Ind AS Reporting Season: Risk Disclosures

The first time Ind AS adopters are having a nerve racking time in getting the pieces together for risk disclosures. The quintessential Ind AS 107 mandates disclosures which will aid the financial statement users to evaluate the nature and extent of risks arising from financial instruments and how the company manages those risks.

Like the other financial instruments standards, scope of Ind AS 107 specifies that the standard applies to ALL the entities. So the myth that risk is for the financial services entities only has to disappear sooner. This disclosure standard merely sets out the amount of information reported to the management for the purpose of running the business which must be made available to the users.

Risk Disclosures of two types are required:

§ Qualitative disclosures: Company has to provide a brief explanation of the their exposure to risk, how they arise and how these risks are measured and managed

§ Quantitative disclosures:
   o Credit risk/ Counter party risk – with information about age of the assets where the counter party has defaulted and the collateral held by the company

   o Liquidity risk – categorize the financial liabilities in maturity buckets

   o Market risk – split between Currency risk, Interest rate risk and Price risk. A sensitivity analysis   must be provided for each type of risk where the effect of let’s say a 1% shift (up/down) in the currencies/ interest rate/ prices on profit or loss and equity

Happy Disclosing!!

Fully Depreciated Assets

Have you come across a situation when you find that the block of assets are fully depreciated in the books but the company is still using them in its operation to generate revenue? 

In this case, the original estimate of assets useful life proved to be incorrect.

These assets are used beyond their useful life, they are fully depreciated and their carrying amount in the books is zero. What depreciation expense can you recognize in the profit or loss?

None, of course – because the carrying amount of the assets cannot be sub zero. As a result, the matching principle does not work here. The expenses simply do not match the benefits gained from these assets.

The standard IAS 16 Property, Plant and Equipment defines the useful life as either:

· The period over which an asset is expected to be available for use by an entity, or

· The number of production or similar units expected to be obtained from the asset by an entity.

Now this is extremely important: IAS 16 requires entities to review assets’ useful lives at least at each financial year-end.

A survey proves that more than 95% of the companies do not revise the useful lives of their assets and book the depreciation charge based on the original rates determined for the block of assets. As a result, the companies are using fully depreciated assets for their production processes.

What is the solution then?

When faced with such a kind of situation the company can either:

1. Review the useful life of its assets at the end of each financial year; (IAS 8 - Change in Accounting Estimate) or

2. Use Revaluation Model (IAS 8 - Change in Accounting Policy)

Review the useful life of its assets at the end of each financial year:

If you change useful life of the assets then it is treated as a Change in Accounting Estimate as per IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. If the revised useful life is different from the original life then, set the new remaining useful life, take the carrying amount and recognize the depreciation charge based on the carrying amount and new remaining useful life.

No restatement of previous periods’ financial statements is required. IAS 8 requires recognizing change in accounting estimates prospectively.

Revaluation Model:

IAS 16 permits 2 models for subsequent measurement of your property, plant and equipment: cost model and revaluation model.

Revaluing assets with zero carrying amount will effectively mean that there is a Change in the Accounting Policy and hence the company will need to apply IAS 8.

IAS 8 mentions that an Accounting Policy can be changed in the following scenario: 

1. The change is required by an IFRS. With our situation, this definitely is not the case.

2. The change results in the financial statements providing reliable and more relevant information about the effects of transactions, other events or conditions on the entity’s financial position, financial performance or cash flows.

In our case, the second situation will match to an extent. But are we really considering the after effects of moving from a cost model to revaluation model for our block of assets? 

Accounting policy means using the prescribed rules and standards how you will report certain transactions in the financial statements – not only now, but also in the future.

So, do you think that changing your accounting policy from cost model to revaluation model would make you provide better information about your assets, not only now but also in the future?

· Revaluation model is used for buildings and land in most of the cases, because it’s easy to get the fair value of these assets regularly. In case of movable assets like plant or machine getting fair value from the market gets a bit difficult. 

· Revaluation of the assets have to be done with sufficient regularity, i.e. atleast annually. 

· Entire class of assets and not an individual assets needs to be revalued. 

· To determine the fair value of the class of assets, IFRS 13 Fair Value Measurement standard needs to be applied. This standard is complex and difficult for movable assets. 

If after considering the above concerns if it is still beneficial for your company to switch from cost model to revaluation model, the new depreciation accounting policy need not be applied retrospectively, just prospectively – no restatement of previous periods.