IASB Meeting 18 May 2004
IASB Chairman David Tweedie welcomed Jan Engstrom to his first Board meeting. Mr. Engstrom joined the Board effective 1 May 2004. His term expires 30 June 2009.
 Business Combinations Phase II – Application of the Acquisition Method
The IASB discussed various sweep issues related to the proposed exposure draft on the application of the purchase method. These issues were:
- Whether the IASB should reconsider the definition of a business included in IFRS 3 and also whether the IASB should include application guidance on identifying a business similar to the guidance that the FASB plans to provide.
- Whether the purchase method should be renamed the acquisition method.
- Whether IAS 12 should be amended to explicitly address deferred tax assets arising from excess tax goodwill.
- The recognition and measurement of operating leases acquired in a business combination.
Definition of a Business
The staff noted that the definitions of a business as set out in the IASB's and FASB's proposals were broadly consistent. The differences related to:
- Whether development stage entities were businesses.
- The inclusion of the word "generally" in the IASB's definition.
- The IASB presumption that where goodwill is present a business exists.
The staff noted that the purpose of the goodwill presumption was to cause a careful examination of the nature of a transaction in which goodwill arises.
The staff recommended that the definitions not be changed.
Some Board members noted that the recognition of the purchase of a basket of assets under the business combination criteria would give rise to different results than if individual asset recognition standards such as those in IAS 16 were applied, and that difference was what caused problems. The Board agreed to discuss with FASB examining initial recognition of assets outside a business combination. In the meantime the Board agreed to eliminate the word "generally", to provide further guidance in this area, and to provide further guidance for using the goodwill presumption.
Change of Name of the Project
The Board agreed to change the name of the project and the wording of IFRS 3 to refer to the Acquisition Method and not the Purchase Method.
Deferred Tax Assets Arising from Excess Tax Goodwill
The Board considered whether a deferred tax asset should be recognised if the amount of goodwill deductible for tax purposes is more than the amount recognised for financial reporting purposes. The Board agreed it should be recognised.
Recognition and Measurement of an Operating Lease Acquired in a Business Combination
Under IFRS 3 favourable and unfavourable operating lease contracts are recognised net.
The Board considered whether the reference to all assets and liabilities acquired in a business combination included the rights and obligations under an operating lease that is neither favourable nor unfavourable. The Board agreed that these were recognised but net at nil. It was noted that this was not to disturb the initial classification and could be affected by future decisions.
Financial Reporting by Small and Medium-sized Entities
The Board considered a previous tentative decision that where an SME standard provided an exemption or simplification from a related IFRS and the entity chooses not to apply the exemption or simplification but reverted to the related IFRS it should apply the related IFRS in its entirety. The Board confirmed its support for the tentative conclusion and for raising the issue specifically in the discussion paper. The discussion paper is expected to be published in June.
Revenue Recognition
The Board considered how the fair value of a reporting entity's performance obligations to its customers is determined. In particular the Board considered whether it should be:
- the amount that would have to be paid to a third party to legally assume responsibility for performing all of the reporting entity's remaining obligations, or
- the amount of consideration paid or to be paid to the reporting entity by the customer, or
- the amount of the reporting entity's costs to perform the activities.
The staff recommended using the amount that would be paid to a third party to assume the obligations and noted that tha FASB had recently affirmed that this measurement requirement be adopted and that it be measured as a business-to-business transaction.
The Board noted that the measurements should include any performance guarantees.
The following example was considered:
Retailer A is a consumer electronics company that sells television sets for $300 that it buys from the manufacturer for $250. Like other consumer electronics retailers, Retailer A also sells for $100 warranty contracts that extend 2 years beyond the manufacturer's 1-year product warranty. Those extended warranties are offered only on products that are sold in the same transaction, and the high profit margins on the warranties allow the products to be offered at highly competitive prices. The fees charged for those extended warranties are not refundable.
Like other consumer product sellers, Retailer A can either service the warranties itself or pay reliable third-party administrators to legally assume the warranty servicing obligations. History indicates that one in 10 sets will experience a failure during the extended warranty period, and that the average incremental cost to repair or replace a defective unit is approximately $140.
Reliable third-party administrators are willing to legally assume the warranty obligations for a price of $30 per contract.
Retailer A sells 10 television sets with extended warranties and collects the selling price in full. However, it has not yet decided whether to engage a third-party administrator to legally assume the liabilities for servicing the warranties or to service the warranties itself (Retailer A has a year between the date of sale and the beginning of the extended warranty period in which to decide).
In this case, Retailer A's performance obligations are unconditional obligations to stand ready to repair or replace any defective television sets that fail during the warranty period. The issue is whether the fair value of the performance obligations should be measured at $1,000 (10 warranties @ $100 customer consideration amount per warranty) or $300 (10 warranties @ $30 legal layoff amount per warranty).
Certain Board members expressed concern as to whether the amount a third party would pay to assume performance obligations can be reliably measured and verified.
The Board asked whether in a sale of goods the staff recommendation resulted in recognising the full gross profit on date of order as the obligation to fulfil the order would be measured at the amount charged by the manufacturer. The staff agreed that this was a correct application of the principle but noted that the longer the time between order and delivery, the greater the risk and this would have an impact on the measurement of the performance obligation.
The Board expressed considerable concerns particularly as to the practical application of the approach but expressed support for the concept and agreed to continue pursuing the approach.
Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets
The staff asked the Board to confirm the previous decisions made as set out in the following decision summary:
Definitions of Contingent Assets and Contingent Liabilities
The Board decided to amend the definition of a contingent asset to:
- A conditional right that arises from past events from which future economic benefits may flow based on the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
The Board decided to amend the definition of a contingent liability to:
- A conditional obligation that arises from past events that may require an outflow of resources embodying economic benefits based on the occurrence or non-occurrence of one or more uncertain future events not wholly within the control of the entity.
Recognition and Measurement of Contingent Assets and Contingent Liabilities
The Board observed that contingent assets (or liabilities) are sometimes accompanied by associated unconditional rights (or obligations) that satisfy the definition of an asset (or liability).
The Board observed that, for a contingent asset that is within the scope of IAS 37, any accompanying unconditional right would be a non-monetary asset without physical substance and, if it satisfied the 'identifiability' criterion in IAS 38 Intangible Assets, it would meet the definition of an intangible asset. The Board therefore decided that an unconditional right that accompanies a contingent asset (that is within the scope of IAS 37) should be accounted for in accordance with IAS 38.
The Board also observed that, for a contingent liability that is within the scope of IAS 37, any accompanying unconditional obligation would meet the definition of a provision (liability). The Board therefore decided that an unconditional obligation that accompanies a contingent liability (that is within the scope of IAS 37) should be accounted for under IAS 37.
The Board also decided that, in the absence of accompanying unconditional rights (or obligations), contingent assets (or liabilities) are themselves not assets (or liabilities) and are not considered for recognition separately as assets (or liabilities) in or outside of a business combination.
Constructive Obligation
The Board decided to amend the definition of a constructive obligation as follows:
- A constructive obligation is an obligation that derives from an entity's actions where:
- (a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to other parties that it will accept particular responsibilities; and
- (b) as a result, the entity has created a valid expectation in those parties that they can reasonably rely on it to discharge those responsibilities.
The Board decided to include additional explanatory material to assist entities in determining whether they have met the definition of a constructive obligation.
Recognition
The Board decided to add to the existing recognition guidance in IAS 37 to explain that the outflow of economic resources required to settle an obligation can be the provision of services. For example, an entity that has issued a product warranty has an unconditional obligation to provide a service for the duration of the warranty. The entity has therefore satisfied the probable outflow criterion (ie IAS 37.14(b)) regardless of the likelihood of the product developing a fault.
Measurement
The Board decided to make the following limited amendments to the existing measurement requirements of IAS 37 for clarification and to remove inconsistencies:
- (a) Provisions should be measured at the amount that an entity would rationally pay to settle the obligation at the balance sheet date or to transfer it to a third party at that time.
- (b) Using an expected value estimation technique would generally be consistent with the above principle, whilst measuring a provisions at a single point estimate of the most likely outcome would not.
- (c) Provisions should be remeasured at each reporting date using a current discount rate.
Application Guidance for Provisions for Restructuring Costs
The Board decided to withdraw the existing guidance on provisions for restructuring costs in IAS 37 (paragraphs 70-83) and to specify that that the existence and announcement of a restructuring plan does not by itself create an obligation. The Board decided that IAS 37 should explain that a cost associated with a restructuring is recognised as a provision on the same basis as if that cost arose independently of a restructuring. The Board also decided that it would specify the treatment of costs that are often incurred in a restructuring as follows:
- (a) The cost of employee termination benefits should be recognised in accordance with IAS 19 (see below).
- (b) The cost of terminating a contract before the end of its term should be recognised in accordance with the requirements for onerous contracts (see below).
- (c) The liability for costs that will continue to be incurred under a contract for its remaining term without economic benefit to the entity should be recognised in accordance with the requirements for onerous contracts (see below).
Application Guidance for Provisions for Onerous Contracts
The Board decided to specify that if a contract becomes onerous as a result of the entity's own actions, the resulting provision for that contract should not be recognised until that action has occurred. For example, in the case of an operating lease on a property that will become vacant as a result of a restructuring, the provision for the unavoidable lease commitment should be recognised when the entity vacates the property.
The Board decided to specify that if the onerous contract is an operating lease, the provision for the unavoidable lease commitment should be reduced by the sublease rentals that could reasonable be obtained for the property.
Termination Benefits
The Board decided that the principles underlying SFAS 146 should apply to all involuntary termination benefits, not just those that are within the scope of SFAS 146 (ie 'one-time' termination benefits). The Board therefore decided that:
- (a) The recognition of termination benefits depends on whether those benefits relate to employees' past service or are paid in exchange for employees' future services (ie are a 'stay bonus').
- (b) Termination benefits are regarded as paid in exchange for employees' future services if they:
- i. are not provided under the terms of an established benefit arrangement (ie employment contract, legislation, union agreement, prior business practice);
- ii. do not vest until the employment is terminated; and
- iii. are provided to employees who will be retained beyond the minimum retention period.
- (c) No liability for termination benefits is recognised until the entity has communicated its plan of termination to the affected employees.
More specifically:
- Termination benefits that relate to employees' past services are recognised when the entity has a present obligation to provide termination benefits. In the case of involuntary termination benefits, this is when the entity has a formal plan of termination that it has communicated to the affected employees. In the case of voluntary termination benefits, this is when the employees accept the entity's offer of voluntary redundancy.
- Termination benefits that are payable in exchange for employees' future services are recognised over that period of future service.
The Board confirmed the decisions subject to wording to clarify that if a provision is measured using an expected value estimation technique, it should be measured, and subsequently remeasured, taking into the risk adjusted measures a third party who assumed the obligation would take into account.
IFRIC Update
The IFRIC chairman updated the Board on recent IFRIC activities. It was noted that IFRIC 1, Changes in Existing Decommissioning, Restoration and Similar Liabilities, had been approved for issue.
IASB Meeting 19 May 2004
Financial Activities - Risk Disclosures
The Board discussed its project on financial risk disclosures and other amendments to financial instrument disclosures. The likely effect of this project will be to withdraw IAS 30 and move some (if not all) of the IAS 32 disclosures to a new standard.
The Board asked the staff to review the disclosures in IAS 32 and determine which disclosures should be retained. The Board intends to issue an Exposure Draft in the third quarter of 2004, with a final standard in 2005. Early adoption will be encouraged, and therefore this standard may be applied by 2005 first time adopters. If early adoption is not elected, applying the standard would be mandatory for financial periods beginning on or after 1 January 2007.
The IASB noted the FASB has a project that will likely require disclosures of similar items and that comments related to the differences in the IASB and FASB proposals should be requested in the ED.
The Board agreed that implementation guidance giving examples should be provided. However, IAS 1 will likely be amended to incorporate an example of a non-financial institution. In addition, the disclosure requirements in IFRS 4 will likely be changed to ensure that companies do not have to follow two different disclosure regimes.
Consolidation including SPEs – Fiduciaries and Power
The purpose of the discussion was to explore consolidation issues related to entities with a fiduciary responsibility. The discussions will guide the staff in developing the overall approach to the consolidations project. Therefore, further consideration will have to be given to the US guidance in FIN 46. There were no decisions taken.
Financial Instruments: Cash Flow Hedge Accounting of Forecast Intra-group Transactions
IGC 137-13 had allowed an intra-group monetary item that is not eliminated in consolidation, and therefore is reported as an asset or liability in the group balance sheet, to be a hedged item. IGC 137-14 had allowed a forecast intra-group transaction also to be a hedged item. In revising IAS 39 in December 2003, the Board incorporated the provisions of IGC 137-13 but not those of 137-14. This apparent prohibition against using a forecast intra-group transaction as a hedged item is causing concerns in practice, and constituents have questioned whether the Board intended such a prohibition, which is a difference with US GAAP.
The Board acknowledged this concern. It noted, however, that a general principle in IAS 39 is that entities can obtain hedge accounting only for external transactions. The rationale for allowing an intra-group monetary balance to be a hedged item does not apply to a forecast transaction because such a transaction is not recognised in the group accounts at all. The Board intends to clarify, however, that a group may use a forecast external transaction as the hedged item at the group level. This clarification will be exposed in the forthcoming exposure draft on guarantees and credit insurance due out in June 2004.
Update on IAS 39 Issues in Europe
The Board received an update on issues raised in Europe related to the application of IAS 39 and discussed the following two key issues:
- Presentation of changes in fair value related to cash flow hedges.
- Issues related to interest margin hedging.
The Board discussed a proposal for presentation of fair value changes related to cash flow hedges presented to it by a section of the European banking group. The Board generally rejected the proposal as it is not in accordance with IAS 1. The Board did note that they believed presentation of permanent and non-permanent equity would be allowed under IAS 1.
The Board noted that several issues related to hedging interest margins have been raised and that a group should be convened to address those issues as a matter of urgency. The members will be determined as soon as possible.
This summary is based on notes taken by observers at the IASB meeting and should not be regarded as an official or final summary.
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