ADAA IFRS Digest

Compendium 2016

Highlights

January 2016 The world will be just fine. The impact of the new lease standard from IASB member Gary Kabureck. Once again, the IASB adjourn. Mandated adjustments are put on hold. Ethical considerations relating to audit fee setting in the context of downward fee pressure. Those Charged with Governance must deal with the intimidation threat. Rotating your auditor. Some things to think about. Year-end accounting reminders. Regulatory interest and key reminders for impairment reviews. Dynamite from the IAASB. A focus on professional skepticism, quality control and group audits. Hans accounting wisdom. Hans Hoogervorst, IASB Chairman, states: “Best thing the IASB can do is to distribute unhappiness as evenly as possible around the world.” IFRS in practice. BDO 2015 publications. USA and IFRS. How the world’s largest economy positions IFRS. And on the back page addressing Why ethics are important? – an insight from ADAA’s Mahmoud Shahin. February 2016 Why change lease accounting?

For many years we have been told that lease accounting does not meet investors’ needs.

85% of all leases are estimated to be off balance sheet. That is USD 3 trillion!

EBIT, EBITDA, and Profit are all affected because operating lease accounting front loads profit recognition compared to finance lease accounting.

Liabilities brought on the balance sheet.

Assessing if sale and lease back of an asset is a sale now falls into IFRS 15 Revenue. The seller-lessee recognises only the amount of gain or loss that relates to the rights transferred to the buyer, and only if the transaction is at fair value.

What are the benefits of the new standard? And how will the standard be received? And on the back page. Lease accounting - an insight from ADAA’s Muhammad Shabbir March 2016 From incurred to expected - not a blissful journey. The birth of IFRS 9 is a response to the financial crisis of 2008. Read more in this holistic coverage of the financial instruments standard development. Revising audit committees’ role. The frontline in combating the risk of fraud. The discounted contribution of audit committees. The EU’s approach in revitalizing audit committees. Effective implementation. The IFRS curriculum. The future of audit, hence, regulation. PCAOB’s director of professional standards commented: “We wouldn’t want auditing standards to be an inhibitor that might otherwise allow technological audit achievements to move ahead.”

And on the back page On the Regulator’s agenda - an insight from ADAA’s Khulood Al Reyami. April 2016 Shining the light on leases. “USD 3.3 trillion worth of leases are off balance sheet.” This cannot be right! Materiality. Responding to market calls for greater coherence, consistency and comparability. Key valuation considerations given current market volatility. What do you need to know? In pursuit of perfect disclosures. Transforming the dream into reality. Why all the fuss about accounting? The answer is transparency. CORE & MORE. FEE is convinced that the growing difference between the market capitalization and net asset value of leading global corporates represents a key rationale for change. And on the back page Revenue. Leasing. Financial Instruments. An insight from ADAA’s Ahmed El Meleegy. May 2016 IFRIC Update from the IFRS Interpretations Committee (IFRIC). IASB Staff Webcast IFRS 16: Exemptions. IFRS in Focus. In China the rate of growth slowed, stock markets dropped, volatility became the new risk. In the US growth was strong, the EU is recovering but Brexit poses a risk, and in the ME we have low oil prices to consider. IASB April Update. The sting is always in the tail! Accounting for common control transactions. Goodwill and impairment. Change in Accounting policy. In the Spotlight impact of IFRS 16 – Airlines. The new standard will change the accounting for lease transactions and

has significant business implications. And on the back page, deciphering the mystery of perfect disclosures - an insight from ADAA’s Muhammad Shabbir. June 2016 Where does it say in the standard I can’t do this? IFRS Foundation and IOSCO answer the question! IAS 40 – Investment Property to be amended to emphasise how the asset is used and if a change in use has occurred. IAASB comparison report differences between Critical Audit Matters (CAM) required by the PCAOB and Key Audit Matters (KAM) required by the IAASB. Investors vs CEOs the definition of business success is changing. We have to give the investor more tools to decide whether a company is a George Clooney or the Hunchback of Notre Dame? IASB Chair gets emotional! Materiality judgements when preparing a financial report. The IASB staff’s four step approach. The Basel Committee Guidance on credit risk and accounting for expected credit losses. And on the back page Common control transactions an insight from ADAA’s Hasina Aladawi. September 2016 The future of IFRS - Better Communication, Improved Quality and Implementation Support. Hans’ message is very clear. Have you mastered IFRS? Here is a chance to prove it. Difficulties in translating IFRS. Produce an odd twist. Need help with that judgement. Why did Sir David Tweedie publish this guide? Islamic Finance, the future of banking? With its ever-growing popularity some argue this is the future of banking. Integrated Reporting. From the IIRC, IAAER and ACCA. A responsible story? Growing mass of data requiring filters and attesting. And on the back page Earnings management – an insight from ADAA’s Mahmoud Shahin October 2016 New Auditor’s Report. Will it make any difference? ISA 701 published earlier this year requires the auditor to provide a commentary in the audit report of the Key Audit Matters (KAM) they considered in completing their audit. Krispy Kreme. Everyone loves a doughnut. Floated in April 2000, two years later the stock was up 235% from its IPO price. Never missed a forecast. March 2009 SEC issued cease and desist findings unfortunately there was a problem. Audit quality study. A simple subject really. When earnings management becomes cooking the books. The line between legitimate and inappropriate accounting techniques can be a blurry one. And on the back page Revenue and lease accounting – an insight from ADAA’s Hasina Al Adawi November 2016 You wouldn’t buy fake Christian Louboutin shoes would you? Inconsistent application of IFRS damages the brand. IFRS Trustees speak out. From accountant to Olympic gold. A courageous leap. ASB Japan study on goodwill and impairment. What’s material and what’s not? Are we expecting a materiality standard to be issued soon? Service Concession accounting. Guidance to reduce diversity in practice. Disclosure checklists and illustrative financial statements. Guidance in preparing financial statements. The Ewings of Dallas had nothing on the Antars of Brooklyn. You couldn’t make this stuff up. Finally on the back page Professional judgment – an insight from ADAA’s Sara Al Sajwani. December 2016 At the end of the day, you manage correctly what you measure correctly. Every now and then a few little nuggets of sense appear. We focus on Haans’ last three speeches. Beware of Value in Use. Valuations is a hot topic for the regulators at IFIAR. IFRS 15 time is running out. Regulators are requesting transparency on the impact of implementing IFRS 15. The IFRS 15 Mole. This month’s suspect is unidentified contracts. On the back page - The disclosure conundrum an insight from ADAA’s Syed Shabbir.

IFRS news, updates from ADAA, IASB and the Accounting Profession January 2016

WHAT’S NEW FROM THE IASB?

The world will be just fine. The impact of the new lease standard from IASB member Gary Kabureck. Once again, the IASB adjourn. Mandated adjustments put on hold. Ethical considerations relating to audit fee setting in the context of downward fee pressure. Those Charged with Governance must deal with the intimidation threat. Rotating your auditor. Some things to think about. Year-end accounting reminders. Regulatory interest and key reminders for impairment reviews.

Dynamite from the IAASB. A focus on professional skepticism, quality control and group audits. Hans accounting wisdom. Hans Hoogervorst, IASB Chairman, stated that: “Best thing the IASB can do is to distribute unhappiness as evenly as possible around the world?” IFRS in practice. BDO 2015 publications. USA and IFRS. How the world’s largest economy positions IFRS? And on the back page addressing Why ethics are important? – an insight from ADAA’s Mahmoud Shahin.

The world will be just fine. The decade long endeavor of IASB and FASB is over. The new lease standard may not be effective until 1 January 2019 but IAS 8.30 requires disclosure of “known or reasonably estimable information relevant to assessing the possible impact that application of the new IFRS will have on an entity’s financial statements in the period of initial application.” So if you are preparing your 2015 financial statements, the new lease standard is in scope! More here. Once again, the IASB adjourn. Narrow-scope amendments to IFRS 10 and IAS 28, postponed. Click here to understand. Ethical considerations relating to audit fee setting in the context of downward fee pressure. The IESBA reminds the accounting profession of the self-interest threat to professional competence and due care. IESBA warns auditors to perform high quality audits regardless of the audit fee. IESBA highlights the critical roles of timing and staffing, and cautions against discounting them. Click here to read the complete publication.

Dynamite from the IAASB. A focus on professional skepticism, quality control, and group audits. Not for a long time has a wide ranging debate been held. This PIOB throws down the gauntlet. “Professional skepticism should govern the performance of auditors and inspire the attitude of other accountants. When accountants (practitioners, non-practitioners, accountants in business) do not display proper professional skepticism it is recognised as a barrier to effective performance.” The IAASB is revisiting and examining the concepts underlying audit quality and they are inviting your opinion. Click here to view the publications. Hans accounting wisdom. Hans speeches are a must read, they provide direction on what the issues are. Points to note:

IFRS 15 is a strongly principled and sufficiently guided standard which evidences the reconciliation of rules and principles cultures.

The leasing standard will mark the New Year.

Accounting language has evolved from multilingual to bilingual. Financial statements needs to be trusted. Disclosures must be free of boilerplate. Click here for the full text.

Rotating your auditor. Some things to think about. IFAC posts an academic study on auditor rotation that concludes the benefits of rotation might not be what they seem. The IESBA code of ethics mandates rotation of the audit partner. This new study concludes in a long-term relationship auditors gain confidence in assessing the truth or falsity of their client’s claims. So when they are assessing if the client’s claims are true or false they can find plenty of psychological evidence to prove it. Rotating auditors are thus at a disadvantage. True or not we don’t know, but we may find out. Click here to understand the rationale driving these conclusions. Year-end accounting reminders. Regulatory interest and key reminders for impairment reviews. Disclosure of significant judgements and assumptions in determining control. Presentation and classification mistakes in cash flow statements. PWC In its IFRS Quarterly Update, offers a synopsis of reporting requirements for your 2015 financial statements.

IFRS in practice. Excellent publications from BDO explain the practical application of new and old standards. Highlights of 2015 are transitioning to IFRS 15, and applying IAS 19. More here. USA and IFRS. The SEC chief accountant spoke at the AICPA National Conference; “In the near term, I encourage the FASB and IASB to continue to focus on converging the financial accounting standards. In my view, continued collaboration is the only realistic path to further the objective of a single set of high-quality, global accounting standards…The transition from a reporting model that currently consists of industry specific and at times disparate models, to a single comprehensive model grounded in core concepts and clear principles is a shift that has the potential to benefit investors by providing more decision useful information.” The SEC deputy chief accountant discussed in her speech the shared origins, knowledge, benefits, and perspectives between IFRS and US GAAP. Click here to view SEC’s representatives’ views on the relationship between US GAAP and IFRS, and the future of conversion.

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ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting Profession January 2016

Why ethics are important - an insight from ADAA’s Mahmoud Shahin

Ethics Perhaps an odd choice of topic for a back page article you might surmise? The Association of Certified Fraud Examiners considers that occupational fraud continues to be a global problem and estimates a typical organisation loses up to 5% of its total revenue to fraud. Fraud is of course a criminal act, and an intentional one. Contrary to the CFO of Enron’s belief that he did not realize at the time what he was doing was wrong, it is not possible to commit fraud by accident. He thought he was correctly using creative accounting to keep losses from the accounts. In fact he was defrauding the shareholders by applying an unethical business practice. So when does ethical become unethical? Where is the line in the sand? How do you protect yourself? The International Federation of Accountants (IFAC) to which all professional accountants’ member bodies are signed up has a dedicated and separate International Ethics Standards Board for Accountants. (IESBA). They set the standards. Ethics - What Are they? The IESBA characterizes ethics into Business Ethics and Practice Ethics. ADAA Subject Entities need to consider Business Ethics for themselves and Practice Ethics for their Statutory Auditors. Business Ethics applies to all aspects of an organisations practices, its people and its interactions with customers and suppliers. It covers issues such as career progression and gender equality and is often partly dealt with by a Code of Conduct. Practice Ethics apply specifically to the Statutory Audit Firms and are crucial to the trust placed by stakeholders in relying on the services provided by them. Practice Ethics deal with how the Audit Firm and its partners and employees operate. So if you are a Professional Accountant in a Subject Entity can you ignore Practice Ethics? Well you could. But is not knowing a supplier is transacting with you unethically a plausible defence? Access to both business ethics and practice ethics is free and is provided in the IFAC IESBA Code of Ethics. Ethics – What do you need to know? The first duty of the Professional accountant in business is not to their employer but to protect the Public. This is seemingly obvious for Public Sector Entities but perhaps less so for others. The IESBA Code states: “A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest.” 320.1 “Professional accountants in business are often involved in the preparation and reporting of information that may be either made public or used by others inside or outside the employing organization. Such information may include financial or management information, for example, forecasts and budgets, financial statements, management's discussion and analysis (MD&A), and the management letter of representation provided to the auditors during the audit of the entity's financial statements. A professional accountant in business shall prepare or present such information fairly, honestly and in accordance with relevant professional standards so that the information will be understood in its context.”

Take a fresh look at your internal budgets. Are you being realistic or are you challenging too hard? Reconsider your assumptions underpinning your forecast, are they supported by market derived evidence? Is your MD&A balanced or have you focused only on the good news? If not, why not? Investors are just as capable to demonstrate irrational exuberance as they are to apathy. Is the management representation letter standard, or are there matters in there that question the quality of the audit evidence, or the quality of the accounting? 320.2 “A professional accountant in business who has responsibility for the preparation or approval of the general purpose financial statements of an employing organization shall be satisfied that those financial statements are presented in accordance with the applicable financial reporting standards." IAS 1 contains a true and fair override. The IFRS Framework defines an asset as “a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.” Sir David Tweedie once said “One day I want to fly in an aircraft that is actually on an Airline’s balance sheet.” Finally his wish is about to come true. But, should it really have taken a new accounting standard to achieve it? Is it not evident to passengers the Airline controls the airplane and receives the proceeds of ticket sales and an operating lease just a financial instrument? The collapse of Lehman Brothers led to the financial crisis of 2008. Lehman was indulging in what is known as Repo 105. An accounting practice signed off by a UK Audit Firm on which it had taken legal advice. That a legal opinion was sought should have sent the ethical alarm bells ringing. Repo 105 was just window dressing. Transactions undertaken to improve the balance sheet at the reporting date, which were unwound shortly after. It covered up a problem. But it didn’t deal with it. So was it ethical? Some window dressing practices might be considered ethical by some. For example locking up the cheque book at the year end to improve reporting of cash. If you think it is ethical, ask your supplier what they think? I’m sure they will disagree. Did your ‘cash generated from operating activities’ change? No it didn’t. So business performance didn’t change. So why did you do it? Were you trying to mislead a user of your financial statements? That’s unethical. Pushing the envelope. Financial engineering. Transaction structuring. Creative accounting. Rainy day provisions. Are these ethical? When does ethical become unethical? When the financial position is misstated. It doesn’t even have to be material. One unethical apple tarnishes the barrel. For the accounting profession, Ethics is a key concern due to the corporate scandals that have taken place in the world (Toshiba in 2015 the latest) questioning the credibility of our profession. These scandals place in doubt the effectiveness of contemporary accounting and auditing practices. Competence in ethics has become an essential component of being a professional accountant.

IFRS news, updates from ADAA, IASB and the Accounting Profession February 2016

WHAT’S NEW FROM THE IASB?

Why change lease accounting?

For many years we are told lease accounting does not meet investors’ needs.

85% of all leases are estimated to be off balance sheet. That is USD 3 trillion!

EBIT, EBITDA, and Profit all affected because operating lease accounting front loads profit recognition compared to finance lease accounting.

Liabilities brought on the balance sheet.

Assessing if the sale and lease back of an asset is a sale now falls into IFRS 15 Revenue (which is a controls based standard). The seller-lessee recognises only the amount of gain or loss that relates to the rights transferred to the buyer, and only if the transaction is at fair value.

What are the benefits of the new standard? And how will the standard be received?

And on the back page. Lease accounting - an insight from ADAA’s Muhammad Shabbir.

For many years we are told lease accounting does not meet investors’ needs. Writes Sue Lloyd, member of the IASB in Investor Perspectives. Because the accounting when applying IAS 17, depended on whether the lease qualified as an operating lease or a finance lease in the financial statements of lessees, some leases would end up on balance sheet whilst most would only result in rent expense. Which was an odd result, since IAS 17 was written to bring assets leased in finance arrangements on the balance sheet not keep them off. 85% of all leases are estimated to be off the lessee’s balance sheet. That is USD 3 trillion. In 2002 Sir David made his infamous plane quote. In 2005 the US SEC expressed concerns at the lack of transparency of information about lease liabilities. Investors adjust financial statements to recognise estimated assets and liabilities arising from off balance sheet leases, and adjust EBIT, EBITDA and interest costs. EBIT, EBITDA, and Profit all affected because operating lease accounting front loads profit recognition compared to finance lease accounting. AASD modelled the impact of arbitraging between operating and finance lease. Higher interest costs in the earlier years has a negative impact on profits. The press

release captures the journey of IFRS 16. Project summary.

Liabilities brought on the balance sheet. IFRS 16.BC.28 “The lessee controls the use of the underlying asset during the lease term and has an obligation to return the underlying asset at the end of the lease term. That obligation is a present obligation that arises from past events. (The underlying asset being made available for use by the lessee under the terms of the arrangement).” If you have a liability, you must a leased asset. Click here to view the webinar. Assessing if the sale and lease back of an asset is a sale now falls into IFRS 15 Revenue (which is a controls based standard). The problem with IAS 17 was it focused on risks and rewards and if you had the asset for 70% of its useful life or made lease payments of more than 90% of the fair value of the asset, then you clearly (probably) had a finance lease. But if 69% and 89% it became an operating lease! Really? What happened to the 51% test? Hans Hoogervorst: “These new accounting requirements bring lease accounting into the 21st century, ending the guesswork involved when calculating a company’s often-substantial lease obligations.” Click here for IASB’s Fact Sheet. What are the benefits of the new standard? And how will the standard be received? A couple of things that Mr. Hoogervorst was certain of are the standard’s facilitation of better capital allocation and management decisions, and the continuation of the leasing business. Click here to view the video.

Big 4 impression. Deloitte interviewed Hans, and Deloitte’s Global IFRS Leader. Auditor’s concerns are the Profit and Loss changes including the resulting KPI differences, definition of a lease, and the short or low value exception clause in the standard’s scope.

Alongside this recording, Deloitte offers a summary of the effects of IFRS 16 on the Aviation, Property Occupiers, and Telecommunications industries.

Deloitte’s IFRS in Focus coverage of leases includes decision maps and observations reflecting the rationale mandating the changes in the accounting model.

After 30 years, change ought to shock the constituents. Each of the big audit firms contributed publicly to the new leasing standard by discussing the changes in measurement, presentation, financial analysis, and disclosures. While doing so, some offered their own observations and insights on the future outcomes.

PWC provided a detailed publication In depth issue.

BDO and EY in their IFR Bulletin and IFRS Developments.

FASB’s view. FASB’s answers to the pressing questions around the new Leases standard are covered in their Leasing Project page.

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ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting Profession February 2016

Lease accounting - An insight from ADAA’s Muhammad Shabbir

Far-reaching is an understatement. A sample of 1,022 listed companies using IFRS or US GAAP disclosed USD 3 trillion of off balance sheet lease commitments in 2014. An IASB survey concluded long-term liabilities of the heaviest users of off balance sheet leases is understated by 27% in the African and Middle East region, 26% Europe, 22% America, 32% Asia/Pacific and a whopping 45% in Latin America! Action required now for 2015 financial statements. Do not be fooled by IFRS 16’s implementation date of 1 January 2019. When a new IFRS has been issued but is not yet effective, IAS 8.30 requires disclosure of known, or reasonably estimable information, relevant to assessing the possible impact that application of the new IFRS will have on the entity's financial statements in the period of initial application. A statement such as “Management is in the process of preparing a detailed analysis” does not tick the box on IAS 8, adds no value to a user of your financial statements, highlights a deficiency of understanding in the Finance department and is quite probably, not acceptable to your Statutory Auditor or Regulator. Financial analysts have been making adjustments for operating leases to treat them as finance leases for years so it really is not possible that you do not know what the impact of IFRS 16 on your existing leasing arrangements will be. ADAA expects to see comprehensive disclosure (qualitatively and quantitatively) which addresses the requirements of IAS 8 in current year reporting. How did we get here? In 2002 Sir David Tweedie, the then Chairman of the IASB, gave a speech to the Australian accounting setters that included his famous wish (pwc.blog). Eight years later an exposure draft was published. Six years later we have a new accounting standard. To say the process has been prolonged is an understatement! Over 1700 comment letters, two exposure drafts, the process of exposition, discussion, deliberation and redeliberation has been exhausting but finally despite all the naysayers, despite all the opposition, new IAS 17 is here, or more precisely IFRS 16 is. And despite suggestion of conspiracy theorists that the IASB has been influenced more by feedback from preparers than from users, the end product achieves its desired aim of bringing operating leases onto not one, but two, balance sheets, (lessee and lessor) and not just under IFRS but under US GAAP too!! What is the old accounting? IAS 17 required leases to be classified as finance leases (which transfer substantially all the risks and rewards of ownership from lessor to lessee) and operating leases (which didn’t). Finance leases were recorded on the lessee’s balance sheet, operating leases were not. Operating leases were supposed to be on the lessor’s balance sheet but if you look into the financial statements of many SPVs in the Cayman Islands you will see that they are not on the lessors (consolidated) balance sheet either. What is the new accounting? It seems unbelievable the accounting profession deceived itself for so long. IAS 37.2 (1988) defined a liability as a present obligation arising from a past event. The IFRS Framework (1989) paragraph 22 Accrual basis stated that transactions are reported when they occur (and not as cash or its equivalent are received or paid). IFRS 16. BC105 defines a lease on the basis of whether a customer controls the use of an asset for a period of time, which may be determined by a defined amount of use.

Accordingly, IFRS 16 eliminates the IAS 17 discredited classifications (for lessees) as operating or finance leases and, introduces a single accounting model. Applying that model, a lessee is required to recognize: (a) assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value; and (b) depreciate the lease assets and record interest on the lease liabilities. What is the impact on your financial statements? Balance Sheet. Generally speaking, balance sheets for companies with operating leases will get bigger as they will now have to record these assets, but because they also include the liability they will show more financial leverage. The carrying amount of lease assets will typically reduce more quickly than the carrying amount of lease liabilities. This will result in a reduction in reported equity compared to IAS 17 for companies with material off balance sheet leases. Income Statement. Total lease expense will be front-loaded even though cash payments are constant. This is now accruals accounting. Key financial ratios. Gearing ratios are likely to go up whereas interest cover and asset turnover will go down.

Profit / loss Balance sheet Ratios

Upwards ↑ EBITDA Total assets Gearing

Downwards ↓

EPS (in early years)

Net assets Interest cover, asset turnover

Does IFRS 16 apply to service contracts? No it does not change the accounting for services. Although leases and services are often combined in a single contract, amounts related to services are not required to be reported on the balance sheet. IFRS 16 is required to be applied only to leases, or lease components of a service contract. Accounting for leases in the financial statements of lessor. IFRS 16 substantially carries forward the lessor accounting requirements in IAS 17. Accordingly, a lessor continues to classify its leases as operating leases or finance leases, and to account for those two types of leases differently. This is because the lessor accounting model in IAS 17 was never ‘broken.’ Anything else? The notion of contingent rent is gone. In substance fixed leased payments, including payments that must be made only if an asset is proven to be capable of operating, must be included in the assessed financial liability (and related leased asset). IFRS 16.B42. If there is no transfer of ownership of the leased asset to the lessee by the end of the lease term, or no purchase option. The asset is depreciated from the lease commencement date to the earlier of the end of the useful life of the right of use asset or the end of lease term. Concluding thought. IFRS 16, if applicable to you, will bring significant changes to your financial statements. It has been issued with a huge amount of guidance and 24 accompanying examples. And although the examples are not intended to be guidance, example 7 will clearly be Sir David’s favourite! We rather like that one, and example 9C. The accounting firms have been busy – they need to be as a key favorite of Structuring Services just disappeared. Comprehensive, technical and industry specific guidance is available in the links below. Publication links: KPMG Deloitte EY PwC. A 6 minute short Debrief video by the IASB Chair and the web link for IASB lease project page.

IFRS news, updates from ADAA, IASB and the Accounting Profession March 2016

WHAT’S NEW FROM THE IASB?

From incurred to expected - not a blissful journey. The birth of IFRS 9 is a response to the financial crisis of 2008. Read more in this holistic coverage of the financial instruments standard development. Revising audit committees’ role. The frontline in combating the risk of fraud. The discounted contribution of audit committees. The EU’s approach in revitalizing audit committees.

Effective implementation. The IFRS curriculum. The future of audit, hence, regulation. PCAOB’s director of professional standards commented: “We wouldn’t want auditing standards to be an inhibitor that might otherwise allow technological audit achievements to move ahead.”

And on the back page On the Regulator’s agenda - an insight from ADAA’s Khulood Alreyami.

From incurred to expected - not a blissful journey. Eight years on from the financial crisis of 2008, renewed interest is shown in the impairment model introduced by IFRS 9 in 2014. However, enthusiasm seems not to be shared by the IFRS reporting community. Despite it being eight years since it was first muted and two years since publication, little seems to be known of the impact of the new expected loss model. The effective date of IFRS 9 is 1 January 2018. IAS 8.30 requires disclosure of known or reasonably estimable information, relevant to assessing the possible impact that application of a new IFRS will have. There is a complexity get out clause. So if you don’t know the impact you can say you don’t know. And the reality is many financial institutions are using this get out, disclosing “Management is in the process of preparing a detailed analysis”. Sue Lloyd in her debrief of IFRS 9 suggests the long lead time is due to required system changes to capture the data to reflect the correct accounting. The old expected loss model was designed to limit the ability to create hidden reserves that could be used to manage earnings growth, potentially misleading investors. The reality was that it reduced provisions to such an extent that when the financial shock happened some banks didn’t have enough reserves to survive.

In his speech at the Asia-Oceania Regional Policy Forum, the IASB Chair accepts standards must be improved when they can be and the standard has been changed, not just in the provisioning model, a risk adjustment must be made now when mark-to-model valuations are used. Hans clearly believes preparers and auditors of financial information have a duty to present information fairly and in a way that can be understood, within the economic environment that exists. IFRS 9 impacts the auditors too: ISA 540, Auditing Accounting Estimates is being revised. The project was initiated by a publication exploring the audit challenges anticipated with the application of IFRS 9. Deloitte’s IFRS 9 readiness survey concludes some entities will require three years to implement IFRS 9, and some may not be ready in time. The IFRS community seems to believe the new provisioning model requires significant changes to current systems and processes to capture new data. But isn’t this the wrong way round? Should accounting standards drive how businesses are run, or should they reflect how business are run? If new data is required, what does that say… Effective implementation. To promote consistent application of IFRS, the IFRS founded the Education Initiative, which aims at spreading the IFRS mindset, creating a common language, establishing a framework based education. Click here to read more on the subject.

Revising audit committees’ role. In a highly integrated world, fraud risk assessment must include third-party providers. Audit committees should take significant steps to mitigate the risk of fraud in the supply chain. Click here to read more on the responsibility of audit committees to ensure proper oversight and mitigation of third-party risks.

The discounted contribution of audit committees. Tone at the top is regarded as the building block of a financially stable organization. The audit committee is the guardian angel, overlooking management’s stewardship. But not all works in the EU as it should do. New EU audit legislation introduces regulation and accountability of audit committees. We think this is worth a look. Click here for EY’s briefing paper.

The future of audit, hence, regulation. The future of audit is Big Data and Artificial Intelligence. In their article, Deloitte debates the fear that cognitive technology means the end of the human auditor.

The explosion of innovation in technology requires transformation of the conventional audit. Not only will enhanced analytics provide better evidentiary support, but also provide insightful perception to management.

This change requires substantially different information architectures and skills, and those who will thrive are the auditors who understand, monitor, and improve analytical and cognitive systems and processes. Analytics will no longer be restricted to the preliminary, final and substantive audit stages, but will also allow auditors to predict outcomes and challenge assumptions. Click here to read more.

ADAA’s hot

topics

The IASB is

located in

Cannon

Street,

London

WHAT’S NEW FROM THE ACCOUNTING PROFESSION?

And finally

please turn

the page

for ADAA’s

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accounting

insight…

WHAT’S NEW THIS MONTH

IFRS news, updates from ADAA, IASB and the Accounting Profession March 2016

On the Regulator’s agenda - an insight from ADAA’s Khulood Al Reyami

No surprises. Well that’s not quite true. We like nice surprises, it’s the not so nice surprises we aren’t so fond of! ADAA hosted 160 regulators from 53 countries, as the International Forum of Independent Audit Regulators (IFIAR) met, for its 10th annual Inspection Workshop, at the Rosewood Hotel, in Abu Dhabi last month. And there were a few surprises! What are your Regulators talking about? = AUDIT QUALITY. No surprise there! But why do we not always find the appropriate level of audit quality we should expect to see? Why are more than 50% of audits inspected deficient? An audit is classified as deficient if fails to document sufficient, relevant, reliable evidence to support the audit opinion provided. It doesn’t necessarily follow that the financial statements are deficient. Although they could be. It may only be a question of audit work not done, or it may not. Audit deficiencies appear in a number of ways. Application issues. In any business, how a standard is interpreted and applied results in variability of reported performance. Consider VW’s device defeat software that enabled engines to pass emissions testing that under normal circumstances they would fail. A case of reported performance being a surprise. International Accounting Standards and International Auditing Standards are produced by committee, and not everyone always agrees the same interpretation. They should, because the standards are principles based. But English can be an imprecise language. Sentences can be misread. This is the reason why the basis of conclusions are issued accompanying standards. So the reasons for the standard setting Board’s conclusions are understood. However, there are other issues in application that are deliberate and are calculated and wrong. This is the ‘where in the standard does it say I can’t do this,’ approach. It is the ‘Entity A is doing it and Auditor X has signed it clean, so why can’t I?’ approach. It is the ‘gathering audit evidence that supports the intended accounting outcome and ignoring any audit evidence that contradicts it,’ approach. There can be a thin line between structuring a transaction to deliver a particular accounting outcome, and misrepresentation, and fraud. Where that line is drawn, is sometimes difficult to decide, and when that line is crossed is sometimes difficult to know. When is a judgement too fine? When is a provision too aggressive? When is taking a position, so deserving employees receive a bonus, not a good idea? Following Enron in 2001 and the cap on non-audit fees and banning of certain services by the auditor in Sarbanes Oxley, three of the four Large Audit Firms sold their consulting arms to focus on tax and audit. But, look again now, and they have reinvented themselves, as four Large Tax, Consulting and Audit Firms. Two thirds of their revenues come from Tax and Consulting Services. Does this create a conflict in the firms between those providing tax and structuring services and those providing the audit service? There are rules in the IESBA Code of Ethics for Professional Accountants in providing second opinions. How often is evidence of those rules being applied, found on the audit file?

Documentation Issues. Before computers it might have been understandable that something did not appear on an audit file. Audit documentation was a decision of the audit partner and audit team. Now, it’s not. Minimum standards are built into the audit firms’ computerized audit programs. If something is not documented now it’s because the auditor was negligent, didn’t have enough time, or the document doesn’t exist. Professional Skepticism issues. Professional skepticism is an attitude that includes a questioning mind, being alert to conditions which may indicate possible misstatement due to error or fraud, and a critical assessment of audit evidence. In 2016 it seems impossible to believe that we regulators should be discussing professional skepticism, but we are. The International Auditing and Assurance Standards Board (IAASB) recently issued its invitation to comment (ITC) enhancing audit quality in the public interest. This is a full 95 page document that focuses on only three audit issues: Professional skepticism, Quality Control, and Group Audits. A presentation on the ITC was provided by the IAASB Chairman. One view is that it is positive the IAASB are holding an open and public debate and have asked so many questions of their audit standards. The other view is that current audit standards are seemingly not fit for purpose. The comment period lasts until the summer and there are unlikely to be any changes to auditing standards anytime soon. So if you are purchasing an audit product, be aware, it might not be as perfect, as robust, as you think. The reassessment of professional skepticism we don’t understand. Because professional skepticism is an attitude that drives behavior. You either behave skeptically, or you don’t. And if you don’t, you don’t because you didn’t want to, or because you couldn’t, or didn’t know you had to. One of which is fraud, and the other two, negligence. Standards level issues. There are international auditing standards, and there are international accounting standards. Both of which are principles based. Some of the older standards aren’t perfect and we are seeing with the new accounting standards on leasing and revenue substantially more application guidance and illustrative examples being provided by the IASB. There are a few reasons for this but the root cause is application error. These new standards result from projects which were joint projects with the American standard setter FASB. Because of history, and the SEC Staff Accountants’ practice FASB had substantially more illustrative examples and application guidance than the IASB. Because if the Staff Accountants didn’t agree with an interpretation of a standard, they would write a Rule! The IASB and the IAASB has always been averse to rule writing. However, that approach resulted in 85% of all leases worldwide being operating leases and off balance sheets. IFRS 16 is intended by the IASB to bring them back on. But will it? There will always be situation where accounting arbitrage can occur. However, when that arbitrage results in financial statements that are wrong, then the audit failed. Conclusion. 160 Regulators from 53 countries based on inspections of thousands of audits came together to discuss audit quality, but you need to discuss audit quality on only one, yours.

IFRS news, updates from ADAA, IASB and the Accounting Profession April 2016

WHAT’S NEW FROM THE IASB?

Shining the light on leases. “USD 3.3 trillion worth of leases are off balance sheet.” This cannot be right! Materiality. Responding to market calls for greater coherence, consistency and comparability between corporate reporting frameworks. Key valuation considerations given current market volatility. What do you need to know?

In pursuit of perfect disclosures. Transforming the dream into reality. Why all the fuss about accounting? The answer is transparency. CORE & MORE. FEE is convinced that the growing difference between the market capitalization and net asset value of leading global corporates represents a key rationale for change. And on the back page Revenue. Leasing. Financial Instruments. An insight from ADAA’s Ahmed El Meleegy.

Shining the light on leases. “USD 3.3 trillion worth of leases are off balance sheet. Despite being off-balance sheet, there can be no doubt operating leases create real liabilities. During the financial crisis, major retail chains went bankrupt, they were unable to adjust quickly to the new economic reality. They had significantly long-term operating lease commitments on their stores and yet had deceptively lean balance sheets. Clearly the accounting did not reflect the economic reality.” Hans Hoogervorst concludes: “While cosmetic accounting benefits of leasing will disappear, the real business benefits of leasing will not change as a result of the new standard.” More from the Chair of the IASB here. Materiality is a concept found in ISAs, IFRSs, Listing rules and many other places. Sometimes abused and misrepresented. The Corporate Reporting dialogue publishes ‘Statement of Common Principles of Materiality’. The IASB defines materiality as: “Information is material if omitting it or misstating it could influence decisions that the primary users of general purpose financial reports make on the basis of financial information about a specific reporting entity.” With such clarity of definition it seems odd professional judgement on what is, or is not material, can be materially wrong. More from the IASB here.

In pursuit of perfect disclosures. Too complicated, voluminous insignificant detail obscures useful information, footnote organization rarely user friendly and frequent boilerplate text often reads straight from a checklist. “You are correct we have heard you!” says IASB board member Gary Kabureck. In June 2013 Hans Hoogervorst delivered the IASB’s 10 point plan to break the boiler plate, then came the IASB’s Disclosure Initiative to explore how disclosure reporting needs to improve to serve investors’ needs. Gary concludes the key question a reporting decision needs to answer is – could this disclosure reasonably influence the decision of a primary user to make or change buy, hold, sell, or lending decisions. If it does its material and it needs to be disclosed. Click here for the article in full. Why all the fuss about accounting? The IASB Chairman in his Hanoi meeting address identifies the benefits of IFRS to the world economies. IFRS was a project started by ten and spread to one hundred and six more countries as it has become obvious that IFRS with its focus on high quality comparable financial reporting, brings not only transparency, consistency and accountability, it also develops a high quality financially astute business community. Attracting international investors, and reducing the cost of capital are obvious appeals. Hans outlines the question of adoption versus adaption of IFRS. More here.

Key valuation considerations given current market volatility. What do you need to know? IAS 36 identifies twenty impairment indicators but unhelpfully advises that these indicators only indicate that the asset may be impaired. So although an asset may exhibit indicators of impairment it may still not be impaired. Does this make any sense? Well yes because management know best as to how they are going to extract value from the asset, most likely from its ongoing use. And that is precisely the problem identified by regulators reports PWC. Evidence from this year’s English Premier League may not be the best evidence that past performance is the best indicator of future performance. But if you look to the European leagues and the Champions League, it clearly is. Of course management and especially football management are paid to be optimistic but owners, investors, deal only in realism. Key valuation considerations? I think we all know. Click here to view the paper.

CORE & MORE. The Federation of European Accountants (FEE) is convinced the growing difference between the market capitalization and net asset value of leading global corporates represents a key rationale for review, enhancement and change of the existing corporate reporting model, so as to capture comprehensively the true value drivers of current businesses. FEE argues technology is instrumental in shaping society, changing markets, transforming the environment in which we operate, live and think in a way and at a pace that are both unprecedented. New business model are emerging, existing ones are disrupted, and yet corporate reporting does not seem to be keeping up. In their discussion paper ‘the future of corporate reporting’ they argue for CORE & MORE. CORE is the information that all businesses should report, and they should report it faster than they currently do. Because in a smartphone connected world timeliness of information is a key benefit. MORE is the information that can be provided later, it enhances the CORE information but by nature take more time to collect and report. Click here to read the view point of the profession on the subject.

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IFRS news, updates from ADAA, IASB and the Accounting Profession April 2016

What the Regulators Think - an insight from ADAA’s Mahmoud Shahin

They say good things come in threes. We have three new accounting standards!

FRS 15 “Revenue from Contracts with Customers” issued May 2015 replaces IAS 18 and is effective for accounting periods beginning on or before 1 Jan 2017.

IFRS 9 “Financial Instruments” issued July 2014 replaces IAS 39 and is effective for accounting periods beginning on or after 1 Jan 2018.

IFRS 16 “leases” issued January 2016 replaces IAS 17 and is effective for annual reporting periods beginning on or after 1 January 2019.

It has taken the IASB almost 15 years to produce a new Revenue standard (G4 +1 communique 2001). 14 years for the new leasing standard (2002 was when Sir David Tweedie made his wish). And a relatively short 8 years for the financial instruments standard (propelled by the financial crisis of 2008). However, since there is a two year transition period the cumulative impact of these three new standards we may have to wait until 2020 to see! They say good things come to those who wait. But must we wait? Is such an analogue answer technologically acceptable in a digital age? What does the internet generation think? We know what FEE with CORE & MORE think. When a new standard (IFRS) or interpretation of a standard (IFRIC) is published by the IASB, but is not yet effective, IAS 8.30 requires IFRS reporters that have chosen not to adopt early the new standard, or new interpretation, to disclose if known or reasonably estimable what the expected impact of the standard will be. What is known, is obviously a matter of fact. What is reasonably estimable, is naturally a matter of judgement. Obviously, if you don’t know something you can’t disclose something. But what is the threshold for reasonable in making a judgement on an estimate? IAS 8.31 says to comply with IAS 8.30 either a discussion of the impact that initial application of the new standard will have on the financial statements, is disclosed, or disclose it is not known or reasonably estimable. IAS 8.31 is interpreted in the IFRS community as a disclosure policy choice. We searched the internet and many financial statements and found the most common disclosure response to the impact of these three standards is…we don’t know. No? Really? Yes. Not, we don’t know what the most common disclosure was, we do. It was, we don’t know. They say that good things come to those that share. Newton’s third law of motion tells us for every action there is an equal and opposite reaction. Unfortunately this dynamic is not confined to physics it also appears in the behaviour of financial reporters and has been there since the inception of the IASB. IFRS 2 is the IASB’s first accounting standard. IFRS 1 does come before IFRS 2 but IFRS 1 is the first time adoption standard which simply relocated the first time adoption parts of all the other standards into one place. IFRS 2 was also the first collaboration with FASB standard and suffered substantial opposition when it was first published. Why? Because it brought a charge in the income statement and a liability on the balance sheet for shares and share options given as compensation to management and employees, reducing reported profit

and increasing leverage. But now, not to account for shares and share options in such a way, is unthinkable. Another project the IASB initiated in its first wave of changes to standards was to reassess IAS 8 to align it with US GAAP. Not least because one aim of the IASB was to have IFRS recognised as suitable for listed entities by the NYSE. US GAAP determined by the FASB is the defacto accounting standards for listed entities on the NYSE. Originally the IASB included in IAS 8 the requirement when a new standard has been issued, but is not yet effective, to explain what the impact of the new accounting standard, will be when it is applied. However, this requirement was considered by the IFRS community to be more arduous than US GAAP, for which SEC Staff had clarified disclosure of the impact is required, but “the Staff understand that the registrant will only be able to disclose information that is known.” IAS 8 BC.31 thus explains, the IASB amended IAS 8 to align with US GAAP. And that seems fair, but is it the whole story? No. IAS 8 BC31 is being interpreted as providing a policy choice, when it does not. It is a statement of the obvious that if you don’t know something you can only disclose that you don’t know it. The question is why don’t you know it? Is it impracticable to know, or is it a data delving timing difference? Meaning you haven’t done the work yet? The question is why? Why, do you not know what you do not know? Part of the NYSE listing requirements is a management discussion and analysis (MD&A) of risks and opportunities that the entity is exposed to. And that discussion is required to be audited. IFRS does not require the equivalent of an MD&A. Its equivalent ‘Management Commentary’ is ‘best practice,’ not mandatory. The application of new accounting standards that will impact revenue, profits, assets, liabilities and leverage are clearly significant risks and would undoubtedly be included in an MD&A and be audited.

Revenue is a key figure in an entity’s financial statements. Investors and analysts focus on revenue growth, one-offs, and information on revenue aligned performance indicators. IAS 18 contained a probability test for recognising revenue. Is the reasonably estimable test in IAS 8 significantly different from a probability test? If the commercial impact of bundling multiple revenue components into single contracts is not known, should they be?

IFRS 16 started 14 years ago with the stated aim of bringing liabilities arising from operating lease commitments onto the balance sheet. Is 14 years not sufficient time to develop a reasonable estimate of what those liabilities might be?

IFRS 9 was fast tracked specifically because the banking community did not have the provisions to deal with the financial crisis. It includes the move from an incurred to an expected loss model, is that not simply a timing difference? Fathers might expect to incur a loss in lending to sons and daughters. Banks don’t in lending to customers. However, if you have seen the film ‘Short’ you will understand the irrational exuberance of markets, and the reality of boom, and bust of economic cycles. Is an expected loss provision not reasonably estimable in relation to the economic cycle?

Estimates will inevitably be wrong, that is understood. But is it not better to try and nearly succeed, than to not try at all?

IFRS news, updates from ADAA, IASB and the Accounting Profession May 2016

WHAT’S NEW FROM THE IASB?

IFRIC Update from the IFRS Interpretations Committee. IASB Staff Webcast IFRS 16: Exemptions. IFRS in Focus. Closing out 2015. In China the rate of growth slowed, stock markets dropped and volatility became the new risk. In the US growth was strong, the EU is recovering but Brexit poses a risk, in the ME we have oil prices to consider.

IASB April Update. The sting is always in the tail! Accounting for common control transactions. Goodwill and impairment. In the Spotlight impact of IFRS 16 – Airlines. The new standard will change the accounting for lease transactions. And on the back page, deciphering the mystery of perfect disclosures - an insight from ADAA’s Muhammad Shabbir.

IFRIC Update. To coin a phrase - when life gets technical, the technical get going! IFRIC members are drawn from the accounting technical partners of the largest network audit firms. So it is somewhat surprising to find that the same network audit firm can come to two different accounting conclusions for the same transaction? Measuring your interest in an associate or JV. Accounting for the proceeds and costs of testing PPE, recoverable cash payments from government, or Service Concession Arrangements. Just some of the issues in IFRIC Update. IASB Staff Webcast IFRS 16: Exemptions. We are seeing a lot of Board member Sue Lloyd lately and this is a good thing. Sue was formerly with the Australian Accounting Standards Board, was the IASB’s Director of Capital Markets, and currently is the IASB’s Director of Technical Activities, and led the development of the financial instrument standard. So Sue knows a bit about FIs’ accounting requirements! With three new accounting standards (Leasing, Revenue and Financial Instruments) we see increasing use of IAS 8.31 (e) (ii). Sorry

Shareholder, we the management appointed by you to safeguard the stewardship of your assets don’t know how much leverage we have hidden in operating leases. Really? Then perhaps we should reconsider our vote on your reappointment at the AGM? If you want to avoid such a situation listen to Sue here. IASB April Update. Common control transactions are scoped out of IFRS 3 which effectively results in an accounting policy choice of applying IFRS 3 by analogy or turning to national GAAP which predominantly uses predecessor carrying amounts. The IASB is coming to the view the latter is best because “common control transactions are not freely negotiated but directed by the controlling party; consequently the use of fair value, and the recognition of gain in such transactions, is not meaningful and may create an incentive to artificially shift values within the group to achieve a desired result.” And finally when is a change in accounting policy really a change in measurement? Why does this matter? Because a change in policy requires a prior year restatement, which is good news, if you don’t want to hurt current year profit. A skeptical view, perhaps, but what would you expect from a Regulator! More here.

IFRS in Focus. Closing out 2015. It was all looking so good and then in January we received the China shock. Preparing high quality financial statements requires the aggregation and fair presentation of many routine transactions. That’s the easy part. The not so easy part, is reaching conclusions on the non-routine, the complex transactions, in making high quality estimates, because the non-routine normally requires judgements. Judgements about what will happen in the future. Discount rates, interest rates, currency rates, commodity prices, growth rates, competition, technological change, macroeconomic factors. By definition an estimate is not likely to be 100% correct. The question is how far wrong will it prove to be? IFRS requires disclosure of the assumptions, of the judgements and estimates that have been made. So that in the future we can make an assessment of how far wrong it was. ISA require the auditor to force management to be more conservative if the evidence is that past judgements have been too far wrong. IAS 1.18 reinforces the observation that the wrong selection of an accounting policy cannot be rectified by disclosure or by notes or explanatory disclosure. More on this from Deloitte in IFRS in Focus here.

In the Spotlight impact of IFRS 16 – Airlines. A lot is already known about the impact of the new leasing standard. All lease liabilities are brought onto the balance sheet together with a right to use asset. EBITDA will go up, probably by about 33% but profits will go down, because operating lease arrangements flat line the expense, whereas finance lease models front load the (finance) expense. Analysts have been adjusting financial statements for years to bring operating lease commitments into their financing assessments. Now they won’t have to. So what’s all the fuss about? The fuss is that trillions of additional lease obligations will be added to the balance sheets of Airlines worldwide. And as most (aircraft) lease obligations are denominated in US-Dollar, foreign currency volatility becomes a risk too. A PwC study concludes the Airline industry will be the second most impacted sector after the Retail industry. The median increase in on-balance debt is projected to be +47% and about 50% of Airlines are expected to increase debts by more than 25%. So is it all doom and gloom? No, the law of unintended consequences is at play. This was a joint project with FASB and FASB like lots of guidance to ensure principles are applied correctly! To have a lease you must have an asset, either implied or specified. So in their example of the check-in machines in the entrance hall PWC conclude there is no lease, because although the amount of space is specified, where the space is in the entrance hall is not. Our view? Not much point having the check-in machines not in the entrance hall, so isn’t the entrance hall the implied asset? Make your own mind up here in PWC Spotlight.

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IFRS news, updates from ADAA, IASB and the Accounting Profession May 2016

Deciphering the mystery of perfect disclosures. An insight from ADAA’s Muhammad Shabbir

Did you recently approve your financial statements? Or are you still trying to complete them? Is meeting regulatory and other reporting deadlines a bit of a challenge? Complying with the requirements of your chosen financial statement reporting framework and meeting the requirements of regulatory standards is no doubt of paramount importance. But, in the process of doing so, did you take the opportunity to truly read your financial statements disclosures? Do you like what they say? As a professional accountant, would you claim to be proud of them? Professional accountants dream of an ideal world. Of a world of financial statements with the perfect disclosures. Unfortunately, our dreams are interrupted by nightmares of compliance. Financial statement disclosure checklists have a lot to answer for. Far from telling a story that is transparent and true, the financial statement story is obfuscated by compliance. Rather than an instrument of communication financial statements can become like a Rubiks cube. Easy to read when all the colours are aligned and a mirage of conundrums of which way to turn, when all mixed up. Many of us have long called for behavioral change, to break the boilerplate norm. In recent times regulators, users, and standard setters, have all proposed various remedies to declutter financial statements and make them useful and meaningful for users. Which is of course the primary objective for their preparation in the first place. In this article we aim to sum up and highlight the underlying reasons, consequences, and solutions. We start with the man at the top, none other than Chair of the IASB, Hans Hoogervorst. In a reference that emotes the ‘no one ever got fired buying IBM’ thinking of the past he said “no CFO ever got sacked for producing voluminous disclosures. While restatements, may be career-limiting.” He identified the following issues;

Many preparers err on the side of caution and throw everything into the disclosures, even if not material.

Lot and lots and disclosure taken to excess can be very handy for burying information that is unpleasant, yet very relevant!

It is just easier to follow a checklist, rather than put in the effort to make the information more helpful and understandable.

The aversion to take on risk on the part of preparers, auditors and regulators.

A tick-the-box production line mentality. Hans’ solution? His 10 point agenda; 1. Too much immaterial information makes material information

difficult to find. Companies should proactively cut the clutter! Less is more.

2. Materiality assessment applies to the whole of the financial statements, including the notes. If an item is not material, it does not need to be disclosed anywhere at all.

3. Every disclosure of applicable standards is not necessarily relevant and should be judged individually on merit.

4. Give greater prominence to the important accounting policies, relegate the less important to the back.

5. IAS 1 was not intended to prescribe the order of financial statements only what they should contain. IAS 1 will thus be amended.

6. To provide users with clarity, to consolidate and link the clutter of scattered debt disclosures, IASB will consider net-debt reconciliation requirements.

7. IASB will work with IAASB and IOSCO to provide guidance and educational material on materiality aimed at establishing a more uniform view of what constitutes materiality for auditors, preparers and regulators.

8. In new standards, the IASB will use less prescriptive wordings for disclosure requirements. Instead, the focus will be on objectives and examples of disclosures to create more explicit room for judgments on materiality.

9. The IASB will create a new disclosure framework by replacing and undertaking a fundamental review of IAS 1, IAS 7 and IAS 8.

10. When the review of the above standards has been completed, the IASB will undertake a general review of disclosure requirements in the remaining standards.

Points 1 to 4 are easy wins and will contribute significantly in improving the communicative value of your financial statements. For points 5 to 10, the IASB has come a long way as the 10-point plan is from 2013. IASB member Gary Kabureck reflects on the IASB’s progress so far here. The regulators views. Recently IFIAR (International Forum of Independent Audit Regulators) released its 2015 survey of findings and consistent with past year, the issue of “Adequacy of Financial Statement Presentation and Disclosures” was again included in the top 10 issues. ESMA’s position. The European Securities and Markets Authority (ESMA) has publicly expressed concerns about the quality of disclosures, whether because disclosures are boilerplate rather than entity-specific, or are unnecessary, because they refer to transactions that are not relevant to the issuer or relate to immaterial items. ESMA has developed five disclosure principles issuers should consider in presenting the disclosures in their annual reports: 1. Telling the entity’s own story by focusing on entity-specific disclosures and

avoiding boilerplate language. 2. Providing relevant information that is necessary to understand the

issuer’s financial performance and position in the financial statements in an easily accessible way.

3. Thinking about materiality and applying the IFRS materiality principle. 4. Promoting readability of the financial statements by producing

information that is written in as clear and concise a way as possible. 5. Providing consistent information within annual reports. Concluding thought. Have a critical look at your financial statements, if much of what is often disclosed may be considered ‘boilerplate’ cut and paste from an audit firm’s latest illustrative financial statements, then this is certainly resulting in disclosure that is not that helpful in providing an insight to how well or not management is thinking they are doing. Measures highlighted in this article have great potential and, taken together, they remove most excuses for boilerplate disclosures. A good starting point to decide what to disclose is to consider the information management sees in taking decisions and assessing its performance. Past publications cover certain elements related to this topic Feb 13, Mar 13, May 13, and Jul 13 but perhaps the real ask here is for behavioral change, from preparers, auditors and regulators alike!

IFRS news, updates from ADAA, IASB and the Accounting Profession June 2016

WHAT’S NEW FROM THE IASB?

Where does it say in the standard I can’t do this? IFRS Foundation and IOSCO answer the question! IAS 40 – Investment Property to be amended to emphasise how the asset is used and if a change in use has occurred. IAASB comparison report differences between Critical Audit Matters (CAM) required by the PCAOB and Key Audit Matters (KAM) required by the IAASB. Investors vs CEOs the definition of business success is changing.

We have to give the investor more tools to decide whether a company is a George Clooney or the Hunch back of Notre Dame? IASB Chair gets emotional! Materiality judgements when preparing a financial report. The IASB staff’s four step approach. The Basel Committee Guidance on credit risk and accounting for expected credit losses. And on the back page Common control transactions an insight from ADAA’s Hasina Aladawi.

Where does it say in the standard I can’t do this? The IFRS Foundation is the owner and guardian of IFRS. IOSCO the International Organisation of Securities Commissions, the guardians of the world’s capital markets issue their joint Statement of Protocols. Their shared objective “promoting and facilitating transparency within the capital markets through the development and consistent application of IFRS standards.” Capital markets authorities are responsible for regulating the form and content of financial reporting. The Foundation’s objectives include the development of in the public interest, a single set of high quality, understandable, enforceable and globally accepted financial reporting standards (IFRS) and the promotion of their use and rigorous application. They have as a common interest IFRS Standards consistently applied across varying national contexts and settings. Timely communication between securities regulators and the IASB can lead to early detection of implementation issues and opportunity to prevent or limit diversity in practice. IESBA Code of Ethics starts with the sentence: “A distinguishing mark of the accountancy profession is its acceptance of the responsibility to act in the public interest. Therefore, a professional accountant’s responsibility is not exclusively to satisfy the needs of an individual client or employer.” So the answer to where in the standard does it say I can’t do this? Is in the accountant’s responsibility to act in the public interest, to be transparent and consistent in the application of IFRS standards.

George Clooney or the Hunch back of Notre Dame? IASB Chair gets emotional! The IASB takes on the Non GAAP elephant in the room. IFRSs don’t specify much about how financial performance is reported. Profit is the primary indicator and using OCI should only occur if it enhances the relevance of profit. Hans questions the wisdom of including changes in the pension liability in OCI and although the employees of BHS might agree, it is doubtful Sir Phillip Green would. Addressing the EAA in Maastricht Hans cites how a loss of $6 billion under IFRS converts to an underlying profit of $6 billion. “…it is rather unnerving most management remuneration packages are based on adjusted earnings. Knowing that even GAAP numbers can be vulnerable to earnings management, remuneration committees should be extremely wary to base their policies on earnings adjusted by management itself!...Economic reality is to a great extent unpredictable and very difficult to control by management. That is why I believe that ultimately the number that counts most is the unadjusted bottom line, where all elements of income come together, both recurring items and exceptional items, whatever those may be”. Full speech available here. Materiality judgements when preparing a financial report. The IFRS Staff’s four step approach. Consider if all the material information has been included, and if the financial report gives a balanced picture of financial performance and financial position. Considering the cumulative materiality of information that was initially assessed as not material in itself. More here.

IAS 40 – Investment Property to be amended to emphasise how the asset is used and if a change in use has occurred. Actual evidence of a change in use is required not merely a change in management intentions. ED paper here. IAASB comparison report IAASB highlight differences between the Critical Audit Matters (CAM) required by PCAOB and the Key Audit Matters (KAM) required by IAASB. Click here. Investors vs CEOs: the definition of business success is changing. Investors call for more measurement and better communication. PWC identify seven key actions in ifrs-news: More quantitative detail. More measurement and better communication of non-statutory information. Improvements to traditional financial statements. Risk reporting must improve. Quality not quantity. Strengthen engagement between investors and companies is critical. And be clear about

the changes being made to respond to changing stakeholder needs. The Basel Committee outlines their expectations for credit risk practices in an expected credit loss model including circumstances when the Committee expects banks to limit their use of simplifications and/or practical measures in the accounting standards. Further discussion in EY’s publication here. Pushdown accounting optional. It’s not new news. Push down accounting is a US GAAP phenomena, where IFRS 3 fair value accounting is applied. Unless it is a common control transaction in which case the parent’s historical cost is used, rather than the transferring entity’s carrying amounts, if different. More here. IFRIC Rejections in short. IAS 19 Employee benefits is one of the least well-read standards in this part of the world however, it is the most debated! Discount rates are one of IFIAR’s most seen failings, great discussion on what is a high quality rate in ifrs-news.

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IFRS news, updates from ADAA, IASB and the Accounting Profession June 2016

Common control transactions an insight from AASD’s Hasina Aladawi

Since 2000 entities around the world have been reporting in accordance with IFRS and IPSAS. And with each additional year of experience, those entities have become quite expert in their technical application of IFRS accounting standards in many, and various, complex transactions and arrangements. And over time more and more countries have adopted IFRS and IPSAS. There is however one (at least) type of transaction that continues to cause diversity in practice. Code for meaning financial statements are not comparable. Comparability being a primary objective of IFRS and IPSAS. The transaction in question is a business combination under common control. And the reason for this lack of comparability, is because IFRS 3, deliberately scopes out such transactions. Which is not very helpful for capital markets with developing or emerging status where inevitably many entities have government as the ultimate shareholder, and therefore it is quite common, during a government led restructuring, for business combinations under common control to occur. To understand the future we must look at the past. The first business combination standard IAS 22 was issued in 1983 by the International Accounting Standards Committee (the predecessor body to the IASB). It was replaced quite quickly with the much improved standard IFRS 3 still called ‘Business Combinations’ in 2004. IAS 22 also scoped out transactions among enterprises under common control. It promoted two types of business combination accounting: 1) pooling of interests, and 2) purchase accounting, which was renamed in IFRS 3, acquisition accounting. Having two ways to account for the same transaction is never a great idea because it encourages accounting arbitrage, and prevents comparability. However, given the ten countries making up the membership of the IASC were racing the IOSCO clock to deliver a full set of quality international accounting standards, it was inevitable that to get to the chequered flag compromise, was required. In deliberating IFRS 3 the IASB debated the two types of business combination accounting in some detail. Generally it was felt that acquisition accounting is the appropriate method of accounting for all business combinations in which one entity obtains control of another entity, because that method is consistent with how the assets and liabilities are assumed or incurred. And the pooling of interest method was a bit of a nonsense given very few (if any) true mergers ever occurred. So pooling went and fair value of the assets and liabilities, and recognising new intangible assets on acquisition, became the new norm. But, the problem still remains for business combinations under common control. And the problem is, the audit firms, and the IFRS reporters don’t agree. This is because, some say, there is a choice. This choice arrives by saying IFRS 3 scopes common control transactions out, but IAS 8 says apply an IFRS by analogy, which is IFRS 3, so we are back to acquisition accounting. Whilst others say. No, that can’t make sense. IAS 8 also says look to other national GAAP and most advocate net assets transferred in a common control

transaction are recognised at the predecessor carrying amounts. So the choice is fair value or, predecessor net book value. Which is a pretty difficult choice to make. So how to choose? Advocates of fair value argue:

Fair value information includes an assessment of goodwill. The recognition of which holds management accountable, because they need to deliver value if a premium is paid.

Fair value is the only relevant measure in a related party transaction because it provides transparency.

Whilst those in favour of predecessor accounting argue:

It preserves trend information.

Predecessor carrying amounts are more reliable. In contrast, fair values determined in a related party transaction are open to management direction and may lead to manipulating future profit.

Unlike a business combination at arms’ length, a common control transaction is not freely negotiated but is directed by the controlling party, it may not be meaningful and creates an incentive to artificially shift values within a group to achieve desired results.

Some say there is no policy choice. The accounting simply depends on the economics of the commercial substance of the transaction. For which there is some guidance in IAS 16.25 and BC 17-24. Basis of conclusions paragraphs are a must read as they are always incredibly revealing as to why the IASB concluded what they did. The previous version of IAS 16 only allowed gains to be recognised on the exchange of assets if the exchange represented the culmination of an earnings process. This was rightly dropped because how does one decide when that occurs? The new test became the commercial substance test because, of course, that is what normally happens when an asset is purchased for cash and, presuming a market based negotiation occurred the transaction’s cost was at that point its fair value. Except sometimes it isn’t because of those anomalous bargain purchase transactions. The test therefore is, did the cash flows change as a result of the transaction? In IAS 16 terms when cash is exchanged for an asset, the answer is clearly yes. But what if cash doesn’t change hands? Then, is the fair value of the asset received reliably measurable? And if not (or you’re not sure) is the fair value of the asset given up reliably measurable? The problem with both of these questions is that they are audit questions and auditors, in assessing the application of IFRS and applying internal auditing standards are different. They can have different evidence requirements and apply different levels of professional skepticism. The result is two out of four audit firms don’t agree. Two say it’s a commercial substance, or lack of test. Two say maybe, but it’s just too difficult to prove. It’s legitimate to say IFRS 3 scopes out business combination common control transactions, so IAS 8 says do something sensible. Custom and practice is either fair value or predecessor carrying amount, so it is an accounting policy choice. We say not very helpful if you are comparing the financial performance of entities and they have different accounting, and the IASB staff seem to agree IFRS STAFF PAPER.

IFRS news, updates from ADAA, IASB and the Accounting Profession September 2016

WHAT’S NEW FROM THE IASB?

The future of IFRS - Better Communication, Improved Quality and Implementation Support. Hans’ message is very clear. Have you mastered IFRS? Here is a chance to prove it. Difficulties in translating IFRS. Produce an odd twist. Need help with that judgement. Why did Sir David Tweedie publish this guide?

Islamic Finance, the future of banking? With its ever-growing popularity some argue this is the future of banking. Integrated Reporting. From the IIRC, IAAER and ACCA. A responsible story? Growing mass of data requiring filters and attesting. And on the back page Earnings management – an insight from ADAA’s Mahmoud Shahin

The future of IFRS - Better Communication, Improved Quality and Implementation Support. At inception of Hans’ second term as Chair of the IASB his message is very clear:

Improve quality. Continually update Standards that no longer stand the tests of time.

Better communication. Increase communication effectiveness of financial statements.

Facelift to the ‘face of the financial statements’. Will improve the organization of the statements of financial performance, the statement of cash flows and the statement of financial position.

Non-financial reporting is relevant. IASB do not anticipate enlarging the scope of work significantly, but will take a fresh look at this issue. Access his speeches in Zurich and Nairobi.

Have you mastered IFRS? Here is a chance to prove it. Take up the challenge here and find out how well do you know your IFRS Standards? This popular quiz invites you to test your

knowledge of IFRS Standards and their use around the world. If you want to revise read this guide. Islamic Finance, the future of banking? With its ever-growing popularity some argue this is the future of banking. As if reporting conventional financial instruments did not have enough challenges. Issues in the application of IFRS 9 to Islamic Finance, a paper prepared by the IASB Staff probes the application of IFRS to Shariah-compliant instruments and transactions. A Key focus is the analysis of economic substance, which considers among other things whether payments made pursuant to the contract are equivalent to payments of principal and / or interest (profit). The IASB has established its very own dedicated Islamic Finance Consultative Group and has recently appointed a new Chair and Vice Chair for the Group. The Group does not judge whether products are compliant with the requirements of Shariah law. It focuses on challenges that may arise in the application of IFRS Standards to instruments and transactions commonly referred to as Islamic finance. More here.

Difficulties in translating IFRS. Australian and Korean standard setters find translational and cultural differences over terms for ‘likelihood’ resulting in materially different accounting conclusions. IFRS contains 35 such terms ranging from ‘possibly’ through ‘more likely than not’ to ‘virtually certain.’ All translate in Korean to the same term. Resulting in provisions for identical transactions being 10% higher in Korea. More from PWC here. Need help with that judgement. Why did Sir David Tweedie publish this guide? Because too often we hear, ‘it’s a matter of professional judgement.’ It is a fact that two different law firms will provide two different answers. The accounting profession is different – or at least it used to be. Almost the first document published by the Institute of the Chartered Accountants in Scotland following Sir David’s appointment as President in 2012 was A professional judgement framework. ICAS republish it in 2016 with a new section on audit committees and ethical decision-making. Whether You are a preparer, auditor, audit committee, regulator, or standard setter this is a must read for all involved in accounting decisions.

Integrated Reporting. From the IIRC, IAAER and ACCA. Meeting users’ information needs: The use and usefulness of Integrated Reporting identifies the key challenges to widespread adoption of integrated reporting. Report here. Factors affecting preparers and auditors’ judgements about materiality and conciseness in Integrated Reporting. Gathers evidence on current practice and issues. Report here . A responsible story. Users of financial information face a growing mass of data requiring filters and attesting. The credibility of continuous reporting would benefit from standards developed for the purpose. It is not enough for information to be principle-based an entity’s business model needs to be described allied to its strategy to be meaningful. Users are not only looking for big positive numbers. More here from DTT in “The Future of Corporate Reporting”. IASB issues new amendments to IFRS 4 Insurance contracts. The new amendments to IFRS 4 arrive after a need for a material improvement to enhance the quality of financial reporting and comparability of insurance accounting around the globe. Further assessment here.

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IFRS news, updates from ADAA, IASB and the Accounting Profession September 2016

Earnings management – an insight from ADAA’s Mahmoud Shahin

Accountants are not very good at jokes. A company seeks to hire a financial reporting accountant. In the interview applicants are provided with financial information and asked what are the net earnings? All applicants but one calculate the correct number but none gets the job. Why? Because the successful applicant simply asked ‘what do you want them to be?’ There are only three ways our successful applicant can achieve the desired outcome. The right way. The less right way, and the wrong way. The right way. Involves changing operational activity to bring forward or delay sales and costs thereby bringing forward or delaying profit recognition. For example, having a ‘sale.’ We see sales in the shops, particularly during Ramadan, to incentivise consumers to bring forward their purchasing decisions and to take market share from competitors. Or releasing a new product earlier. Apple released the Iphone 7 on 16 Sept 2016 and the Iphone 6 on 19 Sept 2015 a difference of three days. Three days may not seem much but in the context of the Iphone providing perhaps half of Apple’s earnings three days of additional earnings maybe significant. Sales, discounts, volume rebates, new products, marketing campaigns are acceptable activities in earnings management. The right way includes engaging with customers and suppliers to share risk and reduce volatility of revenues and costs. An order from a customer for 50 items scheduled over ten years has less risk to a supplier, than an order for 5 items in one year, that may, or may not be repeated. The less right way. The less right way covers a spectrum of ways between the right way and the wrong way. A production engineer seeking to reduce costs in the current period might defer scheduled maintenance expenditure until the next accounting period resulting in higher reported earnings in the current period. Naturally, this also results in reduced earnings in the future when the maintenance expenditure is incurred. Deferral may also be detrimental to future operating performance if it results in machinery breaking down, or not operating at its optimum level, reducing earnings further. Our example relies on the requirement in IAS 16.12 to exclude from the cost of an asset the costs of day-to-day servicing. Though IAS 16 is an old standard and its application apparently straight forward, research shows after revenue, fixed assets is next most likely account balance in which fraud and errors most occur. The problem is not normally with initial recognition since the cost of an asset is normally quite straight forward, to identify. The problem is with subsequent expenditure, and impairment. As the recent purchaser of a nearly new car a car recently serviced is worth more, than one not. But day-to-day servicing is not recognised by IAS 16 as an asset. Unless it is a big service, that usually requires a replacement part. IAS 16.13 uses the example of the replacement of aircraft interiors such as seats and galleys several times during the life of the airframe. Expenditure on new seats and galleys one can physically see, expenditure on servicing one can’t. IAS 36.12 provides four external sources and four internal sources of indication an asset may be impaired and IAS 36.9 requires “if any such indication exist, the entity shall estimate the recoverable amount of the asset.” The sources include: 1) “Observable indications that the asset’s value has declined significantly

more than would be expected as a result of the passage of time or normal use.” A purchaser knows a new car is worth less the moment it is driven off the forecourt, simply because it is no longer new. And when a replacement model is produced, rather than a face lift the same is true.

2) “Significant changes with an adverse effect…in the technological, market, economic or legal environment.” E.g. new regulations rendering your product redundant.

3) “Market interest rates or other market rates of return on investments have increased during the period.” Such as happened in the oil industry with the fall in the oil price.

4) The carrying value of the net assets of the entity is more than its market capitalization.” If a listed entity fails to convince the investment community that the sum of its parts is more than its IFRS amounts is the accounting really true and fair?

5) “Evidence of obsolescence or physical damage of an asset.” If you have an accident in your car and your insurance policy has an excess of AED 10,000 do you not have a loss?

6) “Adverse effect resulting in change in Use” For example, not meeting new emissions regulations,

7) “Evidence from internal reporting indicates economic performance is, or will be worse.” E.g. Fuel consumption achieved much less than expected.

(The eight indicator considers dividends which is not a focus of this article.) If an indicator of impairment exists does it not follow the asset must be impaired? The answer maybe! The existence of an indicator means the asset does not now have the value expected at the time of purchase. However, it does not have to follow the asset’s recoverable amount is less than its carrying amount. IAS 36 requires a comparison of Value in Use (VIU) and via IFRS 13 Fair Value Less Cost to Sell (FVLCTS) and the carrying value. If either is higher, there is no impairment. Would it not be odd if a business could recover more from an asset by selling it than using it? Assets normally operate with other assets so IAS 36 allows aggregation of assets into a CGU and CGU’s with CGU’s for impairment assessment. Taken to the limit, aggregation creep results in the business as a whole being tested for impairment. And how many management teams willingly report to their shareholders their business is impaired? There are other accounting tricks to look out for, a key feature of which is that interpretation of the facts doesn’t quite fit the circumstances described, such as:

Long-term contract (LTC) accounting that is not. LTC accounting requires aggregation of incomes and costs to establish the stage of completion of a contract, to determine how much earnings to report. It usually includes forward assessment and contingency planning. Both of which are opportunities to be more or less aggressive with the accounting.

Applying operating lease accounting to smooth earnings equally over accounting periods rather than accepting the back-end loaded earnings recognition of finance lease or service concession accounting.

The wrong way. The wrong way is wrong. A final thought. In the Preface to the IFRSs the objective of the IASB is: “to develop, in the public interest, a single set of high quality, understandable, enforceable and globally accepted financial reporting standards based on clearly articulated principles. These standards should require high quality, transparent and comparable information in financial statements and other financial reporting to help investors, other participants in the in the various capital markets of the world and other users of financial information make economic decisions.” Some, legitimate earnings management is fine all businesses do it, aggressive earnings management is not because it breaches the transparency and comparability principles with a detrimental effect on economic decisions.

IFRS news, updates from ADAA, IASB and the Accounting Profession October 2016

WHAT’S NEW FROM THE IASB?

New Auditor’s Report. Will it make any difference? ISA 701 published earlier this year requires the auditor to provide a commentary in the audit report of the Key Audit Matters (KAM) they considered in completing their audit. Krispy Kreme. Everyone loves a doughnut. Floated in April 2000, two short years later the stock was up 235% from its IPO price. It never missed an earnings forecast. March 2009 the SEC issued cease and desist findings unfortunately there was a problem.

Audit quality study. A simple subject really. When earnings management becomes cooking the books. The line between legitimate and inappropriate accounting techniques can be a blurry one. And on the back page Revenue and lease accounting – an insight from ADAA’s Hasina Al Adawi

New Auditor’s Report. Will it make any difference? ISA 701 published earlier this year requires the auditor to provide a commentary in the audit report of the Key Audit Matters (KAM) they considered in completing their audit, the audit procedures applied and what the outcomes were. ISA 701 is mandatory for listed entities and in “circumstances when the auditor otherwise decides to communicate key audit matters in the auditor’s report.” The IAASB does not provide guidance on what such ‘circumstances’ might be. Not to worry, ADAA is here to help. The IAASB left some clues in IAS 701.

Why listed entities? Because shareholders do not have the inside knowledge management does. Hence, in situations

where management is not the owner how else can the shareholder assess if that inside knowledge is applied appropriately unless the Auditor explains what they did?

Users of financial statements highlight their interest in accounting estimates having high estimation uncertainty because amongst others things, such estimates are highly dependent on management judgement and are often the most complex areas of the financial statements.

When accounting policies that have a significant effect on the financial statements (and significant changes to those policies) are relevant to understanding the financial statements, especially where an entity’s practices are not consistent with the industry.

We suggest you discuss the impact of ISA 701 with your auditor. IFAC’s auditor report page here and a review of experience from the UK here.

Krispy Kreme. Everyone loves a doughnut. Floated in April 2000, two short years later the stock was up 235% from its IPO price. It never missed an earnings forecast. March 2009 the SEC issued cease and desist findings unfortunately there was a problem with Krispy’s reporting. 1) The Incentive Plan as implemented operated as a defacto

reserve accounting mechanism, reducing profit recognition in good quarters and releasing in bad, guaranteeing the earnings forecast.

2) When reacquiring a franchise, Krispy paid money to the franchisee on the understanding it would be paid. This allowed Krispy to record income in amounts roughly equal to the money paid to the franchisee.

The root cause of Krispy’s problem was the business model. Krispy made doughnuts, it sold directly to the public and to retail stores. It also sold to franchises product and equipment. The different outlets competed, quality went down, and consumer confusion reigned. Fortunately everyone’s favourite doughnut turned around and whilst the CEO and COO took the blame for the accounting there was no intention of fraud.

Audit quality study. A simple subject really. The ACCA and Macquarie University issue a report based on 3 study groups: CFO’s Directors, and Auditors. Perhaps unsurprisingly all agreed size matters, but the next three most important drivers of quality were:

Partner/manager attention to audit.

Partner knowledgeable of client industry.

Manager knowledgeable client industry.

Are you as unsurprised as ourselves that competent people paying attention to what they are doing delivers the highest quality outcome? Ask Mercedes at the 2016 Formula 1 Etihad Airways Abu Dhabi grand prix on 25, 26, 27 November. (Err Yes I did just receive my tickets!). When earnings management becomes cooking the books. The line between legitimate and inappropriate accounting techniques can be a blurry one, but the audit committee must endeavor to make a clear distinction. This article from Ira Millstein appeared in The FT Mastering Corporate Governance publication in May 2005. Prophetically Ira states: “It is important to bring back attention to the substance of financial reporting or risk even more regulation…Audit committee members can in good faith question the outside auditor about discretionary judgements resolved in management’s favour to effect a better earnings picture both currently and looking forward, notwithstanding compliance with GAAP.” Read the detail here.

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IFRS news, updates from ADAA, IASB and the Accounting Profession October 2016

Two new standards are coming and they both potentially affect the key performance indicators (KPIs) of revenue and profit which typically determine dividends and bonuses. If you are a shareholder, management, or employee, understanding how these standards affect your KPIs is imperative. IFRS 15 Revenue from contracts with customers is mandatory from 1 January 2018, IFRS 16 Leasing one year later. However because both can be adopted early or not, there is opportunity for management to bring forward or defer recognition of revenue and profit. Meaning there is opportunity for management to bring forward or defer payment of dividends and bonuses. This is a timing issue. The new standards do not increase or decrease total amount of revenue or profit. However, if you have recognised revenue under IAS 18 that is not recognised until later under IFRS 15, at least for presentational purposes you will be doubling up. IAS 17 operating lease accounting frontloads profit recognition compared to finance lease accounting. It can also result in earlier profit recognition in sale and lease back transactions. IAS 11 and 18 bundling revenue contracts together results in smoothing revenue and profits across reporting periods. Unbundling results in more volatile revenue and profit recognition. There was a huge outcry against changing the status quo from some accountants and lawyers in developing these new standards, specifically because they affect profit recognition. IAS 17 and 18 (issued by the IASB in 2001) are based on standards issued in the 1980s. Globalization did not exist, nor data packages, the internet and Twitter. 17 and 18 are risk and reward standards, and that caused a problem. 17 interacts with IAS 16 and 18 with IAS 39. 16 and 39 are control standards. Risk and reward are matters of judgement control is a matter of fact. The application of judgement rather than fact results in differing accounting outcomes euphemistically referred to as diversity in practice. A higher propensity to accept the risk your accounting might be wrong, means you will likely recognize more revenue under IAS 18 than a conservative accountant. The recognition test in 18 is probable. In IAS 17 it is substantially transfers. Probable is a 51% test, substantially a 90% test that leaves a 39% gap in which the lawyers and structuring accountants like to play. So is this 1982 all over again? Thirty-four years later who is going to win? With IFRS 15 and 16 we don’t just gain two new standards and lose two old ones. We also lose IAS 11. IFRIC 4, 13, 15 and SIC 15 and 27. IAS 11 dates back to 1979, the year of Roger Moore as 007 in Moonraker. As with 007 IAS 11 is the accounting standard that delivers, delivers what the CEO wants. IAS 11 legitimized smoothing of profits, revenues and costs over and between accounting periods. Enabling provisions to be booked in good times, to release, when times were bad. What could possibly be wrong with that you may ask?

Well, applying IAS 11 relies on an excel spreadsheet. A spreadsheet that forecasts the future, based on managements’ judgment. Unfortunately when economic times change judgements can be wrong. That’s not a problem if appropriate disclosure is provided in the financial statements. Conversely, it is, if not. There are few businesses that operate on short cycles. A fisherman sells catch daily, but his fishing boat will last for years. The hotelier may charge for rooms daily, but the hotel will last for years. Neither fisherman nor hotelier can apply long term contract accounting to their revenues but the suppliers of boats and hotels can do. So with IFRS 15 will they still? It is quite difficult to say. Since issuing IFRS 15 the IASB has been testing and amending it. The latest amendment clarifies three things: 1) When performance obligations to deliver goods and/or services are

‘distinct’ and separately accounted. 2) When a license grants a right to use rather than a right to access. 3) When control determines principal or agent accounting. To implement IFRS 15 effectively and to get the accounting right a proper understanding of the commercial substance of the transaction is required. IAS 17 requires profit or loss arising on sale and operating lease back transactions to be recognised if the transactions are at fair value. Application of this in practice has always been difficult because commercially it makes no sense. Why incur the cost of building or buying a long life asset and then sell it and lease it back for the short-term? Why would a commercial entity do that? We can think of only a few situations:

A business needs cash. It sells its shop and agrees a short-term lease. Why? Because the business is not profitable and the solution is to downsize or exit via sale or closure. If things go wrong the shop is easily leased to another tenant, which is what the lessor factored in when they entered the arrangement. Otherwise, why did they buy it?

A shareholder needs cash. The business sells the shop and pays a dividend to the shareholder. To continue the business must lease back the shop. The business will be less profitable because the lessor needs a return but at least the shareholder has their cash.

IAS 17 says sale price and lease payment are usually interdependent because they are negotiated as a package. Which means unusually they cannot be interdependent, giving room for the lawyers and structuring accountants to play. IFRS 16 doesn’t say this. IFRS 16 says to determine if a sale has occurred go look at IFRS 15 and the criteria in IFRS 15 is all about control (and there is application guidance too!) The criteria for sale and leaseback accounting applies to both seller and buyer. This is a significant change. It was possible under IAS 17 to achieve different accounting for lessor and lessee for the same transaction. A bit of a ridiculous situation, but possible with a risk and rewards approach. Under IFRS 16 it is not, it is about control, which must mean the lessor and lessee accounting arrives at the same accounting treatment for the same transaction, which to the non-accountant seems obvious really.

Revenue and Lease Accounting – an insight from ADAA’s Hasina Al Adawi

IFRS news, updates from ADAA, IASB and the Accounting Profession November 2016

WHAT’S NEW FROM THE IASB?

You wouldn’t buy fake Christian Louboutin shoes would you? Inconsistent application of IFRS damages the brand. IFRS Trustees speak out. From accountant to Olympic gold. A courageous leap. ASB Japan study on goodwill and impairment. Finally on the back page Professional judgment – an insight from ADAA’s Sara Al Sajwani.

What’s material and what’s not? Are we expecting a materiality standard to be issued soon? Service Concession accounting. Guidance to reduce diversity in practice. Disclosure checklists and illustrative financial statements. Guidance in preparing financial statements. The Ewings of Dallas had nothing on the Antars of Brooklyn. You couldn’t make this stuff up.

You wouldn’t buy fake Christian Louboutin shoes would you? Inconsistent application of IFRS damages the brand. IFRS Trustees speak out. The Trustees release Review of structure and effectiveness. The IASB, work plan 2017-2021. These are difficult documents to read so, Hans Hoogervorst and Michael Prada provide a video on each one. The IASB will finish its industry standard on Insurance and probably revisit the temporary standard on regulated activities. Those aside the central theme is Better Communication and not just in financial statements. You will be aware of cutting the clutter, removing boilerplate and order and presentation discussions in the recent past, these continue. However, the trustees also focus on the IFRS brand. The Trustees speak: “It is important for IFRS standards to maintain their relevance by requiring entities to provide information that is useful to users. Inconsistent application of IFRS standards undermines their benefits,

both directly by reducing the quality of the information provided and indirectly by damaging the brand.” It is acknowledged policing the application of IFRS is the responsibility of Auditors and Regulators, however the IASB will going forward have a greater focus too. IASB’s implementation, adoption support and education activities are to be combined in one unit. IFRIC obviously continues. The IASB expects with a greater level of support and more involvement by the IASB before application of new standards will reduce the risk of practices inconsistent with the IASB’s objectives becoming established. What’s material and what’s not? Answer-anything (be it misstatements or omissions) if it could reasonably be expected to influence economic decisions. IASB issues Application of materiality to financial statements. Comment letters here. The IASB October staff update reports the challenge is far from over. Questions are being raised concerning the audience, focus and definition to primary users' needs and expectations. Have a read and be ahead of the pack here.

From accountant to Olympic gold. A courageous leap. Something a little different. Accounting isn’t just about standards and numbers. “Get comfortable with the uncomfortable, be passionate and focused, seek knowledge from others.” More in AICPA and CIMA’s JV CGMA publication on Gwen Jorgensen’s story here. ASB Japan study on goodwill and impairment.

Stock markets of US and Europe recognised larger amounts of goodwill compared to Japan and Australia.

US and Europe consistently show higher ratios of goodwill to net assets and goodwill to market cap.

In 2014, 32% of companies in the US and 25% in Europe had goodwill that exceeded 50% of net assets.

Based on the data collected to expense goodwill takes 82, 37, 34, and 9 years in the US, Europe, Australia and Japan. More here

Service Concession Accounting. FASB proposes guidance to reduce diversity in practice of who is recognised as the customer in a service concession agreement. Put simply it’s not the user it’s government. So those service concession assets they are government assets. IFRIC 12 take heed!

Disclosure checklists and illustrative financial statements. Most reporters and statutory auditors have them. They are welcome and useful practice aids but in the wrong hands, you get the wrong result. 2016 reporting deadline is just around the corner, apply professional judgment in determining whether a disclosure is required and what it needs to say. Recently released KPMG illustrative financial statements here and disclosure checklist here.

The Ewings of Dallas had nothing on the Antars of Brooklyn. You couldn’t make this stuff up. Not strictly from the profession! There is a new film in town called ‘the Accountant’ it alludes to the tale of Crazy Eddie and we think it is well worth a view.

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IFRS news, updates from ADAA, IASB and the Accounting Profession November 2016

Professional judgement – an insight from ADAA’s Sara Al Sajwani

“Of all the small nations of this earth, perhaps only the ancient Greeks surpass the Scots in their contribution to mankind." (Winston Churchill). Awarded a Royal Charter by Queen Victoria in 1854, 162 years later Sir David Tweedie President of the Institute of Chartered Accountants in Scotland (ICAS) presents its updated 2012 publication: A-professional-judgement-framework-for-financial-reporting. The publication is one of the first from ICAS since Sir David Tweedie left the post of Chairman of the IASB, the body that issues IFRSs, so it may indicate for IFRS users and reporters where to focus. In 2015, the SEC brought enforcement cases against 191 parties a 54% increase on the year before. The majority of these cases involved financial misstatement. A recent restatements analysis issued by Audit Analytics, found total financial statement restatements have increased 33% since 2001. The root cause of which was a professional judgment poorly made. Which is interesting, because US GAAP is said to be rules based, and IFRS principles based. So how is it possible to get a principle wrong? The golden triumvirate of Preparers, Auditors and Those Charged With Governance (TCWG) review management judgements so how did all three get a judgement wrong. Humans are naturally optimistic their actions will result in a positive outcome, if not prehistoric man would have stayed in his cave, Columbus not have set sail and Boeing not have invented the 747.

‘Optimistic’ appears 5 times in IFRS, ‘pessimistic’ just once: IAS 36 ”Recoverable amount based on the higher of net selling price and value in use...enterprise may make an over-optimistic (pessimistic) estimate of recoverable amount” and “Subsequent cash flow test…losses by using over-optimistic cash flow projections in the value in use calculations.” IAS 19 banning recycling could encourage abuse in setting over-optimistic actuarial assumptions. IFRS 9 the assessment of whether lifetime expected credit losses should continue to be recognised after modification may be perceived to be based on projections that are optimistic. The IFRS Framework Chapter 3 Qualitative characteristics of useful information. “Chapter 3 does not include prudence or conservatism as an aspect of faithful representation because including either would be inconsistent with neutrality. Some respondents disagreed with that view. They said that the framework should include conservatism, prudence or both. They said that bias should not always be assumed undesirable, especially in circumstances when bias, in their view, produces information that is more relevant to some users. Deliberately reflecting conservative estimates of assets, liabilities, income or equity has sometimes been considered desirable to counteract the effects of some management estimates that have been perceived as excessively optimistic. However, even with the prohibitions against deliberate misstatement that appear in the existing frameworks, an admonition to be prudent is likely to lead to a bias. Understating assets or overstating liabilities in one period frequently leads to overstating financial performance in later periods—a result that cannot be described as prudent or neutral.”

So how does Sir David Tweedie’s publication help? One cannot blame the CEO for being over optimistic it’s her job. So do we blame the CFO, TCWG or the Auditor? CFOs (and the finance team) are the first line of defence they gather the knowledge, analyse the transaction and apply the appropriate accounting. If they are proactive, they do this throughout the year so the CEO can decide what actions are required to achieve forecasts. Period 13 adjustments will be rare. Sale and lease back transactions will be rare. Unusual one-off type transactions will be rare. Auditors are the second line of defence they challenge management’s judgement. ISAs require a questioning mind, an alertness to possible fraud or error, and critical assessment of the evidence. That should be enough, shouldn’t it? But it isn’t. Third line of defence are TCWG, typically the Audit Committee, drawn from the non-executive directors of the Board, one of whom should be an accountant. TCWG challenge and assess managements’ judgments and the presentation of transactions by ensuring the facts are clearly laid out, the right people discuss, there is enough time for a full debate, and the culture is conducive to debate and challenge. This involves a review of both CFO’s and Auditor’s papers to assess and constructively challenge the CFO’s judgement and the auditor’s analysis. The final decision is made after assessing and concluding based on the facts available and the responses provided. The fourth line of defence is a line of defence for the consistent application of IFRS in the jurisdiction in which the entity is regulated. The IASB doesn’t do this. Auditors and Regulators do. Two fundamental principles of IFRS are consistency and comparability. ICAS urges Regulators to challenge judgements based on the determinable facts available at the time of the decision rather than using hindsight. And whilst we greatly admire and agree with Sir David’s work with the IASB we can’t agree on this. As British Indie Band Bastille’s sing in ‘Hanging’ hindsight is a wonderful thing. We agree management, preparers and auditors should be prepared to defend the positions taken and judgements made based on available information. If however, later information is available that demonstrates the judgment was wrong. The question of why must be addressed. Could it be self-interest narrowed toward justifying a favorable treatment? Could it be familiarity or trust misplaced that the uncertainty will be solved? Or intimidation is too great and deters objective action? Or was the later information just not possible to know when the judgement was made? It is a question of balance. It is not healthy to burn the candle from both ends. At some point something gives. Accounting is no different. If judgements are too aggressive, the accounting will be wrong. If too prudent, the accounting will be wrong. If targets are too challenging they will not be met too easily and if not they will be easily beat. History tells us a key failure in coming to a wrong conclusion was a failure to understand the business. Lehman Brothers failed because it ran out of cash so maybe window dressing the balance sheet was not such a good idea. Accounting should be (mostly) straight forward and embedded in the business anything that is a one off or requires close scrutinisation of a discounted cash flow spreadsheet model is not a great idea.

IFRS news, updates from ADAA, IASB and the Accounting Profession December 2016

WHAT’S NEW FROM THE IASB?

At the end of the day, you manage correctly what you measure correctly. Rather run the risk of taking a sledgehammer to crack a nut than taking a miniature rock hammer to tunnel out of prison. French accounting’s problematic relationship with fair value reflects the ‘markets must be firmly led from the top’ thinking of John-Baptiste Colbert. Every now and then a few little nuggets of sense appear that ties somethings in. We focus on Haans’ last three speeches.

Beware of Value in Use. Valuations is a hot topic for the regulators at IFIAR. IFRS 15 time is running out. Regulators are requesting transparency on the impact of implementing IFRS 15. The IFRS 15 Mole. This month’s suspect is unidentified contracts. And finally on the back page - The disclosure conundrum an insight from ADAA’s Syed Shabbir.

At the end of the day, you manage correctly, what you measure correctly. Haans makes three interesting speeches: Performance reporting and stability. Low interest rates are no free lunch. Safety in GAAP numbers. Every now and again a few little nuggets of sense appear. In December, Hans delivered us three! Interestingly at a time when the IASB appoints a French national to the Board, Hans references the ‘lead the markets from the top’ instincts of Colbert the Minister of Finances of France for King Louis XIV during the French Dutch War of 1672-78. We all know the French never liked fair value accounting because of the short-term volatility it brings. The cost model is worse argues Hans because it is easy to hide poor financial performance by selling some old assets. Long-term investment should not be encouraged by artificial accounting stability in the numbers. Long-term investment is best served by transparency that the public can trust. The Dutch Pension system, probably the best capitalised in the

World, is acutely aware of the collateral damage of low interest rates. Since 2007, the assets to liabilities ratio has fallen 40%, despite cuts in benefits. The problem is not just a Dutch one, it is a world one and it is driving a debate about the measurement of the pension liability. IAS 19 requires the liability to be measured using a discount rate that reflects a fixed interest return. Critics say if the pension fund is invested in say equities, with a higher expected return, then meeting the future pension liability requires fewer assets and the liability is overstated. An understandable argument. Trouble is, that leads to pension funds investing in more risky assets to achieve higher returns, exactly what is not required in bringing a pension deficit under control. Non-GAAP numbers that consistently flatter a company’s performance are probably not the for sound business decisions. Audit Committees should be concerned by the use of numbers management have determined for themselves. All involved in managing a company should realise there is safety in the GAAP numbers. They are rigorous and based on sound economic principles. They should serve as an anchor, not just in the reporting, but also in management decisions. At the end of the day, you manage correctly what you measure correctly.

Beware of Value in Use. PWC talk through common pitfalls. Valuations has been a hot topic for meetings of the regulators at IFIAR and regulators now have a fair amount of enforcement experience. IAS 36 allows recoverable amounts to be assessed at the higher of fair value or VIU and there is a perception VIU is a more ‘lenient’ method of assessment. It isn’t. It has some prescriptive rules which PWC translates into plain English: “33(a) Reasonable and supportable assumptions that represent management’s best estimate of the range of economic conditions that will exist over the remaining useful life of the asset. Greater weight shall be given to external evidence.” = Make good faith estimates. Do not ignore market data. “33(b) base cash flow projections on the most recent financial budgets/forecasts approved by management, but exclude any estimated future cash inflows or outflows expected to arise from future restructurings or from improving or enhancing the asset’s performance. Projections based on these budgets /forecast shall cover a maximum period of five years, unless a

longer period can be justified.” = Do not create a special forecast for your impairment testing. Test the asset or business you own, not the business or asset you hope to make it into. Click here for more. IFRS 15 time is running out. Regulators are requesting transparency on the impact of implementing IFRS 15. Click here for more. The IFRS 15 Mole. PWC revenue specialist John Chan reports monthly intelligence on the implications of the new revenue standard. This month’s suspect is unidentified contracts. Contracts can be written, verbal or based on normal business practice. The contract must be; approved by both parties, rights to be transferred and payment terms identifiable, and the contract has to have commercial substance. Fail one of these and there is no contract(s) and therefore no revenue. The answers will not be found in the Finance team. The Sales and Marketing teams should know what has been promised to customers. Written terms can be different from the customers’ expectations. So there is a need to consider any correspondence or side letters with customers as well as verbal understandings and normal business practices. Any of these could affect the accounting. More here.

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IFRS news, updates from ADAA, IASB and the Accounting Profession December 2016

The disclosure conundrum – an insight from ADAA’s Syed Shabbir

If William Shakespeare were an accountant might Hamlet’s soliloquy begin…To disclose or not to disclose that is the question. The disclosure conundrum has more in common with the Bard’s Hamlet than you might suspect. Hamlet is far from alone. Ophelia is pretending to read while she waits for Hamlet to notice her, and Claudius and Polonius, have set Ophelia there to overhear their conversation and find out if Hamlet is really mad or only pretending, are hiding behind a tapestry. Even so, Hamlet seems to consider himself alone. We accountants are not alone though, we have the IASB, and we have each other. The objective of IAS 1 is “…to ensure comparability both with the entity’s financial statements of previous periods and with the financial statements of other entities.” IAS 1 is a pure disclosure standard. It does not help you decide what your accounting should be it only helps you explain to others the choices you made. So what can go wrong? “No CFO was ever sacked for producing voluminous disclosures, whilst restatements may be career-limiting.” Said Hans the current Chair of the IASB. Whilst this is undoubtedly true, boilerplate information is not usually “information about the financial position financial performance and cash flows that is useful to a wide range of users in making economic decisions.” Which is the purpose of financial statements disclosed in IAS 1.9. IAS 1.117 requires disclosure of significant accounting policies comprising the measurement basis used and policies that are relevant to understanding the financial statements. Including policies that are not significant clutters the financial statements and distracts from what is significant. The IASB disclosure project amended IAS 1 and gave license to preparers of financial statements to change how they report, to leave out the immaterial, to eliminate cut and paste repetition from the accounting standards, and to change the order of accounting policies and notes to an order that makes more sense. The question is – how much have you changed. Significant accounting judgements and estimates. Many transactions can be measured with a high degree of accuracy. A few transactions may not. A few transactions may require professional judgement to be applied. A few means, not many. If you disclose many significant accounting judgements and estimates is that not an indicator that fundamentally something is wrong. An honest conversation with your friendly Statutory Auditor might be a good idea. The IAS 1.122 requirement is to disclose the judgements management has made in the process of applying the accounting policies that have the most significant effect on the amounts recognised in the financial statements. It is not a requirement to restate the accounting policies you already decided as the most significant in accordance with IAS 1.117. IAS 1.123 provides three examples of what those judgements might be: 1) When substantially all of the significant risks and rewards of ownership

of financial assets, and for lessors, assets subject to leases, transfer to other entities.

2) Whether in substance particular sales of goods are financing arrangements and do not give rise to revenue, and

3) Whether the contractual terms of a financial asset give rise on specified dates to cash flows that are solely payment of principal and interest on the principal outstanding amount.

Contrast those atypical examples with what you see in your financial statements. Some of the disclosures required by IAS 1.122 are required by other IFRSs. E.g. IFRS 12 when determining control and IAS 40 the criteria for determining investment property, separate from own use, separate from held for sale. IAS 1.125 requires disclosure about assumptions made about the future and other major sources of estimation uncertainty that has a significant risk of resulting in a major adjustment to the carrying amounts of assets and liabilities within the next financial year. The required disclosures are a) nature and b) their carrying amount. And quite often that is all that is provided. However, IAS 1.129 states disclosure is provided to help users understand the judgements management makes. This is not just nature but also sensitivity of carrying amounts to methods, assumptions and estimates underlying their calculation, including the reason for the sensitivity, what the expected resolution is, and the range of reasonably possible outcomes. Often this is not provided. IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. When a new IFRS is issued but is not yet effective, IAS 8.30 requires disclosure of known or reasonably estimable information, relevant to assessing the possible impact application of the new IFRS will have or if that impact is not known or reasonably estimable, a statement to that effect. And more often than not this is what is said – we don’t know… The new standard are;

• IFRS 9 Financial Instruments.

• IFRS 15 Revenue from Contracts with Customers.

• IFRS 16 leases. What is known, is a matter of fact. What is reasonably estimable is a matter of judgement. If you don’t know something you can’t disclose something. The IASB knows this so they make it easy for you. That is why IFRS 16 Appendix C has more practical expediencies than you can shake a stick at, which at its simplest says on the date of initial application simply switch all operating leases onto the balance sheet. It doesn’t seem too hard for that impact to be reasonably estimable does it? A final thought. Using generic and boilerplate disclosure does not comply with the spirit of paragraph OB2 of the IFRS Conceptual Framework which states: “The objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investor, lenders and other creditors in making decisions about providing resources to the entity”. It is that time of the year when many resources will be invested in completing your financial statements. Meeting regulatory and other reporting deadlines becomes a paramount challenge. However, it is equally important to ensure that your financial statements tells appropriately your unique story and is not merely a measure of compliance. Related preceding publications available on ADAA’s website here.

ADAA IFRS digest

IFRS news, updates from ADAA, IASB and the Accounting

Profession

December 2016

ADAA EDITORIAL TEAM

Sara Al Sajwani

Khulood Al Reyami

Ebrahim Al Shaikh Ali

Faris Theyab

Ali Al Neyadi

Mohamed Al Shehhi

Mahmoud Shahin

Muhammad Shabbir

Ahmed Al Meleegy

Steven Ralls

Head of Accounting and Auditing Standards

AASD@adaa.abudhabi.ae

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