Industrial companies are making progress with the practical implementation of IFRS 9. This article summarizes the major practical challenges and highlights those areas where most work is needed right now.
The timing of compulsory initial adoption follows the lead given by the IASB and remains January 1, 2018, although prior adoption is permitted. In a paper published on November 10, 2016, the European Securities and Markets Authority (ESMA) expressed its expectation that companies will publish quantitative data on the impact of IFRS 9 on the balance sheets, income statements, economic and regulatory equity and disclosures in their external financial reporting ahead of January 1, 2018, provided that the effects are "reasonably estimable" on a robust basis. At the very minimum, ESMA expects qualitative statements to be made about the content and impact of IFRS 9. The latter should include a discussion of phases I, II and III, of the disclosure requirements and of the transition phase – the five key areas of implementation that confront businesses with challenges of varying magnitude.
For most corporates, phase I "Classification and measurement" probably constitutes less of a challenge. Decisions about where to assign what financial assets within a business model will lead to more of a formal act than to active intervention in the business model. On the other hand, the restrictions imposed by the SPPI criterion ("solely payments of principal and interest") are likely to take effect only in special cases. Accordingly, differing impacts on the subsequent measurement of financial instruments are likely to a lesser degree than under IAS 39. It is therefore reasonable to expect that the practical impact of phase 1 will merely involve realigning charts of accounts or altering the assignment to new measurement categories. By contrast, more testing challenges could arise when determining the fair value of equity instruments, assigning receivables to a business model in the context of factoring or ABS transactions, and assessing investments in funds. Especially when it comes to shares in real estate holdings and start-ups, the policy of measurement at cost witnessed under IAS 39 is no longer permissible. Receivables that may be held for sale must be measured at fair value and pointed out as such in the notes. Funds must also be presented differently depending on whether they constitute equity or debt instruments. For this reason, it is essential to assess whether all of a corporate's financial assets meet the SPPI criterion.
Experience shows that the topic of impairment presents the greatest challenge to corporates. The focus here is on the requirements for implementation:
All these issues have already been explored in the newsletter "IFRS 9 – Key requirements for the impairment of corporates". In particular, the need here is to collect and aggregate data for the entire corporate group in a kind of database, all of which implies heavier operating expenditure on a methodological, technical and process level. Determining expected instances of default solely on the basis of cases of default that have occurred in recent years is methodologically inconsistent. Similarly, bad debts in the course of a year cannot simply be set in relation to receivables at year-end, but must rather be linked to incoming receivables during the same period.
This is therefore a job for Credit Risk Management and Accounts Receivable, who must pool the relevant information and data to determine an overall expected credit loss. Where companies distinguish between customer groups, regions and/or divisions, calculate default probabilities or take account of indicators for the purpose of credit risk management, these parameters too will as a rule probably have to be factored into calculation of the expected credit loss. This in turn will involve dovetailing Credit Risk Management and Accounting. For the smaller group of companies that hold financial assets in the form of traded securities, making separate provision for impairments attributable to credit ratings adds a level of complexity to both measurement and the posting logic that should not be underestimated.
Hedge accounting concerns those companies that use derivatives on a large scale and that designate hedge accounting in this context. In practice, the picture here is more heterogeneous than in phases I and II. Even so, we can already state that the possibility of designating a net position or "aggregated exposure" is likely to play a less important role. On the other hand, companies will tackle calculation of the "currency basis spread" (CBS) component more intensively in the case of currency hedging and the associated entries for the cost of hedging. The abolition of the 80-to-125% effectiveness threshold is perceived as a simplification. However, while the option of component designation constitutes a major simplification for the hedge accounting of commodity risks, corporates have not yet done as much in this area as could perhaps have been expected. Given that the requirements must be met by the time of initial adoption in the financial statements for 2018, and given the cost of calculating the commodity risk to be hedged, companies appear to be delaying this option until the optimization phase following initial adoption, especially as designation can only be applied prospectively.
Numerous changes in disclosure requirements often create more implementation work than expected. This time around, charts of accounts and items in the financial statements must be defined and implemented appropriately to enable group-wide access to the corresponding IFRS 7 information. Considerable extra work is to be expected in areas such as notes on the impairment of financial assets. Extensive changes have also been made in the area of hedge accounting. For example, hedge accounting information must be presented by risk category, which may lead to a separate and substantial data basis.
Current market activity suggests that, so far, the least work has been done to flesh out the topic of transition. Questions about the timing, functionality and technicalities of the transition from IAS 39 to IFRS 9 on the date of initial application thus remain unanswered in many cases. There is also virtually no sign of early adoption of IFRS 9; and the same is true of the option of restatement upon initial application.