Financial reporting
update
By Craig Deegan
December, 2009
.
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Background to this update
The material included in this ‘financial reporting update’ is based on
material recently developed for inclusion in:
Deegan, Craig, Australian Financial Accounting, 6th edition, McGraw Hill
Australia, 2010
.
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Overview of this ‘update’
•
We will start this presentation by considering the current joint
Convergence Project being undertaken by the IASB and FASB, and
how this project is creating significant changes in international financial
reporting requirements.
•
We will then consider two particular areas where there have been
some relatively major recent changes. Specifically, we will consider:
– Recently changed requirements pertaining to how we present financial
statements, in particular, the requirements pertaining to the statement of
comprehensive income and statement of changes in equity
– Recently changed requirements in how we prepare consolidated financial
statements
.
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Overview (cont)
•
We will then consider some areas of financial reporting wherein
significant changes appear likely. Specifically, we will consider likely
future changes in requirements pertaining to:
–
–
–
–
–
•
.
financial statement presentation
the conceptual framework of accounting
accounting for leases
accounting for joint ventures
revenue recognition principles
We will then summarise some recent changes in terminology that have
been embraced by the IASB
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The IASB/FASB Convergence Project
.
•
While a number of countries throughout the world are now using
IFRSs, there are still differences between United States generally
accepted accounting principles (GAAP) and IFRSs, and these
differences are expected to continue for some time.
•
However, there is a joint project between the IASB and the US
Financial Accounting Standards Board (FASB), which is aiming at
converging IFRSs and FASB standards, meaning that further changes
in IFRSs and FASB standards are to be expected.
•
There is an expectation that the US will ultimately adopt IFRS (but it is
not clear ‘when’), and the aim of the Convergence Project is to work
towards the time when a ‘true’ international standardisation of
accounting will become a reality.
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The IASB/FASB Convergence project
.
•
At this point the US adoption of IFRS for use by US companies
appears to be a number of years away.
•
Ultimately, whether the US adopts IFRS will be contingent on whether
the US Securities Exchange Commission (SEC) and FASB are
satisfied with the results generated by the IASB/FASB Convergence
Project.
•
The view that the US adoption of IFRS is still a number of years away
is reflected by a submission made by the US Financial Accounting
Foundation (FAF) in 2007 (the FAF has responsibility for the oversight,
administration and finances of the FASB). The FAF stated:
In our view, now is the time to develop a plan for moving all U.S. public
companies to an improved version of IFRS. We are not recommending
immediate adoption of existing IFRS because various elements of the
U.S. financial reporting system need to change before moving to IFRS,
and those changes will take several years to complete. In addition,
further improvements to IFRS are needed before U.S. public
companies transition to IFRS. (FAF, 2007, p. 5.)
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The IASB/FASB Convergence project (cont)
.
•
Hence, while the FAF considered it to be a sound idea that IFRS
should ultimately be adopted within the US, they should not be
adopted for a number of years in order to give enough time for IFRS to
be further improved and for US reporting systems to be properly
prepared for the transition to IFRS.
•
Because of the convergence efforts we can anticipate many changes
in accounting standards in the near future – and many of these
changes have been, and will be, significant.
•
Therefore, the reality is that many of the accounting standards that
students learn today – even many of those that are relatively ‘new’, are
likely to change in the not too distant future.
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Recent changes to accounting standards
•
There have been a number of recent changes to accounting
standards.
•
Two areas in which there have been significant changes, and which we
will now consider relate to:
– Financial statement presentation
– Preparation of consolidated financial statements
.
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Recent changes: Financial statement
presentation
• A major change recently made to financial statement presentation
relates to the statement of comprehensive income
• The format for disclosing an entity’s statement of comprehensive
income is prescribed within AASB 101 Presentation of Financial
Statements.
• Amendments to AASB 101 in 2007 introduced the statement of
comprehensive income, which in general now replaces the income
statement.
• However, reporting entities have a choice when presenting information
about their financial performance. Effective from 2007, entities can
either:
– present a statement of comprehensive income which provides information
about the entity’s profit or loss plus ‘other items of comprehensive
income’, or
– they can separately provide both an income statement and a statement of
comprehensive income (however, the option to present a separate income
statement is expected to be eliminated in the near future).
.
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Recent changes: Financial statement
presentation (cont)
As paragraph 81 of AASB 101 states:
An entity shall present all items of income and expense recognised in a
period:
(a) in a single statement of comprehensive income; or
(b) in two statements: a statement displaying components of profit or loss
(separate income statement) and a second statement beginning with
profit or loss and displaying components of other comprehensive
income (statement of comprehensive income).
.
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‘Other comprehensive income’
.
•
As a result of the requirements of some accounting standards, some
items of expense and income are not included within profit or loss, but
rather are adjusted directly against equity (perhaps by way of an
increase or decrease in retained earnings).
•
These items form part of what is now referred to as ‘other
comprehensive income’.
•
Paragraph 7 of AASB 101 defines ‘other comprehensive income’ as
follows:
Other comprehensive income comprises items of income and expense
(including reclassification adjustments) that are not recognised in profit
or loss as required or permitted by other Australian Accounting
Standards.
•
‘Total comprehensive income’ is the aggregate of ‘profit or loss’ and
‘other comprehensive income’.
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‘Other comprehensive income’ (cont)
According to AASB 101 paragraph 7, components of ‘other comprehensive
income’ would include:
(a) changes in revaluation surplus (see AASB 116 Property, Plant and Equipment
and AASB 138 Intangible Assets);
(b) actuarial gains and losses on defined benefit plans recognised in accordance
with paragraph 93A of AASB 119 Employee Benefits;
(c) gains and losses arising from translating the financial statements of a foreign
operation (see AASB 121 The Effects of Changes in Foreign Exchange Rates);
(d) gains and losses on remeasuring available-for-sale financial assets (see AASB
139 Financial Instruments: Recognition and Measurement); and
(e) the effective portion of gains and losses on hedging instruments in a cash flow
hedge (see AASB 139).
Hence if we were to look only at ‘profit or loss’ recorded in the statement of
comprehensive income (or in a separate income statement) we would not get a
full picture of all the expenses and income that were recognised in the current
period. A joint consideration of the period’s profit or loss, plus a consideration of
items impacting ‘other comprehensive income’, allows us to more fully
appreciate all the income and expenses of a financial period. That is, we need
to look at ‘total comprehensive income’.
.
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Format of the statement of comprehensive
income
•
Entities may choose a presentation format based on either
– the nature of expenses incurred; or
– the function of expenses within the entity
•
.
Entities must select the most relevant and reliable format
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Format of the statement of comprehensive income (cont) –
function of expense approach
Revenue
Cost of sales
Gross profit
Other income
Distribution costs
Administrative expenses
Finance costs
Profit before tax
Income tax expense
Profit for the year from continuing operations
Loss for the year from discontinued operations
Profit for the year
Other comprehensive income:
Exchange differences on translating foreign operations
Available-for-sale financial assets
Cash flow hedges
Gains on property revaluation
Income tax relating to components of other comprehensive income
Other comprehensive income for the year, net of tax
Total comprehensive income for the year
.
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2012
xxx
(xxx)
xxx
xxx
(xxx)
(xxx)
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
2011
xxx
(xxx)
xxx
xxx
(xxx)
(xxx)
(xxx)
xxx
(xxx)
xxx
(xxx)
xxx
xxx
(xxx)
xxx
xxx
xxx
(xxx)
xxx
xxx
xxx
xxx
xxx
(xxx)
xxx
xxx
34-14
Format of the statement of comprehensive
income (cont)
•
Whilst not shown on the previous slide, the statement of
comprehensive income shall, at the foot of the statement, also show
the:
– Profit attributable to
 owners of the parent
 non-controlling interests
– Total comprehensive income attributable to
 owners of the parent
 non-controlling interests
.
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The statement of changes in equity
.
•
In addition to having to present a statement of financial position, a
statement of comprehensive income, a statement of cash flows and
supporting notes to its financial statements, an entity is also required to
produce a statement of changes in equity.
•
The role of the statement of changes in equity is to provide a
reconciliation of opening and closing equity, and also to provide details
of the various equity accounts that are impacted by the period’s total
comprehensive income.
•
It also provides information about the effects of transactions with
owners in their capacity as owners (distributions and capital
contributions).
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The statement of changes in equity (cont)
In relation to what is to be presented in statement of changes in equity,
AASB 101 requires:
An entity shall present a statement of changes in equity showing in the
statement:
(a) Total comprehensive income for the period, showing separately the
total amounts attributable to owners of the parent and to non-controlling
interests;
(b) for each component of equity, the effects of retrospective application or
retrospective restatement recognised in accordance with AASB 108;
(c) the amounts of transactions with owners in their capacity as owners,
showing separately contributions by and distributions to owners; and
(d) for each component of equity, a reconciliation between the carrying
amount at the beginning and the end of the period, separately disclosing
each change.
.
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The statement of changes in equity (cont)
.
•
A statement of changes in equity reconciles opening and closing equity
which, as we know, represents the difference between assets and
liabilities, and which will comprise multiple accounts, including share
capital, retained earnings, revaluation surplus accounts and so on.
•
In addition, within the statement of changes in equity, the distribution to
and contributions from owners, individual components of total
comprehensive income and non-controlling interests are separately
disclosed.
•
The statement of changes in equity also provides details of any
amounts retained in the revaluation surplus that were transferred to
retained earnings when the asset is derecognised.
•
The next slide provides an example of statement of equity for an
organisation that is not a parent (that is, it has no subsidiaries).
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Format of the statement of changes in equity
Share
Capital
($000)
Balance at 1/01/2011
xxx
Changes in accounting policy
–
Restated balance
xxx
Retained
earnings
($000)
xxx
xxx
xxx
Cash
flow
hedges
($000)
xxx
–
xxx
Revaluation
surplus
($000)
–
–
–
Total
($000)
xxx
xxx
xxx
(xxx)
–
–
(xxx)
xxx
xxx
(xxx)
(xxx)
xxx
xxx
xxx
xxx
–
(xxx)
–
–
–
–
xxx
(xxx)
xxx
xxx
xxx
(xxx)
–
(xxx)
xxx
(xxx)
xxx
xxx
–
xxx
Changes in equity for 2011
Dividends
–
Total comprehensive
Income for the year
–
Balance at 31 December 2011 xxx
Changes in equity for 2012
Issue of share capital
xxx
Dividends
–
Total comprehensive
income for the year
–
Transfer to retained earnings
–
Balance at 31 December 2012 xxx
.
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‘Reclassification adjustments’ as included within
the statement of comprehensive income
•
•
•
•
•
.
Individual accounting standards specify whether and when amounts
previously recognised in ‘other comprehensive income’ are reclassified
to ‘profit or loss’.
AASB 101 requires an entity to disclose reclassification adjustments
relating to components of other comprehensive income in the period
that the adjustments are reclassified to profit or loss.
AASB 101 defines a reclassification adjustment as ‘amounts
reclassified to profit or loss in the current period that were recognised
in other comprehensive income in the current or previous periods’
The purpose is to provide users with information to assess the effect of
such reclassifications on profit or loss.
For example, in relation to available-for-sale financial assets, AASB
139 requires that a gain or loss on an ‘available-for-sale financial
asset’ shall be recognised directly in equity until the financial asset is
derecognised, at which time the cumulative gain or loss previously
recognised in equity shall be recognised in ‘profit or loss’.
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Reclassification adjustments (cont)
.
•
The unrealised gains that have previously been recognised in equity
(such as the gains or losses on the available-for-sale financial asset)
must be deducted from other comprehensive income in the period in
which the realised gains are reclassified to profit or loss to avoid
double-counting items in total comprehensive income when those
items are reclassified to profit or loss.
•
Without this information, users of the financial statements may find it
difficult to assess the effect of reclassifications on profit or loss, or to
calculate the overall gain or loss associated with available-for-sale
financial assets.
•
AASB 101 requires entities to disclose reclassification adjustments
relating to components of other comprehensive income.
•
Specifically, paragraph 92 states:
An entity shall disclose reclassification adjustments relating to
components of other comprehensive income.
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Recent changes: Preparation of
consolidated financial statements
•
In 2008, revised versions of AASB 127 Consolidated and Separate
Financial Statements and AASB 3 Business Combinations were issued.
This created many changes.
For example:
• AASB 3 now allows preparers a choice in how to account for noncontrolling interests in the acquiree – it can either be at fair value
(including goodwill) or at the non-controlling interests’ proportionate
share of the acquiree’s identifiable net assets (excluding non-controlling
interest in goodwill).
• Therefore, under the new requirements we can recognise the noncontrolling interest’s goodwill (previously, only goodwill purchased by
the controlling interest was included within the consolidated financial
statements). This also has implications for how we subsequently
account for the impairment of goodwill.
.
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Recent changes: Preparation of consolidated
financial statements (cont)
.
•
In relation to incremental acquisitions of a subsidiary, whilst the stepby-step method was the method required by AASB 3 until 2008, AASB
3 now requires that the single-date method be applied. This was a
major change in the accounting standard. How we account for
increases in ownership now depends upon whether a controlling
interest is already held.
•
How we account for goodwill on incremental acquisitions has also
changed.
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Calculating non-controlling interests (cont)
•
•
As a result of recent amendments, AASB 3 provides preparers of
financial statements with a choice in the measurement of the noncontrolling interest.
According to paragraph 19 of AASB 3, for each business combination
the acquirer shall measure any non-controlling interest in the acquiree
either:
– at fair value (including goodwill), or
– at the non-controlling interests’ proportionate share of the acquiree’s
identifiable net assets (excluding goodwill).
Specifically, paragraphs 18 and 19 of AASB 3 state:
18 The acquirer shall measure the identifiable assets acquired and the
liabilities assumed at their acquisition-date fair values.
19 For each business combination, the acquirer shall measure any noncontrolling interest in the acquiree either at fair value or at the noncontrolling interest’s proportionate share of the acquiree’s identifiable
net assets
.
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Calculating non-controlling interests (cont)
.
•
If the non-controlling interests are calculated on the basis of the fair
value of the subsidiary, then an amount representing the noncontrolling interest’s share of goodwill will be calculated.
•
This will be in addition to the amount of goodwill allocated to the parent
entity’s interest.
•
This means, in effect, that the full amount of the goodwill of the
subsidiary is being recognised which is in basic accordance with the
entity concept of consolidation, as discussed in Chapter 28 of Deegan
(2010).
•
This approach is referred to by some people as the ‘full goodwill
method’ and does represent a significant change to pre-existing
accounting practice wherein only the goodwill acquired by the parent
entity was included within the consolidated financial statements (the
‘partial goodwill method’)
•
Pursuant to the entity concept of consolidation, all the assets and
liabilities of the subsidiary are included within the consolidated financial
statements whether or not there are non-controlling interests.
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Calculating non-controlling interests (cont)
•
By contrast, if the parent entity elects to account for the non-controlling
interest in accordance with the second option— this being the noncontrolling interest’s proportionate share of the acquiree’s identifiable
net assets—then no additional goodwill will be calculated as being
attributable to the non-controlling interests (which is perhaps
somewhat obvious given that this second option explicitly refers to the
non-controlling interest’s proportionate share of identifiable net
assets which explicitly excludes goodwill).
•
This approach represents the approach that was required prior to the
2008 amendments.
•
Hence, if this option is taken then only a portion of the subsidiary’s
goodwill will be reflected in the consolidated financial statements,
which is not consistent with a ‘pure’ application of the entity concept of
consolidation.
This is often referred to as the ‘partial goodwill method’.
•
.
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Calculating non-controlling interests – the
‘choice’
•
In relation to the choice between using the ‘full goodwill method’ and
the ‘partial goodwill method’, it is interesting to consider how the joint
convergence work being undertaken by the IASB and the US Financial
Accounting Standards Board (FASB) ultimately led to this option being
available within IFRS 3 (and, therefore, within AASB 3).
•
The revised version of IFRS 3 was issued at the same time as the
revised version of the US accounting standard, Statement of Financial
Standards No. 141 Business Combinations.
•
Both Boards had issued exposure drafts on the revised standards, and
within both of the exposure drafts only the ‘full goodwill method’ (the
‘new’ approach) was supported.
However, when the accounting standards were ultimately released, the
FASB retained only the ‘full goodwill method’, whereas the IASB
introduced the option to use either the full goodwill method, or the
partial goodwill method.
•
.
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Justifying the ‘choice’ in relation to
calculating goodwill on consolidation
In understanding the reasoning behind this change, we can refer to the
Basis for Conclusions that was released with IFRS 3. Paragraph BC
210 states:
Introducing a choice of measurement basis for non-controlling interests
was not the IASB’s first preference. In general, the IASB believes that
alternative accounting methods reduce the comparability of financial
statements. However, the IASB was not able to agree on a single
measurement basis for non-controlling interests because neither of the
alternatives considered (fair value and proportionate share of the
acquiree’s identifiable net assets) was supported by enough board
members to enable a revised business combinations standard to be
issued. The IASB decided to permit a choice of measurement basis for
non-controlling interests because it concluded that the benefits of the
other improvements to, and the convergence of, the accounting for
business combinations developed in this project outweigh the
disadvantages of allowing this particular option.
.
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Justifying the ‘choice’ in relation to
calculating goodwill on consolidation (cont)
Hence, the choice of two options within the IASB standard was the
outcome of a political exercise to make sure the standard was
approved, rather than on the basis that the approach was conceptually
sound.
We really have to ponder the impacts such decisions have on the
ultimate quality of financial information being generated in compliance
with accounting standards!!
.
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Elimination of pre-acquisition capital and reserves
in the presence of non-controlling interests
•
•
•
•
•
As with 100 % owned subsidiaries, the carrying values of subsidiaries’
assets must be adjusted to fair value prior to the elimination of the
parent entity’s investment.
This is necessary to prevent the amount of goodwill calculated on
consolidation from being wrongly stated, as the equity (net assets) of
the subsidiary would be undervalued (where the fair value of the net
assets exceeds their carrying amount).
The existence of non-controlling interests does not change the
requirement for the assets and liabilities of a subsidiary to be
measured at fair value as at acquisition date.
If the parent entity does not acquire all of the shares of the subsidiary it
does not acquire an interest in all the share capital and reserves.
There will be a non-controlling interest.
Consider Worked Examples 30.1 and 30.2 (pp 948 and 949 of
Deegan, 2010) which consider and contrast situations where noncontrolling interests are measured at either:
– the proportionate share of the acquiree’s identifiable net assets,
– or, at fair value
.
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Worked example 30.1: Non-controlling interest measured at the
proportionate share of the acquiree’s identifiable net assets
• On 1 July 2012, Parent Entity acquired 70 per cent of the share capital
of Subsidiary Ltd for $800 000, which represented the fair value of the
consideration paid, when the share capital and reserves of Subsidiary
Ltd were:
Share capital
$700 000
Revaluation surplus
$200 000
Retained earnings
$100 000
$1 000 000
• All assets of Subsidiary Ltd were recorded at fair value at acquisition
date, except for some plant that had a fair value $50 000 greater than
its carrying amount.
• The cost of the plant was $250 000 and it had accumulated
depreciation of $180 000.
• The tax rate is 30 per cent.
Required
Prepare the consolidation eliminations and adjustments to recognise
the pre-acquisition capital and reserves of Subsidiary Ltd, assuming
that the non-controlling interest was measured at the proportionate
share of the acquiree’s identifiable net assets (the partial goodwill
method).
.
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Worked example 30.1: Non-controlling interest measured at the
proportionate share of the acquiree’s identifiable net assets (cont)
Subsidiary
Ltd
($)
Fair value of consideration transferred
less Fair value of identifiable assets acquired
and liabilities assumed:
Share capital on acquisition date
700 000
Revaluation surplus on acquisition date
200 000
Retained earnings on acquisition date
100 000
Fair value adjustment ($50 000 ×
(1 – tax rate))
35 000
1 035 000
Goodwill on acquisition date
Non-controlling interest
.
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30% NonParent Ltd’s controlling
70% interest
interest
($)
($)
800 000
490 000
140 000
70 000
210 000
60 000
30 000
24 500
724 500
75 500
10 500
–
310 500
34-32
Worked example 30.1: Non-controlling interest measured at the
proportionate share of the acquiree’s identifiable net assets (cont)
The consolidation journal entries would be:
Dr Accumulated depreciation—plant
180 000
Cr Plant
180 000
(to close off accumulated depreciation in accordance with the net method of asset revaluation)
Dr Plant
Cr Revaluation surplus
Cr Deferred tax liability
(to recognise the revaluation increment after tax)
50 000
35 000
15 000
Dr Share capital (70% of 700 000))
490 000
Dr Revaluation surplus (70% of 235 000)
164 500
Dr Retained earnings (70% of 100 000)
70 000
Dr Goodwill
75 500
Cr Investment in Subsidiary Ltd
800 000
(to recognise the goodwill acquired by Parent Entity and to eliminate the parent’s interest in preacquisition capital and reserves)
Dr Share capital
210 000
Dr Revaluation surplus
70 500
Dr Retained earnings
30 000
Cr Non-controlling interest
310 500
(to recognise the non-controlling interest in contributed equity and reserves at date of
acquisition)
.
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Worked example 30.2: Non-controlling interest
measured at fair value
•
.
Assume the same information as in Worked Example 30.1 above,
except this time we will apply the other option available within the
accounting standard and value the non-controlling interest in the
acquiree at fair value (the ‘full goodwill method’).
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Worked example 30.2: Non-controlling interest measured at fair value
(cont)
($)
Fair value of consideration transferred
plus Non-controlling interest measured
at fair value ($800 000 × 30/70)
less Fair value of identifiable assets
acquired and liabilities assumed
Share capital on acquisition date
Revaluation surplus on acquisition date
Retained earnings on acquisition date
Fair value adjustment ($50 000 ×
(1 – tax rate))
GOODWILL ON ACQUISITION DATE
.
Subsidiary
Ltd
($)
800 000
Parent Ltd’s
70% interest
($)
800 000
342 857
1 142 857
30% NonControlling
interest
342 857
700 000
200 000
100 000
490 000
140 000
70 000
210 000
60 000
30 000
35 000
1 035 000
107 857
24 500
724 500
75 500
10 500
310 500
32 357
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Worked example 30.2: Non-controlling interest measured at fair value (cont)
The consolidation journal entries would be (and the first 3 sets of entries below are the same as
Worked example 30.1):
Dr Accumulated depreciation—plant
180 000
Cr Plant
180 000
(to close off accumulated depreciation in accordance with the net method of asset revaluation)
Dr Plant
Cr Revaluation surplus
Cr Deferred tax liability
(to recognise the revaluation increment after tax)
50 000
35 000
15 000
Dr Share capital (70% of 700 000))
490 000
Dr Revaluation surplus (70% of 235 000)
164 500
Dr Retained earnings (70% of 100 000)
70 000
Dr Goodwill
75 500
Cr Investment in Subsidiary Ltd
800 000
(to recognise the goodwill acquired by Parent Entity and to eliminate the parent’s interest in preacquisition capital and reserves)
Dr Share capital
210 000
Dr Revaluation surplus
70 500
Dr Retained earnings
30 000
Dr Goodwill
32 357
Cr Non-controlling interest
342 857
(to recognise the non-controlling interest in contributed equity and reserves at date of
acquisition)
.
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34-36
Increase in the ownership interest held in
a subsidiary
•
It is common for a parent entity to acquire additional shares in a
subsidiary over time
•
There are two general approaches that potentially could be used when
accounting for increases in the ownership of a subsidiary. These two
approaches have been referred to as the:
– 1. step-by-step method; and
– 2. single-date method.
.
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34-37
The step-by-step method
•
Pursuant to the step-by-step method, which was the method required
by AASB 3 until recently:
– Each individual investment in the subsidiary is accounted for separately,
meaning that we will have multiple consolidation elimination entries.
– Once control of the subsidiary is established, the consolidation worksheet
entries will eliminate the various investments in the subsidiary against the
parent entity’s respective share of the subsidiary’s net identifiable assets as
at each of the respective investment dates (at fair value).
– Because eliminations of each investment are made as at the various
investment dates we need to restate the subsidiary’s assets to fair value as
at each exchange date. This means that we might have numerous entries
to revalue the net assets to fair value.
– For each investment elimination we will calculate a separate amount of
goodwill. This means that the total goodwill acquired for a subsidiary could
be the sum of a number of individual transaction calculations as reflected in
a number of investment elimination entries.
.
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34-38
The single-date method
.
•
By contrast, under the single-date method, goodwill would be
recognised by a single consolidation journal entry at that point in time
when the parent entity ultimately gains control of the subsidiary.
•
That is, the aggregate costs of the investments would be eliminated
against the parent’s share of capital and reserves at the date control is
ultimately established and only one amount of goodwill (or bargain
gain on purchase) is calculated.
•
While the step-by-step method was the method required by AASB 3
until 2008, in 2008 AASB 3 was revised and now the requirement is
that the single-date method be applied.
•
This was a major change in the accounting standard
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34-39
Likely future changes in financial reporting
requirements
•
As a result of the ongoing Convergence Project there are going to
many future changes in various financial reporting requirements. We
will consider some of these possible changes.
Specifically, we will consider likely changes to:
–
–
–
–
–
.
financial statement presentation
the conceptual framework of accounting
accounting for leases
accounting for joint ventures
revenue recognition principles
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34-40
Likely future changes in requirements pertaining to
financial statement presentation
.
•
In October 2008 the IASB issued a discussion paper entitled
‘Preliminary Views on Financial Statement Presentation’.
•
The discussion paper proposes some significant changes to the way
financial statements are to be presented.
•
The project is being undertaken jointly by the IASB and the US
Financial Accounting Standards Board (FASB).
•
The discussion paper represents the first step towards creating a new
accounting standard that would ultimately replace IAS 1 and, therefore,
AASB 101.
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34-41
Likely future changes in requirements pertaining to
financial statement presentation (cont)
•
•
•
•
•
.
There is a belief that the current formats of the various financial
statements do not make it easy for users to see how the information in
the respective statements is linked.
For example, the statement of cash flows separates operating activities
from financing activities, but that distinction is not always apparent in the
statement of financial position and the statement of comprehensive
income.
This makes it difficult to compare operating income with operating cash
flows—a step often taken in assessing the quality of an entity’s earnings.
To provide more useful information, the IASB and FASB intend making
the financial statements more ‘cohesive’; that is, the objective is to format
the information in financial statements so that a reader can follow the flow
of information through the various financial statements.
As IASB (2008, p. 16) states:
To present a cohesive set of financial statements, an entity should align
the line items, their descriptions and the order of presentation of
information in the statements of financial position, comprehensive income
and cash flows. To the extent that it is practical, an entity should
disaggregate, label and total individual items similarly in each statement.
Doing so should present a cohesive relationship at the line item level
among individual assets, liabilities, income, expense and cash flow items.
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34-42
Likely future changes in requirements pertaining to
financial statement presentation (cont)
• An entity would classify income, expenses and cash flows in the same section and
category as the related asset or liability.
• The IASB and FASB are also proposing that financial statements should be
presented in a more disaggregated manner.
• It is proposed that financial statements are prepared in way that separates an
entity’s financing activities from its business and other activities and, further,
separates financing activities between transactions with owners in their capacity as
owners and all other financing activities.
• The ‘Business’ section of the financial statements would include all items related
to assets and liabilities that management views as part of its continuing business
activities.
• Business activities are those activities conducted with the intent of creating value,
such as producing goods or providing services.
• It is proposed that the ‘Business’ section be further disaggregated into an
Operating category and an Investing category. According to the discussion paper:
–The Operating category would include assets and liabilities that management views as
related to the central purpose(s) for which the entity is in business (and changes in those
assets and liabilities). An entity uses its operating assets and liabilities in its primary revenue
and expense-generating activities.
–The Investing category would include all assets and liabilities that management views as
unrelated to the central purpose for which the entity is in business (and any changes in those
assets and liabilities). An entity would use its investing assets and liabilities to generate a
return, but would not use them in its primary revenue and expense-generating activities.
.
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Likely future changes in requirements pertaining to
financial statement presentation (cont)
.
•
The ‘Financing’ section would include only financial assets and
financial liabilities that management views as part of the financing of
the entity’s business activities (referred to as ‘financing assets and
liabilities’).
•
The following table represents the proposed format for presenting
information within the financial statements, excluding the notes. (The
section names are in bold italics; bullet points indicate required
categories within sections.)
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34-44
Proposed presentation format for the
presentation of financial statements
Statement of financial
position
Statement of comprehensive
income
Statement of cash flows
Business
•Operating assets and
liabilities
•Investing assets and
liabilities
Business
•Operation income and expenses
•Investing income and expenses
Business
•Operating cash flows
•Investing cash flows
Financing
•Financial assets
•Financial liabilities
Financing
•Financing asset income
•Financing liability expenses
Financing
•Financing asset cash flows
•Financing liability cash flows
Income taxes
Income taxes
On continuing operations
(business and financing)
Income taxes
Discontinued operations
Discontinued operations
Net of tax
Discontinued operations
Other comprehensive income
Net of tax
Equity
.
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Equity
34-45
Likely future changes in requirements pertaining to
financial statement presentation (cont)
•
Each entity would decide the order of the sections and categories but
would use the same order in each individual statement.
•
Each entity would decide how to classify its assets and liabilities into
the sections and categories on the basis of how an item is used (the
‘management approach’).
•
•
The entity would disclose why it chose those classifications.
Because functional activities vary from entity to entity, an entity would
choose the classification that best reflects management’s view of what
constitutes its business (operating and investing) and financing
activities.
•
Thus, a manufacturing entity may classify the exact same asset (or
liability) differently from a financial institution because of differences in
the businesses in which those entities engage.
it is not anticipated that any changes in presentation formats would be
required before 2012.
•
.
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34-46
Likely future changes in requirements pertaining to
the conceptual framework of accounting
• A revised conceptual framework is necessary because of the Convergence Project.
• Given that efforts are underway to converge the accounting standards being
released by the IASB with those being released by the FASB, there is a need for
one uniform conceptual framework.
• The IASB and FASB are undertaking the work on the conceptual framework in eight
phases, as listed below. As at late-2009, phases A, B, C and D were active:
Phase
Topic
A Objectives and qualitative characteristics.
B
Definitions of elements, recognition and derecognition
C
Measurement
D
Reporting entity concept
E
Boundaries of financial reporting, and Presentation and
Disclosure
F
Purpose and status of the framework
G
Application of the framework to not-for-profit entities
H
Remaining issues, if any
.
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34-47
Likely future changes in requirements pertaining to
the conceptual framework of accounting (cont)
• Whilst there are many changes being discussed, one area that will have
significant implications will be any changes made to the definition of
the elements of accounting.
• The Boards decided to consider the following working definitions in
relation to assets and liabilities:
An asset of an entity is a present economic resource to which, through
an enforceable right or other means, the entity has access or can limit
the access of others.
A liability of an entity is a present economic obligation that is enforceable
against the entity.
• In relation to the proposed asset definition, there will be a movement
away from considerations of ‘control’, ‘expected’, and ‘past transactions
and events’.
• The suggested change to the definition of liability could potentially have
significant implications for financial reporting. For example, the above
definition could act to exclude constructive or equitable obligations that
are not ‘enforceable against the entity’.
.
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34-48
Likely future changes in requirements pertaining to:
accounting for leases
.
•
The International Accounting Standards Board (IASB) and the US
Financial Accounting Standards Board (FASB) are currently working
together on the development of a revised accounting standard.
•
In April 2008, the two Boards jointly stated their intention to produce a
revised standard for lessees by mid-2011.
•
A revised discussion paper was released in March 2009.
•
One of the major concerns of the IASB and the FASB was the
differentiation, perhaps somewhat arbitrary, between finance leases
and operating leases.
•
Current thinking indicates that the differentiation between finance
leases and operating leases should be abandoned such that assets
and liabilities associated with many leases that we would now consider
to be operating leases will, in the future, be included in the statement
of financial position.
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34-49
Likely future changes in requirements pertaining to:
accounting for leases (cont)
As IASB and FASB, 2009 (p. 23) state:
The existing accounting model for lessees fails to meet the needs of
users. In particular, it fails to represent faithfully the economics of many
lease contracts. For example, on entering into a 15-year noncancellable lease of real estate, a lessee obtains a valuable right (the
right to use the property). In addition, the lessee assumes a significant
obligation (the obligation to pay rentals). However, if the lease is
classified as an operating lease, the lessee recognises no assets or
liabilities (other than the accrual of rentals due or prepaid).
.
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34-50
Likely future changes in requirements pertaining to:
accounting for leases (cont)
•
To identify the rights and obligations arising in a simple lease contract the
boards analysed the following example (p. 24):
A machine is leased for a fixed term of five years; the expected life of the
machine is 10 years. The lease is non-cancellable, and there are no rights to
extend the lease term or to purchase the machine at the end of the term and no
guarantees of its value at that point. Lease payments are due at regular
intervals over the lease term after the machine has been delivered; these are
fixedamounts that are specified in the original agreement. No maintenance or
other arrangements are entered into.
•
•
•
.
Under current rules, no asset or liability would be recognised for the purposes
of the statement of financial position. However, this ignores the fact that the
entity does have a non-cancellable financial obligation for the next five years,
as well as having a contractually enforceable right to use the asset.
The Framework for the Preparation and Presentation Financial Statements,
would suggest that such rights and obligations would meet the test for
recognition as an asset and liability respectively.
The draft discussion paper released by the IASB and FASB suggests that a
lease, such as that described above, should be included within the statement of
financial position.
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34-51
Likely future changes in requirements pertaining to:
accounting for leases (cont)
In relation to the example provided on the previous slide, the IASB and FASB
stated (2009, paragraphs 3.16 and 3.17):
3.16 The boards identified the right to use the leased item as an economic resource of
the lessee because the lessee can use it to generate cash inflows or reduce cash
outflows. The boards tentatively concluded that:
(a) the lessee controls the right to use the leased item during the lease term
because the lessor is unable to recover or have access to the resource without the
consent of the lessee (or breach of contract).
(b) the control results from past events – the signing of the lease contract and the
delivery of the item by the lessor to the lessee. Some think that the lessee’s right to
use the machine described in the example is conditional on the lessee making
payments during the lease term. In other words, if the lessee does not make
payments, it may forfeit its right to use the machine (this is similar to the situation
that would arise if an entity failed to make payments on an instalment purchase).
However, unless the lessee breaches the contract, the lessee has an unconditional
right to use the leased item.
(c) future economic benefits will flow to the lessee from the use of the leased item
during the lease term.
3.17 Accordingly, the boards tentatively concluded that the lessee’s right to use a
leased item for the lease term meets the definitions of an asset in the Framework.
.
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Likely future changes in requirements pertaining to:
accounting for leases (cont)
•
Hence, it would appear that the key issue to consider in the future will
be whether a lease is non-cancellable or not, and not whether the risks
and rewards of ownership pass to the lessee—which is the current test
under AASB 117.
• In supporting the view that a non-cancellable lease, such as the
example of the five-year non-cancellable lease provided above, should
be recognised in the statement of financial position, the IASB and
FASB (2009, paragraphs 3.20 and 3.21) state:
3.20 In summary, the boards tentatively concluded that:
(a) the lessee has a present obligation to pay rentals.
(b) this obligation arises out of past events—the signing of the lease
contract and the delivery of the item by the lessor to the lessee.
(c) the obligation is expected to result in an outflow of economic
benefits (usually cash).
3.21 Accordingly, the boards tentatively concluded that the lessee’s
obligation to pay rentals meets the definitions of a liability in the
Framework.
.
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Likely future changes in requirements pertaining to:
accounting for leases (cont)
•
.
Accordingly, the IASB and FASB provided a view that the lessee’s
obligation to pay rentals under a non-cancellable lease meets the
definition of a liability as provided in the IASB Framework for the
Preparation and Presentation of Financial Statements.
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34-54
Likely future changes in requirements pertaining to:
accounting for leases (cont)
•
Specifically, IASB and FASB (2009, p. 29) state:
On the basis of the preceding analysis, the boards tentatively concluded that
the existing lease accounting model is inconsistent with the asset and liability
definitions in the Framework for the Preparation and Presentation of Financial
Statements.
The boards tentatively decided to develop a new approach to accounting for
leases that would result in the recognition of the assets and liabilities identified
as arising in a lease contract. Rather than treating some lease contracts like a
purchase of the leased item (finance leases) and others as executory contracts
(operating leases), the new approach would treat all lease contracts as the
acquisition of a right to use the leased item for the lease term. Thus, the lessee
would recognise the following:
(a) an asset representing its right to use the leased item for the lease term (the
right-of-use asset)
(b) a liability for its obligation to pay rentals.
•
•
.
In terms of how the liability will be measured, a view was presented by the
Boards that, consistent with AASB 117 (and therefore IAS 17), the liability
should be measured at present value.
However, unlike the existing accounting standard, the present value is to be
determined by using the organisation’s incremental borrowing rate, rather than
the interest rate implicit in the lease.
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Likely future changes in requirements pertaining to:
accounting for leases (cont)
• In summary, the implications of the proposals would be:
– The differentiation between finance leases and operating leases
should be abandoned such that assets and liabilities associated
with many leases that we would now consider to be operating
leases will, in the future, be included in the statement of financial
position.
– This will have significant impacts for many organisations in terms
of their reported leverage
– Depending upon the ability of an entity to renegotiate its debt
contracts, should the new standard embrace the criteria we have
just considered, then it could be anticipated that many
organisations will either go into technical default of their debt
agreements, or they will need to renegotiate contracts.
– This will be an interesting area for many accounting researchers to
investigate – specifically, how the proposed standard will impact
the choices organisations make in relation to either buying or
leasing assets.
.
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34-56
Likely future changes in requirements
pertaining to accounting for joint ventures
.
•
AASB 131 initially required interests in joint venture entities to be
accounted for using the equity method of accounting.
•
However, in 2007 amendments were made such that an alternative
approach was also permitted—this being proportionate consolidation.
That is, two alternative approaches were permitted for accounting for
interests in joint venture entities.
•
However, there are efforts now underway by the IASB to now remove
this (recently introduced) alternative.
•
In September 2007 the IASB published for public comment a proposal
to improve the accounting for joint arrangements (‘joint arrangements’
being the new terminology).
•
The proposals in ED 9 Joint Arrangements would replace IAS 31
Interests in Joint Ventures (and therefore replace AASB 131) and
would represent the first major revision to the standard since it was
first issued in 1990.
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34-57
Likely future changes in requirements pertaining to
accounting for joint ventures (cont)
.
•
ED 9 Joint Arrangements proposes to require parties to recognise both
the individual assets to which they have rights and the liabilities for
which they are responsible, even if the joint arrangement operates in a
separate legal entity.
•
If the parties only have a right to a share of the outcome of the
activities (that is, they do not have any control over the assets as
would commonly be the case with interests in joint venture entities, or
any direct obligation for joint venture-related liabilities) their net interest
in the arrangement will be recognised using the equity method.
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Likely future changes in requirements pertaining to
accounting for joint ventures (cont)
•
In relation to allowing the continued use of equity accounting, the Basis
for Conclusions which accompanied the Exposure Draft stated:
BC14 The Board also considered the views of some who point out that
joint control and significant influence are different. They argue that it is
inappropriate to account for an associate and a joint venture in the
same way, using the equity method. Although the Board acknowledges
that significant influence and joint control are different, the equity
method has been used to account for joint ventures in jurisdictions
around the world for many years. The consideration of the equity
method, and any alternative to it, is outside the scope of this short-term
project.
•
.
The above justification is interesting. The IASB have justified the
continued use of equity accounting because it has been ‘around the
world for many years’. This does not seem to be a very strong
justification for their decision!
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34-59
Likely future changes in requirements pertaining to revenue
recognition principles
•
•
•
•
.
The IASB and the FASB initiated a project to review various issues
associated with the recognition of revenue in contracts with customers.
In December 2008 the IASB released a discussion paper that
summarised the views of the two Boards. The discussion paper was
entitled Preliminary Views on Revenue Recognition in Contracts with
Customers and called for interested parties to submit comments and
opinions by mid-June 2009.
It is clear from reading the discussion paper that future changes across
a number of accounting standards appear inevitable.
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Likely future changes in requirements pertaining to
revenue recognition principles (cont)
.
•
Adopting a view that revenue recognition should be consistent with the
conceptual framework (the IASB Framework), the IASB and FASB
embrace a view that revenue recognition should be a direct function of
whether goods and services have been transferred to the control of the
customer (and not be a function of who holds the risks and rewards of
ownership of the asset).
•
As paragraph 6.7 of IASB (2008) states:
An entity satisfies a performance obligation when it transfers goods
and services to a customer. That principle, which the boards think can
be applied consistently to all contracts with customers, is the core of
the boards’ proposed model for a revenue recognition standard.
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Likely future changes in requirements pertaining to
revenue recognition principles (cont)
•
In providing further explanation of the above view, paragraph 4.8 of
IASB (2008) states:
In essence, an entity satisfies performance obligations, and recognises
revenue, when the customer receives the promised goods and
services. Consequently, in the proposed model revenue would reflect
the transfer of promised goods and services to customers, and not the
activities of the entity in producing those goods and services. Activities
that an entity undertakes in fulfilling a contract result in revenue
recognition at the time of those activities only if they simultaneously
transfer assets to the customer and, hence, satisfy a performance
obligation.
.
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Likely future changes in requirements pertaining to
revenue recognition principles (cont)
•
In further considering the ‘core’ requirement that revenue recognition
should be directly linked to the transfer of control of the underlying
goods and services, paragraph 4.62 of IASB (2008) states:
Consequently, activities that an entity undertakes in fulfilling a contract
result in revenue recognition only if they simultaneously transfer assets
to the customer. For example, in a contract to construct an asset for a
customer, an entity satisfies a performance obligation during
construction only if assets are transferred to the customer throughout
the construction process. That would be the case if the customer
controls the partially constructed asset so that it is the customer’s
asset as it is being constructed.
.
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Likely future changes in requirements pertaining to revenue
recognition principles (cont)
•
•
•
•
As we would know, revenue is sometimes recognised from an increase in the
value of an inventory item even though a contract with a customer does not
exist.
For example, revenue is recognised from increases in some biological,
agricultural and extractive products before there is a contract with a customer
(see AASB 141 Agriculture). The same is often the case in respect of
marketable securities.
Recognising revenue in those instances is consistent with the Boards’ existing
definitions of revenue and the recognition principles in their conceptual
frameworks.
However, the Boards suggest that the change in asset value should not be
treated as revenue. As paragraph 6.16 of IASB (2008) states:
In this project, the boards do not intend to change the way those entities
measure inventory. However, in the boards’ proposed model, an entity
recognises revenue only if it has a contract with a customer. Therefore, the
boards need to consider whether those entities should be precluded from
presenting increases in the value of inventory as revenue and should, instead,
present those increases as another component of comprehensive income.
•
.
A change such as that proposed above will have implications for a number of
accounting standards.
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Likely future changes in requirements pertaining to revenue
recognition principles (cont)
•
•
•
In some existing standards (e.g. AASB 111) revenue is recognised
from an increase in the value of inventory under a contract with a
customer.
In AASB 111, an entity’s activities may enhance the value of
inventory and that increase will result in the recognition of revenue
(provided all other necessary criteria are met).
The Boards’ view is that the revenue should only be recognised if the
customer has control of the related asset. As paragraphs 6.18, 6.19
and 6.21 of IASB (2008) state:
6.18 The proposed model focuses on increases in an entity’s net position
in a contract with a customer rather than on the increases in the
value of assets being produced under that contract. If the entity’s
construction activities continuously transfer assets to a customer
(and thus satisfy a performance obligation continuously), then the
boards’ proposed model would not change significantly the present
practice of recognising revenue for construction type contracts
during the construction phase. In other words, if the customer
controls the asset being constructed, there would be no significant
change to present practice.
.
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Likely future changes in requirements pertaining to revenue
recognition principles (cont)
6.19 However, if the construction activities do not result in a transfer of
assets to a customer (and thus do not satisfy a performance
obligation), the entity’s net position in the contract does not increase,
and revenue would not be recognised during the construction phase.
In other words, if the customer does not control the asset being
constructed, the pattern of revenue recognition might be significantly
different from present practice.
6.21 The boards understand that, at present, some entities recognise
revenue throughout construction-type contracts even though
‘ownership rights’ are not continuously transferred to the customer—
that is, even though the customer does not control the asset being
constructed. In those cases, the boards’ proposed model would
preclude the recognition of revenue until the inventory transfers to
the customer. That might differ significantly from present practice.
•
.
If the views of the Boards are ultimately incorporated within
accounting standards, then we can expect significant changes to be
made to the current requirements embodied within AASB 111 and a
number of other accounting standards.
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34-66
Changes in terminology
In recent times there have been many changes in terminology. Some of these
include:
Old terminology
Balance sheet
Income statement
Cashflow statement
Minority interests
Revaluation reserve
Joint venture
joint operations
jointly controlled assets
Financial reports
Balance date
Discount on acquisition (consolidations)
.
New Terminology
Statement of financial position
Replaced by statement of
comprehensive income
Statement of cashflows
Non-controlling interests
Revaluation surplus
Joint arrangement
Jointly controlled operations
Joint assets
Financial statements
Reporting date
Gain on bargain purchase
Copyright  2010 McGraw-Hill Australia Pty Ltd
PPTs to accompany Deegan, Australian Financial Accounting 6e
34-67