Investor Update April 2019

Issue 18 Contents

Spotlight—Crypto-Assets: The Standard Setting perspective

Introduction to crypto-assets and crypto-currencies

Crypto-assets are an asset class that make use of the distributed ledger technology (DLT). A distributed ledger is a type of digital database that may be shared among entities in a network such that each participating entity has an identical copy of the database. Further, rules may be used to ensure that participants have limited access as well as limited ability to alter the records in the ledger. Among the first applications of DLT was the development of ‘block chain’ which is also the process underlying Bitcoin that came into existence in 2008. Bitcoin is the most widely known crypto-currency and can be thought of as the online equivalent of cash.

While most currencies have a well-established track record of acting as a store of value, the same can’t be said about crypto-currencies (cryptos). Most conventional currencies today are issued by central banks that manage the currency’s ability to act as a store of value over-time. On the other hand, cryptos are not implicitly or explicitly managed to act as a store of value over-time. Therefore, the holders of cryptos bear significant price risk (in comparison to the risk of holding traditional fiat currency).

Despite their infancy, cryptos have generated much hype and speculation that has caught the attention of investors and companies. Market participants, regulators and standard-setters are currently debating the implications of DLT on society and financial markets. Consensus building on applications such as cryptos is expected to be drawn out with market acceptance still some time away.

What is the Board doing about accounting for cryptos?

At its meeting in November 2018, the IASB decided not to undertake any standard-setting on crypto-currencies. It made this decision after considering feedback from the IFRS Interpretations Committee (Committee) and national standard-setters. It also considered the prevalence of crypto related transactions by IFRS reporting companies

The Committee discussed the application of IFRS Standards to holdings of crypto-currencies at its meeting in March 2019. It has published a tentative agenda decision for public comment that includes guidance about which IFRS Standards a company applies to holdings of crypto-currencies.  We briefly discuss the Committee’s analysis below.

How does a company classify cryptos?

Can cryptos be treated as cash?

Some investors view cryptos as the online equivalent of cash but for many reasons, at the present time cryptos are unlikely to be treated as cash in financial reporting, because:

  1. cryptos may not qualify as a medium of exchange—an insignificant number of businesses currently use cryptos for transactions.
  2. it is not clear if cryptos can act as a unit of account—little evidence shows businesses using cryptos to price their goods and services.

Most conventional currencies treated as cash in financial reporting are used as a medium of exchange or as a unit of account. In the future, cryptos may develop to such an extent that these characteristics are displayed and, therefore, they would be considered cash.

Can cryptos be treated as financial assets?

A clear distinction exists between most financial assets and cryptos. Most financial assets today exist as digital records with a hierarchical structure of clearing institutions ending at the central bank. In contrast, the technology behind crypto-currencies enables the bypassing of this centralized clearing structure by recording the transaction in a distributed ledger (an electronic asset database shared across multiple sites or locations). This collaborative decentralised approach to managing the supply and issuance of cryptos may seem to give holders with more control over their funds; however, it fails to provide holders with contractual rights to cash from other entities or to exchange financial assets or liabilities under potentially favourable conditions. Therefore, cryptos fail to meet the definition of financial assets under IAS 32 Financial Instruments: Presentation.

Can cryptos be treated as inventory?

In cases where a company holds cryptos for sale in the ordinary course of business (ie dealer of cryptos), such holdings could be within the scope of IAS 2 Inventories. If the company is a broker-dealer (eg a trading platform or exchange) in cryptos, it may be able to measure inventory at fair value less cost to sell. If the company is not a broker-trader, its holdings will be measured at the lower of cost or net realisable value.

Can cryptos be treated as an intangible asset?

IAS 38 Intangible Assets applies to all intangible assets not in the scope of another Standard. Accordingly, the Committee concluded that a company would apply IAS 38 to its holdings of cryptocurrencies if it did not apply IAS 2. Cryptos meet the definition of intangibles in IAS 38 since they typically:

  1. are capable of being separated from the company and sold;
  2. are a nonmonetary item (because they do not include rights to obtain fixed units of currency); and
  3. have no physical substance.

Under IAS 38, cryptos would be recognised at cost on initial recognition, with subsequent measurement using either the cost or the revaluation model.

If a company applies the cost model, it measures intangible assets at cost less any accumulated amortisation and impairment losses.

A company can only apply the revaluation model if an active market exists for the asset class. If a company applies the revaluation model, an increase in the value of the asset is recorded as a gain in other comprehensive income (OCI) and an increase in a revaluation reserve in equity. Gains are not recycled. However, if the gain reverses a prior reduction in the asset’s value, then the gain is recorded in profit or loss to the extent that a loss was previously recognised.

A decrease in the value of the asset is recorded as a loss in profit or loss except where gains have previously been recorded for the asset. When gains have been recognised, the loss must be recorded in OCI and then reduce the carrying amount of the asset in the revaluation reserve to the extent of the gain previously recognised.

What information may companies have to provide about exposure to cryptos?

A company would apply the presentation and disclosures requirements of the Standard it applies (ie IAS 38 or IAS 2) to recognise and measure the holding of cryptos. In addition, a company may have to disclose information related to material non-adjusting events (events that may arise after the reporting date that indicate conditions after the reporting period). For example, a company holding cryptocurrencies may have to consider whether changes in the fair value of those holdings after the reporting period are of such significance that non-disclosure could influence the economic decisions that investors make based on the financial statements.

What about accounting for other crypto-assets?

Neither the Board or the Committee have discussed the accounting for other types of crypto-assets, such as those issued via initial coin offerings (ICOs).

Companies that raise capital via ICOs often provide holders (coin holders) with promises. Generally, the accounting treatment for holders of these coins will depend on the obligations arising for the company issuing the crypto assets. The nature of the obligations could result in these being recognised as equity, liabilities or revenues.

What to look out for in the future?

The market for crypto-assets is fast evolving and issues related to market acceptance, risk and governance of these assets need to be further understood. Even though the Board has decided not to pursue standard-setting for crypto-assets, the IASB staff will continue to monitor their development. We will report back to you in future publications if the IASB decides to do additional work in this area.

Preview—The Essentials: Analysing lessee financial statements and Non-GAAP performance measures

We recently published an ‘Essentials’ article on lessees and non-GAAP performance measures. ‘Essentials’ is the IASB investor publication that covers either key elements of a completed Standard or aspects of a Standard that relate to financial statements and analysis.

This Essentials on leases provides a brief overview of requirements in IFRS 16 Leases. It highlights the similarities and differences between the financial statements of companies that lease assets and companies that acquire assets. IFRS 16 will result in more comparable balance sheets and profit and loss statements, but there will be some notable differences in the cash flow statements of these companies. Differences between items reported in the cash flow statements of lessee companies and companies that acquire assets may result in incomparable metrics such as free cash flow (FCF). Analysts may, therefore, need to exercise care when assessing such measures not defined in IFRS Standards.

The publication explains how investors can develop comparable FCF measures by making appropriate adjustments. We demonstrate how the addition to right of use (RoU) asset disclosure in IFRS 16 that companies must provide on a yearly basis can be used to make these adjustments. Investors may find this information useful in analysing the changes to FCF metrics reported by lessee companies under IFRS 16, and in making comparisons with similar metrics reported by companies that acquire assets.

Read this issue of The Essentials here.

We need your views

The Board sets Standards to help you, the investor, make decisions about companies. But we can’t do it without your views. Your participation helps us understand whether potential changes to the Standards will provide you with the information necessary for investment analysis.

Below are some of the projects that we expect to engage with investors on during 2019.

For a full list of topics please visit the work plan.

IBOR Reform and its Effects on Financial Reporting

Why is the Board publishing an exposure draft

Interest rate benchmarks such as interbank offer rates (IBOR) play an important role in global financial markets. These interest rate benchmarks index trillions of dollars and other currencies worth of financial products, from derivatives to residential mortgages. However, cases of attempted market manipulation of some interest rate benchmarks, together with the post-crisis decline in liquidity in interbank unsecured funding markets, have undermined confidence in the reliability and robustness of some existing interest rate benchmarks. Against this background, the G20 asked the Financial Stability Board (FSB) to undertake a fundamental review of major interest rate benchmarks. Following the review, the FSB published a report1 setting out recommendations to reform major interest rate benchmarks such as IBORs. Public authorities in many jurisdictions have since taken steps to implement the FSB’s recommendations.  In some jurisdictions, there is already a clear progress towards replacing the existing interest rate benchmarks with alternative interest rates that are nearly risk-free and, to a greater extent, based on transaction data. This has in turn led to uncertainty about the long-term viability of existing interest rate benchmarks.

In 2018, the International Accounting Standards Board (the Board) noted an increasing level of uncertainty about the long-term viability of some interest rate benchmarks. In response, the Board added a project to its agenda to consider the financial reporting implications of the reform. Based on outreach activities with stakeholders, the Board identified the two groups of accounting issues that could have financial reporting implications:

  1. issues affecting financial reporting in the period before the replacement of the existing interest rate benchmark with an alternative interest rate (“pre-replacement issues”); and
  2. issues that may affect financial reporting on the replacement of the existing interest rate benchmark with an alternative interest rate (“replacement issues”).

In its forthcoming exposure draft, the Board plans to address only the pre-replacement issues. More specifically, the Board considered the implications for specific hedge accounting requirements in IFRS 9 Financial Instruments and IAS 39 Financial Instruments: Recognition and Measurement, which require forward-looking analysis. As a result of the reform, contractual cash flows from hedged items and hedging instruments that are based on existing interest rate benchmarks would likely change as the existing interest rate benchmarks are replaced with an alternative interest rate. Until decisions are made with respect to what that alternative interest rate is and when that replacement will occur, uncertainties exist regarding the timing and amount of future cash flows arising from the hedged items and the hedging instruments. The Board noted that the hedge accounting requirements in IFRS 9 and IAS 39 provide a clear basis to account for such uncertainties. These uncertainties could affect the entity’s ability to meet specific forward-looking hedge accounting requirements in the period before the replacement. In some cases, entities could be required to discontinue, solely due to such uncertainties, hedge accounting for hedging relationships that may otherwise be effective. Also, IFRS Standards may prevent entities from designating for hedge accounting purposes new hedging relationships that are otherwise expected to be effective. Discontinuation of hedge accounting would often require an entity to recognise gains or losses in profit or loss. In the Board’s view, discontinuation of hedge accounting solely due to such uncertainties before the reform’s economic effects is known, and the resulting effects on profit or loss, would not provide useful information to users of financial statements. Consequently, the Board decided to propose amendments to IFRS 9 and IAS 39 as exceptions from specific hedging accounting requirements to provide relief during this period of uncertainty.

The Board has not yet considered whether and if so how to address the financial reporting implications arising from the replacement of the existing interest rate benchmark with an alternative interest rate, ie replacement issues. The Board noted that a range of issues could arise because of the uneven timing of the replacement coupled with different approaches to replacement being considered in different markets and different interest rate benchmarks. At the time of the Board discussions leading to this Exposure Draft, the specific conditions and details of the replacement are yet to be finalised. The Board therefore decided to monitor developments in this area. As more information becomes available, the Board will assess the potential financial reporting implications of this replacement and determine whether it should take any action and if so what.

Who will be affected by the proposals in this Exposure Draft

The Board expects interest rate benchmark reform will affect many preparers given the extensive use of the interest rate benchmarks in global financial markets. The Board’s proposals will affect entities that apply the hedge accounting requirements of IFRS 9 or IAS 39 to hedges of interest rate risk affected by interest rate benchmark reform, as well as users of those companies’ financial statements.

A summary of the proposals in this Exposure Draft

The proposals modify specific hedge accounting requirements so that entities would apply those hedge accounting requirements assuming that the interest rate benchmark on which the hedged cash flows and cash flows from the hedging instrument are based will not be altered as a result of interest rate benchmark reform. The proposals are not intended to provide relief from any other consequences arising from interest rate benchmark reform. Should a hedging relationship fail for reasons other than those specified by this Exposure Draft, the discontinuation of hedge accounting is required.

Next steps

The Board will publish the exposure draft, consider the comments it receives on the proposals and decide whether to proceed with the proposed amendments to IFRS 9 and IAS 39. The Board plans to complete any resulting amendments to IFRS 9 and IAS 39 in 2019.


1The report Reforming Major Interest Rate Benchmark was published in July 2014. The report is available at http://www.fsb.org/wp-content/uploads/r_140722.pdf.

Proposed targeted amendments to IFRS 17

As of April 2019, the Board has proposed the following targeted amendments to IFRS 17 Insurance Contracts:

  1. deferring the effective date by one year, to 2022;
  2. introducing additional scope exclusions;
  3. allocating acquisition costs to contract renewals;
  4. allocating profit relating to investment components;
  5. extending the risk mitigation option;
  6. recognising recovery of losses from reinsurance;
  7. simplifying balance sheet presentation; and
  8. introducing additional transition reliefs.

The purpose of these targeted amendments is to help companies implement IFRS 17 without diminishing the much-needed improvements the Standard will bring for investors. The Board expects to publish an exposure draft of the amendments around the end June 2019.

View further information on the project.

Stay up to date

Announcements

Board member Martin Edelmann’s second term extended by one year

The Trustees of the IFRS Foundation have extended by one year the second term of Board member Martin Edelmann.

Capital Markets Advisory Committee call for members

The Capital Markets Advisory Committee (CMAC) is seeking new candidates to join the CMAC from 1 January 2020 for a term of three years.

Tadeu Cendon and Rika Suzuki appointed to the International Accounting Standards Board

The Trustees of the IFRS Foundation, responsible for the governance and oversight of the Board, appointed Tadeu Cendon and Rika Suzuki as Board members.

New Standard on leases now effective

IFRS 16 Leases became effective for annual reporting periods starting on or after 1 January 2019. Visit our website to access the Standard and materials prepared to support its implementation.

Discussions on IFRS 17 Insurance Contracts at the March Board meeting

The Board substantively completed its discussions on concerns and implementation challenges in relation to IFRS 17 at its March meeting.

Speeches and events

Speech: What sustainability reporting can and cannot achieve

Chair of the Board Hans Hoogervorst delivered a speech at the Climate-Related Financial Reporting Conference in Cambridge, UK.

Speech: The Primary Financial Statements project—a game changer in financial reporting?

Chair of the Board Hans Hoogervorst delivered a speech at a conference held by the Consejo Mexicano de Normas de Información Financiera. In the speech, he described the global nature of IFRS Standards, recently issued Standards and the Board’s work on improving the formatting and structure of financial statements through its Primary Financial Statements project.

Erkki Liikanen delivers speech in Malaysia as part of Trustees’ meeting

New Chair of the IFRS Foundation Trustees, Erkki Liikanen, talked about the contribution of Malaysia and the Asia-Oceania region to the IFRS Foundation’s work at a stakeholder event during the Trustees’ meeting in Kuala Lumpur.

Resources for Investors

Webcast for investors on IFRS 15 Revenue from Contracts with Customers

Nick Anderson, Board member, and Sid Kumar, Technical Staff—Investor Engagement, present a webcast outlining the information companies will provide about their revenue in financial statements and notes prepared applying IFRS 15.

Investor publication: Analysing lessee financial statements and non-GAAP performance measures

The latest issue of The Essentialshighlights attributes of Free Cash Flow (FCF) measures reported by lessees that limit comparability with FCF measures reported by companies that buy assets.

Feature: Changes in financing liabilities—what does good disclosure look like?

Nick Anderson, Board member and former buy-side investor, discusses the objectives of the new disclosure requirement and explains what companies can do to make their disclosures as useful as possible.

Feature: Materiality modernised

Board member Gary Kabureck explains the steps the Board has taken to modernise the concept of materiality.

Feature: Returns, reinvestment opportunities and dividend distribution

Nick Anderson examines the importance of cash-flow and other factors a company may consider in determining the level of dividend payment, including the relationship between IFRS Standards and the capital maintenance requirements of individual jurisdictions.

Webcast: Achieving the IFRS Foundation’s mission—Evidence from international cross-border investment

In this webcast, Board member Ann Tarca presents academic evidence and discusses research about the impact of IFRS Standards on international cross-border investment.