A European example of issues arising in applying IFRS 5
As part of its activities, the European Securities and Markets Authority (ESMA) organizes a forum of enforcers from 30 different European jurisdictions, all of whom carry out monitoring and review programs similar to those carried out here by the Canadian Securities Administrators. ESMA recently published some extracts from its confidential database of enforcement decisions on financial statements, covering ten decisions taken in the period from August 2016 to July 2017, “with the aim of strengthening supervisory convergence and providing issuers and users of financial statements with relevant information on the appropriate application of IFRS.” There’s no way of knowing whether these are purely one-off issues or more widespread, but some of them certainly have some relevance to matters discussed within Canadian entities once in a while. Here’s one:
- The issuer is a football club, which has entered in 2015 into a firm sale commitment regarding a grandstand of the football stadium in which the team plays its home games. The acquirer already owns the rest of the stadium and the sale is to take place in 2017. From 2017, the football team will play in a new stadium in a different location owned by the acquirer.
- In its financial statements for 2015, the issuer classified the grandstand as a non-current asset held for sale. The issuer refers to paragraph 6 of IFRS 5, which states that an entity shall classify a non-current asset as held for sale if its carrying amount will be recovered principally through a sale transaction rather than through continuing use. The issuer is aware that paragraph 8 of IFRS 5 contains a condition that in order to qualify as a non-current asset held for sale, the sale of the asset should be expected to be completed within a year from the date of classification. However, the issuer considered that this was not an absolute condition to be fulfilled in every case, but rather that it was a factor to be considered in determining whether a sale is probable. In the issuer’s view, the firm purchase commitment by itself makes the sale already probable. Therefore, the one-year condition in paragraph 8 of IFRS 5 would not be relevant.
The enforcer (as ESMA likes to term it) disagreed with this analysis, concluding: “In order for an asset to be classified as a non-current asset held for sale, the sale has to be expected to be completed within one year from the date of classification, except in cases permitted by paragraph 9 of IFRS 5. As, in the case at hand the sale will only be completed after more than a year, it was not appropriate to classify the grandstand as a non-current asset held for sale.” Beyond noting that the IFRS 5 criteria are consistent with those of US GAAP, that’s basically the whole argument.
In broad terms, I suppose the point of IFRS 5 is that if particular assets clearly aren’t relevant to an entity’s ongoing prospects, then it’s helpful to users to distinguish them from the assets which are relevant, and to apply to them a measurement basis better reflecting that reality. Of course, as with everything, it’s necessary to place some clear parameters around an entity’s ability to apply such a presentation. One risk otherwise might be of companies taking (say) under-performing assets and classifying them indefinitely as discontinued operations, perpetually diverting the reader’s attention from them even while continuing to bear all the related responsibilities and risks. I do actually recall an example of this from (very) old Canadian GAAP, although I can’t recall now how the company got away with it.
It’s entirely appropriate then to require, among other things, that if an asset is to be classified as held for sale, then the sale must be highly probable, and to provide some commentary on how to make that determination. I suppose the enforcer is correct that the standard expresses the one year criterion, and the circumstances in which that period might be exceeded, as bright lines. But to say the least, the issuer seems to have a point in noting that a “firm purchase commitment by itself makes the sale already probable.”
This might not get to the right answer in the case of, say, a rapidly depreciating piece of machinery. Suppose that such an item has a three year useful life, and the issuer enters into a firm commitment to sell it for its fair value at the end of the second year. In this situation, it would seem inappropriate to classify the item as held for sale, because its carrying amount won’t be recovered principally through a sale transaction rather than through continuing use. But in ESMA’s fact pattern, the proceeds to be received in 2017 would presumably far exceed whatever depreciation charge might normally be recorded for the grandstand in 2015 and 2016.
If that’s not the case, because for example the grandstand is a broken down old structure that will hardly be worth anything in 2017, then ESMA’s, uh, grand stand might be more compelling. As so often, we don’t have enough facts to know the complete picture. But based on the information provided, this might just be a situation where it wasn’t worth intervening…
The opinions expressed are solely those of the author.