16-17 November 2006, London

16 November 2006

IFRIC Update

IFRIC staff updated the Board on the latest developments from the IFRIC meeting held 1-2 November 2006. Five items were specifically mentioned:

• Draft Handbook on IFRIC Due Process - Review of responses
• IAS 18 Revenue - Real estate sales
• IAS 18 Revenue - Revenue recognition in respect of initial fees paid by a fund manager
• IAS 21 The Effects of Changes in Foreign Exchange Rates - Hedging a net investment
• IAS 41 Agriculture - Recognition and measurement of biological produce

All these items have previously been covered by Notes taken by Deloitte Observers during the November 2006 IFRIC meeting.

IFRIC X Service Concession Arrangements – Vote to approve an Interpretation

The objective on the session on service concession arrangements was to:

• Update the Board on the public meeting held Monday 13 November where the Board had invited parties that had followed the IFRIC's work on this project to express their views on the proposed interpretation.
• Ask the Board to approve the Interpretation and decide an effective date.

The staff had identified three main points raised at the public meeting:

• That the Interpretation should clarify that the 'unit of production method' is an available amortisation method for intangibles in a service concession arrangement. This point was raised because BC 64 in the draft Interpretation refers to IAS 38.98 that states 'there is rarely, if ever, persuasive evidence to support an amortisation method…that results in lower amounts of accumulated amortisation than under the straight-line method'. The problem is that constituents read the 'rarely, if ever', as never. The staff proposed to remove the sentence.

  The Board supported the proposal of removing the sentence as the intention under IAS 38 is to permit other methods if that method is justified in reflecting the pattern of consumption better than the straight-line method. Alternatively the IFRIC could leave the sentence and outline the intention. The Board also discussed and agreed that the real issue with the sentence in BC 64 of the draft Interpretation was a problem with paragraph 98 of IAS 38. The Board decided that it therefore should address this issue in IAS 38 on their agenda for annual improvements.

• The draft Interpretation has three illustrative examples. An issue was raised whether these put any limitation on whether the nature of the consideration given by the grantor to the operator gives rise to an intangible or a financial asset.

  The Board agreed that the nature of the consideration including government guarantees must be determined by reference to the specific terms in the contract. This is clarified in paragraph 16 as well as BC 54 of the draft interpretation.

• The last issue was a point raised by the Spanish industry association. Highly geared arrangements may lead to losses in the first years when amortising intangibles. This does not reflect that the arrangement is profitable if viewed over the life of the arrangement. The staff commented that this was not unique for service concession arrangements and that nothing should be done.

  The Board agreed.

The Board voted to approve the draft Interpretation. It clarified that the vote would stand whether or not the IFRIC decided to make the amendments in the basis for conclusions of the draft interpretation.

The Board also confirmed that the interpretation should be effective from 1 January 2008.

Annual Improvements Process – 2006

The Board discussed three recommendations for its annual improvements projects.

Reporting compliance with IFRS

The Board discussed whether IAS 1 Presentation of Financial statements should be amended to provide guidance on situations where the financial statements of an entity are based on, but not in full compliance with, IFRS. The issue has arisen as concerns have been expressed by the IAASB about how IFRS is referred to in financial statements and audit reports in situations in which the preparer has not adopted IFRSs in full. The concern is specifically that there is potential for misunderstanding of the information given.

The Board agreed that this was an issue and agreed that something had to be done in this respect.

The following additions were proposed to IAS 1:

14A Where the entity's financial statements are described as being based on IFRSs but are not fully compliant with IFRSs, the entity shall:

• a. disclose all instances where IFRSs are not complied with; and
• b. indicate the significance of those differences to its financial statements.

Considering the proposal, Board members expressed specific concerns about the proposal in 14A(b), and whether it would be possible for constituents to deal with the 'significance' requirement. The Board was also concerned that significance was a vague expression and discussed whether 'materiality' would be a sufficient replacement.

The Board stated that it would not take a decision at the November meeting, and decided that the staff should go back and explore whether to change the second sentence in the proposal, and whether more guidance would be necessary.

Presentation of 'net finance costs' on the face of the income statement

The Board discussed how a conflict between the requirements in IAS 1 and IFRS 7 Financial Instruments: Disclosures regarding presentation of finance costs on the face of the income statement should be resolved.

The Board decided that Paragraph IG 13 of IFRS 7 should be deleted as it is confusing. This would clarify that IAS 1 alone addresses presentation of net finance costs, and clarify that interest income and interest expense should not be presented net on the face of the income statement (unless, as previously decided by IFRIC, the gross amounts of interest income and interest expenses are also shown on the face of the income statement).

Classification of the liability component of a convertible instrument

The Board discussed whether the liability component of a convertible instrument with an obligation to deliver cash or other assets more than 12 months from the balance sheet date should be classified as current or non-current.

The Board discussed and agreed to amend IAS 1.60(d) to state that a liability would be classified as current when 'the entity does not have an unconditional right to defer delivery of cash or other assets to settle the obligation for at least twelve months after the balance sheet date'.

This would remove the conflict in IAS 1.60(d) with IAS 1.62 and IAS 32.16, which considers conversion of an obligation into equity as settlement of a liability. Basing the liability classification in the balance sheet on whether there is an unconditional right to deliver cash or other assets would better reflect the entity's liquidity situation.

Financial Instruments: Recognition and Measurement – Comprehensive Project

The Board continued their deliberations of Fair Value Measurements (FVM) and debated a number of key issues relating to recognition and measurement.

Reliability of fair value measurement

The Board discussed the question whether all financial instruments and related items can be measured with sufficient reliability at a reasonable cost. The Board indicated that particularly for some unquoted equity instruments and long-term derivatives subjective assumptions might be necessary. However, it decided that no exceptions should be allowed. The question whether costs might outweigh the benefits was not discussed at this meeting.

Unit of account for recognition

The staff paper considered the following possible units of account for recognition purposes:

• A portion of the individual instrument
• The individual instrument
• A linked (synthetic) instrument

The Board decided that the individual instrument should be used as starting point for recognition purposes. It noted that this approach might be overridden by a specific requirement in a Standard, e.g. by allowing the recognition of linked financial instruments.

Initial measurement

The Board discussed whether a financial instrument should be initially measured at:

• Market exit price
• Transaction price/market entry price

Some Board members noted that the transaction price/market entry price should not differ from the market exit price on initial recognition. Other Board members argued that there might be a difference depending on the evaluation model used by the entity at initial recognition. Finally, the Board was nearly equally split between market exit price model and entry price model and no final decision was made. However, it was noted that for subsequent measurement the exit price should be applied.

Unit of measurement

The staff paper considered the following possible units of measurement:

• Individual instrument
• Portfolio of instruments
  • a. Portfolios of identical financial instruments traded in an active market
  • b. Portfolios of non-identical financial instruments that share broadly similar risks
  • c. Portfolios of non-identical financial instruments with offsetting separately identifiable risks

Reporting of unrealized gains and losses

The Board considered how unrealised gains and losses arising from the remeasurements of financial instruments should be reported. The Board decided not to distinguish between realised and unrealised gains and losses and that all realised and unrealised gains and losses should be reported in profit and loss.

Measurement of guaranteed liabilities

The Board discussed whether a financial guarantee affects the measurement of a guaranteed liability and whether the guarantee should be considered separate from the liability (and hence not affect the fair value of the debtor's liability) or as part of the liability (and hence should be taken into account in measuring the fair value of the debtor's liability). No decision was made but the staff was asked to elaborate this issue further for discussion in a future meeting. Reporting of fair value changes arising from changes in an entity's own credit risk or own share price. No decision was made. The staff was asked to elaborate this issue further for discussion in a future meeting.

Measurement of certain options and embedded options

This issue relates to the question, what expected cash flows should be used in valuing the present contractual rights and obligations of an entity. As an example the Board discussed the option a credit card company writes to the holder of the credit card, under which the holder can either obtain a cash advance or use the card to purchase goods or services.

Two approaches were deliberated:

• Approach A: The cash flows used assume exercise of the option only in those circumstances in which a securities option would be exercised, that is, when the exercise price of an option to buy an item is less than the market price for the same item
• Approach B: All expected cash flows a market participant are considered in valuing the option contract, i.e. to use all the possible cash flows arising from the operation of the existing contract

Conceptual Framework – Elements and Recognition

Definition of an asset

The staff presented the following modified version of the definition of an asset and the essential characteristics of an asset incorporating the decisions made at the July 2006 meeting:

An asset is a present economic resource to which the entity has a present right or other privileged access

An asset of an entity has three essential characteristics:

a. Present means that both the economic resource and the right or other privileged access to it exist on the date of the financial statements.

b. An economic resource is something that has positive economic value. It is scarce and capable of being used to carry out economic activities such as production and exchange. An economic resource can contribute to producing cash inflows or reducing cash outflows, directly or indirectly, alone or together with other economic resources. Economic resources include non-conditional contractual promises that others make to the entity, such as promises to pay cash, deliver goods, or render services. Rendering services includes standing ready to perform or refraining from engaging in activities that the entity could otherwise undertake.

c. A right or other privileged access enables the entity to use the present economic resource directly or indirectly and precludes or limits its use by others. Rights are legally enforceable or enforceable by equivalent means (such as by a professional association). Other privileged access is not enforceable, but is otherwise protected by secrecy or other barriers to access.

• Remove the second 'present' in the definition as it is redundant
• Rephrase the wording of the elaboration of an economic resource by bringing together sentences two and three.
• Remove the last two sentences of the elaboration of an economic resource and include them in an amplifying text or similar.

Board members tested various items that might represent an asset against the proposed definition in order to work out what an asset represented. Particularly it was discussed what represents the asset for the holder of a call option for goods. It was noted that in this case the option is the right to the resource and that the promise of the counterparty to deliver the goods is the resource.

The Board agreed to proceed on the basis of the definition outlined by the staff (with amendments noted above) and asked the staff to continue investigations including the FASB work regarding this issue.

Distinguishing liabilities from equity

The staff presented a paper discussing issues relating to the definitions of liabilities and equity and the distinction between them. The paper identified a number of cross-cutting items associated with liabilities and equity. The Board was asked to decide whether the staff should explore on the following key issues:

• Should there be a distinction between liabilities and equity?
• Should there by only two elements?

The first issue considers whether a single element should be defined to comprise what liabilities and equity now comprise.

Such an element might be termed 'claims' and would be the counterpart to assets. The second issue considers whether three or more elements should be defined in place of what the existing framework define as liabilities and equity. One approach would be to restrict the terms liability and equity to those items that are either 'pure' liabilities or 'pure' equity, and to define one or more elements.

The Board decided to undertake the project and asked the staff to present a revised paper at a future meeting.

17 November 2006

Short-term Convergence: Joint Ventures

The Board was given a very short oral update on feedback that the staff had received on this project when it discussed the tentative decisions that the Board made at its July 2006 meeting with preparers and users. The Board stated that the comments received will not change the direction (tentative decisions made in July) of the project and the staff should continue its work to bring a draft proposal back to the Board at a later meeting.

Short-term Convergence: Borrowing costs – Exposure Draft of Proposed Amendments to IAS 23 Borrowing Costs

The Board discussed comments received on its Exposure Draft (ED) of proposed amendments to IAS 23 Borrowing Costs. The ED proposes to eliminate the option to expense immediately borrowing costs directly attributable to a qualifying asset.

A significant number of respondents expressed strong disagreement with the proposal in the ED to eliminate the option to expense as incurred. In light of comments received, the Board discussed whether it should proceed with the publication of a final amendment to IAS 23 or terminate the project.

The Board was split on how to proceed based on the comments received. Some Board members were persuaded by the quality of the comments from respondents and noted that they would support terminating the project. The proposal would eliminate the option to expense but there would still be significant differences as the requirements for capitalisation under US GAAP and IFRS are different. Other Board members wanted to go forward with the project, noting that even if this was not convergence in detail it was still convergence in principle, and a better alternative than the current standard. Members also noted that the intention of this project was to improve the standard, not to come to the 'right answer'.

As this is one of the projects on the MOU, some Board members were concerned that it could jeopardise the MOU if the IASB dropped this project without at least discussing it with the FASB first. By 'jeopardise', Board members meant that the IASB could be seen not to take the MOU seriously by dropping projects when it met resistance from its constituents. Other Board members disagreed that this should stop them from dropping the project, if it was clear that continuing would result in a solution that is not helpful for constituents.

Due to the comments and the split view by Board members it decided that the staff should do further analysis on comments from respondents before the Board decides how to proceed.

Post-employment Benefits – Recognition and presentation

In July 2006 the Board decided to form a working group on Employee Benefits which would help the IASB by providing practical input on ideas, concepts and proposals developed by the IASB.

At its November meeting the Board discussed two papers that consider revisions to IAS 19 that are intended to provide short term improvements to the standards. These papers and the recommendations would be discussed with the working group in due course.

The intention of this session was for the Board to give preliminary views on what the staff should explore in a future Discussion Paper.

Recognition of changes in defined benefit pension plans

Actuarial gains and losses

The Board discussed whether actuarial gains and losses from changes in actuarial assumptions should be recognised in full in the period in which they occur. This deals only with the issue of recognition, not where to recognise the gains and losses.

The Board agreed that all actuarial gains and losses should be recognised immediately when they occur, and that no gains and losses should be deferred.

Past service cost

Next the Board discussed whether unvested past service costs should be recognised immediately (vested past service costs are already expensed immediately according to IAS 19).

All Board members supported the proposal to require all past service costs, including unvested service costs, to be recognised immediately.

Presentation of changes in defined benefit pension plans

The previous paper presented to the Board considered whether changes in defined benefit plans should be recognised immediately or not, while the second paper considered how these gains and losses should be presented when recognised. The Board discussed whether gains and losses on the following items should be recognised directly in profit and loss when they rise.

• Service costs (past and present)
• Interest cost
• Return on plan assets
• Actuarial gains and losses

Three different alternatives were presented to the Board:

• The staff recommendation that all components should be recognised directly in profit and loss.
• A second alternative which would recognise all components, other than changes in fair value of plan assets, in profit and loss. Changes in fair value of plan assets would be recognised in other recognised income and expense.
• A third alternative that would only require past and present service cost to be recognised in profit and loss.

As a preliminary view the majority of Board members indicated that all components should be recognised directly in profit and loss when they rise.

However, from the perspective of a the Discussion Paper, Board members said that if it was going to present alternatives (such as the alternatives above) they would have to be worked through in such a way that they are alternatives that the Board would consider if respondents were negative to the Board's initial proposal (ie that they not just are alternatives to give alternatives).

The Board decided that the staff should explore further the alternatives set out by the staff, and that the Board at a later meeting would decide whether to include these as alternatives in a Discussion 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.