Specialized Industriesand Hyperinflation: IFRS 4,

IAS 26, and IAS 29

Wiecek and Young

IFRS PrimerChapter 36

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Specialized Industriesand Hyperinflation

Related standards Part 1: Insurance Contracts IFRS 4 Part 2: Accounting and Reporting by Retirement

Benefit Plans IAS 26 Part 3: Financial Reporting in Hyperinflationary

Economies IAS 29 Current GAAP comparisons Looking ahead End-of-chapter practice

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Related Standards

Part 1: Insurance Contracts FAS 163 Accounting for Financial Guarantee Insurance Contracts FAS 120 Accounting and Reporting by Mutual Life Insurance Enterprises and by

Insurance Enterprises for Certain Long-Duration Participating Contracts FAS 113 Accounting and Reporting for Reinsurance of Short-Duration and Long-

Duration Contracts FAS 97 Accounting and Reporting by Insurance Enterprises for Certain Long-Duration

Contracts and for Realized Gains and Losses from the Sale of Investments FAS 60 Accounting and Reporting by Insurance Enterprises

Part 2: Accounting and Reporting by Retirement Benefit Plans FAS 35 Accounting and Reporting by Defined Benefit Pension Plans

Part 3: Financial Reporting in Hyperinflationary Economies FAS 52 Foreign Currency Translation

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Related Standards

Part 1: Insurance Contracts Framework for the Preparation and Presentation of Financial

Statements IAS 37 Provisions, Contingent Liabilities and Contingent Assets IAS 39 Financial Instruments: Recognition and Measurement

Part 2: Accounting and Reporting by Retirement Benefit Plans IAS 19 Employee Benefits

Part 3: Financial Reporting in Hyperinflationary Economies IAS 21 The Effects of Changes in Foreign Exchange Rates

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Part 1: IFRS 4 – Overview

Objective and scope Recognition and measurement Disclosure

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Part 1: IFRS 4 – Objective and Scope

Purpose – applies only to the financial reporting for insurance contracts by the issuer of such

contracts

Standard is limited to(a) insurance contracts, including reinsurance contracts that an entity issues and

reinsurance contracts that it holds(b) financial instruments that an entity issues with a discretionary participation feature

Insurance contract – one party (insurer) accepts significant insurance risk from another party

(policyholder)– insurer agrees to compensate policyholder if uncertain future event adversely affects

the policyholder

Reinsurance contract – is one issued by an insurer (the reinsurer) to compensate another insurer (the

cedant) if an insured event occurs

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Part 1: IFRS 4 – Recognition and Measurement

Temporary Exemption from Other IFRSs provisions of IAS 8 that specify how accounting policies are chosen an insurer is not required to apply the “Framework” in determining how to

account for insurance contracts it issues or reinsurance contracts it holds Specific accounting policies are prohibited and others are required:

(a) Liabilities cannot be recognized for possible future claims under contracts that do not exist at the financial statement date

(b) Liabilities must be tested at the end of each reporting period to ensure the amounts recognized are adequate

(c) Reinsurance assets must be tested for impairment(d) Insurance liabilities are removed from the statement of financial position only

when the related obligation is discharged, cancelled, or it expires(e) Reinsurance assets cannot be offset against insurance liabilities and reinsurance

contract income or expenses cannot be offset against insurance contract income or expenses

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Part 1: IFRS 4 – Recognition and Measurement

Changes in Accounting Policies

IFRS 4 sets out requirements related to accounting changes that move the insurers closer to the criteria in IAS 8

IFRS 4 allows insurers to change their accounting policies only if(i) the resulting financial statement information is more relevant and not less

reliable, or

(ii) it is more reliable and not less relevant.

Specific policies can continue to be used, but are not permitted to change: (a) measuring insurance liabilities on undiscounted basis

(b) measuring contractual rights to future management fees at more than their fair value, as implied by the current fee levels charged by others for similar services

(c) applying non-uniform accounting policies for subsidiaries’ insurance liabilities

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Part 1: IFRS 4 – Recognition and Measurement

Contracts Acquired in a Business Combination or Portfolio Transfer

An insurer is permitted, but not required, to use an expanded form of presentation to split up the following:

– fair value of insurance contracts acquired in a business combination – fair value in the acquisition of a portfolio of such contracts

Expanded presentation results in recognition of intangible assets that are excluded from IAS 38 and IAS 36

Discretionary Participation Features Refers to the contractual right of a policyholder to receive significant benefits

supplementary to those guaranteed by the contract The benefits are contractually based on the performance of a specified group

of assets– the amount or timing is at the discretion of the issuer

Part 1: IFRS 4 – Disclosure

Disclosure requirements of IFRS 4 have two main objectives:

1. identify and explain the amounts in an insurer’s financial statements that arise from insurance contracts

2. provide information useful to users of financial statements in their assessment of the nature and extent of risks associated with these contracts

Examples of required disclosures meant to satisfy the first objective

• accounting policies for the contracts and all related assets, liabilities, income, etc.

• reconciliations of changes in insurance liabilities, reinsurance assets, and related deferred acquisition costs

Examples of disclosures designed to meet the second objective • policies and methods used to manage risks related to insurance contracts

• sensitivity analyses relating changes in risk variables and their effect on profit or loss

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Part 2: IAS 26 – Overview

Objective and scope Defined contribution plans Defined benefit plans All plans: valuation of plan assets Disclosure

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Part 2: IAS 26 – Objective and Scope

Purpose – sets out the accounting and reporting standards for retirement benefit plans as a

basis for the plans’ reporting to all participants as a group

– applies to both defined benefit and defined contribution plans

Retirement benefit plan– an arrangement in which an entity provides annual income or lump sum benefits

to employees at or after the termination of their service

Most retirement benefit plans are based on formal agreements – require separate funds to be established to receive contributions and pay the benefits– such funds are usually administered by an independent party, often called a trustee

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Part 2: IAS 26 – Defined Contribution Plans

Benefits paid to plan participants are a function of the following: – participant and employer contributions into the plan– the return earned on the plan assets– the operating efficiency of the plan’s management

Financial reporting objective (inclusions to the financial statements):(a) a description of the significant activities for the period

(b) a report on the period’s transactions and investment performance, and the plan’s financial position at the end of the period

(c) a description of the investment policies Required presentations:

– a statement of net assets available for benefits – a description of the funding policy

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Part 2: IAS 26 – Defined Benefit Plans Defined benefit plan

– one in which the benefits paid are determined by a formula, usually based on employees’ earnings and/or length of service

The ultimate payment of the promised benefits is dependent on – the financial position of the plan– the ability of contributors to make future contributions– the investment performance and operating efficiency of the plan

Additional reporting objective: – actuarial information on the plan’s obligations and the extent to which these have been

provided

Required information in the plan’s actual financial statements:• net assets available for benefits

• actuarial present value of the obligation for vested retirement benefits and for non-

vested benefits

•explanation of the resulting excess/deficiency of assets available

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Part 2: IAS 26 – All Plans: Valuation of Plan Assets

Retirement benefit plan investments – carried at fair value

in the case of marketable securities this is the market value

When it is not possible to determine an investment’s fair value, the reason must be provided

Other assets used in the operations of the plan are accounted for under applicable IFRSs

Part 2: IAS 26 – Disclosure Required disclosures for both defined contribution and defined benefit plans:

1. a statement of changes in net assets available for benefits

2. a summary of significant accounting policies

3. a description of the plan and the effect of any changes to it during the period

The statement of changes in net assets available for benefits is similar to an income statement and reports

• contributions into the plan, both from the employer and the employee

• investment income such as interest and dividends, and other income

• benefits paid or payable, classified by type

Additional disclosures– information about its benefit obligation– the funding policy and the significant actuarial assumptions made

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Part 3: IAS 29 – Overview

Objective and scope Restatement of financial statements Disclosures

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Part 3: IAS 29 – Objective and Scope

Purpose – sets out how an entity whose functional currency is the currency of a

hyperinflationary economy should restate its financial statements Functional currency

– the currency of the primary economic environment in which entity operates Hyperinflation

– the standard indicates this is a matter of judgment – IAS 29 does not pinpoint a specific rate

Conditions that are characteristic of a hyperinflationary environment:• the country’s wealth is kept in non-monetary assets or in a stable currency

• prices may be quoted in another more stable currency.

• key economic variables are linked to a price index.

• cumulative inflation over three years is high, at close to 100% or more

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Part 3: IAS 29 – Restatement of Financial Statements

An entity whose functional currency is the currency of a hyperinflationary economy– must restate its current period financial statements in terms of the measuring unit at

the end of the reporting period– restate the comparative figures for the previous periods reported in the same way

This requirement applies whether the entity uses a historical cost approach or a current cost approach on its primary statements

Historical Cost Financial Statements Include some recognition of changing prices

– not the same thing as statements prepared on a current or replacement cost basis Specifics:

– restated items cannot be reported at amounts greater than their recoverable amount– restated inventory is reduced to a lower net realizable value– gain or loss on the entity’s net monetary position is included in profit or loss and is

reported as a separate line item

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Part 3: IAS 29 – Restatement

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Part 3: IAS 29 – Restatement of Financial Statements

Current Cost Financial Statements have been adjusted to reflect the effects of changes in the specific prices of assets held the adjustment process is different

– an item’s current cost or replacement cost at the balance sheet date is already expressed in a measuring unit that is current at the end of the period

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Part 3: IAS 29 – Other Issues A variety of other items are addressed by this standard:

• general price index reflects the changes in general purchasing power

• differences between restated amounts and their carrying values in statement of financial position may give rise to deferred taxes

• all items in statement of cash flows are expressed in terms of measuring unit current at the end of the reporting period

• corresponding figures on comparative financial statements are restated in terms of the current period-end measuring unit

• when an economy ceases to be hyperinflationary, entity uses amounts expressed in the measuring unit current at end of the last reporting period as beginning carrying amounts in its subsequent statements

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Part 3: IAS 29 – Disclosures Disclosures are needed in restated financial statements so that the

basis for dealing with the effects of inflation is clear and the results are understandable

What does the entity need to report?– that current and comparative financial statements have been restated for

changes in the general purchasing power of the functional currency – that statements are restated into the measuring unit current at the balance

sheet date

What does the entity need to identify? – whether the statements restated were based on historic cost or current

cost– information about the general price levels and changes in them during the

current and previous periods

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Topics 1, 2, 3: Current GAAP Comparisons

Pages 6, 22, 44 & 152 of 164 ofhttp://www.kpmg.co.uk/pubs/IFRScomparedtoU.S.GAAPAnOverview(2008).pdf

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Looking AheadPart 1: Insurance Contracts IASB

– developed a project on insurance contracts because these contracts are excluded from other relevant IFRSs

due to the diversity of policies being applied by entities with such contracts

– IFRS 4 is the result of the first phase of the project– the second phase will eventually replace this existing interim

standard expected to address accounting by both insurers and

policyholders– in 2007 released a paper which focused on measurement of

insurance liabilities– expects to issue an exposure draft in 2009, with a final standard

planned for 2011– project is not part of the IASB’s Memorandum of Understanding

with the FASB

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Looking AheadPart 2: Accounting and Reporting by Retirement Benefit Plans IASB

– not on the current agenda IASB and FASB

– long-term convergence project – there may be changes in employer’s accounting for employee benefits, to extent any

decisions from this project affect measurements within the plans

Part 3: Financial Reporting in Hyperinflationary Economies IASB

– has not included reporting in hyperinflationary economies on its current project list

Future – conventional financial statements will report more assets at amounts closer to measures

based on current period-end measuring units

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End-of-Chapter Practice

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End-of-Chapter Practice

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End-of-Chapter Practice

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