• FRRP warns of potential significant non-compliance with IFRS 8 - the Financial Reporting Review Panel has expressed its concern about how companies are reporting the performance of key parts of their business upon the introduction of IFRS 8 Operating Segments.  IFRS 8 is a priority for the FRRP this year and it is expecting to see a more thorough analysis in this forthcoming reporting season, even if this means a change to the segmental reporting made previously. The Panel is encouraging directors to revisit their initial thinking on first adoption of the standard and suggests that directors consider certain questions, which we consider in our article below.

• FRC launches campaign to deliver a step change in the quality of information about acquisitions - the FRC has made public its campaign to improve the quality of financial information on acquisitions by publishing its findings from a study it conducted of acquisitions completed in 2008. It has committed to following up on its study in 18 months time and expects companies to make a step change in their approach. The key results from the FRC's study are summarised in our article below.

• Reminder of important change for UK parent companies' individual accounts - the amendments to FRS 8 Related party disclosures that are effective from 6 April 2008 will particularly affect parent companies that prepare their individual accounts under UK GAAP.  Such entities are no longer exempt from disclosing related party transactions with other group entities in their individual accounts.  The amendments are discussed in more detail below, along with a simple example for illustration purposes.
  

• FRRP turns its attention to sectors with heavy discretionary spend - the FRRP has announced that as we enter the next stage of recession where the outlook for corporate spending is uncertain, it will focus on those sectors which rely heavily on discretionary spend in 2010/2011.

• Summary of certain enforcement decisions by national accounting regulators - EECS, which is essentially a forum of national regulators (e.g., FRRP in the UK), has issued a further extract from its database of enforcement decisions.  It publishes these decisions as a means of fostering appropriate application of IFRSs across Europe. We highlight in our article below, those decisions which may be of interest when preparing year end accounts.

• Construction contracts - continuous transfer or percentage of completion? - IFRIC 15 Agreements for the Construction of Real Estate becomes effective for entities applying EU-endorsed IFRS from 1 January 2010.  Since the continuous transfer concept is not well established under IFRS, our article below discusses the factors to consider when assessing whether continuous transfer applies in an agreement for the construction of real estate for others.

FRRP warns of potential significant non-compliance with IFRS 8

In January 2010 the Financial Reporting Review Panel (FRRP) highlighted the challenges of implementing IFRS 8 Operating Segments whilst expressing its concern about how companies are reporting the performance of key parts of their business in the light of the introduction of that standard.  Overall the FRRP was not convinced by the quality of some companies’ analysis on first adoption of IFRS 8 and is expecting to see change in this reporting season. This may mean, for example, reporting more segments than at the interim stage. 

IFRS 8 requires companies to provide an analysis of turnover and profit (and often of assets and liabilities) so that investors can see the performance of the principal operations or 'segments'. The new standard requires management to define the company’s operating segments in accordance with the way its operations are managed in practice and the measures used to manage performance (even if they vary from the accounting policies used in the accounts). The FRRP notes that the standard aims to reduce the ability of management to disguise poor performance of a part of the business and to enable investors to review a company’s operations from the same perspective as management.

The FRRP reviewed a sample of 2009 interim accounts and 2008 annual accounts (where companies had applied the standard early) and asked a number of questions about the implementation of IFRS 8.  Its press release highlights some common themes in those questions. In particular, the Panel notes that it asked a number of companies to provide additional explanations where:

• only one operating segment was reported, but the group appears to be diverse with different businesses or with significant operations in different countries;
• the operating analysis set out in the narrative report differs from the operating segments in the financial statements;
• the titles and responsibilities of the directors or executive management team imply an organisational structure which is not reflected in the operating segments; or
• the commentary in the narrative report focuses on non-IFRS measures whereas the segmental disclosures are based on IFRS amounts.
  

In a sign that it is not comfortable in all cases with the way that the standard was implemented, the Panel’s press release encourages directors to revisit their initial thinking. It suggests that they do this by considering the following questions, to which we have added our comments in the table below:

IFRS 8 is a priority this year for the FRRP and the press release provides a useful introduction to the approach it will take when reviewing IFRS 8 reporting during 2010.  It expects the application of IFRS 8 to reflect internal reporting and to be an opportunity for companies better to link the business review and the accounts, potentially improving investor communication.  It is clear also that it has significant doubts about the way in which some companies implemented IFRS 8 at the interim stage or in 2008 and is looking for a more thorough analysis now, even if this means a change to the IFRS 8 segmental reporting made previously.

FRC launches campaign to deliver a step change in the quality of information about acquisitions

The Financial Reporting Council (FRC) has made public its campaign to improve the quality of financial information on acquisitions.  Previously it has been working behind the scenes by the Financial Reporting Review Panel questioning companies about their accounting.  By publishing findings from a study it conducted examining the quality of accounting and reporting on acquisitions and committing itself to a follow up in 18 months time, the FRC is issuing a serious message to companies.  It is clear it expects companies to make a step change in their approach.

The FRC study looked at 20 acquisitions completed in 2008 and accounted for in accordance with IFRS 3 Business Combinations (2004).  From the study the FRC noted: 
 

• it was often difficult to identify the required disclosures;
• in only four cases were the explanations of the acquisitions in the business review and the amounts reported as intangible assets ‘consistent’;
• two companies did not record any intangibles despite the business reviews highlighting several intangible benefits;
• seven companies failed to disclose separately the different classes of intangibles arising from each material transaction restricting the ability of the user to understand which classes and amounts of intangibles assets arose; and
• no company provided informative descriptions of why goodwill arose on an acquisition - either no description was provided or boiler plate language from the standard was used.

Given the significance of the amounts involved in many business combinations, the FRC warns companies to take particular care in the future to ensure that both the business review requirements and the IFRS reporting requirements for business combinations are met.  It expects the intangibles recognised to be consistent with the explanation of the reasons for the acquisition in the business review.   For example, when the reasons given for an acquisition were to secure a major distribution contract, acquire a valuable database and specific brand names, each of these should result in recognition of a separate intangible asset.

Reminder of important change for UK parent companies' individual accounts

The disclosure requirements of FRS 8 Related party disclosures have been amended for periods commencing on or after 6 April 2008.  These changes particularly affect parent companies that prepare their individual accounts under UK GAAP. Parent companies are no longer exempt from giving disclosure in their individual accounts of related party transactions with other group entities. Only transactions with subsidiaries that are wholly-owned by the group are exempt from disclosure.  Previously, a complete disclosure exemption for all subsidiaries was available when the parent's individual accounts were presented together with the consolidated financial statements. Transactions with non-wholly owned subsidiaries will now require disclosure in the parent company accounts for the first time.      

Similarly, non-wholly owned subsidiaries that trade with other non-wholly owned subsidiaries will no longer be able to claim exemption from disclosing related party transactions. Previously, subsidiaries that were 90% owned were eligible for an exemption from disclosure of transactions with the rest of the group.      

Consider the following example:
Company A owns 95% of Company B, which in turn owns 100% of Company C and 60% of Company D.       

The table below shows those entities that should disclose related party transactions with other members of the group: 

FRRP turns its attention to sectors with heavy discretionary spend

The Financial Reporting Review Panel (FRRP) has announced that its review activity for the year from 1 April 2010 to 31 March 2011 will focus on the following sectors:

• Commercial property
• Advertising
• Recruitment
• Media
• Information technology

Banking, house-builders and travel and leisure have featured as priority sectors for the last two years but as companies enter the next stage of the recession where the outlook for corporate spending is uncertain, the FRRP is turning its attention to sectors that rely heavily on discretionary spend and which might be stretched in the short term.  As such, advertising, media, recruitment and technology all featured in the Panel’s priority list last year as deserving attention but in 2010/11 they take centre stage.

Annual reports and accounts will nevertheless continue to be selected from across the full range of companies within the Panel’s remit (i.e. public and large private companies) and will also be selected for review on the basis of company-specific factors and complaints.

The FRRP notes that recent economic pressures on companies have led some to make changes to the way in which they do business, particularly where this helps them to manage their cash flow.  They might, for example, have introduced new sales incentive arrangements or payment terms.  The FRRP expects that these companies may need to take a fresh look at their relevant accounting policies, such as those affecting revenue recognition and the expensing of costs, to ensure that they remain appropriate. The FRRP has announced that the reporting and accounting impact of such changes to business models is likely also to be a focus of its work, particularly where a company appears to have more aggressive policies than its peers.

Summary of certain enforcement decisions by national accounting regulators

The European Enforcers Coordination Sessions (EECS), a forum which operates under the umbrella of the Committee of European Securities Regulators (CESR), analyses discussions and decisions taken by EU National Enforcers in respect of financial statements published by entities with securities traded on a regulated market and which prepare their financial statements in accordance with IFRS. EECS is not a decision-making forum but maintains a confidential database of individual enforcement decisions, from which it publishes extracts as a means of fostering appropriate application of IFRS.   The seventh extract from the database, issued in December 2009, provided summaries of 17 decisions, certain of which may be helpful when preparing year end accounts.      

Classification of a loan (IAS 1 Presentation of financial statements)
An entity defaulted on a loan prior to its year end.  Subsequent to the year end, the loan issuer had issued a waiver that expired more than twelve months after the balance sheet date. The entity classified the loan as long term in its year end balance sheet.

The enforcer found that the loan should have been classified as short term debt at the year end since the entity did not have an unconditional right to defer payment for at least 12 months from the balance sheet date. IAS 1.65 clarifies that a long term loan is classified as current if it is breached on or before the year end, even if the lender agrees after the balance sheet date not to demand repayment.

Presentation of financial instruments (IFRS 7 Financial instruments: disclosures)
An entity had disclosed in its financial statements how much of the fair value of its available-for-sale instruments had been determined:

• in whole, or in part, directly by reference to published prices in an active market (Level 1);
• through estimation using a valuation technique supported by observable market data (Level 2); and
• through estimation using a valuation technique supported by non observable market data (Level 3).
  

In a subsequent investor presentation, however, it presented this information on a product by product basis, which it had not disclosed in its year end accounts.

The enforcer found that the information provided on a product basis should also have been presented in the accounts in accordance with paragraph 6 of IFRS 7.  Although IFRS 7 does not appear specifically to require this information, the additional detail was necessary in order to enable users to evaluate the significance of the products to the entity’s position and performance, and to meet the overall objective of the standard.

Segmental reporting (IFRS 8 Operating segments)
An entity stated in its accounts that it had omitted certain segmental information on the grounds of commercial sensitivity.   The enforcer noted that IFRS 8 does not provide a ‘competitive harm’ exemption.  Paragraph BC44 of the standard explains that the IASB concluded that such an exemption was inappropriate as it would provide a means for broad non-compliance with the standard.  

Correction of an error (IAS 8 Accounting policies, changes in accounting estimates and errors)
An entity had made an error in its 2006 annual accounts.  On acknowledgement of the error, the entity made a public announcement and, in its 2007 accounts, restated its comparative figures. The 2007 accounts made no further reference to the error or the fact that the comparative numbers in one of its primary statements had been corrected.  

The enforcer concluded that the changes to the comparative figures were material errors and should have been adjusted in accordance with paragraph 42 of IAS 8.  The fact that the entity had made a public announcement about the error did not release it from the obligation to apply IFRS when preparing its annual accounts.  A public announcement is no replacement for information that is required to be disclosed and audited within the annual financial statements.  

Half-yearly consolidated cash flow statement (IAS 34 Interim financial reporting)
In its half-yearly consolidated financial statements, an entity included a condensed cash flow statement which did not include all of the headings and subtotals that were included in its prior year annual cash flow statement.  Also, no note was provided explaining either the nature or amounts comprising cash flows from operating activities.   IAS 34.10 requires that, as a minimum, each of the headings and subtotals included in the entity’s most recent annual financial statements should be included.

The enforcer concluded that the entity had failed to comply with paragraph 10 of IAS 34 since the required headings and subtotals had been omitted. It agreed that IAS 34 does not define what constitutes a condensed cash flow statement and that it could include less information than a complete cash flow statement.  However, the minimum requirements of IAS 7 should be applied.  

Related party disclosures (IAS 24)
An entity has a two-tier board structure consisting of a management board and a supervisory board.  In the related parties' note to the annual accounts, the entity disclosed the total remuneration paid to executive and non-executive directors (comprising the management board) and a total for these two groups.  No further breakdown of the management board remuneration was provided and no disclosure was provided in respect of remuneration of the supervisory board.  

The enforcer found that the entity failed to comply with:

• IAS 24.9 since the supervisory board met the definition of key management personnel; and
• IAS 24.16 which requires disclosure of key management personnel remuneration in total and for each of certain specified categories.

Collective assessment for impairment of loans (IAS 39 Financial instruments: recognition and measurement)
When assessing loans to business customers for collective impairment, a bank used a rating model that was based only on customers with a poor credit quality.  The bank considered that customers with higher credit ratings were expected to be able to repay their loans and would not affect the collective impairment.  

The enforcer did not accept this approach.  Paragraph AG85 of IAS 39 requires that the process for estimating impairment includes all credit exposures, not simply those of poor quality.  All downward migrations from one credit rating to another should be considered, not only those reflecting a severe deterioration in credit.  

Construction contracts - continuous transfer or percentage of completion?

IFRIC 15 Agreements for the Construction of Real Estate provides specific guidance on the accounting for revenue and associated expenses by entities that undertake construction of real estate for others, either directly or through sub-contractors. It applies for those entities applying EU-endorsed IFRS for annual periods beginning on or after 1 January 2010.  (The IASB effective date was for periods beginning a year earlier.)

IFRIC 15 identifies four categories of agreements for construction of real estate.  One of these categories is agreements for the sale of goods under which the revenue recognition requirements of IAS 18 Revenue are met continuously throughout the construction process.  Revenue is therefore recognised via the percentage of completion method more commonly used in IAS 11 Construction Contracts. Activity that falls under a continuous transfer situation may be economically similar to a real estate construction contract under IAS 11, except that the buyer is not able to specify the major structural elements of the property design.

This continuous transfer concept is not well-established under IFRSs and IFRIC 15 provides only illustrative examples, which discuss certain indicators of continuous transfer.  Determining whether an agreement falls within one of the four categories outlined in IFRIC 15 is not a matter of accounting policy choice. The specific terms of each agreement need to be analysed taking account of the relevant legal jurisdiction in order to determine whether continuous transfer exists.

An entity will need to exercise judgement to determine whether the facts and circumstances, taken individually or collectively, indicate that it is appropriate to recognise revenue as the construction activity progresses or to wait until the property is completed and transferred to the buyer.

We consider here which factors may be considered when determining whether continuous transfer exists.  Factors that collectively or individually may indicate that continuous transfer is occurring while construction progresses include:

• the construction activity takes place on land owned by the buyer (IFRIC 15.IE3);
• the buyer cannot put the incomplete property back to the developer (IFRIC 15.IE3);
• if the agreement is terminated before construction is complete, then the buyer retains the work in progress and the developer has the right to be paid for the work performed (IFRIC 15.IE8); and
• the agreement gives the buyer the right to take over the work in progress, perhaps with a penalty, during construction, e.g., to engage a different entity to complete the construction (IFRIC 15.IE11).

Factors that collectively or individually may indicate that continuous transfer is not occurring while construction progresses include:

• the sales agreement gives the buyer the right to acquire a specified unit in an apartment building when it is ready for occupation (IFRIC 15.IE6); and
• the deposit paid by the buyer is refundable only if the developer fails to deliver the completed unit in accordance with the contractual terms (IFRIC 15.IE6).
  

Amendment to FRS 25 issued

The Accounting Standards Board (ASB) has issued an amendment to FRS 25 Financial instruments: presentation for classification of rights issues.  The amendment is effective for annual periods beginning on or after 1 February 2010 and is identical to the amendment to IAS 32 Financial instruments: presentation issued by the IASB in October 2009.

The amendment requires a rights issue involving the exchange of a fixed number of an entity's own equity instruments for a fixed amount of cash denominated in a foreign currency to be classified as an equity instrument.