We are pleased to present the May 2023 edition of our Financial Reporting Update providing insights for all entities and a section specifically aimed at Not for Profit (NFP) entities as we approach the end of financial year.
In this edition we will discuss the new standards effective for the first time for 30 June reporters, some future standards which you need to start thinking about, financial reporting considerations of the current economic climate and a focus on the impairment standard as this is likely to be time-consuming for a number of entities at 30 June 2023.
Relevant to all entities
Standards effective for the first time for June 2023 reporting entities
There are two substantive standards which are effective for the first time for June 2023 reporting entities – note that AASB 2022-3 affects not-for-profit entities only.
AASB 2020-3 Amendments to Australian Accounting Standards – Annual Improvements 2018-2020 and Other Amendments amends a number of standards for principally minor or editorial changes, the ones we consider are most likely to impact our clients are:
- AASB 116 Property, Plant and Equipment – when an entity produces items (e.g., samples created during the testing phase), the proceeds from selling such items, along with the costs of these items, should be recognised in profit or loss rather than being offset against the cost of the asset.
- AASB 137 Provisions, Contingent Liabilities and Contingent Assets – specifies the costs to include when assessing whether a contract is loss-making including both:
- Incremental costs of fulfilling that contract such as direct labour and materials and
- An allocation of other costs, including depreciation charge for an item of property, plant, and equipment used in fulfilling that contract and other contracts.
AASB 2022-3 Amendments to Australian Accounting Standards – Illustrative Examples for Not-for-Profit Entities accompanying AASB 15
There are two elements to standard which arose from the short-term, narrow scope project which the AASB performed into income accounting for NFP entities prior to commencing the post-implementation review in 2022.
- Illustrative Example 7A has been added to AASB 15 which provides a principles-based example on the accounting treatment of upfront fees for NFP which will assist for accounting for fees such as joining fees or other one-off upfront fees charged to stakeholders.
- The basis for conclusions has been amended to note that the option to initially recognise right-of-use assets arising from concessionary leases at cost will now be maintained on a permanent basis.
Standards not yet effective but may be considered for early adoption
AASB 17 Insurance Contracts
Though it may seem tempting to skip over this insurance contracts section, believing it might not apply to your entity, it’s critical to note that under AASB 17, certain transactions not typically classified as insurance contracts may indeed fall within its definition.
An insurance contract is defined as ‘a contract under which one party (the issuer) accepts significant insurance risk from another party (the policyholder) by agreeing to compensate the policyholder if a specified uncertain future event (the insured event) adversely affects the policyholder.’
This may include transactions such as:
- Warranties over products and services
- Financial guarantee contracts and
- Fixed fee service contracts such as roadside assistance and other offerings where customers receive ‘unlimited’ visits for a fixed fee.
The elements of the definition can be explored through the diagram below
AASB 17 has a number of intricacies particular in relation to its scope and related accounting requirements, we strongly advise all entities that suspect they may have an insurance contract to consult with their advisors at the earliest opportunity.
Other standards issued not yet effective
We note that the following standards are also issued but not yet effective and may affect some entities. Entities should consider whether any of these are likely to have a significant impact on the reporting financial position and performance.
- AASB 2020-1 / AASB 2020-4 and AASB 2022-6 – these standards all relate to the classification of liabilities as current or non-current as discussed in the previous edition of the newsletter.
- AASB 2021-2 and AASB 2021-6 – these standards relates to the disclosure of material accounting policy information rather than significant accounting policies and include a definition of accounting estimates.
- AASB 2021-5 Amendments to Australian Accounting Standards – Deferred Tax related to Assets and Liabilities arising from a Single Transaction – this standard clarifies the deferred tax accounting when a transaction results in the initial recognition of an asset and liability and may cause more deferred tax balances to be recognised.
- AASB 2022-5 Amendments to Australian Accounting Standards – Lease Liability in a Sale and Leaseback – this standard provides subsequent measurement requirements for sale and leaseback transactions that satisfy the requirements in AASB 15 Revenue from Contracts with Customers to be accounted for as a sale.
- AASB 2022-10 Amendments to Australian Accounting Standards- Fair Value Measurement of Non-Financial Assets of Not-for-Profit Public Sector Entities – this standard provides guidance for measuring certain assets of public sector entities at fair value.
30 June 2023 reminders for certain Corporation Act entities
We would like to remind entities that two important changes to the Corporations Act become effective at 30 June 2023:
- Grandfathering provisions which allowed certain entities exemption from lodgement are no longer in place and therefore these previously grandfathered companies will need to lodge general purpose financial statements.
- All Australian Financial Services Licence (AFSL) holders are required to lodge general purpose financial statements. Note AFSLs are required to consider whether they are publicly accountable under the definition in accounting standards or whether they are required to prepare Tier 1 financial statements under ASIC’s list (refer ASIC’s media release 22-128MR).
International Interpretations Committee Agenda Decision: Definition of a lease – Substitution Rights
The International Interpretations Committee (IIC) recently received a query in relation to two key points of assessing whether a contract contains a lease:
- Determining the level of evaluation (considering each asset individually or all assets collectively) for contracts involving the use of multiple similar assets.
- Evaluating lease contracts under AASB 16, especially in scenarios where the supplier holds certain substitution rights but might not economically benefit from exercising them.
The fact pattern that the IIC received was a customer signs a 10-year contract for the use of 100 similar new assets—batteries for electric buses. The supplier has the practical ability to substitute batteries throughout the contract, but substitution compensation costs might make this unbeneficial economically for at least the first three years.
The Committee concluded that in such scenarios:
- Each battery is to be evaluated as a potential separate lease component since each battery, along with other readily available resources (e.g., the bus), provides a distinct benefit to the customer. Each battery’s dependence or interrelation with the others does not influence this assessment.
- Each battery becomes implicitly specified as an identified asset once it is made available for the customer’s use. However, the supplier’s right to substitution is not considered substantive throughout the entire period of use, because in the first three years of the contract the cost of substitution outweighs the benefits. Therefore, a battery does not meet the identified asset criteria under paragraph B14(b) of AASB 16 throughout the period of use.
These conclusions highlight the importance of careful and comprehensive assessment of lease components and supplier’s substitution rights in line with AASB 16 requirements when evaluating contracts that potentially contain leases.
AASB 16 is not a set and forget standard and entities need to ensure that all relevant terms and conditions are reviewed for current and new contracts which may contain a lease.
Financial reporting considerations in the current economic environment
The current economic conditions with high inflation and rising interest rates pose significant challenges for financial reporting at 30 June 2023. Transparent communication of the assumptions, judgements, and estimates used, along with their sensitivity to changes in these conditions, will be crucial for users of financial statements to understand the entity’s financial position and performance.
Entities will also need to maintain close communication with their auditors to ensure that any significant estimates and judgements are appropriately disclosed and that all AASB requirements, particularly those related to impairment and the use of estimates and judgements, are adequately met.
We have explored some areas for entities to review as part of the year end reporting process:
Impairment Considerations (subject of a focus article later in this newsletter)
High inflation and high interest rates can lead to a decrease in the fair value of an entity’s assets.
For instance, consider a company that operates in an industry with a high capital expenditure requirement such as manufacturing. Rising inflation will increase the cost of raw materials and maintenance of PPE. Concurrently, high interest rates could lead to higher borrowing costs, negatively impacting profitability. This combination might erode future cash flow projections, leading to a possible impairment of PPE or goodwill if their carrying amount exceeds their recoverable amount.
Estimates, Judgements, and Assumptions
The current economic climate is different from that in previous periods, the preparation of financial statements using Australian Accounting Standards requires a number of assumptions, judgements and estimates. The one thing that is certain is that the judgements, assumptions and estimates used for the 30 June 2023 reporting period will not be the same as those used previous and therefore entities will need to consider the revised numbers and provide support for these figures.
- High inflation may increase the cost of an entity’s inventory and high interest rates may mean lower demand as consumer spending is cut. This will result in a revision of the estimate for the net realisable value of its inventory and a provision if the inventory is expected to sell for less than cost.
- Entities with interest-bearing debt are likely to face higher interest costs, which will need to be factored into their estimates for future cash flows and debt repayments and will require amendments to discount rates used in a number of calculations including provisions under AASB 137.
The ability of an entity to continue as a going concern is likely to come under scrutiny in the current environment. With increasing operational and financial costs, there might be significant doubt about the entity’s ability to continue to meet its obligations. Entities and auditors will need to exercise judgement on this matter, evaluating the entity’s forecasts, funding arrangements, and strategies for dealing with the economic conditions. Entities should ensure that going concern disclosures are included in the financial statements, where relevant and these should be tailored to the entity’s current circumstances and provide the story of why the going concern assumptions remains appropriate.
Focus topic: Impairment under AASB 136 Impairment of Assets
One of the key principles of AASB 136 is that entities need to estimate recoverable amount of their assets where there is an indicator of impairment. AASB 136 contains some indicators which entities need to consider, these include:
- Market interest rates have increased during the period
- Significant changes with an adverse effect on the entity have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the entity operates.
Given these two indicators that it is very unlikely that any entity will be able to state that they are not exposed to impairment indicators at 30 June 2023. Consequently, for the majority of an assets or cash-generating units (CGU’s), there will be a need to estimate the recoverable amount.
Impairment occurs when the carrying amount of an asset is higher than the amount that the entity can recover from the use or sale of that asset.
Where there is an impairment indicator for an asset or CGU or annually for goodwill, indefinite life intangibles or intangibles not yet ready for use, AASB 136 requires entities to estimate the recoverable amount.
Recoverable amount is the higher of the fair value less costs of disposal (what the entity could get from selling the asset after deducting any associated selling costs) and the value in use (the present value of the future cash flows expected to be derived from the asset).
- Fair value less costs of disposal is determined in accordance with AASB 13 Fair Value Measurement and requires an estimate of the amount that would be received if the asset was disposed. Any necessary selling costs are deducted from the fair value.
- Value in use involves estimating the cash flows from the use of the asset over its life which often results in the use of a terminal value as a proxy to cash flows which extend beyond the forecast period. Entities should only consider cash inflows and outflows that arise from continuing to use the asset in its current condition. This means that the estimated future cash flows should not include expected cash inflows or outflows from future refurbishments, enhancements, or improvements to the asset that would increase its performance or productivity.
The discount rate used is a pre-tax rate which reflects current market assessments of the time value of money and the risks specific to the asset.
The entity then compares the recoverable amount with the carrying amount of the asset. If the recoverable amount is lower, the asset is considered impaired and an impairment loss is recognised in the income statement (or revaluation reserve if the asset is held at fair value and there is sufficient reserve balance).
Relevant to NFP entities
Tier 3 update
As reported in our November 2022 edition, the AASB were seeking comments on whether to proceed with a project on Simplified Accounting and Disclosure for certain NFP entities. The comment period ended on 31 March and thanks to the significant level of feedback received, the Board has directed the staff to commence drafting an exposure draft.
The exposure draft will:
- Develop a stand-alone Tier 3 standard with simplified accounting requirements for smaller NFP entities
- Extend the Australian Accounting Standards to certain NFP entities provided a Tier 3 standard is available.
The exposure draft is expected to be released for comment by the end of 2024 so unfortunately we will not see this completed standard available for adoption for a number of years.
Related party transactions disclosure reminders
From 30 June 2023, ACNC registered charities will have to record and disclose information relating to material related party transactions in special purpose financial statements (medium and large charities) and the Annual Information Statement for all charities.
Examples of related party transactions for charities are :
- Fees paid to a related party for providing goods or services to the charity
- Loans from or to a related party
- Salary or wages paid to a related party’s relative
- Transfer of charity property or assets to a related party
- Charity goods or services provided at a discount to a related party
- Significant use of charity property by a related party
- Investment in a related party.
The ACNC has released a significant amount of guidance on their website to assist NFP with collecting and disclosing this information and we encourage all affected charities to develop appropriate policies and procedures to identify and record this information as soon as possible.
If you want any more information on any of the topics discussed in this article or to discuss the application to your specific circumstances, please get in touch with your local Accru representative.