The IFRS Interpretations Committee has concluded that a separate interest revenue line item that contains only interest income on assets that are measured at amortised cost or fair value through other comprehensive income (subject to the effect of applying hedge accounting to derivatives in designated hedge relationships) should be presented in the income statement.
This will be a change to current practice for some entities. It is likely to have the most significant impact on financial services entities, such as banks for whom interest revenue or net interest margin is a key performance indicator.
IFRS 9 introduced a consequential amendment to paragraph 82(a) of IAS 1, under which interest revenue calculated using the effective interest method is required to be presented separately on the face of the income statement.
The IFRS Interpretations Committee (the ‘Committee’) has issued an agenda decision which concludes that this separate line item can be used only for interest on those financial assets that are measured at amortised cost or fair value through other comprehensive income (subject to the effect of applying hedge accounting to derivatives in designated hedge relationships).
This means that interest income on items that are not measured at amortised cost or fair value through other comprehensive income will no longer be able to be included in the same line item.
This change is likely to have the most significant impact on financial services entities, such as banks. Some such entities currently include interest income on certain assets measured at fair value through profit or loss (‘FVTPL’) in the same line item as interest income on assets measured at amortised cost or fair value though other comprehensive income, but they will no longer be able to do this.
Depending on an entity’s existing presentation policy, this change might impact the presentation of gains and losses on some or all of the following:
Some entities might wish, as a matter of accounting policy, to present additional line items, on the face of the income statement, for ‘interest’ on instruments measured at FVTPL. Whilst not addressed by the Committee, IAS 1 permits an entity to present additional line items where doing so is relevant to an understanding of the entity’s financial performance. If such a presentation is adopted, the additional line items should be appropriately presented and labelled. Also, the entity’s accounting policy, including how such amounts are calculated and on which instruments, should be disclosed. Some local regulators have expressed views on the presentation of interest income for financial instruments measured at FVTPL, in which case regard should be had to those views.
The Committee’s agenda decision is effective at the same time as IFRS 9 (that is, for accounting periods beginning on or after 1 January 2018).
IFRS 15, ‘Revenue from contracts with customers’, significantly impacts the accounting for many companies in the pharmaceutical and life sciences (PLS) industry.
A licence granted by a PLS company (the licensor) generally provides the customer (the licensee) with the right to use, but not to own, the licensor’s intellectual property (IP). A common example in the PLS industry is a company that ‘out-licenses’ to a customer the IP that it developed in relation to a drug that has not yet received regulatory approval. Often, under the terms of the licence, the licensee can further develop the IP, and manufacture and/or sell the resulting commercialised product. The licensor typically receives an upfront fee, milestone payments for specific clinical or other development-based outcomes, and sales-based royalties as consideration for the licence. Revenue is generally recognised at a point in time for arrangements in which there is a single performance obligation (that is, the transfer of a ‘right to use’ licence). This publication focuses on arrangements in which the transfer of a ‘right to use’ licence is the only performance obligation. As a result, the accounting treatment described here might differ for arrangements in which there are two or more performance obligations, or those in which there are multiple goods and services combined into a single performance obligation.
In certain out-licensing transactions, licensors receive annual fees payable by the licensee on each anniversary of the inception of the contract until the end of the stated licence term. These fees are sometimes paid for the transfer of additional distinct goods or services to the customer, or they might be payable to the licensor to fund its patent maintenance or patent defence efforts. In general, a commitment to maintain or defend an existing patent would not constitute a distinct good or service, and so it does not result in a separate performance obligation.
If the ‘right to use’ licence is the only performance obligation in the arrangement, these annual fees should be recognised at the time when control transfers to the licensee and the licence term begins. This is because a fixed, non-contingent fee (such as a fee payable in annual instalments), in exchange for a promised good or service, is not variable consideration that is contingent on the occurrence or non-occurrence of a future event. This is likely to result in an acceleration of revenue compared to the current accounting treatment for this payment type.
Out-licensing arrangements in the PLS industry might contain minimum royalty guarantees. The minimum guarantee, in some cases, is negotiated due to uncertainty about the customer’s performance and its ability to successfully exploit the IP.
In other cases, the minimum guarantee is established as a cash flow management tool, to provide the licensor with predictable timing of some cash flows under the contract. The minimum amount could be paid at the beginning of the licence term, or it could be settled either periodically or at the end of the licence term in the event that the sales- or usage-based royalties are lower than the guaranteed amount.
Assuming that the minimum royalty guarantee is binding and not contingent on the occurrence or non-occurrence of a future event (such as regulatory approval), it constitutes fixed consideration that should be recognised at the time when the company transfers control to the licensee and the licence term begins. This would be the case irrespective of whether the minimum guarantee is payable upfront, over time, or at the end of the licence term. However, any royalty amounts above the minimum guarantee should be recognised when the subsequent sale or usage has occurred.
Recognising the minimum guarantee amount upfront is likely to result in an acceleration of revenue compared to the current accounting treatment for this type of arrangement.
The following are key judgements that companies will need to make when accounting for delayed fixed consideration.
A company will need to determine, at the beginning of an arrangement, whether it is probable that it will collect the consideration to which it is entitled. The assessment must reflect both the customer’s ability and intent to pay as amounts become due, and it would include an evaluation of all elements of the transaction price, including delayed fixed consideration. Importantly, if the company concludes that collection is not probable, it is not permitted to recognise revenue related to the arrangement until certain criteria are met. Specifically, revenue cannot be recognised unless the consideration received is non-refundable and either the contract has been terminated or the company has no obligation to transfer additional goods or services.
A company that concludes that collection is not probable is required to continue to reassess this conclusion throughout the term of the arrangement.
It is important for companies to evaluate the contract term, in order to determine the period of time during which both parties have enforceable rights and obligations under the contract. This could impact the determination of the transaction price and recognition of revenue; that is, it will dictate the amount of fees payable in annual instalments or minimum guaranteed royalties to recognise on an accelerated basis under IFRS 15 when compared to current practice.
Companies will be required to assess whether a contract is cancellable when making this determination and, if so, whether there is a substantive termination penalty in the event that the contract is cancelled. We believe that termination penalties could take various forms, including cash payments or the forfeiture of a valuable right to the licensed IP on cancellation without refund of amounts paid for such rights. Significant judgement might be involved in assessing whether forfeiture of a right to IP is substantive in the context of the arrangement.
A contract that can be cancelled without a substantive termination penalty only has enforceable rights and obligations for the period that is non-cancellable. Accordingly, the transaction price would exclude fees that the customer could avoid paying by cancelling the contract (for example, certain delayed fixed payments). Companies will also need to assess, in this situation, whether the contract contains a material right related to future optional purchases.
Given the long-term nature of these arrangements and the existence of fixed consideration payable on a delayed basis, companies in the PLS industry will need to evaluate the timing of these payments relative to the transfer of control of the licensed IP, in order to determine if a significant financing component exists.
There might be a significant financing component, since cash will often be received many years in arrears of performance. If so, the initial amount of revenue recognised on the transfer of control of the licence should be discounted for the time value of money, and a portion of the consideration received (or receivable) should be recognised as interest income (rather than revenue).
Companies should be mindful that the adoption method selected (that is, full retrospective or modified retrospective) will impact a company’s ability to present these accelerated amounts as revenue in the income statement for contracts that were entered into, and performance obligations that were satisfied, before the adoption of IFRS 15.
The IASB has revised its Conceptual Framework. This will not result in any immediate change to IFRS, but the Board and Interpretations Committee will use the revised Framework in setting future standards. It is therefore helpful for stakeholders to understand the concepts in the Framework and the potential ways in which they might impact future guidance.
The IASB has revised its Conceptual Framework. The primary purpose of the Framework is to assist the IASB (and the Interpretations Committee) by identifying concepts that it will use when setting standards.
The Framework is not an IFRS standard and does not override any standard, so nothing will change in the short term. The revised Framework will be used in future standard-setting decisions, but no changes will be made to current IFRS. Preparers might also use the Framework to assist them in developing accounting policies where an issue is not addressed by an IFRS.
Key changes include:
The Board did not make any changes that address challenges in classifying instruments with characteristics of both liability and equity. That will be addressed through the IASB’s standard-setting project on that topic. Other amendments to the Framework might be needed at the conclusion of that project.
The Board and Interpretations Committee will immediately begin using the revised Framework. It is effective for annual periods beginning on or after 1 January 2020 for preparers that develop an accounting policy based on the Framework.
IFRS 15 is required to be applied for annual reporting periods beginning on or after 1 January 2018. Many entities will be required to issue interim financial statements under IAS 34, ‘Interim Financial Reporting’, before they issue their first annual financial statements applying IFRS 15.
Regulators, investors and other stakeholders might focus on disclosures related to the adoption of IFRS 15.
IFRS 15 made consequential amendments to IAS 34 that require disclosure of:
In addition to complying with these specific requirements in each interim report, entities should comply with paragraph 16A(a) of IAS 34, which requires a description of the nature and effect of any changes to their accounting policies and methods as compared with the most recent annual financial statements.
The extent of the disclosures will depend on an entity’s circumstances. Entities apply judgement to determine the extent of the disclosure, taking into consideration, for example:
Entities should also consider whether any of the detailed disclosures required by IFRS 15 in annual financial statements are useful to comply with the requirements of IAS 34, although these disclosures are not mandatory in interim reports.
IFRS 15 is applicable for annual reporting periods beginning on or after 1 January 2018. Any interim financial statements issued before the first annual financial statements applying IFRS 15 will need to consider the above guidance.
Before banks issue their first annual financial statements applying IFRS 9, many will issue interim financial statements under IAS 34. This reporting is likely to receive a lot of focus from investors, regulators and other key stakeholders.
Unlike some other new accounting standards, IFRS 9 made no consequential amendments to IAS 34, ‘Interim financial reporting’, to bring in specific new interim disclosure requirements. So the key requirement for interim reports prepared under IAS 34 is the general requirement in paragraph 16(a) of IAS 34. This states that an entity should provide “a statement that the same accounting policies and methods of computation are followed in the interim financial statements as compared with the most recent annual financial statements or, if those policies or methods have been changed, a description of the nature and effect of the change” (emphasis added). Paragraph 6 of IAS 34 also states that the interim financial report is intended to provide an update on the latest complete set of annual financial statements and, accordingly, it focuses on new activities, events and circumstances.
In certain jurisdictions, there might also be local rules that need to be considered for interim reporting and/or a separate transition document. These could include listing rules, securities legislation or other regulatory requirements.
Given the lack of prescriptive requirements, judgement will be required by banks in designing disclosures for IAS 34 interim reporting and transition documents.
In assessing the appropriate extent of disclosure, a number of factors are likely to be relevant. In particular, regulators might have expectations on the extent and nature of disclosures that are considered appropriate. In addition, the extent of the disclosures should be proportionate to the impact of IFRS 9 adoption. For example, if the impact of adoption is not significant in monetary terms, or it is restricted to a small number of financial statement line items, extensive disclosure might not be warranted. When considering the appropriate extent of disclosure, the potential future impacts of IFRS 9 should be taken into account, as well as the impact at the time of adoption. The extent of disclosures expected of larger, more sophisticated banks is also likely to be greater than for smaller, simpler banks.
However, it would generally be expected that the IAS 34 requirements could be met by disclosing:
The April 2018 IASB update has been published and the work plan updated.
The topics, in order of discussion, were:
David Baur
Partner, Investor Reporting and Sustainability Platform Leader, PwC Switzerland
+41 58 792 25 37