19-21 February 2003, London

Wednesday 19 February 2003

IFRIC - Matters arising from the 4-5 February 2003 IFRIC Meeting

The staff noted that six draft IFRIC interpretations will be sent to the Board by April 2003. Board comments should be given immediately so that the IFRIC can adjust any tentative positions the Board is not comfortable with prior to the Board receiving a final document. In addition, the IFRIC will be sending a document on linkage to the Board. The Board will be asked to consider the appropriate format for that document – amendment to a current standard, new standard, or IFRIC interpretation.

The Board then discussed four IFRIC projects: Rights of Use, Emission Rights, Changes in Decommissioning Liabilities, and Decommissioning Funds. The staff noted that the tentative conclusions in the Rights of Use project are consistent with those of the EITF. The IFRIC will be asked to vote on this document at the April 2003 meeting, which will most likely be after the final decisions of the EITF are known. A pre-ballot draft is being developed and will be distributed to the Board and the IFRIC shortly.

The Board expressed concern that emission rights received could be recorded as income on the date received, but the expense and liability would be recorded over time. One member noted a case could be made for recording a liability on the date the rights are received, as there may be a present obligation to return those rights. The Board reiterated its belief that front ending of income and expense was not desired. The Board agreed with the IFRIC that the emission right meets the definition of an intangible asset and should be accounted for under IAS 38.

One member expressed concern that convergence was not going to be achieved on accounting for changes in decommissioning liabilities. However, the Board did not object to the IFRIC's current tentative decision. The Board also noted that it does not believe an investment in decommissioning funds meets the definition of an originated loan under IAS 39 as the counterparty has no present obligation to refund the deposit.

First-Time Application of IFRSs

The Board discussed issues surrounding the recognition of hedging instruments and the hedged item in the first IFRS financial statements of an entity. The Board confirmed its decision that the hedging instrument should be recognised at fair value with the offset to retained earnings at the date of transition. The Board considered two options for accounting for the hedged item – fair value or deemed cost. Several members expressed concern that if fair value is not required the hedging relationship would no longer exist, even if there is an effective relationship at the date of transition. However, the Board tentatively agreed to require the hedged item be accounted for similarly to other similar items, which will most likely be deemed cost. There was strong opposition to this approach by some members and therefore, the decision may be re-addressed at a future meeting.

The Board discussed whether final first time application standard should include two approaches – (1) use of current IFRS, with limited exceptions, and (2) IFRSs applicable to each period, with no exceptions (the SIC-8 approach). The Board agreed that using the current IFRSs is a superior solution and should be required.

Convergence Topics - Other than Pension Benefits

The Board agreed to take hyperinflation accounting out of the convergence project, as this issue is not as relevant to the US as it is for the IASB. Therefore, it will be added to a longer-term project with the IASB. The staff noted that they would be working with the standard setting bodies in Argentina on this issue. One Board member also suggested that the staff consult with the Mexican standard setters, as they have been helpful on this issue with the FASB in the past.

The staff noted that the scope of FAS 146 in relation to termination benefits is much narrower than the approach in IAS 19 (FAS 146 addresses only one-time termination benefits). Therefore, total convergence is unlikely to exist for all areas, but should exist for one-time termination benefits. The Board discussed the issue of "stay bonuses" and concluded that if a current obligation exists and the payment is probable, a liability should be recognised at fair value.

Translation gains and losses on assets held for sale are included in equity along with other translation gains and losses. The Board discussed whether these items should be recycled to the income statement when the assets are sold as part of the basis in the asset. The Board decided to defer a decision on this issue as it will be covered in the performance-reporting project.

Improvements to Existing International Accounting Standards

The Board addressed improvements to IAS 1, 2, 16, 21, 24, and 33. In addition, the Board was presented with papers that discussed suggested improvements to IAS 8 and 10 along with the withdrawal of IAS 15.

IAS 1, Presentation of Financial Statements

The Board addressed several issues related to IAS 1. The Board concluded that the final standard should provide guidance on the presentation of minority interest in the income statement. The Board tentatively decided to require a subtotal for net profit and loss attributable to controlling shareholders on the face of the income statement. As a result, profits associated with controlling and minority shareholders must be presented separately on the face of the income statement. Sub-points h and g should be deleted from paragraph 76 of the proposed IAS 1.

The Board decided that operating income or loss should remain undefined in the final standard and should be addressed in the performance-reporting project.

The Board discussed the meaning of the phrases "undue cost or effort" and "impractical" used in current IFRS literature to determine when the requirements of a standard should not be followed. The Board noted that the term "impractical" is synonymous with impossible. That is, if it is impractical, the entity just can't do it no matter how much time or money is spent to determine the answer. Conversely, the "undue cost or effort" phrase is meant to be a lower threshold that is focussed more on whether the benefit exceeds the cost of accumulating the information. The Board requested the staff to prepare a paper on when these phrases are used to insure that the right phrase is used in each circumstance. The Board noted that its intention in First-Time Application is for an "undue cost or effort" exception.

IAS 2, Inventories

The Board decided to retain the elimination of the LIFO approach to accounting for inventory. Therefore, only the FIFO, weighted average, or specific identification approaches will be allowed. The Board also decided to retain the requirement to reverse impairment losses recorded on inventory. The Board discussed the scope inclusion for broker-dealers that are measured at net realisable value with the change in value in recorded in the income statement (paragraph 1c). The Board decided to clarify that scope inclusion to brokers that deal in commodities. In addition, the Board decided to replace the phrase "net realisable value" with "fair value less cost to sell and complete".

IAS 8, Accounting Policies, Changes in Accounting Estimates and Errors
IAS 10, Events after the Balance Sheet Date
IAS 15, Information Reflecting the Effects of Changing Prices

While the Board was presented with papers on IAS 8, 10, and 15, there was no discussion related to those items. It would appear, therefore, that the decisions represented in the exposure draft have not been changed. This may be clarified in the IASB's Update newsletter.

IAS 16, Property, Plant and Equipment

The Board discussed several issues related to the improvements to IAS 16, including exchanges of assets, the components approach, and residual value. At its November 2002 meeting, the Board tentatively decided to require that exchanges of assets must have "economic substance" for the exchange to be recorded at fair value. The Board gave guidance to the staff on how to incorporate this requirement into a final standard, which included looking to demonstrated transactions with other parties and attributes related to the terms of the transfer. No decisions were made.

The Board clarified that the components approach is a method of getting a more precise calculation of depreciation. There are questions related to how far down an entity should go to determine a component and the Board clarified that the entity should use its best judgement as to how small the components should be for an accurate calculation of depreciation. The Board clarified, however, that if repair and/or replacement of an item that is not a separate component occurs, that amount should be expensed. If the asset is a separate component, then that amount should be capitalised and the replaced asset should be written off.

The Board confirmed its decisions to require revaluation of residual values on property plant and equipment on an annual basis and to prohibit recognition of credits to depreciation as a result of a change in the residual value. The staff presented an example where the residual value increased above the current amortised cost but below the original cost. The Board was split (7 to 7) over whether the credits up to the original cost should be recognised. The 7 who believe that the credits should be recognised were split over whether to spread the credit over the remaining life of the asset (6 members) or take the gain immediately (1 member). The Board will discuss this issue further.

The Board discussed the IFRIC's current project on recording changes in decommissioning liabilities. The Board noted that not all of the change in the liability should go to the asset, and the revisions to IAS 16 should make this clear. One member noted that the decision by the IFRIC was inconsistent with US GAAP (FAS 143). The staff did not believe convergence in this area was desirable.

IAS 21, The Effects of Changes in Foreign Exchange Rates

The Board confirmed its decision that an entity's functional currency should be the currency of the primary economic environment in which the entity operates. The Board stated its intention that paragraphs 7 and 8 of the revised IAS 21 should be looked at as a hierarchy when determining an entity's functional currency. The Board also noted that there is no such thing as a "group functional currency" and that the final revised standard should make this clear. The Board also decided to require disclosure of why an entity has changed its functional currency, if applicable.

One Board member noted that IAS 29 in its current state is too hard to implement and that the Board should address revisions to its requirements at a future date. There was agreement on adding this to a longer-term improvements project.

The Board confirmed its decision that a reporting entity should be permitted to present its financial statements in any currency. However, the Board views this as a convenience translation from the functional currency of the entity that should be translated at the spot rate. The Board noted that the final standard should clearly distinguish between a presentation currency and a convenience translation.

The Board reaffirmed its decision to eliminate the allowed alternative in paragraph 21 of IAS 21 to capitalise certain exchange differences. One member noted this decision continues an accounting option not based on difference in underlying circumstance and is inconsistent with US GAAP.

The Board discussed whether goodwill and fair value adjustments to assets and liabilities should be considered assets and liabilities of the foreign operation and translated at the closing rate. Several members noted that this decision is inherently requiring pushdown accounting for goodwill. The Board decided to retain the position in the exposure draft and further decided to require goodwill and fair value adjustments to be translated at the closing rate. The Board decided to allow prospective application (but permit retrospective application) for acquisitions after the effective date that give rise to goodwill.

The Board decided to keep the net investment exception to providing changes in the exchange rate in the profit and loss accounts.

IAS 24, Related Party Disclosures

The staff noted that several comment letters requested that management compensation be a required disclosure. Several Board members expressed concern with this requirement, as it would require the Board to define management compensation. The Board tentatively decided to amend the exposure draft to require this disclosure. Therefore, the staff was asked to develop a working definition of management compensation, which the Board suggested should include items such as stock compensation, use of airplanes and apartments, etc.

The Board decided to delete paragraph 3 from the exposure draft – disclosures of related party transactions between consolidated entities. The Board clarified its position that if transactions are eliminated in the financial statements presented, those transactions need not be disclosed. However, if transactions are not eliminated, then those transactions must be disclosed.

IAS 33, Earnings Per Share

The proposed approach to calculating EPS in the exposure draft is based on taking an average of the interim periods presented. The Board noted that not all jurisdictions have similar interim reporting requirements and therefore a different EPS figure could be obtained merely as a result of reporting on a quarterly basis versus a semi-annual basis. The staff noted that the annual reporting period is its own distinct period. The Board decided to withdraw the approach in the exposure draft and replace it with an accumulative method approach. The Board noted that this method would be a divergence from US GAAP. The staff was asked to liaise with the FASB to converge in this area towards an accumulative method approach.

The Board noted that the objective of diluted EPS is to obtain the maximum dilution possible. Therefore, the Board decided that if an instrument can be settled in shares, it should be included in the diluted EPS calculation. This is consistent with SIC 24 (which would be withdrawn and included in the final standard) but inconsistent with the requirements of IAS 32. However, the Board noted that EPS is merely a calculation of a ratio, and therefore consistency with other standards is not required. The Board noted this decision is in conflict with US GAAP and therefore requested that the staff liaise with the FASB to obtain convergence.

The Board also concluded that mandatorily convertible securities should be included in the basic EPS calculation, as their issuance depends only on the passage of time, which is a certainty. The Board discussed the presentation of EPS in parent only financial statements and agreed to allow such presentation if it is useful to the users.

Thursday 20 February 2003

Improvements to Existing International Accounting Standards

Effective Date

The Board agreed that the effective date for the Improvement standards would be 1 January 2005 with earlier application encouraged. The Board noted that publication of the standards will commence in the middle of 2003.

IAS 8

The staff stated that various commentators had requested guidance on the application of materiality. The Board agreed and asked the staff to draft proposed paragraphs. Some Board members expressed concern whether these paragraphs should be in IAS 1 or IAS 8. The staff will consider this and make a proposal to the Board.

The staff proposed a redrafting of the hierarchy in IAS 8 to address concerns around going to other standard setters' pronouncements for further detailed guidance on issues addressed directly in an IASB standard and issues for which an IFRS answer can be found by analogy to other IASB standards or the Framework. The Board stated its view that other standard setters' pronouncements should be used only when an answer cannot be found either directly in or by analogy to an IASB standard or the Framework. The Board asked its staff to redraft the wording to clarify this matter and to consider similar guidance issued by the Canadian standard setter.

Convergence Topics - Employee Pension Benefits

The staff proposed that the scope of the project be expanded to consider amongst other matters:

• The definition of plan assets.
• Consolidation of plans.
• Various measurement issues (in particular the use of fair value for liabilities).
• Final vs Current salaries.

The Board noted that although these issues are, they cannot be resolved in the short term. Consequently the Board did not agree to expand the scope.

Regarding terminology, the Board agreed to used "plan liabilities" instead of obligations and "defined benefit asset or liability" to refer to the amount presented on the entity's balance sheet.

The Board discussed the criteria to be used to limit the amount recognised as an asset by means of the asset ceiling. It was proposed that the following should apply:

• value the entity's rights to refunds and reductions in future contributions. If this is less than the surplus, then
• 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 these two items together are less than the surplus, then
• 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.

The Board noted that a decision summary for the project as of 28 January 2003 date is posted Here (PDF 41k).

Reporting Performance

At prior meetings, the Board has tentatively decided on a performance statement along the following lines:

At today's meeting, the staff proposed, based on discussions with the UK Accounting Standards Board, four alternative models for incorporating a notion of operating performance:

A. Column 2 to include some remeasurements so as to result in a total of operating profit with other remeasurements in column 3.

B. Column 2 and 3 unchanged, but a total of operating profit may be inserted into the Business section of column 2. Some remeasurements may be included within this subtotal and some excluded at the entity's discretion.

C. As for B but with a stipulation as to which items could be excluded from the operating profit subtotal.

D. As for B or C but with certain items such as foreign currency gains and losses arising on translation of net investments included below both of the business and financing categories.

The Board voted for option C (13-1). They Did not however specify what items should be excluded but would consider that at a later stage. The Board also agreed that limited field-testing could commence.

Three options were considered for performance reporting by financial institutions. These were:

1. No differences from other entities.

2. The same categories as other entities but that they could be rearranged to place financing on top.

3. Different classifications from other entities in particular to distinguish operating financing from regulatory capital financing.

The Board proposed that the financing section could be split between operating and non-operating areas provided it was presented together within the financing section. It was further proposed that any entity can choose whichever of business or financing it wished to present first. It was agreed that the staff would draft these proposals for further consideration by the Board.

Liabilities, Equity, and Revenue Recognition

The staff presented examples to illustrate the difference between the "liability extinguishment view" and the "broad performance view" of revenue recognition. In the former, revenues arise from the extinguishment of obligations to customers. In the latter, revenues arise from the entity's extinguishment of obligations by performing those obligations itself. The examples considered were:

Retailer contracts with customers to provide an extended warranty service. Retailer can engage a third-party administrator to perform the warranty servicing by paying either:

(a) $300 if the administrator legally assumes the obligations, or

(b) $290 if the administrator does not legally assume the obligations (the $10 difference between the $300 in Case (a) and $290 in Case (b) reflects the performance guarantee that Retailer bears in this instance).

In Case (a), Retailer would not recognise any revenue relating to the performance of warranty servicing under either the liability extinguishment view or the broad performance view. However, in Case (b), Retailer would recognise revenue of $300 under the liability extinguishment view (together with an expense of $290 for the administrator's fee). Under the broad performance view, it would recognise revenue of only $10 with respect to the performance guarantee that it provides.

The Board noted that some people believe there are substantive difference between these two examples and consequently would expect different results.

The Board in general appeared to support the broad performance view but noted that they have a preference for more rather than less gross presentation of revenue.

Business Combinations Phase II

The staff asked the board to consider whether, as a consequence of the decision to report net profit before eliminating minority share of profit, there should be a change in the numerator in EPS. The Board did not support the proposal.

The Board agreed to consider whether adjustments to equity for changes in a parent's controlling interest should impact EPS calculations.

The Board agreed that the exposure draft for Phase 2 will explicitly state that control can pass to an entity by means other than the acquisition of shares and should be accounted for in the same manner as when control is acquired through the acquisition of shares.

The Board agreed similarly that the same result would arise if control was lost when no shares were sold.

Friday 21 February 2003

Reporting Performance

The staff reviewed its understanding of the format of the income statement based on the Board's discussion on Thursday. The classification is both by function and by nature. The Board asked the staff to review the terminology used, particularly how the two principal columns are labelled. This format will be discussed at future Board meetings.

Financial Institutions

The Board discussed whether financial institutions should use a different format for the income statement. The Board decided to reorder the items by moving financial activities to the top. This format will be discussed at future Board meetings.

First-Time Application of IFRS – Hedge Accounting

The Board discussed how first-time adopters should treat hedge accounting in their opening IFRS balance sheet. The Board concluded by supporting prospective application of hedge accounting under IAS 39 to hedges designated under previous GAAP.

Insurance Contracts Phase I

Disclosure

The Board discussed on the three proposed high level principles:

Principle 1

An insurer shall disclose information that identifies and explains the insurance-contract-related amounts reported in the balance sheet, income statement and cash flow statement.

Principle 2

An insurer shall disclose information that helps users understand the estimated amount, timing and uncertainty of future cash flows from insurance contracts

Principle 3

An insurer shall disclose the fair value of its insurance assets and insurance liabilities (obligations and rights arising under insurance contracts). However, disclosure would not be required for dates before 31 December 2005. Thus, an insurer adopting IFRSs for calendar year 2005 would disclose the fair value of its insurance assets and insurance liabilities at 31 December 2005, but would not need to disclose their fair values at 31 December 2004.

The staff explained that the philosophy of Principles 1 and 2 is to require disclosure of assumptions underlying measurements of insurance contracts. Board members noted that there is no proposed disclosure relating to the cash-flow statement; that the term 'significant' should be explained; that the level of detail and aggregation should be specified; and that claims should be disclosed as well.

Concerning the principle 3, the Board discussed:

• fair value measurement
• effective date

Effective date. The staff will develop a revised proposal for consideration by the Board.

Derecognition

The Board agreed with the following staff recommendations:

(a) the derecognition requirements for an insurer's insurance liabilities (its obligations under insurance contracts) should be the same as those for financial liabilities as set out in the June 2002 Exposure Draft of improvements to IAS 39: "An entity should remove a financial liability (or a portion of a financial liability) from its balance sheet when, and only when, it is extinguished - that is, when the obligation specified in the contract is discharged or cancelled, or expires."

(b) Phase I should address derecognition of an insurer's insurance assets – the rights that it holds under insurance contracts.

Business Combinations

The Board discussed the following:

(a) Should Phase I exclude insurance liabilities and insurance assets (and related reinsurance) from the long-standing general requirement for an acquirer to fair value assets and liabilities assumed in a business combination? Should Phase I include guidance on how to determine those fair values? Should Phase I permit, prohibit, or require an expanded presentation that splits the fair value of acquired insurance contracts into two components:

— (i) a liability measured in accordance with the insurer's accounting policies for insurance contracts that it originated; and

— (ii) an intangible asset, representing the fair value of the rights and obligations associated with the closed book of insurance contracts assumed, to the extent that the liability does not already reflect that fair value?

The Board decided to permit, but not require, an expanded presentation that splits the fair value of acquired insurance contracts into the two components.

(b) Should Phase I address accounting by the transferee for portfolio transfers (the acquisition of a block of existing contracts)? The Board concluded that this subject should not be addressed in Phase I.

(c) The scope of IAS 38, Intangible Assets, excludes intangible assets arising in insurance enterprises from contracts with policyholders. Should this be modified in Phase 1?

(d) The Board agreed tentatively in October 2002 that Phase I should include a loss recognition test (based on IAS 37, Provisions, Contingent Liabilities and Contingent Assets) that would apply if an insurer's existing accounting policies do not require the immediate recognition of a loss when current estimates of future cash flows indicate the existence of a loss. Should this test also cover intangible assets arising from the rights and obligations associated with the closed book of insurance contracts assumed in a business combination or portfolio transfer? If so, should these intangible assets be excluded from the scope of IAS 36 Impairment of Assets? The Board decided that the other Standards should not be amended, but instead these different points should addressed in the Phase I insurance contracts Standard.

This subject relates to the proposed amendments to IAS 22 (ED3) and therefore further amendments will be needed.

Scope and Related Issues

The Board discussed two aspects of the draft guidance: