IFRS 9, 15, and 16 - a Leap Forward

IFRS 9, 15, and 16 - a leap forward

KPMG’s 2017 Annual report market watch

June 2018 2 | IFRS 9, 15, and 16 - a leap forward IFRS 9, 15, and 16 - a leap forward

Introduction The review has prompted our thoughts on key items With the introduction of IFRS 15 Revenue from Contracts for reporters to consider for 2018 reporting and beyond. with Customers (effective 1 January 2018), IFRS 9 Financial (refer to “things to consider”). Instruments (effective 1 January 2018), and IFRS 16 Leases (effective 1 January 2019), IFRS reporters currently face a Sample populations tide of change. The IFRS 15 and 16 analysis covers the 2017 annual reports of the top 75 Dutch listed companies2. Ahead of the adoption dates of these new standards, the European Securities and Markets Authority (ESMA)1 The IFRS 9 analysis focuses on corporate entities only. The published its expectations with regards to the level of detail impact on financial institutions is far greater and demands in companies’ transition disclosures as required its own separate review. We have therefore excluded such by IAS 8. entities from this analysis3. This has resulted in a sample size of 55 entities for IFRS 9. In this market watch publication, we have analysed the transition disclosures in the 2017 annual reports of 75 Dutch listed companies and summarised our key The analysis for each standard is presented separately. observations on the disclosure details, expected impact, and transition approach.

IFRS 9: hedge accounting options available!

The following observations regarding Expected impact IFRS 9 have followed from a review of the 2017 annual reports of 55 Dutch • 50 companies (91%) stated that the listed corporates: impact of IFRS 9 will be immaterial. • The remaining 5 companies (9%) did Stage of transition project not explicitly qualify the significance of the IFRS 9 impact. • 2 companies (4%) indicated they are ready for full implementation of IFRS 9 as at the 2017 year-end. Stage of transition project IFRS 9 Expected impact IFRS 9 • 36 companies (65%) indicated that 0% their initial impact assessment is 4% complete. 9% 22% • A further 5 companies (9%) explained that their IFRS 9 impact assessment is still in progress, and 9% • The remaining 12 companies (22%) 65% did not explicitly comment on the 91% progress of the project.

Ready for full implementation Material Completed initial assessment Not material Initial assessment in progress Not disclosed Not disclosed

1 In October 2017 ESMA published its Public Statement on the European common enforcement priorities for 2017 IFRS financial statements that 2017 annual reports would contain specific quantitative and qualitative disclosures regarding the new standards to be adopted in the following period (https://www.esma.europa.eu) 2 Companies included in AEX, AMX and AScX-indices. One company early adopted IFRS 15 and is therefore excluded from the IFRS 15 analysis. 3 For an analysis of IFRS 9 impact on financial institutions, we refer readers to the KPMG Real-time IFRS 9 web page.

Type of disclosure

• All companies provided qualitative In summary the review shows disclosures on the impact of IFRS 9. that for the vast majority of Dutch • 18 companies (33%) also disclosed listed corporate companies the the expected quantitative impact of impact of IFRS 9 is relatively minor. the transition. This corresponds with Nevertheless, there are still things the fact that for the vast majority of to consider. corporate entities the impact of IFRS 9 is immaterial. •The quantitative impacts that were disclosed related mainly to the impact of the new Expected Credit Loss Type of disclosure IFRS 9 Transition approach IFRS 9 impairment methodology. These disclosed impacts had a negligible impact on equity. This is expected given the stable credit environment 33% we are currently in. 55% 45% Transition approach 67% • 25 companies (45%) have chosen to make use of the available practical 0% expedient to not restate the Qualitative and quantitative Without restatement comparative period. Qualitative only With restatement • The remaining 30 companies (55%) Not disclosed did not comment on the transition approach. Things to consider

Hedge accounting disclosures on this topic. Given the benefits IFRS 9 offers additional hedge accounting and new options provided by IFRS 9 in the 1 options for corporates in comparison to IAS area of hedge accounting, this may be a topic 39. Such opportunities include hedging of risk for additional considerations for corporate components of non-financial items and companies. hedging of aggregate exposures. The "cost of hedging" method also reduces P&L volatility Disclosures further. Effectiveness testing under IFRS 9 IFRS 9 expands the disclosure requirements is required only on a prospective basis and 2 for all companies. The additional information includes a qualitative assessment of required will of course depend on the economic relationships instead of the relevance of the different requirements for 80%-125% rule. each individual company. It is important to assess the additional disclosures rules fully. Our review of the annual reports highlighted Changes to data-gathering processes, IT that only 20 companies (36%) have chosen systems and controls are likely to be required. to adopt IFRS 9 for hedge accounting on It is also important to note that the new transition4. The remaining 35 companies hedge accounting disclosures in IFRS 7 may (64%) plan to defer the adoption of hedge not be deferred even if an entity continues to accounting under IFRS 9 or did not provide apply the IAS 39 hedge accounting model.

4 A deferral of applying IFRS 9 hedge accounting is available until the standard resulting from the IASB’s project on accounting for dynamic risk management is completed.

IFRS 15: we are not yet there!

Last year’s 2016 Annual report market 5 watch revealed that the majority of the Stage of transition project IFRS 15 Expected impact IFRS 15 companies listed in the Netherlands 0% were still assessing the impact of 10% 5% 4% IFRS 15 or had not commenced implementation. Studying the 2017 12% annual reports resulted in the following observations: 9%

Stage of transition project 78% 91%

• Our review found that 58 companies Ready for full implementation Material (78%) indicated that their initial Completed initial assessment Not material impact assessment is complete. Initial assessment in progress Not disclosed •A further 9 companies (12%) Not disclosed indicated that their IFRS 15 impact assessment is still in progress. • The remaining 7 companies (10%) did not disclose the stage of their IFRS 15 transition project. are the revenue streams driving • We understand that a small number these material impacts. of companies are continuing to work Expected impact •A large majority (91% or 67 through the implications of all areas companies) have indicated the new of the standard and consequently • Only 3 companies (4%) disclosed standard will not have a material were unable to include a reasonable that the implementation of IFRS 15 impact on their financial statements. estimate of the financial impact in will have a material impact on the • The remaining 4 companies (5%) their 2017 transition disclosures. financial statements. Software have not disclosed the impact of licensing and telecommunications IFRS 15.

5 KPMG: IFRS 15 Revenue recognition – A (final) call to action

Type of disclosure • The remaining 26 companies (35%) did not disclose whether they would Type of disclosure IFRS 15 • All companies provided qualitative opt for the cumulative effect method information on the impact of IFRS 15. or the full retrospective method. • 19 companies (26%) included a • The choice of transition option will 26% quantitative disclosure of the depend on each companies’ unique expected financial effect on results set of circumstances. The cumulative and the statement of financial effect method involves no position. restatement of the comparative 9% 74% • The remaining 55 companies (74%) period but does require dual reporting relied solely on the qualitative under both the outgoing standards disclosure to inform readers of the and IFRS 15 in the year of adoption. Qualitative and quantitative expected impact of IFRS 15. The retrospective method does Qualitative only • Often the qualitative disclosure involve restating the comparative explains that the initial effect is period but in turn does not require expected to be immaterial and that dual reporting. Each company Transition approach IFRS 15 IFRS 15 will not have a significant therefore faces a level of trade-off impact on revenue recognition between effort and comparability. compared to the current accounting policy. In summary the review shows that 35% the impact of IFRS 15 is expected to 35% Transition approach be immaterial for the vast majority of Dutch listed companies. Despite this • With regards to the transition there are some items which are worth 30% approach 26 companies (35%) considering no matter how minor the indicated that they have opted for impact. Cumulative effect approach the cumulative effect method. Retrospective (full or modified) •A further 22 companies (30%) Not disclosed have chosen the full retrospective approach. Things to consider

New disclosure requirements information to meet the new disclosure IFRS 15 introduces new qualitative and requirements in an efficient manner. This may 1 quantitative disclosure requirements. The aim require significant changes to the existing of the new disclosure is to enable financial data-gathering processes and cause statement users to understand the nature, companies to reassess their IT system amount, timing and uncertainty of revenue capabilities. and cash flows arising from contracts with customers. No matter how minor the impact Embedding new processes of IFRS 15, the requirement to build the new Companies may wish to embed the new disclosures remains. We would encourage all 3 accounting rules which IFRS 15 introduces reporters to ensure sufficient time is allocated beyond the finance function. For example, in the coming months to consider this topic. bid or sales teams can benefit from the To meet these new disclosure requirements knowledge when negotiating new contracts. will require an increase in efforts. It is important to create momentum and bring all internal stakeholders on board. For Systems large companies with a decentralized Aligned to the new disclosure, companies structure and multiple operating companies, 2 need to assess whether their current managing this process can require extra systems and processes are capable of effort, especially when IFRS knowledge is capturing, tracking, aggregating and reporting organised centrally at group level.

IFRS 16: what has been disclosed so far?

The review of the 2017 annual reports Transition approach resulted in the following observations Stage of transition project IFRS 16 regarding IFRS 16: •In total 47 companies (63%) have not disclosed their transition method to Status of impact assessment IFRS 16. Based on the status of IFRS 20% 16 implementation projects, this • 15 companies (20%) have indicated proportion is not surprising, 49% that they have completed a detailed as we expect the detailed impact assessment of the impact of IFRS assessment to influence the 31% 16, of which 5 are early adopters transition method decision. who will adopt IFRS 16 in 2018 • Those companies that did disclose alongside IFRS 15 and IFRS 9. their transition approach are In progress • A further 23 companies (31%) have overwhelmingly choosing the Initial assessment completed stated that they have conducted an modified retrospective approach Detailed assessment completed initial impact assessment and are (29%) instead of the full planning to conclude their detailed retrospective approach (8%). This is Expected impact IFRS 16 assessment in 2018. understandable given the additional • The remaining 37 companies (49%) practical expedients on offer and the have disclosed the assessment simplified nature of the modified 15% phase to be in progress or did not retrospective approach. include any specific disclosure on • From the 22 companies (29%) which the status of their IFRS 16 projects. have disclosed they will use the 27% 58% • These results agree with what we modified retrospective approach, only are seeing in the market: there are a 3 companies have already confirmed handful of front-runners, with the they will calculate the RoU (Right of majority of companies at the Use) asset as equal to the lease beginning or in the midst of their liability (modified retrospective -option Not disclosed transition project. 2). This option is available Material Not material on an asset by asset basis, so it Expected impact is interesting to note that these 3 companies appear to have ruled out Transition approach IFRS 16 • 20 companies (27%) have indicated the alternative option of measuring that the effect of IFRS 16 is likely to any RoU assets retrospectively be material, while 11 companies (modified retrospective – option 1). 29% (15%) anticipate the effect of IFRS 16 to be immaterial. 63% • The companies that indicated the In summary, our analysis shows that 8% impact will be immaterial are mainly whilst Dutch listed companies are from the financial services sector, making progress with their IFRS 16 and hence are businesses with small implementation projects there is still operating lease (lessee) portfolios much to do in the upcoming months Not disclosed relative to their balance sheet. to be ready for transition. Full retroscpective • The majority of the companies (44 Modified retroscpective companies or 58%) did not disclose the expected impact. We understand many companies are reluctant to quantify the impact of IFRS 16 as it will depend on the characteristics and size of the lease portfolio on transition date. As the transition date approaches we expect the impact will become increasingly clear.

Things to consider

Transition approach and practical management systems may already hold expedients some of this data, but in our experience it is 1 IFRS 16 offers a number of practical rare for all the data points to be available in a expedients under the modified retrospective single location. Rent review decisions or CPI transition approach. The standard also offers increases may only be located in emails or reporters ongoing elections to simplify via invoicing. Decisions on the reasonably the accounting process. It is highly certain lease term may need to be set and recommended that the decisions regarding recorded. Collating an IFRS 16 data set, these expedients and elections are made as therefore, requires coordinating inputs from early as possible. Items such as the multiple parties. A structured approach is decision to combine lease advised in order to collect the data in a and non-lease components (which can consistent and timely manner. be selected by asset class), can have a significant impact on the data collection IT systems – Excel versus dedicated lease process and the design of the future software accounting process. 4 The added complexity to generate journal entries under IFRS 16, which standard ERP Discount rates systems are not capable of, means that IFRS 16 requires application of the implicit many companies are choosing to implement 2 discount rate in a lease when it is dedicated lease accounting software or an “readily available”. In the event the implicit add-on to their existing ERP system. The rate is not “readily available” the lessee option of using Excel remains attractive for applies the incremental borrowing rate. many companies. However, in our view this Under the modified retrospective approach would only be recommended for companies the standard mandates the use of the with a very small number of leases and few incremental borrowing rates on transition. anticipated changes in their portfolio. With IFRS 16 requires that incremental borrowing the transition date fast approaching, rates reflect actorsf such as the credit risk standalone tools with minimal integration of the lessee, the term of the lease, the offer the lowest implementation effort. economic environment, and specific risks associated with the lease asset. Determining Processes and judgements an asset-specific discount rate is a challenge. IFRS 16 brings a whole new set of We note that companies are developing 5 judgements and accounting. A new end-to- models to calculate the discount rates end process is required, reaching from the alongside a process to update these rates identification of new lease contracts through periodically. The development of these to the determination of discount rates and models can be complex and is highly the reconciliation between the actual lease dependent upon the company’s lease payments and the IFRS 16 depreciation portfolio. and interest charges. Given the impact new leases and lease modifications can have on Data extraction the financial statements and related KPIs, Collecting the initial lease data requires new controls and safeguards are required. 3 dedicated resources. The required data To support a smooth transition it is points are often captured in multiple sources, recommended to design the new process such as the original contract, contract in detail and ensure all the involved parties addenda, invoices, or other correspondence. are engaged and aware of the role they Lease administration systems or contract will need to play.

IFRS 9, 15 and 16 represent significant For IFRS 9 and 15 we are entering the Our “things to consider” for each change in financial reporting. final stretch: companies must be ready standard highlight some key topics to report under these standards in their which reporters should take into The review of the 2017 annual reports 2018 (interim) financial statements. account. These lists are, of course, shows that although many reporters non-exhaustive and the relevance of have fulfilled ESMA’s expectation In the case of IFRS 16, reporters may each topic will differ according to the of providing specific quantitative have one additional year (assuming no nature of each reporter, but like any and qualitative information on the early adoption) for full implementation, financial reporting implementation, one forthcoming standards in the period but the expected impact will have thing remains constant: the clock is immediately prior to their adoption, to be disclosed in the 2018 annual ticking and there’s work to do! there are outstanding items to be report to meet the IAS 8 disclosure considered in the coming months. requirements on new standards.

Sources

Contact

The contacts at KPMG in connection with this publication are:

IFRS 16 IFRS 15 IFRS 9 Ruben Rog Philip Takken Dick Korf Partner Partner Partner T +31 20 656 8830 T +31 20 656 8372 T +31 20 656 7334 M +31 6 5126 7612 M +31 6 1373 0127 M +31 6 5124 5778 E rog.ruben.@kpmg.nl E [email protected] E [email protected]

Niels Ebbinkhuijsen Lawrence de Waal Valeria Kornooukhova Director Director Manager T +31 20 656 8685 T +31 20 656 8665 T +31 20 656 4054 M +31 6 2139 3012 M + 31 6 2336 9532 M +31 6 1930 3878 E [email protected] E [email protected] E [email protected]

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