How to Evaluate Financial Debts Under IFRS

How to Evaluate Financial Debts? One of the main impacts of IFRS on financial analysis is to show on the balance sheet virtually all financial debt, CT or MLT. The standard distinguishes operational leases and financing (leasing, long-term rentals, etc.). Currently, only finance leases are capitalized in application of the principle of pre-eminence of reality over appearance.

How to Evaluate Financial Debts

A redesign project provides that from 2017, operating leases will also be capitalized, with the exception of leases with an initial term of less than one year. The aim is to discourage companies from converting their finance leasing contracts into operational leases with the sole aim of reducing the apparent debt: “there are more planes flying in the sky than in the balance sheets of the airlines”. The distinction between financing and operational leases will remain. The mandatory rents (or minimum payments) of operating leases will be discounted at a borrowing rate and cumulated to include:

• In financial capital, for a “right of use”
• In financial debt, for a “rental commitment”.

Note, however, that financial analysts are already carrying out this restatement by adding to the financial debts the equivalent of 3 to 4 years of operating lease expenses declared by the company.

Outstanding loans by Mobilization of Receivables

Many companies finance themselves by selling their trade receivables: factoring, securitization, Daily law, etcThe question arises as to whether the funded and unmetered receivables and the corresponding credit outstanding are or are not included in the balance sheet. According to the principle of balance sheet priority, all the risks weighing on the company must appear on the balance sheet.

In “recourse” credits, the transferor always bears the risk of default. The ceded receivable and the corresponding financing therefore appear on the balance sheet. With “non-recourse” credits, the credit risk is transferred to the banker or the financial factor. Sometimes also, the credit risk is covered by a credit insurance contract. However, even in these cases, the auditors ask to keep the receivables financed on the balance sheet by invoking the risk of “dilution” corresponding to the risk of unpaid due to commercial disputes on invoice. Off balance sheet accounts receivable financing cases are therefore rare

It should be noted that the so-called “apparent debt ratio”, which relates financial expenses to apparent financial debts on the balance sheet, makes it possible to detect an off-balance sheet CT debt situation.

“Ad hoc” Entities and Economic Control or “In Substance”

This type of control was initially defined by the SIC 12 interpretation with the aim of combating the numerous deconsolidating arrangements relating to the financing of assets. A special purpose entity is created to carry out a transaction or series of transactions specifically for the account of a company: finance its inventory, receivables, lease capital assets. The entity, often owned by a financial institution, is controlled by the company through a contract or its articles of association. SIC 12 provide that the SPE must be consolidated in the accounts of the enterprise on behalf of which it carries out transactions when:

• Ad hoc activities are carried out on behalf of the company
• The company has the management power, receives the majority of the benefits and bears the majority of the risks of the entity.

The SIC 12 interpretation led to a sharp decrease in deconsolidated entities.

The new IFRS 10 standard on the consolidated financial statements replaces IAS 27 and the SIC 12 interpretation. It does not explicitly refer to special purpose entities, but it now defines a single notion of control encompassing, for example, the case of economic control or in substance. Control is now defined by the following three elements:

• Power over the other entity
• Exposure, or rights, to variable returns from that other entity; and
• Ability to use one’s power to impact one’s returns