Implementation of New Standards


The International Accounting Standard Board (IASB) is responsible to issue new International Financial Reporting Standards (IFRSs). IASB published new standards on IFRS 9 Financial Instruments (IFRS 9), IFRS 15 Revenue from Contract with Customers (IFRS 15), IFRS 16 Leases (IFRS 16).

IFRS 15 – Revenue from Contracts with Customers

The International Accounting Standards Board (“IASB”) has published a new standard, IFRS 15 Revenue from contracts with customers (IFRS 15), which replaces all existing revenue guidance including IAS 18 Revenue (IAS 18) and IAS 11 Construction contracts (IAS 11). Under IFRS 15, the performance obligation for each contract must be identified, impacting the percentage of completion on certain projects.

The core principle of the new revenue standard is that revenue should reflect the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

 

A five-step model is provided by the new revenue standard. Entities will apply a five-step model to determine when to recognize revenue, and at what amount. The model specifies that revenue is recognized when or as an entity transfers control of goods or services to a customer at the amount to which the entity expects to be entitled. Depending on whether certain criteria are met, revenue is recognized:

– over time, in a manner that best reflects the entity’s performance; or

– at a point in time, when control of the goods or services is transferred to the customer.

Analysis of the five-step revenue model

How RAS can help you

Our IFRS expert will understand your current accounting policies of financial instruments and will support with following:

  • Detail gap assessment and implementation of IFRS 15
  • Review contract/agreement with customer to identify the key impacts
  • Quantification of IFRS 15 impact
  • Detail disclosure under IFRS 15

IFRS 9 Financial Instruments

IFRS 9 Financial Instruments was issued in July 2014 by the International Accounting Standards Board (IASB) and is intended to replace IAS 39, which is the current standard dealing with financial instruments. IFRS 9 is mandatorily effective for periods beginning on or after 1 January 2018. IFRS 9 addressed three key aspects:

  • Classification and measurement of financial assets and financial liabilities;
  • Impairment; and
  • Hedge accounting

 

The objective of the new classification and measurement model of financial assets is to reflect how cash flows are managed and the nature of cash flows arising from the debt instruments, namely: (a) business model; and (b) solely payments of principal and interests (SPPI), respectively.

On the other hand, the new Expected Credit Loss (ECL) model for the recognition and measurement of impairment aims to address issues around delayed recognition of losses following the global financial crisis and accelerate the timely recognition of losses by requiring provisions to cover both already-incurred losses as well as losses expected in the future.

Impact of IFRS 9 on the financial sector and corporates:

Topic IFRS 9 Impact
Financial sector Corporates
Classification and measurement New model
Expected credit losses (Impairment) New model
Hedge accounting Amended model

 

  1. Classification and Measurement of financial assets and financial liabilities:

 

IFRS 9 contains three principal classification categories for financial assets which are: measured at amortised cost, fair value through other comprehensive income (FVOCI) and fair value through profit or loss (FVTPL). The existing IAS 39 categories of held-to-maturity, loans and receivables, and available-for-sale are removed.

Classification of financial assets depends on the business model test and cash flow characteristics test (i.e. SPPI test).

Objective of business model can be to collect contractual cash flows or both collecting contractual cash flows and selling financial assets or other business model such as trading.

Classification and Measurement – Overview

For assets classified as subsequently measured at amortised cost, interest revenue, expected credit losses and foreign exchange gains or losses are recognised in profit or loss. On de-recognition, any gain or loss is recognised in profit or loss.

For debt assets classified as subsequently measured at FVOCI, interest revenue, expected credit losses, and foreign exchange gains or losses are recognised in profit or loss. Other gains and losses on re measurement to fair value are recognised in Other Comprehensive Income (OCI). On derecognition, the cumulative gain or loss previously recognised in OCI is reclassified from equity to profit or loss.

For assets classified as subsequently measured at FVTPL, all gains and losses are recognised in profit or loss.

Expected Credit Loss – Impairment Loss for corporates

IFRS 9 replaces the ‘incurred loss’ model in IAS 39 with an ‘expected credit loss’ model. IFRS 9 requires an impairment allowance against the amortized cost of financial assets held at amortized cost.

Under the IFRS 9 impairment model, expected credit losses are measured as either 12 month expected credit losses or lifetime expected credit losses.

A simplified approach is available for trade receivables, contract assets and lease receivables, allowing or requiring the recognition of lifetime expected credit losses at all times.

Under the simplified approach, we are not required to estimate any changes in credit risk of the asset from its origination date to the reporting date. All losses are measured as lifetime expected credit losses.

Entities are allowed to use practical expedients when measuring ECLs, as long as the approach reflects a probability-weighted outcome and reflects reasonable and supportable information that is available, without undue cost or effort at the reporting date, about past events, current conditions and forecasts of future economic conditions.

One of the approaches suggested in the standard is the use of a provision matrix as a practical expedient for measuring ECLs on trade receivables.

For instance, the provision rates might be based on days past due (e.g., 1 per cent if not past due, 2 per cent if less than 30 days past due, etc.) for groupings of various customer segments that have similar loss patterns.

The grouping may be based on geographical region, product type, customer rating, the type of collateral or whether covered by trade credit insurance and the type of customer (such as wholesale or retail). To calibrate the matrix, the entity would adjust its historical credit loss experience with forward-looking information.

Under simplified approach, the loss rates for each bucket are computed as the product of the Probability of default (PD) and the Loss given default (LGD) of that particular bucket.

The loss rate is thus given as, the Final ECL is thus given asthe LGD is the loss given default and is given as:

An Illustration of ECL computation is given below:

Financial Asset Bucket Probability of Default Exposure LGD ECL
Receivables 0-30 Days 25%        200,000 25%          12,500
31-60 Days 50%        100,000 25%          12,500
61-90 Days 75%          50,000 25%            9,375
91-120 Days 100%          25,000 25%            6,250
121-720 Days 100%          10,000 25%            2,500
        Total          43,125


Hedging

The objective of hedge accounting should be to reflect the effects of risk management activities in the financial statements.

Under the new requirements, in order to qualify for hedge accounting only prospective hedge effectiveness testing is required and the threshold of 80%-125% for determining hedge effectiveness has been done away with

Prohibition of voluntarily discontinuation of hedge accounting.

How RAS can help you

Our IFRS expert will understand your current accounting policies of financial instruments and will support with following:

  • Detail gap assessment and implementation of IFRS 9
  • Classification and measurement of financial assets and liabilities under IFRS 9
  • ECL model development under IFRS 9
  • Detail disclosure under IFRS 9