Video transcript: Financial reporting update 2018
Title: Financial reporting update, Amy Hamilton, Manager, Technical, Audit New Zealand
Amy Hamilton
Today’s session that I’m covering is a little bit of an accounting standards update. What we’re going to look at is what is imminent for you guys? What is going to be changing for 30 June 2018 and 30 June 2019? We’re then going to look at some future standards which are coming in, a little bit further into the future, and then also look at some of the items that are being in development and currently out for consultation.
Luckily for us there are no new accounting standards to be applied for the 30 June 2018 financial statements. But there are some minor amendments which do change some of the scopes of the current accounting standards. Now these are not expected to affect most of you in the audience, so we will not be going over them today. But they are included on the slide which will be available on our website for your reference.
It’s also the same for 2019 where there are just some minor amendments in the accounting standards. But hopefully what is all on the forefront of your financial teams’ minds is the fact that PBE IFRS 9 is being early adopted by Treasury in the financial statements of government for the 2019 financial year. We will be covering this shortly, but I just wanted to include it on the slide because it is in the immediate future and does need to be considered by your finance teams.
Just as an FYI – because there’s not too many for-profits in the audience today – there is one new disclosure required for for-profit entities in relation to non-cash movements in financial liabilities. This is now compulsory for for-profit entities to disclose and it is the intention that this disclosure will also be added to IPSAS at some stage, but this has not yet been approved. So, the timing of when you guys are required to do this disclosure is not yet known. An example of this disclosure is included on the slide.
As there are only minor amendments for the current year, we are not going to reissue the Audit New Zealand model financial statements for government departments or Crown entities. The previous versions issued in 2016 and 2017 still remain relevant and can be used by your finance teams as guidance in preparing your own financial statements. We will, however, be reissuing the DHB model as it has been a couple of years and we will be reflecting the same disclosure initiative changes that we have previously made to the government departments and Crown entities model financial statements into this this new DHB model.
We will also be reissuing a revised tier three model to reflect some of the lessons learnt since this was adopted in 2015.
So, looking a little bit more into the future, there is some accounting standards which have been issued and will be coming effective in a little bit more time period. So, looking at the first one here, last year the XRB issued a new suite of group accounting standards. So, this is five new standards that essentially are following along the similar format to the standards that are currently being applied in the for-profit sector. These are compulsory for adoption from 30 June 2020 for June reporters. So, as I said, we’ve still got a little bit of time to prepare for this.
Now, there isn’t too much significant change for most entities, but there are some key changes that I wanted to discuss today. The first one is under this new suite of standards. There is a change from three types of joint arrangements down to two. Depending on that type of joint arrangement, the new accounting standard defines how it is to be accounted for. This is compared to the current accounting standard which allows your entity to choose how it is going to account for those joint arrangements.
One of the other key changes is a slight change in how control is defined. If you have had some previous control assessments, these may need to be reconsidered when this new standard becomes effective. The new suite of standards also includes IPSAS 38, which is a standard specifically covering disclosures relating to your interests in other entities.
This is going to require some much broader and more cohesive disclosures around the impact other entities are having on your financial statements. For instance, more information about how it has been assessed whether you do control or do not control other entities, more information about non-controlling interests, and more information about structured entities, whether they are consolidated or not into your group financial statements. So that can have a little bit of an impact if you do have groups with a lot of different entities included.
One of the other future standards which has been confirmed is the new PBE FRS 48 service performance reporting. This has now been issued and will replace the SSP requirements currently included in PBE IPSAS 1. Now, we anticipate that the public sector is well prepared for the adoption of this new standard as we’ve already had experience reporting performance information under legislation. But there may be some small minor changes depending on how your entity is currently presenting your SSP information.
For instance, comparative information will now be mandatory and if you are making any significant judgements in your SSP, these will be required to be disclosed. So, very similar to what we do for significant judgements made in your financial statements.
While we don’t expect there to be a significant impact on us as in the public sector because we currently report under legislation, not-for-profits may have a significant impact by this as they will now be required to report performance information even if they haven’t been reporting performance information already. So, because of the significant impact on the not-for-profit public benefit entities, there is a significant lead time to allow people to be ready for adoption of this standard. That’s why it’s not going to be compulsory until periods begin on or after 1 January 2021.
Just as an FYI, the SSP reporting requirements for for-profit entities remain unchanged under legislation and under the accounting standard FRS 44.
While there are only small changes coming in for the next year, we all know that this won’t be the case in the near future. We thought it would be useful to highlight some of the key changes that are being proposed and currently being consulted on and what this could mean for your entities. In addition, we’re covering some of the complications that are going to arise between the big three for-profit standards coming in and public sector reporting of groups.
This session is just going to be a little bit of a heads-up. We’re not going into too much detail today on what the accounting standard requirements are, but it’s just to point out some of the key items to consider when we’re looking at adopting these new standards.
One of the principles of the XRB is to try to minimise the differences between the for-profit standards and the public benefit entity standards. But, of course, there are always going to be some minor differences to take into consideration the different characteristics of the two different operating environments. So, while the intention is to minimise the differences, there may always be some ongoing long-term consolidation issues if you do have mixed-group entities.
An example of some of the ones that are already out there is different impairment methodologies or valuations that can be applied by a for-profit versus those that can be applied by a PBE. Therefore, some impairments written off at the for-profit level may actually need to be added back when you consolidate that for-profit into a public benefit entity. As I said before, while we’re trying to minimise those differences, there may always be some mixed-group issues to consider.
Looking at the big three – these are financial instruments, revenue, and leases. They’re going to be effective over the next two years for for-profit entities. PBE groups, as I said before, who have for-profit subsidiaries do need to carefully consider what this means for their ability to consolidate those for-profit financial statements and having early communication with your subsidiaries on any additional information they need to provide in order for your finance team to be able to consolidate those for-profit subsidiaries.
So, the IPSASB have been looking at these standards and have been working through issuing either consultation papers, exposure drafts, or standards to try to get those PBE equivalents available. But there can be a significant time period between when a finalised for-profit standard is available and when the PBE standard is available for adoption which may mean that over the next few years there are additional consolidation adjustments required.
As the IPSASB have not quite completed their IFRS 9 convergence project to issue an IPSAS standard for PBE for IFRS 9, the XRB – after consultation – decided to release a New Zealand-specific public benefit entity standard for IFRS 9. So, this is available to entities to early adopt to minimise those mixed-group issues prior to the IPSASB issuing of formal IPSAS standard on this.
At this stage there is no equivalent accounting standard for IFRS 15 revenue, or IFRS 16 revenue, but as I said before, the IPSASB are working on some projects to consider what this will mean in the public sector going forward. I’ll touch on these shortly.
So just a little bit on IFRS 9. As I said before, the mandatory effective date for PBE IFRS 9 is 1 January 2021 but early adoption is available, and it is being early adopted for the financial statements of government. Some of the key changes which you will see in the new financial instrument standard compared to the current financial instrument standard that could have a significant impact on your entity’s balance sheet and statement of financial performance is different classifications for financial assets and liabilities. Depending on these different classifications, it can result in assets which have previously been measured at cost now being measured at fair value at each balance state or vice versa – previously measured at fair value may now be required to be measured at cost.
In addition to the change in measurement, if it is being fair valued there are some changes between whether those fair value movements go through the profit and loss itself or whether they go through other comprehensive revenue and expense. These changes can increase volatility on your bottom line and it would be worthwhile considering what impact this is going to have on your financial statements and how you are going to be communicating that impact through to your readers.
There is also a change in the impairment model under this newer standard. So, previously impairment has been recognised essentially when a triggering loss event has incurred. So, it’s all about what’s happened in the past that has resulted in impairment. Under this new model it’s an expected loss model. So, essentially, you’re considering what future impairment you are going to have that you need to recognise now. So, it is a change in approach to impairment that may take a little bit more time to work through. I’ll cover a little bit more on this shortly. The other key change is hedge accounting requirements. So, the new IFRS 9 may mean some entities find it easier to comply with the hedge accounting requirements.
Treasury, as I said, are early adopting PBE IFRS 9 for the 30 June 2019 financial statements of government. As there are advantages in aligning the Crown adoption date with that of the for-profit sector and also with the Australian central and state governments who are also adopting this new standard in 2019. This will mean we can more easily benchmark the FSG’s financial instrument portfolios with international comparators and also minimise those consolidation issues between the consolidating for-profit, state-owned enterprises and to the financial statements of government.
What does this mean for you? Our expectation is that entities that are consolidated into the financial statements of government will also early adopt this standard for their own financial statements, rather than having to prepare one set of financial statements for your own annual report and another set of financial statements for consolidation into the financial statements of government. Treasury are working on a number of items to help with adoption of PBE IFRS 9, and this includes working through the detailed requirements of PBE IFRS 9 and engaging with those entities that are likely to have a material impact on the financial statements of government because of this new standard.
They are also assessing what changes are required to disclosures and what this will mean for the information you need to upload into CFISnet, and any other Crown reporting templates. They have also published some guidance on their website for some simple financial instrument transactions such as trade receivables, term deposits and a little bit more information on impairment.
In addition to the work that Treasury is doing to support the adoption of this standard, I would also like to highlight today some of the key things that your entities need to consider early to help enable you to prepare for adoption.
So, the first item to consider is what assets and liabilities actually fall within the scope of this standard. So, sovereign receivables that arise under statute such as fines and taxes do not fall within the scope of this standard and therefore do not need to be considered. But if you have receivables such as student loans or legal aid receivables, these do fall within the scope of the standard and need to be carefully considered.
The second item is bond investments. If you have bond investments you need to carefully consider what your business model is and what is the purpose for holding those investments, as this can determine how they are categorised, how they are then measured, and how those fair value movements if they’re measured at fair value are shown through your financial statements.
On a similar note for share investments that are not held for trading, these would be fair valued and go through the PNL unless you specifically designate them to go through other comprehensive revenue and expense. So, this designation needs to have an add inception and then cannot be changed. So, it is a key decision to make now when you’re preparing to adopt this standard. If you don’t designate it through OCRE, this means it is going through your PNL and can have that impact on your bottom line. In addition, if it is going through fair value through other comprehensive revenue and expense, it is no longer recycled to the PNL on disposal and you’re no longer needing to consider whether it needs to be impaired if the value goes below cost. So, there are some advantages and disadvantages of either designating it through OCRE or leaving it as going through the PNL.
The next one here is one that’s been discussed quite a bit with a few entities that are significantly impacted, and that is concessionary loans. At the moment most of these are measured at amortised cost, which is a more simple measurement principle to use. But under PBE IFRS 9, some receivables and loans where the payments or repayment is contingent on income or profit generation are unlikely to meet the SPPI test, which is solely payments of principle and interest. Therefore, they will need to be measured at fair value.
An example of this is student loans. Other concessionary loans will need to be carefully considered to whether they pass the SPPI test or not. If loans do not meet the SPPI test, then they need to be fair valued and this needs to take into consideration your discount rates and expected losses at each balance date. So, moving from an amortised cost to a fair value model can have a significant impact on your financial teams at balance date when they are needing to complete all these additional steps.
The other one is impairment. So, for trade receivables, as I said before, it’s going from an incurred loss model to an expected loss model. Now an expected loss model you can use approaches such as looking at historical loss information and making adjustments to reflect what we believe the operating environment is going to be like in the future to help determine what we’re expecting those future losses to be. This is very similar to a lot of approaches that are already used by our clients. For assets such as term deposits, in theory these would need to be assessed for impairment and an expected loss provision recognised. However, if you have term deposits in New Zealand with the big four registered banks, the credit rating of those banks is quite high, and the risk of a default is very low. So, if there was to be impairment on these, it would be very immaterial.
If you have other financial instruments such as bonds and loan portfolios, impairment assessments of these are a lot more complex and require a lot more work to complete. If your entity is impacted by these types of financial instruments or financial instruments of material to your entity’s financial statements, we recommend seeking external accounting advice now to enable your finance teams to be ready to adopt this new standard. The earlier preparation can start and the earlier any complexities or judgements are made, the quicker this can go through the process and the easier it is on both yourselves and as the clients in the finance team and also the auditors. A key decision that still needs to be made is also whether you are going to restate your comparatives on adoption or not.
So, I’ve just got one image here on impairment. I’m not going to look into it in detail but it’s just to highlight that the approach to impairment is actually different depending on the credit risk of the item. So, there is three different stages to the impairment cycle and you may move between them depending on if the credit risk of that particular asset changes. So, some of the impairment might be very simple and then the further the credit risk deteriorates, it’s a different impairment model that needs to be used. So, it’s not as straightforward as just one impairment approach – there could be multiple impairment approaches required depending on the credit risk movement of the particular assets.
Looking at the next of the big three topics, which is revenue. For-profit entities need to carefully consider the new revenue standard being IFRS 15. As some of the fundamental concepts of recognising revenue have changed and what we are seeing is entities are struggling to apply this new standard in practice. So, the new model requires a five-step process to be completed for each contract rather than revenue type. So entities are now required to identify each contract; identify each separate identifiable performance obligation within that contract; determine the overall transaction price, including assessment of any variable consideration included in that contract; allocating that overall transaction price to each of those individual performance obligations; and then, depending on the characteristics of each of those performance obligations in that contract, it will determine whether you recognise revenue when or as that performance obligation is being met. So, it can have a significant change if entities have long-term or contracts which have multiple performance obligations included.
So, while there is no PBE equivalent under development in New Zealand, the IPSASB did issue a consultation paper on revenue accounting and accounting for non-exchange expenses such as grants in 2017. The submissions close for this on the 22nd of November. The IPSASB are now in the process of looking at those submissions and considering what the next steps in this process are, but we have no further update on what this is going to mean yet.
So, for PBE groups which do have for-profit subsidiaries, we would recommend discussing with those subsidiaries early to understand whether their new accounting policies for revenue can be incorporated into your PBE accounts or whether consolidation adjustments are going to be required.
So, on the final of the big three topics, which is leases. So, the adoption of IFRS 16 for for-profit entities is a couple of years away, being 30 June 2020 for June reporters. But the implications of this standard are significant for leasees. The new standard will require leasees to recognise most leases on their balance sheets which would typically result in a lease liability being recognised and a right-of-use asset also being recognised. There is also a flow-on impact to ratios or results such as EBIT and EBITDA, as there is now depreciation and interest to consider from those assets.
While there is no PBE equivalent IFRS 11, we do have an IPSASB leases project under way. They’ve recently issued an exposure draft on how they’re proposing leases are accounted for in the public sector. This was issued in January 2018 so it’s very, very recent. We’re not expecting a standard to come out until at least the middle of 2019 which means an equivalent is unlikely to be available for public benefit entities when the for-profit standard becomes effective and we are going to have that potential timing implication.
I just want to touch on briefly one of the key differences in the exposure draft that has been issued by the IPSASB. While IFRS 16, in the for-profit sector, has retained the operating and financial lease classification model, the IPSASB, in its exposure draft, is proposing a different approach which is a single right-of-use model. So, for a lessor, this would mean that under the proposed IPSASB approach, you could be recognising two assets and a liability for the lease, being the underlying asset that you are leasing out, a right to a lease receivable asset, and also a deferred revenue liability. So, this can have a significant impact on your entity’s balance sheet.
As this is a different approach that has been adopted by the for-profit sector and IFRAS 16, it is triggering a lot of debate and a lot of discussion on what this will mean for entities. So, while they’re intending to have a standard out by mid-2019, this may not happen due to the level of discussion around this new approach. If the approach is adopted as it is currently described, it will also mean long-term consolidation adjustments as the lessor accounting by a public benefit entity will be substantially different to that of a for-profit. If you do have any mixed groups, there will be a long-term impact on this approach.
So, if you do have leases in your entity, I would recommend your finance team having a look at this exposure draft that is on the website or the XRB website, considering what it means for your entity’s financial statements and consider putting in a submission to the XRB on the areas which you believe work and the areas that you believe do not work. So, this is your chance to influence what this is going to mean for your entity going forward. Now, comments are due to the XRB by the 31st of May 2018.
One of the other exposure drafts which has come out recently is outside of those big three, but it is on social benefits. This is one of the controversial areas of accounting that is being debated and will continue to be debated in particular around the universal government pension schemes and how these are reflected or not reflected on a government’s balance sheet. So, there’s generally been three arguments of three different points in time when the expense and liability should start being recognised. Should pension liability start being recognised as soon as someone is born? Should it start being recognised when the person meets the entitlement age, at the moment 65? Or should it start being recognised when the person meets the eligibility criteria for each of those pension payments? So, these are three quite different arguments and different approaches and they can all have a significantly different impact on a government’s balance sheet as generally those future benefit payments are funded by future taxes.
So, the proposal in the exposure draft is largely consistent with what is being applied currently for pension schemes and unemployment benefits in New Zealand where an expense is recognised as the eligibility criteria for when each payment is met – so, similar to a cash-based accounting.
In the exposure draft, there is also a proposal that an insurance approach is permitted for schemes that are fully funded from contributions, which would mean the entity if they meet certain criteria can elect to account for the liabilities under the IFRS 17 insurance accounting. This would be relevant for entities such as ACC.
Now, the deadline for submissions to the XRB has passed but the deadline for submissions direct to the IPSASB is open until the end of this month.
Now, on the final slide is looking at what is the IPSASB’s work plan. This is a screenshot out of their strategy document and it talks about the IPSASB’s current projects and projected completion timeline. Most of these we have touched on today but there are a couple that are further down the track – for instance, infrastructure and heritage assets. Now, this is an ambitious work plan and ultimately the progress and ability to complete the projects within the given deadline will be dependent on the decisions that IPSASB make, the feedback that it receives from stakeholders, and the level of agreement or disagreement, and, also, the resources that are available for them to process those submissions and get those documents ready to submit. We will continue to update you on the projects that we believe are key to the public sector at each of our client updates.
Title: For more information and to download presentations, visit: www.auditnz.govt.nz