Three IFRS Updates for analysis of financial statements
If you analyse IFRS financial statements, there are three key updates that you must be aware of:
• IFRS 9 Financial Instruments
• IFRS 15 Revenue from Contracts with Customers
• IFRS 16 Leases
IFRS 9 Financial Instruments (effective for periods beginning on or after 1 January 2018)
There are three changes in IFRS 9 compared to the previous standard which impacts the measurement and disclosures of financial instruments.
The classification of financial assets is based on the business model of the entity and nature of cash flows of the specific instrument. Since the classification is based on the business model, it is possible that the same financial asset is classified and hence accounted for differently by different entities.
An entity is required to incorporate forward-looking macro-economic factors in measurement of expected credit losses. Whilst there is guidance on factors to consider in movements between three stages of the general model or application of simplified approach and practical expedients, there is considerable use of judgement required to estimate the expected credit losses.
The hedge accounting principles have been made flexible in IFRS 9 and allow designation of risk components of non-financial items in hedging relationships. An entity can use the “other comprehensive income” to park the “noise” created in “profit or loss” due to time value of options, forward points and foreign currency basis spread. There is a forward-looking approach to hedge effectiveness test which opens up opportunities to apply hedge accounting.
IFRS 15 Revenue from Contracts with Customers (effective for periods beginning on or after 1 January 2018)
The standard has a five-step framework for recognition of revenue.
• Identify the contract(s) with customer
• Identify the performance obligations in the contract
• Determine the transaction price
• Allocate the transaction price to the performance obligations in the contract
• Recognise revenue when (or as) a performance obligation is satisfied
The application of the standard has a significant impact on the “top line” for entities in certain sectors like telecoms and software where there are multiple performance obligations embedded in a contract. Another key area of impact is the decision on whether to capitalise or expense the costs of obtaining contracts.
It is important for the users to understand the practical issues in applying the standard, including use of judgements and estimates. There are extensive disclosure requirements to help understand the nature of contracts and revenue recognition policies.
IFRS 16 Leases (effective for periods beginning on or after 1 January 2019)
IFRS 16 has introduced a much-awaited change in the accounting for operating leases by lessee. It brings most leases on the balance sheet with an asset and a corresponding liability. There is no distinction between operating and finance leases.
There is a new definition of “Lease” and significant changes to the systems and processes may be required to capture the information required to measure lease liability. There are challenges in application of the standard, for example, determination of lease period, identification of embedded leases in contracts and measurement of lease liability.
IFRS 16 has a significant impact on key financial ratios. There are different approaches and practical expedients that may be used on transition, which has an impact on presentation of financial statements.
This blog was written for IASeminars and can be accessed at https://www.iaseminars.com/latest/681_three_ifrs_updates_for_analysis_of_financial_statements.