SUBSTANCE OVER FORM THE MAIN PROBLEMS

1. SUBSTANCE OVER FORMTHE MAIN PROBLEMS • Capitalisation of interest • Capitalisation of brand names • Leasing IAS 17 • Discontinued operations • Mergers • Goodwill IFRS 3 IAS 36, 37 • Contingent liabilities IAS 37

2. IAS 37 PROVISIONS, CONTINGENT LIABILITIESAND CONTINGENT ASSETS • A provision is a liability of uncertain timing and amount • A liability is a present obligation arising from past events • A contingent liability may be defined as: a possible obligation arising from past events or a present obligation that is not recognised

3. IAS 37 PROVISIONS, CONTINGENT LIABILITIESAND CONTINGENT ASSETS A provision must be recognised when an entity has a present obligation arising from past events when it is probable that an outflow of resources will be required to settle the obligation and a reliable estimate can be made of the amount of the obligation

4. IAS 37 PROVISIONS, CONTINGENT LIABILITIESAND CONTINGENT ASSETS • If it is not clear whether there is a present obligation • recognition or non-recognition depends on management’s assessment of the probability of its existence

5. IAS 37 PROVISIONS, CONTINGENT LIABILITIESAND CONTINGENT ASSETS An obligation may be : • Legal • Constructive when an entity has indicated by past actions that it will accept certain responsibilities creating and a valid expectation that it will discharged those responsibilities

6. IAS 37 PROVISIONS, CONTINGENT LIABILITIESAND CONTINGENT ASSETS Contingent liabilities An entity must not recognise contingent liabilities but does have to disclose in the notes to the financial statements

7. SUBSTANCE OVER FORM The funding or refinancing of a company’s operations in such a way that, under legal requirements and existing accounting conventions, some or all of the finance may not be have to be shown on the entity’s balance sheet

8. OFF BALANCE SHEET TRANSACTIONSAND FINANCING • The ‘creative accounting’ trick which ‘improves’ companies’ balance sheets because under legal requirements and existing accounting rules, some or all of the finance may not have to be shown on an entity’s balance sheet

9. OFF BALANCE SHEET FINANCING - WHY ? • To show low gearing • Reaction of the stock market • Short termism of the city • Impact of particular activities • Reputation of the company

10. FORMS OF OFF BALANCE SHEET FINANCING • Quasi subsidiary • Consignment stocks • Sale and repurchase agreements • Factoring • Securitised assets • Loan transfers

11. QUASI SUBSIDIARY • Minority shareholding • Effective control • Now covered by IAS 27, 28 and IFRS 10, 11, 12

12. CONSIGNMENT STOCK • Often applies to the motor trade • Does the manufacturer have the right to take back the stock ? • Does the dealer have the right to return the stock ? • What is the transfer price agreement ?

13. SALE AND REPURCHASE AGREEMENTS • Is it a financing transaction ? • Is there a call and put option virtually certain to be exercised ? • Is the sale price pre-determined and not based on the market value at the time of repurchase ?

14. FACTORING • Debtors sold to a third party • Accelerates cash flows • May involve sales ledger administration • May involve protection from bad debts • Three possible accounting treatments • derecognition • linked presentation • separate presentation

15. DERECOGNITION • Transaction is at arm’s length for an outright sales • For a fixed amount with no recourse to the seller • Seller derives no benefit and carries no risk if debts outperform or underperform expectations

16. LINKED PRESENTATION • Funds received from the factor are deducted from the gross carrying value of debtors • Balance sheet will show all of: • gross debtors • all deductions • net amount receivable

17. SECURITISED ASSETS • Finance raised from external source through security in the form of a block of specific assets • Receivables such as domestic mortgages and credit card balances are common forms • Non-monetary assets such as stocks or properties sometimes securitised

18. SECURITISED ASSETS • Company A makes a loan to company B, a mortgage company • Company B grants securitisation of mortgages to company A • Company A sells the securitised mortgages to company C for cash • Company C finances the purchase by issuing loan notes for cash

19. SECURITISED ASSETS • Will company A show the securitised loan as an asset in its balance sheet and the cash from company C as a liability ? • Have all significant benefits and risks been transferred to company C ? • Is company C a subsidiary or quasi-subsidiary of company A ?

20. LOAN TRANSFERS • One lender transfers an advance to a different lender • Loan are applicable to the named parties and thus cannot be bought or sold • Three types of arrangement • novation • assignment • subparticipation

21. NOVATION • A new contract with a new lender replaces the original • Loan removed from the balance sheet of the original lender • Not off balance sheet financing

22. ASSIGNMENT • Rights to principal sum and interest transferred to a third party • No transfer of obligations • Statutory assignment usually relates to the whole of the loan and notice must be given to the borrower • Equitable assignment may relate to part of the loan and does not require notice

23. SUBPARTICIPATION • Rights and obligations are not transferred • A third party (the subparticipant) deposits a cash sum with the lender in exchange for a share of the cash flows from the loan • Can the deposit and the loan be offset in the lender’s balance sheet ?

24. LOAN TRANSFERS ACCOUNTING TREATMENT • Does original lender have access to significant benefits and exposure to risks ? • Does the lender have a liability to repay the transfer ? • If the answer to the above is no then • derecognition • If the answer is yes then • linked presentation or • separate presentation

25. The main question Who is at risk?