IFRS hot topics and accounting in the digital age
Marek Walendowski, Director, Ernst & Young LLP and
Jane Hurworth, Associate Partner, Ernst & Young LLP
Marek and Jane provided an update to participants on a number of topical accounting matters for the banking industry.
Hedge accounting disclosures:
In preparation for the conference, Jane carried out a benchmarking exercise on the hedge accounting disclosures of 16 global banks, the majority of which are domiciled in Europe.
Her findings indicated a high level of compliance with IFRS 7 - Financial Instruments: Disclosures requirements across the sample. Most disclosures were provided within a single hedge accounting note with some cross references to risk management reports and the statement of comprehensive income. Jane suggested to participants that these cross references could be more specific, especially if the cross reference is to a lengthy risk report where the underlying information may be hard to locate.
Other improvement points that Jane highlighted were:
- Hedge ratios were often not disclosed, perhaps because the user is left to assume the ratio is 1:1. Greater clarity on these ratios would be useful.
- Disclosures of sources of ineffectiveness tended to be boilerplate in some instances. More tailoring to the specific hedging relationships would be an improvement.
- Average prices or rates of hedging instruments in fair value hedge relationships were often not disclosed.
Overall, the new disclosures provided users with improved information on a bank’s hedge accounting.
Impact of IFRS 16 - Leases (IFRS 16) on the banking sector:
Marek benchmarked 18 European banks’ IFRS 16 transition disclosures based on their 2018 financial statements. The vast majority of banks applied a modified retrospective approach, under which the right of use asset was set as equal to the lease liability. Some banks also followed a modified retrospective approach, but measured the right-of-use asset as if the standard had been applied since commencement date.
The reduction in the banks’ common equity tier (CET) 1 ratio due to implementation of IFRS 16 ranged from 0.05%-0.22%, although the impact on total assets and total liabilities is likely to be far larger. The impact tended to be larger for banks which leased rather than owned large items of property plant and equipment (PPE) such as head offices or datacenters.
Marek also alerted the audience to the IFRS Interpretations Committee’s (IFRS IC) discussions in June 2019 on determining the lease term and calculating incremental borrowing rates. These remain judgmental areas.
Changes to IT operating infrastructure:
In the new digital world, many banks are moving away from traditional, asset-driven IT infrastructure and implement outsourced or cloud based IT services. The focal points for accounting in this environment are:
- The appropriateness of assets’ useful lives
- Accounting for flexible third-party cloud computing services
- The approach to capitalization of development costs for software developed using an agile approach
Marek noted that there is a variety of cloud computing services available to banks. In general, as vendor managed options become more off-site, it is harder to justify capitalization of costs relative to these services. To reiterate this point, he referred participants to the IFRS IC’s conclusion in March 2019 that contracts conveying the right to receive access to software in the future are services, not leases.
On agile approaches to software development, the key accounting challenge under the current standards is to demonstrate which costs are incurred during a development phase rather than in a research phase as no clear lines separating these phases exist under an agile project approach. Initial indications from banks implementing these services are that they either rely on detailed time tracking by development teams or they attempt to estimate capitalization ratios per user story (a description of a software feature from an end-user perspective which defines what they want and why) prior to the project and then they re-assess the ratio as the project progresses. This remains an area where practice, and possibly accounting standards, will probably emerge over time.
From a regulatory perspective, proposed changes to the regulatory treatment of capitalized software, under which certain ‘prudently valued’ software assets will be excluded from the scope of the deduction from the CET 1 ratio, are likely to drive increased focus on the capitalization of these amounts.
Measurement of equity investments in start-up entities:
Jane reminded participants of IFRS 9’s requirements to measure investments in equity instruments at fair value. This remains a challenge for banks that invest in start-up entities with potential to improve their operating model or distribution channels. Where the fair value of the investment has changed materially since initial recognition, re-measurement at fair value will be essential.
Marek briefly took participants through the March 2019 IFRS IC tentative agenda decision regarding the accounting for cryptocurrencies which are:
- Not issued by a jurisdictional authority or other party
- Don’t give rise to contracts between the holder and the other party
The IFRS IC concluded that accounting treatment depends on whether the asset is held for sale in the ordinary course of business. This decision was subsequently confirmed after the conference at the June 2019 IFRS IC meeting.