Proposed changes to IAS 12, IAS 23 and IAS 28 are coming in via the IASB's annual improvements process, says Adam Deller
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This article was first published in the May 2017 international edition of Accounting and Business magazine.
The International Accounting Standards Board (IASB) issued its annual improvements to IFRS Standards in January.
The improvements process is how the board adjusts the standards in areas where they are unclear. While these amendments generally do not significantly change the application of the standards, it is important for entities to determine any potential impact by reviewing their accounting policies. The recent amendments contain changes to three standards: IAS 23, Borrowing Costs; IAS 12, Income Taxes; and IAS 28, Investments in Associates and Joint Ventures.
IAS 23, Borrowing Costs
The principle of IAS 23 is that an entity must capitalise interest on incurred borrowing costs that are directly attributable to obtaining a qualifying asset. A qualifying asset is one that takes a substantial period of time to get ready for use.
Under the existing principle, paragraph 12 of IAS 23 states that if funds are borrowed specifically for the purpose of obtaining a qualifying asset, an entity determines the amount to be capitalised as the actual borrowing costs during the period, less any investment income on the temporary investment of those borrowings.
If an entity borrows funds generally, states paragraph 14, the weighted average of the borrowing costs applicable to the borrowings of the entity is applied to the expenditures on that asset.
Under both of these positions, the entity capitalises the borrowing costs until the qualifying asset is ready for its intended use or sale.
Both of those positions remain intact, but the proposed amendment to paragraph 14 states that when a qualifying asset is ready for its intended use or sale, the outstanding borrowings made specifically to obtain that asset are treated as part of the funds that are borrowed generally. The proposed amendment will not require retrospective application but will be applied prospectively.
The principle of ceasing to capitalise the borrowing costs on specific borrowings when the asset is ready for use is not controversial, but the statement to classify those borrowings as part of the general pool has raised some debate. Some commentators feel that including them in the weighted-average calculation would be inaccurate, as the cash flows on these borrowings are unlikely to remain available, having been spent on the qualifying asset for which they were originally intended.
Some commentators who disagree with the amendment believe that this proposal is at odds with the principle of avoidable costs, which is a key part of IAS 23. The concept that the borrowing costs are directly attributable to the qualifying asset is fundamental to this standard, as it states that only borrowing costs that are directly attributable to the acquisition construction or production of a qualifying asset can be capitalised.
Paragraph 10 of the standard states that ‘the borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those that would have been avoided if the expenditure on the qualifying asset had not been made’.
There is clearly merit in the argument that the borrowing costs on a loan used previously are not directly attributable to a new qualifying asset, as the borrowing costs on loans used for specific qualifying assets that are now completed cannot be avoided by not acquiring a new asset.
However, these borrowings are only dropping into the ‘general’ pool of borrowings for the purpose of calculating an effective rate. The amount to be capitalised from this pool will still remain the expenditure incurred on the asset, multiplied by the weighted average cost of borrowings. It is therefore unlikely that this will have a significant impact on the amount capitalised. The amendment is more a clarification of whether the interest rate should be included or not, and is not intended to mean that specific borrowing costs on these loans can be recapitalised.
IAS 12, Income Taxes
The proposed amendment to IAS 12 is to clarify whether the tax consequences of payments on financial instruments classified as equity should be recorded in profit or loss or equity.
Currently, paragraph 52A states: ‘In some jurisdictions, income taxes are payable at a higher or lower rate if part or all of the net profit or retained earnings is paid out as a dividend to shareholders of the entity. In some other jurisdictions, income taxes may be refundable or payable if part or all of the net profit or retained earnings is paid out as a dividend to shareholders of the entity.’
Paragraph 52B goes on to state that the income tax consequences of dividends are more directly linked to past transactions or events than to distributions to owners. The tax consequences are therefore recognised in profit or loss for the period, unless the tax arises from a transaction recognised elsewhere, such as other comprehensive income.
The issue here is whether the requirements of paragraph 52B of IAS 12 apply only in the circumstances described in paragraph 52A (ie when there are different tax rates for distributed and undistributed profits), or whether they apply beyond these circumstances – for example, to all payments on financial instruments classified as equity if those payments are distributions of profit.
The proposed amendment is to clarify that the requirements apply to all income tax consequences of dividends. It should not be interpreted to mean that an entity recognises the tax consequences of all payments on financial instruments classified as equity in profit or loss. The key is whether the payments on these instruments are distributions of profits (dividends). If so, the tax consequences should be recorded in profit or loss.
There appears to be general agreement with the principle behind the amendment to recognise the tax consequences of dividends in profit or loss. There is slight concern that the amendment doesn’t seem to address the underlying question of how to determine whether a payment represents a distribution of profits.
The Accounting Standards Committee in Germany has raised this concern, stating that it believes this key question of whether payments are distribution of profits has not been answered. In agreement with this, the European Financial Reporting Advisory Group has commented that without further guidance on whether the payments are dividends or not, there may not be an improvement in consistent application. Both these bodies agree with the proposed amendment but they would like to see further guidance issued on this key question.
IAS 28, Investments in Associates and Joint Ventures, and IFRS 9, Financial Instruments
This amendment seeks to clarify when IFRS 9 is applied in relation to an investment in an associate or joint venture.
Investments in associates and joint ventures are accounted for using equity accounting, meaning that one line is recorded in the statement of financial position, showing the value of the investment, and one line in the statement of profit or loss, showing the share of profit from the associate or joint venture.
IFRS 9 does not apply to interests in associates and joint ventures that are accounted for using the equity method. The issue is whether it applies to long-term interest in an associate or joint venture that forms part of the net investment in that venture but to which the equity method is not applied. The IASB aims to clarify that these long-term interests are included within the scope of IFRS 9, meaning they will be included within its impairment requirements.
The proposed effective date for the amendment is 1 January 2018. This is to align with the effective date of IFRS 9 because the proposed amendments clarify the applicability of IFRS 9 to long-term interests. It is easy to understand why the IASB has set this date for the amendment, especially in light of the new expected credit loss model under IFRS 9.
This proposal has largely been welcomed, but there is a feeling that it would be helpful for the IASB to produce illustrative examples.
Overall, these proposals are welcomed and are expected to be amended. It is possible that the IASB will issue further guidance, particularly in relation to how the impairment on the long-term interests relating to associates and joint ventures may be applied. The question of how to determine whether a payment is a distribution of profits remains largely unanswered, and is likely to continue to be raised for some time yet.
Adam Deller is a financial reporting specialist and lecturer
"Amendments generally do not change the application of standards, but it is important for entities to review accounting policy"