19-20 March 2003, London

Wednesday, 19 March 2003

Amendments to IAS 32 and IAS 39, Financial Instruments

Board members made some general comments arising from the recent financial instrument roundtable discussions. The Board considered staff proposals on the issues for future discussion.

General Comments

The following comments were made by individual Board members and do not necessarily reflect the overall views of the Board:

• Most Board members believed that the roundtable discussions were worthwhile.
• In some cases, wording problems caused people to misunderstand the Board's intent in the Exposure Draft (ED) of proposed amendments to IAS 32 and IAS 39.
• Some participants in the roundtables clearly favoured a principle based standard while others wanted more detailed guidance. The Board must assess the appropriate balance.
• Some participants said they supported the principles in the ED but felt that some of the more detailed guidance in the ED was inconsistent with the principles. This was particularly evident in the proposals for dealing with hedge ineffectiveness.
• The Board should bear in mind that this is an improvements project and not a complete rewrite of the financial instruments standards.
• Some commentators objected to the proposals because they did not want to change from their current practices.

Derecognition

The staff proposed reverting to the existing IAS 39 principles with a clarification of the wording and incorporation of certain guidance developed by the former IAS 39 Implementation Guidance Committee (IGCs). Some Board members noted that the changes were proposed because of concerns around the operationality of the current approach and that it could result in different answers being reached by different people. They expressed the view that if the current approach is retained, the meaning of control needs to be clarified.

The Board agreed that the staff should examine keeping a version of the current approach, specifying the wording changes that are needed and identifying the IGCs to incorporate. The Board also asked the staff to consider the interaction of the pass-through arrangements and SIC 12, including the effect on a transfer of portions of assets.

Derivatives and Hedging

The Board still supports the principle that derivatives should be recorded at fair value. Board members felt, however, that the justification for this should be explained in the Basis for Conclusions. Further, the Board agreed that the staff should explore:

• Various hedging issues including proposals to be submitted by commentators, but within the framework of the principles in the ED.
• Inter-group hedging, provided that any profit or loss arising from these transactions is eliminated.
• The use of non-derivative instruments as hedging instruments.
• Eliminating cash flow hedges.

Impairment

The Board agreed that impairment should be based on an incurred-loss model. However, they asked the staff to re-examine the wording and detail of the requirements and to reconsider whether individually tested items should be included in portfolios for further impairment testing.

Liabilities and Equity

The Board asked the staff to consider the comments made and make recommendations based thereon at a future meeting.

Fair Value Option

The Board agreed that the staff should examine the effects of including an entity's own credit risk in fair value adjustments and the potential for 'cherry-picking' instruments on the first-time application of IFRS.

Other

The Board agreed that the staff would consider the following issues:

• Arbitrage transactions.
• Disclosure of assumptions in models to determine fair value.
• Large and small block valuations.
• Reversal of impairment on available for sale assets.
• Management intention in offsetting.

The Board agreed that the Board members should identify which requirements, if any, they believe would require re-exposure based on changes to the ED that have been tentatively agreed to. These should be communicated to the staff so that they are addressed first.

Insurance (within IAS 39)

The Board agreed that the staff should consider the following:

• The definition of insurance contracts.
• That an embedded derivative within an insurance contact should not be separated out where the insurance contract is remeasured such that the embedded derivative is at fair value even if the entire insurance contract is not at fair value.
• The effect of the mixed model between financial assets backing insurance liabilities at fair value and insurance liabilities at a valuation amount.
• The definition of transaction costs.

Insurance Contracts – Phase I

The staff noted that credit insurance would be discussed at the April Board meeting.

Reinsurance

In previous meetings the Board has agreed that:

• A reinsurance contract is simply an insurance contract issued by one insurer (the reinsurer) to indemnify another insurer (the cedant) against losses on one or more insurance contracts issued by the cedant.
• Offsetting reinsurance assets against the related direct insurance liabilities should be prohibited.
• An insurer should not change the measurement basis for its insurance liabilities when it buys reinsurance. An example of a change in measurement basis is a change from an undiscounted basis to a discounted basis.
• The scope of IAS 36, Impairment of Assets, does not, and should not, exclude a cedant's rights under a reinsurance contract. Furthermore, the proposed disclosures discussed include disclosures about credit risk.
• An insurer should unbundle deposit-like components from insurance contracts if the cash flows from the insurance component do not affect the cash flows from deposit-like component.

The staff proposed that reinsurance contracts should initially be measured at their their cost, which is the premium. They further proposed that no gain or loss should arise on inception as a result of removing or restating the insurance liability, which may be recorded on a different basis.

The Board agreed, in general, with this proposal but stated that the ED should also address the subsequent accounting for these items. There was some agreement that this should be a subsequent-event-driven approach, taking the time value of money into account. In addition, if the reinsurance premium is higher than the amount at which the liability is recorded, the liability should be reassessed. If it is determined that the liability is correctly measured, the reinsurance asset is probably impaired.

Unbundling

The Board agreed to include an example in the ED to illustrate the requirements of unbundling deposit-like components of insurance contracts.

Investment Contracts

The Board noted that these are financial instruments and would be dealt with under IAS 39. They tentatively agreed, however, that some guidance should be included on aspects of accounting for these contracts in an appendix to the Phase I ED.

The Board agreed to include wording in IAS 39 to provide guidance on the effects of cancellation and renewal options on effective interest rates. This would build on guidance already included in IAS 39.

The Board agreed that sufficient guidance on index-linked contracts is already included in IAS 39.

The Board agreed to expand the existing guidance in IAS 39 to include changes in liability values as a result of changes in estimates of surrender periods of investment contracts.

The Board agreed that the staff should draft, for the Board's review, guidance that might be added to IAS 18 on accounting for explicit and implicit front-end fees and fees for investment management services. Any guidance on implicit fees included in an item that is carried at fair value would be added to the IAS 39 section dealing with servicing rights.

Decision Summary

The Board discussed and noted a detailed summary of the decisions taken to date.

The Board discussed a proposal that the exemption from applying the proposed hierarchy in paragraphs 5 and 6 of IAS 8 in the Improvements ED should have a limited life after which it would automatically lapse. The Board agreed not to include this in the Phase I ED and Standard but, rather, to state in the introduction to the ED and Standard that it is the Board's intention that this exemption would have a limited life.

Thursday, 20 March 2003

First-Time Adoption of IFRS

The Board discussed certain issues that have arisen from drafting the pre-ballot draft for a final IFRS on first-time adoption of IFRSs. The Board expects a final IFRS in the second quarter of 2003. In addition to miscellaneous drafting issues, the Board discussed the delineation in the Exposure Draft of choices between those made on the basis of cost versus benefit and other choices freely provided in the standard. The Board has decided that all choices in the final IFRS shall be free choices, except for hedge accounting, derecognition and estimates.

Measurement Objectives

The Canadian Accounting Standards Board (CASB) has undertaken a research project on behalf of the IASB to analyse the various measurement objectives in financial accounting. The purpose of the project is to identify, consider, and make recommendations with respect to issues related to the selection of an appropriate measurement objective or set of objectives.

The project is intended to provide the IASB and its national standard-setting partners with a basis for initiating active projects to revise/expand their conceptual frameworks and improve their financial reporting standards by basing them on a coherent conceptual basis.

The IASB discussed the first sections of a discussion paper addressing the measurement on initial recognition of an asset and liability. No decisions were made. The CASB will present its final paper to the IASB in September 2003 for further discussion. Parts of this paper may be discussed in July 2003 with the IASB and with the various meetings of the national standard-setting partners.

Business Combinations - Phase II

At its November 2002 meeting, the IASB agreed that the full goodwill method should be used to recognise goodwill in the acquisition of less than 100 per cent controlling interest in the acquiree. Under the full goodwill method, all of the goodwill of the acquiree, including goodwill attributable to minority interests, is recognised. The Board discussed several issues that stem from the application of this method when the cost of the acquisition is to be determined by reference to the net assets acquired.

The Board concluded that expected synergies and other benefits from combining the business of the acquiree and the acquirer should enter into the measurement of the fair value of the acquiree-but only up to the level of synergies that would be expected in the market. The synergies should be therefore measured at fair value.

The Board concluded that goodwill should be allocated on a reasonable basis to the controlling and non-controlling interests when the combination is an exchange of equal values. The Board concluded that issues related to the measurement of fair value are not unique to this project and, therefore, it would be inappropriate to provide detailed guidance here. The Board did not discuss where or whether such guidance should be provided.

The Board concluded that if the fair value of the acquirer's interest in the acquiree is less than the consideration it paid for that interest (overpayment), that amount should be recorded as an expense. If the result is an underpayment, that amount is a gain. Several Board members expressed serious concern about this decision, as an amount historically attributed to goodwill could become an expense based on the ability of the entity to use internal synergies to improve the asset. For example, an entity may pay 100 more for an asset then anyone else because of its unique abilities to make more money from the asset than anyone else. However, since the market would not presume those synergies, the entity must write off the overpayment even if it thinks it could return 1,000 more.

Another effect of this decision is whether the distinction between measurement of equity securities issued in a business combination at the agreement date or acquisition date will be important. That is, based on the Board's decision, any change in the market price shares to be issued between the agreement date and the acquisition date would imply the valuation at the acquisition date is not longer valid. Therefore requiring measurement of the net assets acquired to determine the cost of acquisition. The Board also concluded that negative goodwill should never be in the financial statements.

The Board also discussed issues related to noncontrolling interests and the possibilities for gaming on disposition of a subsidiary that result from a prior IASB decision. Due to time constraints, the Board did not discuss this issue at length. However, the Board noted general agreement with the Staff's proposal (which was not described in any sufficient detail to the observers). Please refer to the minutes of the IASB for further details on this issue.

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