IFRS First Impressions: Regulatory Deferral Accounts Interim relief for frst-time adopters of IFRS March 2014 kpmg.com/ifrs Contents Interim relief for frst-time adopters of IFRS 1 1 Key facts 2 2 How this could impact you 3 3 Introduction 4 4 Scope and objectives 5 4.1 Activities subject to rate regulation 5 4.2 Application restricted to frst-time adopters 6 4.3 Changes in accounting policy after transition 7 5 Core requirements 9 5.1 Grandfathering approach 9 5.2 Presentation requirements 10 5.3 Disclosure requirements 14 6 Application of other IFRSs 16 6.1 General approach 16 6.2 IAS 12 Income Taxes 17 6.3 IAS 33 Earnings per Share 18 6.4 IAS 36 Impairment of Assets 19 6.5 IFRS 3 Business Combinations 22 6.6 IFRS 5 Non-current Assets Held for Sale and Discontinued Operations 23 6.7 IFRS 10 Consolidated Financial Statements and IAS 28 Investments in Associates and Joint Ventures 25 6.8 IFRS 12 Disclosure of Interests in Other Entities 25 6.9 IFRS 1 First-time Adoption of International Financial Reporting Standards 26 About this publication 28 Content 28 Keeping you informed 28 Acknowledgements 30 Interim relief for frst-time adopters of IFRS On 30 January 2014, the IASB issued the frst specifc guidance on accounting for the effects of rate regulation under IFRS, with the publication of an interim standard – IFRS 14 Regulatory Deferral Accounts. For rate-regulated entities that have deferred transition to IFRS, particularly in Canada, the interim standard will come as welcome news. Accounting for rate-regulated activities has been hotly debated for many years, because – unlike guidance provided by some national accounting standard-setting bodies – IFRS has not previously contained specifc accounting requirements for such activities. This long-awaited guidance will ease the transition to IFRS for entities subject to rate regulation by permitting frst-time adopters to continue to account for regulatory deferral account balances using previous GAAP. This so-called ‘grandfathering approach’ is similar to the approach taken by the IASB for the insurance and extractive industries. Adoption of the interim standard is optional for those entities that are eligible to use it, but the decision to apply it has to be taken in an entity’s frst IFRS fnancial statements. As its application is restricted to frst-time adopters, existing IFRS preparers are not impacted by the interim standard; however, they are not prohibited from providing supplemental disclosures based on the interim standard’s requirements. To clearly show the effect of applying the interim standard, grandfathered regulatory deferral account balances have to be presented separately in the fnancial statements. These separate presentation requirements will help users to compare entities that elect to apply the interim standard with entities that already apply IFRS. The interim standard is effective for fnancial reporting periods beginning on or after 1 January 2016, although early adoption is permitted. It provides temporary guidance only, while the IASB completes its comprehensive project on accounting for rate-regulated activities. It remains unclear whether or when regulatory deferral account balances could be recognised under IFRS in the future – a question that the IASB is considering in its comprehensive project, which is unlikely to conclude for several years. For rate-regulated entities that have deferred transition to IFRS, the interim standard signals the time for action in implementing transition plans. We hope that this publication will assist you in gaining a greater understanding of the interim standard and its impact on the requirements of other standards. Phil Dowad, KPMG’s global IFRS revenue recognition and provisions leader KPMG International Standards Group © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 2 | First Impressions: Regulatory Deferral Accounts 1 Key facts ●● On 30 January 2014, the IASB published its interim standard IFRS 14 Regulatory Deferral Accounts. The interim standard provides temporary guidance for frst-time adopters of IFRS on accounting for regulatory deferral account balances, while the IASB completes its comprehensive project on rate-regulated activities. ●● The interim standard is effective for fnancial reporting periods beginning on or after 1 January 2016, with early adoption permitted. ●● An entity is only eligible to apply the interim standard if it: – is subject to oversight/approval from an authorised body (the rate regulator); – accounted for regulatory deferral account balances in its fnancial statements in accordance with the basis of accounting used immediately before adopting IFRS (previous GAAP); and – elects to apply the requirements of the interim standard in its frst IFRS fnancial statements. ●● Adoption of the interim standard is optional for eligible entities, but the decision to apply it has to be taken in an entity’s frst IFRS fnancial statements. ●● The interim standard permits an entity in its scope to continue to recognise and measure regulatory deferral account balances in accordance with its previous GAAP when it adopts IFRS – i.e. to apply a ‘grandfathering’ approach. ●● The grandfathering approach does not apply to presentation. The interim standard requires regulatory deferral account balances to be presented separately from assets, liabilities, income and expenses that are recognised in accordance with other IFRSs. ●● In applying the interim standard, an entity will also need to consider the interaction of regulatory deferral account balances with other IFRSs – for example: – income taxes relating to regulatory deferral account balances will be presented separately from income tax line items; – the presentation of earnings per share (EPS) will both include and exclude the net movement in the regulatory deferral account balances; – impairment testing in accordance with IAS 36 Impairment of Assets is not required for regulatory deferral account balances; however, IAS 36 applies to cash-generating units (CGUs) that include such balances; – an exception to IFRS 3 Business Combinations will apply for the recognition and measurement of an acquiree’s regulatory deferral account balances; – entities should apply consistent accounting policies in accordance with IFRS 10 Consolidated Financial Statements, which may result in the recognition on consolidation of regulatory deferral account balances that were not previously recognised by a subsidiary; and – additional disclosures under IFRS 12 Disclosure of Interests in Other Entities are required if an entity’s interests in other entities contain regulatory deferral account balances. ●● The interim standard includes disclosure requirements regarding the nature, risk and effects of rate regulation, to help users to understand the rate regulation to which the entity is subject. ●● An entity is permitted to change its accounting policy to discontinue recognition of regulatory deferral account balances subsequently; however, an entity is not permitted to begin recognising such balances after initial adoption of the interim standard. © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. First Impressions: Regulatory Deferral Accounts | 3 2 How this could impact you ●● Critical decision on frst-time adoption: On transition to IFRS, entities will need to decide whether to continue to account for regulatory deferral account balances. The decision made on transition has lasting implications, because it will not be possible for an entity to subsequently change its accounting policy to start accounting for regulatory deferral account balances. ●● Transition considerations: Entities planning to apply the interim standard will need to implement IFRS transition plans. They may need to upgrade accounting systems to ensure that records are maintained under IFRS, previous GAAP and any specifc requirements of the regulator. Staff training requirements, accounting policy elections and optional IFRS 1 First-time Adoption of International Financial Reporting Standards exemptions will also need to be evaluated. ●● Impact on application of other IFRSs: Although the interim standard will ease the transition to IFRS, entities may need to consider the interaction of regulatory deferral account balances with the application of other IFRSs. They will need to identify potential impacts of – or accounting adjustments required by – the exceptions, exemptions or other requirements in the interim standard. ●● Preparing for new presentation requirements: Entities will need to prepare for the new separate presentation requirements – for example: – ensuring that regulatory deferral account balances are separated from assets and liabilities that are recognised in accordance with other IFRSs; – considering any consequential impacts on segment information or key performance indicators; and – making changes to systems and processes. ●● Impact on fnancial ratios: Recognising regulatory deferral account balances and presenting them separately may affect an entity’s working capital ratios or other fnancial ratios. This may affect not only internal reporting requirements, but also compliance with, for example, debt covenants. ●● Additional disclosure requirements: Additional qualitative and quantitative disclosures may be required – e.g. the interim standard requires, for each type of rate-regulated activity, a reconciliation of the carrying amount of each class of regulatory deferral account balances at the beginning and end of the reporting period. Entities will need to assess whether their accounting systems are capable of generating the information required in a timely manner. © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 4 | First Impressions: Regulatory Deferral Accounts 3 Introduction The interim standard offers frst-time adopters relief from derecognising regulatory deferral account balances on transition to IFRS by permitting them to continue accounting for regulatory deferral account balances in accordance with their previous accounting policies. It is intended to minimise disruption, both for users and for preparers, when entities that have not yet adopted IFRS make the transition. However, to promote comparability of fnancial statements, the interim standard requires the separate presentation of these balances, as well as specifc disclosures. It also considers the interaction of other IFRSs with regulatory deferral account balances. For these purposes, a ‘regulatory deferral account balance’ is any expense (or income) account that: ●● is included or expected to be included by the rate regulator in establishing the rate(s) that can be charged to customers; and ●● would not otherwise be recognised as an asset or a liability under other IFRSs. The following diagram summarises how the key concepts of the interim standard are explained throughout this publication. The corresponding section numbers are in brackets. Scope and objectives (4) Core requirements (5) Grandfathering Presentation (5.2) Disclosures (5.3) approach (5.1) Application of other IFRSs (6) This publication addresses the interim standard, whose effective date is 1 January 2016. Early adoption is permitted, and an entity can therefore adopt the interim standard at the same time as it transitions to IFRS. © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. First Impressions: Regulatory Deferral Accounts | 5 4 Scope and objectives The following chart explains the scope of the interim standard. No Are the activities of the entity subject to rate regulation? Yes No Is the entity adopting IFRS and applying IFRS 1? Yes Did the entity account for regulatory deferral account balances in No accordance with its previous GAAP? Yes Entity may continue to account for regulatory deferral Interim standard account balances not applicable 4.1 Activities subject to rate regulation IFRS 14.5, B1 The interim standard applies only to activities that are subject to statutory or regulatory restrictions, through the actions of a rate regulator – i.e. rate regulation. IFRS 14.A Rate regulation is defned in the interim standard as “a framework for establishing the prices that can be charged to customers for goods or services and that framework is subject to oversight and/or approval by a rate regulator”. In this context, a rate regulator is “an authorised body that is empowered by statute or regulation to establish the rate or a range of rates that bind an entity”. Observations – Flexibility in pricing permitted IFRS 14.BC57 The defnitions of ‘rate regulation’ and ‘rate regulator’ permit pricing based on the rate or range of rates established or approved by an authorised body. Entities that have some fexibility in pricing are therefore not precluded from applying the interim standard. During redeliberations of the interim standard, the IASB acknowledged that price fexibility is a common feature of many rate-regulatory frameworks. For example, the rate regulator may: ●● set different prices for different groups of customers; ●● set a maximum price, but the entity can provide goods or services at a discount; or ●● set a range of permitted prices. If such fexibility is within clear restrictions established by the rate regulator, then activities subject to these types of rate-setting mechanisms are in the scope of the interim standard. IFRS 14.7, BC26–BC27 Amounts classifed as regulatory deferral account balances should not include any amounts that are permitted or required to be recognised in accordance with other IFRSs. In other words, regulatory deferral account balances should refect the differences that arise between regulatory accounting requirements and the accounting that would otherwise be required in the absence of the interim standard. IFRS 14.8 Application of the interim standard is optional but, if it is adopted, entities have to apply all of its requirements to all regulatory deferral account balances that arise from all of their rate-regulated activities. © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 6 | First Impressions: Regulatory Deferral Accounts Observations – Rate-regulated activities are either all-in or all-out The interim standard applies on an all-or-nothing basis, meaning that the decision to continue to recognise regulatory deferral account balances cannot be made at a balance-by-balance level. Entities are not able to cease recognition of only certain regulatory deferral account balances on transition, but can elect not to apply the interim standard as a whole. Self-regulation excluded from scope IFRS 14.B2, Activities that are self-regulated are generally not in the scope of the interim standard. For example, an BC22–BC24 entity with a dominant position in a market may decide to self-regulate to avoid external intervention. As there would be no formal rate regulator involved to ensure that a pricing framework is supported by statute or regulation, the oversight of these activities would not meet the defnition of rate regulation. However, entities that are regulated by their own governing body or a related party are eligible to apply the interim standard when: ●● the governing body establishes rates both in the interest of the customers and to ensure the overall fnancial viability of the entity within a specifed pricing framework; and ●● the framework is subject to oversight and/or approval by an authorised body that is empowered by statute or regulation. Observations – Scope restrictions IFRS 14.BC24, BC55 Cases in which an entity has been delegated regulatory power by the government and conducts previously state-run monopolistic activities are intended to be captured by the interim standard. In a similar way, a co-operative subject to some form of regulatory oversight to obtain preferential loans, tax relief or other incentives to maintain the supply of essential or near-essential goods or services falls in the scope of the interim standard. However, due to concern that the scope could be applied to commercial activities with monopolistic features, self-regulation is explicitly excluded from the scope of the interim standard and the rate regulator is required to be supported by statute or other formal regulation. 4.2 Application restricted to frst-time adopters IFRS 14.5, BC15 The interim standard is available only to entities that: ●● are frst-time adopters of IFRS; and ●● recognised amounts that qualify as regulatory deferral account balances in their fnancial statements in accordance with the basis of accounting used immediately before transition to IFRS (previous GAAP). IFRS 14.6 Adoption of the interim standard is optional for entities that are eligible to apply it, but the decision to apply it has to be taken in an entity’s frst IFRS fnancial statements. Entities transitioning to IFRS therefore need to evaluate whether to adopt the interim standard and therefore continue to account for regulatory deferral account balances in their opening IFRS statement of fnancial position. The interim standard permits entities to ‘continue to account for’ rather than ‘continue to recognise’ regulatory deferral account balances as there may be activities for which a regulatory balance did not © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. First Impressions: Regulatory Deferral Accounts | 7 exist immediately before transition, but for which the recognition of a balance arising in a future period would be consistent with the entity’s existing accounting policies (see 5.1.1). Observations – Decision whether to continue to account for regulatory deferral account balances In arriving at a decision whether to apply the interim standard, entities may want to consider various factors – for example: ●● how the interim standard may affect their transition to IFRS; ●● the fact that the guidance is only temporary, and the outcome and expected completion date of the comprehensive project are not known; ●● whether other entities in their jurisdiction intend to apply the interim standard; ●● the impact of discontinuing the recognition of regulatory deferral account balances – e.g. on fnancial ratios or other key performance indicators; ●● the capability of existing accounting systems to generate, in a timely manner, information required for additional qualitative and quantitative disclosures; and ●● the materiality of regulatory deferral account balances. Observations – Implications of transition to IFRS As the interim standard is only available to frst-time adopters, entities should also consider the impacts of adopting IFRS and actions needed to implement transition plans. For example, changes may be required to accounting systems and processes to ensure that records are maintained under IFRS, previous GAAP and any specifc requirements of the regulator. Staff training requirements, accounting policy elections and optional IFRS 1 exemptions will also need to be evaluated. 4.3 Changes in accounting policy after transition IFRS 14.13–15, BC33 An entity that recognises regulatory deferral account balances on transition to IFRS will subsequently be able to change its accounting policy to derecognise such balances, provided that the entity meets the criteria in IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors – i.e. the change would result in information that is more relevant and no less reliable, or more reliable and no less relevant to users. IFRS 14.BC34 However, a subsequent change in accounting policy to start recognising regulatory deferral account balances is not permitted. © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved. 8 | First Impressions: Regulatory Deferral Accounts The following chart summarises the position on subsequent changes in accounting policies. Entity electing Entity not electing to grandfather to grandfather Expand the range of regulatory deferral account balances to recognise û Reduce the range of regulatory deferral account balances to recognise û Derecognise all regulatory deferral account balances ü Start recognising regulatory deferral account balances û üAllowed û Prohibited Not applicable Observations – Changes in accounting policy restricted IFRS 14.BC33–BC35 Entities that do not currently recognise regulatory deferral account balances cannot apply the interim standard and start recognising such balances. In a similar way, entities applying the grandfathering approach are not permitted to recognise categories of regulatory deferral account balances that were not recognised in accordance with their previous GAAP. The IASB’s rationale for these restrictions is that starting to recognise such balances would not make the fnancial statements more reliable under the requirements of IAS 8, given that the policy may need to change again following completion of the comprehensive project. © 2014 KPMG IFRG Limited, a UK company, limited by guarantee. All rights reserved.