22-24 July 2003, London

Tuesday 22 July 2003

Convergence Project

IAS 12, Income Taxes

The Board considered whether a deferred tax liability should be rrcognised on undistributed earnings of subsidiaries.

The Board agreed (vote 12-2) that an entity should provide deferred taxes for future income taxes payable on the undistributed earnings of subsidiaries. The Board agreed to view a subsidiary as an investment and not as consolidated assets and liabilities that should be treated at a group level. Moreover, it was specified that the deferred tax is neither linked to the control notion nor to the distribution of dividends. Therefore a liability exist and should be raised based on the difference between the carrying value of the subsidiary and the expected recoverable amount of the investment, this include retained earnings.

The Board also discussed three related issues:

1. Accounting for withholding taxes for distributions within the consolidated group. The staff clarified "withholding taxes" for distribution within a consolidated group would encompass "additional taxes that a subsidiary will have to pay on a distribution to the parent company".

2. The Board's decision in April that an entity shall measure deferred tax assets and liabilities at the rate applicable to undistributed profits. The Board agreed that a deferred tax should be recognised, and it should be measured by use of the rate at which the distribution will be taxed.

3. Investments in associates, branches, and interests in joint ventures. The Board agreed to eliminate the exemptions in IAS 12.39.

The staff will address disclosure, tax equity, and foreign subsidiaries issues at the next meeting.

IAS 19, Employee Benefits

The Board agreed to add the following additional disclosure requirements related to defined benefit plans:

• Five-year history of the surplus/deficit and (asset and liability amounts should be presented separately).
• Five-year history of experience adjustments.

The Board believes the disclosure of the surplus/deficit (gross presentation) over the last five years will give information about the volatility of the plan and of any emerging trends, for example, persistent over- or under-funding. Experience adjustments are the actuarial gains and losses that arise because of differences between the actuarial assumptions made at the beginning of the period and actual experience during the period. The Board believes a five-year history of experience adjustments gives information about the reliability of the amounts recognised based on those assumptions (ie the service cost and interest cost).

Financial Instruments - issues other than hedge accounting

Purchased loans

The Board agreed IAS 39 should permit purchased loans to be classified as originated loans if they met the criteria for originated loans. However, if they are purchased for trading, then they must be included in financial assets held for trading.

Transaction costs

Transaction costs can include both external and internal costs, as long as they are direct costs of acquiring financial assets (rather than allocated costs). Also, transaction costs should not be included in the initial measurement of financial assets held for trading.

Loan commitments

The Board agreed that loan commitments at rates other than market rates of interest should be treated as financial guarantees. Therefore, they are accounted for under IAS 39 at initial recognition and under IAS 37 subsequently. Loan commitments at market are excluded from IAS 39.

Financial guarantees

The Board agreed that these should initially be measured at fair value. Subsequent measurement should be the higher of the initial measurement and the best estimate as defined in IAS 37. The Board noted that IAS 37 only applies here for measurement purposes and not for recognition.

Hedging interest rate risk on held-to-maturity financial assets

The Board agreed to prohibit the interest rate risk on held-to-maturity financial assets to be a hedged item for hedge accounting purposes.

Changes in credit risk in the fair value measurement of financial liabilities

The Board reaffirmed that changes in fair value should be recognised in the income statement and agreed to add disclosure requirements on the credit risk. The staff will present examples to the Board for discussion at the September meeting.

Effective interest rate calculations

The Board considered (a) whether to clarify the definition of effective interest rate to be consistent with IAS 18, Revenue, on fee recognition; (b) what period should be used when calculating the effective interest rate for financial instruments with a call, put, prepayment, or term-extension option; and (c) the accounting for subsequent changes in estimates used in calculating the effective interest rate for groups of financial assets.

The Board did not reach decisions on items (a) and (b) at this meeting. The Board decided that the cumulative catch-up method should be used for changes in estimates.

Initial measurement of financial instruments

The Board agreed to retain the provisions in the exposure draft and not to clarify further the principles of initial measurement of financial instruments.

Prospective effectiveness test

The Board agreed (vote 9-4) to modify paragraph 146 of IAS 39 by introducing the words "highly effective" in place of "almost fully offset". The 80%-125% hedge effectiveness guideline – which currently applies in assessing retrospectively whether a hedge has been highly effective – would be retained. As a result, the range of 80%-125% could become the guideline for prospective hedging designation as well as for retrospective effectiveness testing, which would converge with the US practice.

Designation of a derivative

The Board agreed that a derivative should not be designated as a hedging instrument for only a portion of the time period during which the derivative remains outstanding.

Application and implementation guidance

The Board agreed that the existing IAS 39 implementation guidance should be split in the body of the Standard and in mandatory appendices. The staff will clarify the split in the pre-ballot draft paper.

IAS 32

The Board tentatively agreed (vote 11-3) with the proposed the following re-drafting of IAS 32.77B(c):

An entity shall disclose ... whether its financial statements contain fair values which are determined in full or in part using a valuation technique based on assumptions that are not supported by observable market prices. If changing any such assumption to a reasonable possible alternative would result in a significantly different fair value, the entity shall make a statement of this fact and disclose the effect on the fair value of a range of reasonably possible alternative assumptions. For this purpose, significant shall be judged with respect to profit or loss and total assets or total liabilities.

However, the Board some Board members expressed concern that this amendment may still not be operational and should be considered further.

Share-Based Payment

The Board decided not to change the proposal in ED 2 that employee options should be measured at their fair value (vote 12-2).

The staff reported to the Board about the meeting of valuation experts held by the FASB on the 8th of July. The experts reported that a more sophisticated model than the Black-Scholes model may be more appropriate to calculate the expense arising from share based payments. The shortcoming of the Black-Scholes is that it is a static model, as the inputs have to be determined at the inception and cannot be updated thereafter.

Measurement of transactions with parties other than employees

The Board confirmed its earlier decisions on the following valuation principles in ED 2 and agreed to develop certain implementation guidance as noted:

• to use option pricing models in the absence of market prices;
• not to recommend a particular model but provide possible guidance;
• to retain a list of factors to be taken into consideration;
• to develop implementation guidance on measuring factors;
• to require that non-transferability/early exercise options be taken into account (and other employee behaviours are to be considered);
• to develop guidance on measuring reload factors in initial measurement.

The Board also agreed that the measurement date for non-employee options should be the date on which the goods or service are received.

Employee options

The Board agreed (vote 12-2)O to retain the proposal to measure employee options at fair value of financial instrument granted. The Board considered but decided against allowing an entity to use the value of services rendered as the measure of expense.

Cash-settled transactions

ED2 proposed fair valuation at each reporting date until the settlement, with changes in the liability recognised in net profit or loss. The majority of the comment letters supported the proposal, and the Board agreed not to change it.

Repricings and modifications

The Board agreed (vote 13-1) to adopt the SFAS 123 approach in determining incremental value given and recognising additional expense after vesting date. Replacements should be accounted for similarly to repricings.

Cancellations

The Board agreed to adopt the SFAS 123 approach of recognising the remaining amount as expense immediately (vote 12-2). Any cash payments should be treated as reduction of equity, with any amount in excess of the original equity credit recognised as expense (vote 14-0).

Accounting for tax effects

ED2 proposed that all tax effects should be treated in the income statement. Most comment letters agreed with ED2, though this treatment is not consistent with the treatment under FASB Statements 109 and 123. The Board agreed (9-3) to recognise all tax effects in the income statement.

Wednesday 23 July 2003

Amendments to IAS 32 and IAS 39

Hedge accounting for a portfolio hedge of interest rate risk

The Board agreed (vote 10-4) that the hedge instrument should be designated as hedging a percentage of the net exposure. Therefore, ineffectiveness may occur when the fair value of the net exposure increases (under hedged) or decreases (over hedged).

Core deposits

The Board concluded that core deposit liabilities may be included in the time bucket management expects the deposits to repay if that time bucket is in a net asset position. The Board decided (vote 11-3) that demand time deposits can be subjected to a fair value hedge only until the earliest date on which the customer can demand repayment. The reasons behind these conclusions will be added in the basis of conclusion.

Measuring effectiveness

The Board discussed methods to assess hedge effectiveness and decided on the following. The initial hedge ratio is applied to the revised estimate of the amount in the time period. For example, assume an entity had estimated that it had 100 of assets in a time period and had decided to hedge an amount of 20. It then re-estimates the assets in this time period as being 120. Under this method, the initial hedge ratio is 20% (20/100 x 100). This percentage is applied to the revised estimate of the assets in the time period of 120, to give a revised hedged item of 24. Ineffectiveness arises on the change in fair value of this revised hedged item (24) that is attributable to the hedged risk, and the change in fair value of the hedging derivative (that would likely have a notional principal of 20).

Effective date

The Board agreed the effective date should be for financial years January 2005 with beginning or after 1 January 2005 and early adoption be permitted. The effects of this Standard should be applied prospectively.

Comment period

The staff proposed a 60 days comment period in order to have comment in by November 2003. The Board realised that it was a short period but said it was the only one possible to meet the Board's March 2004 deadline for issuance of the final IFRS. The Board decided it will put the ED on its website as soon as it is ready to achieve a comment period closer to 90 days.

Transition - IAS 39

First time adopters:

IFRS 1 prohibits retrospective application and requires prospective treatment from January 2001 for derecognition. The Board decided to change the date so that the derecognition provision shall be applied from 1 January 2004, prospectively. Retrospectively application is permitted.

First time adopters (2005 only):

The Board decided that the comparative figures are not required to be restated from local Gaap for IAS 39 only (other than derecognition requirements). Therefore, the Balance sheet and the income statement reconciliations required under IFRS 1 will not include financial instruments.

Entities already under IFRS

The Board agreed that entities already under IFRS should apply the provisions for derecognition prospectively similar to FTA and retrospective for the other requirements.

Transition - IAS 32

For all entities, the effective date will be for financial years beginning on or after January 2005 with retrospectively application required (with prohibition of prospective application).

Reporting Comprehensive Income (Performance Reporting)

The Board discussed on the following items:

• (a) financial and financing (only industries)
• (b) tax
• (c) earnings and eps
• (d) function vs nature
• (e) descriptors
• (f) presentation on the face of the statement

The Board agreed to remove the requirement for a business profit subtotal of 300 (vote 12-1) and allow a choice of the following two presentations (vote 10-3):

(b) The Board re-affirmed (vote 12-0) that the tax expenses should not be allocated and should be presented one line item

(c) The Board re-affirmed that no single figure for measuring performance or comprehensive income (a so-called 'magic number') would be defined. The Board agreed (vote 9-4) that if a number is disclosed, it would have to be reconciled with the appropriate amount on the performance statement. It was determined that only items of the financial statements could be used to calculate the numerator.

(d) The Board agreed that the choice of presenting by nature or function should be permitted and that a mix presentation should not be prohibited.

(e) The column "profit before remeasurements" will be changed to "other than remeasurements".

(f) The Board agreed (vote 7-6) that the comparative columns on the face of the income statement would be the total column only. However, comparative figures are required for all three columns in the footnotes as follows:

Financial Risk Disclosures and Other Amendments to Financial Instruments Disclosure

The Board was presented with:

• A draft IFRS: Financial Risk Disclosures.
• A draft Basis for Conclusions for the draft IFRS.
• Draft Implementation Guidance for the draft IFRS.
• A draft Amendment to IAS 1 that contains a capital disclosure requirement.
• Draft Amendments to IAS 32 that includes additional balance sheet and income statement disclosure requirements.
• A draft memo summarising suggested changes to IAS 30 as part of IAS 32.

IFRS on financial risk disclosures

The Board agreed that a preparer could not apply the draft interpretation without reference to the draft implementation guidance and basis for conclusions. Therefore, the Board requested sections of these to be included in the Standard.

The Board agreed that the scope should be the same than IAS 32.

The Board agreed with the following decisions FAAC made and to include them in the Standard:

(1) There should be a disclosure requirement for information about 'other' risks (eg residual value risk) that underlie financial instruments. By including this requirement the FAAC acknowledged that there are instances when an entity is exposed to other risks associated with financial instruments that warrant disclosure.

(2) For credit risk - To include a requirement for disclosing information about collateral taken. Ie this information is useful because it provides information about the frequency of such activities and the entity's ability to obtain and dispose of the collateral.

(3) For interest rate risk - To add 'Interest Rate Risk' as a risk disclosure category and to include in this disclosure requirement both (1) cash flow interest rate risk and (2) fair value interest rate risk. The FAAC concluded, that unlike IAS 32, it would not distinguish between the two because this distinction is an accounting convention. In practice, for the purpose of financial risk management no distinction is made.

(4) For market risk - There should be a minimum requirement to disclose further information, such as significant terms and conditions, when the sensitivity analysis disclosure is unrepresentative of the risk inherent in a financial instrument. An example may be where an instrument contains significant optionality that is not revealed by the sensitivity analysis.

(5) For market risk - There should be a requirement to disclose asset quality as it relates to market risk. For example, the size of an entity's holding of a specific equity security impacts the quality of the financial asset (ie the value of the entity's equity holdings, its ability to dispose of them quickly).

Draft implementation guidance

The Board agreed with the recommendation not to add supplementary implementation guidance.

Draft amendment to IAS 1 that incorporates a capital disclosure requirement

The Board asked the Staff to find another term than "industry-wide capital requirements"

The Board decided not to add 'shall be provided to the extent it is not prohibited by law' to the capital disclosure requirement.

The Board agreed to add an illustrative example of capital disclosure requirements.

Draft amendments to IAS 32 that includes additional balance sheet and income statement disclosure requirements

The Board agreed with the following balance sheet and income statement disclosure principle: "An entity shall disclose information that enables users of its financial statements to evaluate the significance of financial instruments to an entity's financial position and performance."

Timetable

The Board agreed on the proposed timetable.

Standards for Small and Medium-Sized Entities

The Board agreed with the following 4 step approach:

Step 1: Extract from all existing IFRS and Interpretations the basic principles in those standards. This is likely to include many of the principles in the 'black letter' paragraphs of those standards, plus key elements of the Framework, plus some principles in IASB and IFRIC EDs that have not yet been finalised.

Step 2: Reorganise these topically (perhaps financial statement order) if it is concluded that this makes the presentation of the principles more user friendly.

Step 3: Review these for principles or guidance that had been omitted in the original Step 1 extraction but that, on review, are deemed to be essential to operationalise the standards for SMEs and add these to the principles extracted in Step 1.

Step 4: Review the results of Step 3 with a view to identifying helpful simplifications for SMEs. Present those potential simplifications to the Advisory Group and the Board for deliberation.

The key issues to be addressed by the Board at future meetings:

• Specific definition of entities included in the scope of the project.
• Whether the special guidance for SMEs should be promulgated (i) as separate sections in or blanket exemptions from individual IFRS or (ii) in a separate volume of standards.
• Which specific differences and simplifications.
• How to describe (label) the body of standards in the basis of presentation note and, presumably, in the auditor's report.

The target is to have at least some of the simplifications and/or guidance issued for public comment by June 2004 and approved by the Board by December 2004.

Thursday 24 July 2003

Improvements Project

The Board discussed the following issues on four standards:

IAS 1

Effects of post-balance sheet events on the classification of liabilities

The staff asked the Board to confirm or reverse a decision made during the November 2002 meeting as to whether an entity should classify as non-current at the balance sheet date an obligation that has become payable on demand because of a breach of a loan covenant when the lender has granted at the balance sheet date a period of grace to rectify the breach after the balance sheet date. In particular when the period of grace does not extend beyond twelve months after the balance sheet date and the entity has not cured the breach before the financial statements are authorised for issue.

The Board decided that an item should be classified as current if at balance sheet date, there does not exist an agreement to extend payment beyond 12 months. The Board clarified that post-balance sheet agreement would not be an adjusting event.

Guidance on an entity's ability to consummate a refinancing agreement

The IASB decided that no further guidance should be included on an entity's ability to consummate a refinancing.

IAS 8

Terminology change to replace 'retrospective restatement' with 'retrospective application' for changes in accounting policies

The Board agreed that the staff should work with the FASB staff to agree on consistent vocabulary for: 'retroactive vs retrospective', 'restatement vs application', and 'prospective'. The Board did not express preferences.

Additional guidance on the meaning of 'impracticable'

The Board agreed to give additional guidance on the meaning of 'impractical' and asked the staff to work with the FASB in order to use the same vocabulary. The Board does not want to create a new category, even if the FASB gave additional guidance on what is meant by 'limited retrospective'. The Board agreed to clarify that an entity should go retrospectively as far back as possible.

Additional requirement for a limited retrospective application when full retrospective application is impracticable

The Board confirmed that when the restatement cannot be reasonably allocated to prior periods, the amount of the change should go through the retained earnings of the current period.

Additional disclosures for changes in accounting policies

The Board agreed to add to disclosure requirements the following:

• The nature and justifications of the changes.
• The effect of the change on amounts in each period.

The Board agreed to add guidance to the final standard.

IAS 17/IAS 40

The staff presented the interactions of IAS 17 and IAS 40 for the purpose of lease classification and asked the Board if additional guidance should be added on how to split the land and the building elements in a lease. Additionally, the Board considered the treatment of the liability side of a finance lease.

The Board tentatively decided that the lease liability should be accounted for under IAS 39. Additionally, the Board tentatively decided that contingent rent should be considered an embedded derivative that is not closely related to the host contract. This would presumably change the requirements in IAS 39.25(g) and paragraph A7(f) of the ED. The Board will address this issue at a future meeting.

IAS 16

Initial measurement - asset dismantlement, removal and restoration costs

The staff asked the Board whether, if an obligation is incurred for dismantlement, removal, and restoration costs as a consequence of producing inventory, those costs should be classified as conversion costs under IAS 2, Inventories, or as property, plant, and equipment costs under IAS 16. The Board agreed that example 3 of Appendix C to IAS 37 is on point and further guidance is not needed.

Initial measurement - asset exchange transactions

The Board agreed that if making a non-monetary contribution to a jointly controlled entity, a venturer should consider 'commercial substance' in determining whether to recognise the portion of its gain or loss attributable to the equity interests of the other venturers in the asset.

Recognition - subsequent expenditure

The Board agreed that the general recognition principle should apply to subsequent expenditures. The current derecognition principle shall apply to assets that are replaced.

Recognition - costs of inspection component replacements

The Board decided costs of inspection should be capitalised if they meet the recognition principle in IAS 16.

Subsequent measurement - depreciation period

The staff asked the Board whether an entity should begin depreciating an asset when the asset is available for use or when it is put into use. The Board decided an asset should be subject to depreciation when it is available for use.

Transition

The Board decided that an entity should not apply hindsight to its initial measurement of a previous asset exchange transaction in determining whether it lacked commercial substance.

Business Combinations Phase I Questions in ED 3

Question 8 - Goodwill

The Board confirmed its position in ED3 that goodwill acquired in a business combination is an asset and should be recognised as such (10:1). The Board reaffirmed that the goodwill should not be amortised after initial recognition. Instead, it should be accounted for at cost less accumulated impairment losses.

Question 6 - Reversals of impairment losses for goodwill The Staff noted that the comment letters equally reported two diverged view. The Board agreed (11:0) that reversals of impairment losses recognised for goodwill should be prohibited.

Question 3 - Measuring value in use

Measurement aspect

Most comment letters agreed with the proposal under ED 3. Therefore, the Board agreed not to modify Paragraph 25A of the Exposure Draft of Proposed Amendments to IAS 36 and to retain the following elements to calculate the asset's value in use:

• an estimate of the future cash flows the entity expects to derive from the asset.
• expectations about possible variations in the amount and/or timing of those future cash flows.
• the time value of money, represented by the current market risk-free rate of interest.
• the price for bearing the uncertainty inherent in the asset.
• other factors, such as illiquidity, that market participants would reflect in pricing the future cash flows the entity expects to derive from the asset.

Regarding the Appendix B (guidance), the Board agreed to add additional guidance to clarify the requirements for the determination of cash flows. The staff will come back with a draft paper at next meeting.

Pre-tax cash flow and pre-tax rate

Many comment letters noted that this requirement leads to system issues and the Board asked the staff to come back with analysis if post-tax is used.

Question 5 - Determining whether goodwill is impaired

The Board confirmed its position that the recoverable amount of a CGU to which goodwill has been allocated should be measured as the higher of the unit's value in use and net selling price.

Many comment letters reported the difficulty and cost of the two step approach proposed in ED3 method. The Board agreed (vote 10-1) to eliminate the second step. Therefore, goodwill shall be included in the cash generating unit it belongs to and impairment measurement as the difference between the CGU recoverable amount and CGU carrying amount. That CGU shall be reviewed for impairment annually or when triggered if sooner.

Question 1 - Frequency of impairment tests

The Board decided that each CGU to which goodwill belongs shall be tested for impairment annually. The test should be done at least once a year at the same period.

Question 4 - Allocating goodwill to cash-generating units

The Board concluded that the final Standard should clarify that 'the lowest level at which management monitors returns on its investment' should be interpreted with judgement. In no case should an impairment be reversed in consolidation based on a higher assessment done at a consolidated basis. The Board also confirmed that the CGU should not be higher than the primary or secondary segments.

Measurement Objectives

The purpose of the project is to identify, consider, and make recommendations with respect to issues related to the selection of an appropriate basis (or set of bases) for measuring assets and liabilities. The staff did not ask the Board to vote on the proposed issues but for comments and guidance.

Final part of the preliminary conceptual evaluation (dealing with measurement reliability)

The staff proposes that, when more than one alternative measurement basis achieves an acceptable level of reliability, the most relevant of those bases should be adopted. The Board agreed (informal vote) on this principle, however one Board member noted that the notion of relevant will have to be defined, and include a hierarchy demonstrating the notion of relevant could be used.

The first part of the comparative analysis of alternative measurement bases (dealing with fair value)

The paper distinguishes estimation uncertainty from risk-related volatility, concluding that concerns about the volatility of reported amounts under a particular measurement basis are concerns about the relevance (decision-usefulness) of that measurement basis rather than its reliability. The Board strongly supported that the notion that volatility is not a measurement principle.

Concerning the limitations on measurement reliability, the issues are:

• whether estimation uncertainty and economic indeterminacy are the sources of those limitations, or whether there are other possible sources to consider.
• whether the discussion in the paper provides an appropriate foundation for analysing the alternative measurement bases.

• the nature and extent of measurement uncertainty under each basis, and
• the relevance and reliability of supporting information on measurement uncertainty that can be derived under each basis

A point outline of the comparative analysis of the other alternative measurement bases

The Board discussed the following concerns related to the fair value hierarchy:

• fair value determinations are subject to potentially large areas of indeterminacy in some common situations on initial recognition of assets and liabilities (such as unique assets, and block discounts and premiums on shares).
• it is questionable whether a measurement that must rely to any significant extent on entity specific assumptions can rightfully qualify to be described as 'fair value' when what the market may assume is unknowable.
• recourse must be made to some compromising conventions or substitution of other measurement bases for fair value in order to achieve single amount measurements in situations involving significant indeterminacy.

Revenue Recognition

The Board agreed that the conceptual model should apply only to those contracts that are enforceable, and that the threat of legal action is not the key element.

The unit of account issue concerns applying the definitions of an asset and a liability in the course of recognition (assuming that all of the recognition criteria have been met). More specifically, the issue concerns what is the asset or liability that is to be recognised for wholly or partially executory contracts.

Some believe that the unit of account for all such assets and liabilities should be the contract as a whole. Others believe that the unit of account should be the assets and liabilities arising from the rights and obligations in the contract. Still others believe that the unit of account for some pre-performance assets and liabilities should be the contact as a whole, and for others the unit of account should be the assets and liabilities arising from the rights and obligations in the contract.

The Board agreed the unit of account should be the assets and liabilities arising from rights and obligations in the contract.

Regarding the date of recognition, the Board agreed that the delivery date should be retained and not the assignment date. The Board agreed that future performance should not be assumed. However, the Board was undecided whether revenue should be recognised based on the extinguishment of the liability or performance under the contract (broad performance).

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