Diocesan Finance & Registrar s Conference July 2005 Michael Codling 1
Overview Background First time adoption Investment properties Property, Plant & Equipment Financial instruments main principles loans and receivables fair value hedge accounting derecognition Accounts format Questions Page 2 2
Background what is AIFRS? timetable for adoption: First full set of AIFRS account Opening AIFRS balance sheet Dec year end 31 December 2005 1 January 2004 June year end 30 June 2006 1 July 2004 AASB 1047 disclosures management of transition narrative explanation of key differences in accounting policies quantitative disclosure of all impacts known or reliably estimable Page 3 3
AASB 1 : First time adoption prepare an opening AIFRS balance sheet at date of transition adjustments at date of transition should be recognised directly in retained earnings (and few exemptions) AASB 132 and AASB 139 (ie financial instruments accounting) need not be applied to the comparative year only impacts current year date of transition is start of current year opening adjustments to retained earnings Page 4 4
AASB 140 : Investment properties definition normal entities not-for-profit entities measured at cost or fair value if select cost, need to depreciate unrealised gains/losses recognised in P&L fair value needs to be reconsidered each year end Page 5 5
AASB 116 (& AASB 5) : Property, Plant & Equipment (PP&E) PP&E can be measured at cost or fair value at transition date, the Diocese may elect to measure PP&E at either cost deemed cost fair value revaluation reserve used for unrealised gains/losses in a similar fashion to existing AGAAP not-for-profit entities can offset revaluation increases and decreases across a class of assets frequency of revaluation depends on type of asset (from annually to every 5 years) PP&E held for sale carried at lower of carrying value; and fair value less costs to sell Page 6 6
Question 1 Background A Diocese bought a machine for $30,000 on 1 January 20X4. The machine s useful life is 10 years and it is estimated to have zero residual value. The revalued amount of the machine was $36,000, $34,000 and $31,000 on 31 December 20X4, 20X5 and 20X6 respectively. Assume the Diocese is exempt from income tax. Questions Does management need to depreciate property, plant and equipment carried at revalued amount, since the revalued amount reflects the fair value of the property, plant and equipment? If yes, how should the depreciation be calculated? Page 7 7
AASB 136 : Impairment applies to non-financial assets, except those subject to specific valuation rules (eg investment properties, PP&E at fair value, non-current assets held for sale) such assets cannot be carried in excess of their recoverable amount any write down (impairment loss) to be recognised immediately in P&L recoverable amount is the higher of : (a) fair value less costs to sell; and (b) value in use for not-for-profit entities, value in use is the depreciated replacement cost additional income volatility expected by normal entities because: must discount future cash flows cannot group assets at a high level Page 8 8
AASB 139 : Financial instruments Summary: more financial assets (including all derivatives) at fair value more changes in value to P&L different method for calculating interest income criteria for determining the provision for doubtful debts strict criteria for hedge accounting new (and complex) derecognition rules Page 9 9
Financial instruments definition : any contract that gives rise to both a financial asset of one entity and a financial liability or equity of another entity examples : cash and deposits trade receivables loans listed and unlisted debt investments listed and unlisted equity investments derivatives (eg swaps, forwards, options) trade payables and accruals borrowings bonds and notes issued Page 10 10
Recognition and Measurement main principles Financial assets and financial liabilities to be initially measured at fair value with transaction costs to be included in the initial carrying value Subsequent measurement depends on classification: Asset category Held to maturity Loans and receivables Available for sale At fair value through P&L Remeasurement Amortised cost Amortised cost Fair value Fair value Changes in carrying amount P/L* P/L * Equity & recycle to P/L P/L * Impairment charges Page 11 11
Loans and receivables carried at amortised cost, using the effective interest method cost includes transaction costs less any fees charged to the borrower for the loan establishment income recognised at the effective interest rate (EIR), ie the rate that discounts estimated future cash payments or receipts through the expected life of the loan to its net carrying amount net transaction costs are smoothly brought to P&L over the life of the loan, and recognised as part of interest income Page 12 12
Question 2 Background A Diocese pays a broker $2,500 for sourcing a small business which needs to borrow $100,000. The Diocese lends the $100,000 at a fixed rate of 10% for 5 years, and collects an upfront establishment fee of $585 from the small business. Questions What is the carrying value of the loan on the balance sheet of the Diocese at Day 1? What is the effective interest rate and the carrying value of the loan at the end of each year? Page 13 13
Provision for doubtful debts When to provide against doubtful debts? objective evidence of impairment (OEI) is required How to provide against doubtful debts? Step 1: specific identified doubtful debts use discounted cash flows Step 2: remaining group of loans/debtors separate into similar credit risk profiles (eg by product; by risk grade; delinquency status 30,60,90 days past due) must be evidence that there has been a measurable decrease in future cash flows apply collection rates based on past history where OEI historical collection rates may be adjusted for current conditions Page 14 14
Question 3 Background A Diocese has the following debtors ageing profile at year end Debtor Current >60 days Total Provision Painful P/L 150,000-150,000 75,000 Other 200,000 200,000 400,000 20,000 Total 350,000 200,000 550,000 95,000 The Diocese s most significant customer is Painful P/L and market analysts forecast that Painful s performance will deteriorate over the coming months. On this basis, the Diocese thinks it would be prudent to provide for approximately 50% of the outstanding balance. The Diocese also carries $400,000 of other debtors, $200,000 of which is aged over 60 days. History shows that approximately 10% of balances over 60 days are written off as bad debts. As at 30 June 2006, the Diocese should recognise a provision for doubtful debts for $95,000. Question: True or False? Page 15 Answer Question 4: Impairment loss under AASB 139: Answer is FALSE. As at 31 July 2005, All2Hard recognises a provision for doubtful debt to the amount of $20,000, being 10% of the $200,000 debtor balances over 60 days. As the company has experienced losses previously in relation to over 60 days balances, a provision for loss is allowable to the percentage of losses previously experienced. Therefore, 10% of the $200,000 balances over 60 days is recognisable as provision for doubtful debt. However, no provision should be raised for the $150,000 owing from 2Easy. The market has only made a forecast for 2Easy s performance to deteriorate. This has not yet occurred. Therefore, even though All2Hard expects for there to be losses made by 2Easy, the events have not yet occurred. The amount of debtor cannot be recognised as doubtful debts unless there is other objective evidence of impairment. Technical support: AASB 139.58: An entity shall assess at each reporting date whether there is any objective evidence that a financial asset or group of financial assets is impaired. AASB 139.59: An impairment loss is recognised only if there is objective evidence of impairment resulting from one or more events occurring after the initial recognition (ie cannot recognise a provision on Day 1 of recognising the debt). In addition, the event must be based on current observable data and have a reliably measurable impact on the recoverable amount of the loan. Losses expected as a result of future events, no matter how likely, are not recognised. 15
Fair value of financial instruments active market assets quoted bid price liability quoted asking price no active market use a valuation technique recent arms length market transactions discounted cash flow analysis option pricing models Page 16 16
Hedge accounting not all transactions that mitigate risk can be accounted for using hedge accounting strict criteria must be satisfied in order to apply hedge accounting. Some of the key criteria include: formal documentation of the hedging policy clearly defined hedge relationship reliably measurable expected and actually effective hedges can be one of two things (usually): fair value hedge cash flow hedge Page 17 17
Accounting for a fair value hedge example (assuming 100% effectiveness) Assets Balance Sheet Dec 31, 2005 Liabilities Derivative asset - IRS Borrowing Initial Fair Value (FV) 0 Initial carrying amount 10,000 FV movement 300 Adjustment carrying amount 300 Actual FV 300 Actual carrying amount 10,300 Expense Income Statement 2005 Revenue FV risk hedged (bond) 300 FV movement (IRS) 300 Total 300 Total 300 Page 18 18
Accounting for a cash flow hedge example (assuming 100% effectiveness) Assets Balance Sheet Dec 31, 2005 Liabilities Derivative asset - FX Fwd Equity - Fair Value Reserve (OCI) Initial Fair Value (FV) 0 Opening balance 4,000 FV movement 200 FV movement 200 Actual FV 200 Closing balance 4,200 Expense Income Statement 2005 Revenue Sales - anticipated / hedged 0 (Not yet recognised) Page 19 19
Derecognition Risks and rewards mostly transferred? Yes Derecognise No Risks and rewards mostly retained? Yes Continue to recognise asset No Control of asset retained? No Yes Recognise to extent of continuing involvement Derecognise Page 20 AASB 139 also includes rules on de-recognition of financial assets. So for debt factoring or securitisation the question is whether the receivables should be removed from the balance sheet? In the latest version of these rules and special purpose entities are first consolidated before you consider whether to derecognise the assets. Under these rules there are 3 main considerations: Firstly A financial asset is derecognised when the rights to the cash flows and substantially all the risks and rewards of ownership are transferred. In this case the asset is treated as if it were sold. If substantially all of the risks and rewards of the asset are retained the asset will continue to be recognised and the cash received will be treated as a collateralised borrowing. As this is the most common scenario we will look at an example to illustrate. If the risks and rewards are more evenly split but the company retains control of the asset, the asset is recognised to the extent of the company s interest in the asset. And finally, where the risks and rewards are more evenly split between the two parties, but control of the asset is transferred the asset is derecognised. 20
Accounts format Statement of Financial Performance Income Statement Statement of Financial Position Balance Sheet Statement of Changes in Equity (new) Net gain/loss on disposal of non-current assets Financial risk management disclosures Key management judgements and assumptions disclosures AGAAP Financial Instruments note gone information incorporated in individual notes Transition disclosures Review of Model financial statements Page 21 21
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