change required by the amendments is likely to increase the pressure on the definition of business and potentially on the classification of joint arrangements under IFRS 11. The amendments are effective for annual periods commencing on or after 1 January Narrow-scope amendments to IAS 27 Separate Financial Statements On 12 August 2014, the International Accounting Standards Board (IASB) published Equity Method in Separate Financial Statements (Amendments to IAS 27). The amendments will allow entities to use the equity method to account for investments in subsidiaries, joint ventures and associates in their separate financial statements. The amendments will help some jurisdictions move to IFRS for separate financial statements, reducing compliance costs without reducing the information available to investors. The amendments respond to requests that the IASB had received during its inaugural public agenda consultation. The amendments are effective for annual periods commencing on or after 1 January Reforms of financial instruments accounting On 24 July 2014, the International Accounting Standards Board (IASB) completed the final element of its comprehensive response to the financial crisis by issuing IFRS 9 Financial Instruments. The package of improvements introduced by IFRS 9 includes a logical model for classification and measurement, a single, forward-looking expected loss impairment model and a substantially-reformed approach to hedge accounting. The new Standard is effective on 1 January 2018 with early application permitted. While issuing the standard, Hans Hoogervorst, Chairman of the IASB stated that the reforms introduced by IFRS 9 are much needed improvements to the reporting of financial instruments and are consistent with requests from the G20, the Financial Stability Board and others for a forward-looking approach to loan-loss provisioning. The Board believes the new Standard will enhance investor confidence in banks balance sheets and the financial system as a whole. We take a look at the key elements of IFRS 9 below:- i. Classification and Measurement Classification determines how financial assets and financial liabilities are accounted for in financial statements and, in particular, how they are measured on an ongoing basis. IFRS 9 introduces a logical approach for the classification of financial assets, which is driven by cash flow characteristics and the business model in which an asset is held. This single, principle-based approach replaces existing rule-based requirements that are generally considered to be overly complex and difficult to apply. The new model also results in a single impairment model being applied to all ii. Impairment The financial crisis, was partly attributed to delayed recognition of credit losses on loans (and other financial instruments) - a weakness in existing accounting standards. As part of IFRS 9, the IASB has introduced a new, expected-loss impairment model that will require more timely recognition of expected credit losses. In particular, the new Standard requires entities to account for expected credit losses from when financial instruments are first recognised and to recognise full lifetime expected losses on a more timely basis. The IASB intends to create a transition resource group to support stakeholders in the transition to the new impairment requirements. iii. Hedge accounting IFRS 9 introduces a substantially-reformed model for hedge accounting, with enhanced disclosures about risk management activity. The new model represents a significant overhaul of hedge accounting that aligns the accounting treatment with risk management activities, enabling entities to better reflect these activities in their financial statements. In addition, as a result of these changes, users of the financial statements will be provided with better information about risk management and the effect of hedge accounting on the financial statements. iv. Own credit IFRS 9 also removes the volatility in profit or loss 3 4

3 that was caused by changes in the credit risk of liabilities elected to be measured at fair value. This change in accounting means that gains caused by the deterioration of an entity s own credit risk on such liabilities are no longer recognised in profit or loss. Early application of this improvement to financial reporting, prior to any other changes in the accounting for financial instruments, is permitted by IFRS 9. The Institute intends to undertake a survey on the intended impact of IFRS 9 on financial institutions and also assess those entities that have earlier adopted IFRS 9. This will assist the Institute in developing a series of e-learn resources on IFRS 9 specifically targeting financial institutions as they prepare to transition to IFRS Annual improvements to IFRSs cycle The IASB recently concluded the annual improvements to IFRS cycle. These set of amendments, whose effective dates is 1 July 2016, impacts 4 standards as summarized below:- i. IFRS 5 - Non-current assets held for sale and discontinued operations The amendment clarifies that, when an asset (or disposal group) is reclassified from held for sale to held for distribution, or vice versa, this does not constitute a change to a plan of sale or distribution, and does not have to be accounted for as such. This implies that the asset (or disposal group) does not need to be reinstated in the financial statements as if it had never been classified as held for sale or held for distribution simply because the manner of disposal has changed. The amendment also rectifies an omission in the standard by explaining that the guidance on changes in a plan of sale should be applied to an asset (or disposal group) which ceases to be held for distribution but is not reclassified as held for sale. ii. IFRS 7 - Financial instruments: Disclosures Two amendments to IFRS 7 as:- Servicing contracts - specifies guidance to help management determine whether the terms of an arrangement to service a financial asset constitute continuing involvement. If an entity transfers a financial asset to a third party under conditions which allow the transferor to derecognise the asset, IFRS 7 requires disclosure of all types of continuing involvement that the entity might still have in the transferred assets. IFRS 7 provides guidance on what is meant by continuing involvement in this context. The amendment is prospective with an option to apply retrospectively. The amendments also include a consequential amendment to IFRS 1 to give the same relief to first-time adopters. Interim financial statements - The amendment clarifies that the additional disclosure required by the amendments to IFRS 7 - Offsetting financial assets and financial liabilities is not specifically required for all interim periods, unless required by IAS 34. The amendment is retrospective. iii. IAS 19 - Employee benefits The amendment clarifies that, when determining the discount rate for post-employment benefit obligations, it is the currency that the liabilities are denominated in that is important, and not the country where they arise. The assessment of whether there is a deep market in high-quality corporate bonds is based on corporate bonds in that currency, not corporate bonds in a particular country. Similarly, where there is no deep market in high-quality corporate bonds in that currency, government bonds in the relevant currency should be used. The amendment is retrospective but limited to the beginning of the earliest period presented. iv. IAS 34 - Interim financial reporting The amendment clarifies what is meant by the reference in the standard to information disclosed elsewhere in the interim financial report. The amendment further amends IAS 34 to require a cross-reference from the interim financial statements to the location of that information. The amendment is retrospective. What next PSC notes that the amendments will not affect every entity. However, if you are affected, the impact could be significant hence need to clearly read the amendments, and where necessary, consult with your auditor or the Institute. These amendments will be included in IFRS trainings in 2015 to equip for implementation. 5. Reporting the financial effects of rate regulation Discussion Paper Many governments regulate the supply and pricing of particular types of activity by entities. These activities usually involve providing goods or services that are considered in that jurisdiction to be essential to customers, including utilities such as electricity and water; oil and gas, and transport services etc. Some forms of rate regulation can significantly affect not only the amount of revenue and profit that a rate rate-regulated entity can earn, but also the timing of the related cash flows. The discussion paper describes a type of rate regulation that contains elements of both cost recovery and incentive approaches this type of rate regulation is termed defined rate regulation. The paper seeks feedback on features that distinguish rate-regulated activities and whether these features result in rights and obligations that should be recognised under IFRS. The IASB has not proposed any particular guidance but the paper outlines some possible accounting solutions, including: recognising the rights and obligations as an intangible asset; an exemption from IFRS to enable rateregulated entities to apply regulatory accounting requirements; developing specific IFRS requirements to defer/accelerate the recognition of costs and/or revenue; and prohibiting recognition of regulatory deferral balances. The discussion paper is open for comment until 15 January What next The PSC will receive comments from members for consideration and inclusion in ICPAK submissions. 5 6

4 IPSASB Updates 1. The IPSASB Conceptual Framework The IPSASB recently approved its conceptual framework. The Conceptual Framework establishes the concepts that will guide the IPSASB s approach to standard-setting and guidance. It addresses concepts applicable to both public sector financial statements and a wider set of public sector financial reporting needs. It identifies and responds to the key characteristics of the public sector, notably that the primary purpose of most governments and public sector entities is to deliver services to citizens and others - the purpose of financial reporting in the public sector is to provide useful information for service recipients and resource providers. The Conceptual Framework for General Purpose Financial Reporting by Public Sector Entities (the Conceptual Framework) underpins the development of International Public Sector Accounting Standards (IPSASs) and Recommended Practice Guidelines (RPGs). The chapters of the Conceptual Framework are: Chapter 1 - Role and Authority of the Conceptual Framework Chapter 2 - Objectives and Users of General Purpose Financial Reporting Chapter 3 - Qualitative Characteristics Chapter 4 - Reporting Entity Chapter 5 - Definition Chapter 6 - Recognition Chapter 7 - Measurement Chapter 8 - Presentation The completed Conceptual Framework is expected to be issued by 31 October The framework comes at a time when Kenya, through the public sector accounting standards board, has promulgated the adoption of IPSAS in Kenya and prepared first set of IPSAS based financial statements. 2. The Applicability of IPSASs to Government Business Enterprises and Other Public Sector Entities. On 27 August 2014, the International Public Sector Accounting Standards Board (IPSASB) released for comment a Consultation Paper, The Applicability of IPSASs to Government Business Enterprises and Other Public Sector Entities. Government Business Enterprises (GBEs) are generally commercially oriented entities that can have a significant impact on a government s financial performance and financial position. State corporations are commercially-oriented entities which nevertheless are able to significantly affect financial situation of their governments. Around the world they differ in size and type of activity they perform; many operate in the industry of transportation and utilities. The definition for Government Business Enterprises is contained in IPSAS 1 Presentation of financial statements. However, IPSAS standards are not developed specifically for GBEs. On the contrary, the scope section of each standard states that those entities should follow IFRSs developed by the IASB since they are profit-oriented!!! The practice, however, demonstrates divergences in practical approaches. Constituents indicate that certain state corporations do not completely fall under GBE requirements; certain components of the key definition are also interpreted differently. The Board proposes the following two alternative approaches to address the issue:- i. the Board will provide high-level characteristics for entities which have to follows its standards (IPSASs). This may be done through its own guidance as well as financial statistics guidance for government sector entities. However, in this case there will no longer be a definition for GBE in IPSASs. ii. the definition will be in place, but the Board will improve and specify it more clearly to account only for profit-making government entities. The Board acknowledges that the first option is more desirable as it is based on principles and takes into account high-level characteristics of target entities. The consultation paper is open for public comment until 31 December 2014 IAASB Updates Handbook of International Quality Control, Auditing, Review, Other Assurance, and Related Services Pronouncements The IASB recently published the 2014 edition of the handbook includes ISAE 3000 (Revised) and Conforming Amendments. A third volume has been added to the handbook that contains the International Framework for Assurance Engagements (previously included 7 8

5 NOV 2014 JAN 2015 in Volume II of the handbook) and the recently issued Framework for Audit Quality: Key Elements that Create an Environment for Audit Quality. The handbook was last issued in Staff-prepared Basis for Conclusions documents for each of the pronouncements included in the handbook. The handbook is available for download via www. iaasb.org while a hard copy can be ordered directly or through the institute. Professional Standards Committee (PSC) Updates In the last quarter, the committee has deliberated on the following:- Companies Bill submissions review of the institute submissions, key among them is the proposal to reduce the exemption threshold as contained in the companies bill 2014 and to remove the provision that the CS will approve auditors. Next phase will include engagement with stakeholders to ensure that provisions in the bill do not impact negatively on the business environment. Issued Guidance on statement of Director s responsibility accompanying financial statements Standard setting the committee provided submissions to the IASB and IFAC Boards on the exposure drafts and discussion papers which were due in this quarter. Successful FiRe Award Review of the accountants (amendment) Bill Technical guidance on deferred tax for life insurance business. What next for the PSC Illustrative financial statements for the year ended 31 December Companies Bill submissions- engagement with stakeholders. Technical guidance on deferred tax on capital gains tax. Technical Release on professional clearance provide clear guidance on how professional clearance should be undertaken. Exposure drafts and discussion papers due during the next quarter. Technical guide on anti money laundering for professional accountants - to provide guidance the accountants and auditors requirement to ensure compliance with proceeds from crimes and anti money laundering laws. Registration and Quality Assurance Committee (RQAC) Updates Review of the audit quality framework Policy guidance on issuance of practicing certificates and annual licenses Review of the accountants act Audit Quality Review for practising accountants and their firms. 9 The Institute of Certified Public Accountants of Kenya (ICPAK) is the professional organization for Certified Public Accountants in Kenya established in 1978 by the Accountants Act, CAP 531 and as amended by the Accountants Act No. 15 of ICPAK is dedicated to development and regulation of the accountancy profession in Kenya so as to enhance its contribution and that of its members to national economic growth and development. In this regard, ICPAK wishes to advise the public that an Accountant by Law is an individual who has qualified by passing the three levels of the CPA examinations and is duly registered by the Institute of Certified Public Accountants of Kenya. For more information on this position paper and other papers on Governance and Accountability please contact us on icpak@icpak.com.