21-25 February 2006, London

Tuesday 21 February 2006 (afternoon only)

Short-term Convergence: Income Taxes

Exemption related to investments in subsidiaries, associates and joint ventures

The Board discussed a staff proposal that the exception from recognising deferred taxes on undistributed earnings of foreign subsidiaries and joint ventures currently proposed in the draft ED be changed to an exception for subsidiaries and joint ventures in jurisdictions in which intragroup distributions have taxable consequences. This proposal was made as a result of an analysis of costs and benefits undertaken by the staff.

The Board disagreed with the staff proposal, which would create rather than remove an IFRS/US GAAP difference. The Board did agree to ask a question in the Invitation to Comment accompanying the ED about whether it had reached the right conclusion on removing the exemption currently in IAS 12 paragraph 39.

Transition

The Board discussed staff proposals for transition. The Board modified the staff proposals such that there would be two sets of transitional requirements, depending on whether the entity was an existing IFRS user or a first-time adopter.

(a) Existing preparers

The Board agreed that existing users be required to apply the amendments to the assets and liabilities in the opening balance sheet for the first period starting after the publication of the standard and to all events and transactions thereafter. In applying the amendments to the assets and liabilities in that first opening balance sheet:

• i. a re-analysis of the cumulative amounts recognised through profit or loss or directly in equity should not be allowed and
• ii. assets and liabilities that currently fall under the initial recognition exemption should be treated as if they had been acquired for their carrying amount at the balance sheet date. In other words they would be grossed up to create (i) a new carrying amount and (ii) a deferred tax balance calculated in accordance with IAS 12 with the sum of (i) and (ii) equalling the previous carrying amount.

(b) First-time adopters

The Board modified the staff recommendation such that first-time adopters whose date of transition to IFRSs is later than a specified date shortly after the publication of the final standard should apply the amendments retrospectively except that:

• i. the requirements for the allocation of tax across components of profit or loss and equity should be applied prospectively to events and transactions after the date of transition to IFRS. The cumulative tax effect of transactions recognised directly in equity is also recognised in equity on the transition date and
• ii. the carrying amount of assets and liabilities that would currently fall under the initial recognition exception is determined as if they had been acquired for their carrying amount at the balance sheet date. In other words they would be grossed up to create (i) a new carrying amount and (ii) a deferred tax balance calculated in accordance with IAS 12 with the sum of (i) and (ii) equalling the previous carrying amount.

The Board also agreed that first-time adopters whose date of transition to IFRSs is before date specified above should apply the amendments retrospectively except in those situations in which data is required before the date of adoption that would have required assumptions using contemporaneous judgements. In such situations, the current version of IAS 12 would be used. This approach is similar to that adopted in the transitional approach to amendments to IAS 39.

Board members were asked whether any of them would be presenting Alternative Views in the ED. Two Board Members stated that they might do so, but that both would read the draft ED before committing themselves.

Uncertain tax positions

FASB staff led the IASB through the FASB's recent discussions and redeliberations of their ED Accounting for Uncertain Tax Positions-an interpretation of FASB Statement No. 109, issued in July 2005.

Scope

No discussion.

Recognition

The IASB noted that during their redeliberations, the FASB had reduced the recognition threshold to more likely than not. (The term more likely than not in US GAAP is similar to the term probable as used in IFRS.) The IASB welcomed that decision, which resulted in a common recognition point for all tax assets.

Measurement

The IASB had a wide-ranging discussion on a possible approach to measurement of uncertain tax positions. There was no real conclusion, except that the FASB are interested in the IASB's 'expected outcome' model being developed in the revisions to IAS 37.

Subsequent recognition and measurement

The Board noted that during their redeliberations that the FASB had concluded that the best estimate at the reporting date would be based on all information available to management at that reporting date. Absolute certainty of the resolution of the tax position or finality of the outcome was not necessary. However, changes in estimates about recognition and measurement would be based on new information available to the enterprise, not on a new interpretation of old or previously available information.

The IASB voted (8 in favour; 2 opposed; 2 abstained) to incorporate the FASB's conclusion (in particular that any subsequent recognition and measurement changes be based on new information) in the forthcoming IASB ED.

Changes in judgement

The IASB noted that during redeliberations, the FASB concluded that interim period accounting should follow the guidance in Opinion 28 and Interpretation 18, which currently prescribes changes in judgments in interim periods.

Interest and penalties

The Board noted that during redeliberations, the FASB had concluded that interest and penalties should be recognised in the period they are deemed to be incurred, based on the provisions of the tax law. Interest should be accrued on the full difference between the tax return and the financial statements. In addition, the classification of interest and penalties should be treated as an accounting policy election, and that the election should be disclosed as well as the amount of interest and penalties recognised in the financial statements.

Several Board Members voiced objection to some or all of the FASB's conclusions. However, after a vigorous debate they agreed to include the FASB's conclusions in the IASB ED.

Classification

The Board noted that the FASB had affirmed their conclusions in their ED that the difference between the amounts recognised in the financial statements, and the amounts reported in the tax returns should be classified as a current liability to the extent that amounts are anticipated to be paid within the next 12 months or the operating cycle, if longer.

Additionally, amounts would not be classified as a deferred tax liability unless they resulted from a taxable temporary difference, as defined in Statement 109.

The Board appeared to support a similar approach in the forthcoming IASB ED.

Transition

The Board noted that the FASB had concluded that transition should be made using the cumulative effect of a change in accounting principle. The change in net assets as a result of applying the provision would be treated as an adjustment to the beginning balance of retained earnings. Retroactive application would not be permitted.

The Board agreed to adopt the same approach in their ED.

Effective date

The IASB's ED would not include a proposed effective date.

Business Combinations Phase II

The IASB staff outlined a slightly modified schedule from that proposed in January 2006. This was accepted.

Joint Ventures

The Board agreed that the formation of a joint venture is, by definition, not a business combination. None of the parties to a joint venture have the ability to control the joint venture. The ED of Amendments to IFRS 3 defined a business combination in terns of 'a transaction or event in which an acquirer obtains control of one or more businesses.'

The Board supported a staff recommendation that they should not seek to develop a common definition of a joint venture as part of the Business Combination project; nor should the scope of this project be extended to accounting for joint ventures.

Definition of a business combination

The Board discussed alternatives put to them by the staff related to the definition of a business combination. Board Members debated the merits and faults of the alternatives proposed by the staff. The Board agreed to explore, as its preferred option, whether it would be possible to develop a robust definition of a business combination that is principles-based and would capture those transactions the Board intended it to. (The Board acknowledged this would be a fairly long-term project.) As a fall-back position, the Board agreed that the final Standard should retain the Business Combinations II ED definition of a business combination and provide supplemental guidance that clarifies that particular transactions for which some argue do not result in one entity obtaining control of another are still business combinations.

Board members stressed the need for clarity between acquiring control and a change in control, noting that a change in control need not be an economic event.

Government Grants - future status of the project

The IASB discussed the current status of the project to revise IAS 20 Accounting for Government Grants and Disclosure of Government Assistance. In addition, they discussed a request from the national standard-setter in New Zealand that IAS 20 be withdrawn.

Although some Board members thought that withdrawing IAS 20 would be a step in the right direction, the majority thought that the accounting vacuum that it would leave behind was not desirable. Nor was the accounting for grants in IAS 40 Agriculture thought to be necessarily superior.

The Board noted that certain issues related to recognising and measuring obligations under grants with conditions attached are similar to issues related to recognising and measuring provisions under IAS 37. Because the Board is currently reconsidering IAS 37 as part of the Business Combinations Phase II project, it decided to defer work on the IAS 20 project pending final decisions on revision of IAS 37, which are expected in mid-2007 (8 in favour; 6 opposed). This decision effectively means that work on accounting for emission trading schemes will also be deferred.

Wednesday 22 February 2006

Financial Instruments Puttable at Fair Value

The Board continued its discussion from December 2005 on the proposed amendments to IAS 32 Financial Instruments: Presentation. At the previous meeting the Board decided that financial instruments puttable at fair value and certain obligations arising on liquidation would be classified as equity if certain conditions were met. Under those conditions, in general, shares, partnership interests, and minority interests puttable at fair value, and shares in limited life entities, would generally be classified as equity. At the February meeting the Board was asked to decide on proposed disclosures.

The staff proposed that four categories of new disclosures be added to IAS 1 and not IFRS 7. The Board agreed to the proposal.

The four proposed categories of new disclosures, and Board decisions on each, are as follows:

Disclosure by limited-life entities

As IAS 1 does not currently require limited-life entities to disclose the fact that they have a limited life, the staff proposed adding an explicit requirement by amending paragraph 126 of IAS 1.

The Board agreed.

Disclosure of reclassifications

The staff proposed that disclosures about the nature, amount, and timing of reclassifications of instruments between liabilities and equity, and the reasons therefor, be added to IAS 1.

No discussion. The Board agreed with the staff proposal.

Capital Disclosures

Staff proposed certain amendments to the capital disclosure requirements in paragraph 124 of IAS 1 so that an entity will disclose enough information about financial instruments puttable at fair value to enable users of financial statements to evaluate the entity's objectives, policies, and processes for managing capital.

The Board generally agreed with the staff proposal, though they asked the staff to do some additional research regarding one of the proposed disclosure items.

Disclosures about fair values

Staff proposed:

• disclosures about an instrument's fair value disclosures should be presented in a way that permits comparison with the instrument's carrying amount;
• disclosure of information on how fair value was determined; and
• additional disclosure items for companies who determine fair value based on a formula.

The Board discussed the cost of compliance against the benefits of the user if requirement was set out as in the proposals.

The Board decided to require the disclosures proposed by the staff, but that those disclosures would be required only in an entity's annual accounts, not in its interim accounts.

IFRS for Small and Medium-sized Entities (SMEs)

At its January 2006 meeting, the Board had its initial discussion of a preliminary draft of an Exposure Draft (ED) of an International Financial Reporting Standard for Small and Medium-sized Entities (SMEs). Discussion of that draft continued in February.

On 30-31 January 2006 – subsequent to the Board's January meeting – the IASB's Working Group (WG) on Accounting Standards for SMEs met in London to discuss the draft ED. A preliminary summary of the views and recommendations of Working Group members arising from their January 2006 meeting was provided to the Board in advance of the Board's February meeting. In reviewing the draft ED, Board members considered the WG's recommendations.

The Board made the following decisions on significant issues:

Mandatory Fallback

The Board discussed the WG recommendation of a stand-alone, self-contained IFRS for SMEs - with designated fallbacks to full IFRSs on specific matters, but not a general mandatory fallback. After discussion, by vote of 11/3, the Board reached the following view on this issue:

• Standards in full IFRSs that address transactions, events, or conditions commonly encountered by SMEs should be included in the IFRS for SMEs, either directly or by cross-reference back to the full IFRS. Conversely, standards relating to transactions, events, or conditions not generally encountered by SMEs should not be included in the IFRS for SMEs. The goal would be to minimise the circumstances in which an SME would need to fall back to full IFRSs.

• If the IFRS for SMEs does not specifically address a transaction, event, or condition, an SME should be required to look to the requirements and guidance elsewhere in the IASB Standard for SMEs dealing with similar and related issues (that is, select an appropriate accounting policy by analogy). Failing that, the SME should be required to look to the requirements and guidance in IFRSs and Interpretations of IFRSs dealing with similar and related issues.

Disclosures

Put all disclosures in a separate section.

Glossary

Define all terms in a glossary at the end of the IFRS for SMEs. Highlight defined terms the first time they are used in each section.

Preface

A short preface to the IFRS for SMEs should be included, explaining the nature of IFRSs for SMEs. This material is now in the Introduction section of the draft ED.

Basis for conclusions

The Exposure Draft of the IFRS for SMEs will include a basis for conclusions explaining the basis for any changes from full IFRSs.

Scope

Definition of SMEs should be included in a scope section. This is now included in the Introduction section of the draft ED.

IASB Framework

The draft ED currently includes the objective of financial reporting, qualitative characteristics, definitions of financial statement elements, and recognition concepts from the IASB Framework. This section should be retained.

Pervasive principles

The draft ED currently includes certain pervasive measurement principles intended to be guidance if the IFRS for SMEs does not specifically address a transaction, event, or condition encountered by an SME. Some Board members favoured retaining these pervasive principles, with modifications. Others favoured deleting them. After discussion the Board asked the staff to prepare revised pervasive principles for consideration at a future meeting.

'True and fair override'

The Board decided that a 'true and fair override' similar to that in paragraph 17 of IAS 1 should not be included in the IFRS for SMEs. However, a question about whether to do so should be included in the invitation to comment on the exposure draft.

Use of IFRS for SMEs by small listed entities

The Board believes that full IFRSs are appropriate for an entity whose securities are publicly traded. This should be explained in the basis for conclusions. A jurisdiction that believes that the standards in the IFRS for SMEs are appropriate for small listed entities could adopt those standards, even word for word, as their national standards for small listed entities, in which case the financial statements would be described as conforming to national GAAP.

Combined statement of income and retained earnings

The IFRS for SMEs will provide that if the only changes in an SMEs equity during a period arise from net profit or loss and payment of dividends, the SME may present a combined statement of income and retained earnings in place of separate income and equity statements.

Cash flow statement

The IFRS for SMEs will illustrate only the indirect method. An SME electing the direct method would be cross-referred to IAS 7 for guidance.

Consolidation

An SME group (parent and one or more subsidiaries) will be required to prepare consolidated financial statements. The IFRS for SMEs will include only the basic principles for consolidation, with a cross-reference to IAS 27 for detailed guidance.

Combined financial statements

Guidance should be added regarding preparation of combined financial statements of two SMEs controlled by the same shareholder(s).

Correction of errors

Retrospective treatment should be the principle, as it is in IAS 8. Adjust of retained earnings if retrospective restatement is impractical.

Investments in associates

Allow an SME to elect either (a) the cost method with impairment or (b) fair value through profit and loss in addition to equity method. Cross-reference to IAS 28 would replace the details of the equity method.

Investments in joint ventures

Allow an SME to elect either (a) the cost method with impairment or (b) fair value through profit and loss in addition to (c) equity method and (d) proportionate consolidation. Cross-reference to IAS 31 would replace the details of methods (c) and (d).

Investment property

The section on investment property should be brief. A simple definition of investment property should be included in the glossary. The IAS 40 accounting policy choice of (a) cost-depreciation-impairment model and (b) fair value through profit and loss model should be retained. An SME electing (a) should be referred to the property, plant, and equipment section of the IFRS for SMEs for guidance. An SME electing (b) should be referred to IAS 40.

Business combinations

SMEs need not separate out acquired indefinite-lived intangible assets other than goodwill - may include in goodwill.

Goodwill and indefinite-lived intangible assets that are separated from goodwill

Do an impairment test only if there is an indication of impairment. The Board did not support an amortisation approach.

Leases

Retain the distinction between operating and finance leases.

Assets held for sale

No need for a separate section in the IFRS for SMEs. Include in the section on property, plant, and equipment.

Provisions

Consider whether this section can be simplified. Consider which of the examples in the appendix to IAS 37 should be included in the IFRS for SMEs. Address restructurings and onerous contracts as examples.

Equity - redeemable and puttable capital

The IASB is developing a general exposure draft on this topic. It is a transaction frequently encountered by SMEs. Include the general exposure draft principles in the IFRS for SMEs. Also include the guidance on cooperatives in IFRIC 2.

Next steps

The Board will continue its consideration of the remaining sections of the draft ED at its March 2006 meeting. Staff plans to bring a revised draft to the Board at the May 2006 meeting, including the two sections (financial instruments and income taxes) that are not included in the current draft.

Revenue Recognition

Wholly executory revenue contracts

The objective of the Board's discussion was to debate how the allocated customer consideration approach would be applied to wholly executory (or wholly unperformed) revenue contracts. First, the Board debated whether assets and liabilities arise in an executory contract and after confirming its earlier decision that rights and obligations do arise (and therefore assets and liabilities) consistent with its earlier decisions, the alternatives identified by the Staff were discussed. The alternatives were discussed in the context of assets and liabilities that are fungible and those that are unique.

Alternative 1 - For fungible assets, the assets and liabilities arising for each counterparty would be set-off on the basis that 'net settlement' could be achieved. For non-fungible (unique) assets and liabilities, set-off would not be permitted.

Alternative 2 was sub-divided into two components:

• Alternative 2 - No assets or liabilities arise therefore the distinction between fungible and non-fungible is irrelevant.

• Alternative 2 'Prime' - If the contract requires a unique performance (i.e. non-fungible) only a combined asset or liability arises. It was not clear what the treatment of fungible items would be under this alternative.

The Board expressed general agreement with the analysis performed by the Staff. Some Board members reiterated their view that for an executory contract, if a court can force the parties to perform, each party to the contract has either an asset or a liability arising from a right or an obligation to receive / deliver. The Board discussed briefly whether the right / obligation should have the same value as the item that is the subject of the contract (put differently, does the right to receive a motor vehicle have the same value as the motor vehicle itself?) but deferred that issue to a subsequent meeting when the Board discusses measurement. It was pointed out that in some jurisdictions within continental Europe (for example) the functioning of the law regarding the various rights and obligations that arise from a contract and those laws that apply to the actual performance have resulted in constituents approaching and thinking about the economics of such transactions differently.

The Board decided, consistent with its earlier decisions, that only Alternatives 1 and 2 'Prime' should be explored further.

Accounting for performance

The Board considered a paper presenting two revenue recognition methods: the extinguishment-based method (EBM) and the performance-based method (PBM). The paper went on to (a) compare and contrast those two methods and (b) evaluate each method against the conceptual criteria in FASB Concepts Statement No. 2 and the IASB Framework.

The PBM is a proportionate-performance-type method, and the EBM is a hybrid of a proportionate-performance-type and a sales-type method. Under the sales-type method, recognition is delayed until performance is complete or substantially complete. The Board indicated a preference for the performance-based method but asked the Staff to work through an example that considers the manufacture over a two year period of an item such as a yacht that separately illustrates the effect of milestone payments, a non-refundable deposit and a scenario where the contract requires no payments until delivery.

Amendments to IAS 37 - Comment Letter Analysis

The Board issued its Exposure Draft Amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets and IAS 19 Employee Benefits (ED) on 30 June 2005. The comment period ended on 28 October 2005 and the Board received 123 comment letters.

During this session, the Board considered the main points raised in the comment letters and as a result, were asked to:

• (a) affirm the project objectives;
• (b) approve the initial staff assessment of matters for which the staff:
  • (i) will undertake additional research and ask the Boards to reconsider, or
  • (ii) expect to present to the Board for reaffirmation without additional research; and
• (c) approve the staff's provisional project plan for the redeliberations.

The discussion began with an overarching discussion about general comments received in a number of the comment letters. The point was made that it appeared that the objectives and direction of the IAS 37 project had been misunderstood.

The Board reiterated its view that the amendments to IAS 37 did not amend the requirements of the current Standard or the current version of the Framework. Instead, the amendments were clarifications and a logical extension of the current IAS 37 Standard. The Board went on to point out that the comments received reflected an incorrect interpretation and application of IAS 37 as it currently stands. Board members acknowledged that the current Standard was a compromise pronouncement that did not properly articulate certain principles therefore it does not always read as it was intended. The Board views the amendments to IAS 37 as clarification of those ambiguities.

The Board pointed out that the amendments project should not be viewed as a convergence project between IAS 37 and FAS 5, because these two pronouncements are fundamentally different. Consequently, the Board decided that this project should be viewed on a standalone basis due to the high profile that it has taken on amongst constituents.

The Board affirmed its intention to continue with the project because it was clear that its reasoning in that project was starting to reap benefits in other projects as well - it has helped Board members to think about and understand other difficult issues. Consequently, the Board believes its decisions in this project reflect superior and principled thinking that is applicable to other projects. The Board suggested a communication strategy to help constituents understand this project (for instance, an article with the content presented to the World Standard Setters group).

The Board discussed briefly, how it intends to approach the roundtable discussions by making sure that there is wide geographical coverage.

With minor clarification, the Board approved the staff plan of issues to be reconsidered and those that do not require reconsideration (re-affirmation instead).

It was pointed out that the current project timetable runs until May 2007 and may change depending on progress.

Amendments to IAS 19 - Comment Letter Analysis

With minor clarification, the Board approved the staff's plan of issues to be reconsidered and those that do not require reconsideration (re-affirmation instead).

Thursday 23 February 2006 (afternoon only)

Conceptual Framework

The Board continued its discussion of the definitions of elements of financial statements, focussing on two specific items:

• The definition of assets, which the Board had discussed at previous meetings.
• The definition of liabilities, for which this meeting is the Board's initial discussion.

Definition of Assets

In December 2005, the Board had adopted the following working definition of an asset:

An asset of an entity is a present right, or other access, to an existing economic resource with the ability to generate economic benefits to the entity.

• Associating assets with a particular entity.
• Present right or other access.
• An existing economic resource.
• The ability to generate economic benefits.

Associating assets with a particular entity

The staff proposed that the definition should continue to refer to an asset 'of an entity' and to the ability to generate economic benefits 'to an entity'.

Some Board members expressed concern that referring explicitly to an entity would exclude individuals from the definition. The staff commented that they had viewed entity to also include individuals.

Some Board members also commented that referring to an entity two times in the definition is redundant.

The Board agreed that the staff should continue its work on this part of the definition.

Present right or other access

Next the Board discussed the clause 'present right or other access' in the working definition. The staff had proposed to change this to 'a present right, or other present privilege, of the entity'.

The Board discussed this change and considered whether the change to 'privilege' would be too wide. Board members were concerned that widening the scope too much would affect whether an asset would actually be capable of generating economic benefits. Some Board members questioned whether the word 'privilege' would also capture the word 'right' and therefore make it redundant in the definition.

No decisions were made, and it was agreed that the staff should continue working on this part of the definition.

An existing economic resource

The working definition refers to an 'existing' economic resource. Staff proposed that 'existing' should be deleted because it appears to exclude items such as a forward contract to buy something that does not exist yet.

Some board members disagreed with this proposal, suggesting that an entity has an existing economic resource by receiving a right to lock in a price in the future. Other Board members supported the staff's proposal because retaining 'existing' might suggest that rights to future economic benefits were excluded from the definition.

The Board generally agreed that the definition with or without the word 'existing' would need amplifying text to prevent misunderstanding.

The ability to generate economic benefits

The Board discussed the words 'the ability' when it came to generate economic benefits.

Board members were concerned that this wording could permit recognition of a wide range of things as assets that are not intended to be included in the definition.

The staff had proposed to change the wording to resources 'that are capable of generating' economic benefits. Some Board members were also concerned that these words might suggest, for example, that out-of-the-money options are not assets. In the view of these Board members, the word 'capable' suggests that an item that may provide benefits in the future but does not provide benefits today cannot be an asset.

The Board commented that the definition must be able to capture economic benefits generated today, as well as economic benefits generated in the future.

The staff proposed to specify that economic benefits refer to 'direct and indirect' benefits. The Board did not support this proposal.

The staff agreed to clarify further the proposed wording.

Other characteristics of existing definition of assets

The staff had proposed to specify separately that cash is an asset. The Board discussed this briefly and concluded that the definition of an asset should be able to encompass cash without having to specify separately that cash is an asset.

The Board had a short discussion on stand-ready assets. However, no decisions were made. Staff will bring a proposal to the Board in the future.

Liability Definition

This was the Board's first discussion of the definition of liabilities. Staff proposed the following working definition of liabilities:

Liabilities of an entity are its present obligations to other entities that compel potential outflows or other sacrifices of economic benefits.

The staff presented a paper that identified similarities and differences between definition of liabilities in the IASB Framework and the FASB Concepts Statements. The paper also considered definitions adopted by a number of other standard setters.

The staff indicated that its approach to developing a liability definition involved (a) mirroring the asset definition and (b) relying on notion of economic benefits in the definition of an asset. Staff did not explore a liability definition that was independent of the asset definition.

The Board discussed this briefly and expressed agreement with the staff's approach.

The working definition of a liability uses the term 'compel' to describe an obligation that gives rise to a liability.

Board members discussed the use of 'compel'. Some were concerned that this could imply that a liability would only be recognised and measured based on what an entity would pay, rather than what the entity is obliged to pay.

The Board discussed compulsion in the context of legal, equitable, and constructive obligations. Board members discussed different types of compulsion – such as moral, legal, and economic compulsion – and considered this in conjunction with different examples set out in the staff paper. Some members again expressed their concern that nothing would be recognised if compulsion is the primary criterion for recognising a liability.

The staff noted that its definition of a liability requires an obligation to another entity. Board members agreed with this statement, but added that this should not mean that the counterparty necessarily needs to be identified before an entity will recognise a liability.

The Board concluded discussion by stating that they were pleased with the material provided by staff and thought that staff had taken the right approach in its initial work on the definitions.

Fair Value Measurement

This was a brief session to inform the Board about recent tentative decisions of the FASB on its fair value measurement standard. No observer notes were provided for this session.

The FASB discussed the fair value hierarchy at its last meeting. FASB's exposure draft had proposed a five-level fair value hierarchy. The FASB has come to the conclusion that it is difficult to distinguish levels two to four in the hierarchy. They have therefore reduced the hierarchy to three levels. The FASB has not made other changes to its proposed fair value guidance.

The staff said that discussion will continue in March.

Friday 24 February 2006 (morning only)

Insurance Contracts Phase II

The discussions were based on agenda papers 10A - 10J.

Contractual cash flows that depend on policyholder behaviour (agenda papers 10A - C)

This discussion centred round an extremely simple example developed by staff of a two-year life insurance policy (see paragraphs 3-5 of the paper). The paper considered four possible presentations of the insurer's balance sheet. The Board agreed in principle with the second approach, whereby all future cash flows resulting from future cash flows from the contract were recognised. It was agreed that the right to benefit under the insurance contract represents an asset to the insurer, and that the asset meets the definition of an intangible asset in IAS 38. The intangible asset would be recognised subject to meeting various recognition criteria. It was generally agreed that the intangible asset was a customer relationship that arises out of a contract. This paper did not address how the asset and liability would be presented in the balance sheet (e.g. gross or net).

Summary of possible accounting approaches (agenda papers 10D - E)

Agenda papers D and E summarised the possible accounting approaches the Board is considering for insurance contracts. The papers were background information for other papers, and the Board was not asked to make any decisions on these papers.

Acquisition costs (agenda paper F)

[There is a small typo in the title immediately preceding paragraph 9 in the agenda paper - the title should read 'Acquisition costs and current exit value']

Again, the discussion centred round an example developed by staff. In the example, an insurance contract generates policyholder benefits with a present value of CU 900. The insurer has to incur costs of CU 100 to originate the contract, so will charge the policyholder at least CU 1,000. The contract has a single premium of CU 1,000 which is received at inception. The present value of the insurer's obligation is CU 900 (not CU 1,000). This is true in both the prospective and unearned premium approaches.

The Board agreed that in this example the insurer's liability is CU 900. They also agreed that acquisition costs should not be capitalised. They are only relevant in that they may be considered by the insurer in setting premiums. Furthermore, if these costs were separately capitalised, this would lead to problems of how to measure the costs subsequent to initial recognition.

The paper explored whether there is merit in separately presenting some other contractual rights or obligations, but the Board was not asked to make any decisions. The paper then considered which costs are acquisition costs. No decisions were made, but there was support for the costs encompassing more than just incremental costs. This is because the pricing of the contracts is a function of the costs incurred by the insurer, who will want to recover more than just incremental costs.

Liability adequacy test (agenda paper G)

Paragraph 10 of the paper summarised when staff determined that a liability adequacy test would be needed. The Board agreed with the conclusions except that many Board members felt that a test would be needed for subsequent measurement of both life liabilities and non-life pre-claims when a current entry value was used as a measurement basis.

Paragraphs 12-21 dealt with risk margins. In the example given in paragraph 14, the Board agreed that the liability determined using an adequacy test should be greater than CU105, although not necessarily CU 113 (as in paragraph 14c)). The measurement should be based on exit-value assumptions. As this represented a substantial change to the proposed model, staff will reconsider this example and re-present it at a later meeting.

Shortfall allocations were not discussed, but the Board did agree with the staff recommendations on subsequent accounting after a shortfall. Broadly, these were that if an insurer uses a current entry value approach for pre-claims liabilities, the liabilities also reflect the time value of money and risk margins. Thus interest should be added over time to the shortfall and the insurer should recognise income as it is released from the risk reflected in the margin in the shortfall. In an unearned premium approach, interest should not be accrued on a shortfall, to be consistent with the fact that interest is not accrued on unearned premium. However, because interest is not added, an additional shortfall may arise when the liability adequacy test is applied again. The Board also agreed that a shortfall should be reversed if it no longer exists.

Gain on initial recognition of insurance contracts (agenda paper H)

No decisions were made by the Board, although it was agreed that further work should be done to explore the consequences of not prohibiting the recognition of net profit on initial recognition. Further, analogies were drawn to IAS 39 and the recognition of day 1 profit. It was generally felt that there should be a principle that is applied consistently across all types of contract.

Non-life insurance contracts - Measurement attribute for pre-claims (agenda paper 10I)

The Board agreed with the staff recommendation that a prospective approach be taken for measuring non-life insurance pre-claims. Staff also proposed that, without creating a specific exception to the prospective approach, for short duration contracts unearned premium may often be a reasonable approximation to a prospective measurement. However, an insurer should not make this assumption without testing. This was discussed by the Board, with some Board members concerned that this would offer no relief to insurers, as in order to determine whether they could use an unearned premium approach, they would also have to measure using the prospective approach. Staff indicated that this was not the intention of the paragraph, and that they would reconsider the wording and bring it back to a later meeting.

The Board agreed that non-life claims liabilities should be discounted using a current discount rate. Project planning (agenda paper 10H)

This paper was not discussed at length. Staff clarified that under the proposed timetable the Board could expect to see a first pre-ballot draft of a discussion paper in July 2006.

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