IAS 12 and the initial recognition of decommissioning assets and liabilities
An exposure draft was published in the summer proposing an amendment to the application of the Initial recognition exemption (IRE) to transactions where a deferred tax asset and liability of the same amount are established on initial recognition.
In the past we have seen a wide variation in the accounting in this area but if the proposals are implemented companies may well have to revisit this area.
Representations are required by 14 November 2019
This potential change has been brought into focus as a result of the change to accounting for leases in IAS 16, but it is clear in the various papers published by the IFRS Foundation (and noted in the exposure draft itself) that this potential change is also applicable to the initial recognition of decommissioning liabilities (which would require a corresponding asset).
The IRE has no application to a business combination (BC).
The IFRS Foundation have concluded that the IRE should not be applied in a case where a deferred tax asset and liability of the same amount are initially recognised on a particular transaction.
We have seen a number of broad approaches for the treatment under IAS 12 for temporary differences on non BC decommissioning liabilities and assets but the effect of the change will be to standardize the approach going forward and require companies who have not been compliant with the new approach to amend their accounts with retrospective effect.
The first approach we have seen in the past for accounting in this area is to simply apply the IRE to both the DT asset and liability. No DT is recognized on initial recognition or in the future. This approach will be prohibited.
The second approach is to treat that the asset and liability as “integrally linked” such that no net temporary difference arises on initial set up, the IRE can have no application. This essentially is the approach which we understand the new standard will adopt.
The third approach is also an integrally linked approach where the temporary difference on the decommissioning asset and liability are “netted” in the calculation of deferred tax. Initially no amount is set up but as the asset and liability diverge a DTA is generally set up on a net number. In particular in considering whether the “asset” is recoverable some companies have taken the view that one only needs to consider this net position. This in effect can mean that the DTL can be understated. This netting approach is not new but it increased its popularity for oil companies when the SCT rate was increased to 62% and the recoverability of tax on decommissioning was restricted to 50%. Companies were faced with the possibility of setting up an excess of 12% on the liability compared to the asset.
Although the ED addresses the narrow question of the IRE such that we are not expecting any new wording in the standard to specifically outlaw this netting approach as such, the discussion papers issued as part of the IRE review make it clear that this netting approach is inconsistent with IAS 12 and should not be adopted.
Comparatives will have to be restated as a result of the retrospective application of this new rule (following IAS 8 principles).
A voluntary transitional relief will be available. This will allow one to apply the approach with reference to an assessment of the recoverability of the DTA at the time of the first period for which comparatives are to be restated as a result of the charge, rather than the recoverability position at inception.
A number of representations have been made to date and these have been broadly supportive of the change. This suggests that it is likely that the change will be implemented.
We do not know when this change is to be implemented but it seems unlikely changes will be made in time to be taken into account in the 2019 accounts process. We have however already seen auditors looking at this area more carefully as a result of this development.
We would recommend that companies review their current approach to determine whether the implementation of the changes in the ED could have a material impact on their position.