22-23 January 2003, London

Wednesday 22 January 2003

Amendments to IAS 32 and IAS 39, Financial Instruments

The staff noted that 107 requests have been received by the deadline to participate in the IAS 32/39 roundtable discussions. The Board agreed at a prior meeting that a set of guiding principles and questions would be distributed to participants prior to the roundtable discussions. The discussion focussed on finalising that document to be sent out to the participants.

The document will highlight several guiding principles that underlie the proposals in the ED. The Board will ask the participants whether they agree with these principles at the roundtable. The questions will be organised into the following five sections:

• The distinction between debt and equity, including derivatives on own shares,
• Derecognition of financial assets,
• Derivatives and hedge accounting,
• Impairment of financial assets, and
• Other issues

The Board was clear that the participants should not in any way feel obligated to respond to each question either in writing prior to the discussions or during the discussions. The participants should focus their efforts on those issues that they believe should be improved. After the discussions, the staff was requested to make the appropriate changes, clear those changes through selected Board members, and then post the document to the website.

First-Time Application of IFRS - Consideration of Comments on ED 1

Derecognition

Under the general principles in ED 1, First-Time Application of International Financial Reporting Standards, a first-time adopter would apply the transition provisions of IAS 39 (except for the provision for hedge accounting in paragraph 24 and appendix C of ED 1). Some Board members are concerned that the wording in IAS 39.172(a) prohibits derivatives that are part of derecognition transactions from being recorded in the transition to IAS 39. That is, these derivatives would remain off balance sheet. This was clearly not the intention of the Standard and several members expressed concern over this interpretation.

Nevertheless, the IASB decided to amend the transition provisions of IAS 39 to make it 'crystal clear' that these derivatives should be put on the balance sheet at the date of implementation of IAS 39. The Board noted that this consequential amendment to IAS 39 may be amended during the IAS 32/39 improvements project to require a full retrospective approach.

Special Purpose Entities

The staff noted that the comment letters did not provide any new arguments for changing the current inclusion (or lack of scope exception) of SPEs in the general requirements of ED 1. Therefore, the provisions of SIC 12 for retrospective application (by reference to IAS 8.46) shall be applied.

Transaction Costs

The staff believes that no exception should be made for transaction costs as these amounts are either immaterial or entities should be able to make a reasonable estimation.

Compound Instrument

The staff addressed a concern related to a compound instrument where at the date of transition the liability component was gone. ED 1 would currently require a retrospective split of that amount between retained earnings and equity. The staff noted that such a split was not required in this limited fact pattern. Therefore, the entire fair value should be charged to equity.

Embedded Derivatives

No changes to the current requirements and exceptions are proposed. The Board reiterated the IAS 39 requirement that if an embedded exists, but it cannot be individually measured, then the entire contract should be recorded at fair value.

Available-for-Sale Financial Assets

No changes to the existing requirements were proposed.

Debt/Equity Classification

No changes to the existing requirements were proposed.

Measurement

No changes to the existing requirements were proposed.

Disclosure

No changes to the existing requirements were proposed.

Date of Transition to IFRSs for Some Subsidiaries

The Board discussed the current exception from the scope of ED 1 related to subsidiaries that report IFRS numbers to a parent, but then subsequently issue IFRS statements to the public for the first time with an unreserved statement of compliance (paragraph 5). The concern is that the IASB does not want to create a requirement for an entity to keep two separate sets of IFRS financial statements.

The staff proposed keeping the scope exception, but rewording it so that the subsidiary would adopt the parent's date of transition as its own. The Board also decided to make this scope exception optional. The Board decided to drop the requirement for agreement from all minority shareholders to use the parent's date of transition as its own from the final standard (paragraph 5(b)).

Other FTA Issues

The Board stated that it plans to readdress the necessity of having the requirement that if an entity chooses one exception, it must choose them all (paragraph 14).

The Board decided to provide an exception for intangible assets similar to paragraph 17 for tangible fixed assets. Therefore, if cost can be established (and therefore outside of the measurement exception) and the mark-to-market requirements in IAS 38 have been met, the revalued amount of this intangible may be carried forward as deemed cost.

Convergence - Short-Term Project - Post-Employment Benefits

At a previous meeting, the Board discussed whether to retain the corridor approach in IAS 19 for the return on assets in relation to the performance reporting project. Therefore the discussion was better characterised as a reporting performance discussion if the proposed changes to pension accounting are decided upon. That is, if the Board decided to eliminate the corridor, how should the performance statement report the actual return on plan assets? As a result of the tentative decisions to date (removal of the pension corridor and two-column performance statement) any discussion on this matter depends on successful completion of these projects.

The Board reiterated its previous conclusion to eliminate the current approach in IAS 19 and require that the actual return on plan assets be recognised in the performance statement. The Board also reiterated its previous conclusion that the following presentation in the performance statement should be required:

As a result of this decision, an entity must decide whether the pension assets are available for sale, held for trading, or held to maturity at the purchase date. The change in the value of pension assets would be accounted for similarly to respective assets held outside of a pension plan.

The Board discussed the accounting when, for example, an employee is issued a pension benefit of 500 to be received at the end of 5 years. After year two, the employer decides to double that benefit to 1,000. The current approach in IAS 19 is to account for the portion related to prior service as a prior service cost. The Board reiterated this approach with a 9 to 5 vote. Those objecting preferred a straight-line approach.

The Board also decided to require that entities disclose in their annual financial statements the total fair value of assets by class. The Board noted that IAS 19.120(c)(iii) requires that the company disclose the fair value of plan assets anyway. Therefore, the Board assumes that it should not be too difficult to provide the disclosure by class of asset. A few Board members believed the disclosure by class would be too burdensome and potentially could not be audited in the time frame necessary for an annual report, especially for large multinational corporations.

The Board requested the staff develop a set of guidelines related to classes that should be disclosed. One Board member suggested classes such as equities, fixed return instruments, variable return instruments, and other. The Board also stated that investment in assets or equities of the entity should be disclosed.

The Board discussed practical problems related to the potential elimination of the corridor. The suggestion was that the surplus in plans and the deficit in other plans should be presented separately on the balance sheet if material.

The Board discussed a fact pattern where a large multinational has a general pool of assets that it uses to fund several different pension schemes (in substance similar to a multi-employer plan). The Board agreed that companies should be allowed the same exception in paragraph 30 of IAS 19 for use of defined contribution accounting when sufficient information is not available to use defined benefit accounting.

The Board also concluded that the difference between the change in the pension surplus and the change in the pension asset should be recorded in the remeasurement column in the performance statement.

At a previous meeting, the Board decided to require sensitivity analysis disclosures related to health care cost trend rates. The Board indicated that certain other sensitivity analysis should be disclosed. The staff will identify candidates for this requirement and will provide a paper to the Board for discussion at a future meeting. Regardless of whether a series of candidates can be identified, the Board noted that if the information is material and disclosure of such information is not required by IAS 19, then the requirements in IAS 1 would require such analysis be disclosed.

Convergence - Short-Term Project - Other Issues

Assets Held for Disposal

The Board decided to achieve convergence with US GAAP by creating a separate category of assets held for disposal when disposal is 'likely to occur'. The Board decided that disposal is likely to occur when six criteria (similar to FAS 144.30) are met. There was significant discussion over the difference in the definition of 'probable' under IFRS and US GAAP. The Board noted that for an asset to be classified as held for disposal, the probability of the eventual disposition of that asset must be very high, much higher than 51%. Some members suggested terms such as 'highly probable' and 'highly likely'. The intent of the Board is to achieve the same answer for recognition as under FAS 144.

While convergence on recognition will be achieved, there will still remain differences in measurement. FAS 144 requires assets or groups of assets held for disposal to be measured at the lower of carrying value and fair value less cost to sell. The current impairment test measures the asset at the recoverable amount, which is defined as the higher of value in use or net selling price.

The Board was concerned that the definition of 'net selling price' in IAS 36.5 is basically the same definition as fair value in other standards. The Board decided to amend this definition of net selling price to be fair value less cost to sell.

The Board noted that once the FASB completes its project on FAS 107, a new definition of fair value will most likely emerge. However, in the meantime, the definition of fair value, as used in all of the standards, should be amended to include the notions of 'current transaction' and 'other than by forced liquidation or sale' included in the US GAAP definition of fair value.

The Board may also change the title to 'Disposal of Noncurrent Assets'.

Government Grants

The Board believes that IAS 20 is out of date and inconsistent with the Framework. Currently, US GAAP applies the requirements of IAS 20, as there is no current standard under US GAAP applicable to for-profit entities. Australia has a standard that is preferred by the Board, but as a result of the requirements for Australian entities to adopt IAS 20 in 2005, will be required to take what the Board believes is a retrograde step. The Board discussed the following five possible action steps:

• Do nothing and leave IAS 20 in place.
• Withdraw IAS 20 pending the revenue project.
• Converge with the principles in FAS 116.
• Converge with Australian GAAP (UIG 11).
• Develop a new solution.

The Board asked its staff to prepare a paper that would be similar to UIG 11 for the Board's consideration. If such a project could be done quickly, then the Board will replace IAS 20 with that standard.

The Board noted that IAS 41.34-38 currently has guidance on the accounting for government grants that is consistent with the Board's leanings and generally consistent with UIG 11. Therefore, the Board believes that when IAS 20 is withdrawn (and if it is not replaced by another standard), the five paragraphs in IAS 41 on government grants would be sufficient guidance going forward. Therefore, all government grants would be recorded as revenue or deferred revenue when received.

Business Combinations - Phase II - Application of Purchase Method

Non Monetary Consideration Exchanged in a Business Combination

In October 2002, the IASB agreed to further discuss the provisions of UITF 31. This interpretation deals with situations in which entity B issues shares to entity A, an unrelated third party, in exchange for A's business or other non-monetary assets and as a result of this transaction becomes A's subsidiary, joint venture or associate.

The Board discussed on the following issues:

• Should A's business or other non-monetary asset exchanged for an interest in a subsidiary, joint venture or associate be accounted for at fait value at the date of the transaction, at previous carrying amount or some combination of the two?
• How should A's gain or loss arising on the transaction be reported?

View 1. The business combination is accounted for at fair value, with the measurement based on either the fair value of the non-monetary consideration paid or fair value of the transaction. Similar to other identifiable acquired assets and assumed liabilities, the non-monetary asset transferred to the acquiree as consideration would be recognised on the date control is obtained, and measured at its fair value at that date. As a result, the full amount of any profit or loss arising on the transfer to the acquiree of the non-monetary asset would be recognised in the consolidated financial statements

View 2. As the first alternative, the business combination is accounted for at fair value with the measurement based on either the faire value of the non-monetary consideration paid or fair value of the business acquired. However, from the consolidated group's perspective the non-monetary asset exchanged is viewed as neither part of the consideration paid nor part of the business acquired. Therefore, the full amount of any profit or loss arising on the transfer to the acquiree of the non-monetary asset is eliminated in the consolidated statements

The Board decided on View 2, because A has the control of B and therefore should not be able to recognise a new basis for the asset with the corresponding gain or loss in the consolidated financial statements.

Thursday 23 January 2003

Business Combinations Phase II - Application of the purchase method.

Working Principle

The Board discussed the following working principle with the intention of clarifying certain aspects thereof.

The accounting for a business combination assumes that the transaction is an exchange of equal values. The total amount to be recognized should be measured at either the fair value of the consideration paid or the fair value of the net assets acquired, whichever is a better measure of the fair value of the transaction.

• If the consideration paid is cash or other assets (or liabilities incurred) of the acquiring entity, the fair value of the consideration paid generally determines the total amount to be recognised in the financial statements of the acquiring entity.
• If the consideration paid is in the form of equity instruments, the fair value of the equity instruments ordinarily is more clearly evident than the fair value of the net assets acquired and, thus, generally will determine the total amount to be recognized by the acquiring entity.

In a business combination, the acquiring entity obtains control over the acquired entity and therefore is responsible for the assets and liabilities of the acquired entity. The identifiable acquired assets and assumed liabilities should be recognised on the date control is obtained, and measured at their fair values at that date:

• If the total fair value of the acquired business exceeds the sum of the fair values of the recognised identifiable assets acquired and liabilities assumed, that excess amount (which is the implied fair value of goodwill) should be recognised as an asset.
• If the total fair value of the acquired business is less than the sum of the fair values of the recognised identifiable assets acquired and liabilities assumed, that amount should be recognised as a gain in the income statement (rather than as negative goodwill in the balance sheet).

The Board agreed that the reference to a "business combination" in the first sentence of the working principle should be replaced by a reference to an acquisition as all business combinations would be deemed to be acquisitions and this would avoid any ambiguity.

There was some concern raised that the working principle could be seen to be circular. The staff agreed that they would consider this concern.

A Board member queried whether this principle placed a cap on the amount of negative goodwill/gain arising in a bargain purchase acquisition by not requiring the goodwill in the acquired business to be recognised before the negative goodwill is determined. The staff agreed to consider this.

Insurance Contracts Phase I

The Board discussed certain aspects of investment contracts that do not expose the issuer to significant insurance risk and that, therefore, should be accounted for under the financial instruments standards. The two areas discussed were:

(a) performance-linking features;
(b) cancellation or renewal options held by the policyholder.

Performance-linked contracts

The discussion concerned how to classify the amounts to be paid to investors where the timing and amount of the return, or a portion of the return, is at the discretion of the issuer, but a fixed portion will be distributed to whoever is an investee at the time of distribution.

As the staff believed that there would not be sufficient time to discuss whether these should be equity or liabilities, they proposed that they be scoped out of the liability/equity classification sections of IAS 32 and treated under the same principle adopted for insurance contracts. It was noted that this would not apply to contracts that specify an asset-linked return.

The Board had a lengthy discussion as whether this should apply only to insurance entities and were reluctant to apply an exemption on an industry specific basis. Some Board members were unsure as to why there was a difficulty in this area and why an exemption should be provided.

It was agreed that the staff would identify the feature of these contracts that causes classification difficulties such that an exemption could be worded that would apply to all entities. This proposal will be discussed again.

Investment contracts with cancellation and renewal options

The Board discussed whether guidance should be provided on measuring liabilities arising under investment contracts where the policyholder may either cancel the contract early or extend the contract at favourable terms. In these cases the liability could be measured at:

• Surrender value;
• A range of surrender possibilities discounted to present value;
• The value of the contract assuming no surrender.

It was agreed that the staff would identify the feature of these contracts that is different from those in other industries such that it causes unique problems and that a proposal should be developed that could be applied to all contracts of this type, not only those in the insurance industry.

Insurance Contracts Phase II

The Board discussed various recognition and measurement issues related to insurance contracts the staff will use to develop the project further. The issues were as follows:

Model

Should the accounting model be based on direct measurements of contract assets and liabilities, on deferral and matching of contract revenues and expenses, or some combination of the two?

Most Board members believed that the asset and liability approach, or more basically recognition of the rights and obligations under the contracts, should be the approach adopted. They noted that it could also be seen as a matching and deferral approach based on, amongst other things, risk factors or exposure. There was a concern expressed that the matching and deferral approach had not been fully explored, but this was not supported. The Board voted unanimously to pursue an asset and liability approach.

Measurement

Should an asset-and-liability model use measurements based on fair value, entity-specific value, or some combination of measurement attributes?

The staff proposed that both initial and subsequent measurement should be based on fair value based on market observations and data. Where there was no market data the fair value should be determined based on the entity's data and observations. It was noted that there was an expectation that the fair value would not differ from an entity specific value. The staff proposal was accepted by vote of 12-2.

Discounting

Should the measurement of some or all amounts recognised in the balance sheet be based on their present values?

This was not discussed as it would fall away because of the earlier decision about measurement at fair value.

Asset/Liability interaction

Should the measurement model incorporate expectations about asset performance in determining the carrying amount of the contract liability?

The staff view was that there should not be an interaction between asset and liability measurement. The Board believed that an interaction approach was inconsistent with a fair value approach and consequently supported the staff's views by vote of 14-0.

Risk/Service adjustment

How should the accounting model approach the question of risk (or service) adjustment?

The Board believed that a fair value approach would include these adjustments, although there was a concern among some Board members that these would be subjective and could have a significant effect on valuation and consequently net income. The Board concluded to include this adjustment within fair valuation by vote of 13-1.

Gain or loss on initial measurement/liability recognition

Should the accounting model be constructed in a manner that prohibits or significantly limits the recognition of net profit or loss on initial recognition?

This was not discussed at it was dealt with as a result of previous decisions.

Policyholder behaviour

Should the accounting model incorporate expectations about cash inflows and outflows that are a consequence of policyholder renewals or cancellations of an insurance contract?

The staff proposed that these fair value should take into account any non-cancellable, renewable, and extendable rights that restrict the issuer's rights to re-price whilst premiums are paid. A number of Board members believed that these valuation adjustments should be taken into account where they place constarints on the issuer and provide value to the customer such that further business will flow. They acknowledged that this needs to be restrictively worded. A Board member disagreed, stating that these features should be treated separately as a series of in-the-money options. The Board agreed (by vote of 11-2-1) that the staff should proceed to explore the approach of adjusting the fair value for these features in limited circumstances.

Acquisition costs

Should the accounting model require costs incurred to acquire new insurance contracts to be capitalised as assets and amortised?

The staff proposed that these costs should be expensed as incurred. Some Board members believed that these would be intangible assets but that they would not be initially measured at the cost of the costs. The Board concluded that these costs would be subsumed within the measurement of the liability and should, therefore, not be shown separately as assets. Consequently, they should be expensed. The vote was 9-4-1.

Unbundling

Should the measurement model unbundle the individual elements of an insurance contract and measure them individually?

This was deferred to a later meeting.

Participating contracts

How should the insurer's liability to holders of participating contracts be recognised and measured?

This was deferred to a later meeting.

Credit standing

Should the measurement include the effects of the entity's credit standing?

The staff believed that this would be reflected in the fair value of the liability, because the terms of the contract – including are any regulatory or other specific guarantees – would affect the valuation. It was noted that this would require an assessment of the effectiveness of the guarantees. The Board agreed by vote of 13-1.

First-Time Application of IFRS

A summary of some decisions previously taken was presented to the Board.

The Board agreed that the decision to require all or none of the mandatory exemptions was changed to each of them being a separate choice. The Board also agreed that it would be optional to process the adjustment relating to the liability component of a compound instrument where that liability component is no longer outstanding at the date of transition to IFRS.

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