More industry clarity on the IFRS 17 implementation road

The September Transition Resource Group (TRG) meeting provided further clarity in a range of areas related to insurance under IFRS 17. Our analysis addresses the points that we expect will affect most insurers. Other topics discussed applicable to mutuals and associations will be analysed in a separate blog.

1.      Factors that can affect the length of the coverage period

Consequential insurance coverage:

Insurance liability is the insurer’s obligation to investigate and pay valid claims arising from insured events and is split into two components based on whether the insured event has already occurred:

When does the insured event occur if the insurance risk is consequent to an incurred claim? For example, in the case of disability coverage in the form of an annuity for the period in which the policyholder is disabled: is the insured event a) the accident or illness that made the policyholder disabled or b) the policyholder becoming disabled following an accident or illness specified in the contract?

Practical aspect: In reality either interpretation could apply. Different interpretations will give rise to different coverage periods, ie the coverage period will be longer in the case of disability coverage if b) is the insured event rather than a). A longer coverage period means that in the case of view b) revenue is recognised over an extended period. Judgement is required to determine the accounting policy that will provide the most useful information to the users of the insurer’s financial statements.

Premium waiver:

Premium waiver can be in the form of a contractual term that allows a policyholder not to pay premiums in specified circumstances. For example, a term life contract that provides primary coverage for mortality risk might allow the policyholder not to pay premiums for that contract if the policyholder becomes unable to work due to a disability.

Practical aspect: The premium waiver does not depend on the death of the policyholder (primary coverage – mortality risk) but on an additional insurance risk of the policyholder becoming disabled. The additional adverse effect of the policyholder becoming disabled suggests the insurer provide the same benefits without receiving consideration, ie additional coverage. Additionally, coverage units for mortality and disability risk can lead to a different coverage period over which the contractual service margin will be recognised when the coverage period with the waiver differs from the coverage period related to the base contract without the waiver.

2.      Discount Rates:  top down approach for non-VFA contracts

Under the top down approach, the starting point to determine the IFRS 17 discount rate is an asset rate that is adjusted to exclude factors present in the assets but not present in the group of insurance contracts, for example expected credit losses and differences in amount, timing or uncertainty of cash flows.

However, there is a simplification in the standard not to adjust the asset rate for differences in liquidity between a reference portfolio of assets and the group of insurance contracts. The simplification is available on the basis that the asset rate will be derived from a reference portfolio that is expected to have similar liquidity characteristics to the group of insurance contracts.

Practical aspect: if the simplification is used, measurement will be easier on initial recognition, but, subsequently, more disclosures may be required. That is because small fluctuations in the liquidity of the reference portfolio may lead to discount rate changes. Discount rate changes, even if small, may lead to material changes to the insurance liabilities measured.

Disclosure point: any material effect of a change in the composition of the reference portfolio of assets on the discount rates would be required to be disclosed in accordance with paragraph 117 of IFRS 17.

3.      Premium and acquisition cash flow experience adjustments

Premium experience adjustments are differences between expected and actual premiums. Judgment should be applied in deciding whether the premium experience adjustments relate to current, past or future service. For example, in the case of workers’ compensation coverage, if the premium is based on the expected headcount and the expected headcount differs from the actual one, then the difference between expected vs actual premiums should:

  • be recognised as revenue if it relates to current or past service.
  • adjust the contractual service margin if it relates to future service. That could happen when the actual premium received in the current period for coverage to be provided in the future differs from the expected premium because lapses differ from those expected.

Consistently with premium experience adjustments, acquisition cash flows might be settled in an amount different from the one originally expected (acquisition cash flows experience adjustments). Acquisition cash flow experience variances adjust the contractual service margin if they relate to future coverage or affect insurance revenue and insurance service expense if they relate to current or past service.

Practical aspect: The additional premium recognised as revenue in the current period because the actual headcount was higher than the expected does not affect the release of CSM, i.e. CSM is based on expected coverage units. Instead the premium experience adjustment is an additional component of revenue based on paragraph B124 of IFRS 17.

4.      Acquisition cash flows and their recoverability

Not all commissions meet the definition of IFRS 17 insurance acquisition cash flows. For example, policy administration and maintenance costs in the form of recurring commissions due to intermediaries do not meet the definition of insurance acquisition cash flows, instead they are treated as administrative or maintenance costs.

Those cash flows that are insurance acquisition cash flows under IFRS 17 may also be higher than the premiums, i.e. not fully recoverable. In this regard, the Standard does not require entities to separately identify the recoverable amount of insurance acquisition cash flows at each reporting date. The remeasurement of fulfilment cash flows at each reporting date will capture any lack of recoverability arising from all expected cash flows including acquisition cash flows.

Practical aspect: The insurance revenue cannot exceed the amount the entity is expected to receive as consideration for services provided. If, for example, the acquisition cash flows cannot be recovered from premiums, they should be expensed in profit or loss because the CSM cannot be negative. Insurance revenue, in other words, will be the total reduction of the liability for remaining coverage (closing LRC minus opening LRC) relating to services for which the entity expects to receive consideration, excluding the loss component (that will reflect the irrecoverable cash flows)

5.      Contract boundary considerations

Contract boundary determines which cash flows pertain to existing contracts and which to future contracts. Cash flows that pertain to expected claims or premiums arising from future contracts are outside the initial contract boundary.

Practical aspect: a proportional reinsurance contract held that covers all risks arising from underlying insurance contracts issued in a 24-month period and provides the unilateral right to both the entity and the reinsurer to terminate the contract with a three month notice period has a contract boundary of 3 months (1 January – 31 March). This is because the cedant has no substantive right to receive services with respect to new business that may be ceded in the following 21 months.

Contract boundaries are reassessed in each reporting period if there are changes in circumstances on the entity’s substantive rights and obligations. The contract boundary reassessment should be based on ‘changes in circumstances’ that are ‘narrow’, such as changes in the economic environment (debt spiral situations) or contract term whose commercial substance status has changed from one reporting period to the other.

Practical aspect: a restriction previously assessed as having no commercial substance, could in later years begin to have commercial substance. For example, in the case of a five year health insurance contract which can be re-priced annually, the insurer may initially determine the contract boundary as 1 year, but at the end of the year restrictions on re-pricing that had no commercial substance initially, may have commercial substance at the reporting date. In that case, at the end of the reporting period, the contract boundary is no longer 1 year but reassessed to be 5 years.

6.      Commissions and reinstatement premiums

Commissions due to a policyholder and reinstatement premiums charged to a policyholder are amounts exchanged between the (re)insurer and the policyholder and should be accounted for under IFRS 17 based on their economic substance and not based on what they are called in the contract.

In this regard the following two questions are relevant:

Question 1: Is the amount contingent on claims?

  • Yes. For example, an additional ‘premium’ is charged to the cedant as claims incur. In this case the extra amount charged should be part of the claims and not of the premiums. One TRG member interpreted differently the additional premium charged to the cedant as buying additional coverage to increase the cover, ie as a pricing consideration once you have ‘exhausted’ the first claims’ capacity, ie as part of the premiums.
  • No. For example, profit ‘commission’ due to a cedant does not change as claims incur. In this regard the amount paid to the cedant is effectively a deduction from the premium. The economic effect is a lower premium charge.

Question 2: Is the amount repaid in all circumstances (eg even if the contract is cancelled or the maximum claim limit is reached)?

  • Yes. For example, part of premiums in a retroactively rated insurance contract is refunded to the policyholder in all circumstances. Under these circumstances the amount meets the definition of an investment component and is presented as financial income or expenses and not as part of insurance revenue.

KPI point: the above guidance applies to both insurance (property/casualty contracts with experience-rating provisions or similar features) and reinsurance contracts issued (where the cedant is the policyholder) and is different from existing practice. It is expected to have an impact on important metrics, eg loss ratio and may have an impact on the information provided on the claims development tables.

Future discussions

The challenges brought about by IFRS 17 are significant and many insurers are looking for solutions that capitalise on existing practice. The extent to which these solutions and implementation approaches will reflect IFRS 17’s new principles is an area of much interest. It is expected that many of these views and approaches will be deliberated and positions clarified through discussion forums and as implementation experience develops.

With the application date of IFRS 17 approaching, insurers are trying to understand what changes need to be made in order to be IFRS 17-ready. If you would like to discuss your transition to IFRS 17, please feel free to contact Maria Karamanou or any other member of the Mazars Financial Reporting Advisory team.

Blog author: Maria Karamanou, Insurance specialist, Mazars Financial Reporting Advisory

IFRS 17: 3 early lessons and practical insights

A year and a few months after the issue of the new insurance contracts standard, insurers (issuers of insurance contracts) are recalibrating their IFRS 17 implementation approaches based on the latest technical developments and positions adopted by their peers.

Latest developments include the IASB’s transition resource group discussions, the recent clarifications to IFRS 17 discussed at the June IASB meeting and the standard’s endorsement status in the jurisdictions in which the insurers operate. Below we list three early lessons and practical insights regarding IFRS 17 implementation approaches our clients and their peers have shared with us.

Lesson 1: Leveraging off Solvency II

Maximising the overlap between Solvency II and IFRS 17 will help insurers reduce the implementation costs because both frameworks have a few common measurement principles. However, care must be taken to ensure that the “shared” features that you intend leveraging for IFRS 17 do actually exist in practice for your organisation. There will be differences between the two reporting frameworks that may not be easily reconcilable. These differences arise from different requirements in the two frameworks, regarding, for example, the contractual service margin, the level of aggregation, contract boundaries and discount rates, that reflect the different lenses through which IFRS (IFRS 17 and IFRS 9) and Solvency II look at contracts issued by insurers.

Practical insight: Under IFRS 17, contracts may be grouped at a more granular level than under Solvency II. Under IFRS 17, there is a two-step approach to grouping contracts. The first step is identifying portfolios, i.e. contracts subject to similar risks and managed together as a pool. Lines of business data under Solvency II could meet the IFRS 17 definition of portfolios, but this is not necessarily the case. Even at this step, there may be differences between IFRS 17 and Solvency II. In practice contracts subject to similar or homogeneous risks are not always managed together as a pool.  Insurers need to determine and then document their interpretation of “managed together”.

Lesson 2: Simplified approach may not be that simple

Under IFRS 17, there is an optional simplified approach applicable to contracts that have a coverage period of one year or less. This simplification, known as the “premium allocation approach”, is also optionally applicable to groups of contracts where the insurer reasonably expects the liability for remaining coverage (‘pre-claims liability’) under both the simplified and the default general model not to be materially different (“immaterial difference test”). This eligibility assessment is conducted at the inception of the group and requires consideration of the variability in the fulfilment cash flows. If an insurer expects significant variability in the fulfilment cash flows, this will cause the contract group to fail the immaterial difference test.   Non-life insurers in particular may consider that implementing IFRS 17 will not be unduly challenging for them because the simplified approach is broadly similar to their existing accounting under IFRS 4 / old UK GAAP.  It would be a mistake, however, to assume that the simplified approach will apply to all their contracts.

Practical insight: There will almost inevitably be some contracts with a coverage period in excess of one year and it should not simply be assumed that these are eligible for the simplified approach.  An analysis of the variability of the fulfilment cash flows of these contracts needs to be carried out and the entity will have to try to set objective benchmarks to determine what constitutes “significant variability”.

Another potentially tricky area of the simplified approach relates to onerous contracts. Although entities applying the simplified approach can assume that there are no onerous contracts in the portfolio at initial recognition, this is only the case if there are no facts or circumstances that indicate otherwise.  If there are such facts, the insurer will need to book to profit or loss the amount of the difference between the carrying amount of the liability for remaining coverage based on the simplified approach and the fulfilment cash flows relating to the remaining coverage based on the general model. Many insurers are currently trying to identify which ‘facts and circumstances’ might constitute indicators of onerous contracts.

Practical insight: Some insurers are considering using initial estimated loss ratios to decide whether contracts are onerous and if this approach is taken, entities need to establish, justify and then document how this threshold loss ratio is determined.  For example, is it based on a projected loss ratio for the portfolio?  Or the loss ratio for a less granular line of business?

Lesson 3: Treatment of reinsurance contracts held on a risk-attaching basis

Reinsurance contracts held on a risk-attaching basis, covering underlying contracts with coverage periods of a year or less, might not fall under the scope of the premium allocation approach, subject to the immaterial difference test, because the risk-attaching basis means all claims from ceded underlying policies incepting during the period of the reinsurance contract are covered, even if they occur after the expiration date of the reinsurance contract. As a consequence, the coverage period of the reinsurance is arguably in excess of one year.

Practical insight: Entities will need to consider whether it makes sense to opt for a simplified approach for the inwards business if it is not possible to follow the same approach for the related outwards reinsurance protection. Users may find the financial statements more informative if this potential mismatch is avoided and the general model is applied to both inwards and outwards contracts.

Future discussions

The challenges brought about by IFRS 17 are significant and many insurers are looking for solutions that capitalise on existing practice. The extent to which these solutions and implementation approaches will reflect IFRS 17’s new principals is an area of much interest. It is expected that many of these views and approaches will be deliberated and positions clarified through discussion forums and as implementation experience develops.

With the application date of IFRS 17 fast approaching, insurers are trying to understand what changes need to be made in order to be IFRS 17-ready. If you would like to discuss your transition to IFRS 17, please feel free to contact Maria Karamanou or any other member of the Mazars Financial Reporting Advisory team.

Blog author: Maria Karamanou, Insurance specialist, Mazars Financial Reporting Advisory

4 Hidden challenges and pitfalls when classifying cryptocurrencies and other investments as cash for accounting purposes

The advent of cryptocurrencies has disrupted conventional thinking around cash and cash equivalents, with accounting policies for such instruments still being analysed. Below we take a look at challenges around cryptocurrencies and other pitfalls to look out for when applying the definition of cash and cash equivalents in IAS 7 Statement of Cash Flows and interactions with IFRS 9 Financial Instruments

1.  Cryptocurrencies

Although the relatively new terms “cryptocurrency” or “Bitcoin” may suggest a form of cash, this does not necessarily mean cash for accounting purposes. Based on the fact that this type of investment doesn’t have a short-term life, often has significant fluctuations in value and typically has liquidity constraints it does not meet the definition of cash and cash equivalents.

There is currently some uncertainty on how to appropriately account for investments in cryptocurrencies. Possible classifications currently being considered include intangible asset under IAS 38 Intangible Assets and inventory under IAS 2 Inventories. Companies will need to apply judgement in determining the appropriate accounting classification and treatment of these types of investments, which may be dependent on their business model.

2.  Money market funds

Investments in units of money market funds, although redeemable at any time, typically aren’t cash and cash equivalents for accounting purposes. This is because the definition of cash and cash equivalents requires that the amount of cash that will be received must be known at the time of the initial investment and that the amount must be subject to an insignificant risk of changes in value.

Depending on the business model and the contractual terms and conditions, such investments may be appropriately classified and measured at fair value through profit or loss under IFRS 9.

  3.  Fixed deposits

Investments in fixed term deposits that are not considered to be short-term at acquisition date won’t meet the definition of cash and cash equivalents. This is because the definition requires the investment to be short-term. IAS 7 suggests a maturity of three months or less from the date of acquisition as being short-term.

Depending on the business model and the contractual terms and conditions, such investments may be appropriately classified and measured at amortised cost under IFRS 9.

4.  Overdrafts

Where short-term loans and credit facilities, such as overdrafts, have a notice period (i.e. are not repayable on demand) and do not often fluctuate from being negative to positive, they are a form of financing rather than being an integral part of the entity’s cash management. In this case such arrangements would not be considered cash for accounting purposes. This is the view held by a recent IFRIC decision, which can be accessed here.

Depending on the contractual terms and conditions, these types of overdrafts may be appropriately classified and measured as financial liabilities at amortised cost under IFRS 9.

Companies are also reminded that these overdrafts may fall under the new IAS 7 disclosure requirement to provide information that enables users to evaluate changes in liabilities arising from financing activities.

In the above summary, we have highlighted some of the challenges and pitfalls companies should look out for when applying the definition of cash and cash equivalents under IAS 7. If you would like to discuss the application of this or other financial reporting requirements to your business, please feel free to contact Steve Brice or any other member of the Mazars’ Financial Reporting Advisory team.

5 IFRS errors by EU listed companies we can all stop making

When well-resourced listed companies get aspects of their financial reporting wrong, there is often a good chance that the rest of us could learn something from their mistakes. We provide 5 common errors that are relevant to all IFRS reporters (listed or not), which were included in ESMA’s (the European Securities and Markets Authority) recently published annual report on the activities of European regulators.

1.  Key Performance indicators

UK reporters (except for small private companies) are required to include in their strategic reports an analysis of the development, performance or position of the company’s business using financial and other key performance indicators to aid understanding. When these indicators are not IFRS measures, there are lessons from the experience of listed companies which stem from enforcement actions related to presentation of alternative performance measures. These lessons include ensuring that non-IFRS performance measures are defined, using an appropriate label, and possibly providing reconciliations to the most directly reconcilable IFRS line item, as considered appropriate.

2.  Non-recurring, unusual or infrequent transactions?

A few listed companies incorrectly labelled items in the statement of comprehensive income as non-recurring, unusual or infrequent. Items that affected past periods and/or are expected to affect future periods can rarely be presented as non-recurring or similar.

Quick reminder: it is not permissible under IFRS to label subtotals or line items as “exceptional”.

3.  Debt vs equity judgements

Certain listed companies made incorrect conclusions as to the debt versus equity classification of their issued financial instruments. Although often a complex area, in 2 cases listed companies got the classification of relatively basic instruments wrong. For example, despite a lack of contractual obligation to pay interest and redeem the principal, one instrument was incorrectly classified as a liability. In another instance, an instrument was classified as equity despite a contingent settlement provision effectively requiring classification as a financial liability.

Where significant judgement is applied for debt versus equity classification, the accounting policy and analysis made of the classification should be disclosed, which was inadequately addressed by 16 listed companies.

4.  Presenting the statement of comprehensive income by function?

An instance was also reported where a listed company, who presented its statement of comprehensive income by function (e.g. containing cost of sales, operating and administration expenses line items), neglected to disclose additional information on the nature of the expenses. Under these circumstances, IAS 1 requires disclosure of the amount of depreciation and employee benefit expense to be presented amongst other things.

5.  Consistency in sub-totals

The composition of a sub-total should be consistent with its label and should not be misleading. A couple of listed companies incorrectly excluded operating items from sub-totals relating to operating activities. The presentation of sub-totals is also required to be consistent from period to period in line with the requirements of IAS 1, which was not the case for another listed.

The 2017 activity report can be consulted here.

If you would like to discuss the application of these or other financial reporting requirements to your business, please feel free to contact Steve Brice or any other member of the Mazars Financial Reporting Advisory team.

Do developers need to book revenue separately for the transfer of land in a construction contract under IFRS 15?

land

A recent decision by the IFRS Interpretations Committee (IFRIC) looked at whether or not the new revenue standard (IFRS 15) requires developers to recognise revenue from the sale of land separately from revenue from the construction of a building on that land.

IFRS 15 contains a new unit of account called a ‘performance obligation’ and requires revenue to be accounted for separately for each performance obligation identified in a contract. To determine whether or not the sale of land is to be accounted for as a separate performance obligation, there are two criteria to be assessed:

1. Can the customer benefit from the land on its own or together with other resources readily available to the customer (i.e. the land is capable of being distinct)?

IFRIC guidance: For a contract that transfers both an area of land and an entire building to be constructed on the land, the land is capable of being distinct from the building. This is because contractual limitations are ignored when making the assessment e.g. notwithstanding any contractual limitations, the customer could typically use another developer to construct the building.

2. Is the developer’s promise to transfer the land is separately identifiable from other promises in the contract (i.e. the promise to transfer the land is distinct within the context of the contract)?

IFRIC guidance: The promise to transfer the land is distinct within the context of the contract if it can be shown that:

  • the performance of constructing the building is the same regardless of whether the land is also transferred; and
  • the promise to construct the building is able to be fulfilled even if the land is not also transferred and vice versa.

Practical implication: If a developer concludes that both the above criteria are satisfied, the sale of the land becomes a performance obligation which is treated separately to the performance obligation for the construction of the building. Accounting for revenue relating to the sale of land as a separate performance obligation will require a developer to allocate an amount of the contract price to the sale of the land in accordance with the requirements of IFRS 15 and then to recognise such an amount separately in line with the said requirements.

The above guidance is expected to be useful for developers, many of whom are still coming to terms with the implications of IFRS 15 for their businesses which is effective for years beginning on or after 1 January 2018. Further details regarding the March IFRIC update can be found here.

If you would like to discuss the application of the requirements of IFRS 15 to your business, please feel free to contact Steve Brice or any other member of the Mazars Financial Reporting Advisory team.

In Brief: more answers to industry questions on the new IFRS 17 insurance standard

answers

On 2 May 2018, the second technical meeting of the Transition Resource Group (TRG) was held to discuss questions raised on implementation of the new insurance standard, IFRS 17. We provide a brief summary of some of the key questions and answers. (Click here for our summary of the previous meeting.)

The IASB’s TRG comprises insurance experts directly involved in the implementation of IFRS 17 and provides a public forum for stakeholders to follow the discussion of questions raised by interested parties on implementation of IFRS 17.

Combination of insurance contracts

Treating a set or series of contracts as one contract is not an accounting policy choice. It is only applicable when the legal form of the contracts does not reflect the economic substance i.e. when contracts combined achieve or are designed to achieve an overall commercial effect. A combination of the following factors may be relevant in assessing whether the overall commercial effect is being achieved individually or in combination with other insurance contracts:

  1. Are the rights and obligations similar when contracts are looked together versus individually?
  2. Are the risks covered interdependent?
  3. Does the lapse or maturity of one contract cause the lapse or maturity of the other contracts?
  4. Can you measure one contract without considering the others?

Practical aspect: A discount provided to the policyholder for buying multiple insurance covers that can be allocated to multiple insurance covers is not considered a relevant factor when determining whether the overall commercial effect is being achieved individually or in combination.

Risk adjustment

The risk adjustment is the compensation required and charged by the insurer (issuer of the contract) for the uncertainty arising from non-financial risk about the amount and timing of cash flows and is an entity-specific measure that also reflects diversification benefits. Practically, that means that the risk adjustment for a group of contracts will be the actual amount charged for bearing the financial risk regardless of individual or consolidated reporting i.e.

RA INDIVIDUAL ACCOUNTS = RA CONSOLIDATED ACCOUNTS

Practical aspect: Evidence of what the insurer has ‘charged’ for the non-financial risk can be indirectly found in pricing (component of the price charged) or cost analysis (e.g. cost borne that helps the insurer decide whether or not to write a contract).

Contract boundary

Another significant area of judgement is determining the contract boundary and, more specifically, determining which cash flows relate to existing and which to future contracts. Three aspects of the contract boundary requirements were discussed:

  1. Market constraints, on top of contractual, legal and regulatory constraints, should be considered to assess insurer’s practical ability to reassess policyholder risks and reprice if those constraints have commercial substance and solely apply to new policyholders (future contracts) and not to existing policyholders. A market constraint can be, for example, the expectation of policyholders switching to a competitor, if the insurer increases the price (or decreases the level of benefits) of the contract to reflect an increase in policyholder risks.
  2. Option to add insurance coverage: whether the cash flows arising from the exercised option are within the contract boundary or should be treated as a new contract depends on 1) whether the option is a separate contract and, if not, 2) whether at the option exercise date, the insurer has the practical ability to reprice the whole contract.
  3. When the cedant’s substantive right to receive services from the reinsurer ends before the cedant’s substantive obligation to pay premiums to the reinsurer, then the contract boundary should reflect all the cash flows arising from both cedant’s substantive rights and obligations, ie should not only include the cash flows up to the point the cedant no longer receives services.

Practical aspects: An option is of commercial substance when it guarantees future insurability. Additionally, an option to provide additional services is a current obligation depending on whether the option is exercisable or not on the designated future date.

Determination of coverage units

Determining the coverage units involves judgement to best reflect the provision of service and is not an accounting policy choice. Coverage units establish the amount of the contractual service margin recognised in profit or loss in the period and should reflect the services provided under the group of insurance contracts in that period. The services provided under the group should include the quantity of benefits provided under each contract of the group and each contract’s expected duration.

Practical aspect: Possible methods for identifying the quantity of benefits provided in the period include the maximum contractual cover in each period and the amount the insurer expects the policyholder to validly claim in each period if an insured event occurs. For contracts with investment-related services, i.e. containing investment components treated under the variable fee approach, the coverage provided should also reflect the investment-related services.

A few TRG members considered that the probability of claims can affect coverage units and that maximum contractual cover does not always have commercial substance and may not be appropriate as a method when there are contracts in a group with relatively high and low coverage limits.

Implementation challenges

Discussions also highlighted those requirements that may prove to be more challenging to apply in practice, particularly for general insurers:

  • identifying premiums received related to groups of insurance contracts and the liability for incurred claims related to groups of insurance contracts.
  • the treatment of contracts acquired in their settlement period is a significant change from existing practice because under current practice they are accounted for as liability for incurred claims of the acquirer. Under IFRS 17, those contracts acquired in their settlement period will be accounted for as liability for remaining coverage because they provide coverage for the adverse development of claims. General insurers applying the Premium Allocation Approach may need to apply the general model for those contracts acquired in the settlement period which could have wide ranging accounting and systems implications.

Future meetings: The TRG will continue to meet to discuss industry questions on IFRS 17. The next meeting is scheduled to take place on 26 September 2018.

If you would like to discuss your transition to IFRS 17, please feel free to contact Maria Karamanou or any other member of the Mazars Financial Reporting Advisory team.

 

Blog author: Maria Karamanou, Senior, Mazars Financial Reporting Advisory

Investments in shares: Is a change in the making to EU endorsed IFRS 9?

stocks

For companies holding investments in equity instruments, the default treatment under IFRS 9 (the new standard on financial instruments currently effective) is measurement at fair value with changes in fair value recognised in profit or loss. However, IFRS 9 also allows on option for these types of investments to be measured at fair value with changes in fair value recognised in other comprehensive income i.e. outside profit or loss. Differences characterising this new option from the IAS 39 “Available for sale” category are:

  • gains or losses in OCI are allocated directly to retained earnings and never recognised in profit or loss; and
  • no impairment model.

The European Commission picked up on these differences during the IFRS 9 European adoption process and as part of its work requested technical advice on whether the existence of an impairment model is an important element in the re-introduction of recycling of gains and losses.

In a recent discussion paper, European Financial reporting Advisory Group (“EFRAG”) presents arguments for the importance of an impairment model for re-introducing recycling of gains and losses. It also proposes two possible models: a “revaluation model” and an “impairment model” similar to IAS 39. (The comment period for the paper is open until 25 May 2018).

In addition to the Discussion Paper, EFRAG has also published an academic literature review on the interaction of IFRS 9 and long-term investment decisions. The review focuses primarily on papers published in accounting and finance journals since 2005 and identifies several themes, including the pros and cons of recycling and the factors that influence investment strategies.

From the above papers, it is clear that the debate on how to treat investments in equity instruments is not over yet in the EU. However, there is still a long road ahead and many hurdles to overcome before the possibility of recycling and impairment for investments in equity instruments becomes a reality under EU endorsed IFRS 9.

If you would like to discuss the application of IFRS 9 to your business, please feel free to contact Steve Brice or any other member of the Mazars Financial Reporting Advisory team.

Help for developers: applying the new IFRS revenue standard to the sale of a real estate unit

house keys

A recent decision by the IFRS Interpretations Committee (IFRIC) addressed application of the new revenue recognition requirements of IFRS 15 to the construction and sale of a real estate unit in a residential multi-unit complex by providing guidance to developers on the timing of their revenue recognition.

IFRS 15 requires revenue to be recognised over time if any 1 of 3 criteria are satisfied. If none of these criteria are satisfied, revenue is required to be recognised at a point in time (which is typically on completion and delivery of the asset).

A developer could recognise revenue over time in accordance with IFRS 15 if it is demonstrated that the customer controls the real estate as it is created or enhanced. The IFRIC provided the following points of guidance:

  • the customer’s exposure to changes in the market value of the real estate and ability to direct the real estate must be in place in order to demonstrate control; and
  • the asset created is the real estate and not, for example, the right to obtain the real estate in the future. The implication is that any right to sell or pledge a right to obtain real estate in the future is not considered evidence of control of the real estate itself.

Another criterion for recognising revenue over time for a developer is that:

  1. the real estate created must not have an alternative use to the developer, and
  2. the developer must have an enforceable right to payment for performance completed to date.

An example of requirement 1) is a practical right within the contract for the customer to prevent the developer from using the real estate for another purpose.

In respect of requirement 2), developers should consider evidence of relevant legal precedent available to it which could override an enforceable right to payment contained within the contract, although it does not need to undertake an exhaustive search for evidence of such legal precedent. It should be noted that the likelihood of the right being exercised is not relevant to this assessment.

The above guidance is expected to be useful for developers, many of whom are still coming to terms with the implications of IFRS 15 for their businesses which is effective for years beginning on or after 1 January 2018. Further details regarding the March IFRIC update can be found here.

If you would like to discuss the application of the requirements of IFRS 15 to your business, please feel free to contact Steve Brice or any other member of the Mazars Financial Reporting Advisory team.

Insurance experts answer industry’s questions on the new IFRS insurance standard

lightbulb smaller

In February, the first technical meeting of the Transition Resource Group (TRG) was held to discuss questions raised on implementation of the new insurance standard, IFRS 17. We highlight some of the key findings below.

The IASB’s TRG comprises insurance experts directly involved in the implementation of IFRS 17 and includes within its membership 9 insurers and 6 audit practitioners. The purpose of the group is to provide a public forum for stakeholders to follow the discussion of questions raised by interested parties on implementation of IFRS 17.

Although the mood of the TRG seemed to be resistant to change from existing practices, some issues were clarified and are closed for now:

Separating insurance components

Separating insurance components from a single contract is not an accounting policy choice. The contract is generally the lowest unit of account. An example was provided of a possible rare exception to this principle when more than one type of insurance cover is included in one legal contract solely for the administrative convenience of the policyholder and the price is simply the aggregate of the standalone prices for the different insurance covers provided.

Contract boundary

Boundary of contracts determines which cash flows to use to measure those contracts, ie which cash flows relate to existing and which to future contracts. Contract boundary is an important determinant of contracts’ profitability and 3 aspects were discussed:

a) Contracts with annual repricing mechanisms

The issue was whether to include only those cash flows related to premiums up to their annual re-pricing date or also to include cash flows related to premiums beyond that date. The answer depends on whether the entity has the practical ability to reassess the insurance and financial risks of the portfolio of policyholders and to reset the price of that portfolio on that date. If yes, only cash flows related to premiums up to their annual re-pricing date are included. If no, cash flows may also include those related to premiums beyond that date.

b) Reinsurance contracts held

For reinsurance contracts held, the boundary includes cash flows arising from the substantive rights of the holder (ie to receive services from the reinsurer) and cash flows arising from the entity’s substantive obligation to pay amounts to the reinsurer (ie to pay premiums to the reinsurer). Two important changes from existing practice were highlighted:

  • under IFRS 17, future underlying contracts expected to be covered by the reinsurance contract need to be estimated on initial recognition of the reinsurance contract held, even if they are not issued yet, and
  • netting the effect in profit or loss of the reinsurance against the insurance contract is not permitted under IFRS 17.

c) Acquisition costs

A two-step approach was suggested: Firstly, identify all the costs of originating contracts at a portfolio level and secondly, appropriately allocate them to groups of contracts.

In identifying the costs of originating the contracts there are those costs that are directly attributable to individual contracts or a group of contracts and those that are not (usually general overheads). In allocating these costs, those that are directly attributable to a group of contracts or individual contracts cannot be included in the boundary of any other group of contracts apart from that group they are directly attributable to. An example of directly attributable costs to a group of contracts or individual contracts is insurance acquisition cash flows unconditionally paid when the initial contract is written (no claw back provision). On the other hand, the appropriate allocation of general overheads will require more judgement.

Insurance acquisition cash flows under the fair value transition approach

The fair value transition approach is a ‘fresh-start’ approach. Therefore, any insurance acquisition cash flows incurred prior to the transition date should not be included in the estimates of the future cash flows.

Future meetings

One of the pervasive issues to be discussed further at the next TRG meeting in May is coverage units, ie the amount of the contractual service margin (unearned profit) to be recognised in profit or loss for services provided in a period. Coverage units will be discussed also in the context of contracts without and with investment components.

If you would like to discuss your transition to IFRS 17, please feel free to contact Maria Karamanou or any other member of the Mazars Financial Reporting Advisory team.

Blog author: Maria Karamanou, Senior, Mazars Financial Reporting Advisory

Post-Carillion: IFRS reporters are advised to get these disclosures right

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The FRC has recently issued a reminder to companies highlighting key financial reporting obligations. Although the reminder is directed at the construction industry following the collapse of Carillion, it is also relevant to other companies.

Going concern

A decision that there is no material uncertainty relating to the application of the going concern assumption doesn’t mean that companies have nothing further to disclose in relation to this decision. Albeit that there may be no material uncertainties to disclose, if the directors’ decision involved significant judgement, the company will need to consider the disclosure requirements of IAS 1 relating to key judgements.

Auditors are also reminded to remain alert to any events or conditions which may create significant doubt as to a company’s ability to continue as a going concern.

Strategic report

The strategic report should include a clear and detailed description of the principal risks and uncertainties facing the company. Quoted construction industry companies are also likely to require an explanation of the factors that are most important to the outcome of their key contracts to help users understand how value will be generated and preserved over the longer term.

Key judgements and sources of estimation uncertainty

Companies should consider the disclosure requirements of IAS 1 relating to key judgements and sources of estimation uncertainty. In particular, revenue recognition and measurement may involve key judgements and significant estimates, e.g. IAS 18 requires a reliable estimate of a contract’s outcome for recognition of revenue from services rendered. Judgement may also be required for the recognition of related costs, e.g. judgement applied in determining which costs are expensed as incurred and which are amortised over the contract term.

Impact of new standards not yet effective

Where the impact of new standards issued and not yet effective are reasonably estimable, companies should provide detailed quantitative disclosures of the expected effect of their adoption as well as an explanation of how their accounting policies will change. For example, since 2017 accounts will be published after the requirements in IFRS 15 Revenue from Contracts with Customers become effective, it is expected that companies will have substantially completed their implementation analyses by then and that the impact of the initial application of IFRS 15 will be known or reasonably estimable at the time of the preparation of the 2017 accounts.

Cash flows

2017 accounts will be the first to require an explanation of changes in a company’s financing liabilities under a new amendment to IAS 7. Companies that use financing facilities such as invoice discounting and reverse factoring are also advised to consider the classification of these cash flows within the statement of cash flows e.g. non-recourse factoring of debtors classified as a financing cash flow rather than as an operating cash flow.

Pension schemes

Where companies have complex defined benefit schemes they should carefully consider the completeness and understandability of their disclosures as required by IAS 19. Companies may also need to explain these risks in their strategic report if considered to be principal risks to the business.

The full report of the FRC can be accessed here.

If you would like to discuss the application of these or other financial reporting requirements to your business, please feel free to contact Steve Brice or any other member of the Mazars Financial Reporting Advisory team.