1.  Revenue recognition from insurance brokerage

Enquiry:

We recognise revenue from consultancy and brokerage services on later of billing date or effective date of underlying policy. We recognise revenue in light of the example 17 para 23A.21 of IFRS for SMEs which states that revenue are recognized on the effective date of commencement or renewal of the related policies, if the agent is not required to render further service, otherwise the commission or part thereof is deferred and recognized as revenue over the period which the policy is in force.

The rationale for later of billing date or effective date of underlying policy is due to the fact that amount of revenue can be measured reliably at that point in time.

We understand that insurance contracts are considered ‘uberrima fides’ that is correct of utmost good faith and the only thing available is a policy document which undertakes that on happening of an event, which cannot be predicted, the insured will be indemnified.

Since the probability to render further services is not measurable therefore the revenue is recognized at later of billing date or the effective date of underlying policy.

Additionally, as we record the revenue at the later of effective date of insurance policy or invoice date, exchange gains or loss arising on foreign currency denominated invoices are not recorded for services that fall between more than one financial years as revenue is recognized on the invoice date only instead of stage of completion method.

You are requested to please guide us which policy to follow.

Opinion:

Paragraph 23.14 of section 23 of IFRS for SMEs provides guidance on the revenue recognition from rendering of services. The paragraph is reproduced as under (underline is ours):

“When the outcome of a transaction involving the rendering of services can be estimated reliably, an entity shall recognise revenue associated with the transaction by reference to the stage of completion of the transaction at the end of the reporting period (sometimes referred to as the percentage of completion method). The outcome of a transaction can be estimated reliably when all the following conditions are satisfied:

a) the amount of revenue can be measured reliably;
b) it is probable that the economic benefits associated with the transaction will flow to the entity;
c) the stage of completion of the transaction at the end of the reporting period can be measured reliably; and
d) the costs incurred for the transaction and the costs to complete the transaction can be measured reliably.”

Further, paragraph 23.15 provides guidance on the revenue recognition in cases:

• where services are performed by an indeterminate number of acts over a specified period of time; or
• when a specific act is much more significant than any other act.

Accordingly, it is to be noted that the revenue recognition example related to insurance agency commission (quoted in paragraph 23A.21 of IFRS for SMEs Standard) is based on the basic premise that all revenue recognition requirements (contained in paragraph 23.14) have been fulfilled.

The revenue from rendering of services is generally recognised on the performance of the services, under the terms of the agreement. Further, generally its recognition is based on the performance of the service and not to the billing arrangement.

Generally, the revenue from insurance brokerage commission would be recognized when the performance obligation is satisfied (effective date of the policy or upon completion of a milestone).

Further, paragraph 30.7 states that:

“An entity shall record a foreign currency transaction, on initial recognition in the functional currency, by applying to the foreign currency amount the spot exchange rate between the functional currency and the foreign currency at the date of the transaction.

Based on the above discussion, the Board is of the view that:

• Revenue from the consultancy and brokerage services earned under the terms of agreement(s), in accordance with the principle set out in paragraph 23.14 of IFRS for SME Standards.

• The foreign currency transactions (revenue from the consultancy and brokerage services), in accordance with the paragraph 30.7 of IFRS for SMEs Standard.

• The gain on loss on the foreign currency revenue related monetary assets, in accordance with the principle outlined in paragraph 30.10 of IFRS for SME Standards.

(March 12, 2018)

2.  Applicability of two options for the medium sized companies

Enquiry:

Your kind attention is drawn towards provisions of SRO 929 (I)/ 2015 dated 10 September 2015. At serial No. 3 the IFRS for SMEs were made applicable for medium sized companies. In column No. 4 of the above SRO the following is mentioned:
“A Medium-Sized Company with appropriate disclosure in its financial statements may have option to adopt the following:
(i) The revaluation model included in the IAS – 16, ‘Property, Plant and Equipment’; and
(ii) The capitalizing of borrowing costs as permitted by IAS – 23, ‘Borrowing Costs’”.

The third schedule of the Companies Act, 2017 as amended up to date vide SRO 1169(I)/2017 dated 7 November, 2017 does not include the above mentioned clarification as included in SRO 929(I)/2015 allowing the medium-sized companies to adopt revaluation model and to capitalize the borrowing costs as mentioned in (i) and (ii) above respectively.

You are requested to please clarify the applicability or otherwise of the above two options for the medium-sized companies under the third schedule of the Companies Act, 2017.

Opinion: The International Accounting Standards Board (IASB) issued the IFRS for SMEs in July 2009. In Pakistan, the Securities and Exchange Commission of Pakistan (SECP) through S.R.O 929(I)/2015 (dated September 10, 2015) prescribed the IFRS for SMEs as the financial reporting framework for medium-sized companies. However, under S.R.O 929(I)/2015 two modifications were made in the IFRS for SMEs. These modifications are reproduced as under:

“A medium sized company with appropriate disclosure in its financial statements may have the option to adopt the following:

a. The revaluation model included in the International Accounting Standard (IAS) 16 ‘Property, Plant and Equipment’.

b. The capitalizing of borrowing cost as permitted by International Accounting Standard (IAS) 23 ‘Borrowing Cost’.”

It is to be noted that in 2015 IFRS for SMEs were amended by IASB. Amongst the incorporated amendments was addition of revaluation model in relation to the property, plant and equipment. Relevant paragraph 17.15 of section 17 (Property, plant and equipment) of IFRS for SMEs (2015 version) is reproduced hereunder:

“An entity shall choose either the cost model in paragraph 17.15A or the revaluation model in paragraph 17.15B as its accounting policy and shall apply that policy to an entire class of property, plant and equipment. ……………..” (Underline is ours)

Pursuant to the above amendment in the IFRS for SMEs the only modification/ difference between the IFRS for SMEs issued by IASB and financial reporting framework prescribed by SECP through S.R.O 929 (I)/ 2015 related to the borrowing costs.

IFRS for SMEs require that all borrowing costs are charged to profit or loss, and the relevant paragraph 25.2 of section 25 (Borrowing Costs) of IFRS for SMEs is reproduced hereunder:

“An entity shall recognise all borrowing costs as an expense in profit or loss in the period in which they are incurred.”

The Board understands that SRO 929 (I)/ 2015 was issued under the repealed Companies Ordinance, 1984. The Companies Act, 2017 has been enacted on May 30, 2017 and the Board would like to draw your attention to the third schedule of the Companies Act 2017. The Third Schedule of the Companies Act, 2017 specifies that a medium-sized company is required to prepare statutory financial statements in accordance with IFRS for SMEs. However, in the Third Schedule of the Companies Act, 2017 no modification has been prescribed in the IFRS for SMEs.

Based on the above discussion the Board concludes that a medium-sized company in accordance with IFRS for SMEs:

• Can choose either cost model or revaluation model for measurement after initial recognition of property, plant and equipment.

• Shall recognise all borrowing costs as an expense in the statement of profit or loss in the period in which they are incurred.

(January 12, 2018)

3. Assets on Ijarah

Enquiry:

Please guide whether the finance lease liability of our client, which is a medium sized entity, be classified as operating lease as per Islamic Financial Accounting Standard 2 (IFAS 2), Ijarah, or finance liability as per International Financial Reporting Standards for Small & Medium Sized Entities (IFRS for SMEs)?

IFAS 2 was made applicable on companies through SRO 431(1)/2007. However, later SECP made changes in the Companies Ordinance, 1984 by classifying companies as small, medium and large companies and vide their SRO 929(1)/2015, SECP has specified applicability of IFRS for SMEs for medium sized entities for financial periods beginning or after January 01, 2015 and thus restricting to apply these standards while preparing financial statements of medium sized entities. These standards do not require medium sized entities to record Ijarah Assets as operating lease instead it requires applying the concept of substance over form and record asset as finance lease if it qualifies the said criteria.

Our client is a medium sized entity as per fifth schedule of the Companies Ordinance, 1984. In accordance with the SRO No. 929(1)/2015, SECP has directed the non-listed small and medium sized entities, classified under fifth schedule to the Companies Ordinance 1984, to follow applicable financial and accounting reporting standards. The applicable financial and accounting reporting standards for non-listed small and medium sized entity include IFRS for SMEs.

Opinion:

The Board considered your query and would like to draw your attention to SRO 929 of 2015 issued under the repealed Companies Ordinance, 1984 which provides classification of the companies and the accounting framework to be followed by such companies.

Further, under the repealed Companies Ordinance, 1984, SECP has notified the Islamic Financial Accounting Standard (IFAS) 2, Ijarah, through S.R.O 431(I)/2007 which states that:

“In exercise of the power conferred by sub-section (3) of section 234 of the Companies Ordinance, 1984 (XLVII of 1984), the Securities and Exchange Commission of Pakistan is pleased to direct that the Islamic Financial Accounting Standard 2, annexed to this notification, issued by the Institute of Chartered Accountants of Pakistan, shall be followed in regard to the financial statements by companies and modarabas while accounting for Ijarah (Lease) transactions.”

With regard to the enquired scenario, an Ijarah contract shall be accounted for in accordance with the IFAS 2, and the statement of compliance shall include IFAS as part of the approved accounting standards.

(October 02, 2017)

4. Presentation of investment property

Enquiry:

Sections 4.2(ea) and 4.2(f) of IFRS for SMEs states that “investment property carried at cost less accumulated depreciation and impairment” and “investment property at fair value through profit or loss” respectively, should be shown as Iine items on the statement of financial position.

Our question is that should the complete nomenclature as mentioned herewith be shown on the statement of financial position together with the amounts of accumulated depreciation and impairment, or an abbreviated name can be shown on the face of the statement of financial position and amounts of depreciation and impairment be given in the notes?

Opinion:

Section 4.2 of the IFRS for SMEs lists down minimum line items, to be presented, in the statement of financial position. The relevant part of section 4.2 of the IFRS for SMEs is reproduced hereunder:

“4.2 As a minimum, the statement of financial position shall include line items that present the following amounts:

(a) ……
(ea) investment property carried at cost less accumulated depreciation and impairment”.

Section 16 of the IFRS for SMEs deals with investment property and section 17 of the IFRS for SMEs deals with the property, plant and equipment. However, section 17.31 contains the disclosure requirements relating to property, plant and equipment and investment property carried at cost. Therefore, the disclosure requirements of investment property carried at cost less accumulated depreciation and impairment are set out in section 17 of the IFRS for SMEs.

Section 17.31 requires that:

“An entity shall disclose the following for each class of property, plant and equipment determined in accordance with paragraph 4.11(a) and separately for investment property carried at cost less accumulated depreciation and impairment:

a) the measurement bases used for determining the gross carrying amount;

(b) ………………..;

(e) a reconciliation of the carrying amount at the beginning and end of the reporting period showing separately:
(i) additions;
(ii) disposals;
(iii) acquisitions through business combinations;
……………………………………………………………………………
(vii) depreciation; and
(viii) other changes. (Underline is ours)

Based on the above, the net amount of investment property carried at cost shall be presented in the statement of financial position, and the reconciliation of opening and closing carrying amounts, including depreciation charge and impairment shall be disclosed through the notes to the financial statements.

From the above provisions of IFRS of SMEs, it is apparent that net amount of investment property will be presented on the face of the statement of financial position. The depreciation charge and impairment with reconciliation of opening and closing amounts will be disclosed through the notes.

(October 02, 2017)

5.  Defined Benefit Plan under Section 28 of the IFRS for SMEs

Enquiry:

This inquiry pertains to Gratuity plan of a Company. Section 28.15 (a) requires an entity to measure defined benefit obligations at the present value. Section 28.17 elaborates the procedure for calculating the discounted present value. An entity has the option to either calculate defined benefits under ‘projected unit credit method’ as described in section 28.18 OR under the permitted simplifications as explained in section 28.19.

Our first question is that if an entity opts for section 28.19, will it still be required to work out the discounted present value? Kindly provide the opinion of relevant committee in this regard.

The relevant sections mentioned above are reproduced below:

“28.15    An entity shall measure a defined benefit liability for its obligations under defined benefit plans at the net total of the following amounts:

1. the present value of its obligations under defined benefit plans (its defined benefit obligation) at the reporting date (paragraphs 28.16-28.22 provide guidance for measuring this obligation), minus
2. the fair value at the reporting date of plan assets (if any) out of which the obligations are to be settled directly. Paragraphs 11.27-11.32 establish requirements for determining the fair values of those plan assets that are financial assets.”

“28.17  An entity shall measure its defined benefit obligation on a discounted present value basis. The entity shall determine the rate used to discount the future payments by reference to market yields at the reporting date on high quality corporate bonds. In countries with no deep market in such bonds, the entity shall use the market yields (at the reporting date) on government bonds. The currency and term of the corporate bonds or government bonds shall be consistent with the currency and estimated period of the future payments.”

“28.19   If an entity is not able, without undue cost or effort, to use the projected unit credit method to measure its obligation and cost under defined benefit plans, the entity is permitted to make the following simplifications in measuring its defined benefit obligation with respect to current employees:

1. ignore estimated future salary increases (i.e. assume current salaries continue until current employees are expected to begin receiving post-employment benefits);
2. ignore future service of current employees (i.e. assume closure of the plan for existing as well as airy new employees); and
3. ignore possible in-service mortality of current employees between the reporting date and the date employees are expected to begin receiving post-employment benefits (i.e. assume all current employees will receive the postemployment benefits). However, mortality after service (i.e. life expectancy) will still need to be considered.

An entity that takes advantage of the foregoing measurement simplifications must nonetheless include both vested and unvested benefits in measuring its defined benefit obligation.”

Our second question is with reference to section 15.6 read with section 15.8 of the “Accounting and financial Reporting Standards for Small-Sized Entities” (AFRS for SSEs) where unfunded gratuity provision is made as under:

“However, an entity may opt to calculate the accrued liability by reference to any other rationale method e.g. a method based on the assumption that such benefit are payable to all employees at the end of the accounting year”.

Will discounting be required to work out present value in the above case?

Opinion:

The Committee would like to draw your attention to the following paragraphs of IFRS for SMEs:

Actuarial valuation method

“28.18   If an entity is able, without undue cost or effort, to use the projected unit credit method to measure its defined benefit obligation and the related expense, it shall do so………….”

“28.19  If an entity is not able, without undue cost or effort, to use the projected unit credit method to measure its obligation and cost under defined benefit plans, the entity is permitted to make the following simplifications in measuring its defined benefit obligation with respect to current employees:

1. ignore estimated future salary increases (i.e. assume current salaries continue until current employees are expected to begin receiving post-employment benefits);
2. ignore future service of current employees (i.e. assume closure of the plan for existing as well as any new employees); and
3. ignore possible in-service mortality of current employees between the reporting date and the date employees are expected to begin receiving post-employment benefits (i.e. assume all current employees will receive the post-employment benefits). However, mortality after service (i.e. life expectancy) will still need to be considered.”

Section 28.18 spells out that an entity shall use projected unit credit method to measure provision for gratuity. Section 28.19 of the IFRS for SMEs provides the mechanism to work out provision for gratuity where an entity is not able to use the projected unit credit method. In the simplified version there are no salary increases and services assumed for future (i.e. closure of the plan assumed) this is called “discontinuance approach” in which case no discounting is required.

This concession conveys the same meaning as by section 15.6 of the Accounting & Financial Reporting Standards for SSEs which is reproduced bellow:

“However, an entity may opt to calculate the accrued liability by reference to any other rationale method e.g. a method based on the assumption that such benefit are payable to all employees at the end of the accounting year “.

Hence, the Committee is of the view that the provision for gratuity under section 28.19 of IFRS for SMEs and section 15.6 of AFRS for SSEs will be calculated without discounting for present value, that is, “closure of the plan” and “benefits are payable to all the employees at the end of the accounting year”.

(August 26, 2016)