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<title>Expected credit losses for banks under IFRS 9 - what next?</title>
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<description>Considerations ahead of 2020 year-end I’m somewhat of a connoisseur when it comes to good tequila and, as luck would have it, my favourite anejo (not sold in stores) is top-shelf at a local cantina. During my first visit there in months last week, it was a relief to feel...</description>
<content:encoded>Considerations ahead of 2020 year-end 
I’m somewhat of a connoisseur when it comes to good tequila and, as luck would have it, my favourite anejo (not sold in stores) is top-shelf at a local cantina. During my first visit there in months last week, it was a relief to feel that things might become normal again. Sort of. Like many, I’d hoped for a quick lockdown, V-shaped recovery and rapid vaccine. Yet with the first two ‘crisis quarters’ behind us, it’s becoming clearer that’s unlikely to be the case. For estimating expected credit losses (ECLs) for banks under IFRS 9, that warrants a pause to think about where we are and what challenges might be next, including any necessary changes to adapt ahead of year-end reporting if crisis uncertainty continues to loom.&#0160;
Thus far, billions have been booked in incremental provisions, while defaults are yet to rise. In many cases, delinquencies haven’t even transpired thanks to payment holidays and enormous government support. So enormous, in fact, that some individuals have found themselves better off than before. For banks, that means a few things. Firstly, losses are likely coming. Provisions set aside will be consumed as delayed defaults come to fruition. Secondly, risk will continue to be very challenging to measure. Put simply, normal rules don’t apply. Being jobless or unprofitable usually reduces one’s ability to pay, which leads to delinquencies and ultimately to defaults – not true (immediately, at least) when money’s free and repayments are on hold.&#0160;
What’s next? Optimistically, I still hope for a quick resolve – a fast return to life like we once knew (with a few exceptions, like in-store shopping and travel, perhaps). Rationally, I acknowledge that may not be the case. Of course, in many ways, all that we really know is that we don’t really know. That’s important since what comes to pass will determine the credit losses that eventually transpire. In estimating ECLs today, we average the good, the bad and the ugly by probability-weighting different outcomes. In real life, we don’t. For that reason, provisions are sure to evolve as reality unfolds.&#0160;
Given all of the above, to date most have adapted their estimates by moving away from core models and doing new or different analytics, adding a lot of (necessary) judgement along the way. Thinking ahead to year-end, things to focus on now are:
<ul>
<li>continuously refining the estimate as conditions evolve (for example, reflecting epidemiological developments and changes to government stimulus packages);&#0160;</li>
<li>assessing whether adding more alternative scenarios, when modelling estimates, might be a better way to address increased uncertainty;&#0160;</li>
<li>testing judgements, including by comparison to peers, market inputs (such as credit default swap spreads), current pricing of similar loans, and consistency with fair value disclosures;&#0160;</li>
<li>focusing on governance, process and controls, in order to bring the same level of rigour to new or changed methods as would normally be applied to core models (a particular challenge for Sarbanes-Oxley or similar requirements);&#0160;</li>
<li>thinking differently about validation, including whether overlays and other adjustments can be covered by similar processes;&#0160;</li>
<li>considering what new data might become available (such as cash flow information from the borrower’s different accounts or changes to government programmes) and how it will be collected and incorporated into estimates;&#0160;</li>
<li>planning for an agile future by rethinking the ‘model’ definition and implementing frameworks that allow for quick pivots from core models to risk analytics without having to compromise on quality; and&#0160;</li>
<li>putting transparency first, by considering what disclosures might be most useful for users, depending on how things might shake out between now and year-end.&#0160;</li>
</ul>
The only certainties right now are that none of us really knows where we’ll be in six months’ time, and that what worked in the past isn’t working now. Focus to date has been on finding ways to estimate until things become clearer. In the event they become less clear, it’s worth figuring out how to migrate from short-term fixes into longer-term solutions.&#0160;
<div>Our guest blogger is Chris Wood, Banking Partner and IFRS 9 specialist, connect with him on LinkedIn here.</div>
<div>&#0160;</div>
<div><a href="https://www.linkedin.com/in/chriswoodcpa/" rel="noopener nofollow noreferrer" target="_blank">https://www.linkedin.com/in/chriswoodcpa/</a></div></content:encoded>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Fri, 04 Sep 2020 14:50:33 +0100</pubDate>
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<item>
<title>Expecting the unexpected: Modelling relationships between economic factors and expected credit losses during COVID-19</title>
<link>https://pwc.blogs.com/ifrs/2020/06/expecting-the-unexpected-modelling-relationships-between-economic-factors-and-expected-credit-losses.html</link>
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<description>When we estimate expected credit losses (ECLs), we form expectations about possible forward-looking macroeconomic scenarios, assign probabilities to each, and then use historical relationships between the macroeconomic variables and our loss parameters to estimate the losses that would arise under each scenario. Sometimes those past relationships are better predictors than...</description>
<content:encoded>When we estimate expected credit losses (ECLs), we form expectations about possible forward-looking macroeconomic scenarios, assign probabilities to each, and then use historical relationships between the macroeconomic variables and our loss parameters to estimate the losses that would arise under each scenario. Sometimes those past relationships are better predictors than others. Take unemployment, for instance. Normally, when people become unemployed it means that they’re out of work without a job to return to. It takes time to find a new one and until they do, cash isn’t flowing in.&#0160;
From an ECL perspective, that means that the ‘probability of default’ (PD, being the risk that the loan cannot be repaid) increases. For argument&#39;s sake, let’s say that on average it takes a year to find a new job and that as a result, PD typically doubles. Why might that be different during the coronavirus (COVID-19) pandemic?&#0160;
For starters, there are new government programs and reliefs that may increase cash flows available to support loan repayment. Secondly, unlike usual circumstances, the employees and businesses themselves may not have failed. In other words, there may be jobs available to return to once lockdown eases. If so, that means less time in limbo and less time without normal cash inflows. With any luck, that should mean less risk (compared to normal unemployment) that the loan will not be repaid.&#0160;
Of course, it’s also possible that it could turn out to be worse and that can’t be overlooked either. After all, we don’t know what effects government relief programs will ultimately have, how long lockdown and social distancing will continue, whether there’ll be another wave, or when a vaccine might be developed. Each could have a very significant impact on how and when loan losses will transpire.&#0160;
Since transition to IFRS 9, our application of the ‘multiple scenarios’ requirement in estimating ECLs has focused predominantly on forecasting and modelling various economic variables and what we think those variables might be in the future. That worked well while conditions were benign - but now the underlying relationships between those economic variables and the variables we need to estimate ECLs might change too. In other words, our consideration of uncertainties may need to be extended to include reviewing both the economic variables and their relationships with loan losses.&#0160;
All of this has meant that over the past few months, banks’ models are often producing unusual results when using recent macroeconomic data. This could be the manifestation of unusual economic conditions, limitations in the models themselves, or both. Typically, models go through calibration during development and validation, including testing them under a range of conditions. That’s not necessarily to say that they’re certain not to work in conditions outside of that range, but they weren’t developed with them in mind and so there’s a chance that they may not. How do you discern between the effects of unusual economic conditions and outliers in evaluating model outputs? We’d start by asking:&#0160;
<ul>
<li>What’s causing us to believe there are outliers?</li>
<li>Have known limitations been identified during model development and validation?</li>
<li>How can we measure it and what alternatives exist (e.g. scalar, overlay or other)?&#0160;</li>
<li>What additional validation and internal control procedures are necessary?</li>
</ul>
To assess this, some banks start by comparing results to those generated by stress-testing results, Basel capital models, internal budgets, external sources of projected default rates, historical loss experience (e.g. during the Global Financial Crisis) and other available reference points. Where limitations are confirmed, models might be applied within the calibration range and overlays used to address identified shortcomings beyond them. Depending on the portfolio, individual loan reviews or other approaches may be applied as well.&#0160;
Whichever approach is taken, keep in mind that robustness and consideration of all possibilities is key and when it comes to data points and triangulating adjustments, more is better.&#0160;
Our guest blogger is Chris Wood, Banking Partner and IFRS 9 specialist, connect with him on LinkedIn&#0160;<a data-saferedirecturl="https://www.google.com/url?q=https://www.linkedin.com/in/chriswoodcpa/&amp;source=gmail&amp;ust=1593089095077000&amp;usg=AFQjCNGukW-gq7YN-5h36QAy0Jz_eRl8qQ" href="https://www.linkedin.com/in/chriswoodcpa/" rel="noopener" target="_blank">here.</a>&#0160;&#0160;</content:encoded>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Wed, 24 Jun 2020 13:45:49 +0100</pubDate>
</item>
<item>
<title>Earnings Before Interest, Taxes, Interest, Depreciation, Amortisation and Coronavirus (EBITDAC) – is this a profit ‘bridge too far’?</title>
<link>https://pwc.blogs.com/ifrs/2020/06/earnings-before-interest-taxes-interest-depreciation-amortisation-and-coronavirus-ebitdac-is-this-a-.html</link>
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<description>This week's guest blogger is Dave Walters, Partner in UK Accounting Consulting Services. The recently announced performance measure, EBITDAC has been greeted with scepticism. Indeed, I’m yet to find a single investor that thinks it is useful. I’ve been wondering why until I considered the following analogy. Like many in...</description>
<content:encoded>This week&#39;s guest blogger is Dave Walters, Partner in UK Accounting Consulting Services.&#0160;
The recently announced performance measure, EBITDAC has been greeted with scepticism.&#0160; Indeed, I’m yet to find a single investor that thinks it is useful.&#0160; I’ve been wondering why until I considered the following analogy.&#0160;
Like many in my profession, I awaited my professional exam results with a fair degree of trepidation.&#0160; I’d not performed at my absolute best in the tax exam in particular, and the question on deferred taxes was based on a portion of the manuals that I just couldn’t read without my eyes glazing over. But what if I’d been able to mark my own exam papers and then adjust for the utter mess I made of that deferred tax question?&#0160;&#0160;
I could have assumed, instead of the disappointing reality, that I’d actually read the question properly, that I’d remembered the existence of critical exemptions, that I’d successfully multiplied the right timing difference by actual tax rate and I’d written something more enlightening than “Because” to answer the question “Give reasons why the company might not recognise the deferred tax asset that you calculated in the answer to part (a)”.&#0160; In my hypothetical world, I, like many, would have scored full marks and I need not have worried.&#0160; However, it would have been zero use in assessing how I had actually performed.
EBITDAC is, in essence, the same.&#0160; In reporting financial performance, it represents a hypothetical reality that never happened.&#0160; The impact of COVID-19 is pervasive.&#0160; It has resulted in inefficiencies, increases in costs, the need to impair assets across the balance sheet and, perhaps the most pervasive impact of all, a loss of revenue.&#0160; Given the likely duration of COVID-19’s impact, it’s hard to argue that EBITDAC is relevant.
Consider what adjustments should be made to reported results to report EBITDAC. A starting point might be pulling out incremental costs (for example, safety equipment).&#0160; But where do you stop?&#0160; How about adding back impairments (or those portions of impairments that arose solely due to COVID-19 and not due to other factors?)&#0160; What about adding back portions of costs which were actually incurred but where production efficiency was impaired so there was little or no revenue to absorb the costs? What about adding additional hypothetical revenues and profits that you would have earned if the crisis had never happened?&#0160; The problem with any adjustments is that no two entities will approach this the same way and the more you move from actual numbers to allocations, the more you move from real to hypothetical.&#0160; What decision-useful information is contained in reporting what is, in effect, budgeted revenue and profit, in a world that has fundamentally and possibly irretrievably changed?&#0160;
One argument that has been advanced in favour of EBITDAC is that such an adjusted profit measure is necessary to understand performance as defined in banking covenants. But, in many cases banking covenants are based on frozen GAAP (so not actually based on the reported numbers) and the permitted adjustments are defined in a different, often much more subjective way, than those in the financial statements in an era where APM’s have to be much more clearly and consistently defined.&#0160; In this context, it is not clear why subjective COVID-19 adjustments should be excluded from an APM that is designed to inform all investors – this may be better dealt with in disclosures within the body of financial reports or within correspondence with the bank.
In 2008, I don’t recall seeing a rash of reporting of EBITDABC (Profits before banking crisis).&#0160; We did see some adjusting or exceptional items – for example, impairments, but even there, the ‘underlying profits’ earned in 2007/8 were of little relevance to the long journey to recovery.&#0160; I don’t see this time is any different.&#0160; Meanwhile, regulators the world over are encouraging entities to disclose, in narrative form, the various impacts of the financial crisis but are actively discouraging management from devising new adjusted performance measures.&#0160; Maybe they have a point – as following the logic of consistent application of adjusted measures – shouldn’t this year’s EBITDAC become next year’s comparator against which 2020 and onwards performance will be judged?
Reporting in a post-COVID-19 world is rightly focusing on how businesses will manage in the here and now in the immediate future.&#0160; This explains the focus on liquidity and going concern disclosures and post balance sheet events trading updates.&#0160; EBITDAC is attempting to report a version of the past assuming COVID-19 didn’t exist.&#0160; But COVID-19 exists and will be with us for a prolonged period, so it’s not clear that EBITDAC is of any practical benefit to users of the financial statements.&#0160;
All views expressed are the authors
&#0160;</content:encoded>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Tue, 09 Jun 2020 22:11:46 +0100</pubDate>
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<item>
<title>A journey through the IFRS 9 looking glass: Using write-off weighted coverage to assess the adequacy and reasonableness of expected credit losses for banks</title>
<link>https://pwc.blogs.com/ifrs/2020/06/a-journey-through-the-ifrs-9-looking-glass-using-write-off-weighted-coverage-to-assess-the-adequacy-.html</link>
<guid isPermaLink="true">https://pwc.blogs.com/ifrs/2020/06/a-journey-through-the-ifrs-9-looking-glass-using-write-off-weighted-coverage-to-assess-the-adequacy-.html</guid>
<description>As someone who spends the majority of his time buried deep within IFRS 9’s expected credit losses (ECLs) and related modelling intricacies, it’s easy to focus on details. However, it’s also helpful to step back and understand how one bank’s reserves compare to history and its peers. Of course, banks...</description>
<content:encoded>As someone who spends the majority of his time buried deep within IFRS 9’s expected credit losses (ECLs) and related modelling intricacies, it’s easy to focus on details. However, it’s also helpful to step back and understand how one bank’s reserves compare to history and its peers. Of course, banks aren’t identical, and nor should their provisions be. Each has its own unique portfolio, geography, risk appetite, loss experience, expectations about the future, assessments of risks, and techniques for managing them. Together with the fact that each also has unique data and models, it’s easy to lose hope for meaningful comparison. Still, I think it can be done.
While two banks might have very similar allowances in proportion to their loans, that doesn’t necessarily mean they’re equally provided, given that banks don’t lose money at the same rate (for the reasons mentioned above). One approach to taking this into account is to use what we call the write-off weighted coverage (‘WoW coverage’ for short). Consider two banks – Bank A and Bank B. In order to determine the WoW coverage, I first want to know how much each bank has lost historically per dollar loaned (that is, historical net write-offs each year as a percentage of gross loans outstanding during the year, calculated over a reasonable period of, say, 10 years). Let’s assume that it averages 1% for Bank A and 2% for Bank B. I then want to know how much each bank has currently reserved per dollar of performing loan outstanding (that is, for Stages 1 and 2, the allowance for credit losses as a percentage of loans). Call it 3% for each. Notwithstanding that they’re equal (at 3%), using WoW coverage which provides a lens based on historical loss experience, you can quickly see that Bank A looks to be twice as well provided as Bank B:
<a class="asset-img-link" href="https://pwc.blogs.com/.a/6a00d83451623c69e20263e94e3173200b-pi" style="display: inline;"><img alt="Table" border="0" class="asset asset-image at-xid-6a00d83451623c69e20263e94e3173200b image-full img-responsive" src="https://pwc.blogs.com/.a/6a00d83451623c69e20263e94e3173200b-800wi" title="Table" /></a>
Is it a perfect measure? No, of course not. For starters, loss experience might have changed considerably over the historical period (for example, think changes in products, portfolio composition, risk management policies, strategy, acquisitions, divestitures and the like). For those reasons and others, the range of write-offs during that period is certainly worthy of examination and, while 10 years might be reasonable as a starting point, for some banks or jurisdictions a shorter period might be necessary to better reflect current portfolios and conditions. Write-off policies might differ between banks too, though our hope is that over a reasonable period they’d even out. On the plus side, using historical losses means that many of the bank-specific attributes (such as portfolio mix, risk appetite, and credit risk management practices) should be captured.
As has been said many times, ECLs are not an estimate of the losses ultimately expected to transpire under a single outcome, but rather a probability-weighted average using a range of possible outcomes. For that reason, WoW coverage is not a surrogate for the details and complexity that banks necessarily apply in developing ECLs. Rather, it’s a useful starting point for asking questions about the adequacy and reasonableness of their result. Put simply, what WoW coverage tells us is (all other things being equal) how conservative or aggressive one bank’s provision is compared to another’s, by taking into account their relative historical loss experience, notwithstanding that there might be valid reasons for differences. For instance, some banks might be more optimistic and have a more favourable economic outlook, which should be reflected in the measurement of their ECLs. In our example, Bank B might believe that the economy is due for a quick rebound, which could explain why it appears to be significantly less provided on the basis of its WoW coverage. That would make sense and the question then is how reasonable is the speed and magnitude of that rebound and its effect on Bank B’s ECL. On the other hand, if Bank B’s outlook is drearier than Bank A’s, there’s surely cause for deeper investigation.
Our guest blogger is Chris Wood, Banking Partner and IFRS 9 specialist, connect with him on LinkedIn&#0160;<a data-saferedirecturl="https://www.google.com/url?q=https://www.linkedin.com/in/chriswoodcpa/&amp;source=gmail&amp;ust=1591365127056000&amp;usg=AFQjCNGfvaUEYNsNu0G5WRBD7ofaKxfEMA" href="https://www.linkedin.com/in/chriswoodcpa/" rel="noopener" target="_blank">here.</a>&#0160;</content:encoded>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Thu, 04 Jun 2020 16:27:14 +0100</pubDate>
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<title>IFRS 9 - Why be sensitive about sensitivities?</title>
<link>https://pwc.blogs.com/ifrs/2018/07/ifrs-9-why-be-sensitive-about-sensitivities.html</link>
<guid isPermaLink="true">https://pwc.blogs.com/ifrs/2018/07/ifrs-9-why-be-sensitive-about-sensitivities.html</guid>
<description>After four long years, pens have finally started to go down on the IFRS 9 transition. Despite expectations to the contrary, provisions have been relatively stable so far (save for transition adjustments), thanks in large part to stable economic outlooks. Nevertheless, analysts, regulators and others are already asking 'what if'...</description>
<content:encoded>After four long years, pens have finally started to go down on the IFRS 9 transition. Despite expectations to the contrary, provisions have been relatively stable so far (save for transition adjustments), thanks in large part to stable economic outlooks. Nevertheless, analysts, regulators and others are already asking &#39;what if&#39; questions, seeking to understand the new approach and its inherent sensitivities. So far, we’ve seen few such disclosures - probably due to first-mover reluctance, post-transition exhaustion and uncertainty about what disclosures might actually be meaningful. Even so, it wouldn’t be our approach. Here’s why…
Two things are critical when thinking about what disclosures to provide – firstly, how IFRS 9 came to be, and secondly, why they’re required to begin with. On the former, the new expected loss model is meant to provide an earlier warning to financial statement users about management’s perception of changes in the risks underlying the portfolio by reflecting them in impairment provisions on a forward looking basis each period. On the latter, IFRS requires disclosure of information about the assumptions about the future and other major sources of estimation uncertainty. This is so as to help users to understand the imprecision in an estimate, its sources and the possible magnitude of any change in the estimate within the next financial year. While much of this disclosure is naturally qualitative, the standard gives examples that make it difficult to argue that qualitative disclosures alone are sufficient. What quantitative disclosure to provide is a matter of judgment, though they may often include a range of possible outcomes. Think of it as laying out management’s view of the fairway.
Some argue that sensitivities that show the effect of changing only one economic variable would be misleading since there would never be an isolated change in one variable without corresponding changes in others (in the real world, that is). We agree. Indeed, the real world is complicated and so coming up with meaningful sensitivities won’t be easy. There is no ‘magic bullet’. That said, something is likely better than nothing. So, what then? One approach might include showing your math, or summarized versions of it. Expected losses are probability-weighted estimates that already contemplate multiple alternative outcomes, so, you could provide those outcomes, the probabilities assigned to them and the expected losses (i.e. unweighted) were they to arise. Remember too that sensitivities should consider all variables, not just macroeconomic ones. There are two key advantages to presenting this information – that it doesn’t require additional analysis, and that (hopefully) it aligns with information that’s already being prepared and reviewed internally by management and audit committees. On the other hand, a significant disadvantage of this approach is that disclosing scenarios might be misleading if they aren’t reasonably possible of occurring in the coming year. The math is only half the story too. Like most aspects of IFRS 9, the models themselves are extremely complicated (even for those who built them), so ensuring you tell the whole story – including the methodology applied and its limitations, will be key.
Why take the leap now? For starters, because there’s safety in transparency. As we often hear from our own clients, bad news might not be avoidable – surprises usually are. During the financial crisis, fingers pointed quickly at shortcomings in disclosures and accounting, so better to build the ark before the storm. Remember too that these disclosures take time to assess, debate, develop and embed (not to mention, audit).
For those who wait to find out what others are doing, it may be too late by the time they see.
<a class="asset-img-link" href="http://pwc.blogs.com/.a/6a00d83451623c69e2022ad37e5243200d-pi" style="display: inline;"><img alt="Chris wood" border="0" class="asset asset-image at-xid-6a00d83451623c69e2022ad37e5243200d img-responsive" height="132" src="https://pwc.blogs.com/.a/6a00d83451623c69e2022ad37e5243200d-800wi" title="Chris wood" width="132" /></a>
This month&#39;s guest blogger is Chris Wood, Banking Partner and IFRS 9 specialist, connect with him on LinkedIn <a href="https://www.linkedin.com/in/chriswoodcpa/">here. &#0160;</a></content:encoded>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Wed, 04 Jul 2018 09:21:51 +0100</pubDate>
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<title>Accounting for Initial Coin Offerings (“ICOs”)</title>
<link>https://pwc.blogs.com/ifrs/2018/02/accounting-for-initial-coin-offerings-icos.html</link>
<guid isPermaLink="true">https://pwc.blogs.com/ifrs/2018/02/accounting-for-initial-coin-offerings-icos.html</guid>
<description>The views in this blog are the views of the author and do not constitute a PwC view on accounting for ICOs. Discussion of the accounting issues associated with digital currencies is not investment advice or the endorsement of digital currencies or digital currency investing. What is an initial coin...</description>
<content:encoded><table style="border-color: #000000;">
<tbody>
<tr>
<td>The views in this blog are the views of the author and do not constitute a PwC view on accounting for ICOs. Discussion of the accounting issues associated with digital currencies is not investment advice or the endorsement of digital currencies or digital currency investing.</td>
</tr>
</tbody>
</table>
What is an initial coin offering?&#0160;
When I first heard about an ICO (<a href="https://www.pwc.ch/en/industry-sectors/financial-services/fs-regulations/ico.html">“Initial Coin Offering”),</a> I said “are you sure you don’t mean an IPO buddy?” After being told I needed to get with the times, I decided to keep quiet and do a bit of research to make sure I could still hang with the cool crypto kids.
&#0160;You, like me, might need a crash course in ICOs. Here’s my layman’s take on them. An ICO is a combination of crowd funding with blockchain. A group of people put together a white paper requesting funding for an innovative idea (often an eCommerce platform), describing the business model, and explaining what investors might get if they choose to invest.&#0160;
Investors are ’issued’ with a digital coin (based on blockchain technology) if they decide to take part in the ICO. They typically pay in cash or in another cryptourrency. The digital coins detail who the investors are and the white paper explains what benefits holding the digital coins will provide. ICOs are relatively new and their terms and conditions can vary significantly. Some digital coins give the investors access to a portion of the benefits from the underlying venture or activity. For example, it might be a portion of the fee that a developed platform charges on each transaction or maybe a discount on those fees for the coin holder. The benefits of the digital coins are unlikely to be access to the future profits of the venture (like a normal share), but rather give the coin holder access to free or discounted goods that are the output of the activity or venture. And some ICOs provide no benefit other than that the initial digital coins are issued at a discount to the expected issue price of future coins. If the venture is successful, the investors can sell their digital coins to other parties, , and pocket the appreciation. However, if the developers don’t manage to finalise their idea, often there is no obligation to refund any funding to the investors.
So what are the accounting issues?&#0160;
Unsurprisingly IFRS isn’t designed with blockchain business models in mind. Here are a couple of the juiciest problems that are keeping me awake at night:&#0160;
<ol>
<li>Is it a barter arrangement for the issuer (developer) and the investor? How should the developers account for the initial issuance of the digital coins? The developers are often receiving a cryptocurrency (rather than traditional currency) in exchange for issuing the digital coins. That seems like a barter arrangement, i.e. a digital coin for some cryptocurrency. This might allow the developer to determine the value of consideration by reference to the spot value of the cryptocurrency that they receive. But it doesn’t help decide what to do with the credit.&#0160;</li>
<li>If ICOs are a capital raising, are they debt or equity? Many digital coins do not give the holder a right to any residual interest in the platform or the entity that issued the coins, nor do they generally give the holder the ability to vote on any decisions relating to the operating activities of the platform. However, the digital coins generally last as long as the underlying activity exists and give their holders special benefits that others do not enjoy. They don’t seem to meet the definition of equity, but it does feel in many cases like the holders are entitled to benefits into perpetuity, much like a share. What about those coins that entitle the holder to a portion of every transaction fee? Does the entity have a contractual obligation to make a stream of payments in perpetuity? Or even a constructive obligation? If so, does the entity need to recognise a liability for the present value of all the future expected transaction fees to be paid to coin holders when the coins are issued. Interesting recognition and measurement issues:– good luck with that.</li>
<li>If not debt or equity under IAS 32, what else?&#0160;The developer has promised to develop the proposed platform and provide discounts or other benefits in exchange for consideration; but the investor has no right to a refund if the developer fails. Is this in the scope of IFRS 15? There seems to be a contract as defined by IFRS 15 and an implied obligation to develop and maintain the platform and maybe provide other benefits.</li>
<li>If in the scope of IFRS 15, how many performance obligations are there? What are the promises in the contract, if the ICO consideration is deferred revenue? Is the promise to build a platform and make it available and provide benefits for as long as the platform exists. Are these distinct? IFRS 15 requires an allocation of the consideration based on relative stand-alone selling prices. What is the relative stand-alone selling price of an untested IT platform and VIP access to that platform indefinitely? Even if an entity could allocate, the access to the platform is indefinite or as long as the platform operates. We are left trying to work out how to recognise an obligation to provide access indefinitely? – I think I’d have more luck trying to guess the price of Bitcoin in a year’s time!&#0160;</li>
</ol>
Conclusion
I don’t know what the answers at this stage, but I do think this is an area that needs focus from regulators, standard setters and auditors if we’re going to try and provide users with useful information. Is it time to think about an ICO for a platform that will solve by consensus all the difficult accounting problems in the world – subscribe now, tokens are limited ;-)
This week&#39;s guest blogger is Gary Berchowitz, connect with him on <a href="https://www.linkedin.com/in/garyberchowitz/">LinkedIn.</a>
<a class="asset-img-link" href="http://pwc.blogs.com/.a/6a00d83451623c69e201b8d2db939c970c-pi" style="display: inline;"><img alt="Gary" border="0" class="asset asset-image at-xid-6a00d83451623c69e201b8d2db939c970c img-responsive" height="168" src="https://pwc.blogs.com/.a/6a00d83451623c69e201b8d2db939c970c-800wi" title="Gary" width="168" /></a></content:encoded>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Mon, 19 Feb 2018 08:14:27 +0000</pubDate>
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<title>Have you got your Christmas list in order?</title>
<link>https://pwc.blogs.com/ifrs/2017/12/have-you-got-your-christmas-list-in-order.html</link>
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<description>So, it’s 21 December and there are only 4 sleeps before Christmas! If you have been lucky you might have already made a snowman this winter. But now you are getting ready for the big day. Have you ordered your food? Are all the Christmas presents bought and wrapped and...</description>
<content:encoded>So, it’s 21 December and there are only 4 sleeps before Christmas! If you have been lucky you might have already made a snowman this winter. But now you are getting ready for the big day. Have you ordered your food? Are all the Christmas presents bought and wrapped and under the Christmas tree? If you are expecting a visit from Santa you’ll also need to make sure you have some milk and mince pies to leave out, and don’t forget the carrots for the reindeer!&#0160;
Another important date that will be arriving soon is New Year’s Day. This means another list of important things to get done. Maybe you have even started thinking about your New Year resolutions? No doubt your hedge documentation is already in place for the New Year! Yes, that’s right, IFRS 9 is effective from 1 January 2018 and it is nearly here.&#0160;
But we might have some help for you in this busy period as we are delighted to announce the release of our latest and most comprehensive guide to IFRS 9&#39;s hedge accounting requirements for corporates.&#0160; In this publication we answer the questions we are asked most often by corporates applying IFRS 9&#39;s hedge accounting rules for a range of hedging strategies commonly used in practice.&#0160;
It’s comprehensive, at over 200 pages!&#0160; But it needs to be. Not only have we illustrated in detail how to apply the standard to some common hedge relationships; we have also given an overview of the requirements and of what has changed from IAS 39, as well as answering some of the most commonly asked questions that have arisen in practice.&#0160;&#0160;
Overall, we believe that, by placing greater emphasis on an entity’s risk management practices, IFRS 9 is an improvement for hedge accounting. It will provide more flexibility, and it might allow companies to apply hedge accounting where previously they could not. As a result, this is an opportunity for corporate treasurers and boards to review their current hedging strategies and accounting, and to consider whether there are any improvements or beneficial changes that can be made under IFRS 9. However, some of the changes might lead to greater complexity in accounting and systems requirements and therefore companies should carefully assess the impact of the changes.&#0160;&#0160;
Maybe the adoption of IFRS 9 means a bit more work for you before the New Year. But we hope this publication will help guide you through some of the common issues we see so that you also have time to enjoy the festive period.&#0160;
If you’d like to read the full document please download this&#0160;<a href="https://inform.pwc.com/s/Achieving_hedge_accounting_in_practice_under_IFRS_9_PwC_In_depth_INT2017_09/informContent/1701045512146487#ic_1701045512146487">publication</a>&#0160; from&#0160;<a href="http://inform.pwc.com/">inform.pwc.com</a>.&#0160;
This week&#39;s guest bloggers are <a href="https://www.linkedin.com/in/sandra-thompson-b893715a/">Sandra Thompson</a>&#0160;and <a href="https://www.linkedin.com/in/christopher-raftopoulos-92566556/">Chris Raftopoulous</a>. Connect with them on LinkedIn.
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<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Thu, 21 Dec 2017 08:40:11 +0000</pubDate>
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<title>Accounting for Cryptocurrency</title>
<link>https://pwc.blogs.com/ifrs/2017/11/accounting-for-cryptocurrency.html</link>
<guid isPermaLink="true">https://pwc.blogs.com/ifrs/2017/11/accounting-for-cryptocurrency.html</guid>
<description>What is cryptocurrency? Before we get out our big sexy accounting books, a quick refresher on crytocurrencies. A cryptocurrency is a medium of exchange such as the US dollar. There are currently many different types of cryptocurrency in existence. The most popular, Bitcoin, was the first cryptocurrency to appear in...</description>
<content:encoded>What is cryptocurrency?&#0160;
Before we get out our big sexy accounting books, a quick refresher on crytocurrencies. A cryptocurrency is a medium of exchange such as the US dollar.&#0160;
There are currently many different types of cryptocurrency in existence. The most popular, Bitcoin, was the first cryptocurrency to appear in January 2009. However, since then the marketing folks have gotten hold of this and we have even funkier names such as Ethereum, Ripple, Litecoin and many more (I’m just waiting for IFRSCoin and then I’m investing!)&#0160;
Like the US dollar, cryptocurrency has no intrinsic value in that it is not redeemable for another commodity, such as gold. Unlike the US dollar, however, cryptocurrency has no physical form, is not legal tender, and is not currently backed by any government or legal entity. In addition, its supply is not determined by a central bank and all transactions are performed and validated by the users of the system without an intermediary (such as a bank) facilitating these functions. The term cryptocurrency is used because the technology is based on public-key cryptography (for those without a PhD in programming, this just means that the communication is secure from third parties).&#0160;
If you’re more interested in cryptocurrencies than the accounting thereof, take a look&#0160;on this <a href="https://www.pwc.com/us/en/financial-services/fintech/bitcoin-blockchain-cryptocurrency.html">link.</a>
So what’s the accounting issue?&#0160;
The speed, ease and cost savings associated with this type of currency means it has the potential to become the popular choice for payments, with large brands such as EBay, Dell and PayPal accepting Bitcoin payment. Although the function of a cyptocurrency is to improve the ability of parties to transact digitally with each other, to date most investors in cryptocurrencies are investing in them with the hope of realising capital gains. For example, the value of Bitcoin increased approximately 700% between January 2017 and the beginning of November 2017 (now if only I was investing in these things rather than trying to work out the accounting, sigh).&#0160;
Holdings of cryptocurrencies can be both large and their value can be volatile – so users of financial statements probably want to know about them. However, there is a significant shortcoming: today’s accounting standards are not written with cool cryptocurrencies in mind!&#0160;
What is wrong with today’s accounting?
Most common sense accountants (yes, there are still some of us left) would agree that the best accounting for a cryptocurrency would be fair value. After all, that’s the value at which investors will either realise their investment or be able to transact in exchange for other goods and services.&#0160;
Unfortunately ye olde accounting rules haven’t quite moved with the times it seems. In order to be able to measure cryptocurrencies at fair value (sheesh, typing out cryptocurrency is getting tiring, can I just say Bitcoin from now on please, you know what I mean?), the Bitcoin needs to meet the accounting definition of a financial asset. And that’s where the back wheels fall off, because Bitcoins are:
<ol>
<li>Not legal tender (i.e. cash as defined);</li>
<li>Not cash equivalents because their value is exposed to significant changes in market value; and</li>
<li>Not a contractual right to receive either cash or a cash equivalent.&#0160;</li>
</ol>
So Bitcoins fail the definition of a financial asset. Okay, so where does that leave us (other than scratching our collective heads in consternation). Well, today’s accounting rules would lead to accounting for Bitcoins either as an intangible asset or inventories.&#0160;
If the Bitcoins are recognised as inventory, then they would need to be measured at cost.&#0160; I guess at a pinch the entity could disclose the fair value of the Bitcoins, but that’s about as good a solution as eating baby food because you have no teeth.&#0160;
If the Bitcoins are recognised as intangible assets, then the default position would also be to measure them at cost. There is the possibility that if the Bitcoins are accounted for as intangible assets, an entity might be able to justify that there is an active market for the Bitcoins, in which case the Bitcoins would be able to be measured at fair value. However, this is still only second prize, because movements in that fair value would be recognised through other comprehensive income and the gain would not be recycled through profit and loss when the Bitcoins are realised.&#0160;
Conclusion
Accounting for Bitcoins at fair value with movements reflected in profit or loss would provide the most useful information to investors. However, existing accounting requirements do not seem to permit this.
Accounting for cryptocurrency is not on the agenda of the International Accounting Standards Board. How long do you think it will take before cryptocurrency is a big enough deal that we need a bespoke solution?
<a class="asset-img-link" href="http://pwc.blogs.com/.a/6a00d83451623c69e201b8d2c24cad970c-pi" style="display: inline;"><img alt="Gary" border="0" class="asset asset-image at-xid-6a00d83451623c69e201b8d2c24cad970c img-responsive" height="141" src="https://pwc.blogs.com/.a/6a00d83451623c69e201b8d2c24cad970c-800wi" title="Gary" width="141" /></a>
This week&#39;s guest blogger is Gary Berchowitz, PwC Partner. Connect with him on <a href="https://www.linkedin.com/in/garyberchowitz/">LinkedIn. </a>
&#0160;
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<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Tue, 28 Nov 2017 07:58:15 +0000</pubDate>
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<title>Meet the Experts – tackling tremendous financial reporting change</title>
<link>https://pwc.blogs.com/ifrs/2017/11/meet-the-experts-tackling-tremendous-financial-reporting-change.html</link>
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<description>I’m very much looking forward to welcoming all those attending Meet the Experts next week. I’m finalising my introductory slides as I type so time is getting short! We’ve got plenty of content this year, with sessions hosted by investors, preparers, regulators and cyber security experts – so there’s truly...</description>
<content:encoded>I’m very much looking forward to welcoming all those attending <a href="https://www.pwc.co.uk/services/audit-assurance/capital-markets-accounting-advisory-and-structuring/insights/meet-the-experts-2016.html">Meet the Experts</a> next week. I’m finalising my introductory slides as I type so time is getting short! We’ve got plenty of content this year, with sessions hosted by investors, preparers, regulators and cyber security experts – so there’s truly something for everyone involved in the financial reporting space.
We’re currently in a year of tremendous change for financial reporting, with a number of complex new accounting standards coming in that will affect the majority of companies. At Meet the Experts we’ll be hosting sessions giving a technical focus on the three main new standards: IFRS 9, IFRS 15 and IFRS 16.
Below I’ve listed a few suggested actions for companies, along with what you can expect from this year’s conference.
IFRS 9
The new financial instrument standard affects both financial and non-financial services companies. All affected should now be in the midst of their transition programmes looking at the underlying detail to work out what the impact will be.
There are disclosure requirements in your upcoming financial statements to say what you think the impact of the new standard will be, and the more detail you can give there the better. You also need to be ready for next year when the standard goes live, as numbers will be impacted and for many it’ll be a substantial change. For example, anyone with a December year end who wants to hedge account has only a matter of weeks now to get the appropriate documentation updated! At Meet the Experts we’ll be looking at some of the complexities of this standard in more detail and gleaning from the practical experience of those who have been through the transition exercise.
IFRS 15
The new revenue standard has an impact on anyone who has revenue - which is hopefully most companies! For those impacted, there’s a lot of work to do in respect of this standard. It’s based on contracts, so actually identifying your contracts and the contractual terms is a key first step.
Given where we are in the cycle, most companies are beyond the ‘finding the contract’ stage and looking at developing the underlying systems to capture additional data that’s required by the standard, with a view to not only getting the numbers right next year but to disclosing as much information as possible in this year’s financial statements as to what they think the impact will be. There’s a lot of work that’s ongoing and we’ll be hearing at this year’s conference on some of the pitfalls.
IFRS 16
IFRS 16 will be coming into effect in 2019, so there’s a little bit more time for companies. This doesn’t mean they should put off preparations though. IFRS 16 will affect anyone who has leases, so in my experience, much like IFRS 15, that will mean most companies! It will have a significant impact on the balance sheet and on the profit and loss account too so companies should be thinking about the impact and identifying where their leases are.
The earlier companies think about the impact on their financial statements, and disclose the impact to investors and other users, the better. Indeed, it has an impact broader than financial statements, for example, don’t overlook the impact on covenants and bonus schemes!
Other accounting changes
It may seem like the standard setters have been focusing on just the three main standards mentioned which we see having a significant impact over the next couple of years. But actually there have been a number of other changes in financial reporting too covering topics ranging from tax to cash flows. Attendees will be hearing from the standard setters on some of these, but companies should be assessing the impact now, as even in advance of applying the new standards you’ve got disclosures to make around the likely impact in the following years’ financial statements.
So, a lot to think about! As stated, this is a year of tremendous change – but at Meet the Experts, we’ll seek to equip attendees with the tools, latest knowledge and information to stay ahead of the curve. Coupled with direct interaction with standard setters, we’ll aim to leave you as prepared as possible.
<a href="https://finance.knect365.com/meet-the-experts-conference/">Should you wish to attend Meet the Experts, you can purchase tickets here.</a>
This week&#39;s guest blogger is&#0160;Dave Walters, Partner in Accounting Consulting Services and host of Meet the Experts.
 <a class="asset-img-link" href="http://pwc.blogs.com/.a/6a00d83451623c69e201b7c933747f970b-pi" style="display: inline;"><img alt="Dave" border="0" class="asset asset-image at-xid-6a00d83451623c69e201b7c933747f970b img-responsive" src="https://pwc.blogs.com/.a/6a00d83451623c69e201b7c933747f970b-800wi" title="Dave" /></a> 
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<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Mon, 13 Nov 2017 12:29:53 +0000</pubDate>
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<title>IFRS 9 hedge accounting – should I stay or should I go now?</title>
<link>https://pwc.blogs.com/ifrs/2017/09/ifrs-9-hedge-accounting-should-i-stay-or-should-i-go-now.html</link>
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<description>IFRS 9, the new financial instruments standard, is well recognised as having a big impact on banks. But what about corporates? There seems to be a perception that, with a few exceptions, IFRS 9 will have little or no impact. I have heard rumours that a few corporates are thinking...</description>
<content:encoded>IFRS 9, the new financial instruments standard, is well recognised as having a big impact on banks. But what about corporates?&#0160; There seems to be a perception that, with a few exceptions, IFRS 9 will have little or no impact. I have heard rumours that a few corporates are thinking they might ‘keep’ their IAS 39 accounting and not move to IFRS 9.&#0160; Is this a good idea? And why are companies thinking this way?
First, let’s be clear about what choice companies have. IFRS 9 gives companies a free choice on whether to adopt its new hedge accounting requirements when the rest of IFRS 9 becomes mandatory for 2018.&#0160; This is an ‘all or nothing’ choice – a company must either move all of its hedge accounting to IFRS 9, or must continue to apply IAS 39 to all of its hedges. This choice applies to all kinds of entities – both banks and corporates; and to all kinds of hedges – both macro and micro.&#0160; But it is limited to hedge accounting.&#0160;
All entities must apply IFRS 9’s classification, measurement and impairment requirements and the new disclosure requirements – including the new hedge accounting disclosures. This is something I return to below.
&#0160;Why continue with IAS 39 hedge accounting?&#0160; A corporate that has only a few ‘simple’ hedges that qualify for hedge accounting today would still need to do some work when it moves to IFRS 9. For example, hedge documentation must be redone to be IFRS 9 compliant and it will need to discount cash flow hedges if it hasn’t in the past. This comes in a year when companies also have to adopt IFRS 15, the new revenue standard - that for many will require significant work.&#0160; A company with an over-full ‘to do’ list and that has so far done little work on IFRS 9 (or 15!) may think that changing its hedge accounting seems like ‘one thing too many’.&#0160; That company may rightly point out that it can elect to apply IFRS 9 hedge accounting at a later date.
I would caution companies to think carefully before leaping to this conclusion. Moving to IFRS 9 will likely have some significant upsides.&#0160; The IASB’s main objective in revising IAS 39’s hedge accounting requirements was to remove some of the ‘rules’ that can prevent economic hedges qualifying for hedge accounting. For example,
<ul>
<li>The 80-125% ‘bright line’ effectiveness test is replaced with a requirement that there is an economic relationship. This removes a key reason why some hedge relationships fail to get hedge accounting today</li>
<li>Companies can designate more risk components and ‘layers’ of groups of items.</li>
<li>Hedging with options, cross currency swaps and forwards can lead to less volatility in the income statement.</li>
</ul>
It is more likely, under IFRS 9, that where a hedge is economically effective the accounting will reflect this. This is important for three reasons:
<ul>
<li>IFRS 9 is a significant opportunity for corporates to get their accounting more in line with how they manage risk.</li>
<li>IFRS 9 is a chance for companies to reassess their hedging strategies. Past strategies that were rejected because they gave rise to income statement volatility might now be used. Adopting IFRS 9 could impact risk management and not be ‘just’ an accounting change.</li>
<li>IFRS 9 will enable companies to ‘tell the risk management story’ better. Investors increasingly focus on risk and how it is managed so this is a key part of any company’s communication strategy.</li>
</ul>
Which brings me back to disclosure. A company that chooses to keep their IAS 39 accounting will nevertheless need to give the new IFRS 9 disclosures.&#0160; These complement the IFRS 9 hedge accounting requirements. Much of the work needed to comply with IFRS 9 hedge accounting will be required for disclosures anyway. The corporate that has only a few ‘simple’ hedges that qualify for hedge accounting today will need to document and disclose its risk management strategy, how it determines that there is an economic relationship and how it establishes the hedge ratio for each kind of hedge.&#0160; By which time it has likely done the work needed to adopt IFRS 9 hedge accounting.
My own view is that the benefits of moving to IFRS 9 will in almost all cases outweigh the costs. The one exception may be for certain kinds of macro hedge.&#0160; These, however, tend to be much more prevalent for banks. So, if I were a corporate, I would not be crossing this off my ‘to do’ list just yet.
<a class="asset-img-link" href="http://pwc.blogs.com/.a/6a00d83451623c69e201bb09c028e9970d-pi" style="display: inline;"><img alt="Sandra" border="0" class="asset asset-image at-xid-6a00d83451623c69e201bb09c028e9970d img-responsive" height="174" src="https://pwc.blogs.com/.a/6a00d83451623c69e201bb09c028e9970d-800wi" title="Sandra" width="174" /></a>
This weeks guest blogger is Sandra Thompson, IFRS Financial Instruments Leader. Connect with her on LinkedIn <a href="IFRS%209 hedge accounting – should I stay or should I go now?">here. </a>
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<category>Financial instruments</category>
<dc:creator>Ruth Preedy</dc:creator>
<pubDate>Tue, 05 Sep 2017 07:46:19 +0100</pubDate>
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