ITEMS PRESENTED AND DISCUSSED AT THE DECEMBER 5, 2022, MEETING
Impact of Climate-related Risk on Financial Statements
In recent years, the demand for sustainability reporting has risen. In response to this increasing demand, the IFRS® Foundation announced the creation of the International Sustainability Standards Board (ISSB) in 2021. On its website, the ISSB says its goal is to “deliver a comprehensive global baseline of sustainability-related disclosure standards that provide investors and other capital market participants with information about companies’ sustainability-related risks and opportunities to help them make informed decisions.”
In March 2022, the ISSB published the Exposure Drafts “IFRS S1 General Requirements for Disclosure of Sustainability-related Financial Information” (IFRS S1) and “IFRS S2 Climate-related Disclosures” (IFRS S2). As proposed, an entity would be required to include sustainability-related financial disclosures as part of its general-purpose financial reporting, which encompasses, but is not restricted to, an entity’s general-purpose financial statements. The ISSB is currently redeliberating certain aspects of IFRS S1 and S2.
With respect to financial statements based on IFRS Accounting Standards, there is currently no single explicit standard on climate-related matters. However, climate risks and opportunities may impact several areas within an entity’s financial statements. While the immediate impact to the financial statements may not necessarily be quantitatively significant, more stakeholders expect entities to explain qualitatively how climate-related matters are considered in preparing financial statements to the extent they are material.
The Group discussed certain impacts of climate-related risks and opportunities on an entity’s financial statements prepared in accordance with IFRS Accounting Standards.
Issue: Under current IFRS Accounting Standards, how are climate-related risks and opportunities integrated in financial statements, including disclosures?
Analysis
With investors increasingly focusing on climate-related matters, entities should assess how climate change, including their commitments and actions to address climate change, may affect their financial statements and other reporting obligations. For example, entities may commit to net-zero or other climate targets, and establish a climate strategy, including a transition plan. These strategies and targets can have a direct impact on financial statements.
The Group’s Discussion
A few Group members commented that this is an evolving area of reporting across several jurisdictions and that entities will need to continue to monitor developments and assess their impact on their financial statements. It was also noted that the impact on financial statements will be affected by political initiatives and the actions of governments and regulators, and may vary from jurisdiction to jurisdiction.
The Group considered the following examples of climate-related matters and the impact they may have on an entity’s financial statements. This list is not exhaustive.
Disclosures
Financial statement users expect companies to provide clear and transparent climate-related disclosures. To meet these expectations, entities should consider the specific disclosure requirements in individual IFRS Accounting Standards as well as the overarching requirements of IAS 1 Presentation of Financial Statements.1
Regarding the general requirements, entities should consider the definitions of material information in IAS 1 in determining what, if any, additional information they must provide to bridge any gap with user’s expectations. Materiality involves both quantitative and qualitative considerations, so while information may not be material in amount, it may be material in nature.
Additionally, entities may consider paragraph 112 of IAS 1 that requires disclosing information relevant to understanding the financial statements but is not specifically required by IFRS Accounting Standards or presented elsewhere in the financial statements. Furthermore, paragraph 17(c) of IAS 1 notes that, in certain circumstances, entities may need to include additional disclosures to achieve a “fair presentation” in the financial statements.
When recognizing and measuring an asset’s useful life or fair value, entities may use significant estimates and judgments to reflect climate risks and opportunities in their analyses. Where material, an entity should disclose how climate change and climate-related goals have been reflected in these assumptions when major sources of estimation uncertainty exist. Alternatively, entities may need to disclose why these have not been considered, especially in industries or sectors where stakeholders may expect climate risk to have a material impact on significant estimates and judgments. As their analysis may include multiple scenarios covering a wide range of possible outcomes, entities may need to provide sensitivity analyses for a range of scenarios with accompanying disclosures on how the uncertainties are incorporated in the estimates and sensitivities disclosed.
The Group’s Discussion
Several Group members observed that the requirements in IAS 1 do not specifically address the disclosure of climate-rated risks. They also thought that it would be useful for the ISSB to work with the IASB to provide guidance on how these disclosures may be included in financial statements. A few Group members expressed concern that, without clear guidance, the information provided by entities in similar industries may not be comparable, given the individual entity’s perspective on the impact of climate change. Another Group member commented that entities may be at different stages of maturity in terms of their assessment of how climate-related risks affect their financial statements. Therefore, preparers may not be excluding this information intentionally, rather they may not have completed sufficient analysis to provide meaningful climate-related risk disclosure. Furthermore, in the absence of meaningful analysis, it will be difficult for entities to provide entity-specific, non-boilerplate disclosure. Another Group member commented that they currently observe disclosures associated with climate-related risks within an entity’s management, discussion, and analysis.
One Group member noted that many measurement elements are associated with climate-related risks and that these measurements may be subject to a high degree of judgment. In preparing its financial statements, an entity is required to disclose judgments, apart from those involving estimations, which have the most significant effect on the amounts recognized in their financial statements.
Long-lived assets
Entities are required to review the residual value and the useful life of their amortizing long-lived assets at least at each financial year-end. A climate transition plan that includes the replacement of carbon-heavy assets may affect the estimated useful lives and residual values assigned to these assets. Consequently, this may impact depreciation and amortization expense. Other climate-related risks that may impact the useful life of a long-lived asset could include new regulations restricting the use of certain assets, such as mineral exploration licenses or limitations on carbon-emitting assets.
A change in a long-lived asset’s useful life and/or residual value would require disclosing the nature and amount of the change in estimate. Entities may also consider if those estimates are subject to higher estimation uncertainty, which would require disclosures in accordance with paragraph 125 of IAS 1.
The Group’s Discussion
The Group agreed with the analysis.
One Group member commented that modifying an asset for environmental reasons may qualify for recognition in accordance with paragraph 11 of IAS 16, Property, Plant and Equipment. They also noted that contractual commitments to acquire new property, plant and equipment to replace carbon-heavy or “dirty” assets should be disclosed in accordance with paragraph 74(c) of IAS 16.
Impairment
A decrease in the useful life or the residual value of a long-lived asset may be an indicator of impairment. Other indicators of impairment may include increased environmental awareness from stakeholders resulting in weakening performance of a cash-generating unit (CGU) due to:
- changes in customer preferences to more sustainable goods or services;
- increased costs from suppliers as a result of their own climate transition strategy;
- a higher market interest rate or discount rate for asset specific risk in climate-intensive CGUs;
- emerging regulatory requirements leading to growing compliance costs; and
- rising insurance or maintenance costs due to the physical impacts of climate change, (e.g., an increase in the frequency and severity of extreme weather events).
When determining an asset or a CGU’s recoverable amount using value-in-use (VIU) or fair value less costs of disposal (FVLCD), there may be several considerations related to climate-related risks and opportunities. These impacts may vary depending on the location, nature of specific restrictions, and industry characteristics of an asset or a CGU. Therefore, careful consideration may be required to determine the effect, if any, climate-related risks and opportunities have on an asset or a CGU’s recoverable amount. Areas an entity may need to consider in the determination of an asset or a CGU’s recoverable amount may include the following:
- Forecasted cash flows: Environmental change may impact the timing or amount of projected cash flows.
- Scenario analyses: Given the uncertainty in the cash flows, entities may need to consider probability-weighted scenarios and different pricing curves in determining cash flows (e.g., anticipated cost increases from suppliers due to rising fuel costs and the possibility of passing on those higher costs to customers).
- Capital expenditures: Entities may need to incur capital expenditures to meet evolving regulatory requirements or to decrease their carbon footprint. Under a VIU model, they should consider whether those investments are required to continue to operate the assets (similar to maintenance) or whether they are betterments. Under a FVLCD model, they should consider whether a market participant would also make such investments;
- Discount rates: Entities may consider incorporating uncertainty related to climate risks and opportunities within an entity-specific risk premium in the discount rate. Alternatively, those risks may need to be considered as part of an industry-specific risk premium within the discount rate.
- Terminal value: The growth rate in the terminal period should consider how climate-related matters may impact the entity in the long term, and entities may need to consider negative growth rates, depending on the nature of the specific asset or CGU.
The Group’s Discussion
The Group agreed that climate-related risks may impact the recoverable amount of an asset or CGU.
A few Group members commented that climate-related risks could positively impact an entity. For example, customers may change their purchasing behaviour to transact with companies whose products are more environmentally sustainable. In addition, these customers may also be willing to pay a higher price for sustainably sourced or produced products. Furthermore, manufacturers may benefit from improved sustainability practices by reducing their packaging and other associated costs.
Fair value measurement
In determining fair value under IFRS 13 Fair Value Measurement, entities consider the price that they would receive when they sell an asset or the amount they would pay to transfer a liability in an orderly transaction in the principal market at the measurement date under current market conditions. Entities should carefully consider whether, and to what extent, climate change might affect the assumptions used to measure fair value.
Climate change can have a tangible effect on an entity’s assets and liabilities now and in the future. A government’s or an entity’s response to climate change may be known or only anticipated. These climate-change impacts could potentially drive market participants’ assumptions in determining fair value, whether the risks or opportunities are real or perceived. However, despite the increased focus on climate-related factors, incorporating such factors into a fair value measurement may be particularly challenging as inputs might not be observable at this stage. In some cases, there might be no standard framework to measure and validate climate-related risks and opportunities. In others, changes may be agreed in principle, but the timing may be unknown or subject to change. Even if the risk can be quantified and the timing estimated, the market(s) and market participants might not yet know how to adjust for it in the price of the asset or the liability.
As a result, entities need to consider whether, and how, they can factor relevant climate-related risks and opportunities into a fair value measurement. Market participants’ ability to reliably incorporate climate change variables into valuations will likely improve with time.
When climate-related risks and opportunities are material to a fair value measurement, entities will need to provide relevant disclosures, particularly for those fair value measurements categorized within Level 3 of the fair value hierarchy (see paragraphs 72-99 of IFRS 13). During the transition period, as market participants begin to adjust for climate-related risks and opportunities, entities may be required to exercise significant judgment to determine appropriate assumptions. These assumptions may need to be disclosed.
The Group’s Discussion
The Group agreed with the analysis.
One Group member commented that it may be difficult to determine the fair value of an asset or CGU because there is no observable market that illustrates the discount or premium associated with an entity’s environmental activities. However, another Group member noted that transactions at higher or lower values because of the impact of climate-related risks and sustainability are being observed, and in the future, it may become easier to incorporate these into fair value assessments as observable transactions increase.
Provisions
For existing environmental and decommissioning obligations, a decrease in the useful life of a related item of property, plant and equipment may result in an earlier decommissioning than previously estimated. This will increase the provision and related long-lived asset. New legislation may result in new obligations, such as changes in product end-of-life requirements for recycling or new decontamination laws.
An entity’s public commitment regarding its climate targets or transition plans may create a constructive obligation. The entity should assess whether a provision needs to be recognized in accordance with paragraph 14 of IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
Additionally, the costs to provide a service or a good using greener materials or processes may be greater than initially planned. This cost increase may cause a previously profitable contract to become onerous. In this case, a provision may need to be recognized for the onerous contract.
The Group’s Discussion
Several Group members commented that provisions generally are not recognized as the result of an entity making a public statement about its climate plans and/or targets because such statements often do not meet the criteria in IAS 37. One Group member commented on the need to update the measurement of an entity’s existing provisions to reflect any new estimates of the expenditures required to settle the obligation. Changes to estimates may result from shifts in government action and could require more frequent updates as climate-related initiatives accelerate.
Corporate reorganization
If within its climate strategy, an entity commits to sell or dispose of certain carbon-heavy assets, a group of assets or a major line of business not aligned with its climate strategy, IFRS 5 Non-current Assets Held for Sale and Discontinued Operations may apply. This would require the entity to account for the long-lived asset or disposal group at the lower of its carrying amount and fair value less costs to sell. The entity should present the post-tax profit or loss of the discontinued operations as a single amount in the statement of comprehensive income.
Alternatively, as part of its transition plan, an entity may decide to close some of its operations and may need to recognize a restructuring provision. In light of disclosures made related to its climate transition plan, an entity should apply judgment to determine when it has raised valid expectations for those affected by the plan. This decision is also likely to be a potential indicator of impairment of the related long-lived assets.
Taxes on carbon emissions and emissions trading schemes
As regulators and governments may impose taxes and other penalties on carbon-heavy operations, entities will need to assess, based on the specific regimes, whether these would be accounted for under IAS 12 Income Taxes or IFRIC 21 Levies.
IFRS Accounting Standards do not specifically address emissions trading schemes. Depending on the nature of an entity’s operations, consideration may need to be given to IAS 2 Inventories, IAS 38 Intangible Assets, IFRS 13, IAS 20 Accounting for Government Grants and Disclosure of Government Assistance, and IAS 37.
Contract modifications
As part of its transition plan, an entity may renegotiate contracts with stakeholders (customers, suppliers, employees), which may result in financial impacts. For example:
- Leases: An entity may seek to reduce its physical footprint, resulting in modifying or cancelling leases.
- Revenues: An entity may modify existing contracts with customers (e.g., to change the transaction price in order to pass on rising costs).
- Employee benefits and share-based payments: An entity may modify existing compensation arrangements to include climate-related vesting conditions.
Entities should consider specific guidance on the accounting for contract modifications in various IFRS Accounting Standards. They may also need to disclose information so the financial statement users understand the effect of these modifications.
Financial instruments
Sustainability-linked loans (or green bonds) are structured such that their payments (interest) vary based on specified environmental, social, and governance (ESG) targets. For example, the contractual interest rate is reduced if the borrower meets specific targets for reducing carbon emissions or increased if the borrower does not meet those targets. These sustainability-linked adjustments to contractual cash flows generally give a borrower incentive to contribute to the development of green projects and minimize their negative impact on the environment. The Group discussed the accounting for these loans from the issuer’s perspective at its September 2021 meeting. From the holder’s perspective, entities will need to assess whether ESG features meet the solely payments of principal and interest (SPPI) criteria under paragraph 4.1.2 of IFRS 9 Financial Instruments to record the loans at amortized cost.
In addition, paragraph 5.5.1 of IFRS 9 requires the use of forward-looking information to recognize expected credit losses. Entities should consider the physical risks that can reduce a borrower’s creditworthiness because of business interruption, lower asset values, and unemployment. Transition risks could also result in credit quality rapidly deteriorating in affected sectors and/or countries, particularly if policy changes are quickly implemented.
Paragraph 31 of IFRS 7 Financial Instruments: Disclosures requires an entity to disclose information that “enables users of its financial statements to evaluate the nature and extent of risks arising from financial instruments to which the entity is exposed at the end of the reporting period.” Paragraph 32 of IFRS 7 further indicates that these risks are not limited to credit risk, liquidity risk, and market risk. Consequently, climate-related risks arising from an entity’s financial instruments should be disclosed and quantified if material.
The Group’s Discussion
The Group agreed with this analysis.
Other possible areas for consideration
Other areas of the financial statements that may be impacted by climate-related risks and opportunities include:
- IAS 1 – Going concern assumption;
- IFRS 17 Insurance Contracts – Measurement of insurance contracts;
- IAS 2 – Net realizable value of inventories;
- IAS 12 – Recognition of deferred tax assets;
- IAS 20 – Accounting for government grants;
- IFRS 15 – Climate-related risks may add a constraint on variable consideration or consideration payable to a customer for any climate-related incentives for purposes of revenue recognition;
- IFRS 8 Operating Segments – Operating segments may change to align with a new climate-related strategy; and
- IAS 34 Interim Financial Reporting – Disclosures on the seasonality or cyclicality of interim operations because of climate change (e.g., increased risks during certain months depending on the geographical location of an entity’s operations).
The Group’s Discussion
The Group agreed with this analysis and encouraged entities to consider how climate-rated risks affect insurance contracts and revenue contracts. A few Group members noted the importance of considering how climate-related risks affect investments in associates and joint ventures because they could affect the entity-investor’s equity accounting for such investments. One Group member noted the importance of monitoring other jurisdictions’ progress with new corporate reporting requirements in this area, such as the European Union. Canadian entities with global operations will need to determine the scope of their reporting requirements across all relevant jurisdictions.
One Group member indicated that Canadian stakeholders should monitor the development of the Canadian Sustainability Standards Board (CSSB) and consider the types of entities that will be impacted by its mandate. They also noted the Public Sector Accounting Discussion Group had an interesting discussion recently on the impact of climate-related risk on financial statements. The Group member said stakeholders might find this discussion helpful in developing their understanding of this topic, even though the discussion was in the context of another framework.
Overall, the Group’s discussion raised awareness of the pervasive impact that climate-related risks may have on the application of various IFRS Accounting Standards. No further actions were recommended to the AcSB.
1 Material that links to the CPA Canada Handbook is available to subscribers only. However, all relevant information is provided in this meeting report.
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Special Purpose Acquisition Companies (SPAC): Accounting for Warrants at Acquisition
In October 2022, the IFRS Interpretations Committee (the Interpretations Committee) published an agenda decision, “Special Purpose Acquisition Companies (SPAC): Accounting for Warrants at Acquisition” (October 2022 Agenda Decision). In this agenda decision, the Interpretations Committee responded to a fact pattern where a SPAC raises cash in an initial public offering. Through a series of transactions, the SPAC becomes a wholly owned subsidiary of an entity that was privately held prior to the transaction. The acquisition of the SPAC allows the previously private entity to obtain the cash raised by the SPAC as well as its listing on a stock exchange. The SPAC does not meet the definition of a business in IFRS 3 Business Combinations and had no assets other than cash at the acquisition date. The acquisition of the SPAC is affected by the entity issuing new shares and warrants (replacement instruments) to replace the shares and warrants held by the original SPAC shareholders. The fair value of the replacement instruments exceeds the fair value of the SPAC’s identifiable net assets.
Among the several issues about how to account for the transaction, the Interpretations Committee discussed which IFRS Accounting Standard applies to the instruments issued. The Interpretations Committee observed that:
- IFRS 2 Share-based Payment applies to the instruments issued to acquire the stock exchange listing because the stock listing is a “good or service” acquired in a share-based payment transaction.
- IAS 32 Financial Instruments: Presentation applies to the instruments issued to acquire the cash held by the SPAC because IAS 32 applies to the issuance of financial instruments with certain exceptions, including instances where IFRS 2 applies. IFRS 2 does not apply in this case because the accounting standard does not apply when equity instruments are issued to acquire financial assets (i.e., cash is not a “good or service”).
See the agenda decision for the complete fact pattern and analysis.
The Group discussed this fact pattern at its May 2022 meeting. At that meeting, the Group also discussed the analysis of a fact pattern in which the SPAC acquisition is structured as a reverse acquisition, which was included in the Interpretations Committee’s March 2022 Agenda Paper. However, the Interpretations Committee subsequently removed this analysis from its agenda decision as the submitter had not asked about the accounting for a reverse acquisition transaction in their original submission. Nonetheless, the analysis included in the agenda decision may indirectly affect how entities account for (or have previously accounted for) reverse acquisition transactions.
The Group first considered how the Interpretations Committee's October 2022 Agenda Decision interacts with the previous agenda decision “Accounting for reverse acquisitions that do not constitute a business” published in March 2013 (March 2013 Agenda Decision).
Background on the March 2013 Agenda Decision
The March 2013 Agenda Decision analyzed a transaction in which the former shareholders of a non-listed operating entity become the majority shareholders of the combined entity by exchanging their shares for new shares of a listed non-operating entity. In this transaction, the listed non-operating entity acquires the entire share capital of the non-listed operating entity.
The March 2013 Agenda Decision set out that the legal acquirer would be identified as the acquiree for accounting purposes by applying the guidance in paragraphs B19-B27 of IFRS 3 on reverse acquisitions by analogy. This results in identifying the non-listed operating entity as the accounting acquirer, and it is deemed to have issued shares to obtain control of the listed non-operating entity. However, as the listed non-operating entity does not meet the definition of a business, IFRS 3 does not apply in accounting for the remainder of the transaction. Therefore, the Interpretations Committee noted that the transaction is a share-based payment transaction that should be accounted for in accordance with IFRS 2.
The Interpretations Committee observed that on the basis of the guidance in paragraph 13A of IFRS 2, any difference in the fair value of the shares deemed to have been issued by the accounting acquirer and the fair value of the accounting acquiree’s identifiable net assets represents a service received by the accounting acquirer. The Interpretations Committee concluded that this difference is identified as a service of a stock exchange listing in exchange for the deemed shares and is recognized in profit or loss as it does not meet the recognition criteria in IAS 38 Intangible Assets.
Issue 1: Is the October 2022 Agenda Decision consistent with the March 2013 Agenda Decision?
Analysis
It may appear that the two agenda decisions are contradictory in that the October 2022 Agenda Decision states that two IFRS Accounting Standards apply to the instruments issued, whereas the March 2013 Agenda Decision concludes that only IFRS 2 applies. However, the precise wording and the differences between the fact patterns included in both agenda decisions should be considered.
The March 2013 Agenda Decision does not describe any of the assets or liabilities held by the listed non-operating entity, only that it was not a business as defined by IFRS 3 and was listed on a stock exchange. In addition, the March 2013 Agenda Decision notes that IFRS 2 applies only to any difference in the fair value of the deemed instruments and the acquired identifiable assets. It does not conclude that IFRS 2 applies to all the instruments deemed to have been issued by the non-listed operating entity. Finally, the March 2013 Agenda Decision does not consider how the shares issued to acquire any other identifiable assets or liabilities of the listed entity should be accounted for.
In contrast, the October 2022 Agenda Decision specifically indicates that the SPAC held cash and a stock exchange listing prior to being acquired. Therefore, it considered which IFRS Accounting Standards apply to acquire those two items.
Therefore, given the difference in the fact patterns considered in the two agenda decisions, the October 2022 Agenda Decision does not contradict the March 2013 Agenda Decision.
The Group’s Discussion
Overall, the Group agreed that that the Interpretation Committee’s October 2022 Agenda Decision does not contradict its March 2013 Agenda Decision for the reasons provided in the analysis. A couple of Group members thought the March 2013 Agenda Decision could be clarified to reflect that the transaction was in scope of IFRS 2 because the acquired listed non-operating entity is not a business, and the transaction did not include monetary items. One Group member thought it is unlikely that this type of transaction would not include any monetary assets or liabilities.
The Group then considered the potential effects of the October 2022 Agenda Decision on the following two reverse acquisition transactions.
Fact Pattern 2A
- A private operating company (Company A) is acquired through a share-for-share exchange by a small, listed company with no assets or liabilities (Company B).
- Company B becomes the legal parent of Company A, however, for accounting purposes, Company A is identified as the accounting acquirer. Therefore, this transaction is a reverse acquisition transaction.
Fact Pattern 2B
- Assume the fact pattern is identical to Fact Pattern 2A, except Company B holds $500,000 in cash, which it raised as a Capital Pool Company (CPC)®. The Toronto Stock Exchange website describes the CPC Program as “a unique Canadian invention that supports earlier stage private companies to complete a go public transaction.” A qualifying transaction is “effectively a reverse takeover of a CPC by an operating business that will access the capital, shareholders, and expertise of the CPC to complete a listing” on a stock exchange. CPCs are subject to specific rules and regulations.
Issue 2: In both fact patterns, which IFRS Accounting Standards apply to the instruments deemed to have been issued by Company A?
Analysis
In Fact Pattern 2A, since Company B does not hold any assets or liabilities, the October 2022 Agenda Decision does not apply. Consistent with the March 2013 Agenda Decision, Company A should apply paragraph 13A of IFRS 2 to account for the instruments issued to acquire the stock exchange listing service.
In Fact Pattern 2B, since Company B holds both cash and a stock listing, the October 2022 Agenda Decision applies. Company A should apply IAS 32 to account for the instruments issued to acquire the cash and IFRS 2 to account for the instruments issued to acquire the stock exchange listing service.
The Group’s Discussion
The Group agreed with the analysis. Some members noted that Fact Pattern 2A is not commonly observed in practice since generally there is some cash and liabilities and the listed company sometimes is in a net liability position. Two Group members thought the accounting conclusion in Fact Pattern 2B may not be how Canadian entities have historically accounted for these transactions. Therefore, entities will need to analyze past transactions and assess whether the application of the October 2022 Agenda Decision materially impacts their financial statements.
Issue 3: Implications of the October 2022 Agenda Decision on accounting practices
Analysis
In general, Canadian entities have applied IFRS 2 to account for the acquisition of a listed entity that does not meet the definition of a business, which is consistent with the March 2013 Agenda Decision. However, following the October 2022 Agenda Decision, entities may need to apply IAS 32 and IFRS 2 to two sub-sets of the shares deemed to have been issued by the accounting acquirer. This approach may have several financial reporting implications.
Classification of instruments issued
IAS 32 and IFRS 2 have different classification requirements for a financial instrument. For example, paragraph 16(b)(ii) of IAS 32 requires derivatives that meet the “fixed-for-fixed” criterion to be classified as equity. IFRS 2 has no such requirement. Therefore, two contractually identical instruments may be classified differently depending on whether they are within the scope of IAS 32 or IFRS 2.
Consequently, a misclassification between IAS 32 and IFRS 2 may result in significant differences in the subsequent measurement of a derivative liability. This is because the derivative liability that fails the “fixed-for-fixed” criterion is required to be remeasured at fair value through profit or loss under IAS 32 but would not be remeasured under IFRS 2. Therefore, if too few instruments are allocated to IAS 32 and their fair value changed significantly subsequent to the initial recognition, the measurement of these instrument may be materially misstated. Assessing materiality for this matter may be challenging for entities, especially those considering retrospective restatement.
Transaction costs
Qualifying transaction costs associated with equity instruments issued in the scope of IAS 32 are accounted for as deductions from equity in accordance with paragraph 37 of IAS 32.
Transaction costs incurred relating to the issuance of instruments in the scope of IFRS 2 are recognized in profit or loss unless they meet the recognition criteria of another IFRS Accounting Standard. For example, transaction costs incurred in a share-based payment transaction to acquire an item of property, plant, or equipment are included in the cost of that item if they are eligible to be capitalized under IAS 16 Property, Plant and Equipment.
Retrospective restatement
The October 2022 Agenda Decision is effective for financial statements with reporting periods ending on or after October 24, 2022, subject to entities having “sufficient time” to implement an agenda decision. Entities should refer to the IASB article, “Agenda decisions – time is of the essence” and the Due Process Handbook, Sections 8.2-8.7, for guidance on the timely implementation of agenda decisions.
If an entity thinks it needs to change its accounting policies to conform with the analysis in the October 2022 Agenda Decision, it would be required to do so on a retrospective basis per paragraphs 19-21 of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Given the timing of the October 2022 Agenda Decision and the many reverse acquisition transactions in Canada that have occurred in the last 12-18 months, an entity that applies this agenda decision to a reverse acquisition transaction in the comparative period may have to do one or both of the following:
- restate comparative figures (e.g., presentation of transaction costs);
- reclassify financial instruments that continue to be recognized in 2022 and restate the accounting for any differences in the subsequent measurement requirements because of the reclassification.
The Group’s Discussion
The Group agreed with the analysis and the potential accounting implications of applying the October 2022 Agenda Decision to both current and past transactions. One Group member commented that the retrospective restatement of these transactions may be immaterial to the extent that the instruments issued would be classified as equity in accordance with both IFRS 2 and IAS 32. Another Group member encouraged stakeholders to consider whether the October 2022 Agenda Decision may apply more broadly to other transactions, including asset acquisitions, when monetary items are acquired as part of the transaction.
Issue 4: Allocation between IAS 32 and IFRS 2 Analysis
Analysis
The October 2022 Agenda Decision sets out two approaches an entity may apply to determine what portion of the deemed instruments issued are in the scope of IAS 32 and IFRS 2. An entity could:
- allocate the shares and new warrants to the acquisition of cash and the stock exchange listing service on the basis of the relative fair value of the instruments issued (i.e., in the same proportion as the fair value of each type of instrument to the total fair value of all issued instruments.)
- use other allocation methods if they meet the requirements in paragraph 10-11 of IAS 8. However, an accounting policy that results in the entity allocating all the new warrants issued to the acquisition of the stock exchange listing service solely to avoid the new warrants being classified as financial liabilities applying IAS 32 would not meet these requirements.
The Group’s Discussion
The Group agreed with the analysis.
The purpose of this discussion was to raise awareness of the interaction between the Interpretations Committee’s October 2022 Agenda Decision and its March 2013 Agenda Decision, to illustrate the application of these agenda decisions to different fact patterns and to identify the implications of the October 2022 Agenda Decision on accounting practices. One group member commented that the classification and measurement differences between IFRS 2 and IAS 32 for the same financial instrument does does not generate comparable or meaningful information and questioned the usefulness of bifurcating instruments with the same terms into different standards with potentially different accounting classifications. The AcSB’s interim Chair responded that while little can be done in the context of the recent Interpretations Committee’s Agenda Decision, the AcSB may consider this in the context of its response to the IASB’s forthcoming Financial Instruments with Characteristics of Equity project. No further action was recommended to the AcSB.
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Canadian Interest Rate Benchmark Reform: Cessation of CDOR
On May 26, 2022, Refinitiv Benchmark Services (UK) Limited, the regulated administrator of Canadian Dollar Offered Rate (CDOR) announced that CDOR would cease publication after June 28, 2024. This announcement set in motion the transition timeline set by the Canadian Alternative Reference Rate Working Group2 (CARR) to replace CDOR with the Canadian Overnight Repo Rate Average (CORRA) as a key risk-free interest rate benchmark in Canada.
On October 7, 2022, CARR published a notice setting out an intention to begin a process for developing a Term CORRA benchmark. In this notice, CARR noted that the Term CORRA benchmark will likely only be available for loans and associated products. Accordingly, it is possible that borrowers will have loans or credit facilities that reference Term CORRA while the derivatives used to hedge the interest rate risk will refer to the overnight CORRA. This can have implications for borrowers who apply hedge accounting requirements in IFRS 9 Financial Instruments when transitioning the CDOR-based hedging relationships to CORRA.
The Group considered the following fact pattern and discussed the implications that transitioning from CDOR to CORRA may have on qualifying hedging relationships.
Fact Pattern
- After the discontinuation of CDOR, Entity A originated a five-year term loan with quarterly interest payments based on three-month CORRA.
- Entity A wishes to reduce cash flow interest rate risk arising from this loan. Therefore, it purchased a five-year interest rate swap with quarterly settlements to pay a fixed interest rate at 2 per cent and receive a floating interest rate based on an overnight CORRA.
- Entity A would like to designate the interest rate swap as a hedging instrument under IFRS 9.
Issue 1: What factors should Entity A consider in establishing whether the overnight CORRA derivative qualifies as an eligible hedging instrument to hedge cash flow interest rate risk in the Term CORRA loan?
Analysis
To apply hedge accounting, Entity A will first need to formally designate the interest rate swap as a hedging instrument, including all necessary documentation.
Entity A would also need to consider other qualifying criteria for hedge accounting, including the following:
- effects of credit risk;
- hedge ratio; and
- whether there is an economic relationship between the hedged item (CORRA term loan) and the hedging instrument (interest rate swap).
As the interest rate swap is based on an overnight CORRA, which does not match the three-month CORRA Term loan, Entity A may need to use a quantitative assessment to demonstrate a forecasted economic relationship exists between the three-month CORRA and overnight CORRA throughout the term of the hedging relationship.
The Group’s Discussion
The Group agreed that Entity A may need to use a quantitative assessment to demonstrate a forecasted economic relationship between the hedged item (Term CORRA loan) and hedging item (overnight CORRA derivative).
Issue 2: Will Entity A achieve perfect effectiveness in such a hedging relationship?
Analysis
The mismatch between the overnight CORRA and the three-month CORRA may create ineffectiveness in the hedging relationship that needs to be recognized in profit or loss. Entity A should follow paragraph 6.5.11 of IFRS 9 to calculate and account for the effective and ineffective portion of this hedging relationship.
Entity A may use a hypothetical derivative that perfectly matches the hedged risk and references Term CORRA to measure effectiveness despite such derivatives not existing. Accordingly, Entity A would need to establish the pricing of such a hypothetical derivative, which may be complex. The extent that the cumulative change in value of the actual derivative exceeds the change in value of the hypothetical derivative will create ineffectiveness that should be recorded in earnings.
The Group’s Discussion
The Group agreed with the analysis. One Group member commented that the CORRA derivative market is still developing and encouraged entities to monitor these developments and consider their impact on hedging relationships. This member also highlighted that IFRS 9 provides accounting relief when an entity is transitioning to alternative benchmark rates, including for hedge accounting.
Issue 3: As an alternative, could Entity A identify that the overnight CORRA is a qualifying risk component of the loan’s cash flows?
Analysis
Paragraph B6.3.8 of IFRS 9 states that a “risk component” can be an eligible hedged item if it is a separately identifiable component of the financial item and the changes in the cash flows or the fair value of the item attributable to changes in that risk component must be reliably measurable.
It is unlikely that Term CORRA will be computed using a formula that explicitly references overnight CORRA. Therefore, an entity also needs to consider the requirement in paragraph B6.3.9 of IFRS 9 associated with whether the risk component is identifiable within the context of the particular market structure to which the risk or risks relate. It is currently unknown whether the Term CORRA market structure will identify overnight CORRA as a risk component. However, it is not common in practice to identify overnight rates as a risk component of other term rates.
The Group’s Discussion
The Group agreed that it is unlikely that Term CORRA will be computed using a formula that explicitly references overnight CORRA. One Group member commented that this issue is not unique to the hedging relationship in the fact pattern and that it may be relevant to other loan arrangements when the benchmark rate used differs for the hedged item and hedging item.
The objective of this discussion was to raise awareness of recent developments in Canada’s Interest Rate Benchmark reform and its potential impact on hedge accounting relationships. Stakeholders are encouraged to stay informed of ongoing developments in this market. No further action was recommended to the AcSB.
2 The Canadian Alternative Reference Rate Working Group consists of financial sector firms and public sector institutions in Canada to coordinate Canadian interest rate benchmark reform.
OTHER MATTERS
Recent Amendments Made to IFRS Accounting Standards
Lease liability in a sale and leaseback (amendments to IFRS 16)
The amendment to IFRS 16 Leases specifies how a seller-lessee should apply the subsequent measurement requirements in IFRS 16 to the lease liability that arises in a sale and leaseback transaction. The amendments are effective January 1, 2024, with early application permitted.
Non-current liabilities with covenants (amendments to IAS 1)
The amendments to IAS 1 Presentation of Financial Statements aim to improve the information an entity provides when its right to defer settlement of a liability for at least 12 months is subject to compliance with covenants. The amendments also respond to stakeholders’ concerns about the classification of such a liability as current or non-current. The amendments are effective January 1, 2024, with early application permitted.
Recently Published IFRS Interpretations Committee Agenda Decisions
In October 2022, the IFRS Interpretations Committee (Interpretations Committee) published the following three final agenda decisions:
Lessor forgiveness of lease payments (IFRS 9 and IFRS 16)
This agenda decision is in response to a request about a lessor’s application of IFRS 9 Financial Instruments and IFRS 16 in accounting for a particular rent concession. The rent concession is one for which the only change to the lease contract is the lessor’s forgiveness of lease payments due from the lessee under that contract.
The Interpretations Committee concluded that the lessor accounts for the rent concession described in the request by applying:
- the derecognition requirements in IFRS 9 to forgiven lease payments that the lessor has recognized as an operating lease receivable; and
- the lease modification requirements in IFRS 16 to forgiven lease payments that the lessor has not recognized as an operating lease receivable.
Multi-currency groups of insurance contracts (IFRS 17 and IAS 21)
This agenda decision is in response to a question about how an entity accounts for insurance contracts with cash flows in more than one currency. The agenda decision explained:
- Because paragraph 14 of IFRS 17 Insurance Contracts refers to “similar risks” without specifying any particular types of risk, an entity is required to consider all risks – including currency exchange rate risks – when identifying portfolios of insurance contracts. However, “similar risks” does not mean “identical risks”. Therefore, an entity could identify portfolios of contracts that include contracts subject to different currency exchange rate risks. What an entity considers to be “similar risks” will depend on the nature and extent of the risks in the entity’s insurance contracts.
- In measuring a multi-currency group of insurance contracts, an entity:
- applies all the measurement requirements in IFRS 17 to the group of insurance contracts, including the requirement in paragraph 30 to treat the group – including the contractual service margin – as a monetary item;
- applies IAS 21 The Effects of Changes in Foreign Exchange Rates to translate at the end of the reporting period the carrying amount of the group – including the contractual service margin – into the entity’s functional currency at the closing rate(s); and
- uses its judgment to develop and apply an accounting policy that determines on initial recognition the currency or currencies in which the group – including the contractual service margin – is denominated (currency denomination). The entity could determine that the group – including the contractual service margin – is denominated in a single currency or in the multiple currencies of the cash flows in the group.
SPAC: Accounting for warrants
This agenda decision addressed a request on how an entity accounts for warrants on acquiring a SPAC. The Interpretations Committee concluded that the entity applies IFRS 2 Share-based Payment in accounting for instruments issued to acquire the stock exchange listing service and IAS 32 Financial Instruments: Presentation in accounting for instruments issued to acquire cash and assume any liabilities related to the SPAC warrants as these instruments were not issued to acquire goods or services and are not in the scope of IFRS 2.
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PRIVATE SESSION
The Group’s mandate includes assisting the AcSB in influencing the development of IFRS Accounting Standards (e.g., providing advice on potential changes to IFRS Accounting Standards). The Group’s discussion of these matters supports the Board in undertaking various activities that ensure Canadian perspectives are considered internationally. Since these discussions do not relate to assisting stakeholders in applying issued IFRS Accounting Standards, this portion of the Group’s meeting is generally conducted in private (consistent with the Board’s other advisory committees).
Primary Financial Statements
At its December 2022 meeting, the Group provided input to the IASB staff on selected tentative decisions the IASB made that change the proposals in the 2019 Exposure Draft, “General Presentation and Disclosures.”
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