By Vinayak Pai V.
Chartered Accountant
1. Key Recent Updates
IAASB:
Auditing ECL Accounting Estimates
On 31st
August, 2020, the International Auditing and Assurance Standards Board (IAASB)
published New Illustrative Examples for ISA 540 (Revised) Implementation:
Expected Credit Losses (ECL). The examples were developed to assist
auditors in understanding how ISA 540 (R) may be applied to IFRS 9 Expected
Credit Losses, viz. a) credit card, b) significant
increase in credit risk, and c) macroeconomic inputs and data.
IAASB:
Using Automated Tools and Techniques in Audit Procedures
A month
later, on 28th September, 2020, IAASB released a non-authoritative
FAQ publication regarding the Use of Automated Tools and Techniques in
Performing Audit Procedures to assist auditors in understanding whether
a procedure involving automated tools and techniques may be both a risk
assessment procedure and a further audit procedure. It provides specific
considerations when using automated tools and techniques in performing
substantive analytical procedures in accordance with ISA 520, Analytical
Procedures.
AICPA:
Considerations Regarding the Use of Specialists in the Covid-19 Environment
On 6th
October, 2020, the American Institute of Certified Public Accountants (AICPA),
the International Ethics Standards Board for Accountants (IESBA) and IAASB
jointly released a publication,Using Specialists in the Covid-19
Environment: Including Considerations for Involving Specialists in Audits of
Financial Statements. The publication provides guidance to assist
preparers and auditors of financial statements to determine when there might be
a need to use the services of a specialist to assist in performing specific
tasks and other professional activities in the Covid-19 environment.
FRC: The
Future of Corporate Reporting
Two days
later, on 8th October, 2020, the UK Financial Reporting Council
(FRC) released a Discussion Paper: A Matter of Principles – The Future of
Corporate Reporting outlining a blueprint for a more agile approach to
corporate reporting. The proposals in the discussion paper include: a)
unbundling the existing purpose, content and intended audiences of the current
annual report by moving to a network of interconnected reports; b) a new common
set of principles that applies to all types of corporate reporting; c)
objective-driven reports that accommodate the interests of a wider group of
stakeholders, rather than the perceived needs of a single set of users; d)
embracing the opportunities available through technology to improve the
accessibility of corporate reporting; and e) a model that enables reporting
that is flexible and responsive to changing demands and circumstances.
SEC:
Auditor Independence Rules
On 16th
October, 2020, the US Securities and Exchange Commission (SEC) updated the Auditor
Independence Rules. The amendments to Rule 2-01 of Regulation S-X
modernises the rules and more effectively focuses the analysis on relationships
and services that may pose threats to an auditor’s objectivity and
impartiality. The amendments reflect updates based on recurring fact patterns
that the SEC staff observed over years of consultations in which certain
relationships and services triggered technical independence rule violations
without necessarily impairing an auditor’s objectivity and impartiality.
FASB:
Borrower’s Accounting for Debt Modifications
On 28th
October, 2020, the Financial Accounting Standards Board (FASB) issued a Staff
Educational Paper – Topic 470 (Debt): Borrower’s Accounting for Debt
Modifications. According to the FASB, because of the effects of
Covid-19 there may be increased modifications or exchanges of outstanding debt
arrangements. The educational material provides an overview of the accounting
guidance for common modifications to, and exchange of, debt arrangements and
illustrative examples of common debt modifications and exchanges.
PCAOB:
Impact of CAM Requirements
And on 29th
October, 2020, the Public Company Accounting Oversight Board (PCAOB) released
an Interim Analysis Report – Evidence on the Initial Impact of Critical
Audit Matter (CAM) Requirements providing insights and perspectives of
the Board on the initial impact of CAM requirements on key stakeholders in the
audit process. Key findings include: a) Audit firms made significant
investments to support initial implementation of CAM requirements, b) Investor
awareness of CAMs communicated in the Auditor’s Report is still developing, but
some investors find the information beneficial, and c) the most frequently
communicated CAMs were revenue recognition, goodwill, other intangible assets
and business combinations.
2. Research: Capitalisation of Borrowing Costs Setting
the context
Borrowing
costs, in general, are period costs expensed to the income statement unless an entity
incurs the same for acquiring a qualifying asset, in which case the same is
capitalised as part of the cost of that qualifying asset.
Under the
IFRS framework, the core principle of IAS 23, Borrowing Costs is
‘Borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset form part of the cost of that
asset. Other borrowing costs are recognised as an expense.’ [IAS 23.1]
In this
context, a Qualifying Asset is an asset that necessarily takes a
substantial period of time to get ready for its intended use or sale, and Borrowing
Costs are interest and other costs incurred in connection with
borrowing of funds. Borrowing costs include interest expense, interest on lease
liabilities and exchange differences arising from foreign currency borrowings
to the extent they are regarded as an adjustment to interest costs.
US GAAP
has similar principles although certain terminologies and the computation
process slightly differ from IFRS.
In the
following sections, an attempt is made to address the following questions: How
did capitalisation of borrowing costs as an accounting topic originate? What
have been the related historical developments and the approaches adopted by
global standard-setters? What are the principles that underpin them? What is
the current position under prominent GAAPs?
The
Position under Prominent GAAPs
USGAAP
Capitalisation
of borrowing costs has its genesis in USGAAP. SFAS No. 34, Capitalisation of
Interest Cost was issued by the Financial Accounting Standards Board (FASB)
in 1979 (Extant US GAAP ASC 835).
Tracing
its origins, the American Institute of Accountants set up a Committee in 1917
on ‘Interest in Relation to Cost’. The Committee concluded that interest
on investments should not be included in production cost. However, the
accounting issue of capitalising interest cost was never resolved under US
accounting literature until the issuance of SFAS No. 34.
Capitalisation
of interest cost was practised by US Public Utilities: The rate of return on
investment was used to set regulatory prices in the industry. Accordingly, as a
practice, interest cost incurred in connection with capacity expansion was
capitalised as expensing the same would have meant that current users of
utility services would have to pay for future capacity creation. There was no
codified accounting standard on interest capitalisation and the same was also
not explicitly prohibited.
It was in
1974 that the US capital market regulator, the SEC, becoming concerned with the
increase in non-utility registrants adopting a policy of capitalising interest
costs, proposed a moratorium on adoption or extension of a policy of
capitalising interest costs by non-public utility registrants that had not publicly
disclosed such a policy until then. The moratorium applied till such time as
the FASB developed a related accounting standard. Accordingly, five years later
the FASB issued SFAS No.34.
The FASB
considered three basic methods of accounting for interest costs as part of the
standard-setting process, viz:
i) Account for interest on debt as an expense
of the period in which it is incurred,
ii) Capitalise interest on debt as part of the
cost of an asset when prescribed conditions are met, and
iii) Capitalise interest on debt and imputed
interest on stockholder’s equity as part of the cost of an asset when
prescribed conditions are met.
The
standard-setter opined that the historical cost of acquiring an asset includes
the costs necessarily incurred to bring it to the condition and location
necessary for its intended use. If an asset requires a period of time in which
to carry out the activities necessary to bring it to the condition and location,
the interest cost incurred during that period as a result of expenditures for
the asset is a part of the historical cost of acquiring the asset. The
objectives of capitalising interest were: (a) to obtain a measure of
acquisition cost that more closely reflects the enterprise’s total investment
in the asset, and (b) to charge a cost that relates to the acquisition of a
resource that will benefit future periods against the revenues of the periods
benefited.
On the
premise that the historical cost of acquiring an asset should include all costs
necessarily incurred to bring it to the condition and location necessary for
its intended use, the FASB concluded that, in principle, the cost incurred in
financing expenditures for an asset during a required construction or
development period is itself a part of the asset’s historical acquisition cost.
IFRS
The
accounting topic of Capitalisation of Borrowing Costs made its
entry into International Accounting Standards (now IFRS) in 1984 with the
inclusion of IAS 23, Capitalisation of Borrowing Costs in the accounting
framework. This standard underwent a revision in 1993 as part of the
standard-setters’ ‘Comparability of Financial Statements’ project.
It may be
noted that the 1993 version of IAS 23 permitted two treatments for accounting
for borrowing costs that are directly attributable to the acquisition,
construction or production of a qualifying asset. They could be capitalised or,
alternatively, recognised immediately as an expense. The IASB concluded that during
the period when an asset is under development, the expenditure for the
resources must be financed, and financing has a cost. The cost of the asset
should, therefore, include all costs necessarily incurred to get the asset
ready for its intended use / sale, including the cost incurred in financing the
expenditures as a part of the asset’s acquisition cost. The Board reasoned that
a) immediate expensing of borrowing costs relating to qualifying assets does
not give a faithful representation of the cost of the asset, and b) the
purchase price of a completed asset purchased from a third party would include
financing costs incurred by the third party during the development phase.
Accordingly,
extant IAS 23 Borrowing Costs was issued in 2007 by way of revision to
the 1993 version and was made effective from 1st January, 2009.
Indian
Accounting Standards (Ind AS 23, Borrowing Costs) is aligned with its
IFRS counterpart IAS 23.
AS
AS 16, Borrowing Costs requires borrowing costs that are directly
attributable to the acquisition, construction or production of a qualifying
asset to be capitalised as part of the cost of that asset. Other borrowing
costs should be recognised as an expense in the period in which they are
incurred. Borrowing costs include: a) interest and commitment charges, b)
amortisation of discounts or premiums, c) amortisation of ancillary costs, d)
finance lease charges, and e) exchange differences arising from foreign
currency borrowings to the extent that they are regarded as an adjustment to
interest costs.
IFRS for
SMEs
Section
25, Borrowing Costs of the IFRS for SMEs Framework requires all
borrowing costs to be recognised as an expense compulsorily in the period in
which they are incurred.
AICPA’s
Financial Reporting Framework for Small-and Medium-Sized Entities (FRF for
SMEs)
The US FRF
(a special purpose framework for SMEs, not based on USGAAP) does not contain a
separate chapter on Borrowing Costs. However, capitalisation of interest
costs is permitted as detailed herein below.
14, Property, Plant
and Equipment states that the cost of an item of PPE that is acquired,
constructed or developed over time includes carrying costs directly
attributable to the acquisition, construction or development activity, such as
interest costs when the entity’s accounting policy is to capitalise interest
costs. The Chapter on Intangible Assets contains similar provisions with
respect to Internally-Generated Intangible Assets.
Chapter 12, Inventories states that
the cost of inventories that require a substantial period of time to get them
ready for their intended use or sale includes interest costs, when the entity’s
accounting policy is to capitalise interest costs.
Accordingly,
under the FRF for SMEs framework, capitalisation of interest costs is permitted
if an entity elects to do so as an accounting policy choice. It is not a
mandatory requirement.
Snapshot
of position under Prominent GAAPs
A snapshot
of the position under prominent GAAPs is provided in Table A.
Table
A:
|
Accounting framework
|
|
Capitalisation of borrowing costs
|
|
|
|
USGAAP
|
If an asset requires a period of time in which to carry out the
activities necessary to bring it to the condition and location of intended
use, interest cost incurred during that period is part of the historical cost
of acquiring the asset
|
ASC 835-20, Capitalisation of
Interest
|
|
IFRS
|
Borrowing costs directly attributable to the acquisition,
construction or production of a qualifying asset are capitalised as part of
the cost of the asset
|
IAS 23,
Borrowing Costs
|
|
Ind AS
|
Same as IFRS
|
Ind AS 23,
Borrowing Costs
|
|
AS
|
Similar in principle to Ind AS except that the definition of
borrowing costs differs
|
AS 16,
Borrowing Costs
|
|
IFRS for SMEs
|
All borrowing costs are required to be expensed
|
Section 25,
Borrowing Costs
|
|
US FRF for SMEs
|
Interest costs incurred for PPE, internally generated
intangibles acquired / developed / constructed over time can be capitalised
if an entity elects to do so
|
No separate chapter
|
In
Conclusion
Capitalisation of interest costs started as an industry practice in the
US public utilities industry and non-utilities, too, started embracing this
accounting treatment. The capital market regulator had to step in to curb this
practice by way of a moratorium on fresh adoption, thereby forcing the
accounting standard-setter to issue an accounting standard for the first time
in 1979.
The
International Accounting Standards permitted an accounting policy choice of
capitalising interest costs on qualifying assets or expensing them. This being
at variance with USGAAP, the IASB, as part of a short-term convergence project
with USGAAP, removed this option in 2009.
USGAAP and
IFRS are aligned in principle in this accounting area albeit
capitalisation of exchange differences is not permissible under USGAAP.
The IASB,
in the process of revising IAS 23 in 2007, acknowledged that capitalising
borrowing costs does not achieve comparability between assets that are financed
with borrowings and those financed with equity. However, it does achieve
comparability among all non-equity financed assets, which it perceived as an
accounting improvement.
References:
– SFAS No.
34, as originally issued
– IAS 23
Basis for Conclusion
-http://archives.cpajournal.com/printversions/cpaj/2005/205/p18.htm
3. Global Annual Report Extracts: ‘Statement –
Fair, Balanced and Understandable’
Background
The UK
Corporate Governance Code (applicable to all companies with a premium listing)
published by the FRC requires a company’s board to explicitly state in the
annual report that they consider the annual report and accounts as fair,
balanced and understandable. This requirement was first made applicable in
2013. This reporting obligation cast on the Board is contained in section 4,
Principle N, Provision 27 of the 2018 Code (extracted below).
Section 4
– Audit, Risk and Internal Control
Principle
N – The Board should present a fair, balanced and understandable assessment of
the company’s position and prospects.
Provision 27 – The directors should explain in the annual report their
responsibility for preparing the annual report and accounts, and state that
they consider the annual report and accounts, taken as a whole, is fair,
balanced and understandable and provides the information necessary for
shareholders to assess the company’s position, performance, business model and
strategy.
Extracts
from an Annual Report
Company: Ascential plc (FTSE 250 Listed
Company, 2019 Revenues – GBP 416 million)
Extracts
from Director’s Report:
We
consider the Annual Report and Accounts, taken as a whole, is fair, balanced
and understandable and provides the information necessary for shareholders to
assess the Group’s position and performance, business model and strategy.
Extracts
from the Report of the Audit Committee:
Section –
Fair, balanced and understandable
The Board
asked the committee to consider whether the 2019 Annual Report is fair,
balanced and provides the necessary information for shareholders to assess the
Company’s position and prospects, business model and strategy. In performing
this review, the Committee considered the following questions:
Is the
Annual Report open and honest with the whole story being presented?
Have any
sensitive material areas been omitted?
Is there consistency between different sections of the Annual Report,
including between the narrative and the financial statements, and does the
reader get the same message from reading the two sections independently?
Is there a clear explanation of key performance indicators and their
linkage to strategy?
Is there a
clear and cohesive framework for the Annual Report with key messages drawn out
and written in accessible language?
Following
this review, and the incorporation of the Committee’s comments, we were pleased
to advise the Board that, in our view, the Annual Report is fair, balanced and
understandable in accordance with the requirements of the UK Corporate
Governance Code.
4. COMPLIANCE: CHANGES IN LIABILITIES ARISING FROM
FINANCING ACTIVITIES
Background
Ind AS
requires entities to provide disclosures that enable users of financial
statements to evaluate changes in its ‘Liabilities from Financing Activities’.
Ind AS 7, Statement of Cash Flows mandates disclosure of movement
between the amounts in the opening and closing balance sheets for liabilities
for which cash flows were, or future cash flows will be, classified as
financing activities in the Cash Flow Statement.
An entity
needs to take into consideration relevant requirements of Ind AS 7 (Paragraphs
44A to 44E), IAS 7 – Basis for Conclusions, and Ind AS 1, Presentation
of Financial Statements in complying with this requirement. The same is
summarised in Table B herein below.
5. INTEGRATED REPORTING
Key Recent
Update
On 11th
September, 2020, the five Global Sustainability, ESG and IR Framework and
standard-setting organisations (GRI, CDP, CDSB, IIRC and SASB) co-published a
shared vision of the elements necessary for more comprehensive corporate
reporting and a joint statement of intent to drive towards this goal. A report
titled Statement of Intent to Work Together Towards Comprehensive
Corporate Reporting was released that inter alia discusses: a)
the importance of recognising various users and objectives of sustainability
disclosures and the resulting distinctive materiality concepts; b) addresses
the unique role of frameworks and standards in the sustainability information
eco-system; and c) outlines an approach to standard-setting that results in a
globally agreed set of sustainability topics and related disclosure
requirements.
Materiality
in Sustainability Reporting
Background
Global Reporting Initiative Standard GRI 101: Foundation applies
to organisations that want to use the GRI Standards to report about their
economic, environmental, and / or social impacts in their sustainability
reporting. In sustainability reporting, materiality is the principle that
determines which relevant topics are sufficiently important that it is
essential to report on them. A material topic is a topic that reflects a
reporting organisation’s significant economic, environmental and social
impacts; or that substantively influences the assessments and decisions of
stakeholders.
Extracts
from Annual Integrated Report of Netcare Limited, a leading healthcare
service provider in SA
Materiality
Matters
that have the potential to substantively affect our ability to create value for
all stakeholders in the short (one to two years), medium (three to five years)
and long term, and which are likely to influence their decisions in assessing
this ability, are considered material.
The
material matters, mapped to the Group’s strategic priorities, informed the
preparation of and are discussed throughout the Integrated Report.
Materiality
Themes
Deliver
outstanding person-centred health and care,
Adapt
proactively to developments in the local and global healthcare sectors,
Demonstrate
our commitment to transforming healthcare in SA,
Defend and
grow sustainable profitability,
Continue
to develop visionary and effective leadership.
6. FROM THE PAST – ‘Lack Of Transparency Directly
Feeds Into Lack Of Stability’
Extracts
from a speech by Mr. Hans Hoogervorst (then Chairman, IFRS Foundation Monitoring
Board) at a conference in Brussels organised by the European Commission in
February, 2011 related to objectives of financial reporting are reproduced
below:
‘Stability
should be a consequence of greater transparency, rather than a primary goal of
accounting standard-setters.
What
accounting standard-setters can also not do is to pretend that things are
stable which are not. And, quite frankly, this is where their relationship with
prudential regulators sometimes becomes testy. Accounting standard-setters are
sometimes suspicious that they are being asked to put a veneer of stability on
instruments which are inherently volatile in value.
The truth is that investors around the world have had little faith that
the financial industry has been facing up to its problems in the past years. In
such circumstances, markets often become suspicious and they tend to overreact.
Thus, lack of transparency directly feeds into lack of stability.
There is
one final reason why I think that both the accounting and prudential community
should be fully committed to transparency. That reason is that preventing a
crisis through full risk transparency is much less costly than letting things
go and cleaning up afterwards’.
