Stephen Sheen: Do we need a statutory override for IFRS 9?
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IFRS 9 remains contentious
The accounting standard IFRS 9 has prompted much debate. Last week, Peter Worth argued against a statutory override. This week Stephen Sheen makes the case for it.
In a previous article for Room 151, Peter Worth argued that the implementation of IFRS 9 Financial Instruments accounting requirements brings with it no reasonable justification for statutory overrides.
There can be no perfect case for, or against, statutory overrides because they are at the discretion of government: to amend what government would regard as undesirable effects of proper accounting practices on council tax setting.
They have variously been activated to:
- Manage the revenue/capital split.
- Allow accrued expenditure to be financed instead on a cash basis (eg, pensions costs).
- Make outcomes more equitable (eg, spreading premiums and discounts generated by the early redemption of debt).
- Ease the transition to new accounting requirements.
There has been only one occasion where a statutory override has been given wholly on the basis of affordability: allowing deferral of the costs of losses arising on the collapse of Icelandic banks.
Statutory overrides are therefore only normally given if there is proof of a positive need for them. New overrides are also approached cautiously as they can introduce opportunities for authorities to take unreasonable advantage of their provisions (as has happened with the premium spreading rules).
The burden is therefore on the proposer of an override to demonstrate that it would be necessary.
I agree that there is no case for overrides in the area where a small number of authorities might experience the most substantial effect of transition to IFRS 9 — the change in the impairment allowances model from incurred losses to expected losses.
The incurred loss model was widely recognised as imprudent, and the wise authority either ignored it or supplemented its modest allowances by setting aside earmarked reserves to cover the expected loss position.
If any authorities are going to be required to make substantial new allowances for risky loans at 1 April 2018, then it would be appropriate for them to seek specific government assistance rather than be allowed to benefit from a general amnesty in the shape of an override.
Implementation
However, the case is different for the other key aspect of IFRS 9 implementation: the change in default treatment of financial assets from storing up fair value gains/losses in a revaluation reserve to posting them against the general fund balance as they arise.
If governments do not legislate, there will be a de facto change in policy to basing council tax on unrealised investment gains and losses.
This would be the prerogative of the respective governments. However, the policy could have an adverse impact on authorities that made investment decisions based on the framework that applied before 1 April 2018.
It is possible that authorities will have negative balances on their “available for sale” reserve (the previous name for the revaluation reserve for financial instruments) which will be written out to the general fund balance on transition; not held on the balance sheet to be offset against expected future gains.
It is these authorities that the Ministry for Housing, Communities and Local Government has certainly been encouraging to come forward with details of the impact on budgets so that transitional provisions can be considered. If there is no clear demand, there will be no supply.
Designation
The longer term need for statutory overrides, though, is to balance the attractiveness of particular investment types with their relative riskiness.
For instance, in England and Wales investment properties and most types of shareholding are covered by the definition of capital expenditure, shielding revenue from the implication of losses. But loan capital, money market funds and the CCLA Local Authority Property Fund are not. The risk of revenue losses is therefore disproportionate to the overall risk of loss.
There are opportunities under IFRS 9 to designate equity instruments to a revaluation reserve treatment, but these opportunities were expected to be taken rarely (and not at all for investments on which entities were anticipating making a return). Even by companies for whom the difference in treatments would largely be presentational. It would be unwise to rely on designation to solve a fiscal problem.
Designation also does not apply to puttable equity instruments (ones that an authority has a right to cash in), with the consequence that the more fiscally favourable accounting treatment provides an incentive to acquire unputtable investments over puttable ones.
An overhaul of statutory overrides is therefore required to avoid incentivising riskier investments and to limit the extent to which authorities are tempted to use the IFRS 9 designation.
Stephen Sheen is the managing director of Ichabod’s Industries, a consultancy providing technical accounting support to local government.
