Now that local authorities are in the middle of preparing their first financial statements under the new IFRS 9 Financial Instruments accounting standard, here’s a reminder of what might need doing differently this year.
Impairment
The new impairment rules are probably the most wide-ranging change in IFRS 9. Instead of waiting for objective evidence of impairment, such as payments being overdue, a loss allowance must now be set aside for most financial assets with contractual payments.
This allowance will probably be small, even immaterial, for treasury investments. But the numbers will be much larger for trade and lease receivables, loans to other bodies, commitments to lend in future, and guarantees given over others’ loans. And existing provisions for doubtful debts might not meet the stricter requirements of IFRS 9. Many of these higher allowances will have an impact on revenue.
Reclassification
The main reclassification change is the removal of the available for sale category. Balances in the AFS reserve therefore need to be cleared out, but the double entry could be to one of several places.
IFRS 9 comes with an option to elect to move this balance, and future capital gains and losses, on equity instruments to a revaluation reserve. There has been much discussion over whether shareholdings in pooled funds count as equity – a consensus is slowly forming that provided the fund has no contractual obligation to meet withdrawal requests, so that investors cannot sue if redemptions are suspended, then the election is available.
Making the election prevents capital gains and losses from hitting the revenue account, which could be very important come the next recession. Local authorities in England that don’t elect their pooled funds are protected for another four years by a statutory override, but if that is not renewed in 2023 it will be too late by then to make the election.
The other reclassification change likely to affect local authorities concerns financial assets where the expected receipts do not meet the IFRS definition of principal and interest. One common example is loans to homeowners where the amount to be repaid depends on the sale price of the house. Such loans must be marked to market each year with the change counting as income or expenditure.
Debt Restructuring
In a code update published on 15th April, CIPFA/LASAAC confirmed the new rules for modified or restructured debt where the new loan is too similar to the old loan to count as an extinguishment. Now both the premium paid and the present value of the interest savings are taken to revenue up-front, rather than being spread over the life of the loan.
Assuming that restructuring was meant to be beneficial, with interest savings exceeding the premium, this will result in a credit to revenue, possibly of several millions of pounds. Local authorities will need to search out their historic records of debt restructuring where they still have modified loans on the balance sheet in order to make the required accounting entries.
Hopefully this will be the last example of the unwelcome practice of making accounting changes after the end of the financial year to which they relate. At least this change was trialled in advance and confirmed earlier than last year’s 15th May statement on contracts with LOBO clauses.
Presentation
So, the transition to IFRS 9 is likely to change the values of many financial assets and reserves. However, none of this should show as income or expenditure in 2018/19. Instead an additional row should be added to the Movement in Reserves Statement between the closing balances for 31st March 2018 and the opening balances for 1st April. And in a change to normal practice, comparative figures for 2017/18 should not be restated.
Disclosure
IFRS 9 comes with vastly increased disclosure note requirements, especially around credit risk and loss allowances. But the key thing to remember is that disclosure notes should provide additional useful information to the readers of the accounts. The focus should therefore be on the greatest risks – the largest exposures and/or those with the highest chance of default. Whole pages of figures close to zero might be accurate data, but won’t meet the overarching requirement to impart useful information.
David Green is strategic director at Arlingclose Limited.
