Insurance CEOs embrace disruption

CaptureInsurance CEOs are more concerned than those in any other sector about the combined threats to their growth prospects from over-regulation, the speed of technological change, changing customer behaviour, and competition from new entrants. But while this indicates that insurance is an industry most affected by disruptive change, insurance CEOs are fairly confident their companies can Continue reading Insurance CEOs embrace disruption

Illustrative Financial Statements of Private Equity Fund holding an Investment Entity subsidiary

This publication provides illustrative disclosures which are considered best practice disclosures to be made by an Investment Entity (as a result of the Investment Entities Applying the Consolidation Exception: Amendments to IFRS 10 – Consolidated Financial Statements, IFRS 12 – Disclosure of Interests in Other Entities and IAS 28 – Investments in Associates and Joint Ventures) (the “Amendments”) which has a controlled subsidiary, that itself meets the definition of an “Investment Entity”, and which had previously consolidated that subsidiary.

 

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Illustrative IFRS financial statements 2016 – Private equity funds

image_ifrs_financial_statements_2016_final

This publication provides an illustrative set of financial statements, prepared in accordance with International Financial Reporting Standards (IFRS), for a fictional private equity limited partnership, ABC Private Equity LP. This is based on the requirements of IFRS standards and interpretations for the financial year beginning on 1 January 2016.

ABC Private Equity LP is not traded in a public market. ABC Private Equity LP’s investment objectives are to seek medium- to long-term growth by investing directly in private unlisted companies with high growth potential. It classifies all of its investments as ‘fair value through profit or loss’ (FVTPL) and does not apply hedge accounting.

The Partnership is presented as an Investment Entity in accordance with IFRS 10. As a result, the Partnership does not consolidate any subsidiaries unless they provide investment related services. No portfolio companies are consolidated, regardless of the level of holding as the Partnership meets the definition of an Investment Entity and instead, fair values these portfolio companies through its holdings in its investment holding subsidiary companies. There is only one controlled portfolio company (‘controlled subsidiary investment’) as at the period-end date of these financial statements.

The illustrative disclosures should not be considered the only acceptable form of presentation. The form and content of each reporting entity’s financial statements are the responsibility of the entity’s management. Alternative presentations to those proposed in this publication may be equally acceptable if they comply with the specific disclosure requirements prescribed in IFRS. These illustrative financial statements are not a substitute for reading the standards and interpretations themselves or for professional judgement as to fairness of presentation. They do not cover all possible disclosures that IFRS requires, nor do they take account of any specific legal framework. We recommend that readers also refer to the most recent IFRS disclosure checklist publication.

 

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News on IFRS: December 2016 / January 2017

Our latest IFRS News provides perspectives on key considerations for impairment tests, current IC rejections and the PwC leases lab.

Pension Disclosures – Remain silent and be thought a fool or speak and remove all doubt?

Pension deficits are increasing. Brian Peters, Partner, and Paul Allen, Senior Manager, leaders of the UK PwC’s pension accounting business, explain the importance of pension disclosure.

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IFRS 9 Disclosure – It’s time to tell your own Story

IFRS 9 disclosures in 2016 annual are unlikely to begin ‘once upon a time…’ or make for light bedtime reading. The effective date of 1 January 2018 is approaching fast, banks need to start to tell their story. What will applying IFRS 9 in 2018 mean to them?

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The IFRS 15 Mole

In the first of this series, John Chan, PwC revenue specialist and the IFRS 15 mole, investigates some of the things you need to think about when looking at a contract with a customer.

Suspects: Unidentified contracts
Incident description: There are a 2 potential incidents;

  • Is the contract in the scope of IFRS 15?
  • Are all the contract terms understood?Facts: Is it a contract?

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Cannon Street Press

  • Insurance Contracts
  • Disclosure Initiative: Materiality Practice Statement
  • Conceptual Framework
  • FICE

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The PwC leases lab

IFRS 16 gives rise to many challenges, so Professor Lee Singh starts a new experiment – this time with his assistant Derek Carmichael

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Demystifying IFRS 9

In the IFRS 9 expected credit loss (ECL) model, a significant increase in credit risk of a financial asset marks a clear change. If there has been a significant increase in credit risk, the asset is in ‘stage 2’ and lifetime ECL is booked. Lifetime ECL is equal to the expected credit losses that result from all possible default events over the expected life of a financial instrument.

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IFRIC Rejections in short – IAS 27

Tatiana Geykhman of Accounting Consulting Services examines the practical implications of IFRIC rejections related to IAS 27.

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In brief – A look at current financial reporting issues

  • Annual Improvements to IFRS Standards 2014: PwC In brief INT2016-19
    Read more…
  • Amendment to IAS 40, ‘Investment property’: PwC In brief INT2016-18
    Read more…
  • Foreign currency transactions and advance consideration: PwC In brief INT2016-17
    Read more…

News on IFRS: November 2016

Our latest IFRS News provides perspectives on key considerations for impairment tests, current IC rejections and the PwC leases lab.

IFRS 15 – Time is running out

Companies are facing the adoption of several major new accounting standards in the next few years. For many it will be the most significant change in accounting since the adoption of IFRS.

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Beware of Value in Use

Mary Dolson talks through the common pitfalls of using value in use (VIU) in an impairment review.

Impairment of non-financial assets under IAS 36 remains a hot topic with regulators and users. Six years past the start of the financial crisis, slow or no growth and low commodity prices continue to challenge companies. These issues and new ‘unknowns’ such as Brexit are working their way through into impairment testing.

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Cannon Street Press

  • Disclosure initiative
  • Conceptual Framework
  • Clarifications to IFRS 8 Operating Segments arising from the Post implementation Review
  • IFRS Implementation issues
  • Financial Instruments with Characteristics of Equity

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The PwC leases lab

Contracts for the use of an asset in a predetermined manner will not meet the definition of a lease and result in fewer leases recognised on the balance sheet.

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Demystifying IFRS 9

Credit risk management sits at the core of banking and IFRS 9’s new expected credit loss (ECL) requirements go straight to the heart of this. This first column in our series looks at how to understand and apply IFRS 9’s new impairment requirements for financial assets.

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In brief – A look at current financial reporting issues

  • More flexibility in the application of IFRS 9 – the IASB publishes an amendment to IFRS 4: PwC In brief INT2016-16

    Read more…

The wait is nearly over – IFRS 17 is coming, are you prepared for it?

We are close to a new IFRS insurance contracts accounting standard. IFRS 17 (previously referred to as IFRS 4 Phase II) is expected to be issued in early 2017 with an effective date of 2021.

IFRS 17 applies to all insurance contracts. The general model is the Building Blocks Approach (BBA) and is based on a discounted cash flow model with a risk adjustment and deferral of up-front profits through the Contractual Service Margin (CSM) which cannot be negative.

  • Changes in the initial building blocks are treated in different ways thus determining Profit recognition:
  • Changes in cash flows and risk adjustment related to future services are recognised by adjusting the CSM, whereas those related to past and current services flow to the P&L
  • The CMS amortisation pattern is based on the passage of time and drives the Profit recognition Profile
  • The effect of changes in Discount rates can either be recognised in OCI or P&L

The IASB has recognised the diversity in insurance contracts and have introduced alternative approaches to address particular features, subject to eligibility criteria as illustrated.

Download the full report here.

FVA – The Price of Money

Before going deeper into the topic of FVA, a brief brush up on some of the underlying theory might be appropriate.

Discounting – or the time value of Money

What is the correct discounting rate? This question is surprisingly more difficult than would be assumed at first glance. Let’s first look at the situation for a price maker.
To establish the correct discounting rate, one way is to think of an opportunity cost argument. If I receive CHF1 in one year’s time instead of today, I can determine the opportunity by borrowing the currency unit for one year in the financial market. The cost of borrowing determines how much less the current value should be compared to the future value of the CHF1. To be precise, the interest rate payments to be incurred would have to be discounted to t-zero at the same interest rate. This works for certain or near certain cash flows.

If future cash flows are risky, a survival probability can be multiplied by the discount factors (DFs), which results in lower DFrisky and hence higher zeroRatesrisky. But this is a different topic with its own specific quirks.

For a price taker (for example a corporate that is trading interest rate swaps with an investment bank), the discounting rate on such products is simply the rate that the bank is using.

The Cost of Funding

TheCostofFundingDuring the financial crisis, it became increasingly clear that LIBOR was in fact not a risk free rate, that it did not represent the funding rate of the banks, and that it had a number of design flaws. The big investment banks were relatively quick to adopt a new regime of using Overnight Indexed Swap (OIS) rates or a similar rate for discounting future cash flows, as this was much closer to the true cost of funding, which was often just overnight borrowing of cash from the respective central bank.
To complicate matters further, it was noticed that the interest rate terms of a Credit Support Annex (CSA), where applicable, would be the most appropriate approximation of the cost/benefit of funding and hence the discounting rate. In older CSAs, this rate could be LIBOR +/– a spread, in newer ones this will often also be something close to an OIS rate.

CSA – Credit Support Annex

A CSA is an addition to an ISDA master agreement that acts as the framework for most OTC derivative transactions. The CSA defines the rules by which collateral is exchanged between the counterparties. The posting of collateral has similarities to the margin required by derivatives exchanges.
These days collateral is mostly cash exchanged between banks; however, it can also be bonds or other securities, depending on what is negotiated between the counterparties.

Jon Gregory (The XVA Challenge, The Wiley Finance Series, 25 September 2015) describes collateral thus: “The fundamental idea of OTC derivative collateralisation is that cash or securities are passed […] from one party to another primarily as a means to reduce counterparty risk.”

Optionality in the Collateral

Up to this point, the FVA can be seen as just the application of a more appropriate discounting curve. However, there are situations which result in more complex adjustments than that.
CSAs can also define more than one form of collateral. This could be several currencies for cash collateral and/or different bonds and other fixed income securities. This creates optionality in the form of a cheapest to deliver option for the party required to post collateral. This is similar to optionality in bond futures. As an example, if counterparty A needs to post collateral to counterparty B and the CSA allows for both EUR and USD (assumed at EURIBOR and LIBOR flat respectively), counterparty A can check if its own funding rate for one of the currencies is cheaper and post in this currency. As this may change over time, both counterparties can post collateral in the cheaper currency and expect that on aggregate the anticipated funding rate under the CSA will be less than any one of the individual currencies.

We can describe the situation by means of these formulas:

Case of two defined collaterals, ignoring the value of the optionality:

FundingRateMin = MIN(collateralRate1, collatreralRate2)

This can be rewritten as:

FundingRateMin = collateralRate1 – MAX(0,collateralRate2 –
collateralRate1)

The MAX() term describes a spread option which represents the cheapest to deliver option. Its value is strictly > 0, even if the intrinsic value is 0. Hence,

FundingRateMin < collateralRate1
AND
FundingRateMin < collateralRate2

Therefore the FundingRateMin cannot be replicated without option pricing calculations.

If you have any further question feel free to contact Werner Brönnimann or Roman Schnider.

News on IFRS: September-October 2016

Our latest IFRS News provides perspectives on key considerations for impairment tests, current IC rejections and the PwC leases lab.

IFRS 4 Phase II – an opportunity to shine a light on value creation in the insurance industry

The insurance industry’s long wait for a comprehensive standard for insurance contracts is nearly over. IFRS 17 has been a long time in development but is expected in late 2016 or early 2017. Chris Hancorn and Matt Donnery outline some of the key implications for the industry.

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IFRS9 – Myth Buster

IFRS 9, the new financial instruments standard, is well recognised as being a big change in accounting by banks. This is largely due to IFRS 9’s requirements in the area of loan loss impairment and the introduction of the expected loss model. The new rules will generally result in earlier recognition of losses compared to today’s incurred loss model.

There are a number of common misconceptions over the expected loss model. The following table busts some of the more significant myths!

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Cannon Street Press

  • Change in accounting policy and accounting estimates
  • Draft Interpretation on long-term interests in an associate or joint venture
  • Financial Instruments with Characteristics of Equity (FICE)
  • Conceptual Framework

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The PwC leases lab

Lease contracts denominated in a foreign currency under IFRS 16 will create a lot of additional volatility in profit or loss for lessees.

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IFRIC Rejections in short – IAS 24

IIAS 24 Related party disclosures is a disclosure standard. It sets out how related party relationships, transactions and balances, including commitments, should be identified and what disclosures should be made, and when.

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In brief – A look at current financial reporting issues

  • More flexibility in the application of IFRS 9 – the IASB publishes an amendment to IFRS 4: PwC In brief INT2016-16

    Read more…

xVA – fair values are not what they used to be

Valuation adjustments are a relatively new thing. Even now it is not clear to a number of people what they are all about and why they should care. In the times before the financial crisis, there was no need to really delve into this topic. LIBOR was the rate at which banks actually lent money to each other (as opposed to now) and it was considered risk free, until it no longer was. A few aspects of this traditional model that did not quite fit in were considered obscure, and most people did not really know what was going on. An example is the intra-currency basis from swaps vs. 3 months LIBOR and swaps vs. 6 months LIBOR: Swaps with a 3 months LIBOR floating leg trade at a lower rate than otherwise identical swaps with a 6 months LIBOR floating leg. Another one is the cross currency basis: The discounting in cross currency swaps on non-USD swap legs was done at LIBOR+/- a spread, rather than just LIBOR. Back then it was difficult to find someone in a bank who could explain these topics in an accurate and comprehensive manner. The one valuation adjustment that was common was the credit charge on derivative instruments with counterparty credit risk. However, this was seen more as a reserve taken against potential losses and not really as an integral part of the instrument value.

In the post-financial crisis world, valuations suddenly became a lot more complicated. Funding rates were all but clear; discounting could no longer be done with LIBOR in the expectation that this would truly reflect the time value of a product. Differential discounting started to become a term that banks had to deal with and certain banks started employing people who would only quote funding rates for MTNs, which was previously something that a treasurer would set once every blue moon to satisfy the needs of the issuing desks.

There were regulatory changes too. Capital charges for banks started to increase and it became necessary to incorporate this factor into the prices and valuations of financial products. Here too, the impact was hard felt in those products which are traded on thin margins and are capital intensive (such as long term interest rate swaps). Further adjustments came in the form of multi-currency CSAs, which in effect allowed counterparties to choose which currency to use for collateral calls and implicitly contain a cheapest to deliver option. These are known from bond futures and commodity contracts. The application is not trivial, but they do affect the value and there is a lot of work to be done to incorporate this properly.

In fact there are many factors that influence the fair value of a financial product these days:

  • Credit and debit valuation adjustments (CVA/DVA)
  • Overnight index swap discounting followed by credit support annex discounting for cash collateral (OIS, CSA)
  • Funding valuation adjustments (FVA) often split into FVB(enefit) and FVC(ost)
  • KVA to introduce the cost of capital
  • ColVA and MVA to account for the cost of all collateral types and initial margins

For the trading and sales operations of the large investment banks that operate as market makers on OTC derivatives, it was an urgent task to incorporate any adjustments that were considered relevant into their quoted prices. On the accounting side, the timeline of acceptance of these adjustments was different. Whilst CVA/DVA was accepted quite soon, FVA was ignored for much longer, also because dealing with overlaps between CVA/DVA/FVA was difficult. However, where FVA was accepted, it replaced DVA, and it merged with OIS and CSA discounting.

 

Capture

Why should you care?

  • Price negotiations with third parties – what is the incremental value of a new derivative to an existing portfolio?
  • In the future, non-cleared OTC’s will become increasingly rare, and hence it is important to understand how this will affect my costs (MVA)
  • Fair values under IFRS 13
  • Future crisis => larger credit spreads; how do I hedge my CVA exposure?

If you have any further question feel free to contact Werner Brönnimann or Roman Schnider.

 

News on IFRS: August 2016

Our latest IFRS News provides perspectives on key considerations for impairment tests, current IC rejections and the PwC leases lab.

Tax accounting and the research agenda– all quiet on the western front?

The IASB discussed the research project on income taxes and decided to delete it from the work plan. Anna Schweizer from Accounting Consulting Services looks into the finer details of the issues around IAS 12 Income Taxes, which news we can expect in the near future and which not.

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Variable payments for the separate acquisition of PPE and intangible assets

The IC declined to address the accounting in such cases. The current diverse practice is expected to continue. This article looks at the impact and provides an insight into the issue.

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Impact of a decommissioning liability in determining the recoverable amount of a CGU

The IC declined to address this accounting issue for impairment tests under the fair value less costs of disposal approach. This article looks at the impact and provides an insight into the issue.

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Current IC rejections

The IC was asked to clarify if cash received from the government to perform R&D should be recorded as a government grant or a forgivable loan.

The fact pattern submitted was:

  • Government gives cash to an entity to perform research.
  • The cash is repayable if the entity decides to exploit and commercialise the results of the R&D.
  • The IP is transferred to the government if the entity decides to abandon the project.

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Difficulties in translating IFRS

IFRS has greatly contributed to bringing transparency, comparability, and efficiency to financial markets. However, as the guidance is written in English, the risk of incorrect translation is likely (or is it probable?). Sam King-Jayawardana explores the current research

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Cannon Street Press

  • Applying IFRS 9 Financial Instruments with IFRS 4 Insurance contracts
  • IAS 40 Investment property: Transfers of investment property
  • Annual Improvements 2014-2016 cycle
  • Conceptual Framework

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The PwC leases lab

IFRS 16 will have significant impact on the Communications industry, including how contracts are entered into and Key Performance Indicators (KPIs) in financial statements.

Read more…

IFRIC Rejections in short – IAS 23

IAS 23 covers recognition, measurement, and disclosure of borrowing costs. The IC has rejected two matters related to IAS 23 over the last decade.

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In brief – A look at current financial reporting issues

  • Accounting for government loans to fund research and development: PwC In brief INT2016-14
    Read more…
  • Variable payments for the separate acquisition of PPE and intangible assets: PwC In brief INT2016-15