Three small steps to perfection: proposed annual improvements

The IASB has issued for comment its latest proposed annual improvements to the standards, with comments to be received by April 12, 2017.

There are just three items:

Borrowing costs IAS 23 Borrowing Costs states: “To the extent that an entity borrows funds generally and uses them for the purpose of obtaining a qualifying asset, the entity shall determine the amount of borrowing costs eligible for capitalization by applying a capitalization rate to the expenditures on that asset. The capitalization rate shall be the weighted average of the borrowing costs applicable to the borrowings of the entity that are outstanding during the period,  other than borrowings made specifically for the purpose of obtaining a qualifying asset.”  This wording might be interpreted to mean that such asset-specific borrowings would never be treated as part of this calculation, even after the asset for which the borrowings were originally made has been completed and put into use.  The IASB proposes to address this by specifying that these asset-specific borrowings are excluded only “until substantially all the activities necessary to prepare that asset for its intended use or sale are complete.” It’s probably a useful clarification, although from what I recall, this is hardly the only application question that arises regarding IAS 23’s somewhat arbitrary and vaguely expressed mechanisms. Given the possible difficulties of amending past calculations for such matters, the IASB proposes that the amendment would apply only to borrowing costs incurred on or after the date of first applying the amendments.

Income taxes IAS 12.52B says: “…the income tax consequences of dividends are recognized when a liability to pay the dividend is recognized. The income tax consequences of dividends are more directly linked to past transactions or events than to distributions to owners. Therefore, the income tax consequences are recognized in profit or loss for the period.” This is except to the extent that the tax arises from (among other things) a transaction or event which is recognized, in the same or a different period, outside profit or loss, either in other comprehensive income or directly in equity. The ordering of IAS 12 raises a question about whether this principle applies to all payments on financial instruments classified as equity, or only in circumstances when different tax rates exist on distributed and undistributed profits. The proposed amendment would clarify that it’s the former, and that this should apply retrospectively.

Applying the equity-method The last, somewhat tortuous item provides another example of the abstract complexities that add up to a good argument for getting rid of equity accounting. In discussing the mechanics for recognizing losses under the equity method, IAS 28.38 notes that an entity discontinues recognizing its share of losses, once the losses already recognized “equals or exceeds its interest in the associate or joint venture.” It describes the “interest in the associate/joint venture” for this purpose as encompassing the carrying amount determined using the equity method “together with any long-term interests that, in substance, form part of the entity’s net investment in the associate or joint venture.” This might include, you’ll recall, such items as preferred share interests in the investee, or long-term loans. This concept of the net investment is also significant in IAS 21, but IAS 21 expresses it slightly differently.

Elsewhere, IAS 28 says (or will say once IFRS 9 is implemented):  “IFRS 9 Financial Instruments does not apply to interests in associates and joint ventures that are accounted for using the equity method. When instruments containing potential voting rights in substance currently give access to the returns associated with an ownership interest in an associate or a joint venture, the instruments are not subject to IFRS 9. In all other cases, instruments containing potential voting rights in an associate or a joint venture are accounted for in accordance with IFRS 9.” The proposed amendment addresses whether this principle also applies to long-term interests in an associate or joint venture of the kind described above. The IASB proposes adding the following clarification: “An entity also applies IFRS 9 to other financial instruments in an associate or joint venture to which the equity method is not applied. These include financial instruments that are long-term interests that, in substance, form part of the entity’s net investment in an associate or joint venture.” So, for example, a loan to an associate has to be accounted for by applying the usual principles for recognizing and measuring financial instruments – including the requirements relating to impairment – regardless that for certain limited purposes it might be regarded as a “long-term interest,” thus affecting the equity-method calculation that would otherwise have been carried out. It proposes that this should be effective at the same time of implementation as IFRS 9 (so it needn’t be worried about in an IAS 39 world).

One member of the board voted against this particular item, on the basis that he: “disagrees with proposing amendments to IAS 28 without also specifying the types of interests in an associate or joint venture that an entity accounts for using the equity method, and the types of interests in such entities that an entity accounts for applying IFRS 9.” He thinks the types of long-term interests that form part of the net investment are quite limited and that the IASB “could specify the types of interests that form part of the net investment within a relatively short period of time.” I wonder if the IASB could likewise specify within a relatively short period of time what actually counts, standard-setting-wise, as a “relatively short period of time”…

The opinions expressed are solely those of the author

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