12-14 November 2002, London

12 November 2002

Insurance Contracts - Phase I (Project Information)

In May, the IASB agreed to split the insurance contracts project into two phases, so that some components of the project can be put in place by 2005 without delaying the rest of the project. The first phase will address the application of existing IFRSs to companies that issue insurance contracts. Phase II is a comprehensive project on accounting for insurance contracts addressing all issues afresh. Click for information about the Insurance Contracts - Phase II (Comprehensive) Project.

The Board's goal for Phase I is to publish an Exposure Draft promptly so that a final Standard can be in place and effective by 2005. The current timetable is for the ED to be issued in first quarter of 2003 and a final IFRS in 2004.

At today's meeting, the Board discussed the following Phase I issues:

• Unbundling of an investment contract component of an insurance contract.
• Application of IAS 39, Financial Instruments: Recognition and Measurement, to investment contracts (contracts that do not transfer enough insurance risk to qualify as insurance contracts).
• Measurement of financial assets backing investment contracts and insurance contracts.
• Embedded derivatives.

Unbundling

The Board tentatively decided that, to the extent that the cash flows in an insurance contract are not affected by an insured risk, the contract contains an investment contract component (sometimes called the 'deposit component') that must be 'unbundled' and accounted for separately as a financial instrument.

Application of IAS 39

Under IAS 39 as it currently stands, the issuer generally treats the investment contract component of an insurance contract as a held-to-maturity investment carried at amortised cost. Under IAS 39 as it is proposed to be Amended, however, the issuer will have a choice of measuring investment contracts either at amortised cost or at fair value.

The Board agreed that investment contracts should be treated the same as other financial instruments under IAS 39, including related transaction costs. A proposed amendment to IAS 39 would restrict the amount of transaction cost included in the cost of a financial asset to external transaction costs. Internal transaction costs would be expensed. In the case of a company that issues insurance contracts, internal transaction costs would include the costs of sales agents on the issuer's own staff.

The Board generally agreed with the staff's recommendation that the IFRS that results from Phase I should provide guidance on applying IAS 39 in the following situations:

• Whether costs of administering an investment contract over its life (including overheads) are included in the future cash flows used to determine amortised cost or estimate fair value.
• Payouts denominated in units of a pool of reference assets or linked to an index.
• Clarification that future cash flows from assets should not be considered in determining the amortised cost or fair value of investment contract liabilities (except for performance-linked contracts, which will be addressed at a later meeting).
• Whether there is a need for a loss recognition test, analogous to an asset impairment test. The test would identify whether, and when, the amortised cost of a financial liability should be increased if future cash flows differ from previous estimates because of variations in lapses or changes in administrative costs.
• Clarification that the amortised cost of a financial liability is not increased when market interest rates increase, even if the return on available assets is below the effective interest rate on the liability.
• Whether an insurer should measure the portion of separate account assets representing contract holder funds at fair value and report it in the insurer's financial statements as a summary total, with an equivalent summary total for related liabilities (also measured at fair value).

Measurement of Financial Assets

A new category of financial asset (financial assets held to back insurance liabilities) will not be created. IAS 39 should be applied.

Embedded Derivatives

The Board tentatively decided that a derivative embedded in an insurance contract (such as an equity-indexed return or a guaranteed interest rate in a life contract) should be accounted for as a separate derivative under IAS 39 if either (a) it is 'out of the money' at issuance or (b) it is leveraged. The cash surrender value of a life insurance contract is an embedded derivative (a put) whose risks are closely related to those of the host insurance contract and, therefore, is not an embedded derivative that must be separated.

Other Issues

While the Phase I IFRS will not establish new accounting standards for insurance contracts, in the basis for conclusions appendix the Board plans to indicate the direction in which it has been leaning in its deliberations on Phase II, to provide guidance regarding adoption of new accounting policies, and changes to existing accounting policies, by companies that issue insurance contracts. The Board's main leanings have been:

• Insurance contracts should be measured at entity-specific value.
• The deferred and fund methods of accounting for insurance contracts should not be used.

Improvements to IFRS (Project Information)

The Board received over 150 letters of comment on the Exposure Draft. At today's meeting, the Board discussed the comments received on the proposed improvements to IAS 1, IAS 16, IAS 17, and IAS 40.

IAS 1

The Board decided tentatively not to modify its proposals that:

• An entity will be in compliance with IFRS even if it believes that a 'true and fair override' is appropriate but local law requires compliance with all IFRS and therefore prohibits the override. Disclosure would be required.
• The category of extraordinary items will be abolished. Labelling of items in the income statement as unusual, nonrecurring, or abnormal is not prohibited, but they may not be presented on a net-of-tax basis.
• A post-balance sheet agreement to refinance a short-term obligation on a long-term basis (more than 12 months) does not justify classifying the short-term obligation as non-current (disclosure of the agreement will be required).
• If a borrowing agreement has a covenant that makes a liability payable on demand if certain conditions related to the borrower's financial position are breached, and those conditions are breached at the balance sheet date, the liability is classified as current, even if corrected after balance sheet date. An exception to this principle is proposed if, prior to the balance sheet date, the lender has granted a grace period in which to correct the breach and, when the financial statements are authorised for issue, either (a) the borrower has corrected the breach or (b) the grace period has not yet expired.
• Significant judgements made by management in applying accounting policies should be disclosed.
• Key assumptions about the future and other sources of measurement uncertainty should be disclosed.

Classification of minority interest in equity was not disucssed. It will be considered by the Board at its December meeting, as will other IAS 1 improvements issues.

IAS 16

Exchanges of similar items of property, plant, and equipment should be measured at fair value, with net gain or loss recognised. The gross proceeds should not be reported as revenue. Likewise for exchanges of similar intangible assets.

The Board decided to modify its proposal that depreciation should continue when a depreciable asset becomes temporarily idle or is retired from active use and held for disposal. Under the modified approach, depreciation would continue unless the asset (a) is not being used, (b) is held for disposal, and (c) is available for immediate delivery to a buyer.

IAS 17 and IAS 40

The Board did not change its proposals regarding leases of land. Therefore:

• A lease of land and building(s) should be separated into two elements – lease of land and lease of building(s).
• A property interest held under an operating lease can be classified as investment property provided that the rest of the definition of investment property is met and the lessee uses the fair value model as set out in IAS 40.27-49.

Though commentators raised a number of other issues relating to IAS 17, the Board decided not to address any of them as part of the Improvements Project. It also decided not to consider, in the Improvements Project, whether to eliminate the choice in IAS 40 between the cost model and the fair value model.

13 November 2002

Improvements to IFRS (Project Information)

This was a continuation of the discussion from 12 November.

IAS 27

The Board reaffirmed the proposal in the Improvements Exposure Draft that minority interest be presented as a separate component of equity in consolidated financial statements. Classifying minority interest either as a liability or as a separate category between liabilities and equity will be prohibited. The IASB will discuss the implications of this decision for the income statement in December.

Business Combinations–Phase II (Project Information)

The Board reaffirmed the proposal in the Improvements ED that if an entity acquires less than a 100% interest in another entity, both the acquirer's and the minority interest's share of goodwill should be recognised. Under IAS 22 currently, only the acquirer's share of goodwill is recognised. To illustrate, if P pays 900 for a 60% interest in S, and on that date the fair value of S's identifiable net assets is 1,200 and the full fair value of S is 1,500, goodwill of 300 will be recognised in consolidation (1,500 - 1,200). Minority interest of 600 will be recognised (40% x 1,500).

The IASB is working on this project jointly with the US Financial Accounting Standards Board. While the two Boards have reached consistent decisions on the fundamental principles for applying the purchase method, their views have diverged on certain issues. The following issues have been identified as areas of current divergence that potentially can be eliminated before the two Boards publish their exposure drafts:

• The treatment of blockage factors in the initial measurement of equity consideration.
• The treatment of amendments to post-employment benefit plans that are a condition of the business combination.
• The treatment of intended changes by the acquirer to employee benefit and other post-retirement benefit plans.
• The treatment of constructive obligations.
• The treatment of an intangible that becomes separable (and therefore eligible for separate recognition apart from goodwill) after the business combination.

Liabilities and Revenue Recognition (Project Information)

The IASB is exploring a revenue recognition approach that focuses on changes in assets and liabilities and that is not overridden by tests based on notions of an earnings process. The Board's working criteria for revenue recognition comprise the 'element criterion' and the 'measurement criterion':

Element criterion: To recognise revenue, there must be either (a) an increase in assets that increases equity without a commensurate investment by owners or (b) a decrease in liabilities that increases equity without a commensurate investment by owners (such as the forgiveness by owners of a debt owned to them by the entity).

Measurement criterion: To recognise revenue, the change in assets or liabilities can be appropriately measured, specifically (a) the assets or liabilities are measured by means of a relevant attribute (such as fair value) and (b) the increase in assets or decrease in liabilities is measurable with sufficient reliability.

This project is a joint project with the US FASB. While the FASB has decided that fair value is the relevant attribute for measuring assets or liabilities at initial recognition or for any fresh-start measurements, and therefore is the relevant attribute for the related measurement of revenue, the IASB has not reached a similar decision. In fact, the IASB has tentatively agreed not to specify the measurement attribute for recognising assets and liabilities arising from a revenue-generating arrangement until it develops measurement concepts for the IASB Framework.

The IASB discussed a series of cases to test the application of the foregoing element and measurement criteria.

The IASB also discussed the recent decisions of FASB's Emerging Issues Task Force on Revenue Recognition in Multiple-Element Revenue Arrangements. [Click here to download the EITF's Draft Abstract on multiple-element revenue arrangements (PDF 77k)].

This was an educational session on Liabilities and Revenue Recognition, and no Board decisions were reached.

14 November 2002

Convergence Topics (Project Information)

IAS 19, Employee Benefits

The Board discussed two areas for possible convergence with US GAAP:

(1) Consolidation of defined benefit plans:

• Whether defined benefit plans should be consolidated.
• How the assets and liabilities that result from either consolidation or nonconsolidation should be presented.

The Board concluded that the net figure of the defined benefit obligation less the plan assets should be interpreted as a reflection of the asset or liability arising from the entity's net interest in the defined benefit plan rather than as a one-line consolidation of the plan.

(2) Further guidance on the asset ceiling. The Board considered whether there should be a limit on the amount that can be recognised as an asset in respect of a surplus in a defined benefit plan. The Board had concluded that the asset should be limited to the rights the entity has to benefit from the surplus. In measuring those rights, the following hierarchy should be followed:

• first, value the entity's rights to refunds and reductions in future contributions. If this is less than the surplus, then
• second, value the entity's rights to fund increased benefits to current and future employees. No value should be ascribed to the entity's right to fund increased benefits to past employees. If the two items above together are less than the surplus, then
• third, value the entity's right not to fund future losses in the plan to the extent that the losses will be absorbed by the surplus.

IAS 35, Discontinuing Operations

The Board discussed three possible areas for converging IAS 35, Discontinuing Operations, and FASB Statement 144, Accounting for the Impairment or Disposal of Long-Lived Assets:

(1) IAS 35 makes no distinction between operations that are disposed of by sale and those disposed of otherwise (for example, by abandonment). Under SFAS 144, however, an operation that is abandoned cannot be reported as discontinued until it is abandoned whereas an operation that is held for sale can be reported as discontinued prior to disposal. The distinction under SFAS 144 arises due to the different measurement basis of assets classified as held for sale vs. those held and used.

(2) The criteria for the "initial disclosure event" in IAS 35 are similar to those in IAS 37 for the purpose of recognising a restructuring provision. The possible amendment to IAS 35 for (1) above might result in a restructuring provision that relates on an operation that will eventually be classified as discontinued being initially recognised in continuing operations and subsequently reported as part of discontinued operations. The Board discussed whether it would need to amend IAS 37 if it converages with SFAS 144.

(3) SFAS 144 sets out how operations classified as discontinued should be reported. The Board discussed poossible amendments it might make to the disclosure requirements of IAS 35 in the light of both SFAS 144 and the IASB's performance reporting project.

Discussion of convergence of IAS 35 will be continued at the Board's December meeting.

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