Fair Value Measurement (information session)

The staff informed the Board that the FASB had formed a Valuation Resource Group (VRG). The purpose of the VRG is to provide the FASB with input for clarifying the guidance related to the application of the principles in SFAS 157 Fair Value Measurement when fair value is required or permitted under US GAAP. The VRG is drawn from accounting firms, valuation advisers, preparers, users, regulators and standard setters. The first meeting of the VRG is planned for 1 October 2007. Issues raised at that meeting will be brought to the October FASB meeting.

The IASB staff noted that any decisions made by the FASB are likely to have implications for valuations performed under IFRSs because constituents may apply the US guidance in the absence of IFRS guidance. The staff will keep the Board informed of the project.

No decisions were made.

Amendment to IFRS 1 – Cost of Investment in a Subsidiary – Redeliberation of the January 2007 Exposure Draft

At the June 2007 meeting the Board discussed issues raised by constituents in response to the Exposure Draft of Proposed Amendments to IFRS 1 First-time Adoption of International Financial Reporting Standards - Cost of an investment in a subsidiary (ED). The Board asked the staff to prepare an analysis considering the possibility of amendments to the ED and IAS 27 Consolidated and Separate Financial Statements.

Deemed cost

Regarding paragraph B5(a) of the ED respondents pointed out that in many jurisdictions entities currently show a carrying amount that reflects cost including intangible assets and goodwill not currently recognised in the subsidiary's financial statements under IFRSs. The use of the net asset option could result in a significant reduction to their initial cost on transition to IFRS because such intangible assets and goodwill would be stripped out of this cost figure. This may result in an adverse taxation and/or legal scenarios.

The Board discussed the following alternatives regarding the net asset option (in both cases the fair value at transition date option in paragraph B5(b) would be retained):

Alternative 1:

Calculate deemed cost based on the amounts of the underlying assets and liabilities of the subsidiary in the consolidated financial statements at the date of transition to IFRSs. Accordingly the deemed cost would include intangible assets and goodwill related to the subsidiary.

Alternative 2:

Calculate deemed cost based on the amounts under previous GAAP.

The Board had a thorough debate and was nearly equally split between the two alternatives.

Board members in favour of alternative1 noted that this alternative would be consistent with the exemptions provided for business combinations in IFRS 1. In addition, they believed that this alternative would not be burdensome as the amounts would have to be determined for consolidation purposes anyway. One Board member responded that this would not be the case for (intermediate) parents that do not prepare or are not included in consolidated financial statements.

Other Board members noted that alternative 2 is also consistent with the exemption provided to restating business combinations in IFRS 1. These Board members believed that it would be the simplest way to respond to the issues faced by constituents and would be readily accepted. Board members in favour of alternative1 raised the concern that alternative 2 might result in a 'cost' that has low information content, in particular in situations where nominal/par values were used to measure cost (such as the merger relief in the UK).

No final conclusion was reached, however, eight Board members indicated that they could accept alternative 2 and six indicated that they could accept alternative 1. Two Board members were not present.

Scope of the exception

The Board unanimously agreed to extend the deemed cost exemption to initial measurement of investments in associates and interests in joint ventures on transition to IFRSs.

The cost method in IAS 27 (dividends)

Constituents suggested amending IAS 27 to permit pre- and post-acquisition dividends received from subsidiaries to be treated as investment income, subject to an impairment test of the value of the subsidiary in the parent's accounts in accordance with IAS 36 Impairment of Assets.

The Board agreed to the constituents' suggestion and decided to remove the definition of the cost method from paragraph 4 of IAS 27. Accordingly all dividends from subsidiaries would be treated as a return on investment and presented in investment income. The Board noted that under the fair value option all dividends would result in a reduction of the fair value while under the cost option a dividend would be an indication that the investment may be impaired.

Next steps

Given the extent of changes to the ED as currently drafted, the Board agreed to re-expose the ED. The Board decided to ask the large accounting firms for informal feedback on the practicability of the intended changes. After that the staff will draft the re-exposure for discussion at a future meeting.

In addition, the amendments to IAS 27 will be exposed separately.

In July the Board directed the staff to draft an amendment to IAS 27 to clarify that paragraph 37 does not apply to the formation of a new parent entity for an existing group when there are no changes in substance resulting from the revised organisation structure. The Board decided to also expose this issue separately in the proposed amendments to IAS 27.

Related Party Disclosures – Amendments to IAS 24 – consideration of responses to the exposure draft

The staff presented their analysis of comments received on the IASB's Exposure Draft of Proposed Amendments to IAS 24 Related Party Disclosures – State-controlled Entities and the Definition of a Related Party (ED). The analysis is available in the Observer Notes section of the IASB's website (Agenda Paper 11).

No initial views were expressed by Board members and no decisions were made at this meeting.

State-controlled entities

Most respondents supported the Board's proposal to provide relief from the disclosure requirements in paragraph 17 of IAS 24 for entities that are related simply because of control or significant influence by a common state. The main comments related to this proposal were:

• To extend the exemption to other type of entities, that is, non-state-controlled entities.
• To provide the exemption additionally to entities that are jointly controlled by a state.

Most respondents also supported the indicator approach proposed in the ED. The comments mainly related to suggestions for clarifying how and when to apply the indicators; for example:

• Amending paragraph 17A(b) to include the influence exercised directly by a common state.
• Clarifying whether the indicators suggested in paragraph 17B of the ED are rebuttable presumptions.

Definition of a related party

In principle most respondents agreed with the Board's proposal to amend the definition of a related party. However, several raised practical and cost-benefit concerns.

Most respondents agreed that. However, a large number of respondents believe that the proposed wording improves the definition but that it is still complex and difficult to apply. Main comments were:

• Defining the term 'significant voting power'.
• Reinstating the word 'may' in the proposed definition of 'close members of the family of a person'.
• Removing inconsistency related to key management personnel in paragraph 9(b)(vii ).

Definition of a related party transaction

Most respondents agreed with the proposal to clarify the definition of related party transaction. However, many were concerned by the new example of a related party transaction proposed in paragraph 20(j) of the ED.

Project plan

The Board agreed to discuss the issues in detail at the October and November meeting. It was noted that because of the large number of issues raised an additional session may be required.

IFRIC Update

The IFRIC Co-ordinator reported the results of the September 2007 IFRIC meeting. Deloitte's report on that meeting was Posted on www.IASPlus.com.

Wednesday 19 September 2007

Post-employment Benefits – Discussion paper issues relating to defined benefit promises

Cash balance and similar plans – Definitions of defined promises

At the July meeting the Board discussed the definitions for three categories of benefit promises - defined benefit (DB), defined contribution (DC) and defined return (DR). The Board suggested some changes to the proposed definitions. In particular, the Board noted that DC promises are a subset of DR promises and asked whether these two categories could be combined. Furthermore, one Board member questioned the rationale for using the DB category as the residual category instead of the DR category.

At this meeting, the Board discussed the following three issues: the clarified definition of DR promises, the combination of DC and DR promises and the classification of the residual category.

Clarification of the definition of defined return promises

The objective of the amended definition for DR promises was to clarify the following matters:

• the classification of the post-employment benefit promises is made by reference to the way the benefit is accumulated. The way in which the liability for post-employment benefit promises is settled does not affect the definition.
• the contribution requirement must be independent of future salary increases.
• the benefit promise classification should focus on whether or not it can be expressed independently of future salaries. The same benefit promise may be described as current salary (independent of future salaries) or career average (dependent on future salaries).
• the benefit promises of fixed amounts to be paid at future date are DR.
• the employer's liability for any negative returns on contributions paid is included in the promised return component.
• some benefit promises may include a combination of any two or more types of promised returns.

The proposed amended definition of a DR promise is 'a post-employment benefit accumulated through a contribution amount which, for any given period, can be expressed independently of the salary that will be earned after the end of that period.

For some DR promises the entity may have an obligation for the promised return on the contribution amount. The promised return is a guaranteed fixed return, the change in the value of an asset, or group of assets, the change in value of an index, or any combination of these'.

The above definition for DR leads the Board into a lengthy debate about the characteristics and features of DC, DR and DB plans. The Board was reminded that the objective of DR category was to capture schemes where specified contributions (independent on future salaries) paid by the employer and there is a promised return on assets. The Board finally decided to proceed with the proposed definitions and to clarify in the discussion paper what the Board tried to capture in order to obtain the respondents view on the subject. The Board considered that they have given their 'best shot' on these definitions.

Combining defined contribution and defined return promises

At the July meeting, the Board asked the staff to consider whether DR and DC promises should be combined into one category. The only difference is that, for DC promise, the entity has no further obligation once the contributions are paid, whereas for DR promise, the entity has an obligation for a promised return. Therefore, the DC promises are simply a special case of DR promises.

The Board acknowledged that sometimes it is difficult to distinguish between the two. Some DC promises allow the employer to delay payment of contributions to the plan for a specified period. The employer will have an obligation for the delayed contributions and, possibly, the promised return on those contributions. This could lead to have some promises categorised as DC if the contributions have been paid or DR if they have not yet been paid.

The Board decided to combine DC and DR promises as DR promises. Otherwise, either benefit promises could have their categorisation changed depending on when the employer pays the contributions, or an arbitrary rule that sets the period of time within which the contributions must be paid. Furthermore, the Board acknowledged that in some situations it is difficult to distinguish between DC and DR plans, and therefore if both schemes are captured under the same category, DR, this simplify the issue as the underlying accounting principles would be the same.

The residual category

The Board decided that the residual category should remain DB. The Board noted that there is a residual collection of benefit premises which have not yet been considered (e.g. post-retirement medical plans). Furthermore the scope of this Phase I is limited to the work that can be done in a four year period and any changes should be limited to the troublesome plans that are clearly identified.

Measurement of the liability for defined return promise

Based on previous decisions made by the Board, the staff has identified different approaches for accounting for the contribution requirement and premised return in a DR promise. The staff proposed that the employer's liability should be measured at fair value.

There was some disagreement among the Board members regarding whether or not the proposed measurement should effectively be called fair value. The Board view was that the contribution requirement and the promised return that are being measured are based on the assumption that there is no change in the benefit promise. Therefore, the Board directed the staff to a 'building blocks' approach for the measurement of this DR promise and considered that this should be the basis for the discussion paper. These building blocks should explain the key principles in the measurement of the DR promise.

Measurement of benefits in the payout and deferment phases

In most post-employment benefit arrangements, the promises made to employees could be viewed as having three distinct phases: accumulation phase, deferment phase and payout phase. During the accumulation phase, the measurement of benefits will differ between DR and DB schemes.

A question is whether the measurement should change once we entered into the deferment or payout phase, as this could lead to the recognition of a gain or loss on the plan liabilities on retirement because of the change in measurement attribute. The Board has a lengthy debate on the subject and their preliminary view was that no gain or loss should be recognised once we entered into the deferment or payout phase. This is consistent with the current IAS 19 accounting for DB where PUC method is used during the accumulation and deferment/payout phase. The Board could not really conclude on the subject and therefore decided to bring this back at the next meeting.

Conceptual Framework – Reporting Entity

Comments on pre-ballot draft

The Board members and five external reviewers received in July a pre-ballot draft on the reporting entity discussion paper with request for comments.

At this meeting, comments received and proposed amendments where discussed with the Board members in order to determine whether the Board is satisfied with the changes made and would allow the staff to proceed with preparing a ballot draft of the discussion paper.

General issues in the context of an individual reporting entity

The comments received on this section raised a lack of clarity about the objectives this section was trying to achieve as well as the difficulty to understand its link with the section dealing with group reporting entity. The revised section clarifies why:

• the Board considered whether to develop a definition of a reporting entity
• the legal existence is sufficient to establish that a reporting entity exists
• a component of a legal entity, such as a branch, can be a reporting entity.

In addition, the revised section is more clearly linked with the objective of financial reporting. The description of a reporting entity has also been slightly modified to become 'a circumscribed area of business activity of interest to present and potential investors and creditors'.

One Board member stressed that it would be relevant to link what we mean by 'business' to the available definition in IFRS. Another member question whether subsidiary individual financial statements can be considered as general purpose financial statements as the completeness assertion cannot be met. Please refer to further discussion in the below section. In the end, the Board agreed with this revised section provided that minor amendments are made.

Other comments received

In the section on parent-only and consolidated financial statements, the pre-ballot draft states that 'the majority of the FASB members concluded that, in concept, parent-only financial statements should not be a required part of a parent entity's general purpose external financial report'. This statement raised significant debate among the Board on whether parent-only financial statements were required in all cases, in certain circumstances or if addition information would be sufficient. At some point, the Board considered to vote on whether parent only financial statements where required as part of general purpose consolidated financial statements of a parent. However, the Board could not figure out the exact question to vote on and therefore decided to postpone the vote to the next Board meeting.

Finally, the Board agreed to leave it up to the Project Manager to decide what would be the most efficient: to prepare the pre-ballot draft based on all comments received without submitting it one last time to the Board or whether the paper should go one more time to the Board. Some Board members express some concerns due to the number of comments to be incorporated.

Conceptual Framework – Objectives and Qualitative Characteristics

The staff presented a revised objective of financial reporting for the forthcoming exposure draft in order to address constituents' concerns about the role of stewardship in financial reporting:

The objective of general purpose external financial reporting is to provide financial information about the reporting entity that is useful to present and potential investors and creditors in making decisions in their capacity as capital providers.

Annual Improvements 2006-2007 – Sweep issues

IAS 39 – Reclassification of financial instruments into and out of at fair value through profit or loss

One Board member and the financial instruments staff noted that the proposed annual improvement in respect of this issue, as agreed at the June meeting, was inconsistent with the fair value option.

The Board agreed to clarify paragraph 9 (a) (ii) and (iii) of IAS 39 Financial Instruments so that no changes to the basis of accounting for non-derivative financial instruments should be permitted after initial recognition (other than those required in paragraphs 50 - 54 of IAS 39) if an entity changes the way in which it manages the instrument.

This results in paragraphs 50A (c) and 50A(d) being deleted from the proposed amendment and the definition of financial assets and financial liabilities at fair value through profit and loss being amended as follows:

• (a) It is classified as held for trading. A financial asset or financial liability is classified as held for trading if it is:
  • (i) it is acquired or incurred principally for the purpose of selling or repurchasing it in the near term;
  • (ii) on initial recognition it is part of a portfolio of identified financial instruments that are managed together and for which there is evidence of a recent actual pattern of short-term profit-taking; or
  • (iii) it is a derivative (except for a derivative that is a financial guarantee contract or a designated and effective hedging instrument).

IAS 19 – Replacement of the term 'fall due' with expected to be settled'

This proposed amendment to IAS 19 Employee Benefits was intended to introduce consistency between the terms used in the definitions and the terms used in paragraph 8.

The staff recommended that the focus should be on the timing of the entitlement of the employee rather than the expected timing of the use of the benefit.

The Board agreed that the term 'fall due' should therefore be replaced with the term 'to which the employee becomes wholly entitled'.

IAS 33 – Impact of forward purchase contracts on EPS calculation

The Board agreed, with one dissent, that shares subject to repurchase should be accounted for as a participating debt instrument and that as such, dealt with as a separate class of participating instruments in accordance with the two class method for the calculation of EPS.

The Board agreed, with one dissent, that shares subject to repurchase in accordance with a gross physically settled forward purchase contract with remittance of dividends should be accounted for as a non-participating debt instrument and that as such, dealt with as a separate class of non-participating instruments in accordance with the two class method for the calculation of EPS.

The Board's understanding was that these approaches would give the same EPS result for both IFRS and US GAAP. The Board agreed that the EPS calculations for forward purchase contracts with a choice of gross physical or net settlement, gross physically settled written put options and written put options with a choice of gross physical or net settlement should be consistent with that described above for gross physical settled forward purchase contracts. The Board acknowledged this gives a different EPS result from US GAAP and agreed that this should be identified as a known difference between IFRS and US GAAP in the Basis for Conclusions on IAS 33.

The Board did not conclude on the following issues which were raised by the staff paper:

• Whether dividends paid in respect of shares subject to repurchase in accordance with a gross physically settled forward purchase contract should be presented as an expense in profit or loss
• Whether a liability for discretionary dividends payable in respect of shares subject to repurchase in accordance with a gross physically settled forward purchase contract should be recognised when the dividends are declared, irrespective of whether those dividends are presented as a finance expense in profit or loss or as an equity distribution.
• Where the shareholder to whom the dividends are paid and the counterparty from the entity receives the remittance of the dividends are different parties, whether at the date that the dividends are declared, the liability for the dividends payable and the receivable for the dividends to be remitted qualify for an offset presentation.

IAS 41 – Miscellaneous wording revisions arising from the ballot process

The Board agreed that IAS 41 Agriculture should be amended as follows, with the exception that the final sentence should be clarified in respect of when that part of the grant retained should be recognised in profit or loss:

36  Terms and conditions of government grants vary. For example, a government grant may require an entity to farm in a particular location for five years and require the entity to return all of the government grant if it farms for less fewer than five years. In this case, the government grant is not recognised in profit or loss as income until the five years have passed. However, if the terms of the government grant allows part of the government grant it to be retained based on according to the passage of time, the entity recognises the government grant that part in profit or loss as income on a time proportion basis.

IFRS for Small and Medium-sized Entities

The Board agreed that the deadline for comment letters should be deferred until 30 November 2007 to allow organisations participating in field tests to factor the results into their comment letters.

Friday 21 September 2007

Financial Instruments Puttable at Fair Value and Obligations Arising on Liquidation

The Board re-examined the characteristics that result in puttable instruments being considered as the residual interest, i.e. to qualify for equity classification.

The Exposure Draft Financial Instruments Puttable at Fair Value and Obligations arising on Liquidation (ED) identified the residual interest in the net assets of an entity by requiring all individual puttable instruments

• a) to be in the most subordinate class of instrument,
• b) to be issued and puttable at the fair value of the pro-rata share of the net assets of the entity, and
• c) to have neither a limited nor guaranteed return.

With regard to requirement b) above the Board tentatively agreed that the full participation in the performance of the issuer can be best demonstrated when the instruments are issued and puttable at the fair value of the instruments.

Some constituents noted that, in particular, requirement b) makes the scope of the proposed amendment too narrow.

The 'Revised Approach'

In response to these comments the staff presented the Revised Approach. The main feature of this approach is that the class of puttable instruments as a whole is required to represent the residual interest in the entity. Accordingly, the put price of the individual instrument would be of little relevance for classification of the class of puttable instruments as long as the class as a whole represents the residual interest in the entity. However, all individual instruments still need to be equal in all other respects.

The Revised Approach eliminates requirement b) and, accordingly, the definition of residual interest much more relies on requirement c) above.

The staff proposed that the ED should be modified to describe what type of return is characteristic of equity rather than only stating what type of return does not qualify for equity classification. The following amendment was proposed:

'The total return of the puttable instrument is based substantially on the net earnings or the change in net assets of the entity (excluding any possible effect the puttable instrument may have on net earnings or net assets). An example of a puttable instrument with a return that is not based substantially on the net earnings or the change in net assets of the entity is a puttable instrument that has a fixed or guaranteed total return to any extent, before or at liquidation'.

The staff drew to the attention of the Board that the definition of returns does not address the issue that there might other (less subordinated) instruments that are absorbing most of the variability in the performance of the entity and leaving only a predetermined (but slightly variable) amount of net earnings or net assets for the class of puttable instruments. To address this potential flaw the staff suggested including the following guidance in the ED:

'The variability of the total return to the class of puttable instruments is not substantially absorbed by another contract or financial instrument, or some combination thereof. If a determination cannot be made that these conditions are met, the puttable instruments are classified as liabilities.

Ordinary commercial contracts, like leases, mortgages, and franchise and license agreements may include provisions based on elements of the entity's performance (for example, a percentage of gross revenue). Contracts entered into on normal commercial terms with unrelated parties are unlikely to fall within the meaning of this test. For example, if commercial practice for lessors is to base rentals in part on a percentage of gross sales, and the percentage in the entity's lease is consistent with amounts charged in the are area, then the lease should not be considered to absorb substantial variability in net earnings or net assets.'

Mandatory dividends and partnership remuneration

The staff suggested that the ED should not provide guidance as to whether a mandatory dividend is a contractual obligation.

The Board agreed to this by majority vote but pointed out that the following principle should be clarified in the ED:

• If a mandatory dividend is required to be paid in the absence of profit the instrument does not qualify as equity classification.
• If a mandatory dividend is requried to be paid only if sufficient profit is available such a clause should not prevent the instrument from being classified as equity.

Derivatives on puttable instruments and limited life obligations The Board unanimously decided to retain the guidance in the ED that derivatives on puttable instruments or limited life entity shares are not equity.

Reclassification of instruments

The Board decided to include the following guidance on how to reclassify an instrument under the ED:

• On reclassification from liability to equity the instrument is classified as equity with a carrying value equal to its previous carrying value. There should be no gain or loss.
• On reclassification from equity to liability the equity instrument will be carried at cost while IAS 39 Financial Instruments: Recognition and Measurement requires initial recognition of a liability to be at fair value (paragraph 43). Any difference between the carrying value of the equity instrument and the fair value of the newly recognised financial liability should be recognised in equity.

Mandatory redemption

The staff noted that the ED does not address this issue explicitly but that the criteria in the ED (also under the Revised Approach) would not prohibit an instrument in which the embedded put is automatically exercised on the occurrence of specific certain or uncertain events (such as death or retirement) from being classified as equity.

There seemed to be a consensus that mandatory redemption on death or retirement does not prohibit an instrument from being classified as equity. One Board member noted that such clauses have been used for decades and that any change to this principle would have massive implications for many instruments currently classified as equity under IFRSs, i.e. would go far beyond this project.

Implications of the re-deliberations to obligations arising on liquidation of limited life entities

The Board unanimously agreed to the staff proposal to provide separate guidance for puttable instruments and obligations arising on liquidation of limited life entities to reduce complexity of the ED. Constituents had indicated that they have problems in identifying what criteria relates to which type of obligation.

Effective date and transition requirements

The Board tentatively decided the effective date to be 1 January 2009 with early adoption being permitted. The proposed amendments should be applied retrospectively with an exception relating to compound instruments in which the liability component is no longer outstanding.

Next steps

The staff was asked to prepare a revised ED including the Revised Approach and the decisions made on the other issues. The Board intends to hold roundtable discussions on the revised ED in November 2007 in London. Based on the outcome of the roundtables the Board will decide whether re-exposure is required.

IFRS 1 – Cost of Investment in a Subsidiary – Follow-up From Day 1 Tuesday 18 September 2007

Deemed cost

The board finalised their conclusion on the deemed cost alternatives regarding the net asset option (refer to IASPlus notes from day 1 of this meeting). On day 1 of the meeting eight Board members indicated that they could accept Alternative 2 to calculate deemed cost based on the amounts under previous GAAP and six indicated that they could accept Alternative 1 to calculate deemed cost based on the amounts of the underlying assets and liabilities of the subsidiary in the consolidated financial statements at the date of transition to IFRSs. However, no final conclusion was reached on day 1 as two Board members were not present. These Board members were present at the Friday session and both indicated that they could accept Alternative 2 (that is, Alternative 2 commands the support of 10 Board members).

Technical Plan

The Board discussed the timetable for document publication dates (detailed draft chart omitted from the observer notes). In addition to the changes resulting from the outcomes of the current meeting, it was noted by the staff that the current Q4 2007 plan will not be met. At this stage, staff could not identify all projects that will not meet the Q4 2007 deadline; however, it was noted that the post-employment benefits discussion paper was highly unlikely to be published in Q4 2007.

We have updated our Project Agenda and Timetable to reflect the discussion at the September 2007 Board meeting.

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