In recent years, companies have spent significant resources implementing new accounting standards such as those relating to revenue, leases and financial instruments. While companies will welcome the break from new accounting standards, there being none that are effective for the forthcoming reporting season, there are a number of amendments to standards that are. This article outlines those key amendments.
The amended guidance on business combinations provides a clarified framework to assist companies in assessing whether their acquisition represents a business. The amendments to the financial instruments standards provide targeted relief for financial instruments qualifying for hedge accounting in the lead-up to Interest Rate Benchmark Reform. In response to COVID-19, an amendment to the leasing standard has been issued that simplifies the accounting for certain rent concessions. This latter change is covered separately in our article ‘Lease accounting: recent changes and key messages from FRC’.
What has changed? The previous definition of a business was considered broad and challenging to apply. The amendments narrow the definition of a business, introduce an optional fair value concentration test and add guidance to help entities assess whether the acquisition meets the new substantive process requirement to qualify as a business combination.
The changes to the definition of a business are likely to result in more acquisitions being accounted for as asset acquisitions and will be particularly relevant for industries such as real estate, pharmaceutical and oil and gas.
The optional concentration test is an assessment of whether substantially all of the fair value of the gross assets acquired is concentrated in a single asset (or group of similar assets), such as land and buildings. If the test is met, then no further assessment is needed, and the acquisition represents an asset acquisition.
If the concentration testing is not met (or is not applied – as it is optional), at a minimum, to be considered a business the acquired activities are required to include an input and a substantive process that together significantly contribute to the ability to create outputs. Examples of an input include land, buildings, equipment, intellectual property and employees. The amended guidance provides a framework to evaluate when a substantive process is present. An acquired substantive process will, in most cases, consist of an organised workforce. Absence of a substantive process results in the acquisition being an asset acquisition.
Although the new definition is narrower, applying the amended framework may require a complex assessment.
The accounting implications of a business combination differ from an asset acquisition. Business combinations are accounted for using the acquisition method, which among other things, may give rise to goodwill and recognition of additional intangible assets. For asset acquisitions, the amount paid is allocated to the individual assets acquired and liabilities assumed and no goodwill is recognised.
When do the amendments apply? The amendments apply to acquisitions made in accounting periods beginning on or after 1 January 2020. Transactions that occurred in prior periods do not have to be revisited.
Visit our web article for a flowchart that outlines the steps that an entity takes to assess whether the set of assets and activities acquired meets the definition of a business.
Interest Rate Benchmark Reform, also known as IBOR (interbank offered rates) reform, refers to the replacement of interest rate benchmarks (such as LIBOR) with alternative risk-free rates. This is in response to concerns over the reliability of current interest rate benchmarks.
IBOR Reform – Phase 1
What has changed?
In phase 1 of its project addressing the accounting implications of IBOR reform, the IASB has issued amendments to IFRS 9, IAS 39 and IFRS 7 to address uncertainties leading up to the replacement of IBORs (pre-replacement issues).
The uncertainties could lead to the discontinuation of hedge accounting, for example, because forecast LIBOR based cash flows may no longer be considered highly probable. This could lead to significant profit and loss effects. The amendments provide targeted relief for financial instruments qualifying for hedge accounting and mean that companies will not discontinue hedge accounting, for example, if the LIBOR based cash flows are not considered highly probable as a direct consequence of the IBOR reform. A company will not have to discontinue its hedge accounting if all of the hedging accounting conditions would otherwise be met.
When do the amendments apply?
Phase 1 amendments are mandatory and effective for accounting period beginning on or after 1 January 2020. These amendments are discussed in further detail, along with the required disclosures, in our article, IBOR reform – First phase amendments issued.
IBOR Reform – Phase 2
What has changed?
Phase 2 of IBOR reform deals with what happens when the replacement of IBORs actually occurs. There are a wide variety of issues that may arise from changes in contractual terms that may be necessary as a result of IBOR reform. For example, IBOR reform may result in changes to the contractual terms of LIBOR based loans that could lead to the recognition of material modification gains or losses in the P&L. The post-replacement impacts may also be wider than financial instruments in the scope of IFRS 9, for example lease contracts which are linked to LIBOR.
Amendments to IFRS 9, IAS 39, IFRS 7, IFRS 16 and IFRS 4 have been issued to provide relief for the Phase 2 impacts. The amendments offer a practical expedient that enables an entity to account for certain modifications to loans (or similar instruments) by updating the effective interest rate rather than by recognising a modification gain or loss. Also, the amendments offer relief in respect of lease modifications and some hedge accounting rules that would otherwise cause the cessation of hedge accounting.
When do the amendments apply?
Phase 2 amendments are mandatory and effective for accounting period beginning on or after 1 January 2021. Whilst these can be early adopted, at the time of writing this article they are yet to be endorsed by the EU. The amendments will not be available to entities applying EU IFRS until they are endorsed.
For more information on the Phase 2 amendments and their particular impact for corporates, listen to our podcast and read our web article. Visit home.kpmg/IBORreform to keep up to date with the latest news and discussion, including our forthcoming Webex with Bloomberg on this topic.
The other amendments effective for accounting periods beginning on or after 1 January 2020 are Amendments to References to the Conceptual Framework in IFRS Standards and Definition of Material – Amendments to IAS 1 Presentation of Financial Statements and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. For most of you, these amendments will not require changes to your reporting this coming year end.
For the full list of IFRS developments effective for the accounting period beginning 1 January 2020 and beyond, visit our New standards page.