‘IFRS 9 transforms the way banks financial assets and liabilities will be accounted for’

Innocent Okwuosa is IFRS consultant with Entop Consulting Limited, UK and a member of the Governing Council, Institute of Chartered Accountants of Nigeria. He is the Deputy Chair Financial Reporting Faculty of ICAN and a doctoral researcher at University of Reading. Recently, he was in Nigeria and spoke to Iheanyi Nwachukwu. Excerpts  

You are an IFRS Consultant in UK and lecture International Financial Reporting at University of Liverpool, and a doctoral researcher in accounting at University of Reading, are there developments in IFRS that will be of interest to Nigeria.

First of all Nigeria has adopted IFRS and the nature of IFRS is that it keeps changing. This is because financial reporting operates in a dynamic business environment. The dynamic nature of global business environment in which IFRS operates compels it to be in a constant evolutionary state such that there must always be developments that will be of interest to any country that has adopted.

Can you give a highlight of such developments?

Developments can always be found in the International Accounting Standards Board (IASB) plan on newly published Standards, upcoming Standards, published Exposure Drafts, upcoming Exposure Drafts, published Discussion Papers and upcoming Discussion Papers.

On newly published Standards, I will only speak in terms of those already issued but are effective or will become operational in future years such as IFRS 9 that will transform the way assets and liabilities of banks especially financial assets and liabilities will be accounted for going forward.

This is in the area of measurement, recognition and impairment testing. Although it is aimed at simplifying the complexities of current measurement and recognition under IAS 39 where you have four different classifications for financial assets and liabilities, many will still find that it may not have simplified these as one would have thought, having introduced the concept of business model in the process. The question is whether the business model described in that IFRS 9 is the concept of business model out there in the business world?

The practicalities of it becomes obvious when you consider the concept of business model as described by another wider and far reaching standard or will I say framework – the Integrated Reporting Framework, issued by International Integrated Reporting Council (IIRC), but that is a discussion for another day. IFRS 9 is effective January, 2018 and now is the time to begin to key into the knowledge as it will have far reaching effect on bank’s assets and liabilities especially the application of the new impairment test model.

The IASB published a Discussion paper on ‘Reporting the Financial Effects of Rate Regulation’ that considered common features of rate regulation, exploring which of them, creates a combination of rights and obligations that are distinguishable from the rights and obligations arising from activities other than rate-regulated.

In December 2012, the IASB developed an interim Standard which provides short-term guidance for first-time adopters pending completion of the project.  IFRS 14 Regulatory Deferral Accounts was issued in January 2014 and is effective for financial statements periods beginning on or after 1 January 2016. Early application is permitted. But remember the work is on-going as what we have is an interim standard.

Under upcoming Standards we have IFRS 4 on Insurance Contracts and IAS 17 on Leases. While IFRS 4 on Contracts is currently at Analysis stage, IAS 17 on Leases is at the drafting stage with the expectation that a substantive standard will be issued within the next 3 months. But this standard on Lease has been so controversial because of its far reaching proposal to abrogate the dichotomy between Finance and Operating Leases with the introduction of ‘right of use’ as the main operating word. I doubt whether there will be that standard in the next three months as envisaged.

Under published Exposure Drafts, we have Conceptual Framework, whose comment period just ended last month and the direction of the project is expected to be within the next 6 months.  Then we have the Disclosure Initiative: Materiality Practice Statement, whose aim is to reduce the voluminous annual report and its verbosity. During awareness creation and implementation of IFRS in Nigeria, those of us that did training use phrases like ‘IFRS is about transparency, disclosure, disclosure, disclosure’. It has seen became clear to users that this disclosure creates volume in financial report and leads to clutter that distracts from the message being communicated, hence the need for this project. Financial Reporting Council in the UK carried out a similar exercise to reduce clutter in UK financial reports. So under IASB initiative, materiality becomes the key determinant of whether an item should be disclosed or not.

Under upcoming Exposure Drafts we have ‘Disclosure Initiatives: Changes is Accounting Policies and Estimates’ which is currently under analysis. Of course there is a link between accounting policies disclosure and the wider Disclosure Initiative I have earlier talked about as IAS 8 that deals with Accounting policies is all about disclosure.  It is the thinking of IASB that it will be able to publish Exposure Draft within the next 6 months.

Under Published Discussion Papers, we have ‘Dynamic Risk Management: a Portfolio Revaluation Approach to Macro Hedging’ that I spoke about before which again is at analysis stage and IASB expects to publish a Discussion Paper within the next 6 months. The Accounting for Dynamic Risk Management project was discussed at the May, 2015 IASB meeting. In addition we have, ‘Rate Regulated Activities’ another topic that IASB expects to publish a Discussion Paper within the next 6 months.

Finally under analysis is, ‘Disclosure Initiatives: Principles of Disclosure’ that a Discussion Paper is expected. That is a brief overview.

You talked about newly and upcoming Standards, Exposure Drafts, Discussion Papers and analysis, what is the difference between them and how does one distinguish between them.

This will take us to IASB due process of standard setting.  IFRSs are developed through an international consultation process which the IASB refers to as the “due process”. This involves interested individuals and organisations from around the world. That due process comprises six stages and as IASB makes us to understand, the Trustees of the IFRS Foundation ensures compliance at the various stages which are: Setting the agenda

The IASB considers investors needs and determines whether a topic of interest is added to its work plan and agenda. That is done through asking its staff to identify, review and raise such issues that might warrant the IASB’s attention. Then it passes through the next phases: planning the project; developing and publishing the Discussion Paper, including public consultation; developing and publishing the Exposure Draft, including public consultation; developing and publishing the Standard; and procedures after an IFRS is issued.

You talked about public consultation, does the Nigerian public participate in this process

If Nigerian public is not participating, then it must be an awareness issue. The IASB standard setting process is such that individuals, companies, industry representatives, professional organisations, NGOs, National Regulatory bodies can participate in the process. But what you find is that many of those who participate and exert influence are from Developed countries and most institutions in Nigeria are absent including our Financial Reporting Council who I expect to bring to bear African financial reporting on IFRS standard setting. This is because it is through this process that peculiar circumstances of peculiar economies are brought to the attention of IASB IFRS. However I know that the Institute of Chartered Accountants of Nigeria (ICAN) has of late been participating by sending responses to Exposure Drafts through comment letters, the depth of which I consider to be shallow but at least it is the first step in the right direction.

You talked about ICAN commenting and I understand you are a Council member of the Institute and a member of the Financial Reporting Faculty, why is ICAN not liaising with FRC in that direction.

Yes I am not just a member of ICAN Financial Reporting Faculty but the Deputy Chair of that faculty. Being a Council member, I cannot be a Chair of a Faculty according to the ICAN Council rule, so we have a Chair that is an IFRS Partner in one of the Big 4 accounting firms in Nigeria. We have a Professor of Accounting as a member as well as IFRS experts both in consulting and other Big 4 audit firms.  So I can only talk about ICAN Financial Reporting Faculty where huge talents abound on issues of IFRS and look forward to corroboration between ICAN and Financial Reporting Council in this area.

You did not appear to have addressed the issue of corroboration between ICAN and FRC.

I have because the Financial Reporting Faculty of ICAN as well as even ICAN Research and Technical Committee can liaise with FRC but it must be at the invitation of FRC. Remember that FRC is an offshoot from ICAN and ICAN is always ready to support FRC in technical accounting issues.

Talking about technical accounting issues, there has been a recent financial reporting regulatory intervention in a case involving Stanbic IBTC, CBN, KPMG and FRC, what is ICAN’s position more-so that FRC has asked CBN to seek ICAN opinion on the matter.

I am just a Council member of the Institute. I am not the President neither can I speak on behalf of the Council which is the final mouthpiece of the Institute, so who am I to speak on ICAN position on a weighty matter like that. Don’t forget it is already a matter before the Courts and even if I am ICAN President, I cannot speak on it because of that. Above all, even if it is not before the Courts, we do not have all the facts.

But the press have reported a lot on the case such that we all know the issues involved like CBN made a statement faulting FRC and FRC countered saying the CBN failed in its regulatory role, as an expert in IFRS, what will you say about that?

Again I am unable to say anything on that. But I do know that Section 59 (2) of Financial Reporting Council Act specifically provided that where there is any conflict or inconsistency between financial statements prepared under Banks and Financial Institution Act (BOFIA),  other Acts that use to regulate Financial reporting of certain institutions and the guidelines adopted by FRC, then that of FRC shall prevail. That vests the final power on issues of financial reporting on FRC.

In UK the Financial Services Authority (FSA) which is in charge of banking regulation has been replaced with two successor organisations the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA), but in all the Financial Reporting Council of UK remains in charge of financial reporting and has the final say on the matter. The IMF/World Bank 2011 ROSC report that recommended the establishment of Nigeria FRC had the UK arrangement in mind when it made that recommendation. So borrowing from UK, it is not in doubt that should regulate financial reporting and who is in charge of prudential and financial conduct regulation.

No, the question is not about who is in charge but whether a due process has been followed?

Well I am not in a position to comment about due process, I can only talk on technical IFRS issues and financial reporting generally.

As a technical IFRS expert what is the provision of IFRS on how to account for software developed by an organisation and sold to the same organisation.

I hope your question is not in relation to the matter before the court

No, talking about IFRS and financial reporting generally

Software developed by a company under IFRS is referred to as internally generated intangible asset. The process of developing such software normally passes through a phase known as research and development phase. Intangible assets generally are covered under IAS 38.

The major problem is difficulty in determining whether to expense or capitalise the cost incurred in developing the software which is usually tied to the flow of economic benefit associated with incurring such cost and even when that is settled, there is the question of reliability in measuring the cost involved.

Sometimes IAS 38 is of the view that it is usually difficult to distinguish such costs from those of maintaining or enhancing the entity’s internally generated goodwill. As such, in order to assess whether an internally generated intangible asset meets the criteria for recognition, IAS 38 (Paragraph 53) requires entities to classify the generation of software intangible asset into (a) a research phase; and (b) a development phase. Paragraph 54 stipulates that no intangible asset arising from the research phase of an internally generated software intangible shall be recognised or capitalised but rather they should all be expensed immediately when incurred. Paragraph 55 provides explanation why this should be the case and that is because at the research phase, an entity cannot demonstrate the existence of intangible asset that will generate probable future economic benefits.

Every accountant knows that both the Conceptual Framework and  IAS 16 views asset as a resources controlled by an entity as a result if past events from which future economic benefits is expected to flow to the entity. So if you are carrying out research or developing software, you are not sure of success not to talk of guaranteeing the flow of future economic benefit. As such all the costs incurred at the research phase of building the software should be expensed. I have deliberately used the term ‘build’ and not ‘develop’ as ‘development’ under IAS 38 is a technical term.

But you used the term research and development cost, that is research and development cost of building the software, shouldn’t that be the same.

That is exactly why IAS 38 is making the distinction between them. As I earlier explained the distinction lies in ability to show that there is a probability of future economic benefit arising from incurring such expenditure. The general assumption of IFRS is that, that is not possible at the research phase and I totally agree as the case with pharmaceutical companies and oil prospecting. For example all costs incurred in prospecting for oil in Lake Chad no matter how much should be expensed so long as no oil is found. Continuing with our software example, once the software has been written if I will use that term, then the next phase of costs to be incurred are aimed at development for use.

At this point, there is a probability that the software can now be put into use to generate economic benefit. From this point IAS 38 (Paragraph 57) allows capitalisation, imposing certain conditions which are that the entity must demonstrate the following: (1) the technical feasibility of completing the intangible asset so that it will be available for use or sale; (2) its intention to complete the intangible asset and use or sell it (3) its ability to use or sell the intangible asset (4) how the intangible asset will generate probable future economic benefits. In the example we are discussing you can see that selling the software presupposes it is in a state it can be used or sold to generate economic benefit. So yes it can be treated as intangible asset.

What about selling to the company?

Do you mean selling to itself or selling to another company?

Selling to it, can he make profit and pay tax on that?

It is doubtful that a company can develop software and sell to itself. IFRS will not permit that. It will not be sale but capitalisation of costs incurred which is why IAS 38 requires distinction between research phase and development phase. If you follow what I have described above, what happens is capitalisation of cost of development which according to IFRS can be recovered over the estimated useful life of the software through the use of the software to generate economic benefits which these costs offset. However what is possible is that in a group company, one subsidiary can develop software and sell it to the parent company or another company within the group.

What happens when a subsidiary develops software and sells to the parent company or another subsidiary?

Whether the term sale is appropriate remains a question to be clarified because what governs group relationship is again technical and different when you speak at the group level. From a layman point of view, it may be seen as sale but in technical IFRS sense it is transfer of intangible assets within the group. Can the selling/transferring subsidiary make profit out of it, yes and no!! Supposing a Nigerian subsidiary develops software which is sold to a UK parent because of licensing issues, yes of course the Nigerian subsidiary can make profit but from the UK parent group perspective, it is intra group profit which in the technical sense is no profit to the group. This is because what constitutes profit to the group is transaction with third parties.

There is issue of tax on profit made at the end of the year by the company, are you saying no tax is payable on profit made by transferring such software?

No that is not what I am saying; I am talking at the group level to where what constitutes profit payable by a group is based on transactions with third parties and not within the group. However since the Nigeria subsidiary is expected to pay tax based on its profit, yes it is a profit that arises from disposal of intangible asset. In that case, the entire cost of development should have been known and the agreed transfer price is matched against that to determine profit or loss on disposal. It is only profit that attracts tax but a loss will not, anyway that is beyond financial reporting to determine how much is the tax.

Are you saying that IFRS does not provide for how companies should treat tax in their financial statement?

No, that is not what I am saying. I am talking about determining the actual amount of tax payable. What financial reporting does is a provision while the FIRS are the body that determines the actual income tax payable by companies? So in financial reporting distinction is made between current taxes payable and deferred taxation by IAS 12. Prior to introduction of IFRS, some companies did not make provision for deferred tax because the Nigerian GAAP allowed either the deferral or liability method. So, some companies hid under deferral method and made no provision with accounting policies notes that read, no deferred tax is provided because the directors are of the opinion that potential tax liability arising out of timing differences will not reverse in the foreseeable future.

With the introduction of IFRS, they are now unable to hide under the deferral method, as IAS 12 does not permit the deferral method but allows only the liability method. To make matters worse for them, it introduced balance sheet liability method as opposed to the old income statement liability method. Well this is going into technicalities that may distract from our discussion. So IAS 1 Presentation of Financial Statement requires the statement of financial position to include line items that present among others, amounts in respect of (1) liabilities and assets for current taxes payable and (2) deferred tax liabilities and deferred tax assets. In order both should not be aggregated. Aggregation in financial reporting leads to obscurity and hence loss of transparency

What will you say in case of franchise?

Provision is dealt with in IAS 37 and it talks about making a provision when there is a present obligation as a result of past events that will involve an outflow of economic benefit from the entity but I will not talk in relation to franchise lest we stray into an area that we should not. I have to go so I do not miss my flight. There are a lot of developments in the financial reporting world that will fundamentally change the foundation of financial reporting. I talked about the Exposure Draft on Conceptual Framework. Its proposals are far reaching talking about definition of elements of financial statements like assets, liabilities, income and expenses. For example it is proposing a definition of income and expenses that will no longer lay emphasis on the flow of economic benefits flowing to or from the entities. If the definition of an asset or liabilities is no longer tied to flow of economic benefit, then what happens? Attention then shifts to measurement and recognition, so that is the future that alters everything and the CFO should be concerned.