Here’s a tentative agenda decision (open for comment until October 6th) arising from an issue recently considered by IFRIC:

• The request asked how an entity determines whether costs that are directly attributable to the origination or issuance of a financial instrument but are incurred before entering into the contractual arrangement are ‘incremental’ and, therefore, meet the definition of transaction costs in Appendix A of IFRS 9.
• In the fact pattern described in the request, an entity intends to enter into a loan contract with a bank and incurs legal and advisory fees while analysing the terms and conditions of the proposed loan. The entity expects to proceed with the contract, but the loan contract has not been signed as of the date the entity’s financial statements are authorised for issue.
• The request outlined two views:
  • in one view, costs that are incurred before entering into the contractual arrangement cannot meet the definition of transaction costs set out in Appendix A of IFRS 9;
  • in the other view, costs that are incurred before entering into the contractual arrangement can meet the definition of transaction costs set out in Appendix A of IFRS 9 even if there is a possibility that the financial instrument might not be originated or issued.
• Assuming that the costs are determined to be transaction costs, the request asked how to account for such costs in the period between incurring the costs and entering into the contractual arrangement.
• Evidence gathered by the Committee [to date] indicates no diversity in applying IFRS 9 that could have a material effect on entities’ financial statements with regards to determining and accounting for costs incurred before entering into a contractual arrangement. Feedback suggests that:
  • costs that are directly attributable to the origination or issuance of a financial instrument but are incurred before entering into the contractual arrangement, can be incremental and, accordingly, can meet the definition of transaction costs in IFRS 9; and
  • transaction costs are recognised in the statement of financial position, often as prepayments or other assets.

All of that being the case, the Committee “concluded that the matter described in the request does not have widespread effect. Consequently, the Committee [decided] not to add a standard-setting project to the work plan.”

The staff paper noted a few sources to support its conclusions:

• (a) the last sentence in paragraph 37 of IAS 32 Financial Instruments: Presentation might imply that costs incurred before the occurrence of an equity transaction can be included as transaction costs unless the equity transaction is abandoned;
• (b) paragraph B5.4.2 of IFRS 9 provides examples of fees that are an integral part of the effective interest rate of a financial instrument, including loan commitment fees, despite the possibility that the commitment might expire without the financial instrument being recognized;
• (c) paragraph B5.4.8 of IFRS 9 provides examples of transaction costs that appear to include not only fees contingent on a completion of a deal; and
• (d) guidance on accounting for transaction costs under IFRS 9 issued by some of the large accounting firms.

Regarding the recognition of a prepayment: “Some respondents said that, in their view, the transaction costs accumulated at the end of a reporting period and relating to unsigned contractual arrangements are generally not material. This is because transaction costs in general are often not material and the time lag between the incurrence of the costs and entering into a financial instrument contract is generally insignificant.” (The originator of the request had a different perspective on the issue’s significance, stating: “It’s worth noting that, in the EU alone, total outstanding loans to non-financial corporations and households amounted to EUR 13.6 trillion as of the 2023 year-end. If we assume, conservatively, that transaction costs represent approximately 0.1% of loan amounts, then the transaction costs associated with outstanding loans at any given time would amount to approximately EUR 14 billion in the EU alone).

The paper also observes that one accounting firm (a firm with a good memory it seems) said: “although in their experience most entities apply View 2, in the Agenda Decision Transaction costs (IAS 32) published in September 2008 the Committee recommended that the IASB develop common definitions for terms ‘incremental’ and ‘directly attributable’ across different IFRS Accounting Standards and Interpretations. The respondent said this recommendation is still relevant.”

One online commentator said: “It’s disappointing that the draft agenda decision doesn’t include any explanatory material. It more or less says: most companies apply this approach, but the IFRS Interpretations Committee won’t say whether it aligns with IFRS 9. That doesn’t really support consistent application of IFRS to be honest…” Well, I don’t know: it seems fairly uncontroversial to me that certain costs can by their nature be viewed as incremental to a particular transaction even if, as a matter of timing, they were incurred in advance of it crystallizing; the prepayment mechanism provides a well-established, low-tech way of dealing with such matters…

The opinions expressed are solely those of the author.