The IASB listened to the views of the national standard setters about experience and recommendations for a project on accounting by small and medium-sized entities and in emerging economies. In particular, there was discussion about:

• what are the entities involved, and whether, if a differential reporting framework were developed, the IASB's should identify qualitative or quantitative characteristics to determine if an entity could use such differential reporting requirements. In that respect, views were expressed that the IASB should not go for a route supporting quantitative characteristics;
• what are the users and what are their needs;
• whether some IFRS are less relevant for some entities;
• whether the cost of applying some IFRS outweigh the benefits in some situations; and
• whether the concerns of smaller entities are different from those of large entities.

The national standard setters have adopted various approaches, such as a comprehensive set of simplified standards (UK), targeted adjustments in standards (Canada and USA) or a differential reporting framework (Canada and New Zealand). Comments were also expressed that a major issue is, in fact, the lack of infrastructure and education in some parts of the world to enable a proper implementation of IFRS.

As a conclusion to the discussion, the IASB's Chairman indicated that a possible direction for the project might be to consider issuing, as a first step, literature that would help draw the companies subject to the discussion ultimately into IFRS, as opposed to developing literature that would have a basis of accounting different from the IFRS literature. Particular consideration would be needed about disclosure and the cost/benefit balance of the requirements. Market participants would need to be involved in the discussions.

Finally, questions were raised whether, if an enterprise were to apply some literature with requirements that differ from IFRS, it could claim compliance with IFRS.

Discussion of possible amendments to IAS 32 and IAS 39

1. Derecognition

The aim is to provide a set of clear rules or principles on derecognition. The derecognition rules in IAS 39 as it currently stands are deficient in that an enterprise may effectively choose whether or not to derecognise an asset according to which paragraph of the IAS it applies. This resulted from trying to combine a risks and rewards approach with a control approach.

The proposal is to have one clear rule, with no exceptions. The proposal is to derecognise an asset or liability, or component thereof, to the extent that the enterprise has no continuing involvement in the asset or liability. If any continuing involvement is retained, then at least some of the asset or liability must continue to be recognised (the portion relating to the risks retained).

This approach has been labelled a 'sticky fingers' approach in that it is much easier to recognise an asset or liability than to derecognise it. It is a very different and much simplified approach. It is not a move to conform to US GAAP, but is a move to make IAS 39 operable in the short term.

2. Measurement and Hedge Accounting

The main proposal is to allow any financial instrument that would otherwise be held at amortised cost to be measured at fair value. This would reduce the need for hedge accounting, allow better matching of assets and liabilities, reduce the complexity of accounting for hybrid instruments and produce less volatile results. In other words, designation is to override intent.

Several people were worried that opening up the categories would lead to profit manipulation. However, it was pointed out that the categories were already effectively fairly open for assets and that the proposals simply allow this for liabilities too. Also, designation must be done at origination and cannot be changed thereafter.

The name of the category 'held for trading' was an issue, as it was pointed out that this is now an inaccurate description and should be changed to something like 'financial instruments held at fair value with changes recognised in the income statement'.

It was pointed out that the move to open up the categories for liabilities is important for insurance companies as under the current standard insurance assets are held at fair value and insurance liabilities at amortised cost. Additionally, it is looking increasingly likely that there will be an insurance standard in the near future where insurance assets and liabilities will be held at a current value.

The changes are also important for any company that manages its asset and liability portfolios by looking at the fair values of the financial instruments and their cash flows.

The other proposals are intended to reduce the differences between IAS 39 and US GAAP. These include classifying hedges of firm commitments as fair value rather than cash flow hedges, prohibiting any basis adjustment when a cash flow hedge gives rise to a new asset or liability, and eliminating the option of recognising gains or losses on the sale of available for sale assets in the income statement (all gains and losses must now be recognised in equity).

3. Presentation

The proposal is to measure the liability element of a compound liability/equity instrument first and then to assign the residual value to the equity. This is both the easier way of measuring the components and is consistent with the definition of equity as a residual.

4. Portfolio Assessments of Impairment

It was decided at the November 2001 IASB meeting that a financial asset that is individually identified as impaired should not be included in a group of assets that are collectively assessed for impairment.

It was further decided that a financial asset that had been individually assessed for impairment and found not to be impaired, could be included in a portfolio assessment based on some objective criteria. It remained to be decided what those criteria are.

An asset that has been individually assessed for impairment and found not to be individually impaired should be included in a collective assessment of impairment. The occurrence of an event or a combination of events should not be a precondition for including an asset in a group of assets that are collectively evaluated for impairment.

Assets should be grouped by similar credit risk characteristics that are indicative of the debtors' ability to pay all amounts due according to the contractual terms.

Contractual cash flows and historical loss experience should provide the basis for estimating expected cash flow. Historical loss rates should be adjusted based on relevant observable data that reflect current economic conditions.

The methodology for measuring impairment should ensure that an impairment loss is not recognised immediately on initial recognition. For the purposes of measuring impairment in groups of assets, estimated cash flows (contractual principal and interest payments adjusted for estimated credit losses) should be discounted using an effective interest rate that equates the present value of the estimated cash flows with the initial net carrying amount of those assets.

5. Accounting for Derivatives on Own Shares

In the November meeting, a tentative conclusion on how to classify derivatives indexed to, or that may be settled in, own shares. Having reviewed numerical examples, the Board continued this discussion. The tentative conclusion reached in November was as follows:

	Physical Settlement	Net Cash Settlement	Net Share Settlement	Issuer Choice	Counterparty Choice
Forward buy	Liability	Asset/ Liability	Asset/Liability	Asset/Liability	Liability
Forward sell	Equity	Asset/ Liability	Asset/Liability	Equity	Asset/Liability
Purchased call	Asset	Asset	Asset	Asset	Asset
Written call	Equity	Liability	Liability	Equity	Liability
Purchased put	Equity	Asset	Asset	Equity	Asset
Written put	Liability	Liability	Liability	Liability	Liability

The basic principle was to ask if there was a residual interest. If no, then classification as a liability was appropriate; if yes, then it was necessary to ask if there was cash settlement. If yes, then classification as a liability was appropriate; if no, then classification as equity was appropriate.

The Board had trouble with the physical settlement results. They felt it inappropriate for the value of equity to change based on the change in value of an entity's own shares.

It was decided that for physical settlement, or for issuer choice where historically physical settlement has been used, then a forward buy, purchased call and written put, the embedded derivative should be ignored. In other words, the embedded option should be thought of as a change in terms rather than as a forward.

6. Joint Value Attributable to Interdependent Embedded Derivative Features in Issued Compound Instruments

The example given was that of convertible debt with an embedded call option. Thus the value of the debt will determine whether the call or conversion is exercised. It was decided in December that the with-and-without method for valuing the instrument should be used such that the liability is measured and the difference between the value of the whole instrument and that of the liability is assigned to equity.

The issue is how much disclosure should be given. Whilst in general the Board feels it inappropriate to disclose exact methods for measuring financial instruments, this is an exception owing to the importance of debt equity ratios. Hence consideration was given to disclosing the effective interest rate used in determining the value of the liability.

7. Incorporation of Draft SIC 34

The conclusion reached in SIC D34 (that puttable instruments should be classified as liabilities and not equity) is to be incorporated in IAS 32. However, it was felt that disclosing an income statement with zero net profit is not useful. Whilst the disclosure of change in net asset value, as is currently given, was felt to be useful, the wording needs to be changed, so staff are to look at changing the wording.

Next Steps

The aim is to produce an exposure draft by the end of first quarter 2002, with a 3 month comment period.

First-Time Application of IAS [Project Summary]

The IASB's staff summarised the tentative conclusions for a new Standard on First-Time Application of IFRS (refer to November 2001 IASB meeting).

National standard setters did not make any comment on the project, except that the UK Chairman, supported by some IASB members, raised concerns about the proposed exception to the requirement to restate under IFRS for financial instruments (i.e., those financial instruments that were derecognised under local GAAP before 1 January 2001 that would meet the recognition criteria under IFRS).

Discussion of Improvements Project

IAS 2

The proposal is to remove the option of using LIFO as a cost formula for measuring inventory. National standard setters advised to go ahead and expose.

IAS 17

The tentative proposal is to remove the option of expensing lessors' initial direct costs for finance leases. More thought needs to be given to lease accounting in general, but it was felt that this was a self contained area that would not get in the way of the separate project and would be consistent with the Board's goal of eliminating choice. The proposal is in line with IAS 39, which requires capitalisation of initial acquisition costs. A decision was made to go ahead and expose.

IAS 23

The proposal is to eliminate the option to capitalise certain borrowing costs and instead to require that they all be expensed as incurred. It was felt that this area needed more consideration, as the proposed treatment would not be in line with many countries' current treatment. Additionally, where countries do capitalise borrowing costs, they are not always capitalising the same costs.

IAS 1

IAS 1 permits a true and fair override in extremely rare circumstances. Not all countries currently permit this, and are wary about doing so. Countries that do permit this pointed out that only a very few times is this used. The Board needs to debate this further, and is planning to do so later in the week.

Discussion of Responses to the Report of the Joint Working Group of Standard Setters (JWGSS)

Overall

The mandate of the JWGSS was to develop a draft comprehensive standard on accounting for financial instruments at fair value. 284 responses were received. Two thirds of these were from preparers, the remainder from a wide variety of groups, but responses from users were few in number.

About 75% of respondents were opposed to the proposals in the paper. Of the 25% for the proposals, the vast majority of these were non-preparers. Of the objections, there were 2 main types: problems of principle, and practical problems.

The problems of principle included: