Implementing IFRS

1. Implementing IFRS October 2013 Presented by: David Potts FCA On behalf of BKR International

2. Programme • Overview of all recent developments and update on project plans • Employee benefits – IAS 19 revised • Business combinations – emerging issues • Financial instruments – current state of play (and IFRS 9) • Fair values • Update on leasing and revenue recognition projects

3. Key points • USGAAP/ IFRS have five main projects • Financial instruments – IFRS 9 • Leases • Revenue recognition • Insurance • Rate regulated activities • US have no current plans to adopt IFRS

4. Overview of all recent developments

5. New Standards/ issues • IAS 19 Revised – takes effect for accounting periods starting on or after 1 January 2013 • Consolidations (IFRS 10-12) • Minor amendments in June 2012 • Effective from 1 January 2013 but not until 2014 in the EU • Application is retrospective • IFRS 13 – fair values • EU endorsed and effective for year ends commencing on or after 1 January 2013

6. IFRS Interpretations • IFRIC 20 Stripping costs • Of a surface mine • Effective from 1 January 2013 • SIC 12 – special purpose entities • Now superseded by IFRS 10 • IFRIC 21 – levies • Timing of recognition of obligations arising from government levies • HGV Road User • Community Infrastructure • Obligating event = entity action resulting in levy

7. IFRS projects • Financial instruments • Presentation addressed within IFRS 9 • Measurement and hedging guidance to follow in 2013 • Macro hedging concessions

8. IFRS Projects - 2 • Leasing – still on agenda – see later • Revenue recognition • Final deliberations before revised IFRS (replacing IAS 11 and 18) by 31 December 2013 • Insurance contracts • Comments on latest proposals by 25 October 2013

9. IFRS application in the USA • SEC allow foreign issuers as defined to use IFRS for SEC filings • SEC conducted impact assessment (cost assessment) of wider IFRS use in the USA in spring 2012 • SEC no plans to change current position

10. IFRS and the EU • IFRS issues must be adopted by EU Accounting Regulatory Committee (ARC) before being required by law in EU • IFRS 9 and IFRS for SMEs remain unadopted

11. Employee benefits IAS 19 Revised

12. IAS 19 revised • Applies to accounting periods starting on or after 1 January 2013 • Will apply to interim reports if issued • Major changes to Defined Benefit pension scheme accounting? • Revised disclosure requirements • Other clarifications may require estimation

13. IAS 19 revised – main changes • DB schemes – gains and losses must all now be charged immediately to OCI (the corridor option has been withdrawn). • Past service cost amendments and curtailments • Treatment of all such costs now aligned • Option to defer over remaining service lives has now been withdrawn

14. IAS 19 revised – further changes • Elements of profit and loss charge simplified • Interest cost to include effect of all discounting • Re-measurements through OCI now defined • Actuarial gains and losses • Difference between return on assets and interest calculation for DCF • Changes in asset ceiling

15. IAS 19 revised - amendments • Actuarial assumptions now more clearly defined • What mortality rates to use for example • Disclosures to concentrate on the pension scheme risks and impact on the financial statements • Termination benefits – clear date for recognition established (when rest of restructuring charge recognised); and • New definition of a short term employee benefits

16. IAS 19 (R) - examples • How should a multi-employer DB scheme be accounted for under IAS 19 (R)? • When should holiday days accruing to a staff member on maternity leave be accrued for? • What is the accounting difference between a ‘short term employee benefit’ and other employee benefits? • Employees have been offered redundancy terms; £20,000 to leave immediately, £60,000 to work a further 18 months to final shutdown date. When to provide and how much?

17. Business combinations IFRS 10 – 12 and refresher

18. IFRS framework at May 2012 • IAS 27 – Separate financial statements of investor • Consolidation details now covered in IFRS 10 • Revised from 1 Jan 2013 (early adoption) • IAS 28 – Associates and Joint Ventures • Revised for IFRS 11 from 1 Jan 2013 • IAS 36 – Impairment • Long standing with no real changes • IAS 38 – Intangible assets – recognition and measurement • As IAS 36

19. IFRS framework at May 2012 (continued) • IFRS 3 – Business combinations • To be applied prospectively for acquisitions on or after date of first year end starting after 1 July 2009 • IFRS 10 – Consolidated financial statements • From 1 Jan 2013, early adoption is permitted • IFRS 11 – Joint arrangements • From 1 January 2013, early adoption is permitted • IFRS 12 – Disclosure of interests in other entities • From 1 January 2013, early adoption is permitted • IFRS 9 – Financial instruments • From 1 January 2015, early adoption is not permitted in the EU

20. Investments in other entities - overview • Interest = control = subsidiary • = consolidate • Interest = shared control = joint arrangement • = report under IFRS 11 • Interest = significant influence = associate • = equity method • Interest = any other = investment • = report under IAS 39/ IFRS 9

21. Pre IFRS 10 regime Apply ‘control’ tests in IAS 27 SIC 12 provided guidance on Special Purpose Entities IFRS 10 Single, universal test of control Apply from 1 Jan 2013 or earlier Retrospective adjustment required if entities to be consolidated for first time IFRS 10 - overview

22. Control test under IFRS 10 • Defined as exposure to or rights to variable returns and ability to affect those returns • Voting powers and potential powers • Ignore powers/ votes that are administrative • Look at agency arrangements • Control linked to specific assets not the entity

23. Associates • Ability to exercise significant influence • Apply equity method accounting under IAS 28 (unchanged) • One line consolidation of assets and liabilities

24. Joint ventures – the issue

25. IFRS 11 – Joint arrangements • Provides guidance for all types of joint arrangement (JA) consistent with IFRS • Proportional consolidation option for joint ventures is withdrawn • JA = contractual agreed sharing of control • Key decisions require unanimous agreement

26. Joint operations Venturers have rights and obligations over specific assets and liabilities Venturers reports those rights and obligations using the IFRS for the assets and liabilities involved Joint ventures Venturers have rights to the net assets Apply IAS 28 IFRS 11 Joint arrangements

27. IFRS 12 - Disclosures • Applies to subsidiaries, associates, joint arrangements and other unconsolidated structured entities • Users to understand • Assumptions and judgements in reaching decisions on types of arrangement • Users to evaluate • Restrictions on ability to use assets/ settle liabilities • Risks associated with consolidated and unconsolidated structured entities, joint arrangements, changes in owners interests and consequences of loss of control

28. Financial instruments

29. Financial instruments – summary of guidance • Presentation – IAS 32 or IFRS 9 (compulsory from 1 January 2015 – but not permitted within EU) • Recognition and measurement – IAS 39 or IFRS 9 • Disclosures – IFRS 7

30. Categories of financial instrument – assets (IAS 39) • At fair value through profit and loss • Trading • Derivative • Held-to-maturity • Loans and receivables • Available for sale

31. Categories of financial instrument - liabilities • At fair value through profit and loss • Trading • Derivatives • Held at amortised cost

32. Criticisms of IAS 32/ 39 framework • Based on USGAAP system – prescriptive and rule based • Choice of categories too rigid • Fair value option and treatment of gains and losses did not reflect the business model

33. IFRS 9 – Financial instruments

34. IFRS 9 – Financial assets • Amortised cost • Fair value through profit and loss (FVTPL) • Designated • Classified • Fair value through other comprehensive income (FVTOCI) • Designated

35. IFRS 9 – contract types

36. Asset category selection • 100% equity • Held for trading = FVTPL • Classified = FVTPL • Designate at original recognition = FVTOCI (irrevocable) • Derivative • FVTPL • All other assets • Objective to collect contract cash flow? No = FVTPL • Cash flows solely payments of capital and interest? No = FVTPL • Evoke option to reduce accounting mismatch? Yes = FVTPL • None of the above = amortised cost

37. Embedded derivatives • IAS 39 • Separate from host contract if economic characteristics are different • IFRS 9 – treatment depends on nature of host contract • Host = financial instrument • Apply IFRS 9 to entire contract • Host = outside scope of IFRS 9 • Apply IAS 39 rules

38. Business model tests • Apply at entity or portfolio level – not at individual contract level • Asset sales before maturity are not a problem as long as consistent with business model • Category changes are also acceptable on the same grounds

39. Unquoted equity valuation under IFRS 9 • Must be at fair value • Can use cost as a reasonable estimate of fair value; if • Insufficient recent evidence of fair value • Range of fair values and cost is a reasonable estimate • Check for evidence cost not approximation of fv

40. IFRS 9 – financial liabilities • Amortised cost; or • FVTPL • Classified • Designated (at original recognition) • Reduce accounting mismatch; or • Group of liabilities or liabilities and assets where performance assessed on a FV basis • Financial liabilities may not be reclassified

41. Fair values – IFRS 13

42. Fair value – key elements • Arms length transaction • Willing buyer • Willing seller • Exit value • Asset = cost realised from sale not price to buy • Liability = cost to discharge not that received for taking on the debt

43. Fair value evidenced from an ‘active market’ • Prices readily and regularly available • Represent actual regular market transaction • Transactions on an arms length basis • Observable inputs

44. Forward planning Leasing and revenue recognition

45. Lease project timescale • Re-deliberations on earlier plans • No planned date for final IFRS or implementation • IASB remain adamant that change is necessary: • Off balance sheet opportunities of current structure • Diversity in existing accounting treatments • Bright line tests which encourage structured solutions

46. Right of use assets • A lease is a contract which allows one party (the lessee) the right of use of another party’s (the lessor) asset • All leases should be covered by the same accounting framework

47. Lessee accounting for right of use assets • Step 1 • Capitalise the asset; and • Report a lease obligation • Step 2 • Determine whether the lease consumes significant proportion of asset economic benefit • If so – account as currently for a finance lease • If not – charge the lease rental to profit on a straight line basis

48. Lessor accounting for right of use assets • Step 1 – does the lease consume a not insignificant proportion of the asset? • If yes • Part of the asset has been sold • Account for disposal and the gain or loss compared with proceeds • Still report any residual asset • Report the sales proceeds (the PV of lease payments) as a receivable • As lease rentals collected • Reduce receivable and reflect interest income

49. Lessor accounting continued • If lease consumes insignificant proportion of asset • Current operating lease accounting for lessors • Show receivable and deferred income • IASB provide examples of when a ROU lease consumes significant proportion • Planes, trains and automobiles for example • And when it does not • Most property leases

50. Revenue recognition – the proposals • IAS 11 and 18 viewed as lacking in two main aspects • Multiple deliverables – lack of guidance • Provision of services over time – over emphasis on straight line basis • Equivalent USGAAP guidance is considerable but based on the USGAAP framework • New IFRS is therefore required