Global Adoption of IFRS - Turbulent Times!

Published February 2013 The European Commission has labelled 2013 as the 'year of truth' regarding globalisation of IFRS and convergence. The US Financial Accounting Foundation has warned that written commitment to a single set of global accounting standards, as currently proposed, may exclude many jurisdictions which are major players in global capital markets, including the United States. Closer to home, the Institute of Chartered Accountants in England and Wales (ICAEW) has published a report commenting that convergence has served its purpose and there is little desire to continue with it. Has the appetite for a single set of global accounting standards disappeared?

Why the apparent melt-down?

'The IASB has broken deadlines so often... nobody believes them any more'. Strong words, particularly when uttered by the Chairman of the International Accounting Standards Board. He has further commented that the current leasing project will be an 'uphill battle' and has described as 'deeply embarrassing' the failure to find a workable model that would require financial assets to be impaired on an expected loss basis. There is indeed much frustration that key standard - setting projects which the IASB and FASB have been jointly working on for many years and which were originally planned for completion by June 2011 have since become moving targets. So much so that the plan for implementation of these standards in 2015 is at this stage seriously in question. While easy to ask what has gone wrong, one should not lose sight of the success that has been achieved.

A success story?
The spread of IFRS around the globe has been - and continues to be - a major success story. Today, well over 100 countries - including more than two thirds of G20 countries - require or allow their listed

companies to prepare their financial statements using IFRS or national standards based closely on IFRS. The increasingly cross border nature of trade and capital-raising have contributed to a need for a widely accepted set of international accounting standards, and the global spread of IFRS does much to serve this. Claims that financial reporting somehow caused or prolonged the crisis have been shown to be largely unsubstantiated. However, the financial crisis did expose the need to improve aspects of accounting. While progress has been made in such areas as the consolidation model and fair value, with revenue recognition approaching finalisation, the failure to reach conclusion on financial instruments continues to be a major gap in that progress.

Challenges to progress
The commitment of the SEC to incorporating IFRS into US accounting seems more elusive than ever. Senior US accounting figures have indicated that it may be up to another five or six years before this is achieved. Some other significant economies are hesitating, quite probably with an eye on US developments. The complex economic trading and financial environment is reflected in the increasing complexity of standards, producing outcomes which many find very difficult to understand and which then produce financial reporting which is less than obviously understandable. This may ultimately discourage some countries from fully embracing international standards. With no easing of these factors, it is difficult to see where solutions are coming from. The increasing focus on reducing disclosure may ultimately provide some relief, but work is only in its early stages and there is a considerable way to go. Other challenges to be dealt with include: G20 needs to consider whether all members should allow

optional use of IFRS in their capital markets. Regulators around the world need to work together more

closely to deliver consistent enforcement. An effective feedback mechanism is essential and operable

models for undertaking effects and post-implementation reviews need to be developed. The IASB has major challenges to confront and deal with from an increasingly diverse population of constituents.

IASB/FASB working together?

The IASB and the FASB no longer see a future in working together and are planning to bring their formal partnership to an end after ten years working together. The frustration expressed by the IASB Chairman further extends to complaining of 'dysfunctional working processes and dysfunctional decision making'. The IASB must not put reaching agreement with the United Stated ahead of finding quality solutions which will serve its constituents well. While convergence appears to be no longer an immediate prospect, close liaison with the US, the world's largest capital market, remains important. A prime example of an area where substantial time has been expended by both Boards without it seems ever coming close to a properly converged solution is the impairment of financial assets. The Boards have found it impossible to reconcile their different objectives with the IASB focusing on credit risk being a component in the pricing of financial assets, while the FASB's focus is on ensuring a sufficient allowance is provided at each reporting date to cover future expected losses. The proposed solution of the IASB is based on classifying financial assets in three separate buckets. Bucket 1 would be where there is no identified credit deterioration. Buckets 2 and 3 would be evaluated for credit deterioration, either at the portfolio level or the individual financial instrument level, with an allowance measured over the lifetime of the asset of expected credit losses. The FASB has developed a proposed model of accounting for the impairment of financial assets - the Current Expected Credit Loss (CECL) model. This is a single impairment approach for all financial assets measured at amortised cost or fair value through other comprehensive income. Under CECL, a reporting entity would recognise an impairment allowance equal to the current estimate of expected credit losses (i.e. all contractual cash flows that an entity does not expect to collect) for financial losses at the end of each reporting period. While the approach of both Boards is moving from an incurred loss model to an expected loss model, it is unfortunate that after such a lengthy period of evolution and dialogue a converged solution has not been reached.

Conclusion
The progress of IFRS and its continuing momentum towards global

acceptance must be sustained. The development efforts of the IASB and the FASB have produced much but it is clear that despite best efforts there is an inability to come together on other substantial matters. Time will tell whether working apart they may well come up with higher quality solutions to the advantage of all constituents and which may ultimately evolve to a global consistency of accounting. First published in Finance Dublin Online.

Global report

convergence

progress

The leaders of Canada, France, Korea, United Kingdom and United States have sent a joint letter to the other leaders of the G20 countries highlighting the need for continued co-operation on the regulatory reform agenda to strengthen the international financial system. At their summit meeting in September 2009, the G20 leaders agreed to this agenda which set out as one of its many goals the complete convergence of accounting standards across the G20 countries by June 2011. The letter commented that 'there can be no let up in our commitment to implementing international standards and agreeing to undergo periodic peer reviews to evaluate our adherence to these standards'. Achieving the objective The spread of International Financial Reporting Standards (IFRS) has grown widely over the past decade and many major countries have already adopted IFRS with many others currently in the throes of doing so, and even the U.S. laying tentative plans with a view towards the possibility of moving to IFRS in the middle part of this decade. The publication of IFRS for SMEs by the IASB in 2009 has been responded to with enthusiasm in most parts of the world meaning that IFRS is no longer seen as being only for the 'big players' but is also becoming the financial reporting language for all entities on a global basis. For the many of us that support international standards the portents

are positive towards achieving global comparability of financial information with improved transparency and consistency. This has to be good news! Much work to do The two major standard-setting bodies in the world are the International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB). The first major joint initiative of the IASB and the FASB towards convergence was their Memorandum of Understanding (MoU) in 2002 which was redrawn in 2006 and updated again in 2008. The MoU outlines the main objectives with regard to improvement and convergence of standards in all the key areas. In November 2009 the two Boards released a joint statement reaffirming their commitment to this objective with the aim of completing each major project by June 2011. The Boards also committed to developing outreach programmes to provide potential respondents with enhanced opportunities to engage with them to help them consider the proposals. The Boards have changed their work methods to enhance the likelihood of completing the major MoU projects by the June 2011 timeline and to ensure that the resulting standards will improve both IFRSs and US GAAP and reduce the differences between them. To this end, the Boards are meeting with far more regularity, with 22 meeting days since last November and a further seven sessions on specific issues; are making the record of their considerations more publicly available; and are developing extensive outreach programmes. The Boards will also be publishing a separate discussion paper to seek views on ways to implement the improved standards so as to minimise the disruption and cost to the financial reporting system. Are milestones being achieved? The IASB and FASB published their quarterly progress report on 31 March 2010 outlining the progress being achieved in relation to the eight specific areas identified in their November statement and also under the headings of 'Other MoU Projects' and 'Other Joint Projects'. The Appendix to the report sets out the timetable for document publication indicating a very busy few months ahead with exposure drafts on seven of the eight specific areas expected in Q2 2010, which include from an IASB perspective: Financial instruments o Liability classification and measurement o Hedging

Consolidation o Disclosures about securitisation and investment vehicles (with early release of standard expected in June 2010) o ED of proposed standard

Fair value measurement Revenue recognition Leasing Financial instruments with characteristics of equity Financial statement presentation

o Reporting comprehensive income o Disclosures about discontinued operations o Main standard: replacement of IAS 1 and IAS 7 The IASB is also proposing to release a standard on joint ventures in June together with an ED on insurance accounting and has already released an ED on pension accounting in April. Two areas on which the timing of publication has yet to be determined by both Boards are derecognition, which is one of the eight specifically identified topics, and emissions trading. The FASB has a generally consistent publication programme on the areas outlined above. The sheer volume of material to be assimilated and digested will once again place considerable strain on companies, and their accounting departments, to come to terms with the proposed new requirements and many will need support from their advisors. All in agreement? One of the more controversial accounting topics over recent years has been financial instruments giving rise to great complexity which, while in part conceptual, was perhaps even more a reflection of the underlying markets and intricacies of various financial services products. This has been the focus of much comment and debate over the past couple of years with a global demand for greater simplicity and transparency and earlier recognition of loan impairment losses. Difficulties continue with financial instruments standing out as the area where the Boards are having difficulty with developing a common approach. The IASB has been replacing its financial instruments requirements in a phased approach, whereas the FASB has been developing a comprehensive proposal. Those differing

approaches have contributed to the Boards reaching different conclusions on a number of important technical issues, which include: The measurement model, with FASB proposing fair value for

all financial instruments The approach to the calculation of credit impairment

provisions The Boards expect to commence joint discussions in the third quarter of 2010 but sound a warning signal in their March 2010 progress report - 'although our recent experiences with joint meetings show that we have been able to resolve differences on several projects, there is no guarantee that we will be able to resolve all, or any, of our differences on this project'. This clearly raises the concern that if one of the building blocks to achieving global convergence is missing, does this cause the overall structure to tumble and it presumably must undermine the prospects of the U.S. coming on board the IFRS juggernaut. As commented in the recent G20 letter 'an agreement to act is just a start, it is acting on the agreement that matters'. The work which the IASB and the FASB are currently undertaking can yield major benefits in the form of a globally accepted financial reporting language. It is a fervent wish of all involved that this major initiative succeeds and is not taken off the rails by one of its constituents. First published in Finance Dublin online

Lease Accounting - A proposed new model

June 2013 The global leasing industry has grown substantially in recent years, with the World Leasing Yearbook reporting 20% growth on international markets in 2012. Ireland is a major centre for crossborder leasing, particularly aircraft leases, with many of the international leasing companies having established operations here. The scale of the leasing industry and perceived weaknesses in lease accounting have led to it receiving focused attention in recent years from the two major standard-setters, the International Accounting Standards Board (IASB) and the US Financial Accounting Standards Board (FASB). The IASB and the FASB have worked together to develop a proposed new lease accounting model and have been successful in reaching conclusions which are nearly identical for both, one of the more successful projects undertaken in their programme of convergence of accounting standards. In May 2013 they published for public comment a revised Exposure Draft (ED) outlining a new proposed accounting model. This ED is open for comment until September 13, 2013. The ED revises proposals made in an earlier ED issued in August 2010.

A New Model - why?

The current lease accounting model classifies leases between

operating leases and finance leases. The 'substance over form' principle underlies the accounting distinction and may be quite obscure in some cases requiring focus on a number of criteria for classification, including transfer of ownership at end of lease, renewal options, proportion of estimated useful life and proportion of fair market value. The major difference between the two lease classes is that finance leases are recorded on the balance sheet, while operating leases are off - balance sheet. The arguments as to whether lease accounting needs to change turn on two different views. The first view is that leasing is a form of hidden leveraging that should not be allowed to remain off balance sheet, a big issue both conceptually and economically. The second view is that the economics of leasing may not really be that clear cut and current operating leases could possibly be considered as similar to simple service, or executory-type, contracts. Many are concerned that current lease accounting is subject to easy manipulation that can result in questionable outcomes. At present, the hidden leverage that may arise from the off-balance sheet accounting for operating leases can only be "guessed" by applying arbitrary multiples to basic disclosures in financial statements. This is not satisfactory to those that hold that view, given the scale involved. It is estimated that $1.5 trillion of leasing activity would be brought onto the balance sheets of US companies alone.

What is being proposed?

The ED published in May sets out proposals which would significantly affect the accounting for lease contracts by both lessors and lessees. The main changes from current lease accounting are as follows: Lessees Off balance sheet treatment would be eliminated for operating leases, other than short-term leases Classification of leases as property or non-property would determine the manner in which the lease expense is recognised each period, which will require detailed analysis of leases and lease payments. Lessors The nature of the underlying leased asset will dictate whether the asset is derecognised and the pattern of income recognition. The 2013 ED defines a lease as a 'contract that conveys the right to

use an asset (the underlying asset) for a period of time in exchange for consideration'. Short-term leases, for 12 months or less, would continue to be eligible for the current operating lease accounting model. For lessees, the two-track system proposed would recognise the costs and cash flows of most property leases evenly over the term of the lease, while the costs of most non-property leases would be front loaded, being higher in early years of a lease and lower in later years. This is in response to concerns expressed by constituents about proposals made in the 2010 ED. Property leases are referred to as Type B leases in the ED, with non-property leases referred to as Type A. Continuing with a dividing line between Type A and Type B leases is likely to be of concern to some, as a main objective of the standardsetters when initiating the project was to remove the 'bright line' between finance and operating leases, and have one consistent approach to all leases. The proposals addresses leases with variable lease term with the determining factor being whether there is a significant economic incentive to exercise an option to increase or otherwise change the lease term. Accounting for variable lease payments is also considered in the ED proposals, with treatment depending on the nature of the payments.

Challenges of Implementation
The proposals would require management to exercise significant judgement in some areas including identifying a lease, determining the lease term and measuring assets and liabilities. Clear and unambiguous accounting policy disclosures will be essential, including dealing with the question of what falls within the definition of a lease under the proposals, and what constitutes a 'right of use'. Some other practical issues that may need to be considered are: Financial statement ratios and metrics may be affected by the

changed accounting, including gearing ratios, debt covenants and other key performance ratios The complexity of data collection and analysis with regard to

lease classification, reassessment of variable elements of leases and other matters; and Deferred tax consequences

Conclusion
Development of the proposals has taken quite some time and commitment of resources by both the IASB and the FASB. The standard-setters are intending to publish a final standard in 2014 with implementation in 2017. However, there may still be a way to go as the proposals are likely to generate significant further debate. While many may support the balance sheet recognition of the majority of leases, concerns may be expected about the separate classification between Type A and Type B leases with the consequent differences in cost and cash flow measurement and recognition. While for some these may be practical steps, others may see it as a blurring of conceptual coherence and a practical issue with consistent application which may risk continuing manipulation to achieve desired results. While implementation of the standard may not be until 2017, companies with substantial leasing arrangements would be well advised to examine the proposals and develop a model to help them understand and consider the impact on the financial statements and financial metrics. Those that prepare well will be in a stronger position to keep investors and other stakeholders well informed of any major changes. Our Deloitte Global newsletter, IFRS in Focus, provides a summary of the main proposals and offers some observations.