17-19 June 2002, Berlin, Germany

17 June 2002

Insurance Contracts:

Board discussions began by noting that, conceptually, there are two sorts of insurance contracts: year-to-year and long-duration contracts. The view among the Board members was unanimous that premiums on year-to-year contracts should be recognised as income for the period. The Board was less clear on how to treat premiums received on long-duration contracts.

The Board considered an example known as a 'term-to-100' contract, under which the policyholder pays a fixed premium annually until age 100. If the policyholder dies before age 100 or lives to age 100, the policy will pay $100,000. However, if at any point the policyholder decides not to pay the annual premiums any more, the insurer will not be obliged to pay anything.

The Board considered two possible ways of analysing the issue:

1. The premium received is accounted for the same way as under a year-to-year contract, that is, as current income. No further asset and no further liability is recognised. The rationale is that, since there is no enforceable right to receive future premiums, and thus no asset, there cannot be a liability beyond the current period either. This view was rejected by the Board.

2. Under the second view, a liability covering the 'standing ready to pay' would be assumed. During the discussion an issue emerged as to whether there are in fact two liabilities: a liability covering the mortality risk, and a second liability which is similar to a written (continuation) option. The project manager pointed out that, if this route were to be followed, it would deviate from the princples on which IAS 37, Provisions, Contingent Liabilities and Contingent Assets is based.

There was considerable debate over several issues under the second view. Firstly, some Board members raised doubts as to whether the 'standby' constitutes a liability in terms of the Framework. Under the contract, the insurer does not have an obligation to pay unless the policyholder pays the annual premium. Nevertheless, the insurer does have an obligation to provide a service. After some discussion, the Board agreed that a liability exists.

A second issue arose on whether in setting up a liability to cover the continuation risk an asset embodying the expected future premiums would have to be recognised as well. One Board member pointed out that the insurer had no enforceable right to receive future cash flows, since it would be left to the discretion of the policyholder if the contract continues. Thus, it would not be justified to recognise an asset for the premiums to be received in future periods. On the other hand, there may well be an asset in terms of an internally generated intangible asset (such as a customer list). A majority of Board members seemed to agree that (a) an asset existed, (b) the asset was linked to the liability incurred, and (c) once the liability is recognised, the asset should simultaneously be recognised. There also seemed to be a consensus that the asset and liability should be presented net. The Board members were less clear about income statement presentation (gross or net).

However, when asked to vote formally on the proposals, several Board members said that they would not have enough information to decide on whether the route proposed was the one to follow. Two issues were of primary concern: the distinction between insurance and non-insurance contracts and the differentiation between certain types of insurance contracts. It was suggested that typical contracts be exemplified and brought before the Board to see whether the proposals could be sustained as a working basis.

The Board tentatively decided that further research be needed and directed to project manager to devote resources to the following points:

• Whether the measurement objective of the DSOP should be retained (that is, a risk-adjusted cash flow-based measurement technique).
• The relation between insurance and non-insurance contracts (the outcome of the research could well lead to major changes in accounting for other types of contfracts involving future promises, such as airline loyalty programs).
• The dividing line within the population of insurance contracts (at which point a liability would have to be recognised).
• Whether an instant gain or loss would have to be recognised on initial recognition.
• Possible alternatives to the approach suggested.

Share-Based Payment

The Board received an update from the project manager on a meeting with the advisory group on share-based payment.

Measurement of expected volatility

Regarding how to take expected volatility into account when valuing an equity instrument of newly listed or unlisted companies, the advisory group suggested taking and adjusting a volatility factor by reference to other companies with similar characteristics. A minimum value approach as taken by SFAS 123 was dismissed as inappropriate, especially for start-up companies such as high tech companies). The Board accepted the view without taking a formal vote.

Grant date value adjustments

The Board reaffirmed its prior decision that grant date valuation reflect the possibility of forfeiture. The alternative of subsequently truing-up the grant date value to capture the 'correct' figures was rejected on the following grounds:

• The introduction of a true-up adjustment to earnings would, in effect, shift the focus from grant date to vesting date.
• Truing-up would lead to a fair value adjustment on an entity's own equity instruments which would not be in line with the Framework.
• The change in fair value is caused by factors other than movements in the share price of the equity instrument.

Repricing

If a repricing on the contract is negotiated, the Board discussed whether the difference between the fair values of the old option and the new option should be expensed when the contract is renewed or should be spread over the remaining vesting period. A slight majority of the Board favoured the first approach.

Lapsed options

Regarding lapsed options, the Board unanimously decided to leave the amount in equity, consistent with the accounting treatment for warrants that lapse unexercised. Two Board members noted that their local GAAP would require taking the amount to income if the option was not exercised.

Share appreciation rights settled in cash

If share appreciation rights are settled in cash rather than equity, the Board unanimously decided that

• A liability should be accrued over the vesting period.
• The liability should be measured at fair value (comprising both intrinsic and time value).
• The change in fair value between grant date and settlement date should be reported either on the face of the income statement or in the notes.

Share plans with cash alternatives

The key accounting issues for share plans that offer cash alternatives are whether and when a liability or eqjuity interest arises, measurement of those liabilities and equity interest, and accounting for their settlement.

There was general agreement that an equity interest arises when delivery of shares becomes more likely than a cash payment. At that time, the plan may result in a compound financial instrument that would have to be split into its equity and debt components. Although IAS 32 says that the equity component of a compound instrument is measured residually, in this case the equity component cannot be measured by subtracting the value of the debt instrument from the plan's entire value since that entire value is unknown. The liability component would have to be remeasured to fair value with changes in fair value going into the income statement.

Transfers of equity instruments by shareholders directly to the beneficiary

The Board decided unanimously that transfers of equity instruments by shareholders directly to a beneficiary should be accounted for as share-based payment unless the purpose of such transfers was clearly not for remuneration.

18 June 2002

Performance Reporting - Financial Instruments:

Board deliberations focused on the display of the performance of financial instruments, specifically where to set the dividing line between the two columns envisaged for the performance statement: current performance in column 1 and revisions of past measurements in column 2:

Column 1 Income and Expenses Relating to Current Period Operations

Column 2 Income and Expenses Resulting from Revisions to Prior Expectations about Future Periods (Remeasurements)

Total

The two columns are a consequence of the following principle previously approved by the Board:

Income and expenses resulting from the re-measurement of an asset or liability should be reported separately. 'Remeasurement' refers to the revision of estimates embedded in the carrying values of assets and liabilities.

The principle was then discussed separately for:

• Financial assets and liabilities measured at amortised cost.
• Financial assets classified as available for sale.
• Financial assets and liabilities classified as held for trading.
• Fair value and cash flow hedges.

Financial assets and liabilities measured at amortised cost

For items measured at amortised cost, there are two performance reporting issues: interest income/expense and impairment. The staff's proposal was to have interest (as calculated under IAS 39) displayed in column 1, whilst any charge for impairment would be presented in column 2. The reason for having the latter in column 2 is that it would be interpreted as a revision to an estimate.

Although a majority of the Board supported this idea, some members expressed concern because the interest shown in column 1 would most likely include a factor covering credit risk that had been priced in the original interest rate. They felt it would seem odd that an impairment, being a revision to the original assumption about the credit risk embedded in the particular asset, would be shown in column 1, whilst the factor under revision -- the credit spread over the risk-free rate -- would be presented in column 1. After discussion, the Board agreed to the staff's proposal on the grounds that the credit risk was priced into the interest rate, not into the value of the loan.

Financial assets available for sale

The staff's proposal is that interest be presented in column 1 and any change in the fair value of the financial asset be presented in column 2. Two alternatives were discussed for measuring interest income: historical cost and fair value. The Board agreed to the general principle but decided to address the issue of measuring interest at fair value when it considers the report of the Joint Working Group on Financial Instruments.

Financial assets and liabilities held for trading

The staff's proposal is that remeasurement of fair value be recorded in column 2. There was considerable debate among the Board members on this proposition. Firstly, it was pointed out that not all assets classified as held for trading are really held for trading purposes. Derivatives are an example. The Board agreed to change the label of the category into 'financial assets and liabilities carried at fair value'.

The Board then debated whether a gain or loss on disposal of a financial asset could arise. Several Board members hold the view that recording a gain or loss for an item that is constantly remeasured to fair value is inconsistent with the notion of remeasurement. They argued that the gain or loss would show up simply because the reporting entity did not remeasure the item concerned frequently enough. They suggested the item being remeasured first before being derecognised. Upon derecognition no gain or loss would arise.

Other Board members thought that the nature of the business the reporting entity needed to be considered. They argued that if a company engaged regularly in trading activities, recording a gain or loss on disposal would be justified. The question came up whether the income should be classified as revenues or gains, but that was left open for future discussion. When the Board finally voted on the issue whether a gain or loss could be encountered on disposal (that is, recorded in column 1 rather than column 2), a slight majority of seven to six members voted against it.

Hedge accounting

For fair value hedges, the staff proposed to have all changes in fair value of both the hedged item and the hedging instrument be recorded in column 2, preferably in the same line item. The Board agreed unanimously.

For cash flow hedges, the staff basically proposed two alternative approaches:

Alternative A: Account for a cash flow hedge the same way as for a fair value hedge, that is, display any change in fair value of the hedging instrument in column 2 in the same line where the future transaction would show up. When the future transaction occurs, it would be reported in column 1.

Alternative B: For presentation purposes only, 'recycle' the income effect of the hedging instrument originally recorded in column 2 to column 1 upon occurrence of the future transaction. One Board member pointed out that, in order to be consistent with prior decisions reached (not allowing for recycling and not addressing recognition or measurement issues in the Performance Reporting project), the remeasurement of the hedging instrument would have to go to column 2, whilst the forecasted transaction hedged would be recorded in column 1 (Alternative A). If the hedge covered more than one period, the amount recorded in column 2 would not be an accumulated amount but solely the change in fair value of the hedging instrument for the current period.

Several Board members raised serious concerns. Whilst being consistent with the fundamental principles, Alternative A would be less decision useful because it does not show the offsetting effect of the hedging relationship. They acknowledged, however, that loosening the fundamental principles could lead to consequential amendments to other standards that allow for remeasurement, such as IAS 16 and IAS 21.

After considerable debate the Board directed the staff:

• to develop an example covering inter-period hedges,
• to carry out further research about the possible consequences (and necessary amendments) that could arise for other subjects than cash flow hedge accounting if Alternative B were adopted, and
• bring both before the Board in July.

19 June 2002

Business Combinations Phase 2:

Definitions of contingent assets and contingent liabilities

The Board discussed the treatment of contingent assets and contingent liabilities. The staff pointed out that the notion of contingency differed between the US standard FAS 5 and IAS 37. However, they concluded that the difference would not lead to a different accounting result in practice and therefore staff proposed not to change the definition in IAS 37.

Some Board members did not accept the staff view. They perceived the IAS definition to be conceptually flawed and thought that, if the FASB definition was conceptually superior to the IAS 37 definition, IAS 37 should be amended, even as part of a project on business combinations. By a 12 to 1 majority, the Board decided to change the definition in IAS 37 and to make it consistent with the FASB definition.

As regards contingent assets the Board briefly touched on the issue but did not reach a decision on whether to copy the FASB definition. Several Board members proposed not to clean up all the persisting inefficiencies within the Business Combinations project but to deal with them as part other projects.

Recognition and measurement issues related to acquired assets and assumed liabilities in a business combinations

The Board has previously agreed that acquired assets and liabilities should be measured at their fair values. The staff proposed to apply a three stage hierarchy as follows:

1. If there is an observable market transaction, the amount of cash exchanged for the same or similar item should be used.

2. If market values are not available, an enterprise should use an estimation technique (such as present value, option pricing models, or appraisals) using market-based assumptions with the objective of determining the item's fair value.

3. If neither market values nor market-based assumptions for estimating a value are available, management should use the same estimation techniques as above incorporating information that was not contrary to market-based assumptions.

The Board discussed the measurement hierarchy in length. Several Board members mentioned that the terms 'market' and 'fair value' were not precise enough and would need clarification:

• Which market should be considered when determining a market price (e.g. wholesale/retail; geography)?
• Does fair value include transaction costs?
• Is fair value meant to be an entry or an exit price?

The Board decided by a 10 to 3 majority to pursue the hierarchy principle further. The Board members dissenting were concerned about the practicability of the third stage of measurement. They perceived the principle to be neither precise enough in order to be workable nor leaving room for other measurement attributes such as current replacement costs. The Board directed the staff to explore possibilities of rephrasing the third principle to accommodate the concerns.

Convergence Topics

The project manager provided a short introduction regarding the work already carried out. Seven IASs have been compared with their equivalents in liaison countries to identify possible convergence topics.

IAS 2, Inventories

The project manager proposed that this standard does not include major convergence issues to be explored further. The Board agreed unanimously.

IAS 10, Events after the Balance Sheet Date

The project manager proposed that this standard does not include major convergence issues to be explored further. Although the Board agreed in general, it asked the staff to explore potential differences between IAS and local GAAP in more detail and bring the matter back to the board.

IAS 12, Income Tax

The project manager pointed out that the main difference between the liaison countries with regard to deferred tax accounting was concept of either a temporary or timing approach. As convergence between these two approaches was considered to be a major project, the project manager proposed to address only convergence issues arising under the temporary approach. The Board directed the staff to clarify the scope of a convergence project.

IAS 14, Segment Reporting

IAS 14, Segment Reporting, was identified as an important convergence issue. The discussion focused on whether segment reporting under IAS and US GAAP would lead to comparable results and whether one approach was preferable to the other. The Board decided that empirical data regarding the preference of the analyst community should be obtained before the topic is pursued further by the staff.

IAS 23, Borrowing Costs

The Board decided to not address borrowing costs for convergence until the Canadian Accounting Standards Board finishes its project on initial measurement.

IAS 28, Accounting for Investments in Associates

The Board decided that the staff should explore potential differences between IAS 28. It was agreed that scope of the analysis should include IAS 31 as well. The results of the analysis will be presented and discussed at the meeting with the national standard setters in October 2002.

IAS 35, Discontinuing Operations

The project manager suggested looking at potential differences in the definition and timing aspects. The Board agreed unanimously.

IAS 19, Post-Employment Benefits

IAS 19 has already been identified as a potential convergence area. The Board briefly discussed the possibility of limiting the project down to convergence issues only but decided that the differences between IAS 19 and the national standards most likely could not be overcome without major overhaul. It was therefore decided to discuss this issue with the Standards Advisory Council. In addition to that, the staff was directed to summarise the similarities and differences between the standards.

This summary is based on notes taken by observers at the IASB meeting and should not be regarded as an official or final summary.