IFRIC Update is a summary of the decisions reached by the IFRS Interpretations Committee (Committee) in its public meetings. Past Updates can be found in the IFRIC Update archive.

The Committee met on 1 February 2022, and discussed:

Committee's tentative agenda decisions

The Committee discussed the following matters and tentatively decided not to add standard-setting projects to the work plan. The Committee will reconsider these tentative decisions, including the reasons for not adding standard-setting projects, at a future meeting. The Committee invites comments on the tentative agenda decisions. Interested parties may submit comments on the open for comment page. All comments will be on the public record and posted on our website unless a respondent requests confidentiality and we grant that request. We do not normally grant such requests unless they are supported by a good reason, for example, commercial confidence. The Committee will consider all comments received in writing up to and including the closing date; comments received after that date will not be analysed in agenda papers considered by the Committee.

Negative Low Emission Vehicle Credits (IAS 37 Provisions, Contingent Liabilities and Contingent Assets)—Agenda Paper 2

The Committee received a request asking whether particular measures to encourage reductions in vehicle carbon emissions give rise to obligations that meet the definition of a liability in IAS 37.

The request

The request described government measures that apply to entities that produce or import passenger vehicles for sale in a specified market. Under the measures, entities receive positive credits if in a calendar year they have produced or imported vehicles whose average fuel emissions are lower than a government target, and negative credits if in that year they have produced or imported vehicles whose average fuel emissions are higher than the target.

The measures require an entity that receives negative credits for one year to eliminate those negative credits, either by purchasing positive credits from another entity or by generating positive credits itself in the next year (by producing or importing more low emission vehicles) and using those positive credits to eliminate the negative balance. If the entity fails to eliminate its negative credits in one or other of those two ways, the government can impose sanctions on the entity, for example restrict the entity’s access to the market.

The request considered the position of an entity that has produced or imported vehicles with average fuel emissions higher than the government target, and asked whether such an entity has a present obligation that meets the definition of a liability in IAS 37.

Applicable requirements

Paragraph 10 of IAS 37 defines a liability as ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’. Paragraph 10 of IAS 37 distinguishes legal obligations (which derive from an operation of law) from constructive obligations (which derive from an entity’s actions) and defines an obligating event as ‘an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation’. Paragraph 17 of IAS 37 clarifies that an entity has no realistic alternative to settling an obligation only if settlement can be enforced by law or, in the case of a constructive obligation, where an event (which may be an action of the entity) has created valid expectations in other parties that the entity will discharge the obligation. Paragraph 19 of IAS 37 further clarifies that it is only those obligations arising from past events existing independently of an entity’s future actions that meet the definition of a liability.

The Committee’s conclusions

The Committee concluded that an entity that has produced or imported vehicles with average fuel emissions higher than the government target has a legal obligation that meets the definition of a liability in IAS 37, unless accepting the sanctions that the government can impose is a realistic alternative to eliminating negative credits for that entity. The Committee’s reasoning was that:

  • the activity that may give rise to an obligation to eliminate negative credits is the production or import of vehicles. To the extent that an entity has produced or imported vehicles with average fuel emissions higher than the government target by the end of the reporting period, that obligation has arisen from past events.
  • the measures that create the obligation and give the government the authority to impose sanctions derive from an operation of law. Hence, the obligation is a legal obligation and the sanctions the government can impose are the means by which settlement can be enforced by law. The requirement that ‘settlement of the obligation can be enforced by law’ is met, unless accepting sanctions for non-settlement is a realistic alternative for an entity.
  • an entity can settle its obligation either by purchasing positive credits from another entity or by generating positive credits itself in the next year and using those positive credits to eliminate the negative balance. In either case, settlement involves an outflow from the entity of resources embodying economic benefits. In the first case, the resource is cash; in the second case, the resources are the positive credits the entity will receive for the next year and surrender to eliminate its current negative balance. The entity could otherwise have used those self-generated positive credits for other purposes—for example, to sell to other entities with negative credits.
  • the obligation arises from past events and exists independently of the entity’s future actions (the future conduct of its business). Under the measures, the only action required to trigger an obligation is the production or import of vehicles with average fuel emissions higher than the government target, and this action has already occurred. The entity’s future actions will determine only the means by which the entity settles its present obligation—whether it purchases credits from another entity or generates positive credits itself by producing or importing more low emission vehicles. The fact pattern described in the request differs from the fact pattern in other examples that illustrate or interpret the application of paragraph 19 of IAS 37 and for which the conclusion is that no present obligation exists—for example, part (a) of Illustrative Example 6 (Legal requirement to fit smoke filters), IFRIC 6 Liabilities arising from Participating in a Specific Market—Waste Electrical and Electronic Equipment and Example 2 in IFRIC 21 Levies. In all these other examples, the entity has not yet taken the actions necessary to trigger an obligation under the applicable legislation.

The Committee considered the position of an entity that:

  1. has produced or imported vehicles with average fuel emissions higher than the government target; but
  2. does not have a legal obligation that meets the definition of a liability in IAS 37, because accepting sanctions is a realistic alternative for that entity, meaning the obligation cannot be enforced by law.

The Committee concluded that such an entity nevertheless could have a constructive obligation that meets the definition of a liability in IAS 37. The entity would have such an obligation if it has taken an action (for example, made a sufficiently specific current statement) that has created valid expectations in other parties that it will eliminate negative credits generated from its past production or import activities.

The request asked only whether the government measures give rise to obligations that meet the definition of a liability in IAS 37. The Committee noted that, having identified such an obligation, an entity would apply other requirements in IAS 37 to determine how to measure the liability. The Committee did not discuss those other requirements.

The Committee concluded that the principles and requirements in IFRS Accounting Standards provide an adequate basis for an entity to determine whether, in the fact pattern described in the request, an entity has an obligation that meets the definition of a liability in IAS 37. Consequently, the Committee [decided] not to add a standard-setting project to the work plan.
 

Agenda decisions for the IASB's consideration

TLTRO III Transactions (IFRS 9 Financial Instruments and IAS 20 Accounting for Government Grants and Disclosure of Government Assistance)—Agenda Paper 3

The Committee considered feedback on the tentative agenda decision published in the June 2021 IFRIC Update about how to account for the third programme of the targeted longer-term refinancing operations (TLTROs) of the European Central Bank (ECB).

The Committee reached its conclusions on that agenda decision. In accordance with paragraph 8.7 of the IFRS Foundation’s Due Process Handbook, the International Accounting Standards Board (IASB) will consider this agenda decision at its March 2022 meeting. If the IASB does not object to the agenda decision, it will be published in March 2022 in an addendum to this IFRIC Update.
 

Other matters

Profit Recognition for Annuity Contracts (IFRS 17 Insurance Contracts)—Agenda Paper 4

The Committee received a request about the recognition of profit when applying IFRS 17. An entity includes unearned profit in the measurement of insurance contracts and recognises it as revenue as the entity provides services. The request is about determining how to recognise unearned profit as revenue by assessing the services an entity provides to policyholders of annuity contracts.

The Committee will discuss this matter at a future meeting. To prepare for that discussion, the staff provided the Committee with an overview of the applicable IFRS 17 requirements and other background related to those requirements.

The Committee was not asked to make any decisions.

Work in Progress—Agenda Paper 5

The Committee received an update on the status of open matters not discussed at its meeting in February 2022.

Addendum to IFRIC Update—Committee’s agenda decisions

Agenda decisions, in many cases, include explanatory material. Explanatory material may provide additional insights that might change an entity's understanding of the principles and requirements in IFRS Standards. Because of this, an entity might determine that it needs to change an accounting policy as a result of an agenda decision. It is expected that an entity would be entitled to sufficient time to make that determination and implement any necessary accounting policy change (for example, an entity may need to obtain new information or adapt its systems to implement a change). Determining how much time is sufficient to make an accounting policy change is a matter of judgement that depends on an entity's particular facts and circumstances. Nonetheless an entity would be expected to implement any change on a timely basis and, if material, consider whether disclosure related to the change is required by IFRS Standards.

The Committee discussed the following matters and decided not to add standard-setting projects to the work plan.

TLTRO III Transactions (IFRS 9 Financial Instruments and IAS 20 Accounting for Government Grants and Disclosure of Government Assistance)—Agenda Paper 3

Published in March 20221

The Committee received a request about how to account for the third programme of the targeted longer-term refinancing operations (TLTROs) of the European Central Bank (ECB). The TLTROs link the amount a participating bank can borrow and the interest rate the bank pays on each tranche of the operation to the volume and amount of loans it makes to non-financial corporations and households.

The request asks:

  1. whether TLTRO III tranches represent loans with a below-market interest rate and, if so, whether the borrowing bank is required to apply IFRS 9 or IAS 20 to account for the benefit of the below-market interest rate;
  2. if the bank applies IAS 20 to account for the benefit of the below-market interest rate:
    1. how it assesses in which period(s) it recognises that benefit; and
    2. whether, for the purpose of presentation, the bank adds the benefit to the carrying amount of the TLTRO III liability;
  3. how the bank calculates the applicable effective interest rate;
  4. whether the bank applies paragraph B5.4.6 of IFRS 9 to account for changes in estimated cash flows resulting from the revised assessment of whether the conditions attached to the liability have been met; and
  5. how the bank accounts for changes in cash flows related to the prior period that result from the bank’s lending behaviour or from changes the ECB makes to the TLTRO III conditions.

Applying the requirements in IFRS Accounting Standards

The Committee observed that IFRS 9 is the starting point for the borrowing bank to decide how to account for TLTRO III transactions because each financial liability arising from the bank’s participation in a TLTRO III tranche is within the scope of IFRS 9. The bank:

  1. assesses whether it would separate any embedded derivatives from the host contract as required by paragraph 4.3.3 of IFRS 9;
  2. initially recognises and measures the financial liability, which includes determining the fair value of the financial liability, accounting for any difference between the fair value and the transaction price and calculating the effective interest rate; and
  3. subsequently measures the financial liability, which includes accounting for changes in the estimates of expected cash flows.

The Committee noted that the request did not ask about the existence of an embedded derivative and, therefore, this agenda decision does not discuss the requirements in IFRS 9 regarding the separation of embedded derivatives.

Initial recognition and measurement of the financial liability

Applying paragraph 5.1.1 of IFRS 9, at initial recognition a bank measures each TLTRO III tranche at fair value plus or minus transaction costs, if the financial liability is not measured at fair value through profit or loss. A bank therefore measures the fair value of the liability using the assumptions that market participants would use when pricing the financial liability as required by IFRS 13 Fair Value Measurement. The fair value of a financial liability at initial recognition is normally the transaction price—that is, the fair value of the consideration received (paragraphs B5.1.1 and B5.1.2A of IFRS 9). If the fair value at initial recognition differs from the transaction price, paragraph B5.1.1 requires a bank to determine whether a part of the consideration received is for something other than the financial liability.

The Committee observed that determining whether an interest rate is a below-market rate requires judgement based on the specific facts and circumstances of the relevant financial liability. A difference between the fair value of a financial liability at initial recognition and the transaction price might indicate that the interest rate on the financial liability is a below-market rate.

If a bank determines that the fair value of a TLTRO III tranche at initial recognition differs from the transaction price and that the consideration received is for only the financial liability, the bank applies paragraph B5.1.2A of IFRS 9 to account for that difference.

If a bank determines that the fair value of a TLTRO III tranche at initial recognition differs from the transaction price and that the consideration received is for more than just the financial liability, the bank assesses whether that difference represents the benefit of a government loan at a below-market rate of interest (treated as a government grant in IAS 20). An entity assesses this difference only at initial recognition of the TLTRO III tranche. The Committee noted that if the difference is treated as a government grant, paragraph 10A of IAS 20 applies only to that difference. The bank applies IFRS 9 to account for the financial liability, both on initial recognition and subsequently.

Should a portion of a TLTRO III tranche be treated as a government grant in IAS 20?

IAS 20 defines:

  1. government as referring to ‘government, government agencies and similar bodies whether local, national or international’;
  2. government grants as ‘assistance by government in the form of transfers of resources to an entity in return for past or future compliance with certain conditions relating to the operating activities of the entity…’; and
  3. forgivable loans as ‘loans which the lender undertakes to waive repayment of under certain prescribed conditions’.

Paragraph 10A of IAS 20 requires an entity to treat as a government grant the benefit of a government loan at a below-market rate of interest. The benefit of the below-market rate of interest is measured as the difference between the initial carrying amount of the loan determined by applying IFRS 9 and the proceeds received. Paragraphs 12 and 20 of IAS 20 specify requirements for an entity to recognise government grants in profit or loss.

The Committee observed that a TLTRO III tranche would contain a portion that is treated as a government grant in IAS 20 if the bank assesses that the ECB meets the definition of government in paragraph 3 of IAS 20 and:

  1. the interest rate charged on the TLTRO III tranche is a below-market interest rate as referred to in paragraph 10A of IAS 20; or
  2. the loan is a forgivable loan (as defined in paragraph 3 of IAS 20) to which paragraph 10 of IAS 20 applies.

The Committee observed that making these assessments require judgement based on the specific facts and circumstances. The Committee therefore noted that it is not in a position to conclude on whether the TLTRO III tranches contain a benefit of a government loan at a below-market rate of interest or a forgivable loan in the scope of IAS 20.

The Committee acknowledged that judgement may also be required to identify the related costs for which the portion of the TLTRO III tranche that is treated as a government grant is intended to compensate. The Committee nonetheless concluded that IAS 20 provides an adequate basis for the bank to assess whether the TLTRO III tranches contain a portion that is treated as a government grant in IAS 20 and, if so, how to account for that portion.

Calculating the effective interest rate at initial recognition of the financial liability

Appendix A to IFRS 9 defines both the amortised cost of a financial liability and the effective interest rate. Calculating the effective interest rate requires an entity to estimate the expected cash flows through the expected life of the financial liability by considering all the contractual terms of the financial instrument.

In calculating the effective interest rate for a TLTRO III tranche at initial recognition, the question arises as to what to consider in estimating the expected future cash flows and, specifically, how to reflect uncertainty that arises from conditionality related to the contractual interest rate. The Committee noted that the question of what to consider in estimating the expected future cash flows to calculate the effective interest rate is also relevant for fact patterns other than that described in the request. The Committee therefore concluded that considering how to reflect conditionality in the contractual interest rate when calculating the effective interest rate is a broader matter, which it should not analyse solely in the context of TLTRO III tranches. Such an analysis could have unintended consequences for other financial instruments, the measurement of which involves similar questions about applying IFRS Accounting Standards. The Committee is therefore of the view that the IASB should consider this matter as part of the post-implementation review of the classification and measurement requirements in IFRS 9, together with similar matters already identified in the first phase of that review.

Subsequent measurement of the financial liability at amortised cost

The original effective interest rate is calculated based on estimated future cash flows at initial recognition as required by IFRS 9. The Committee noted that whether a bank alters the effective interest rate over the life of a TLTRO III tranche depends on the contractual terms of the financial liability and the applicable requirements in IFRS 9.

The contractual terms of TLTRO III tranches require interest to be settled in arrears on maturity or on early repayment of each tranche. There is therefore only one cash outflow over the life of the tranche.

Paragraphs B5.4.5 and B5.4.6 of IFRS 9 specify requirements for how an entity accounts for changes in estimated contractual cash flows.

For floating-rate financial instruments, paragraph B5.4.5 of IFRS 9 specifies that the periodic re-estimation of cash flows to reflect the movements in the market rates of interest alters the effective interest rate. IFRS 9 does not define what a floating rate is.

Paragraph B5.4.6 of IFRS 9 applies to changes in estimated contractual cash flows of financial liabilities other than those addressed in paragraph B5.4.5, irrespective of whether the change arises from revisions of estimated contractual cash flows or from a modification of the contractual terms of the liability. However, when changes in contractual cash flows arise from a modification of the contractual terms, an entity assesses whether those changes result in the derecognition of the original financial liability and the recognition of a new financial liability by applying paragraphs 3.3.2 and B3.3.6 of IFRS 9.

The Committee also noted that the application of paragraph B5.4.6 of IFRS 9 depends on a bank’s estimates of expected future cash flows in calculating the effective interest rate at initial recognition of the financial liability because paragraph B5.4.6 requires the use of the original effective interest rate to discount the revised cash flows.

The Committee observed that the question of how conditionality related to the contractual interest rate is reflected in the estimates of expected future cash flows when applying the effective interest method affects both initial and subsequent measurement. As this question is part of a broader matter, the Committee considered that it should not be analysed solely in the context of TLTRO III tranches. The Committee is therefore of the view that the IASB should consider this matter as part of the post-implementation review of the classification and measurement requirements in IFRS 9, together with similar matters already identified in the first phase of that review.

Disclosure

If a bank assesses that the ECB meets the definition of government in IAS 20 and that it has received government assistance from the ECB, the bank needs to provide the information required by paragraph 39 of IAS 20 regarding government grants and government assistance.

Given the judgements required and the risks arising from the TLTRO III tranches, a bank also needs to consider the requirements in paragraphs 117, 122 and 125 of IAS 1 Presentation of Financial Statements, as well as paragraphs 7, 21 and 31 of IFRS 7 Financial Instruments: Disclosures. These paragraphs require a bank to disclose information that includes its significant accounting policies and management’s assumptions and judgements in applying its accounting policies that have the most significant effect on the amounts recognised in the financial statements.

Conclusion

The Committee concluded that IAS 20 provides an adequate basis for the bank to assess whether TLTRO III tranches contain a portion that is treated as a government grant in IAS 20 and, if so, how to account for that portion.

Regarding the question of how conditionality related to the contractual interest rate is reflected in the estimates of expected future cash flows when calculating the effective interest rate at initial recognition or in the revisions of estimated future cash flows on subsequent measurement of the financial liability, the Committee concluded that the matters described in the request are part of a broader matter that, in isolation, are not possible to address in a cost-effective manner and should be reported to the IASB. The IASB should consider this matter as part of the post-implementation review of the classification and measurement requirements in IFRS 9.

For these reasons, the Committee decided not to add a standard-setting project to the work plan.

1In accordance with paragraph 8.7 of the Due Process Handbook, at its March 2022 meeting, the International Accounting Standards Board (IASB) discussed, and did not object to, this agenda decision.