Standards for Non-Publicly Accountable Entities (NPAEs) At the February meeting, the Board expressed general agreement with a project plan proposed by the staff. The plan includes organising round-table meetings with preparers and users of NPAE financial statements and others to discuss possible recognition and measurement modifications of IFRSs in standards for NPAEs. To identify the issues for discussion at those round-table meetings, the plan includes sending a questionnaire to those who responded to the Discussion Paper, SAC, and the NPAE working group. The Board agreed to request comments from any other interested parties as well.

The staff intend to have the responses to this questionnaire in time for the SAC meeting in the 3rd week of June and the working group discussions thereafter.

The Board discussed and agreed on changes to be made to the questionnaire as regards its structure and wording. In addition to the content of the questionnaire, the Board decided that respondents should be requested to provide information about their entities that would allow the IASB to gauge the size of the entity (such as number of employees, revenue, etc.) and thereby to assist with the interpretation of the responses.

The staff will finalise the questionnaire with the Board NPAE sub-committee before distributing it for public comment.

ED 7 Financial Instruments: Disclosures

Sensitivity analysis of market risk

At its December 2004 meeting, the Board agreed to retain the proposed requirement for a sensitivity analysis but asked the staff to develop more guidance on how to prepare such an analysis.

The Board has also confirmed that it would not provide exemptions from the sensitivity analysis for market risk for non-financial institutions, NPAEs, or wholly or substantially owned subsidiaries. The disclosures proposed in this project would be reconsidered for NPAE purposes during the deliberations on that project.

As regards the staff proposals, the IASB disagreed with the notion of a 'maximum reasonably possible change in the relevant risk variable', concluding instgead that the word 'maximum' should be deleted.

In addition, the staff was asked to clarify that the sensitivity disclosure requirement would be based on the change in the relevant risk variable based on the balance sheet position at the reporting date, not an analysis of the change in the profit or loss of the prior period. The sensitivity analysis would be for the ensuing year (12-month period).

The Board also decided that the requirements should specify whether the disclosures would be of pre-or post-tax amounts.

Implementation guidance

At its December meeting, the Board noted that many respondents disagreed that the Implementation Guidance proposed in ED 7 is sufficient, but noted that respondents generally made a request for 'more guidance' or 'more detailed guidance' without specifying what that guidance should be. The Board decided that it would seek the views of its financial instruments working group. The staff made proposals as regards the status of some of the implementation guidance by making certain paragraphs mandatory and others non-mandatory but issuing both together with the IFRS when finalised. The Board agreed with these recommendations.

Fair value option disclosures

The Board agreed with the staff recommendation as regards the mechanics of the disclosure requirements on the fair value option. The effect of the requirements would be as follows:

• For those applying the unrestricted fair value option, the disclosures in the original ED 7 would be applicable together with the subsequent changes made as a result of respondent's comments and the Board's deliberations (the unrestricted fair value option would be in existence until the effective date of the restricted version).
• For those that may chose to early adopt the restricted fair value option, the new disclosures in the latest ED 7 proposals would apply.

To achieve the above, the IASB will finalise ED 7 as an IFRS on the basis of the unrestricted fair value option. When the restricted version of the fair value option is finalised, the changes to the disclosure requirements will be taken as consequential amendments to the new IFRS on financial instruments disclosures.

Insurance contracts

At its February meeting, the Board decided to amend IFRS 4 to be consistent with the new IFRS arising from ED 7, with modifications that reflect the Board's temporary special treatment in Phase I of the insurance project for insurance contracts.

In particular, the Board decided to permit a choice of whether to provide quantitative sensitivity analysis disclosures for insurance risk only. This means that, for insurance risk, entities would be able to choose to provide:

• the terms and conditions disclosures together with a qualitative sensitivity analysis presently required by IFRS 4; or
• the quantitative sensitivity analysis proposed in ED 7.

Such a choice would be a temporary solution to be eliminated in Phase II of the insurance project.

After receiving input from the Insurance Working Group, the IASB agreed with the staff recommendation to confirm its previous decisions. The Board also agreed with the staff's other recommendations and agreed to proceed subject to editorial amendments.

Transition issues

ED 7 proposed that the new IFRS would be effective for annual periods beginning on or after 1 January 2007, with earlier application encouraged.

ED 7 also proposed to amend IFRS 1 to permit entities that adopt IFRSs for the first time before 1 January 2006 and choose to adopt the new IFRS before 1 January 2006 an exemption from presenting the comparative disclosures required by the new IFRS in its first IFRS financial statements.

The staff sought to clarify certain of the Board's December 2004 decisions so the staff could commence the drafting of the final standards, as follows:

• Entities adopting IFRSs for the first time for annual periods beginning before 1 January 2006 that choose to adopt the new IFRS before 1 January 2006 would be exempt from presenting comparative disclosures about the significance of financial instruments for financial position and performance.
• All entities adopting the new IFRS for annual periods beginning before 1 January 2006 (rather than just first time adopters) would be exempt from presenting comparative disclosures about the nature and extent of risk arising from financial instruments and about capital. However, such entities that are not first time adopters would still need to present comparative disclosures about the significance of financial instruments for financial position and performance.

Specifically, the staff recommended the following to the Board:

• that the capital disclosures are issued as a stand-alone amendment to IAS 1, effective for annual periods beginning on or after 1 January 2007.
• that the Board does not require entities to present disclosures from its previous, non-IFRS compliant financial statements in place of comparative information.
• that the Board confirm that it will encourage early application of the new IFRS.

The Board agreed with those recommendations.

Sweep issue: Minimum disclosures and materiality

The Board agreed at its December meeting to clarify that the minimum disclosures proposed in the ED are subject to the materiality requirements in IAS 1. That clarification is required because some respondents were confused about whether it would be necessary to provide immaterial disclosures. Some believed that the heading 'minimum disclosures' implied that the disclosures that followed, including the sensitivity analysis, were to be provided regardless of materiality.

Although agreeing that the proposal could be read in this way, the Board disagreed with the staff's proposal since IFRSs in general only apply to material items.

Other issues

No Board member indicated an intention to dissent against the finalisation of this IFRS. The staff indicated that they would proceed to a pre-ballot draft with the goal of issuing a final IFRS in June 2005.

Fair Value Option – Effective Date and Transition Requirements

The staff presented the effective date and transition requirements issues to the Board on the basis that the fair value option debate would be finalised in substantively the same form as currently drafted. The staff recommended the following:

• the effective date is annual periods beginning on or after 1 January 2006, with earlier application encouraged.
• entities be permitted to change their designations of which financial assets and financial liabilities the fair value option will and will not be applied to on the application date of the amendment.
• when entities do change their designations, entities should be required to restate comparative financial statements.

The Board discussed this issue at length, going through a number of scenarios including those posed by the 'carve out' adopted in Europe. The Board concluded that on the effective date of the restricted fair value option, an entity will be required to 'de-designate' any instrument that does not meet the new criteria for the fair value option. The fair value of that instrument on that date will become the deemed cost and the subsequent accounting will be on the basis of IAS 39.

A first-time adopter whose transition date coincides with the effective date of the restricted fair value option, or a first-time adopter of IFRS that also early adopts the restricted fair value option will be required to comply with IFRS 1 in this regard.

Financial Instruments – Convergence with US GAAP (Educational Session)

This was an educational session. The Board was not asked to made decisions.

The aim of the education session was to present to the Board the project plan proposed for convergence with US GAAP and to ask for suggestions on the approach to the project. The list of convergence issues identified so far is:

• Accounting for securities sold but not yet purchased (short trading)
• Definition of a derivative
• Derecognition of financial assets
• Classification of financial assets - held to maturity
• Effective interest method
• Impairment
• Unquoted equity instruments

Generally the Board was supportive of the methodology used to identify differences and the analysis provided on these topics. The Board asked that cash flow hedge accounting be inserted into the paper as a convergence issue and that the FASB be asked to consider the IFRS requirements.

However, the Board expressed its frustration in that the differences highlighted indicated the need to not only improve the current financial instruments standards (IAS 39 and FAS 133 - the US GAAP equivalent) but also to simplify them. Some Board members believe the IASB and the FASB should work more closely and concentrate on the fundamental issues of financial instrument accounting and deal with those issues so as to eliminate the differences and inconsistencies that arise in the detail of the Standards. One of the fundamentals given as an example was whether or not all financial instruments should be measured at fair value; agreeing on this point would allow the Board to simplify the requirements of financial instrument accounting.

FASB staff agreed with the comments made (via video link) and indicated that the same issue would be discussed with the FASB on 16 March. The IASB suggested that these issues be discussed at the joint meeting of the two Boards in April.

Short-term Convergence – Income Taxes

At its January 2005 meeting, the Board decided to consider whether to include in IAS 12, guidance on certain areas that are covered in SFAS 109. The staff recommended that guidance on the following areas be included in IAS 12:

• computation process for determining deferred taxes
• special deductions
• alternative minimum taxation requirements
• impact of a change in an entity's tax status on current and deferred taxes - the timing of recognition of the tax effects of a change in tax status
• measuring the realisability of deferred tax assets
• allocation of current and deferred taxes for a group that files a consolidated tax return.

The staff did not recommend the inclusion of guidance on the following areas:

• income statement recognition requirements following a business combination
• regulated entities

Generally, the Board agreed with the staff recommendations for the reasons outlined in the Board papers.

The Board considered the difference in approach between the IASB and the FASB as regards use of the distributed or undistributed rate of income tax. The Board decided to discuss this issue at the joint meeting of the two Boards in April. Some Board members tentatively indicated that they were not convinced with the FASB position (the distributed rate approach).

Segment Reporting

The staff recommended an amendment to the proposed new IFRS for segment reporting to extend the scope so as to include non-public entities. The Board disagreed with this proposal on the basis that it would consider this scope issue when it deals with the NPAE project.

The Board agreed with the staff two other recommendations, which were that:

• the wording for the capital expenditure of the new IFRS should have the same approach as that of the SFAS 131, but should be expressed in terms already used in IFRSs; and
• requirements for interim period segment information should be included in IAS 34 by means of a consequential amendment of the proposed IFRS on segment reporting.

Wednesday 16 March 2005

Fair Value Option

The notes from this day's meeting were compiled based on a telephone link that was not always very clear. Technical problems did not allow us to listen to some of the discussion. No Board decisions were made during any of the sessions.

Insurance Session

There was general support for the latest draft of the restricted fair value option in comparison to the first draft of the same. Some participants made the point that they preferred the original unrestricted fair value option although they could work with the restricted version.

Some participants congratulated the IASB for listening to responds and developing the revised approach.

Various comments were made regarding detailed issues related to the fair value option, which suggested that there would be some difficulty in applying the new approach to certain specific situations, but it did not seem as though those challenges would undermine the proposals.

Some participants suggested that where the unrestricted fair value option had been applied, that for those instruments, entities should be allowed to continue with that designation after the new approach becomes effective so as not to create a mismatch going forward.

The IASB staff provided an overview of the discussions regarding the transitional provisions agreed upon by the Board (see notes from 15 March 2005 Board meeting).

Banking Session

There was general support for the new approach as drafted. Participants encouraged the IASB to proceed with the finalisation of the restricted fair value option as currently drafted subjected to any minor editorial amendments.

The point was made that in South Africa, the unrestricted fair value option has been applied already for some time and that an assessment of the instances in which it had been used indicated that use of fair value measurement would continue under the restricted option. Consequently, there was general support for the proposal on that basis.

There was some discussion of the detailed issues related to the proposal with some participants requesting additional guidance to cover areas of application difficulty.

Other Session

The point was made as to why if an entity manages its financial instruments on a fair value basis it should not be required to use fair value accounting (not just an option to do so, or a restricted one for that matter).

Concern was raised regarding the words 'significantly reduces' in paragraph 9(b)(i) of the proposals as it is not clear on what basis this would be measured - that is 'significantly reduces' in comparison to what? In the same paragraph, the notion of 'an accounting mismatch' is introduced where as in the Basis for Conclusions, the notion of a mismatch in an economic hedge is discussed. The issue raised was whether these two notions are supposed to refer to the issue, and what that issue really is.

It was clarified that on first-time adoption of IFRS, an entity can designate any instrument for fair value measurement under the new approach, not just new instruments arising after first-time adoption.

Board session

After the round-table sessions, the Board convened to discuss and summarise the issues raised as well as to map out the way forward. The following issues were identified for consideration:

• Transition problems particularly for entities subject to the 'carve out'.
• What is an accounting mismatch in comparison to what is a mismatch of an economic hedge? The point was made that guidance could be drafted on the basis of clarifying that an accounting mismatch is a broader concept than just the mismatch in an economic hedge. In addition, the Board would be careful not to introduce a type of effectiveness test to this area of IAS 39.
• The meaning of a 'significant reduction' in a measurement or recognition inconsistency.
• Can an entity designate or de-designate into or out off the fair value through profit or loss category?
• There was a request for guidance on the level of documentation that would be required to fulfil paragraph 9(b)(ii) as regards a 'documented risk management or investment strategy'. The Board indicated that such documentation would not be at the same level required for hedge accounting.
• Whether the fair value option can be applied to a component of a financial instrument (for instance, interest rate risk).

Regarding some of those issues, the Board seemed to identify the need for additional guidance on how to tackle specific issues facing preparers as the underlying concerns. The staff was requested to formulate proposed solutions for the Board to consider at the April meeting.

Thursday 17 March 2005

Puttable Instruments

Background

The Board considered the issue of financial instruments that are puttable at a pro rata share of the fair value of the residual interest in the issuer. An example would be an open ended mutual fund, which gives unit holders the right to redeem their interests in the enterprise at any time for an amount of cash equal to their proportionate share of the net asset value of the entity.

The Board noted that financial instruments puttable at fair value are classified as liabilities under IAS 32, but this gives rise to strange accounting whereby the fair value of the entity differs from the reported carrying amount of the entity's net assets, for example, because of unrecognised assets (such as goodwill) and the measurement of some assets at cost.

At its July 2004 meeting, the Board rejected two possible solutions to this issue. The rejected options were:

• to continue to classify these instruments as liabilities but amend their measurement so that changes in their fair value would not be recognised; and
• to separate all puttable instruments into a put option and a host instrument.

The proposal

The Board's proposed solution is an amendment to IAS 32 to classify puttable instruments at fair value as equity. The proposed amendment will allow the entity to have other instruments classified as equity so long as the instruments rank above the puttable instruments and do not have an interest in the residual net assets of the issuer.

A board member pointed out that this solution would mean, for example, that 10-year bonds puttable at fair value are classified as equity, which is not really an acceptable answer. Whether the words of the proposal actually implied this, however, was debatable according to other board members.

Treatment of mandatorily redeemable instruments was considered due to feedback indicating that there is some confusion over whether 'puttable instruments' include puttable instruments with a fixed term.

IAS 32.18(b) suggests that a 'puttable instrument' does not include an instrument mandatorily redeemable on a fixed date. This contrasts with IAS 32.BC7, which argues that it makes no difference whether an instrument is puttable on only one date or on a variety of dates for deciding its classification as a financial liability. The latter view is the basis of the proposal.

As per the proposal, there are many examples of fixed period activities where the equity holders are sharing the residual risk of the activity. In the present case, allowing for a fixed date redemption should not increase the risk of financial engineering because the redemption event must be the same for all of the instruments.

Therefore the proposal suggested a consequential amendment to the definition of 'puttable instruments' in IAS 32.18(b) to clarify that the term 'puttable instrument' includes puttable instruments that have a fixed term such as mandatorily redeemable with a fixed term.

The Board accepted the need for guidance but raised several points for consideration:

• An entity could potentially end in a negative equity position if it has puttable options on equity also classified as such.
• The proposal was too rules-based, and could, therefore still lead to financial engineering.
• The FASB and the IASB are currently working on a project which considered classification between debt and equity issues. This proposal is not consistent with FASB's thinking so far.
• Perhaps the amendment should wait until the debt vs. equity project is finalised, or should be included in that project rather than considered separately.
• Why should only the lowest ranking classes apply the options? What if they were all similar, except for the redemption feature? There is no guidance in the proposal on which rank higher.

Staff were instructed to extend the scope to consider:

• Puttable minority interests.
• Partnership entities.
• Limited life entities.
• Different classes of shares.

Also, staff should consider the FASB project on debt vs equity.

Financial Guarantees Contracts and Credit Insurance

Background

In previous meetings, the topic of whether accounting for financial guarantee contracts should be in accordance with IAS 39 or IFRS 4 has been discussed at length, with different possible approaches considered. However, the costs and benefits of this project, had in the past, led to a proposal to drop the project. However, the project was re-discussed by the Board.

The approach considered was to apply IFRS 4 if certain 'insurance' characteristics are significant, otherwise default to IAS 39.

The insurance characteristics are those that are commonly found in credit insurance contracts, but less commonly found in financial guarantees issued by banks; and those that generate accounting issues that are difficult to resolve in the short term (eg regular premiums, subrogation rights, significant origination costs, participation features).

The proposed features are as follows:

• Relatively significant direct acquisition costs.
• The overall final premium for the contract can be determined only at the end of the contract period because the contract contains:
  • profit sharing features or premium adjustments based on experience.
  • discretionary participation features (as defined in IFRS 4).
  • a method for determining the premium that depends on the total sales for the period.
• The premium is paid in instalments over the term of the contract rather than at inception.
• Payments to the counterparty are reduced by deductibles.
• Reinsurance contracts may be available to mitigate risk.

Whilst several Board members still believed the project should be dropped, the following reasons to keep the project were raised:

• It deals more with accounting issues (than contract details), which is useful.
• It gives guidance to non-insurance companies on how to account for guarantees.
• If dropped, entities will revert to the guidance given by the local regulators, which vary all over the world.

• More rigorous criteria (the current insurance characteristics noted above are too open). Wording to be amended to try and push banks into applying IAS 39, and insurance companies towards IFRS 4.
• Disclosures in the respective standards to be followed. (The original proposal was to have a catch all disclosure regardless of which standard was applied).

The possible exemption for inter-company guarantees is to be re-discussed at the next meeting.

IFRIC Update: Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies

At its meeting in February 2005, the IFRIC decided to issue its Interpretation Applying the Restatement Approach under IAS 29 Financial Reporting in Hyperinflationary Economies, subject to additional clarification and editorial changes.

The final Interpretation as approved by the IFRIC was tabled, and the IASB approved it subject to certain additional clarifications and editorial changes.

Business Combinations II – Purchase Method Procedures

FASB staff presented, by video link, the issue of the comment period and effective date for both the business combinations and non controlling interests Exposure Drafts.

Normally, comment periods for IASB exposure drafts have been 90 days, with 20 days given to non English speaking countries in order to give them time to translate the drafts. However, the complexity of the ED and the time of year it is issued (to take into account holidays) may lead to a shorter or longer period. After some discussion, the Board tentatively agreed the comment period for Business Combinations should be 120 days, which would include the 20 days for countries to translate the standard. The FASB tentatively agreed that this would work, and could do the same for the non-controlling interests document.

With regards to the effective date, this was the subject of some discussion. The proposed deadline for a finalised standard is June 2006, and the effective date of 1/1/07 was considered. However, one board member felt 6 months was too long a lead time, and another thought this would not be a good message to be sending out. Another proposal was that the effective date should follow fiscal years, however, one board member pointed out that it is impossible to predict when the deliberations would conclude, and when a standard would be finalised, and therefore suggested that it would be better to include in the draft an effective date of X months after the issuance of the standard.

The Board tentatively agreed to include an effective date of 3 to 6 months after issuance of the standard.

Liabilities and Equity

The FASB presented to the IASB the approach being developed by the FASB regarding the accounting for instruments that could potentially be classified as liabilities or equity. The Powerpoint presentation is available on the IASB's website in the observer notes section and will be posted to FASB's website in due course.

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