Are you really in compliance with IFRS® Standards in 2021?

— Intangible assets

— Employee benefits

— Inventory

— Presentation of financial statements

— Leases

— Financial instruments

In the fact pattern discussed by the IFRS IC, a customer enters into a Software as a Service (SaaS) arrangement with a supplier. The contract conveys to the customer a right to access the supplier's application software over the contract term (i.e. a service) but does not convey to the customer a software asset (e.g. a software license). The customer incurs costs for customizing and/or configuring the software (i.e. modifying or writing an additional code and/or defining values or parameters so the software functions in a specific manner).

Having concluded that the SaaS arrangement does not give rise to a software asset, the IFRS IC advised that the accounting for those costs generally hinges on whether:

• they give rise to a separate intangible asset under IAS 38; and
• if not, whether the costs are a prepayment of SaaS services, which in turn depends on whether the activities underlying those costs are distinct from the SaaS.

US GAAP (ASC 350-40) has specific guidance for configuration, customization and other implementation costs incurred by customers in SaaS arrangements.

Companies will generally capitalize fewer SaaS implementation costs under IFRS Standards than US GAAP.

For more on cloud computing arrangements, read KPMG IFRS Perspectives article here and KPMG US GAAP Handbook, Software and website costs.

Over what periods of service should an entity attribute benefits under IAS 19?

In the fact pattern discussed by the IFRS IC, an entity sponsors a post-employment defined benefit plan for its employees. Under the terms of the plan, employees are entitled to a lump sum payment only when they reach a retirement age of 62, if they are still employed by the entity. The amount of retirement benefit is calculated as one month of final salary for each consecutive year of service before the retirement age, capped at 16 years of service.

IAS 19 requires an entity to attribute the benefit to periods of service under the plan’s benefit formula from the date when employee service first leads to benefits under the plan until the date when further employee service will lead to no material amount of further benefits under the plan. Further, an entity must attribute the benefit to periods in which the obligation to provide post-employment benefits arises (i.e. as employees render services). Employee service gives rise to a constructive obligation because, at each reporting date, the amount of future service an employee will have to render before becoming entitled to the benefit is reduced.

In the fact pattern presented, the IFRS IC concluded that an entity should attribute the retirement benefit to the last years of service subject to the cap (i.e. each year in which an employee rendered service from the age of 46 (or, if the employment commences on or after the age of 46, from the date the employee first renders service) to the age of 62.

We believe the same conclusion would be reached under US GAAP in this scenario.

Are the estimated costs ‘necessary to make a sale’ limited to incremental costs when determining the net realizable value (NRV) of inventories?

IAS 2 states that the objective of writing inventories down to NRV is to avoid them from being carried ‘in excess of amounts expected to be realized from their sale’. The IFRS IC observed that including only incremental costs could fail to achieve this objective. Accordingly, when determining the NRV of inventories, an entity estimates the costs necessary to make the sale in the ordinary course of business and does not limit them to those that are incremental.

Unlike IFRS Standards, US GAAP does not specify if costs necessary to make the sale can be limited to those that are incremental, and differences may arise in practice. For further discussion, read KPMG IFRS Perspectives article, Inventory accounting: IFRS vs US GAAP.

Referred to the Board:

April 2021

How does an entity determine the current or noncurrent classification of debt with covenants under amended IAS 1 (not yet effective)²?

The IFRS IC discussed whether an entity has the right to defer settlement of a liability for at least 12 months after the reporting date – i.e. it can classify the liability as noncurrent, when: (1) the right to defer settlement is subject to the entity complying with specified conditions after the reporting date, but (2) the specified conditions would not be met at the reporting date if hypothetically tested at that date.

The IFRS IC referred this issue to the Board for standard setting. In November 2021, the IASB Board published the Exposure Draft, Non-current Liabilities with Covenants (proposed amendments to IAS 1), to improve the information companies provide about long-term debt with covenants.

In the fact pattern discussed by the IFRS IC, an entity was a going concern in 2017 through 2019 but is no longer one in 2020 when it prepares its 2019 financial statements. The 2019 financial statements are not prepared on a going concern basis.

Assuming the entity in the fact pattern has not previously prepared financial statements for prior periods (2017 and 2018), can it prepare financial statements for those periods on a going concern basis?

No. The IFRS IC concluded that an entity that is no longer a going concern cannot prepare financial statements on a going concern basis, including for prior periods that have not yet been authorized for issue.

Assuming the entity in the fact pattern has previously issued financial statements for 2018 on a going concern basis, should it restate the 2018 comparative information in the 2019 financial statements to reflect the non-going concern basis of accounting?

The IFRS IC did not formally conclude on this question, but its research showed that publicly listed IFRS reporters that prepare financial statements on a non-going concern basis do not restate comparative information to reflect that basis. The IFRS IC observed no diversity in the application of IFRS Standards with respect to this scenario and has not obtained evidence that it is a widespread issue.

Unlike IFRS Standards, US GAAP applies the liquidation basis of accounting only from the point that liquidation becomes imminent. The going concern basis of accounting applies up to that point regardless of when the financial statements are prepared. Subsequent events should however be considered.

Does an electricity retailer (retailer) account for a power purchase agreement in a gross pool electricity market under IFRS 16?

In the fact pattern discussed by the IFRS IC, a windfarm generator (Supplier) enters into a contract with retailer. Both parties are registered participants in an electricity market. The contract: (1) identifies Supplier’s windfarm; (2) covers notionally all of the electricity the windfarm will supply to the electricity grid over a 20-year period; (3) allows Supplier to receive a fixed price per megawatt for electricity supplied to the grid, for which retailer net settles with Supplier the difference between the fixed price and the spot price per megawatt for that volume of electricity; and (4) transfers to retailer all renewable energy credits that accrue from use of the windfarm.

The IFRS IC concluded that the agreement is not a lease. This is because it does not give retailer the right to obtain any of the electricity the windfarm produces and supplies to the grid. Accordingly, retailer does not have the right to obtain substantially all the economic benefits from use of the windfarm.

We believe the same conclusion would be reached under US GAAP.

Does a lessee include non-refundable value-added tax (VAT) payments as part of the ‘lease payments’ under IFRS 16?

The IFRS IC considered outreach indicating that the issue was not material to most lessees and that there may be little diversity in the matter. The IFRS IC did not consider a technical analysis of the question.

We believe that if VAT is a tax that is levied on the lessee and collected by the lessor, who is acting as an agent for the tax authority, then the VAT is not a lease payment or a payment for a non-lease component regardless of whether it is recoverable or non-recoverable. This is because the payment is not made in exchange for the right to use an underlying asset, or a good or a service provided to the lessee. Instead, we believe a lessee should account for this VAT as a levy under IFRIC 21. Conversely, lessee’s payment of VAT that is levied on the lessor is a lease payment. See section 6.4 in KPMG Handbook Real estate leases.

Under US GAAP, we believe the accounting for non-refundable VAT by a lessee depends on (1) which party (the lessee or the lessor) is the primary obligor for the tax and (2) whether the tax is incurred at or before lease commencement or over the lease term. See Question 4.2.70 in KPMG Handbook, Leases.

Can a hedge of the variability in cash flows arising from changes in the real interest rate, rather than the nominal interest rate, be accounted for as a cash flow hedge?

In the fact pattern discussed by the IFRS IC, an entity wants to hedge a floating rate (LIBOR) debt with an inflation swap – which would swap the variable interest cash flows of the floating rate debt for variable cash flows based on an inflation index – in a cash flow hedge.

The IFRS IC’s analysis focused on whether, in accordance with IFRS 9, the floating rate instrument had exposure to variability in cash flows attributable to the real interest rate risk component, and whether that risk component was separately identifiable and reliably measurable.

The market structure needs to support the eligibility of a real interest rate component as a non-contractually specified risk component. As such, the real interest rate must represent an identifiable pricing element in setting the floating benchmark interest rate.

Additionally, nominal interest rates do not change as a direct result of changes in inflation or the real interest rate – i.e. they are not identifiable pricing elements in setting nominal rates. Therefore, there is no exposure to variability in cash flows that is attributable to changes in the real interest rate in the cash flow hedging relationship.

As a result, the IFRS IC concluded that the real interest rate risk component would not meet the requirements in IFRS 9 to be designated as an eligible hedged item.

Unlike IFRS Standards, only contractually specified interest rates (and not an inflation index or a real interest rate risk component) are eligible to be designated in a cash flow hedge of interest rate risk related to variable rate financial instruments under US GAAP. Therefore, we believe the same conclusion would be reached under US GAAP. 

Referred to the Board: 

September 2022

Should an entity derecognize trade receivables and recognize cash on the date the cash transfer is initiated or the date it is settled?

In the fact pattern discussed by IFRS IC, an entity receives a cash transfer via an electronic transfer system that takes three working days to settle. As an example, an entity recognizes a trade receivable on November 30, 20X0 for a sale to a customer, and on December 31, 20X0 (entity’s reporting date), the customer notifies the entity that a payment has been initiated. On January 2, 20X1, the entity receives the cash to settle the trade receivable.

In September 2022, the IASB, in consideration of the discussions and comments relating to this fact pattern, decided to explore narrow-scope standard-setting as part of its post-implementation review of IFRS 9.

Does an issuer reclassify an issued warrant from derivative financial liability to equity after initial recognition under IAS 32?

In the fact pattern discussed by the IFRS IC, an issuer classifies a warrant at initial recognition as a financial liability because at that date the warrant exercise price is unknown and the amount of cash the issuer will receive in exchange for shares is not fixed. The IFRS IC considered whether the issuer reclassifies the warrant as equity when the exercise price subsequently becomes known, and the ‘fixed-for-fixed’ condition in IAS 32 is met. 

The IFRS IC did not formally conclude on this question, but observed that IAS 32 has no general guidance for reclassifying financial liabilities and equity instruments after initial recognition when the instrument’s contractual terms are unchanged. Instead, it referred the matter to the Board to consider as part of the Board’s broader discussions on the Financial Instruments with Characteristics of Equity Project.

Like IFRS Standards, under US GAAP, classification of an instrument as either a financial liability or equity is made on initial recognition. However, unlike IFRS Standards, classification of a contract that is indexed to, and potentially settled in, an entity’s own stock is reassessed at each reporting date, and any change in classification is accounted for prospectively.