2022 IFRS® Interpretations Committee Agenda Decisions

How does a lessor account for a rent concession in an operating lease when it has an outstanding receivable? 

In the fact pattern discussed by the IFRS IC, the lessor in an operating lease legally releases the lessee from its obligation to make specifically identified lease payments, some of which are amounts contractually due but not yet paid – i.e. the lessor has recognized an operating lease receivable – and some of which are amounts that are not yet contractually due. No other changes or negotiations are made. 

The IFRS IC concluded that, before the rent concession is granted, the lessor applies IFRS 9. Under IFRS 9, the lessor measures expected credit losses on the operating lease receivable in a way that reflects an unbiased and probability-weighted amount determined by evaluating a range of possible outcomes, including considering its expectations of forgiving lease payments recognized as part of that receivable.

The lessor accounts for the rent concession by applying:

• the derecognition requirements in IFRS 9 to those forgiven lease payments recorded as an operating lease receivable on the date of the rent concession; and
• the lease modification requirements in IFRS 16 to forgiven lease payments not yet contractually due (and therefore not included in the lessor’s operating lease receivable).

We believe this accounting would generally result in a difference from US GAAP. Under US GAAP, forgiving either type of lease payment would be accounted for as a lease modification, and all of the forgiven lease payments – whether or not recognized by the lessor as an operating lease receivable – would be treated similarly, as a lease incentive. 

How to assess whether a contract contains a lease when the supplier has particular substitution rights? 

In the fact pattern discussed by the IFRS IC, the contract is for the use of multiple similar assets (e.g. 100 batteries used in electric buses) and the supplier has the practical ability to substitute alternative assets throughout the period of use. However, the supplier would not benefit economically from exercising its substitution right in the first three years of the contract.

The IFRS IC tentatively concluded that there is an identified asset in this fact pattern (which is one of the conditions for a lease to exist) since the supplier’s substitution right is not substantive throughout the period of use. Further, if a contract contains multiple independent assets, the supplier’s substitution right must be assessed individually for each asset.

Do measures to encourage reductions in vehicle carbon emissions give rise to obligations that meet the definition of a liability in IAS 37?

In the fact pattern discussed by the IFRS IC, companies receive positive or negative credits if in a calendar year they have produced or imported vehicles whose average fuel emissions are respectively lower or higher than the government target. Negative credits must be eliminated by obtaining and surrendering positive credits in the next year. If the company fails to eliminate its negative credits, the government can impose sanctions (e.g. restricting the company’s access to the market).

The IFRS IC concluded that a company with a negative credit balance has a legal obligation that meets the definition of a liability in IAS 37, unless accepting the sanctions that the government can impose is a realistic alternative to eliminating negative credits for that company. In this latter case, a constructive obligation may still exist.

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

Can demand deposits with contractual restrictions be classified as cash and cash equivalents in the statement of cash flows and the balance sheet?

In the fact pattern discussed by the IFRS IC, a company has a third-party contractual obligation to keep cash in a separate demand deposit account to use for specified purposes. The bank does not restrict the company from accessing the amounts held; however, if the company uses the funds for a purpose other than specified, the company would breach its contractual obligation. 

The IFRS IC concluded that restrictions on the use of demand deposits do not preclude these deposits from being cash and cash equivalents when they are available to the company on demand. Therefore, they should be included in cash and cash equivalents in the statement of cash flows and the balance sheet. 

When relevant to understanding its financial position, the company should disaggregate and present demand deposits subject to contractual restrictions as a separate line item. Further, adequate disclosure should be provided on significant cash and cash equivalents balances with restrictions on use.

Under US GAAP, restricted cash (and restricted cash equivalents) balances are included in the total cash and cash equivalents in the statement of cash flows regardless of the balance sheet presentation. Cash and cash equivalents balances between the two statements need to be reconciled in the notes, with adequate disclosures about restrictions provided.

In a group of annuity contracts, how is the amount of contractual service margin to be recognized in profit or loss in a period because of the transfer of insurance coverage for survival determined?

Under IFRS 17, this determination affects the amount of insurance revenue recognized in profit or loss each period. 

The fact pattern discussed by the IFRS IC illustrates a group of annuity contacts under which each policyholder pays the premium upfront and has no right to cancel the contract or seek a refund, receives the period payment from the start of the annuity period for as long as the policyholder survives, and receives no other services under the contract. The annuity period can start immediately or be deferred.

The IFRS IC considered two alternative methods to determine the quantity of the benefits provided in a period: 

• Method 1, based on the amount the policyholder is able to validly claim in each period; and
• Method 2, based on the total of the amount the policyholder is able to validly claim in each period and the present value of expected future annuity payments. 

Note that no contractual service margin is recognized in profit or loss over the deferral period in a deferred annuity contract under Method 1.

The IFRS IC concluded that only Method 1 is appropriate in the fact pattern considered. 

Under US GAAP, for long-duration insurance contracts, the concept of a contractual service margin does not exist, and the calculation of period-to-period profits is based on different concepts. Therefore, we believe that differences from IFRS Accounting Standards may arise in practice.

Multi-currency groups of insurance contracts (IFRS 17, Insurance Contracts and IAS 21, The Effects of Changes in Foreign Exchange Rates)

Are currency exchange risks considered when identifying insurance contract portfolios under IFRS 17? How are IAS 21 and IFRS 17 applied in measuring a multi-currency group of insurance contracts? 

Companies may issue insurance contracts with cash flows in more than one currency. IFRS 17 requires companies to recognize and measure groups of insurance contracts. This involves identifying portfolios of contracts subject to similar risks and managed together. 

The IFRS IC concluded that currency exchange risks should be considered when grouping contracts. However, a portfolio may include contracts subject to different currency exchange rate risks in certain situations.

Under IFRS 17, a group is measured at the total of the fulfilment cash flows and the contractual service margin (CSM). To measure a multi-currency group, an entity does the following.

• Apply the IFRS 17 measurement requirements to the group, including the CSM, as a monetary item.
• Apply IAS 21 at the reporting date to translate the carrying amount of the group, including the CSM, at the closing rate(s), using the company’s functional currency. 
• Develop an accounting policy to determine what currency(ies) the insurance portfolio is denominated in upon initial recognition.
• Apply judgment in developing and applying an accounting policy based on the specific circumstances.

Under US GAAP, long-duration insurance contracts are accounted for using different concepts. Therefore, differences from IFRS Accounting Standards may arise in practice.

Does a special purpose acquisition company (SPAC) classify public shares it issues as a financial liability or equity?

A SPAC is a listed shell company formed to acquire a target operating company. See KPMG Perspectives article, SPACs: What GAAP applies?

In the fact pattern discussed by the IFRS IC, a SPAC issues two classes of shares (A and B). Class B shareholders:

• individually have the contractual right to demand redemption for cash of their shares if the SPAC’s shareholders approve the acquisition of a target company;
• are reimbursed if the SPAC is liquidated; and 
• along with Class A shareholders, have the contractual right to extend the SPAC’s specified life if no target company is acquired.

IAS 32 is silent about how to assess whether the shareholders’ contractual right to extend the SPAC’s life indefinitely gives the SPAC the unconditional right to avoid paying cash to settle a contractual obligation – i.e. whether a decision of shareholders is treated as a decision of the entity. 

The IFRS IC concluded that the request was too narrow to be addressed in isolation and noted that the IASB will consider such issues in its Financial Instruments with Characteristics of Equity (FICE) project. However, the IFRS IC noted the importance of financial statement disclosures around classification of public shares.

Like IFRS Accounting Standards, conclusions around classification of temporary equity under US GAAP frequently involve significant judgment and depend heavily on the specific facts and circumstances. However, because the accounting requirements under IAS 32, IFRS 2, and IFRS 9 significantly differ from the corresponding US GAAP requirements, we have observed significant differences between US GAAP and IFRS Accounting Standards in practice. 

How does a company account for warrants on acquiring a SPAC? 

In the fact pattern discussed by the IFRS IC, a SPAC that is not a business and with cash as its sole asset identifies a target operating company for acquisition. However, the operating company acquires the SPAC by issuing shares and warrants to the SPAC’s shareholders in exchange for the shares and legal cancellation of the warrants of the SPAC. The SPAC shareholders are not SPAC employees, nor will they provide services to the company after the acquisition. 

The IFRS IC concluded that the company accounts for the acquisition of the SPAC by recognizing the individual assets acquired, the stock exchange listing service acquired, the liabilities assumed in the transaction, and cash. Based on the facts and circumstances, the company needs to determine whether or not it has assumed the SPAC warrants as part of the acquisition because this affects the accounting for the newly issued warrants. 

The Agenda Decision further explores the accounting when SPAC warrants are assumed, noting that: 

• IAS 32 applies to new warrants issued to acquire cash or assume any liability related to the SPAC warrants, and
• IFRS 2 applies to warrants issued to acquire a listing service. 

Although not addressed in the fact pattern discussed by the IFRS IC, in the United States, warrants are also often issued to PIPE (Private Investment in Public Equity) investors, which makes this Agenda Decision applicable to those warrants as well. 

Because of the different requirements, we have observed significant differences between US GAAP and IFRS Accounting Standards in practice, when accounting for warrants in SPAC acquisitions. 

TLTRO III transactions (IFRS 9, Financial Instruments and IAS 20, Accounting for Government Grants and Disclosure of Government Assistance)

Final: February 2022

How does an entity account for targeted longer-term refinancing operations (TLTROs)?

The third program of the TLTROs of the European Central Bank (ECB) links the amount a participating bank can borrow, and the interest rate the bank pays on each tranche of the operation, to the volume and amount of loans it makes to nonfinancial corporations and households.

The IFRS IC discussed the overall application of IFRS 9 to these transactions, from measurement to disclosures. The IFRS IC concluded that a TLTRO tranche would contain a portion that is treated as a government grant if:

• the participating bank determines that the ECB meets the definition of government; and 

Either:

1. The fair value of a TLTRO III tranche at initial recognition differs from its transaction price because of a below-market interest rate; or 

2. The loan is forgivable. 

When this is the case, the requirements in IAS 20 should be followed. 

The IFRS IC did not conclude on determining the effective interest rate and referred the matter to the IASB to consider as part of the post-implementation review of IFRS 9. 

Unlike IFRS Accounting Standards, US GAAP does not allow interest on low-interest or interest free loans from a government to be imputed.