Wednesday 15 December 2004
 Financial Guarantees and Credit Insurance [Education Session]
This was a public education session and therefore no decisions were made.
The session was led by representatives of:
- The International Credit Insurance & Surety Association (ICISA); and
- The Association of Financial Guaranty Insurers (AFGI)
The background to this session was that the Board issued an Exposure Draft in July 2004 proposing amendment to IAS 39 and IFRS 4. The comment deadline was 8 October. ICISA and AFGI both submitted comment letters.
ICISA and AFGI addressed the Board and explained the following areas:
- (a) What their credit insurance / financial guaranty business is and how it operates.
- (b) Similarities and differences between credit insurance, financial guaranty business and products offered by banks.
- (c) Current accounting practice for these contracts and implication of applying IFRS 4.
- (d) Practical implications of applying the proposals in the ED if the Board confirms them.
ICISA addressed the Board first and highlighted the main differences between credit insurance and products offered by banks. The main points highlighted included:
- Banks give guarantees over known specified debtors whereas credit insurance covers wide portfolios of unspecified debtors;
- Credit insurance policies include maximum liability clauses, e.g. of a €9billion portfolio, the maximum liability of the credit insurers may be capped at €335million, whereas banks provide guarantees for the full amount.
The differences were discussed. A Board member suggested that the first was merely an 'operational' difference in the two products that would not necessarily result in different accounting treatments, whereas the second was a difference in contractual arrangements rather than a difference per se between banks and insurers. However, the Board reached no conclusion, as the purpose of this session was purely educational.
The AFGI then highlighted the impact of the proposed accounting treatment in the ED. AFGI recommended that financial guarantees should be included within the scope of IFRS 4 pending the outcome of phase II of the Insurance Project. The three key issues of concern to the AFGI going forward are:
- The treatment of deferred acquisition costs (and the potential for differences to US GAAP).
- The need for symmetry in treatment of financial guarantee contracts and contracts that are reinsurance of financial guarantee contracts.
- The treatment of salvage provisions within financial guarantee contracts.
The staff expects to ask the Board to discuss the comment letters in January.
IAS 39 – Cash Flow Hedge Accounting of Forecast Intra-group Transactions [Education Session]
This session was held as an educational session - no decisions were made.
The issues discussed relate to the fact that the old version of IAS 39 contained an exception to the principle that entities can obtain hedge accounting only for transactions that involve transferring risk to a party external to the entity. The old version of IAS 39 allowed the foreign currency risk in an intra-group monetary item to be designated as a hedged item in consolidated financial statements as long as the intra-group item results in an exposure to foreign exchange rate gains or losses that are not fully eliminated on consolidation under IAS 21. This is retained in the revised version of the standard.
However, IGC 137-14 under the old standard also allowed a forecast intra-group transaction to be designated as the hedged item in a foreign currency cash flow hedge in consolidated financial statements. The revised IAS 39 does not allow this.
The Board issued an exposure draft in July 2004 with proposals to allow a group to obtain hedge accounting in the consolidated financial statements by designating the hedge as a hedge of a highly probable forecast external transaction, and the linked forecast intra-group transaction could form part of the tracking mechanism for associating the hedging instrument with an external transaction.
Two issues arising from this were highlighted to the Board by the staff:
Issue 1
The first issue affects existing adopters of IAS 39. The version of IAS 39 (which includes IGC 137-14) currently being applied by existing users of IAS 39 allows hedge accounting for a hedge of foreign exchange risk of a highly probable forecast intra-group transaction. However, in 2005 groups will not be able to use hedge accounting for such transactions in consolidated financial statements. Moreover, they will also have to unwind the hedge accounting applied in previous periods, since the improved IAS 39 requires full retrospective application for existing adopters. The impact of this will be significant for many adopters.
An issue of communication arises because shortly after releasing 2004 financial statements, companies intend to let analysts know how the 2004 figures will be restated to comply with the revised IAS 39 and the other new Standards. Board members noted that the issue of communication to analysts was not the key issue (depending for instance on whether IGC 137-14 is reinstated).
Furthermore, the July 2004 ED will not have been agreed by 1 January 2005 and therefore cannot be implemented, with the potential impact that these entities will have to change their hedge accounting for a second time in six months if they are allowed to use the 'tracking mechanism' described above.
The Board stated that it was sympathetic to this problem. Various options were considered by the board including:
- Reinstatement of the exception of the old version of IAS 39 (i.e. IGC 137-14).
- Redesignation of hedges only prospectively, i.e. not restate the 2004 comparatives.
It was agreed that no decision would be made by the Board in this session as the ED has not yet been agreed by the Board.
Issue 2
This issue relates to both existing users and first time adopters of IAS 39. This issue arises because all hedging relations have to be designated at the inception of the hedge. In the absence of the final Standard on Cash Flow Hedge Accounting of Forecast Intragroup Transactions, the question arises as to what should groups designate as the hedge item at 1 Jan 2005 - highly probably forecast external transactions or highly probably forecast intra-group transactions? If a group does not designate a hedge in the 'right' way, it will not be able to obtain hedge accounting and will experience volatility in its consolidated profit or loss accounts.
The Board acknowledged that this is an issue and that it is sympathetic to this problem. However, it is unable to make a decision at this time, and the objective of this session was for the staff to alert the Board to some of the issues highlighted by the comment letters. The Board discussed the possibility of inserting in the December IASB Update an appropriately worded statement expressing the fact that the Board is sympathetic to the concerns of constituents on this issue.
It was agreed that the staff would perform their comment letter analysis and report to the Board in the February meeting when the issue would be discussed again by the Board. The staff expressed the view that it might be difficult for the Board to finalise amendments to the standard arising out of the Exposure Draft before the third quarter of 2005. Board members expressed the view that the Board should, if at all possible, try to finalise the amendment by 30 June 2005.
Business Combinations Phase II – Purchase Method Procedures
The decisions reached by the FASB at its 24 November meeting relating to the drafting issues in the joint IASB-FASB business combinations Exposure Draft were discussed by the Board.
EITF 95-8 Accounting for Contingent Consideration Paid to the Shareholders of an Acquired Enterprise in Purchase Business Combinations
The staff proposed that the guidance on this issue in EITF 95-8 (Additional Factors to Consider in Determining Whether Certain Contingent Arrangements Should be Accounted for as Part of the Exchange for the Acquiree) be included as part of the implementation guidance in the joint exposure draft.
The Board agreed with the principles of the guidance but suggested that the wording is too long to be included in the implementation guidance as it stands. The Board asked the FASB staff to re-draft the wording to retain the principles but to make the guidance shorter.
EITF 04-1 Accounting for Preexisting Relationships between the Parties to a Business Combination
There were several issues considered in relation to EITF 04-1. It should be noted that, where the Board agreed with the conclusions reached by the EITF, it was requested that the wording be reduced for inclusion in the implementation guidance for business combinations.
The issues discussed were as follows:
(i) Whether a business combination between two parties that have a pre-existing relationship should be evaluated to determine if a settlement of a preexisting relationship exists, the requiring accounting separate from the business combination
- 'Pre-existing relationship' refers to circumstances in which the acquirer and the acquiree have a contractual (e.g. licensor/licensee) or other relationship before the business combination.
- 'Settlement of a pre-existing relationship' refers to the fact that some of the pre-existing contractual relationships are effectively 'settled' as a result of the business combination.
The EITF conclusion was that the two elements (i.e. the settlement of the pre-existing relationship and the business combination) should be accounted for separately.
The Board discussed the issue and considered the situation where, if the EITF conclusion was not concurred with, there would be potential for entities to avoid accounting for items such as onerous contracts with third parties by buying the entity with whom the contract existed.
Thus, the Board agreed with the consensus in the EITF that the two items must be accounted for separately.
(ii) How the effective settlement of an executory contract in a business combination should be measured
The EITF had reached a consensus that the effective settlement of an executory contract in a business combination as a result of a preexisting relationship should be measured at the lesser of:
- (a) the amount by which the contract is favourable or unfavourable from the perspective of the acquirer when compared to pricing for current market transactions for the same or similar items; or
- (b) any stated settlement provisions in the contract available to the counterparty to which the contract is unfavourable.
The Board agreed with the consensus on the basis that the contract would effectively no longer be favourable/unfavourable upon consolidation, but requested that the wording in the guidance be reduced.
(iii) Whether the acquisition of a right that the acquirer had previously granted to the acquired entity to use the acquirer's recognised or unrecognised intangible assets should be included in the measurement of the settlement amount or included as part of the business combination
The Board agreed with the EITF consensus that the acquisition of a right that the acquirer had previously granted to the acquired entity to use the acquirer's recognised or unrecognised intangible assets should be included as part of the business combination.
(iv) Whether the acquirer should recognise, apart from goodwill, an acquired entity's intangible asset(s) that, before the business combination, arose solely from the acquired entity's contractual right to use the acquirer's recognised or unrecognised intangible asset(s).
The EITF had reached the consensus that the reacquired right should be recognised as an intangible asset apart from goodwill.
There was much debate amongst the Board members over whether the reacquired right should be recognised as a separate intangible asset or be subsumed within goodwill.
There were several views put forward:
- The reacquired right should not be recognised as a separate asset, as effectively the reacquired right is a contract between the entity and itself and therefore it is non-sensical to recognise a separate asset - it should be included within goodwill;
- The reacquired right meets the definition of an intangible asset in accordance with IAS 38, and is separately identifiable since it has previously been sold, and therefore should be treated as a separate asset apart from goodwill;
- The reacquired right may be treated as a separate asset if the 'day 2' accounting problem of how to account for the asset in terms of amortisation can be resolved.
The Board could not reach an agreement on this issue, and requested the FASB staff to consider the 'day 2' accounting problem and to present a solution to the Board for consideration.
(v) Whether it is appropriate for an acquirer to recognise a settlement gain in conjunction with the effective settlement of a lawsuit or an executory contract in a business combination
The Board agreed with the EITF consensus that a settlement gain or loss should be recognised in conjunction with the effective settlement of a lawsuit or executory contract in a business combination, unless otherwise specified in existing authoritative literature.
Other Business Combination II issues:
(a) Definition of a Business Combination
At its 17 November meeting, the Board expressed its preference for developing a new
definition of a business combination if it could be done quickly and not delay issuance of the joint Exposure Draft. As a second choice, the Board stated that it would adopt the FASB definition that was developed in phase II. That definition is "a transaction or other event in which an acquirer obtains control over one or more businesses."
Prior to the FASB's meeting, the staff distributed a memo to the FASB that provided two new alternatives for defining a business combination. Those alternatives were:
- Alternative One - A business combination is a transaction or event that brings one or more businesses into a reporting entity by means of obtaining control or otherwise.
- Alternative Two - A business combination is any transaction or event that results in the initial inclusion of one or more businesses in the financial statements of an acquirer.
Neither the staff nor the FASB could come to agreement on any one definition. Each had their pros and cons. Because the FASB believed that a new definition could not be developed quickly and because a majority still preferred the FASB's definition, the FASB decided to retain its definition.
The majority of the Board agreed.
(b) Identifying the Acquirer
Consistent with the Board's 17 November decision, the FASB agreed to explore developing converged guidance for identifying the acquirer. Prior to the FASB's meeting, the staff distributed a memo to the FASB that illustrated the approach that the staff suggested for converging the guidance. That approach is the same as the approach discussed by the IASB at its November 17 meeting, which is:
- a. The first step would be to identify the party who obtained control-Neither Board would provide any control guidance in the joint Exposure Draft. The IASB's Exposure Draft would refer to IAS 27 and the FASB's Exposure Draft would refer to ARB No. 51, Consolidated Financial Statements (as revised), and FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, for guidance on control.
- b. If it is not obvious which party obtained control, the second step would be to consider other factors-Those factors would then be similar to the factors provided in both IFRS 3 and Statement 141.
The FASB agreed with that approach and agreed to provide suggested wording for guidance in the joint Exposure Draft. The guidance was discussed briefly by the Board and the majority voted in favour (only 1 against).
(c) Definition of goodwill
The FASB had agreed that it prefers the Board's approach for defining goodwill by its nature rather than by its measurement. However, the FASB suggested a modification to the IASB's definition of goodwill that it would like the Board to consider.
The FASB proposed modifying the definition as follows (part in square brackets marked for deletion):
Future economic benefits arising from assets that are not [capable of being] individually identified and separately recognized.
The Board agreed that capable is not the right word to describe whether an intangible asset should be recognized separately from goodwill. For example, in many instances intangible assets that are subsumed in goodwill are capable of being individually identified, however they are not recognized separately from goodwill because they do not meet the recognition criteria.
(d) Report Issues
- Reliable Measurement of Intangible Assets. The Board discussed whether the criteria for recognising intangible assets separately from goodwill needed to include the requirement that the fair value of an intangible asset must be reliably measurable to be recognised separately from goodwill. The Board had discussed this at its 17 November meeting and concluded that this requirement for 'reliably measurable' should be retained. However, the FASB had decided not to include this in its criteria. The Board held with its original view on the basis that intangible assets could not be reliably separated from goodwill if they are not reliably measurable. The Board asked the FASB staff to encourage the FASB to reconsider its reasons.
- Adjustments Made to the Provisional Amounts Recorded in a Business Combination. It was reported to the Board that the FASB had agreed to adopt the Board's approach in IFRS 3 and require that any adjustments made to the provisional amounts recorded in a business combination be accounted for retroactively (that is, adjust previously reported amounts) rather than prospectively. Thus, this issue is resolved.
Proposed Amendments to IAS 37 - Measuring Termination Benefits
At its September meeting, the Board considered a first draft of the exposure draft of amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets. The exposure draft also includes complementary amendments to the requirements for termination benefits in IAS 19 Employee Benefits.
At the September meeting, the staff proposed that termination benefits should be measured at fair value. However, some Board members raised concerns about this proposal and asked the staff to reconsider the issue. The staff therefore presented their new proposals to the Board.
The staff recommended retaining the existing requirement in paragraph 139 of IAS 19 (i.e. where termination benefits fall due more than 12 months after the balance sheet date, they shall be discounted using the discount rate [used to discount post-employment benefit obligations]', i.e. a discount rate 'determined by reference to market yields on high quality corporate bonds') for measuring termination benefits, but:
(a) specifying that when termination benefits fall due more than 12 months after the balance sheet date, an entity should subsequently follow the recognition and measurement requirements for post-employment benefits; and
(b) clarifying that when termination benefits are provided through a post-employment benefit plan, the liability and expense recognised initially includes only the value of the additional benefits that arises from the providing those termination benefits.
It was noted by the staff that this recommendation will result in some termination benefits being accounted for similarly under US GAAP and IFRS. Nonetheless, reconciling items will still arise for some termination benefits (particularly those provided for involuntary termination) because of difference in either recognition or measurement.
The Board commented that the Staff had done very well in a difficult area and that it was impressed by, and supported, the proposals.
Amendments to IAS 39 - Transition and Initial Recognition of Financial Assets and Liabilities - Sweep Issues
(i) Straight-line amortisation
This discussion related to whether straight-line amortisation is an appropriate mechanism of recognising any difference between a transaction price (used as fair value in accordance with paragraph AG 76) and a valuation made at the time of the transaction.
A commentator on the fatal flaw draft had noted that companies have attempted to use the following statement in the November IASB Update, and in the Basis for Conclusions in the near final draft published on the subscriber website, as a justification for using straight-line amortisation when in his view, that would not be appropriate:
[The Board] "...concluded that although straight-line amortisation may be an appropriate method in some cases, it will not be appropriate in others".
The commentator had requested that any reference to straight-line amortisation be removed.
The Staff put forward its view that it was not convinced that removing the explanation in the Basis would rectify this problem. In the absence of any guidance, the argument that straight-line is acceptable in a given circumstance can still be made, and this is a matter for professional judgement.
One Board member asked if anyone could think of an example where straight-line amortisation would be appropriate.
In the absence of any examples, another Board member suggested that a more appropriate method should be used if possible, but if not, the straight-line method could be used.
The Board agreed with the Staff that the guidance should be retained as it is and that it is not practicable for more detailed guidance to be given at this time. However, it was agreed with Staff that it would be advisable to add a sentence to the guidance to the effect that it is outside the scope of the IASB's current project to state when it would be appropriate to use straight-line amortisation.
IFRIC Update
The Board was given an update of the last IFRIC meeting. No decisions were made by the Board as a result of this update.
It was noted that there had also been an EFRAG meeting and that there had been much debate about IFRIC 3 concerning emission rights at this meeting. It was thought that EFRAG did not believe that IFRIC was incorrect in its interpretation, but there were concerns whether a more management intent-driven model would be appropriate.
Thursday 16 December 2004
Revenue Recognition
In October 2004 the staff of the IASB and FASB conducted small non-public meetings to gauge the response of IASB and FASB members to the following three broad issues
- a. Whether an increase in net assets that occurs at contract generation gives rise to revenue that should be recognised if it can be measured reliably.
- b. Whether the standard or revenue recognition should include a 'special' reliability threshold for measuring the increase in net assets at contract generation.
- c. If the standard includes a 'special' reliability threshold and that threshold is not met, how the increase in net assets at contract generation should be recognised and measured and when that increase should be recognised as revenue in the income statement.
In considering these questions Board members had been asked to consider a very specific fact pattern in which cash is given for entering into a non-refundable contract. The objective of the simplified fact pattern was to focus debate only on one side of the journal entry (because the fair value of cash consideration is readily measurable). In real situations the fair value of the consideration received, related service obligations etc may in fact be quite complex.
Prior to commencing their discussion of this matter Board members emphasised the specific fact pattern they had considered, that they were not discussing recognition of profit on taking an ordinary sales order, and that they did not expect the proposals to result in a revenue recognition model that they would expect to be implemented in the short term.
Once a determination had been made on that fact pattern the intention was to develop a conceptual method of dealing with revenue recognition (based on the broad concepts previously agreed: that revenue and expenses should be determined by reference to assets and liabilities) which would then be road tested on a number of fact patterns.
On point a, whether an increase in net assets at contract generation gives rise to revenue, a majority of both Boards had indicated in the small group meetings that they did not understand what other possible alternative there was, and therefore agreed that this would be the case. It was noted that not all members might agree with the method suggested in determining the increase in net assets (such as measuring the performance obligation at its legal lay-off amount). However, the Board agreed that where an increase in net assets had occurred, this would result in the recognition of revenues.
On the second point, a majority of Board members agreed that a 'special' threshold should not be introduced for the measurement of revenue. They noted that where a 'special' threshold came into play this would necessarily result in the recognition of a 'special' liability (to recognise the dangling credit) which would not meet the recognition criteria for liabilities. The Board did note that its discussion paper should clearly set out the reasons why a 'special' threshold is not considered possible, in order to address the concerns of those who believe a 'special' threshold is appropriate. This discussion would include the pros and cons of such a threshold and illustrate why it is not possible or desirable. Therefore the third question relating to accounting if there is a 'special' threshold did not require resolution by the Board.
Standards for Small and Medium Sized Entities (SMEs)
The Board considered the responses from commentators on the discussion paper on SMEs, and considered recommendations made by the sub-committee on SMEs.
The following responses from the comment letters were noted
- An overwhelming majority of respondents believed that full IFRS was not suitable for all entities (however, the Board clarified that they do not believe this means all entities should be prohibited from applying full IFRS)
- A majority of respondents believed separate standards should be developed for SMEs, with a minority favouring the existing standards simply stating which paragraphs need not be applied by SMEs (an 'IAS minus' approach)
- Many respondents said that the decision as to whether full IFRS should apply to all listed entities should be left in the hands of local regulators. The Board noted that where an entity which did not qualify for SME accounting (as defined by the Board) used SME accounting (even under the direction of a regulator) this could not be claimed to be full IFRS or SME IFRS, and would instead be considered national GAAP
- Nearly one half of respondents agreed with the objectives of the SME accounting as set out by the Board in the discussion paper, with the majority of reservations expressed being in relation to whether SME standards should be built on the same conceptual framework as IFRS (the Board also noted some confusion from respondents as to the use of the word 'enforceable' and noted that the Board had no intention or desire of enforcing standards, simply that their standards must be written in such a way as to be enforceable by the relevant regulatory bodies)
- A majority of respondents agreed that a 'characteristics' approach was a better method of defining SMEs, rather than issuing quantitative guidelines.
- Respondents supported a proposal that where SME standards did not address a particular issue the entity should be required to revert to the requirements of full IFRS in respect of that issue
- A majority of respondents however disagreed with the proposal that where an entity wishes to apply full IFRS rather than the SME standards they should be allowed to (the Board had proposed that entities could adopt entire full IFRS standards in replace of the related SME standard if they so desired)
- A majority of respondents agreed that the IASB should complete the SME project by starting with full IFRS and working back to SME standards, there was very little support for starting from scratch
- Respondents noted that full IFRS should be amended where considered necessary after consideration of user needs and a cost/benefit analysis
- A clear majority of respondents agreed that it was likely that disclosure and presentation modifications to full IFRS would be needed in respect of SMEs having taken into account user needs and cost/benefit analyses
- A majority of respondents disagreed that the Board should approach this project with a presumption that no modification should be made to recognition and measurement requirements, believing instead that the Board should keep an open mind on this issue
- A majority of respondents agreed that IASB Standards for SMEs should be published in a separate printed volume
- Views of respondents as to whether SME standards should be presented in IFRS sequence or topically were divided
- Having heard the views expressed by constituents, the chair of the sub-committee, Tom Jones, put forward the recommendations of the sub-committee.
The Board agreed that they are strongly committed to this project. The Board agreed that the project should focus on companies without public accountability that have external users. It was noted that the definition of SMEs should be framed in such a way as to presume full IFRS is appropriate to all entities, but noting that they are not designed with all entities in mind SME standards are necessary.
The Board agreed to keep an open mind as to the possibility of recognition and measurement differences between full IFRS and SME standards. The Board agreed that there should be two attestations - IFRS and IFRS for SMEs. It was noted that the term 'small and medium-sized entities' is misleading as it does not adequately disguise the entities being targeted by the Board and suggested that alternative names should be considered.
The Board agreed to require that where an issue is not dealt with in SME standards, an entity must apply full IFRS in respect of that issue. It was noted that the hierarchy for SMEs would be to look at the relevant SME standard, look at the remaining SME standards and then default into full IFRS and the hierarchy of IAS 8. The Board agreed by a narrow margin that an entity could not elect to apply full IFRS to particular scenarios - they must either use SME standards or full IFRS rather than cherry-picking between the two. One of the justifications for this was the issue of comparability, although the Board acknowledged the 'comparability' objective may not be as relevant to SMEs as it is to those with full public accountability. The Board agreed to proceed with this as its working assumption (that full IFRS standards could not be defaulted to on a voluntary basis) but noted that this decision may need to be revisited.
The Board agreed that IFRS for SMEs should be organised topically rather than by standard. It was noted that this was consistent with a project being undertaken in the US to re-codify US GAAP by topic. It was greed that the IASB would work on SME standards on a 'full IFRS standard by full IFRS standard' basis, and once those amendments are complete will consider the best way for structuring the SME standards. In presenting SME standards topically a concordance will be required in order to enable entities to identify where the requirements come from.
The Board agreed that standards should be consistent with the conceptual framework and amended to reflect user needs and cost benefit analysis. The Board agreed that there should not be a requirement for entities that feed full IFRS information up to a parent to prepare its own accounts on a full IFRS basis, despite the fact that cost benefit analyses would not be relevant as the information was prepared anyway.
Staff were asked to prepare a paper summarising the conclusions for circulation to the sub committee and agreement at the January Board meeting.
Friday 17 December 2004
Amendments to IAS 39: The Fair Value Option
The Board considered a proposal for how to proceed with this project, following on from consideration of 116 comment letters received, most of which were in disagreement with the proposals contained in the exposure draft issued in April 2004. The overwhelming majority of respondents had expressed a preference for retaining the full fair value option as currently contained in IAS 39. However, a number of regulators do not support this, and reverting to the full fair value option would not solve the regulators' concerns that that Board had tried to resolve through the exposure draft. The Board noted, however, that not all regulators in Europe disagree with the full fair value option.
Some of the regulators had proposed an alternative approach under which items could be measured at fair value when they are part of a group of financial assets and financial liabilities managed together on a fair value basis in accordance with a documented risk management policy. The Board agreed that it was not able to make such a suggestion operational, for a number of reasons. These include defining when a group of assets and liabilities is considered to be 'managed together' and providing guidance on the interpretation of the phrase 'documented risk management policy'. Furthermore, such a proposal would not work for activities where it is not possible for both the assets and liabilities to be measured on a fair value basis, for example the insurance industry. It was also noted that this proposal would be more restrictive than the existing 'carve-out' version of IAS 39, because it would restrict the application of the fair value option to assets as well as liabilities.
It was noted that in South Africa, the full fair value option had been implemented early. While some difficulties have been experienced, in general it has been found that the full fair value option as is currently in IAS 39 is workable. It was noted that because IAS 39 requires designation at inception, designating something at fair value through profit and loss is not done spuriously because it has long term consequences. Therefore the reality has been that it is not possible to designate something at fair value through profit and loss to simply effect the recognition of a short term gain.
Staff noted that one of the major concerns that has been expressed is around the issue of 'admission' - that is, when is an entity eligible to adopt the fair value option. The Board considered a proposal that the entity is able to adopt the fair value option when the following criteria are met
- Use of the fair value option corrects a measurement mismatch; or
- The nature of the entity's activities is such that the use of the fair value options provides more useful information; or
- The fair value option is simpler to apply than the accounting requirements that would otherwise apply, for example, accounting for embedded derivatives.
It was noted that this proposal had been published on the IASB's website and widely circulated for comment by 1 January 2005, as part of the IASB's extended due process. Comments received to date from regulators indicate that they are not supportive of this proposal.
Some respondents to the revised option had suggested the inclusion of more examples, with some even proposing that the examples form an exhaustive list of when the full fair value option is allowed. The Board disagreed, believing that there would always be one more example to be discovered, and that they could not justify an approach whereby the examples given were considered to be exhaustive. The Board agreed further examples should be considered for inclusion, and should be used to 'road-test' the revised criteria as proposed above. The Board agreed to proceed with endeavouring to operationalise the criteria described above, and to use the examples as assistance to do this rather than replacement criteria.
The Board noted that prima facie there appear to be internal inconsistencies between the objections raised by regulators in respect of the full fair value option and the proposals from the regulators to fix the problem. Concern was expressed that the Board appeared to be caught in the middle of what is ultimately a political debate, and that the perceived inconsistencies suggested to some Board members that they may not fully understand the concerns raised. It was noted that Board members have access to all documents sent to the Board highlighting concerns, but it appears the communication channels between regulators and the Board are such that the documents being received are not adequately illustrating to the Board the concerns. It was agreed that there was a need for round table discussions in which regulators who object to the option could discuss with other parties who support the option and try to come to an understanding of each others' views and how those parties together would wish the Board to proceed.
The exposure draft proposed that the fair value option could only be used where fair value is 'verifiable' - this was the most criticised aspect of the Exposure Draft. Respondents felt that it was an un-necessary extra test, the nature of responses indicated that the word 'verifiable' had not been consistently understood, and would therefore be unlikely to be consistently applied, and a 'verifiability' criteria might result in entity's going around in circles in respect of instruments that contain embedded derivatives. The Board noted that reliability underlies all IFRS, and there was no justification for an increase in the threshold in IAS 39. The Board believed the existing guidance on fair value (including that it should be free from bias) was sufficient to ensure an appropriate degree of reliability, but that paragraph 48A as exposed should be retained - this effectively brings the guidance from the application guidance into the standard.
The Board also noted that significant concerns had been expressed about 'own credit risk', and the fact that where an entity's own credit rating declines, application of the fair value option would result in a gain arising from the decrease in the fair value of its own liabilities. The Board acknowledged that this is of concern, but noted that no robust, readily implementable solution had been identified. The Board also noted that it seemed highly unlikely that an entity would designate a liability at fair value through profit and loss at inception simply to take advantage of its own expected future credit deterioration. Accordingly they agreed the existing disclosure requirement in IAS 32 in respect of this was a sufficient proxy of the effect of own credit risk, but was not sufficiently accurate to justify requiring it to be recognised in the accounts. Therefore the disclosure will continue to be required, but until a method of determining the effects of own credit risk can be determined that is capable of being made operational as part of an accounting standard, no recognition criteria will be introduced. The Board agreed a robust discussion of this issue and the reasons recognition requirements in respect of this are not addresses would be needed in the basis for conclusions.
A large proportion of constituents had objected to the inclusion of the reference to the role of the regulator in the exposure draft. The Board had agreed to include this reference at the request of certain regulators, believing it to be a gratuitous statement. However, a number of constituents were concerned that this sentence was bestowing on regulators a power to 'meddle' in the accounting policies used in general purpose financial statements by regulated entities. The Board noted that in some jurisdictions the regulator does have that power, but where the result of using that is non-compliance with IFRSs to meet regulatory requirements, the entity could not claim to be IFRS compliant.
A number of regulators had indicated that the inclusion of this sentence is considered a deal-breaker, and without it endorsement would not be possible. This concerned the Board greatly, as they did not understand how a sentence that they had understood as gratuitous could be a deal-breaker, and therefore believed that regulators are placing greater importance on this sentence than the Board did. Accordingly the Board agreed they need to obtain a greater understanding from both regulators and constituents as to what was meant by this sentence before proceeding. It was proposed that this should be raised in the roundtable discussions. Subject to anything that might be uncovered by obtaining this greater understanding, eight Board members agreed to retain the sentence as exposed with a more robust explanation in the exposure draft.
The comments received on the revised criteria will be brought to the next Board meeting, and the Board would aim to hold roundtable discussions with invited constituents in February 2005.
ED 7 Financial Instruments: Disclosures
The Board considered responses to ED 7. It was noted that there were a large number of minor comments raised by different respondents, and that it would be most expedient for the Board to form a small group to identify which of these issues justify further Board discussion.
Respondents generally agreed that the Board should issue a standard containing the disclosure requirements in relation to financial instruments. Some Board members questioned whether it would be best to combine these requirements into IAS 32 to minimise the number of financial instruments related standards on issue. However, the Board agreed that as the liability/equity distinction is to be reconsidered in the future, it is easier to split the disclosures out into a separate standard at this juncture.
Board members considered whether the standard should try and separate the disclosure requirements into different categories - one for all IFRS preparers and one for financial institutions. However, the Board confirmed its earlier decision that it would not be possible to operationalise such a proposal, particular in trying to define the distinguishing features of the different types of entity. The Board agreed to keep a watching brief - the objective is that the disclosures made under ED 7 should fit the circumstances of the entity - if, for example, it appeared financial institutions were making insufficiently detailed disclosures to comply with the disclosure principles the requirement for a separate set of more detailed requirements will be reconsidered.
The Board confirmed its intention that the standard will require:
- Disclosure of financial assets and financial liabilities by classification.
- Net gains or net losses by classification.
- Fee income and expense.
The Board agreed to reconsider at a later meeting the appropriateness of the proposed disclosures of information about any allowance account.
Respondents expressed significant concerns about the disclosure of the fair value of collateral and other credit enhancements. The range of concerns included that the information was difficult to obtain, may be misleading, and is potentially not worth having. The Board agreed that there was a need to disclose the relationship between collateral and the related liabilities for performing assets. A view was expressed that the requirement to disclose collateral was adequately dealt with by the impairment requirements where impairments had been recognised, and therefore the key disclosure issue rests with assets that are not performing but not yet impaired.
A large number of constituents objected to the proposed disclosure of a sensitivity analysis, citing concerns such as cost/benefit, comparability, and commercial sensitivity. It was noted that comparability should not be considered to mean that all the entities had completed their sensitivity analysis in exactly the same manner. Some constituents supported exemptions to this requirement for certain entities. The Board noted that it was inappropriate for SMEs to be excluded as this was a decision to be taken in the course of the SME process. The Board will further consider the appropriateness of the sensitivity analysis disclosure at a future meeting.
There was strong disagreement with the proposed disclosures relating to capital. Many constituents opposed the disclosure of external capital requirements, and an overwhelming number opposed the disclosure of internal capital requirements. Constituents felt that they may be penalised by the market if they disclosed breaches of internal capital requirements, and staff acknowledged a risk that as a response entities would set their requirements such that they would never be breached, and would therefore be meaningless. It was noted that the regulators involved in the development of the exposure draft had initially indicated their acceptance of these disclosures but some regulators had subsequently expressed doubts as to the appropriateness of the disclosures.
The Board confirmed the effective date and transitional provisions would be as exposed, with one change. An existing IFRS user that early adopts ED 7 will not be required to provide comparative information in respect of those disclosures not already required by IAS 32. It was noted that some of the new disclosures proposed by ED 7 – for example, the sensitivity analysis – are of limited value in historical information, and therefore granting an exemption did not detract greatly from information provided to users.
Many respondents did not agree that risk management type disclosures should be required in the financial report. Some noted that this seems unusual given that they are also in many jurisdictions required in the MD&A. The Board noted that they only have jurisdiction over the financial statements themselves, and entities could choose to incorporate information by cross reference rather than by duplication, providing that information would be subject to the audit requirements applying to the financial statements.
Many respondents supported the proposal that the disclosure requirements of IFRS 4 be changed for consistency with those proposed in the ED. However many insurance entities objected to this proposal, preferring instead to wait until Phase 2 of the insurance project is completed before making further comprehensive changes. The Board agreed that it would determine the requirements to be contained in the final standard and would then decide in conjunction with the insurance team how, if at all, these should be introduced into the requirements for accounting for insurance activities.
In general respondents felt that the implementation guidance was insufficient. Respondents requested more guidance, more examples and more illustrative disclosures. The Board discussed releasing the standard prior to the implementation guidance but agreed that this was not acceptable, as the implementation guidance is a good way of road testing the standard before release. The Board agreed to consider the extent of disclosures appropriate a t a future meeting after this has been considered by a smaller group and the advisory group.
A majority of respondents agreed that the additional disclosures proposed by the FASB's recent exposure draft should not be incorporated into the final standard. The Board agreed that inclusion of the additional requirements should not be required, and that as the requirements are in exposure draft format only, the Board should note that the FASB's thinking is still evolving. The Board agreed to advise the FASB that it would not include the additional requirements in the final standard and its reasons for choosing not to do so.
The Board noted that many respondents did not appear to have considered the issue of materiality in relation to disclosure – if a disclosure is not material it is not required. The Board agreed that the term 'minimum disclosure' had contributed to this confusion. The Board agreed to include in the basis for conclusions a statement regarding the impact of materiality considerations on the disclosures made and referring readers to IAS 1.
The Board will further debate the issues raised above that were not cleared at the meeting at a future meeting, as well as considering issues identified by the small group as needing Board consideration.
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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