Monday 18 September 2006
 Insurance Contracts - Phase 2 [Education Session]
Helmut Perlet (representing the CFO Forum), Jerry de st Paer (representing the Group of North American Insurance Enterprises (GNAIE)), and Masaaki Yoshimura (representing four major Japanese life insurers) presented a summary of recommendations those organisations have made regarding the development of an accounting model for insurance contracts.
The representatives made a brief introduction explaining the insurance industry's role in the economy and its objectives for developing a global accounting standard. They then summarised their proposals, which were also presented to the Insurance Working Group in June.
Below we highlight those proposals that were subject to discussion at the Board. A comprehensive list of the proposals made by the insurance industry is in the observer notes available from the IASB Website.
Initial measurement
The insurance industry is proposing that no gains or losses should arise on initial recognition.
The Board commented that this differs from the tentative decision made by the Board that gains or losses can arise on inception if the insurance company makes errors or omissions when pricing their contracts.
Liability measurement
Mr Perlet explained the view of the CFO Forum that the liability on both life and non-life contracts should be discounted to reflect the present value of future cash flows with allowance for inherent risk and uncertainty.
GNAIE on the other hand believes that life and non-life insurance contracts have significant differences that should be reflected in measurement. For most non-life contracts, it would be difficult to predict whether losses will occur, when they will occur, or the amount that should be paid to the policyholder. Their disagreement with an 'exit value' model, which the Board has indicated that it favours, is based on a belief that this value cannot be measured reliably because there is no active market for non-life insurance contracts where values can be obtained. Mr Paer explained that applying discounting to such contracts in many cases would add an element of uncertainty to the liability component that would produce incomparable and generally less useful results.
Board members commented on the model introduced by GNAIE. Many Board members said that it seemed like a step backwards from the current liability measurement model, which is based on 'exit value' and the Framework. It was noted that the model presented by GNAIE would conceptually not be in accordance with the current model applied for pensions in IAS 19 or for liabilities measured under IAS 37.
Separate customer intangible asset
The industry believes that a separate intangible asset should be recognised that represents costs of acquiring the insurance contract, in addition to an intangible representing future payments that the policyholder must make to retain a right to guaranteed insurability.
Board members seemed to have difficulty understanding what would justify recognising two different intangible assets as the policy would only represent one cash flow.
Unbundling
The insurance industry proposes that no underlying financial or non-financial contracts should be unbundled because policyholders view insurance products as one product. Unbundling of contracts would require extensive judgment and is viewed as unnecessary since the industry values all components in a contract on an aggregate level.
Board members discussed this briefly. Some questioned whether bundling when the entity has more than one component would disguise different profit margins.
Participating contracts
The proposal from the insurance industry is that liabilities should be the best estimate of future policyholder benefits. These should be based on assumptions reflecting what the policyholder will receive on the insurance contract. It was also stated that payments, such as dividends, to a policyholder were fundamentally different from dividends paid to equity-holders and should not be included in equity as the insurance company could choose to pay the policyholder without paying the shareholder.
The Board probed the proposal by the industry to understand how the liability is measured. Based on explanations from the insurance industry participants, measurement of the liabilities would depend on what the insurance company would pay to the policyholder rather than what the insurance company is contractually obliged to pay. This differs from the Board's tentative conclusion that the part of the liability that does not represent an unconditional obligation should be recognised in equity.
Consolidations (including Special Purpose Entities) [Education Session]
Staff presented to the Board the application of the proposed consolidation framework to entities that are currently within the scope of SIC 12. The aim of the session was to apply the work to date to common transaction types. No decisions were taken.
Staff's intention is not to have a separate Standard (or Interpretation) for special purpose entities (SPEs). The aim is to have a single consolidation standard that can be applied to all entities. In addition, staff does not intend to define an SPE. Instead, the control model should capture those entities that are controlled through traditional methods, such as voting rights, and those that are controlled through exposure to risks and benefits. It is presumed that those entities with exposure to risk/benefit will generally have control in order to protect their exposure to risk/benefit.
The proposed approach recognises that entities that are not consolidated through voting rights (known as strategic control) may be consolidated through exposure to the variability in the cash flows of the entity. This approach is very similar to FIN-46R in US GAAP. The proposed approach would differ from US GAAP, as bright lines would not be created to distinguish between voting interest entities, variable interest entities, and QSPEs as in US GAAP. The one other significant difference between the approach in FIN-46R and the staff's proposed approach is that under FIN-46R, an entity will consolidate a variable interest entity if it has the majority of the overall variability of the entity, even when the holder may not have exposure to certain assets within the SPE. The staff considered such an approach to be inconsistent with the concept of control, as the entity consolidating may have no ability to control certain assets within the entity. The staff therefore proposed a different approach from FIN-46R in this respect that, in certain cases, would allow a holder of an interest in an SPE to consolidate only certain assets within the vehicle.
The staff described three scenarios: (i) asset backed securitisation; (ii) synthetic lease; and (iii) multi-seller conduit. Staff and Board members discussed those scenarios and how the proposed approach could be applied. It was evident from discussions of these three summarised fact patterns that determining whether consolidation would result, and which factors would lead to consolidation, was very difficult. The staff agreed to spend further time producing a paper that would include the principles of the control model, and how it would be applied to common fact patterns. The aim is to provide many common transaction types that illustrate the factors that would need to be assessed in determining control.
Tuesday 19 September 2006
Amendments to IAS 37
Project plan
The Board reviewed and agreed the project plan for the next phases of redeliberations.
Scope of the proposed amendments to the IAS 37 measurement principle
The Board considered three alternatives proposed by the staff:
- Revert back to the wording of the existing IAS 37 measurement principle (the entity's 'best estimate' of the expenditure required to settle the present obligation at the balance sheet date).
- Reconsider the IAS 37 measurement principle and identify all possible measurement principles and evaluate the relative merits of each principle to determine which is the most appropriate for liabilities within the scope of IAS 37.
- Adopt 'fair value' as the IAS 37 measurement principle (without identifying and evaluating other possible measurement principles)
The Board discussed these alternatives, but concentrated on the first bullet. The Board noted that there was much confusion and misunderstanding – some of it at the Board level – that was unhelpful to constituents. The current IAS 37 model, an expected value model, is not a fair value model – although many of the inputs to the model are the same or similar.
A Board member noted that some of the problem was in the use of terminology such as 'best estimate', which was associated with a traditional notion of a single point estimate. The Board's approach is similar to its approach to insurance, but is complicated because IAS 37 is 'schizophrenic' – combining best estimates with expected values. That is, IAS 37 mis-describes the measurement method. In the view of many Board members, an expected value is the current settlement price using current inputs, not an estimate of the ultimate settlement amount.
The Board approved the first approach.
Reconsidering the existing IAS 37 measurement principle
The Board continued its theme of distinguishing the current settlement vs net settlement. Board members noted that there are several notions of settlement in IAS 37, including settlement with the counterparty and transfer of the obligation to a third party (which may or may not represent an extinguishment). Both are 'settlements' for the purpose of IAS 37, but are not necessarily the same amount. Both are current measures and do not incorporate expected changes in law, technology, etc. Neither represents the value of cash expense expected to be incurred in the future.
The Board confirmed that the measurement principle in IAS 37 is current settlement, not ultimate settlement. They concurred with the staff that there are several opportunities in Standard to improve the explanation of this principle, including changes in terminology and improving the explanation in the Basis for Conclusions.
Will a current settlement principle provide better information?
Much of the discussion in this section revolved around the notion of 'reliable'. The Board noted that the Preliminary Views on the Conceptual Framework (Phase 1) contains a better explanation of 'reliable' than what was available when the ED of the IAS 37 proposals was published. The Board asked the staff to ensure that the redraft of IAS 37 subsequent to the current redeliberations should reflect 'reliable' as used in the Conceptual Framework Preliminary Views.
The Board noted that the current settlement approach looks for the mean of the possible current settlement amounts, not the mode. Thus the amount included in the financial statements is one of a range of possible outcomes, estimated at the balance sheet date, and would change from period to period as information about the inputs changed. The Board acknowledged that there are audit issues surrounding verifiability, but at least the inputs are current inputs, not assessments of future inputs.
The Board agreed with the staff recommendation that there should be an explanation of how a measurement principle based on a current settlement notion provided useful information about liabilities within the scope of IAS 37 in the Basis for Conclusions accompanying any final Standard.
Is more guidance on the IAS 37 measurement principle required?
The Board agreed that more guidance is required to ensure that any final standard could be applied consistently in practice. A Board member suggested that such guidance be included as Application Guidance (that is, mandatory material) and that the staff should limit Illustrative Examples to a minimum (if any).
Other points that were noted included that the choice of the discount rate should be that appropriate to the liability and not the entity's cost of capital or the risk free rate. That is, the discount rate should be related to the credit risk of the obligation, not that of the entity.
Financial Statement Presentation
Financing liabilities and treasury assets
The Board agreed that financing liabilities, treasury assets, and related activities shall be presented gross in the same section in the statements of financial position, comprehensive income, and cash flows.
There was much discussion about the approach being adopted, in particular what the impact of a 'through the eyes of management' approach meant in practice, in particular the extent to which management could include or exclude items from the definition of financial liabilities and treasury assets. Part of the problem was that the Board had not yet agreed the definition of these items. However, the basic approach was agreed.
The Board agreed that financing liabilities and treasury assets should be defined 'narrowly' for the purposes of presentation on the face of the financial statements.
The staff outlined that the IASB and the FASB had similar definitions of financial liabilities and treasury assets but used different methodologies to arrive at them. It would be helpful to constituents to have one approach! The IASB shifted its position in July 2006 and agreed to adopt the 'narrow' definition – one that attempts to define financing liabilities directly. The Standard would directly describe the amounts to be reported in the financing section, as opposed to giving a broad definition and describing allowable exclusions. Board members noted that this approach provides more flexibility.
Strategic investments
The Board noted that the Joint International Group on Financial Statement Presentation (JIG) had not supported a category of 'strategic investments'. The Board, also, does not like the idea. The Board agreed not to include in the Preliminary Views document the notion of a strategic investment. However, the Board agreed that the Invitation to Comment should ask a series of questions about whether 'certain financial assets' should be classified in the business activities section of the financial statements and whether those assets could be a category within that section.
Income taxes
The Board agreed that income taxes should be presented as a separate section (along with the business and financing sections) in the financial statements, thereby eliminating the need for intraperiod tax allocation and the presentation of discontinued operations and items of other comprehensive income on a net-of-tax basis.
In addition, the Board agreed that income taxes related to transactions with owners should not be recognised directly in equity. The Board noted that the income tax consequences did not represent a transaction with owners in their capacity as owners.
Discontinued operations
Definition of a 'discontinued operation'
The Board noted that IFRS 5 defines a discontinued operation, while the equivalent FASB standard does not. It was agreed that developing a common definition of discontinued operation should be part of the scope of this project.
Presentation
The Board agreed that agree that discontinued operations should continue to be presented separately in the financial statements and that information related to a discontinued operation should be displayed as a separate section in the financial statements.
Display
The Board agreed that:
- the assets and the liabilities of a discontinued operation should be presented separately and not be offset;
- the income statement effects be presented as one amount on the face of the income statement and further disaggregated either on the face of the statement or in the notes; and
- the cash flows from a discontinued operations be presented as a single amount in the statement of cash flows.
Disaggregation
Working principle
The Board agreed to revise the working principle as follows:
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Financial statements should present information in a manner that disaggregates line items if that disaggregation enhances the usefulness of that information in predicting future cash flows.
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The staff noted that the revised working principle did not include the phrase "and present subtotals and totals where appropriate" because it is already included in the project objective. (Note that the issue of sub-totals is now not part of the working principle.)
Nature vs Function
The Board agreed that information should be presented on the statement of comprehensive income by function with supplemental information provided by nature about items important to understanding an entity's business.
Presentation on a gross or net basis
The Board agreed that assets and liabilities and income (revenues and gains) and expenses (expenses and losses) be shown on a gross basis except when:
- net presentation is required or permitted by a standard other than the financial statement presentation standard; or
- there is no incremental value in the additional information provided in a gross presentation.
Nature of guidance
The Board agreed to retain the language in IAS 1 paragraphs 83 and 84 in the financial statement presentation standard and to apply it to each of the financial statements. No 'bright line' guidance should be provided.
Working principles on comparability
The Board agreed to eliminate the working principles related to comparability as they are encompassed by the qualitative characteristics of financial reporting.
Other
Board members noted that the meeting of the JIG held on 15 September had been very good; well run and productive. They expressed their thanks to all involved – JIG members, FASB and IASB members, and staff.
Fair Value Measurements
The staff noted that FAS 157 Fair Value Measurements was issued on 15 September 2006 (see IAS Plus News Story of 19 September 2006). The IASB staff can now complete the preparation of an IASB Discussion Paper on Fair Value Measurements, which will comprise:
- FAS 157;
- excerpts of existing FVM guidance in IFRSs; and
- an Invitation to Comment that expresses the Board's preliminary views and requests constituent input on certain matters
Non-performance risk
The Board noted that IFRSs currently do not discuss non-performance risk in relation to the fair value of liabilities. IAS 39 requires the fair value of a financial liability to reflect the credit quality of the instrument. Reflecting credit quality in the fair value measurement of a financial liability effectively causes the fair value measurement to reflect the risk that the obligation will not be fulfilled. FAS 157 extends this principle to the fair value measurement of both financial and non-financial liabilities.
It was noted that non-financial liabilities include both credit risk (which related to the financial component) and non-performance risk (which related to the activity). After some discussion, the Board agreed to include a preliminary view in the invitation to comment agreeing with the concept that the fair value of a liability should reflect the non-performance risk relating to that liability (in addition to credit risk).
Issues in the Invitation to Comment
Entry and exit prices
The Board agreed that the Invitation to Comment should discuss the concepts of entry and exit prices without stating a preliminary view. The Discussion Paper will address two views without stating a preference. The discussion note that the notion of a price established between 'a willing buyer and a willing seller' matters only when one is shifting markets. In many IASB standards, 'fair value' is used to mean an exit price; in a few (such as IFRS 3, IAS 39, and IAS 41), the phrase is used to mean an entry price. Board members found using the same phrase to communicate two different measurement objectives confusing. Board members noted that they might need to reassess the measurement objective in IFRS 3, IAS 39, and IAS 41 should they adopt the approach in FAS 157 paragraph 17(d), which allows the use of a price other than the transaction price to represent fair value if the transaction occurred in a market other than the principal or most advantageous market.
The staff proposed wording 'on the fly', which they will bring back to the Board.
Principal or most advantageous market
IAS 39 requires an entity to use the most advantageous active market in measuring the fair value of a financial asset or liability when multiple markets exist, whereas IAS 41 Agriculture requires an entity to use the most relevant market. By comparison, the FAS 157 requires an entity use the principal market for the asset or liability. In the absence of a principal market for the asset or liability, the entity uses the most advantageous market. The principal market is the market in which the reporting entity would sell the asset or transfer the liability with the greatest volume and level of activity for the asset or liability. The most advantageous market is the market in which the reporting entity would sell the asset or transfer the liability with the price that maximizes the amount that would be received for the asset or minimizes the amount that would be paid to transfer the liability, considering transaction costs in the respective market(s). In either case, the principal (or most advantageous) market (and thus, market participants) should be considered from the perspective of the reporting entity, thereby allowing for differences between and among entities with different activities.
The Board reconfirmed their view taken in May 2006, namely:
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When multiple markets exist for an asset or liability, the fair value measure should be based on the principal market for that asset or liability. If there is no principal market, the most advantageous market should be used. In both instances, the principal or most advantageous market should be determined from the perspective of the reporting entity.
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A question will be asked on this topic in the Invitation to Comment.
Calling 'level 3' measurements 'fair value'
The Board noted that FAS 157 establishes a three level hierarchy for categorising and prioritising inputs for fair value measurements. Level 3 of the hierarchy is 'unobservable inputs' for the asset or liability (that is, they are not observable in a market). Unobservable inputs are used to measure fair value only to the extent that observable inputs are not available. These inputs reflect the reporting entity's own assumptions about the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). When Level 3 measures are used, FAS 157 prescribes additional disclosures.
The Board agreed that the disclosure requirements in FAS 157 highlight sufficiently the nature of the fair value measurement so that users of financial statements can develop a view of the potential uncertainty of that measurement. Therefore, it would not be necessary to include in the Discussion Paper a discussion of whether measurements comprised of significant Level 3 inputs should be labelled something other than fair value.
Block premiums and discounts
The Board agreed to address the issue of whether block premiums and discounts should be discussed in the Discussion Paper. Such premiums or discounts may arise when a larger-than-normal quantity of an asset or liability is being sold in a market. Board members noted that the requirement to use the 'Price x Quantity' formula is limited to Level 1 measures, and that this opens the treatment of block purchases and sales to abuse, since it could be argued that these should be measured using Level 2 or 3 inputs.
Board members also agreed that there is a need to distinguish illiquidity caused by the size of the block from that caused by the thinness of the market.
The staff will draft a question on this issue for inclusion in the Invitation to Comment.
Day 1 gains and losses
The Board noted that an exit price measurement objective could have significant implications on certain fair value measurements in IFRSs, particularly in IAS 39 on initial recognition. They reasoned that it is important to highlight situations where the guidance in FAS 157 differs significantly from current IFRSs. Further, convergence on the day-one gain matter is a high-profile issue to many large financial institutions and is an area where the staff expects many comments. The Invitation to Comment will contain a discussion and question on the transaction price presumption.
US GAAP-specific material contained in FAS 157
The Board agreed that, in the interests of timely publication, they would not alter FAS 157 in any way for the purposes of the Discussion Paper and Invitation to Comment, and that it would therefore have US GAAP-specific material. The Invitation to Comment would note that any Exposure Draft would be IFRS-specific.
Next steps
On a poll, 12 Board members voted to issue the Invitation to Comment and Preliminary Views, and one Board member abstained, pending resolution of the discussion of entry and exit prices.
The Discussion Paper is scheduled for publication in late 2006.
Financial Instruments – Due Process Document
The Board discussed issues raised by the staff about the scope of the proposed due process document on financial instruments.
Scope
After discussion, the Board agreed that the scope of the due process document should be based on a common definition of financial instruments, rather than instruments with similar probable outcomes. The latter alternative was seen as too wide and potentially would scope in items that the Board did not intend to.
The Board agreed that the Invitation to Comment should discuss whether noncontractual obligations to deliver cash (or other financial instruments) and rights to receive cash (or other financial instruments) should be part of the definition of a financial instrument.
Definition of a financial instrument
The staff proposed and then discussed a definition of financial instruments:
A financial instrument is defined as:
- (a) cash;
- (b) evidence representing a residual or other ownership interest in an entity;
- (c) a contractual obligation of one party to deliver a financial instrument to a second party and a corresponding contractual right of the second party to require receipt of that financial instrument in exchange for no consideration other than release from the obligation; or
- (d) a contractual obligation of one party to exchange financial instruments with a second party and a contractual right of the second party to require an exchange of financial instruments with the first party.
A financial asset is a financial instrument that is an asset.
A financial liability is a financial instrument that is a liability.
A financial instrument classified by an entity in the equity section of its balance sheet (or statement of financial position) is neither a financial asset nor a financial liability to that entity.
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Ownership interests
The proposed definition is based on that in FAS 107 Disclosures about Fair Value of Financial Instruments, which refers to evidence of ownership interests with no reference to contracts. The Board agreed that the approach taken in FAS 107 is clearer and hence preferable. That is, to specifically include ownership interests and include contracts requiring the delivery and exchange of ownership interests with other delivery and exchange contracts.
Symmetry of contractual rights and obligations
The Board agreed that the contractual obligation of one entity to deliver creates another entity's contractual right to receive, and that exchange contracts create rights and obligations for both parties.
Reference to cash and financial instruments in contracts that are financial instruments
The Board agreed that a separate reference to cash was not needed. IAS 32 and Statement 107 explicitly refer to obligations to deliver cash or financial instruments and rights to receive cash or financial instruments-even though cash has previously been specified as a financial instrument.
Grouping of delivery and exchange rights and obligations
Statement 107 states that:
A financial instrument is defined as a contract that both:
- (a) Imposes on one entity a contractual obligation (1) to deliver cash or another financial instrument to a second entity or (2) to exchange other financial instruments on potentially unfavourable terms with the second entity; and
- (b) Conveys to that second entity a contractual right (1) to receive cash or another financial instrument from the first entity or (2) to exchange other financial instruments on potentially favourable terms with the first entity.
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The Board agreed that it was both clearer and more logical to group the two sides of the contract (the right and obligation to deliver or exchange) together.
References to favourable and unfavourable contracts
The Board agreed that the reference to 'favourable' and 'unfavourable' was not necessary to ascertain whether something is an asset or a liability. The due process document could describe a financial asset as a financial instrument that is an asset (and similarly that a financial liability is a financial instrument that is a liability).
Right to require delivery or exchange
The Board agreed that the right to require receipt or exchange is what creates a right to an economic resource, and hence creates an asset (rather then the ability to simply receive or exchange).
Inclusion of components of non-financial contracts
The Board agreed that the definition of a delivery contract could be improved by stating that the right to receive a financial instrument in a delivery contract is the only form of consideration to be received in exchange for releasing the other party from its obligation.
Multiple element contracts
After discussion the Board agreed that they wished to view multiple element contracts as separate sets of rights and obligations. Some Board members were not convinced and would explore a 'whole instrument approach' with the staff.
Possible adjustments to scope
The Board agreed to exclude the following items from the scope of the due process document:
Matters being considered in other current projects:
- Investments in consolidated subsidiaries, consolidated variable interest entities (FASB only), and associates (equity method investees in FASB terms) or joint ventures
- Contingent consideration in business combinations
- Leases
- Royalty contracts and other contracts for rights to use assets (revenue recognition issues)
- Pensions and other post employment benefits
- Financial instruments classified as equity by the reporting entity
- Insurance and related contracts
Addressed by other recent Standards:
- Financial instruments and derivatives related to share-based payments
The Board agreed to include the following:
- Contracts that are financial instruments by definition but are not recognized under current GAAP (for example, loan commitments, letters of credit)
- Intra-group balances [in the context of separate financial statements]
- Financial instrument servicing contracts
The Board noted that 'strategic investments' are within the scope of financial instruments generally and will not be considered as a separate type of financial asset.
The Board concluded that contracts that are very similar to related financial instrument contracts should not be included in the scope of the due process document.
Wednesday 20 September 2006
Insurance Contracts - Phase 2:
Project plan
The Board reviewed the project plan. Although the staff remains confident that the Discussion Paper would be published in December 2006, some Board members were more sanguine, suggesting that the issues still to be reviewed by the Board were not trivial.
Reporting changes in insurance liabilities (other than premium presentation)
The Board discussed whether an insurer should be required to present separately any specified components of the changes in the carrying amount of insurance liabilities (to be specified later). The issue is closely related to the issue of whether an insurer should present all premiums as revenue, all premiums as deposit receipts, or some premiums as revenue and some premiums as deposit receipts (the 'gross or net' question).
The Board seemed not to agree the detail in the staff recommendations; rather it agreed that the Financial Statement Presentation project should drive the presentation. The Discussion Paper should ask constituents whether certain items related to the change in the measure of the insurance liability should be disclosed, either on the face of the financial statements or in the footnotes. The subsequent Exposure Draft would address these issues in greater detail.
Investment contracts: comparison of IAS 39 and IAS 18
The Board considered whether the Discussion Paper should document the key differences that exist between the proposed current exit value model for insurance contracts and the current treatment of investment contracts under IAS 39 and IAS 18, and seek feedback on whether the Board should consider eliminating these differences.
The staff identified the following significant differences:
- (a) Liability measurement at inception:
- (i) the current exit value model is based on expected values. Under IAS 39 the liability is subject to a minimum of the surrender value; and
- (ii) under IAS 39 and IAS 18, non-incremental origination costs are likely to give rise to a loss at inception, even if the contract is priced to recover those costs. Under the current exit value model, this is not likely to be the case (see appendix for further discussion)
- (b) Subsequent measurement of liability:
- (i) the current exit value model is based on expected values. Under IAS 39 the liability is subject to a minimum of the surrender value; and
- (ii) the current exit value model is based on current values. Under IAS 39, where an investment contract is measured at amortised cost, some assumptions are locked in: in particular, although the cash flows are based on current estimates,1 the measurement reflects the original effective interest rate (including the original quantity and price of risk).
- (c) Income and expense recognised in profit and loss at inception:
- (i) the current exit value model recognises gains on inception (if any gain arises). Under IAS 18 gains are not likely to be recognised at inception unless it could be demonstrated that a service had been performed at that time; and
- (ii) treatment of origination costs
The items identified by the staff highlighted areas in which the Board seemed uncomfortable with the model being developed for insurance and how it interacts with existing standards, creating the possibilities for accounting arbitrage. Some Board members were firmly of the view that if an insurance contract contained a financial instrument that was not inseparable from the insurance risk, that financial instrument should be accounted for using IAS 39. Other Board members noted that this idea almost presupposed unbundling insurance contracts.
The Board seemed to agree that a basic approach would be concentrate on the notion of the interdependence of cash flows already in IFRS 4. Therefore, if the cash flows are so interdependent that to unbundle them would lead to arbitrary allocations between the components of the contract, unbundling should be prohibited. However, if the cash flows are not interdependent, then the contract should be unbundled. The Board agreed to raise this issue in the Invitation to Comment.
Should there be a portfolio basis for measurement?
The Board discussed the issue of whether insurers should measure their rights and obligations under insurance contracts on a portfolio basis rather than contract by contract.
The Board agreed that risk margins should be determined for a portfolio of insurance contracts that are subject to broadly similar risks and managed together as a single portfolio (again, this wording is consistent with IFRS 4). However, the Board agreed that the diversification benefits between portfolios was not part of initial measurement. The Board saw a distinction between a portfolio of similar risks and a collection of portfolios of different risks. (Thus, if an insurance company managed a portfolio of marine risks and another of environmental risks together, the risks inherent in the two portfolios would fail the 'broadly similar' test, but the diversification within the marine book and within the environmental book would meet the 'broadly similar' test.)
Unbundling
The Board agreed to modify its previous position (April 2006) to require unbundling of insurance contracts unless the insurance element and the financial element were 'so interdependent that an entity cannot measure the financial element separately (that is, without considering the insurance element)' or similar words, in which case it would be prohibited. This position is based on the existing guidance in IAS 39 AG33(h).
Policyholder participation rights
The Board recognised that there was a dilemma created by the definitions of a liability and equity with respect to policyholder participation rights. In most cases, policyholder participation rights would not meet the definition of a liability, because there is usually no unconditional obligation to pay them. However, policyholders may not be shareholders, so the participation rights are not dividends.
Board members drew an analogy between policyholder participation rights and dividends on cumulative preference shares. Current accounting standards do not require recognition of such dividends unless they are declared, but the entity is often prevented from paying a dividend on ordinary shares unless it first pays a dividend on the cumulative preference shares. In other words, not all retained earnings can be attributed to the ordinary shareholders.
The Board agreed to explore whether it was possible to develop a presentation (either on the face of the financial statements or in the footnotes) that would enable an entity to distinguish those elements of shareholders' equity to which the shareholders did not have a claim, either by way of dividend or on liquidation. The presentation would show the restriction on distribution/ appropriation of retained profit attributable to the policyholders. (This would affect both the balance sheet and the statement of recognised income and expense.)
Universal life contracts
The Board discussed aspects of accounting for universal life contracts – those that permit the insured, after the initial payment, to pay premiums at any time, in virtually any amount, subject to certain minimums and maximums.
Some Board members expressed deep dissatisfaction with some of the consequences of the model being developed by the staff. However, after discussion, the Board agreed not to change their prior articulated Preliminary View but directed the staff to conduct further research on the effects of 'guaranteed insurability' once the Discussion Paper is issued.
Crediting rates in universal life contracts
The Board discussed a proposal that estimates of crediting rates [in a given situation] should reflect what the insurer actually expects to do [in that situation], rather than assume that the insurer pays the absolute minimum that can be contractually required. Some Board members expressed deep discomfort about this concept, especially the implications of such an approach on the notion of 'exit value' discussed earlier in the meeting (see 19 September). The Board did not seem to conclude on this issue.
Amendments to IAS 14 Segment Reporting
The Board continued its consideration of comments received from constituents on its proposals to align IFRS with US GAAP with respect to segment reporting, and its redeliberations of those proposals.
The Board confirmed the proposals in the ED with respect to the following matters:
- The draft IFRS should not define the measures of segment revenues, segment expenses, segment results, segment assets and segment liabilities that are required to be disclosed.
- Reconciliation at the individual segment level should not be required.
- Segment information by individual country should not be required.
- The Board should proceed with the consequential amendments to IAS 34 Interim Financial Reporting.
The staff also brought various minor matters to the Board's attention, none of which was discussed at the meeting. One item to note is that the effective date for the standard will be 1 January 2009 (not 2007 as exposed). Early adoption would be permitted.
The Board agreed to add a requirement that an entity should report a measure of liabilities for each reportable segment if those amounts are regularly provided to the chief operating decision maker. (This is a requirement additional to those in FAS 131.)
The Board discussed issues raised by the Publish What You Pay campaign related to disclosures at the individual country level. Many Board members were sympathetic to the campaign's objectives (transparency with respect to payments to governments in resource-rich countries, which are often less developed countries.) However, the Board noted that it was not appropriate to attempt to address their concerns in this project, which was a tightly-focused convergence project.
The Board agreed that the campaign's request was a legitimate and serious one, and one to which the Board should be responsive. The Board established a sub-group of the Board (Messrs Cope, Garnett and Gelard) to assist the staff in engaging the campaign and others that could be of assistance. As the matters raised by these constituents were political as well as technical, groups that should be involved include the IASCF Trustees, the International Public Sector Accounting Board, the International Monetary Fund and its agencies, the World Bank, IOSCO, and the Financial Stability Forum.
IFRIC Issues
The IFRIC Coordinator presented the results of the September IFRIC meeting (see our report on this meeting Elsewhere on www.IASPlus.com). With respect to the IFRIC's conclusions on the treatment share-based payments employees who transfer between entities in a consolidated group, a Board member noted that (while not objecting to the IFRIC's conclusions) the issue demonstrated that the IASB is schizophrenic with respect to the application of IFRSs in separate financial statements.
IAS 39 Financial Instruments: Recognition and Measurement – Derecognition Application Issues
The Board discussed various issues related to the operation of derecognition principles in IAS 39 paragraphs 15-37 and illustrated in IAS 39 AG36.
Groups of assets
The Board discussed the possible meanings of the phrase 'group of similar assets' contained in IAS 39 paragraph 16.
The Board agreed that IAS 39 does requires the derecognition tests to be applied to transfers of groups of financial assets (such as loans, mortgages, etc) that include the following derivative contracts:
- Credit insurance contracts/financial guarantees that are originated with certain loans.
- Interest rate swaps and currency swaps.
- Credit insurance contracts/financial guarantees that are not originated with the loans
In particular, the Board noted that because a bundle of assets (e.g., mortgage loans and mortgage indemnity guarantees) was transferred in a single transaction does not imply that the bundle was 'one asset'. In other words, the transferor had to assess the mortgage loans and the mortgage indemnity guarantees separately for the purposes assessing 'similar' in the derecognition tests.
Board members noted that the IFRIC might be uncomfortable with the consequence of this conclusion: that a derivative that can be either an asset or a liability must pass both derecognition tests before it can be removed from the balance sheet.
Pass-through arrangements
The Board which transfers of financial assets are required to satisfy the 'pass through' tests in IAS 39 paragraph 19. The Board noted that IAS 39 paragraph 18(b) states the pass-through tests in paragraph 19 have to be met when an entity transfers a financial asset and 'retains the contractual rights to receive cash flows of the financial asset, but assumes a contractual obligation to pay the cash flows to one or more recipients'. Conversely, the pass-through tests are not applicable when the entity 'transfers the contractual rights to receive the cash flows of the financial asset' (paragraph 18 (a)).
The Board agreed that IAS 39 did not require the pass-through test to be applied to transfers of financial assets in which (a) the legal ownership has not changed; and (b) the transfer is conditional.
Report to IFRIC
The Board noted that the topics discussed in this session had been referred to the IFRIC and asked the staff to make a complete report to the IFRIC, together with the Board's basis (essentially the Board papers), so that the IFRIC could make an informed decision as to how to proceed.
Amendments to IAS 24: Related Party Disclosures
Costs and benefits: disclosing related party transactions
The Board agreed that only related party relationships which arise through common control from the State should be considered for relief from the disclosure requirements of IAS 24. Other related party relationships, for example between entities controlled by the State and the State itself, are presumed to be material related party relationships that warrant disclosure (and are therefore not the type of relationship from which the amendments are designed to provide relief).
The State
The Board agreed that 'State' referred to all levels of government, such as central, national, federal, provincial, state, regional, local, town, or municipality.
Relief for State-controlled entities
The Board agreed that any relief provided by amendments to IAS 24 should be strictly limited to those entities that meet the definition of a related party simply because of common control from the State and that this relief should not include entities that are significantly influenced by the State.
The Board noted that any relief considered would be granted 'horizontally' but not 'vertically.' That is, for transactions between State-controlled entities but not for transactions between the State entities controlled by it.
What would the relief be?
The Board agreed that to distinguish between those transactions that should and should not be disclosed, IAS 24 should include indicators similar to the following.
IAS 24 would start from a presumption that State-controlled entities would make the assertion that common control from the State does not give rise to transactions that need to be disclosed by the reporting entity with respect to transactions with other State-controlled entities. However, certain indicators that might lead the entity to identify that related party relationships exist and that the entity should be disclosing the relationship and transactions. Those indicators could include the following situations:
- The existence of direction or compulsion from the State for entities to act in a certain way
- The existence of transactions at non-market rates between the two entities (other than by way of regulation)
- The use of shared resources
- Economically significant transactions between the common controlled entities
- Common board members between the two entities controlled by the State.
Board members noted that in the majority of situations, the nature of the transaction would trigger the assessment above: essentially, "if it looks odd, it's probably a related party transaction."
The Board agreed that, in the situation in which any of the indicators of a related party transaction exist, the full requirements of IAS 24 paragraph 17 should be complied with.
Definition of related party transaction-clarification
The Board agreed that the definition of a related party transaction, together with a consequential amendment to IAS 24 paragraph 17 were necessary, as follows:
Definition:
A related party transactions is a are transfers of resources, services or obligations between related parties an entity and its related parties, regardless of whether a price has been charged.
Amendment to paragraph 17:
If there have been transactions between related parities the entity and its related parties, the an entity shall disclose…
A Board member raised a concern about the effect of the amendments on transactions between an entity (including its consolidated subsidiaries) and an associate, both in the context of consolidated financial statements and separate financial statements. This topic will be explored further in a later meeting.
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Thursday 21 September 2006
IFRS for Small and Medium-sized Entities
[This summary includes items discussed on the morning of 22 September 2006.]
The Board continued its discussions of a draft Exposure Draft (ED) of an International Financial Reporting Standard for Small and Medium-sized Entities (IFRS for SMEs).
Financial instruments
The Board considered a revised draft of ED Section 12 Financial Assets and Financial Liabilities. That draft reflects comments of the Board on the version of Section 12 discussed at the July 2006 meeting, as well as suggestions made by two independent expert reviewers.
An SME would have a choice of applying Section 12 or IAS 39 in accounting for financial instruments. Section 12 simplifies the provisions of IAS 39 in a number of respects, including:
- Two categories of financial assets rather than four.
- Three types of financial instruments will be measured at cost or amortised cost when certain conditions are met. These are (a) receivables, payables, and loans, (b) most commitments to make or receive loans, and (c) equity instruments whose fair value cannot be reliably measured and options on such instruments. Categories (a) and (b) may optionally be at fair value through profit or loss. All other types of financial instruments will be measured at fair value through profit or loss.
- Section 12 includes a clear and simple principle for derecognition – if the transferor has any significant continuing involvement, do not derecognise. As a result, derecognition would be allowed in fewer circumstances than under IAS 39. However, staff does not expect this to be a problem for most SMEs. For one thing, banks and other financial institutions will be prohibited from using the IFRS for SMEs, so the fact that many securitisations may not result in derecognition is not likely to affect most SMEs unfavourably. Another simplification is that the complex 'pass-through testing' and 'control retention testing' of IAS 39 are avoided. Further, an SME can always choose to use IAS 39 instead of Section 12.
- For hedge accounting, Section 12 addresses the four kinds of risk hedges that SMEs typically do. Hedge accounting is not allowed for any other kinds. Additionally Section 12 imposes strict conditions on the designation of a hedging relationship. The benefit for the SME is that if the SME meets those conditions, hedge accounting provisions are greatly simplified.
The draft of Section 12 included two alternative approaches to hedge accounting simplification. One would impose strict conditions on the designation of a hedging relationship with subsequent hedge effectiveness assumed without need for measuring ineffectiveness. The other would (a) relax the conditions for designating a hedging relationship somewhat and (b) require periodic measurement and recognition of ineffectiveness for all hedging activities, but would not require as a qualifying condition that the hedging relationship be effective within a range of 80% to 125%. IAS 39 has such an 80%-125% condition, requiring somewhat complex and retrospective calculations.
The Board discussed those two approaches and also a third approach. The third approach would be not to include any hedge accounting provisions in Section 12 but, instead, to refer SMEs to the hedge accounting provisions of IAS 39 if they wish to do hedge accounting.
After discussion, the Board concluded that in the ED Section 12 should reflect the first approach (effectiveness assumed) and that the Invitation to Comment in the ED should describe the second approach (simplified effectiveness measurement) in detail. Respondents should be invited to express their views regarding the two approaches.
The Board also asked the staff to revise Section 12 as follows:
- Clarify that futures contracts can be hedging instruments.
- Clarify that options cannot be hedging instruments.
- Add guidance on whether and how an SME could change from following Section 12 to following IAS 39 and vice versa.
The Board also agreed that Section 12 should include an appendix of fair valuation guidance from IAS 39.
Income taxes
The Board discussed a revised draft of Section 29 Income Taxes of the ED. Under that draft, an SME would be required to recognise deferred income taxes on all items of income or expense that are recognised in profit or loss or in equity in one period but, under tax laws or regulations, are included in taxable income in a different period (sometimes called 'timing differences'). An SME would also recognise deferred taxes arising from tax losses and tax credits that, under the law, are available to offset taxable profit or tax payable in future periods, although technically these are not timing differences.
Staff characterised this approach as a 'timing differences plus' approach.
Board members generally agreed that deferred taxes should be recognised on all or most timing differences and on tax loss/credit carryforwards. However, some Board members felt that deferred taxes should be provided in more circumstances than just timing differences and carryforwards (including differences between the tax basis and carrying amount that arises when an asset or liability is initially acquired). And some Board members felt that – consistent with IAS 12 Income Taxes – Section 29 should take a 'temporary differences' approach, rather than a 'timing differences plus' approach.
The draft of Section 29 proposed that an SME should not recognise deferred taxes on differences between the tax basis and the carrying amount of assets and liabilities that arise at initial recognition of those assets or liabilities – whether acquired in a business combination or in another transaction. After discussion, the Board did not agree with that proposal. The Board acknowledged that these are not timing differences, but they do create benefits or obligations that meet the definitions of assets and liabilities. The Board asked the staff to revise the draft of Section 29 accordingly.
The Board discussed problems that an SME may encounter in adopting Section 29 for the first time when its previous national accounting framework did not recognise deferred income taxes. The Board agreed that the principle in Section 29 should be that deferred taxes are recognised on differences between the tax basis and the carrying amount of all assets and liabilities. However, the Board also agreed that an exception should be included on first-time adoption of Section 29 when measurement of deferred taxes would require undue cost and effort.
The Board discussed whether an entity should recognise deferred taxes on unremitted earnings of foreign subsidiaries, associates, and interests in joint ventures. The Board concluded that such deferred taxes should not be recognised unless it is probable that the timing difference will reverse in the foreseeable future.
Employee Benefits
The draft of Section 28 Employee Benefits that the Board had discussed in June 2006 did not include standards on accounting for defined benefit plans. Instead, SMEs were cross-referred to IAS 19 Employee Benefits. At that meeting, the Board concluded that because many SMEs provide benefits under deferred benefit plans or government-mandated programmes that are similar to defined benefit plans, Section 28 should include guidance on defined benefit plan accounting directly, rather than by cross-reference to IAS 19.
The revised draft of Section 28 discussed at the September 2006 meeting included new paragraphs addressing defined benefit plans. Those paragraphs were based on the relevant paragraphs in IAS 19.
The Board agreed that an SME should be required to use the projected unit credit method to determine the present value of its defined benefit obligations and the related current service cost and, where applicable, past service cost. That actuarial method is generally consistent with the asset and liability definitions and recognition provisions of the IASB Framework.
The draft of Section 28 proposed that an SME should recognise actuarial gains and losses in their entirety either in profit or loss or directly in retained earnings, and that the non-recognition and partial recognition (spreading) options of IAS 19 should not be included in the IFRS for SMEs. The Board agreed that the non-recognition and partial recognition options of IAS 19 should not be included in Section 28. However, the Board did not agree with allowing an option to recognise actual gains and losses directly in retained earnings. The Board asked the staff to revise Section 28 to recognise actuarial gains and losses in their entirety in profit or loss. Similar treatment will apply to actuarial gains and losses arising in connection with other long-term benefits. Also, an SME should recognise increases or decreases in past service in their entirety in profit or loss when they arise.
Inventories
The Board decided to add an exclusion, in Section 13 Inventories, that Section 13 does not apply to the measurement of inventories held by:
- producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value (above or below cost) through profit or loss; or
- commodity brokers and dealers who measure their inventories at fair value less costs to sell through profit or loss.
Provisions
In the criteria for recognising a provision in Section 21, clarify that probability must be assessed only with respect to transfer of economic benefits. Also, add guidance from paragraph 15 of IAS 37 Provisions, Contingent Liabilities and Contingent Assets on what to do in the rare cases when it is not clear whether there is a present obligation.
Revenue
Include in Section 23 Revenue guidance on accounting for construction contracts, rather than requiring SMEs always to look to IAS 11 Construction Contracts.
Impairment
- Section 27 Impairment of Non-financial Assets should address how to allocate an impairment loss to individual assets when a group of assets is tested for impairment.
- Include in Section 27 the guidance on how to measure goodwill impairment, rather than cross-referring to paragraphs 80-99 of IAS 36 Impairment of Assets.
Discussion Paper: Measurement Bases for Financial Reporting – Measurement on initial recognition
The Board discussed an analysis of the comments received on the Discussion Paper Measurement Bases for Financial Reporting-Measurement on Initial Recognition, which was published for comments in November 2005.
The session was a feedback session and no decisions were taken by the Board at the September meeting, as the staff had no specific questions to raise.
The staff highlighted 13 issues that constitute the main comments that constituents had raised. (These are not reiterated here as they can be found in observer note 'Agenda Paper 6' on the IASB Website).
As a general observation, constituents who provided comments did not support the proposals put forward in the Discussion Paper. A point that was discussed at some length by the Board was the response on the relevance of fair value. Board members were confused by the fact that a majority of respondents were not supportive of the paper's proposal regarding the relevance of fair value on initial recognition, especially that some stated that fair value has no relevance.
The Board intends to consider the comments from constituents on the Discussion Paper during the measurement phase of the joint IASB/FASB Conceptual Framework project. The paper will also be considered in other IASB projects where the responses to this paper could provide valuable input.
Conceptual Framework
Asset Definition
As part of their deliberations on the development of an asset definition, the Board identified a cross-cutting issue: what constitutes the asset when an entity holds an option over an asset? The Board decided that it had to agree on the accounting for an option to acquire/sell an asset directly as part of their deliberations on treatment of options held over entities.
After a short discussion, the Board concluded that the only asset that the entity would have is the option that it holds over the asset and not the underlying asset itself.
Reporting Entity
The Board has identified eight cross-cutting issues in the Reporting Entity phase of its project on the Conceptual Framework. The Board discussed a paper that (a) summarised all previous Board decisions about the reporting entity and (b) identified remaining issues. The session was split into three major sections.
- Individual reporting entity
- Group reporting entity
- Control issues
The staff noted that the Board had decided that the conceptual framework related to general purpose external financial reports (GPEFR) and that the analysis presented considered only issues related to this. It was also noted that the analysis only considered issues from a conceptual level as different considerations might apply when considering the issues at a standard-setting level.
Individual Reporting Entity
The Board considered the following issues regarding the individual reporting entity:
- whether further research is necessary about what constitutes an 'individual entity' for financial reporting purposes, and
- whether the conceptual framework should describe what constitutes an individual entity, but not define it.
The Board agreed that further research about what constitutes an individual entity is unnecessary. It also decided that the conceptual framework should discuss what constitutes an individual entity but should not develop a definition.
Group Reporting Entity
Most of the session on the conceptual framework was devoted to discussing cross-cutting issues related to the Group reporting entity. In the discussion, Board members tried to understand what would distinguish the models presented (described in materials not available to observers).
The Board discussed the following issues:
- What is the purpose of consolidated financial statements? Why do some jurisdictions require parent-only financial statements, others require consolidated financial statements, and others combined financial statements?
- Is 'control' the right basis for consolidation?
- What does 'control over an entity' mean? Should this be defined at the concepts level or at the standards level?
Parent entity versus group entity
The Board noted that different views about the reporting entity concept, including different views about whether a parent-only entity can prepare 'general purpose financial statements' and, if so, whether different accounting requirements are appropriate. The Board had previously asked the staff to research whether a parent-only entity could be a reporting entity for the purposes of general purpose financial statements instead of or in addition to a group's consolidated financial statements. Previously, the Board agreed that a parent-only entity could be a reporting entity, but individual Board members reached that conclusion using different approaches. The staff therefore developed three approaches for the Board to consider:
- One entity-Two displays: Under this approach, the consolidated financial statements are regarded as being an alternative way of presenting information about the same set of assets, liabilities, and activities that appear in the parent-only financial statements. The entity can choose which to present. The Parent-only financial statement would be regarded as general purpose financial statements.
- One entity-One display: The consolidated financial statements are regarded as presenting information about a different set of assets and liabilities than the set of assets and liabilities that appear in the parent-only financial statements. The parent-only financial statements are not regarded as being general purpose external financial statements.
- Multiple entities: Under this approach, the parent-only financial statements relate to the parent entity. The consolidated financial statements relate to the group entity. Hence, both sets of financial statements are regarded as general purpose financial statements.
After a long debate that focused on trying to understand what distinguished the different approaches, the Board voted (9 members in favour) for the multiple entity approach (that is, both consolidated and parent-only entity could be a reporting entity).
Group reporting entities – approaches
The Board discussed the issue of when two or more entities should be combined and regarded as one entity for the purpose of providing financial information that is useful to both present and potential investors. The staff developed three models:
- Controlling entity model: A group entity comprises the controlling entity (the parent) and other entities under its control (its subsidiaries). Hence, the group is united by the parent entity's control over other entities. This approach requires that there be a parent entity.
- Common control model: In December 2005, the Board agreed that the staff should conduct further research into whether the boundaries of a group reporting entity should be based on a broader concept of control, for example, a concept that encompasses entities under common control.
- Risks and/or rewards model: Entities should be combined into a group entity when the activities of the second entity affect the wealth of the residual shareholders (or claimants) of the first entity.
The discussion around which model to apply was conducted in parallel with the debate on the parent entity versus the group entity debate above. As such, it was difficult to summarise the Board's discussion, as it was focused on trying to understand what the different models presented represented.
The Board seemed to agree that the group entity should be based on a 'modified controlling entity' model. This model will include 'sister-entities' as well as subsidiaries as part of the group. The Board voted 12-1 in favour of this model.
Control issues
For the issues set out below, the Board was asked to agree (a) whether the issue should be dealt with in the conceptual framework project and (b) whether they agree with the conclusion on that issue.
Revenue Recognition
Measurement approach under a customer-consideration model and its interaction with IAS 37
The purpose of this session was to get initial input from the Board about how the approach for accounting for performance obligations in the revenue recognition project interacts with the approach for accounting for non-financial liabilities in the project to reconsider IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
Issue
In its discussions on the IAS 37 project, the Board has considered the accounting for warranty obligations to be a liability recognition and measurement issue. The Exposure Draft had emphasised that issuing a warranty gives rise to a stand-ready obligation and that both initial and subsequent measurement of that obligation will be a current measurement issue. In the project on revenue recognition, the Board has also agreed that the issuance of a warranty gives rise to an obligation as under IAS 37. However, the initial measurement of the obligation is performed by reference to the customer consideration which is received and, in the examples considered to date, the subsequent measurement is by reference to the revenue recognition.
The objective of the Board's discussion was to explore how these approaches interact and, particularly, what a customer-consideration model might mean for subsequent measurement of a performance obligation.
The Board explored two approaches.
- Approach A: Under Approach A all estimates about the performance obligation are locked in at inception. Those estimates are not revised until the measurement of the liability is deemed inadequate compared to a direct measure of the liability under IAS 37. In such cases, the liability is remeasured.
- Approach B: Under Approach B, customer consideration is viewed largely as a current measurement approach, with only specified aspects of the measurement locked in at inception.
The Board discussed the two approaches. A Board member also introduced a third approach in which the customer consideration would be recognised over the service period on a straight-line basis.
No conclusions were reached. The Board asked staff to investigate further the alternative approach that was introduced.
The Board will continue its discussions at a later meeting.
Friday 22 September 2006
IFRS 1 – Cost of a subsidiary in the separate financial statements of a parent on first-time adoption of IFRSs
In May 2006, the Board discussed potential amendments to IFRS 1 to grant relief from determining cost in accordance with IAS 27 on first-time adoption of IFRSs and directed the staff to analyse one of those methods (the 'proposed relief') further.
The proposed relief permits a parent to use deemed cost for its investments in subsidiaries instead of restating cost in accordance with IAS 27. This deemed cost is to be calculated by reference to the underlying IFRS-compliant net asset position at the date of transition.
At this meeting the staff's recommendations were discussed.
Measurement of initial cost – the Proposed Relief
Some constituents have argued that, in some cases, it is difficult to measure the cost of an investment in a subsidiary in accordance with IAS 27 on first-time adoption of IFRSs. This is because entities adopting IFRSs may have measured the cost of an investment in a subsidiary under their previous GAAP in a manner that is not in accordance with IAS 27. Particularly, when a method of accounting other than the purchase method in accordance with IFRS 3 was used under previous GAAP, the parent would have to reconstruct the business combination using the purchase method in order to determine cost on adoption of IFRSs.
Based on its analysis, the staff recommended that IFRS 1 be amended to allow a parent to use either:
- The carrying amount of the net assets of a subsidiary (in accordance with IFRSs); or
- The fair value of a subsidiary at the date of the parent's transition to IFRSs.
The Board agreed to the staff's recommendation.
Profit distributions
In addition to measuring the initial cost of an investment, constituents have highlighted difficulties in determining the cost of an investment in a subsidiary on first-time adoption when dividends have been paid since acquisition. IAS 27 requires an assessment whether dividends received by a parent from the subsidiary relate to pre- or post-acquisition profits of the subsidiary. Under IAS 27, pre-acquisition profits received from the subsidiary reduce the investment in the subsidiary and post-acquisition profits are recognised as income. In some jurisdictions, there was no requirement to assess whether distributions were received from the pre- or post-acquisition profits of a subsidiary. In these jurisdictions a parent would have to reassess every distribution received.
The Board agreed that:
- If a parent applies the relief from restating the cost of an investment in a subsidiary in accordance with IAS 27 on transition to IFRSs, the accumulated profits of the subsidiary at that date are deemed to be pre-acquisition profits for the purposes of the cost method in IAS 27.
- If a parent does not use the relief from restating the cost of an investment in a subsidiary in accordance with IAS 27 on transition to IFRSs, the pre-acquisition accumulated profits of the subsidiary under the previous national GAAP at that date are deemed to be the pre-acquisition profits for the purpose of IAS 27.
Conclusion
No Board member indicated an intention to dissent to an Exposure Draft based on the staff's recommendations.
Technical Plan
The Board discussed progress on the IASB work program. The IASB has published the revised technical plan on its website.
On their short-term agenda the Board have extended the timeframe on two projects:
- Joint ventures: The Board has extended the timeframe for issuing an Exposure Draft (ED) until Q2 of 2007 (from Q4 of 2006). This means that a final IFRS is not expected before 2008.
- Income tax: An ED is now expected to be issued in Q1 of 2007 (previously was Q3 of 2006). This means that a final IFRS is not expected before 2008.
The Board confirmed that it expects to issue a Discussion Paper on post-retirement benefits (including pensions) in Q3 of 2007. No timing is set for an ED or a final IFRS.
Regarding other projects, the Board noted that dates have been moved for two items:
- Earnings per share – treasury stock method (IAS 33): An ED will be issued in Q4 of 2006 (previously was Q3 2006), with a final IFRS expected in second half of 2007.
- First-time adoption – cost of investment in subsidiary (IFRS 1): An ED will be issued in Q4 of 2006 (previously was Q3 2006), with a final IFRS expected in second half of 2007
Business Combinations Phase II – Redeliberations of proposed revisions to IFRS 3
Intangible Assets
The Board continued its deliberations on Phase II of the joint IASB-FASB project on business combinations. At the September meeting the Board focused on accounting for intangible assets acquired in a business combination.
The staff asked the Board to clarify several matters before the upcoming joint meeting with the FASB in October.
Should intangible assets be recognised separately from goodwill?
The Board agreed that intangible assets should be recognised separately from goodwill when there is a reliable and relevant measurement attribute available.
Should a market value or an entity-specific value be used to measure intangible assets?
Both IFRS 3 and FAS 141 require intangible assets to be measured at fair value. During discussions by the FASB on project, the staff has become aware that FASB members question the relevance and reliability of fair value as a measurement attribute for non-financial items when significant unobservable (non-market) input data is used. In addition, FASB members have questioned the cost/benefit of separating and measuring intangible assets when observable market values do not exist. The IASB was asked whether they want the staff to explore an entity-specific measurement attribute.
The Board confirmed that intangible asset acquired in a business combination should be recognised at a market-based estimate of fair value and that further exploration of a entity-specific value was not necessary.
The Board also had a short discussion on whether entities could measure intangible assets acquired in a business combination at zero if the acquiring entity has no intention to use the asset. Board members seemed to agree that an intangible should not be measured at zero just because an entity did not intend to use it. The value must still be determined based on whether the intangible has a market value, for example by preventing others to produce something of value.
Can intangible assets be measured separately from goodwill?
Most of the discussion focused on situations in which an entity should separate the intangible from goodwill. Some Board members expressed a view that while it is possible to separate an intangible in many cases, doing so should depend on cost/benefit considerations. For example, it may not be cost-beneficial to separate intangibles with an indefinite life from goodwill because the subsequent accounting would not be different.
At the end of this section the staff raised some specific questions for the Board:
"Do the Boards agree that a fair value measurement of an identifiable intangible asset is sufficiently reliable if it is based on inputs in Level 1 (quoted market price), Level 2 (other observable market data), or Level 3 (non-observable data) of the fair value hierarchy?"
The Board agreed.
"If not, how do the Boards want to define sufficient reliability for recognising identifiable intangible assets separately from goodwill?"
In light of the answer to the previous question, this was not discussed.
The Board did not conclude on the remaining part of the questions set out in the agenda paper.
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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