In May 2022, the European Securities and Markets Authority (ESMA) published further extracts from its confidential database of enforcement decisions taken by European national enforcers.
ESMA is an independent EU Authority that was established on 1 January 2011. ESMA’s mission is to enhance the protection of investors and promote stable and well-functioning financial markets in the European Union.
The European national enforcers of financial information monitor and review financial statements published by issuers with securities traded on a regulated European market who prepare their financial statements in accordance with International Financial Reporting Standards (IFRS) and consider whether they comply with IFRS and other applicable reporting requirements, including relevant national law.
ESMA regularly publishes extracts from its internal database of enforcement decisions on financial statements, with the aim of providing issuers and users of financial statements with relevant information on the appropriate application of IFRS. Such publication, together with the rationale behind these decisions, will contribute to a consistent application of IFRS in the European Union.
Extracts from the database of enforcement decisions can be downloaded here.
Topics covered in the latest (26th) batch of extracts, covering the period from March 2020 to November 2021:
From the above mentioned enforcement decisions issued by ESMA in May 2022 we have selected two enforcement decisions, which may be applicable for a number of entities that report under IFRS.
Financial year end: 31 December 2019
Category of issue: Definition of “costs necessary to make the sale”, net realisable value
Standards or requirements involved: IAS 2 Inventories
Description of the entity’s accounting treatment
The issuer is a sports retailer whose inventories had been increasing over the years and amounted to 37% of its sales in 2019 (25% in 2015). The issuer experienced declining sales in 2019 and launched a campaign to sell its obsolete and aged stock at a reduced price to reduce storage costs and inventory. In this process the issuer determined the net realisable value at a lower amount than the book value.
In calculating the net realisable value, the issuer considered that “estimated costs necessary to make the sale”, which are part of the definition of net realisable value in paragraph 6 of IAS 2, only relate to the incremental costs of selling the aged and discounted inventory during the campaign period. The issuer did not consider marketing costs or transportation costs from the warehouses to the stores within the calculation, noting that a part of the already incurred overall marketing costs was allocated to the campaign. Therefore, the issuer considered that these costs were not incremental.
The enforcement decision
The enforcer disagreed with the issuer and considered that all costs necessary to make the sale of the entire inventory as of 31 December 2019 should be considered when calculating the net realisable value and not only the incremental costs for the campaign to sell the aged and discounted inventory.
The rationale for the enforcement decision
The enforcer acknowledged that IAS 2 does not define “costs necessary to make the sale”. However, the enforcer considered that these costs relate to the sale of the entire inventory and not just part of it. Furthermore, the enforcer considered that the costs should have included the marketing and distribution costs related to the sale of the inventory at year-end and not only incremental marketing costs related to a single campaign.
In its June 2021 Agenda Decision, the IFRS IC observed that IAS 2 does not allow an entity to limit “costs necessary to make the sale” to only those that are incremental, thereby excluding costs that the entity must incur to sell its inventories but that are not incremental to a particular sale.
Financial year end: 31 December 2019
Category of issue: Definition of cash and cash equivalents, Classification of cash-flows from operating activities, Change in accounting policies, Accounting estimates
Standards or requirements involved: IAS 7 Statement of Cash Flows; IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors
Description of the entity’s accounting treatment
The issuer uses the indirect method to report the cash flows from operating activities. Historically, the issuer has considered bank overdrafts as part of cash and cash equivalents following the application of paragraph 8 of IAS 7. On 1 January 2019, the issuer changed its classification of bank overdrafts as cash and cash equivalents because the bank account balances no longer fluctuated from being positive to overdrawn and overdrafts no longer formed an integral part of the issuer’s cash management. Hence, the issuer considered that, as of January 2019, the bank overdrafts no longer met the requirements set out in IAS 7 to be classified as cash and cash equivalents.
The issuer considered the change in the classification of bank overdrafts as a voluntary change in accounting policy in accordance with paragraph 14(b) of IAS 8. Hence, the issuer applied this change retrospectively and adjusted the impacted comparative amounts for the 2018 cash-flows in the 2019 consolidated cash flow statement. In doing so, the issuer excluded bank overdrafts from cash and cash equivalents and presented the difference as a movement in trade and other payables which resulted in a material decrease in the cash flows from operating activities.
The enforcement decision
The enforcer concluded that the change in the classification of bank overdrafts did not constitute a change in accounting policy in accordance with IAS 8 and, therefore, did not agree with the retrospective application of the change in classification of banks overdrafts in the statement of cash flows. The enforcer also disagreed with the issuer’s reclassification of the outstanding bank overdrafts as a part of the item “trade and other payables” within the cash flows from operating activities.
Furthermore, the enforcer considered that the change in the composition of cash and cash equivalents should be presented separately from cash flows from operating, investing and financing activities as a reconciling item in the 2019 consolidated cash-flow statement.
The rationale for the enforcement decision
Based on paragraph 47 of IAS 7, the enforcer considered that a change in cash management constitutes a change in facts and circumstances. Therefore, in accordance with paragraph 16(a) of IAS 8, this is not a change in accounting policy and therefore it should not be accounted for retrospectively. Hence, the 2018 comparative amounts should not have been adjusted.
Furthermore, the enforcer highlighted that, according to paragraph 20 of IAS 7, the reclassification of the outstanding bank overdrafts from cash and cash equivalents did not constitute an adjusting item to determine the cash flow from operating activities when using the indirect method for determining cash flows from operating activities.
The enforcer considered that, based on paragraph 45 of IAS 7, the reclassification of the outstanding bank overdrafts should have been disclosed as a reconciling item of the components of cash and cash equivalents in the 2019 consolidated cash flow statement.
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