Tuesday 15 April 2008 (afternoon only)

Annual Improvements Project 2008 – Application of IAS 39.2

The purpose of this session was to seek Board members' views on adding to the Annual Improvements Project 2008 an amendment regarding the applicability of the scope exemption in IAS 39.2(g), which excludes from the scope of IAS 39 Financial Instruments: Recognition and Measurement contracts between an acquirer and a vendor in a business combination to buy or sell an acquiree at a future date. The question raised was whether this applies only to binding contracts (forwards) or whether it applies more widely and whether it could be applied by analogy.

Originally, this issue had been referred to the IFRIC along with the question whether IAS 39 paragraph 2(g) could be applied to similar transactions (such as contracts with an associate) by analogy. The IFRIC concluded that the standard is ambiguous, which could lead to diversity in practice.

The staff presented an analysis of the scope exemption for three types of financial instruments in a business combination:

1. Binding contracts (such as forwards) constituting control within the period necessary to complete a business combination.
2. Currently exercisable option contracts to acquire shares in another entity the exercise of it would result in a transaction to which IFRS 3 applies.
3. Non-currently exercisable option contracts to acquire shares in another entity.

On forward contracts, the staff analysis concluded that the scope exemption in paragraph 2(g) applies. For currently exercisable options, the staff noted that IAS 39 provides another scope exemption in paragraph 2(a), which precedes paragraph 2(g). Finally, the staff concluded that paragraph 2(g) is not applicable to non-currently exercisable option contracts.

The Board only discussed this issue briefly. One Board member noted that originally the Board excluded such contracts because there might be a period between agreement and closing of a business combination. Some Board members suggested drafting changes. The Board agreed to the proposed wording by the staff subject to drafting changes.

The staff then asked the Board if it would concur with the staff recommendation that paragraph 2(g) could not be applied to similar transactions by analogy. The Board agreed.

Furthermore, the Board confirmed that this amendment should be included as part of the Annual Improvements Project 2008.

Amendment to IAS 39: Exposures Qualifying for Hedge Accounting

At the March Board meeting, the staff presented the Board with a preliminary comment letter analysis on the proposed amendments to IAS 39 on what risks can be hedged and what can be designated as a hedged item. No decisions were made at that meeting. The purpose of this meeting's session was to present possible ways forward along with a staff recommendation.

The staff presented three possible ways forward with one approach having further possible alternatives:

• Approach A: Wait for the responses to the Discussion Paper on reducing complexity in reporting financial instruments before deciding what, if anything, to do on hedge accounting
• Approach B: Move forward with a short-term amendment using the rules-based approach of the ED
  • Approach B1: Move forward with a limited amendment to IAS 39 that addresses only issues where there is diversity in practice
  • Approach B2: Move forward with an amendment based on scope of the ED (hedged financial items)
  • Approach B3: Move forward with an amendment based on the ED but extend the scope to include non-financial hedged items.
• Approach C: Move forward with a short-term amendment but develop a principle-based approach to address financial (and possibly non-financial) hedged items

The staff recommended Approach B1, that is, to continue with the ED to address the issues that created diversity in practice.

The Chairman questioned whether it would be sensible to defer the ED to await the outcome of the FASB's project on simplifying hedge accounting. One Board member noted that waiting for completion of FASB's project would be tantamount to accepting approaches the Board does not consider appropriate. The staff noted that approach B1 could lead to further submissions to IFRIC on similar issues.

The Board agreed to continue with approach B1.

Wednesday 16 April 2008

Open Meeting with Representatives of the European Financial Reporting Advisory Group (EFRAG) and European Standard-Setters

This meeting was the formal semi-annual encounter between the IASB and the principal accounting standards bodies in the European Union. The meeting was an opportunity for European groups to raise issues of concern with the IASB, to share progress on EU-level initiatives and to exchange information.

PAAinE Activities

Several European representatives spoke of the various initiatives being pursued by the Pro-active Accounting Activities in Europe group, noting the release of two discussion papers in recent months: one on distinguishing between debt and equity and another on pension accounting. They also noted that a discussion paper addressing aspects of the IASB's project on financial statement presentation (phase II) was expected later this year. In addition, the French standard-setter is 'stress testing' the working definition of an asset developed by the IASB and FASB in the elements phase of the Conceptual Framework project. The EFRAG chairman noted that, although typically one national standard-setter leads the drafting of a discussion paper with the assistance of others, many other national standard-setters (including some outside Europe) review them and offer comments. He also noted that the PAAinE initiative is an integral part of involving the accounting profession and others in Europe in IASB projects at an early stage and is a way of feeding information to the IASB in a structured and constructive manner.

IASB-FASB Memorandum of Understanding

At the invitation of the EFRAG chairman, IASB Chairman Sir David Tweedie outlined the reasons behind the potential reconsideration of the 2006 IASB-FASB Memorandum of Understanding scheduled for debate on 21 April 2008 as part of the joint IASB-FASB meeting.

In response, acknowledging that neither Board had debated the memorandum prepared by a working group of Board members and staff of both Boards, various European representatives expressed willingness to cooperate with the IASB in any way to make the IASB more efficient. They also suggested relative priorities from a European perspective, noting in particular insurance and leasing were high priorities (even though insurance is not included in the MOU), while down-playing debt-equity classification (although this is described as critical for US acceptance of IFRS). They also expressed the hope that discussion papers on all remaining chapters of the IASB Conceptual Framework be issued by 2009.

Current Financial Market Situation

The context of this discussion was "how is the IASB planning to react to the 'credit crunch' and how can EFRAG and the national standard-setters assist?"

All participants noted that the IASB was being bombarded by (often conflicting) requests for action by various supra-national bodies. Prompt action was being demanded, often with little (if any) understanding of the IASB's operating practices and due process requirements.

The IASB is focussing on consolidation and derecognition issues, including both IAS 27 and SIC 12. It is likely that any revisions will still require the careful use of judgement around the 'control' line. In addition, disclosures similar to those in FAS 157 Fair Value Measurements and some enhancement of the disclosures in IFRS 7 Financial Instruments: Disclosures may be proposed. It was also likely that the IASB would hold roundtable sessions before an exposure draft is published, so that there is as much consensus as possible before the ED.

At the same time, the IASB is working with a panel of valuation experts on issues of measuring financial instruments in illiquid markets. However, many at the IASB are convinced that the current credit crisis is a banking business model problem more than an accounting standards problem, and that possible alternatives proposed recently in the financial press (such as rolling averages or directors' valuations) inhibited transparency and did not help capital markets.

EU Endorsement of IFRSs

The EFRAG chairman and staff reported that nine final IASB and IFRIC documents were in the queue for EU endorsement. Given the new EU comitology process – involving the Commission, a Parliamentary Committee, and the Council after recommendations from the Accounting Regulatory Committee (ARC) and EFRAG – for a document to be endorsed by the end of the year, it had to have cleared the ARC by August. EFRAG was hopeful that the current queue could be cleared this year, but offered no guarantees.

Liabilities – Amendments to IAS 37 (was part of Business Combinations Phase II project)

Measurement Guidance

The IASB staff introduced the first draft of possible application guidance to accompany the measurement requirements of proposed revisions to IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

The Board did not make any real progress, and it was evident that they were still divided as to their understanding of 'transfer' and 'settlement'; the notion of 'rational' actions; and the measurement attribute being applied.

Some Board members thought that they had decided (in January 2008) that 'settlement' implied that there was a counterparty. Other Board members noted that, in some cases, there is an obligation but no counterparty, often because the obligation is imposed by stature or as a condition of a mineral resource licence.

Board members noted that, for some liabilities, it was not possible to transfer the liability and that the only 'rational' action for the entity would be to discharge the obligation itself (which challenged the 'settlement with counterparty' understanding noted above). Environmental remediation obligations were cited as a good example for such liabilities. Other Board members expressed unease with the suggested 'building blocks': probability-weighted cash flows, time value of money, and adjustments for risk. In particular, the adjustment for risk was challenged. A Board member noted that if risk can be diversified, it should not affect measurement. Other Board members agreed with that as a general proposition but noted in return that liabilities related to asset retirement and environmental remediation obligations were often not capable of such risk diversification.

A simple example demonstrated that IAS 37 supported at several notions of measurement. Using the example of a deep-sea oil rig to be decommissioned in 20-30 years' time (see IAS 37.App C, Ex 3), these included:

• (a) what it would cost the entity to transfer the obligation to decommission the rig in 20-30 years' time to an unrelated party at the balance sheet date;
• (b) what it would cost the entity if the asset was retired at the balance sheet date (that is, cease production now, before the end of the oil well/rig's useful life, and dismantle the rig);
• (c) the present day price to decommission the rig in 20-30 years' time adjusted for future price changes and discounted back to the present day assuming the entity undertakes the work;
• (d) as for (c) but assuming that the entity will sub-contract the work to another entity (that is, the sub-contractor will expect to earn a margin).

At this point, the debate was closed. The staff was asked to work with the Board advisers on the project and to return with proposals at a subsequent meeting.

General Requirements for Restructuring Costs and Specific Guidance for Contract Termination Costs

The Board discussed several issues that had been included in the 2005 Exposure Draft but that had not yet been redeliberated by the Board.

Whether disclosures similar to those in FAS 146 Accounting for Costs Associated with Exit or Disposal Activities, paragraph 20, should be included in the revised IAS 37

The Board agreed in principle that disclosures similar to those in FAS 146.20 should be included in the revised IAS 37. However, several Board members expressed reservations. One was concerned that such a requirement would lead to unnecessary disclosure that is included 'to be on the safe side' without any real consideration of its information content. Another disagreed with taking this decision before the Board had determined what the measurement attribute in IAS 37 was. They said that the discussion in the previous session seemed to prove that in five years work revising IAS 37, the Board was still uncertain as to what that attribute was.

Constructive obligations

The staff noted that the manner in which constructive obligations were discussed in the Exposure Draft may have contributed to commentators' misunderstanding of the Board's intentions. The Board accepted a staff proposal to amend paragraph 15 of the 2005 ED as follows:

15 In the absence of legal enforceability, particular care is required in determining whether another party can rely on the entity to act or perform in a particular way. an entity has a present obligation that it has little, if any, discretion to avoid settling. In the case of a constructive obligation, this This will be the case only if:

(a) by an established pattern of past practice, published policies or a sufficiently specific current statement, the entity has indicated to the other parties party that it will accept particular responsibilities;

(b) as a result the entity has created a valid expectation in that party the other parties that it can reasonably rely on expect the entity to perform those responsibilities; and

(c) the other party parties will either benefit from the entity's performance or suffer harm from its non-performance.

Board members expressed concern with aspects of drafting, especially paragraph 15(b), which several thought 'too weak'. Those Board members thought that the counterparty should have a legal remedy against the entity: while this was very close to the US notion of promissory estoppel [a contractually enforceable right that protects a party who would suffer harm], without that notion earnings management would be very easy.

Onerous contracts

The Board agreed to clarify guidance paragraph 57 of the Exposure Draft about contracts that become onerous due to factors outside the entity's control along the following lines:

In some cases, contracts become onerous as a result of events outside the entity's control. For example, a contract that requires an entity to make specified payments regardless of whether it takes delivery of contracted products or services may become onerous if the market price of the products or services declines below the contracted price and as a consequence the benefits that the entity can derive from the products or services become less than the unavoidable costs under the contract....

The staff suggested clarifying the Board's intention with respect to contracts that become onerous through the entity's own actions by amending the illustrative examples and clarifying the Basis for Conclusions. While not disagreeing with those proposed changes, Board members expressed the view that the clarification should also be made in the Standard; amending non-authoritative material was not enough.

The Board agreed that amendments to the text in the Exposure Draft were unnecessary with respect to a perceived inconsistency between ED paragraphs 15 and 55 with respect to constructive obligations; nor with respect to guidance in ED paragraph 58 on sublease income.

The Board agreed to amend ED paragraph 55 to state that 'if an entity has a contract that is onerous, it shall recognise as a liability the net present obligation under the contract...' In addition, it agreed to amend ED paragraph 58 as follows: 'If the contract is an operating lease of an asset that the entity no longer uses, the entity determines the net present obligation unavoidable cost by reference to the remaining lease rentals payable, reduced by estimated sublease rentals that could be reasonably obtained for the property, even if the entity does not intend to enter into a sublease.'

IFRS for Small and Medium-sized Entities (SMEs)

The Board held a second discussion on the responses to the February 2007 Exposure Draft of a Proposed IFRS for Small and Medium-sized Entities (the ED). At this meeting the staff presented the main issues identified in the field tests, that is, the problems encountered in implementing the ED. The staff's summary of issues raised in the field test is presented in Agenda Paper 6 available on the IASB's website. No decisions were made.

The staff noted that 116 entities from 20 countries participated in the field tests. The staff pointed out that they did not work with the individual field test entities but that professional accounting bodies and accounting standard-setters took the lead in identifying field test entities and in helping those entities preparing their reports.

The entities were asked to:

• provide background information about their business and reporting requirements,
• submit their most recent annual financial statements under their existing accounting framework,
• prepare financial statements in accordance with the ED for the same financial year (without presenting comparative prior year information)
• respond to a series of questions designed by IASB staff to identify specific problems the field test entity encountered in applying the ED.

Demographics of the field test entities

The staff provided an overview and, among other things, highlighted the following:

• Of the 116 entities 12 entities were full IFRS reporters because national law permits or requires unlisted entities to use IFRSs, whereas all other participants currently report under their national GAAP.
• Approximately 70% of the field test entities have 50 or fewer employees, including 35% with less than 10 employees.
• Approximately 60% of the field test entities have an annual turnover of less than US$ 5 million including 35% with annual turnover of less than US$ 1 million.

The Board was particularly interested in whether there was a correlation between the problems encountered and the demographics and asked the staff whether it would be possible to analyse the field test results using criteria such as size and proximity of the respective national GAAP to IFRSs (including a separate analysis for the 12 full IFRS reporters). One Board member pointed out that the responses of entities with less than 10 employees (so called 'micros') should be considered separately.

The staff responded that such an analysis would be possible and indicated that the quality of implementation was mainly influenced by the proximity of the respective national GAAP to IFRSs rather than the size of the entities. In particular, the staff explained that the 12 entities already applying full IFRSs in general reported fewer problems than the other entities. Limitations encountered during the field testing

The staff noted that overall the feedback received from the field test entities was very helpful and that only minor limitations were encountered.

Among other things the staff highlighted the following:

• Some field test entities provided financial statements without responding to the IASB's field test questionnaire and vice versa. The staff noted that the reasons for not providing financial statements often were concerns regarding confidentiality of the data rather than the inability of the entity to apply the ED, that is, the financial statements were prepared in accordance with the ED but not sent to the IASB.
• Some field test entities did not prepare a full set of financial statements. The parts omitted by these entities were mainly the statement of cash flows, the statement of changes in equity and certain note disclosures. The staff was of the view that in many cases the omitted parts were considered to be too onerous to prepare for a voluntary field test but that the entities would be able to prepare them if required for financial statements.

General issues raised in the field test comments

The staff highlighted a number of key issues that are not related to a specific section of the ED. The Board discussion focussed on the following topics:

Overall impression

The staff noted that overall the responses received from field test entities were positive. In particular, about half of the field test entities listed no, or only one or two, issues or problems.

Use of fair value

Many field test entities noted that the requirement to perform annual fair value measurements for common financial instruments and residual values of non-financial assets is complex, costly, and often not possible due to lack of reliable values and inability to bear necessary specialists' fees.

The Board asked whether these concerns relate to complex financial instruments only. The staff assumed that this issue would be more a classification issue since many field test entities were not certain which financial instruments qualify for measurement at cost or amortised cost less impairment.

Disclosures are too burdensome

Another significant area of concern was the nature, volume and complexity of disclosures.

• A significant number of the field test entities commented that the required disclosures are too onerous to prepare, in terms of time and costs.
• A few field test entities noted that, in some cases, they were required to publicly disclose sensitive information. The staff explained that disclosures on remuneration of key management personnel (for instance, some SMEs have only one key manager) and related parties are the main areas of concern in this context.

Further simplifications are required

In addition to disclosure requirements being identified as too complex, many field test entities stated the ED itself should be simplified because it currently provides little relief from full IFRSs.

Field test issues related to specific sections in the ED

Only a few topics were mentioned and no strong views were expressed.

Amendment to IFRS 5: Discontinued Operations

The Board discussed potential amendments to IFRS 5 resulting from decisions made by the IASB and FASB in recent joint projects. The following issues were addressed at this meeting:

• Measurement of non-current assets held for sale at fair value rather than at fair value less costs to sell (the 'measurement portion')
• Converged definition of discontinued operations (the 'discontinued operations portion')

Measurement of non-current assets held for sale at fair value rather than at fair value less costs to sell (the 'measurement portion')

In their joint project on business combinations, the Boards decided that all non-current assets held for sale (that is, including those that do not relate to business combinations) should be measured at 'fair value' rather than 'fair value less costs to sell'. However, the Boards decided that an opportunity for constituents to comment on this decision should be provided and, consequently, the revised business combination standards allowed a temporary exception to the measurement principle of fair value until IFRS 5 (and FASB Statement No 144) are amended. The staff pointed out that the main reason for making this amendment was to avoid the recognition of so called 'Day 2 Losses'. Day 2 Losses would occur if non-current assets are measured at fair value on Day 1 of the business combination and measured at fair value less costs to sell in accordance with IFRS 5 on Day 2.

The staff noted that there are three other situations in which the term 'fair value less costs to sell' is used in IFRSs:

1. In IAS 2 Inventories, commodity broker-traders are exempted from applying the measurement requirements in IAS 2 if they measure their inventories at fair value less costs to sell.
2. In IAS 36 Impairment of Assets, the term recoverable amount is defined as the higher of fair value less costs to sell and value in use.
3. In IAS 41 Agriculture, biological assets and agricultural produce are required to be measured at fair value less estimated point-of-sale costs.

The staff summarised the potential issues to be addressed in the measurement portion of the project as follows:

Issue 1: Whether the measurement attribute for non-current assets held for sale should be changed from fair value less costs to sell to fair value.

Issue 2: Whether the scope exception related to commodity broker-traders should be changed from those who measure their inventories at fair value less costs to sell to those who measure their inventories at fair value.

Issue 3: Whether the definition of recoverable amount should be changed from the higher of fair value less costs to sell and value in use to the higher of fair value and value in use.

Issue 4: Whether the measurement attribute for biological assets and agricultural produce should be changed from fair value less estimated point-of-sale costs to fair value.

The Board was then asked to determine the scope of the measurement portion of the project. Some Board members raised the concern that including all issues would require significant staff resources. Other Board members responded that it is important to remove exceptions as soon as possible.

Finally, by majority vote the Board decided to include all four issues in the scope of the measurement portion.

Converged definition of discontinued operations (the 'discontinued operations portion').

At their respective January 2007 Board meetings discussing financial statement presentation, the Boards tentatively decided to converge the definition of discontinued operations. The Boards decided that a discontinued component of an entity would be reported in the discontinued operations section of the financial statements only if that component meets the definition of an operating segment, as defined in IFRS 8 Operating Segments.

Based on that decision, the Boards tentatively agreed to the following converged definition of discontinued operations:

A component of an entity that has been (or will be) disposed of and meets the definition of an operating segment under IFRS 8 would be reported as a discontinued operation on the face of the financial statements.

The Boards also decided at their respective January 2007 Board meetings that an entity would be required to disclose in the notes to the financial statements disaggregated financial information for both (a) a discontinued component of an entity reported as a discontinued operation in the financial statements and (b) a discontinued component of an entity reported in continuing operations because it did not meet the definition of an operating segment.

The Boards tentatively agreed to require the following disclosure for all components of an entity that have been (or will be) disposed of:

• The major classes of revenues and expenses, including impairments, interest, depreciation and amortisation expense, and minority interest.
• The major classes of cash flows (operating, investing, and financing).
• The major classes of assets and liabilities.
• The nature of the disposal activities and the use of the proceeds from the disposal activities.

The Board discussion focussed mainly on whether referring to IFRS 8 in the definition of a discontinued operation would also have consequences for presentation and measurement of discontinued operations. Some Board members noted that in accordance with IFRS 8, information on operating segments does not necessarily need to be based on IFRSs, and that some of the disclosures may not be presented in the segment reporting.

The Board had a thorough discussion of this issue and finally seemed to reach a consensus that the objectives of IFRS 5 and IFRS 8 are fundamentally different. Consequently, the Board decided:

• to look at IFRS 8 when determining whether a component of the entity constitutes a discontinued operation; and
• to look at IFRS 5 only regarding presentation and measurement of discontinued operations.

By majority votes, the Board reaffirmed the decisions made in January 2007 and asked the staff proceed with the discontinued operations portion of the project.

The Board agreed that the amendments to IFRS 5 related to discontinued operations should be applied prospectively with one exception: The amount presented on the face of the statement of comprehensive income in accordance with paragraph 33(a) of IFRS 5 should be restated based on the revised definition of discontinued operations for all periods presented. If an entity reclassifies its amounts reported in prior periods, it should disclose that fact and the amounts reclassified.

The Board also decided that disclosures related to components of an entity that have been (or will be) disposed of should not be required for subsidiaries acquired and held exclusively with a view to resale.

Other issues

The Board agreed that this project does not need to go through the formal agenda decision process because it was spun off from existing projects.

The Board agreed that the comment period of the exposure draft should be 120 days and asked the staff to prepare a pre-ballot draft of the exposure draft.

Thursday 17 April 2008

Consolidation – Including Special Purpose Entities

Over the past few months IASB staff have been analysing financial statements, meeting with representatives from investment banks and accountancy firms and assessing statements from regulators about what they perceive to be good practice and good disclosure relating to consolidation. The purpose of this session was to provide the Board with an overview of this analysis and to describe how the staff expects this analysis to translate into new proposals to replace IAS 27 Consolidated and Separate Financial Statements and SIC 12 Consolidation – Special Purpose Entities.

The IASB staff introduced Agenda Paper 8A and indicated that the issues relating to consolidation also encompassed disclosures around securitisations, for example, those in IFRS 7. As a consequence, the project is also likely to result in change to disclosure requirements.

The underlying issue that the project is attempting to address is the potential conflict between the requirements of IAS 27 and SIC-12, with the ultimate goal of producing a single model of control as an approach to the consolidation of all entities.

The staff the introduced a diagram representing a framework for the questions and issues being resolved as part of the project (copied below from Agenda Paper 8A, paragraph 17):

One Board member noted that the term 'critical accounting policy' was misleading as consolidation is not an accounting policy; rather it is a question of fact whether an entity controls another entity. The point was noted by staff and it was clarified that the staff intended the statement to mean that there was a requirement to make a judgement. The staff also clarified that joint control is not intended to be part of this project as the focus of the project is on consolidation; however, the project team does meet with the project team dealing with joint arrangements on a regular basis.

The staff highlighted that the focus of the project was on consolidation (right hand side of the diagram) rather than anything on the left hand side of the diagram. However, the staff also clarified that they were not ignoring the other aspects and consideration may also be relevant as part of the project, in particular relating to disclosure. One Board member added that disclosure is an essential part of the project to solve the overall problem. Just focusing on the top right box does not solve the problem as the Board needs to come to a coherent solution. A Board member suggested this was an expansion of the consolidation project. Another Board member noted that the Board didn't want to lose focus on this project.

The Board then moved on to discuss specific aspects of the agenda paper. One Board member highlighted that some of the disclosures suggested in the paper were simply segment information from a legal entity focus. Some other Board members agreed.

Another Board member then suggested that the focus of the project is on whether an entity should consolidate or not, that is, the application of control. A second Board member added that the biggest question the Board needs to answer is around consolidation, but they also need to consider disclosure; in particular, the Board needs to decide what to do about significant involvement and possible involvement. The staff responded to this suggestion by clarifying that the term significant involvement is merely a descriptor, not a category. It was not the intention of the staff to redefine anything. The staff also noted that it is important to understand the effect the legal structure have on the overall group, for example, whether there are any restrictions over use of assets. The question that may need to be addressed is whether the Board currently has the right level of detail in IFRS 7. The staff then moved on to explain their working definition of control:

A reporting entity controls another entity when it has sufficient rights that it has the power to be able to use or manage the assets and liabilities of that entity as if they are its own. That power must give the reporting entity the ability to affect the financial variability of the entity and the benefits from, or exposure to, that financial variability.

The staff also introduced the working principles on which this definition is based:

• a. Only one party can control an entity. The party that controls an entity is able to exclude others from using or managing the assets and liabilities of that entity and from the related benefits.
• b. Assessing whether a reporting entity controls another entity is a continuous process. A reporting entity begins consolidating the financial statements of another entity with its own financial statements when it achieves control and ceases consolidation when it loses control
• c. Control refers to the 'present ability' to control another entity; it is not based on whether the reporting entity controlled yesterday or might control tomorrow.

It was noted by one Board member that in many circumstances an entity would not know if another entity is claiming to have control over a subsidiary. So, it is not possible to always avoid the scenario where two entities claim control over a subsidiary.

The Board then discussed some of the consequences of the principles highlighted by the staff. It was noted that there were some apparent inconsistencies in the consequences; for example, one consequence noted by the staff is 'A reporting entity does not control another entity if action must be taken for it to gain control. For example, holding an option or convertible instruments that would give the holder control if exercised is not the same as having control after exercise', whereas another consequence is noted as 'One entity's ability to terminate the activities of another entity for its own benefit (perhaps by having the right to acquire all assets of the entity at any time) is like to constitute control. It was noted by one Board member that the ability to terminate was like an option and therefore the two statements were in conflict. Further, the Board did not agree with the first consequence (relating to options), and the staff agreed that more work needed to be done in this area to clarify the consequences.

The staff indicated that they expect that the next due process document over the next few months. The staff expects to bring back the proposals to the Board as one complete package, rather than as piecemeal issues. The staff concluded the discussion by stating that the intention of the staff was to make the next due process document an exposure draft rather than a discussion paper. The Board agreed.

IFRS 1 – Cost of a Subsidiary in the Separate Financial Statements of a Parent on First-time Adoption of IFRSs

Staff introduced the agenda papers for the Board meeting. The staff noted that an exposure draft of proposed amendments to IFRS 1 was released in January 2007, and following redeliberation by the Board, a revised exposure draft was released in December 2007. Comments closed in February 2008.

In summary, the staff indicated that the comment letters were broadly supportive of the proposals with the following two exceptions:

• The requirement to test for impairment; and
• The formation of a new parent.

The staff suggested to the Board that they did not intend to discuss the non-controversial aspects of the exposure draft, namely; deemed cost, inclusion of associates and joint ventures in the proposals, and the elimination of the cost method in IAS 27, as they believed these aspects could be finalised with a minor editorial changes. The Board agreed.

The staff then moved on to discuss the first of the controversial issues – presentation of dividends as income and requirement to test the investment for impairment.

Staff noted that respondents were split as to whether dividend receipts should always be presented as income, however, respondents were nearly unanimous in their rejection of the Board's proposal to require impairment testing. The staff recommended to the Board to:

• Retain the proposal that an investor shall recognise as income in its separate financial statements dividends receivable from a subsidiary, jointly controlled entity or associate; and
• Modify the proposal to require an impairment test of the related investment such that the right to receive the dividend may be an indicator of impairment, particularly in situation where the amount of the dividend reduces the recoverable amount of the investment below its carrying amount in the investor's separate financial statements.

The Board agreed with the first proposal, and also agreed with the second proposal, with the exception that the second part of the sentence should be deleted as this would already be an impairment by definition. It was noted by one Board member that these proposals affect all dividends received, not just dividends from subsidiaries. The Board agreed.

The staff then moved on to discuss the second of the controversial issues - accounting for the formation of a new parent.

The staff indicated that comment letters expressed mixed views in relation to this proposal. Just over half of the comment letter supported the Board's proposal.

In light of the comments received the staff identified three approaches the Board could choose:

• Approach A – proceed with the proposal in the ED to amend IAS 27 to require entities to use the carryover basis
• Approach B – do not amend IAS 27 at this time. Wait and address the issue in the common control project.
• Approach C – amend IAS 27 to clarify that entities may use either fair value or a carryover basis until the issue is addressed in the common control project.

It was also reiterated that the issue being addressed is within the separate financial statements. From the perspective of the group nothing has changed. Staff also noted that IAS 27 is currently being interpreted by many constituents as requiring fair value on the formation of a new parent. It was also clarified that the proposals being discussed did not impact on the ability of the parent to elect to apply IAS 39 fair value when accounting for an investment in a subsidiary. The proposals related only to how 'cost' is measured for such investments.

The Board voted in favour of Approach A (8 in favour). 4 Board members voted in favour of Approach C.

The staff then requested Board input into additional issues raised by the comment letters. The first issue raised was whether the amendment applies when preference shares (or similar securities) remain in the previous parent. A number of Board members sought clarification as to what was meant by this issue. It was clarified by the staff that in such a scenario the assets and liabilities of the group do not change and the relative ownership interests of the owners of the previous parent do not change. On the basis that it was clear that the relative ownership does not change the Board agreed.

A second issue to be addressed was whether the amendment should apply to intermediate holding companies. The staff indicated that they never intended for the amendment to apply to such entities. A number of Board members queried 'why not'? The Board did not support the staff proposal that the amendment should not apply to the formation of an intermediate parent company.

The third issue to be addressed was whether the amendment should apply when the new parent finances part of the share purchase with debt. One Board member noted that he could not see how you can finance an accounting entry. The Board agreed with the staff suggestion that the amendment not apply to the formation of a new parent that is financed partly with debt.

The Board then considered how the carryover basis should be measured when the previous parent has net liabilities or net assets less than the nominal value of the shares issued. The Board agreed that the entity should carryover whatever was recorded in the previous parent accounts.

The staff then moved on to issues relating to transition and effective date. The exposure draft proposed that all of the amendments be applied prospectively. Some respondents requested that the Board permit (but not require) entities to apply the amendments retrospectively. The Board did not agree that retrospective application for the amendments to IAS 27 was appropriate and voted to retain the proposal in the exposure draft to require prospective application.

By majority vote the Board decided that entities should be permitted to apply the amendment for new parent formations retrospectively.

The Board also decided that the effective date of the amendments should be 1 January 2009.

Joint Arrangements (Joint Ventures)

The staff presented an analysis of the comment letters received on the exposure draft ED 9 Joint Arrangements (the ED). The staff pointed out that the majority of respondents (approximately two-thirds) were not supportive and disagreed with different aspects of the exposure draft. The main concerns were:

• The changes introduced are too far reaching, in particular, many respondents believed that the reference to 'rights to use' an asset and the elimination of proportionate consolidation require further research and should not be addressed in a short-term project.
• The proposed changes to the terminology, definitions of types of joint arrangements, the accounting treatment based on recognition of contractual rights and obligations and the elimination of proportionate consolidation are not adequately justified in the Basis for Conclusion.
• The elimination of proportionate consolidation. This appeared to be the single most problematic area. Many respondents disagreed with its removal mainly for the following reasons:
  • Proportionate consolidation offers more useful information and provides a better reflection of the economic substance of the arrangements. These respondents were of the view that management decision making and risk management are based on a detailed understanding of the underlying operations, assets, liabilities, cash flows and risks, and not on the share of net outcomes.
  • The elimination of proportionate consolidation will lead to the same accounting treatment for 'joint control' and 'significant influence', which was considered inappropriate.
  • The ED does not offer compelling arguments for its removal.
• The removal of joint control from the definition of joint assets and joint operations lessens the importance of joint control and does not reflect the essence of these joint arrangements.
• A number of important concepts in the accounting for joint arrangements are currently being deliberated and reviewed in other active IASB projects, for example, 'control' (Consolidation project), the 'definition of assets and liabilities' (Conceptual Frameworks project) and 'rights of use' (Leases project). These respondents highlighted that completion of these other projects was necessary before making changes to current practice. It would avoid the new IFRS being based on concepts and principles that might be subject to change.

Consequently, these constituents stated that the ED does not achieve its objectives and will not enhance financial reporting. Many of the constituents disagreeing with the ED suggested the postponement of the new IFRS on joint arrangement until the issues raised have been resolved in a broader project.

The Board's discussion predominantly focussed on the comments received regarding the elimination of proportionate consolidation.

Some Board members acknowledged that the elimination of proportionate consolidation will result in a loss of information for users. One Board member noted that proportionate consolidation better enables users to project future cash flows whereas applying the equity method collapses all information in one number.

However, a majority of Board members gave more weight to consistency with the framework. These Board members stated that it is not appropriate to recognise assets, liabilities, income and expenses when the venturer is merely entitled to a share of the outcome of the underlying activities but not the assets and liabilities themselves. Consequently, if the entity has a share in the output (joint ventures) it should apply the equity method; if it has a share in the asset/liability (joint assets and joint operations) it should recognise its share in that asset/liability.

With respect to the elimination of the proportionate consolidation method, the Board decided to proceed with the ED as currently drafted, in particular, not to further elaborate whether the equity method is the most appropriate method to account for joint ventures. However, the Board acknowledged that the rationale for the Board's decisions should be made clearer.

In addition the Board decided to take the following steps before finalising the project:

• Go back to certain constituents to ensure that the Board understood the concerns correctly. The Board intends to primarily contact users and representatives of certain industries such as extractive industries. In this context analysts should be asked what information will be lost on elimination of proportionate consolidation.
• Based on the outcome of the consultations to take into consideration requiring additional disclosures when the equity method is applied in order to compensate for any losses of information.

Revenue Recognition

The staff presented a draft version of three chapters of the forthcoming discussion paper on revenue recognition discussing definitional and recognition issues relating to the proposed contract-based model. The three chapters are:

• Chapter 2: Accounting for contracts with customers (Agenda Paper 11B)
• Chapter 3: Performance obligations (Agenda Paper 11C)
• Chapter 4: Satisfaction of performance obligations (Agenda Paper 11D)

The staff noted that these issues are independent of measurement and suggested to stop referring to two models. Instead it should be outlined that the Board has developed a single revenue recognition model that has two measurement approaches being 'customer consideration' and 'current exit price'.

Chapter 2: Accounting for contracts with customers

The staff explained that this chapter was redrafted based on the comments made by the Board at the November 2007 meeting with the main changes being:

• Amending the discussion about the focus on assets and liabilities to clarify that the pursued assets and liabilities approach is not the only possible approach for a revenue recognition model.
• A clearer explanation of what the Boards mean by a contract.
• A discussion of when a particular contract should first be recognised.

Some Board members asked for clarification on the recognition of a net position (net asset or liability) at inception of the contract, in particular, whether this would lead to the recognition of an executory contract. The staff responded that under the customer consideration measurement approach this position would be zero while under the current exit price approach a day 1 asset or liability could arise.

Some Board members questioned the term 'enforceable or otherwise recognisable at law' in the contract recognition principle. There seemed to be a consensus to align this term to the language used in IFRSs.

Chapter 3: Performance obligations/ Chapter 4: Satisfaction of performance obligations

The two chapters were discussed together. The staff explained that these chapters were redrafted based on the comments made by the Board at the January 2008 meeting with the main changes being:

• An amendment to the description of when a service obligation is satisfied to remove the notion of the customer 'receiving an immediate benefit'. Some Board members noted the awkwardness of saying that a customer has received a benefit if, for example, a painter has only painted half the customer's house, because at that point the customer would probably consider himself to be in a worse position than he was before painting began (even though he has received economic resources).
• Modifications regarding the two views about return rights.

Some Board members asked how the revenue recognition model would interact with IAS 11 Construction Contracts. The staff responded that the model may cause changes to the accounting for construction contracts since IAS 11 refers to contract activity whereas the model exclusively focussed on whether an economic resource has been transferred. The staff also noted that the model may result in a continuous sale if the customer obtains enforceable rights to the economic resources on an ongoing basis.

Way forward

Overall the Board's comments were more of editorial nature rather than challenging the principles in the draft chapters.

The staff intends to present to Board a complete first draft of the discussion paper in May and to discuss the measurement approaches (Chapter 5) at the May Board meeting. The staff noted that the topics 'revenue recognition outside a contract' and 'variable consideration' are still outstanding.

Friday 18 April 2008 (morning only)

Fair Value Measurements (education session)

Representatives of the International Valuation Standards Committee (IVSC) presented an education session to the Board on four valuation issues. No decisions were made at this education session.

The four issues presented by the IVSC delegation were:

• What is the difference between 'price' and 'value'?
• Is there a valuation difference between an entry and an exit price?
• Highest and best use
• What makes the market?

What is the difference between 'price' and 'value'?

The representatives made clear that in their view 'price' is the amount agreed on in a transaction while 'value' is the outcome of a valuation. In practice, most valuations assume a transaction but, depending on the purpose of the valuation exercise, a value could also be entity-specific. It was made clear that in many cases price and value would result in (nearly) the same number. It was also noted that the IVSC standards use three types of valuation with two of them taking a market view and one of them being an entity-specific approach – which could possibly result in different amounts for the same valuation object.

Some Board members were confused by the terminology used by the presenters and it was agreed that this could be the cause for much confusion within the constituency and that any communication by the Board must clearly articulate what they mean. One Board member noted that 'value' must always be accompanied by an adjective as people understand different things in different situations. Other Board members were confused about where the difference in amounts results from. The IVSC representatives explained that there are many reasons (for example, synergies).

Is there a valuation difference between an entry and an exit price?

The delegation moved then on to the second question. The representatives explained that the profession holds the view that for non-entity-specific values entry and exit price for the same market should be the same. Often a perceived difference results because entry price is determined on a different market than the exist price. The Board had a lengthy discussion on that issue with a view on the guidance in US GAAP.

Highest and best use

The highest and best use is terminology from the US GAAP standard SFAS 157 Fair Value Measurements that assumes an entity would also use its asset the best way it can. It was highlighted that the SFAS 157 definition is very similar to the IVSC one. It was noted that this is not a different type or basis of value and that it is inherent in any basis that requires the estimate of an open market transaction. Some Board members expressed their doubt that this always could be assumed for liabilities.

What makes the market?

The representatives explained that there is an opinion that fair values could only be made where active markets exist. They made it clear that in their view this is not the case. The valuation profession assumes as long as there is enough evidence to establish a valuation it is assumed that a market exist even if the degree of reliability is lower than that for a market with frequent transactions. They would not necessarily link value and liquidity. The Board showed interest in the valuation for some of the instruments where markets have contracted recently and had some debate on that point with the representatives.

The Chairman closed the session by asking the IVSC representatives if they have experts on valuing liabilities that could participate in the planned IASB technical experts group. The representatives confirmed that such experts would be available to participate in the group.

JOINT MEETING OF THE IASB AND THE FASB 21-22 APRIL 2008

Monday 21 April 2008

Update on the status of the Memorandum of Understanding Between the IASB and FASB, including current priorities

This session considered the Recommendations of a Working Group (PDF 81k) of IASB and FASB Board members and staff tasked by the chairmen of the respective Boards with reviewing the 2006 Memorandum of Understanding (PDF 68k) and suggesting changes to it.

Wayne Upton (IASB staff) introduced the session noting that the group's objective was to 'outline the improvements to existing IFRS that are needed to facilitate mandatory adoption of IFRS in all major capital markets.' In developing their recommendations, the group assumed that (a) for capital markets not yet adopting IFRSs, the target date of mandatory adoption is no later than 2013; and (b) a 'quiet period' of at least a year before that date is provided. Therefore, the timescale that the MOU could realistically contemplate is the progress that could be made between April 2008 and around mid-2011.

The 30 June 2011 date was also a constraint: it represents a date on which there is a considerable IASB member turnover (including the Chairman and Messrs McGregor and Yamada). Another constraint was that a project to amend a standard should be undertaken only when it would result in a 'substantive improvement' in financial reporting. Sue Bielstein (FASB staff) noted that, to succeed, the Boards needed to establish almost immediately both their objective in amending a standard and the scope that that objective implied. The meeting then turned to discuss projects identified by the working group.

Revenue recognition

The working group assigned a 'high priority' to this project and recommended that the Boards proceed on the basis of the 'customer consideration' model to be included in the forthcoming Discussion Paper (DP), because that that model has sufficient support (or the least opposition). In particular, the Boards would need to address the following areas:

• (a) The definition of a performance obligation.
• (b) When/how performance obligations are satisfied/extinguished.
• (c) When, if ever, the initial amount assigned to a performance obligation should change for reasons other than performance.
• (d) The accounting for conditional obligations such as rights of return.
• (e) Disclosure.
• (f) Testing the conclusions reached against existing practice problems.

An IASB member noted that he was fundamentally opposed to the approach being taken to the MOU. He noted that the working group's memorandum was prepared without involving any of the project teams and, as such, without their views on whether the working group's suggestions were capable of being achieved. He thought that the concept of trying to issue as many final documents as was implied by the memorandum was totally unrealistic – both in terms of what the Boards could realistically accomplish and what constituents would accept. In addition, the Board member was highly critical of the implied consequence of the working group's approach: that there would be inconsistent treatment of similar items. This was especially critical for performance obligations.

Addressing the revenue recognition project proposals directly, several IASB members were prepared to accept the working group's recommendations, but did not want the significant work and study that had gone into the forthcoming DP to be lost: constituents needed to be given a clear idea of where the Boards were likely to go. In particular, the measurement (and re-measurement) of performance obligations was critical. These IASB members were expecting that they would develop an approach to measurement that was a hybrid of the 'customer consideration' and the 'asset and liability' models, but that performance obligations would be re-measured.

A FASB member noted that the recommendation that the conclusions reached must be field tested was critical to the successful implementation and completion of the project.

The IASB Chairman noted that the IASB would issue the Revenue Discussion Paper and that the project would continue to be in the MOU.

Fair value measurement guidance

The working group recommends that this project should be completed by mid-2011 by limiting its objective to the following:

• (a) Amending existing IFRS to replace the various measurement terms used with either entry price or exit price based on the intent of the existing standard.
• (b) Defining exit price identically to FAS 157.
• (c) Defining a comparable entry price, and providing disclosures about entry and exit price measurements.

The staff noted that the IASB would not have the time to re-debate or re-tune things in FAS 157; nor would they be able to discuss 'when' fair value should be the measurement requirement: that is, the existing IFRS requirements as to when fair value is used would remain. In any event, the disclosures about 'Level 3' measurements contained in FAS 157 would be useful and would represent an improvement to IFRS reporting.

IASB members agreed, but noted that they should be able to debate areas of confusion or areas in which FAS 157 had proved difficult to apply.

Consolidation policy

There was a fair degree of confusion about this topic. Both the FASB and IASB are under high-level pressure to 'do something' on consolidation and other standards as a result of the current economic situation. IASB members were worried that the progress made by the IASB staff on control and consolidation policy should not be lost in the rush to respond to the Financial Stability Forum (IASB) and the President's Working Group on Financial Markets (FASB).

The staff noted that the 'effective control' model would need additional guidance when it was applied to special purpose entities and that some of the principles underlying FIN 46R might be adapted to good effect.

Derecognition

The staff noted that significant progress toward a replacement standard has been made in the form of a staff research paper developed in consultation with a team of Board advisors. More work is needed, however, primarily to address securitisation issues. As such, the staff was not in a position to make specific recommendations and discussion was deferred to October 2008.

Financial statement presentation

The staff noted that this project remains a priority, but that the scope should be limited to presentation on the face of the primary financial statements and related note disclosure. The staff clarified that the consequences of this limitation would be that tax allocation would not be addressed in detail, and that the current 'net of tax' display of items in Other Comprehensive Income, discontinued operations, and equity items would remain as the only items presented net of tax for the moment.

An IASB member was concerned that the Board had gone on record, in papers and in Board debates, as saying that financial statement presentation would 'solve' many of the contentious problems in other projects – for example, post-employment benefits and insurance.

Two IASB members suggested that the re-scoped project would not result in a 'substantive improvement' in financial reporting and should not be included in the revised MOU. Two FASB members supported this view.

Post-employment benefits

The staff noted that the IASB had issued a discussion paper on phase 1 of its project focused on measuring cash balance plans, elimination of 'smoothing' devices (the Corridor), and income statement presentation of changes in plan assets and benefit obligations. The DP offers alternatives for the display of the change in the pension benefit obligation but no preferred view. The staff noted that they did not think there was sufficient Board member support for a single charge to profit and loss, but they also thought that there was not sufficient support for any one of the OCI approaches either.

Board members questioned the 'challenging and problematic' aspects of the project: were the challenges technical or push-back from constituents? The staff noted that some challenges are technical, but some are resistance to change. An IASB member asked what the push-back would be like if the IASB was unable to fix the presentation issue. The IASB chairman noted that the IASB would then 'be in trouble.'

The staff acknowledged that some matters included in the DP might need to be removed from any subsequent ED (for instance, cash balance plans).

Lease accounting

The staff noted that significant lessee obligations are excluded from corporate balance sheets, distorting financial ratios and complicating financial analysis for investors and lessor accounting raises many derecognition and revenue recognition issues. However, because lessor accounting appears to be a relative lower priority for investors and some Board members, the staff was suggesting that any project be targeted to lessee accounting only.

The staff recommendation would leave the classification of finance leases in IAS 17 unchanged. What were previously operating leases would then be reflected as the acquisition of an intangible asset: the right-of-use inherent in the lease, matched by the obligation to pay for that right. The current accounting treatment for contingent rentals would remain.

IASB members in particular were unhappy with leaving contingent rentals unchanged, especially given IFRS 3 (2008)'s requirements for contingent consideration. More generally, the Boards were uncomfortable to proceed without a proper idea of the scope of the project they were being asked to accept. However, on a poll, only one IASB and one FASB member were opposed to the project.

The IASB Chairman noted that discussion of the MOU recommendations would continue as time permitted, most likely on Tuesday.

Revenue Recognition – EFRAG presentation on PAAinE discussion paper

The Joint Board meeting welcomed representatives from Europe's Pro-active Accounting Activities in Europe (PAAinE) initiative to present an overview of the discussion paper Revenue Recognition–A European Contribution. The paper was published in July 2007 jointly by European Financial Reporting Advisory Group (EFRAG) and the German and French accounting standards boards. Its objective is to stimulate debate on revenue recognition in Europe and to develop European views to be considered by the IASB and FASB in their joint revenue recognition project.

The PAAinE representatives introduced the paper by noting that it was prepared based on the revenue recognition project currently being undertaken by the IASB and FASB. The representatives noted that the IASB and FASB's proposal that revenue should be recognised as the legal layoff amount (the amount the recipient of the revenue would have to pay a third party to fulfill the obligation to deliver goods or services) made many constituents in Europe uncomfortable. PAAinE believe that there is a need for new principles based on existing standards, but indicated that they do not believe that this necessarily means that fair value is the appropriate answer.

The PAAinE paper received 70 comment letters with quite mixed responses.

The representatives highlighted that the PAAinE paper:

• Develops an asset/liability approach starting from the question 'what shall revenue reflect' (revenue being the top line of the income statement).
• Discusses different possible meanings of the revenue number.
• Discusses when revenue arises under different approaches (recognition).

The paper does not discuss measurement issues in depth. The representatives highlighted that it does not discuss defining revenue as changes in the fair value (legal layoff amount) of performance obligations.

The representatives then moved on to discuss what the revenue number should reflect. In this discussion, it was noted that the paper indicated that a binding contract is a necessary precondition for revenue to exist. One Board member queried the emphasis on a binding contract. The Board member was not sure that the boards have a notion of a binding contract. He went on to ask whether the PAAinE representatives believe that a right of return was a binding contract – because, if you can return a good for a refund it is not very binding. The Board member concluded by stating that this was fundamental to the notion of revenue.

The representatives moved on to provide an overview of the models discussed in the PAAinE paper (diagrammed below):

The representatives noted that there is a grey area between the 'critical events approach' and the 'continuous approach' and that, rather than being separate models, the two actually merge into each other.

The discussion then focussed on Approach C. One Board member asked whether the term 'substantively' in Approach C was important. The representatives responded by saying that it wasn't and that the model could be read without the term included.

Some Board members queried how this approach was consistent with the assets and liabilities approach. It was noted that the approach seemed to be more in line with an earnings process.

The representatives moved on to discuss the critical events approaches (A-C). The critical events approaches require that revenue should reflect that the company has completed a defined part or all of a contract.

• Approach A: complete contract fulfilment
• Approach B: fulfilment of part contract as defined by contract itself
• Approach C: fulfilment of part contracts as defined by economic measures

In explaining Approach C it was highlighted that for revenue to be recognised under this approach, the paper says that the customer can use the product for its intended purpose. The representatives clarified that this meant that, for example, if a customer is delivered a computer monitor, they are able to use that monitor as a monitor, rather than for some other purpose (for example, as an ashtray). Some Board members were concerned that this would involve understanding customer intention. Given how difficult it was to determine management intention, Board members queried how customer intention might be determined. One Board member also queried whether revenue could be recognised differently for the sale of the same item to different customers depending on customer intention.

The representatives noted that this was a good point and was not addressed in the paper.

Following general discussion on the models, the representatives then moved on to discuss the continuous approach (Approach D). Under Approach D, revenue reflects the activity of the company under a binding contract in a way that mirrors progress under a contract. The progress of the contract could be measured in a number of different ways, for example:

• as the supplier incurs the costs inherent in the contract;
• as the risks inherent in the transaction decrease or are eliminated by the supplier;
• as the value of the goods created under the contract increases; or
• with the passage of time.

It was clarified that these are not intended to be measurement options.

One Board member queried whether the representatives thought this would be a choice as to which option to take. The representatives did not think so.

Finally, the representatives very briefly highlighted that the paper outlines the differences between the two approaches. In sale of goods scenarios (for example, buying produce at a supermarket) little difference to existing practice is expected. However, for services, more difference are expected to arise.

The representatives said that a summary of comments will be released in early April; however, no decision has yet been made on what, if any, further work will be done on the project.

The IASB Chairman thanked the representatives for their efforts.

Conceptual Framework – Objective and Qualitative Characteristics (Phase A) and Reporting Entity (Phase D)

Phase A: Perspectives of financial reporting

The staff presented a paper summarising the implications of the Boards' decision to adopt the entity perspective in the Phase A discussion paper Preliminary Views on an improved Conceptual Framework for Financial Reporting: The Objective of Financial Reporting and Qualitative Characteristics of Decision-useful Financial Reporting Information (the DP). Board members had raised concerns that this decision and its implications for other parts of the conceptual framework project had not been adequately communicated to constituents in the DP.

Entity perspective: Under the entity perspective, the objective is to provide financial information about the entity's business to the entity's capital providers. Accordingly, there is no conceptual distinction between the various parties who have a financial interest in the entity since they are all capital providers or claimants (Accounting equation: Assets = Claims).

Proprietary perspective: The alternative perspective discussed in the Phase A deliberations was the proprietary perspective. Under the proprietary perspective, the objective of general purpose financial reporting is to provide financial information about the proprietor's business to the proprietor, that is, the reporting entity is assumed to have no substance of its own separate from that of its proprietors or owners. Accordingly, the accounting equation is: Assets minus liabilities = Proprietorship (Equity).

The Boards discussed the following issues:

• Potential implications for defining elements of financial statements (Phase B)
• Potential implications for the reporting entity (Phase D)

The staff was of the view that a full examination of the implications of perspective on all future phases of the conceptual framework project cannot and need not be conducted before publishing the Phase A exposure draft for public comment. Accordingly, the staff recommended proceeding with the Phase A exposure draft without delay and explaining in the basis for conclusion the decisions that have been reached with regard to entity vs. proprietary perspective as well as the implications that have not yet been deliberated.

Some IASB and FASB members stated that all implications should be deliberated as part of Phase A in order to avoid inconsistencies at later stages of the project. In particular, it was noted that the entity perspective may not be consistent with the parent company approach to consolidated financial statements discussed in Phase D.

Other Board members pointed out that the entity perspective has significant implications on the liability/equity distinction to be discussed in Phase B. They questioned whether under the entity perspective it would still be appropriate to present debt interest and dividend payments to owners differently. Some Board members responded that in their view the entity perspective would not preclude a different treatment of liabilities and equity since a distinction can still be made by ownership characteristics of the claims.

Finally, the majority of IASB and FASB members was in favour of the staff recommendation.

Phase D: Comments on second pre-ballot draft of the discussion paper

The Boards discussed the three views developed regarding to the usefulness of parent-only financial statements.

View A:

Both parent-only financial statements and consolidated financial statements are capable of providing decision-useful information to external users and parent-only financial statements should generally be provided in addition to consolidated financial statements.

View B:

Both parent-only financial statements and consolidated financial statements are capable of providing decision-useful information to external users and parent-only financial statements should 'sometimes' be provided in addition to consolidated financial statements.

View C:

The parent entity can have only one set of general purpose external financial statements (GPFS), which are its consolidated financial statements. Accordingly, parent-only financial statements should not be included in the general purpose financial report of a parent entity, although some parent-only information might be included, for example, in the notes to the consolidated financial statements.

The staff noted that a majority of FASB supports View C whereas the IASB has not yet reached a majority view. The Boards had a thorough debate and apparently a significant number of IASB members acknowledged that parent-only financial statements can be GPFS. However, no majority view on one of the three views was expressed by the IASB. One FASB member expressed frustration with regard to the progress made in the conceptual framework project. Finally there seemed to be a consensus to adopt the staff recommendation, that is, to express the following preliminary view in the Phase D discussion paper:

• A parent entity should always present consolidated financial statements.
• The presentation of parent-only financial statements should not be precluded at the conceptual level, provided they are included in the same financial report as the consolidated financial statements.
• It would be a standards-level issue to determine whether parent-only financial statements should be required (either always or in particular circumstances) or merely permitted, or whether similar types of information should be presented in another format.
• It would also be a standards-level issue to determine the manner in which information should be presented in the consolidated financial statements.

Tuesday 22 April 2008

Meeting of IASB, FASB and Corporate Reporting Users' Forum (CRUF)

The second day of the Joint Board meeting started with an open meeting between both Boards and the Corporate Reporting Users' Forum (CRUF). The delegation of CRUF introduced the session as a discussion forum of users of financial statement founded in 2005 with the objective of influencing the future development of both US GAAP and IFRSs. CRUF is made up of users from the buy and sell side, equities and credit side, located around the world. The representatives noted that all views presented in this session are their personal views and not those of their respective companies.

The representatives said their overriding objective is to understand and forecast business activity. They noted that the view users would prefer is that of a rational external investor, not management. They requested an appropriate post-tax earnings figure and considered comprehensive income not relevant for their needs. Furthermore, the representatives made clear that they are in favour of a stewardship concept (making reference to the Framework Project on Objectives), as the information from financial statements is often used as an intervention trigger.

The CRUF delegation presented four major areas of concern:

• Firstly, cash flow information was considered extremely important, as cash flow is the ultimate driver of value. However, they highlighted that international standards on cash flow reporting are in dire need of change as they are open to abuse by prepares and sometimes show items that are not cash flows at all. They also noted that the question of the indirect versus direct method for presenting operating cash flows is not an issue. Also, it was noted that the current cash flow standard lacks the possibility to reconcile net debt to the cash flow statement.

• Secondly, as an example for 'good' standard setting, the delegation highlighted expensing share-based payments, especially stock option schemes, despite a considerable amount of resistance from certain constituents.

• Thirdly, as an example for 'not so good' standard setting they presented IFRS 3 as revised in 2008. Although the demise of goodwill amortisation was welcomed, the tendency to strip out more intangibles during the purchase price allocation brings back amortisation by the back door. It was noted that the selection of items to be capitalised and choosing the amortisation period are highly subjective. In the eyes of CRUF it does not provide useful information, although it was admitted that it cannot be generalised that intangible asset accounting does not provide any useful information at all. The revision of IFRS 3 was presented as adding complexity and cost for preparers without adding useful information for users.

• Finally, the CRUF representatives said that revenue recognition is not a major concern for most investors, and any revision to the current standard should stay close to the customer consideration model.

The delegation then moved on to discuss the subject of the future of standard setting. It was noted that standards should result in less uncertainty and reduce information risk. Also, accounting and disclosure should provide clear information on transactions and associated risks. Also, appropriate disclosure of accounting policies, choices, assumptions, and estimates are necessary. The representatives favoured more disclosures about ranges of estimates along with sensitivities.

One IASB member questioned the irrelevance of comprehensive income given that material items are presented there, such as the reserve for available-for-sale financial instruments and the reserve for actuarial gains and losses. One of CRUF's representatives made clear that pensions are very important for a range of reasons, especially as they replace cash salary and represent a long-term risk for entities. Another IASB member noted that significant items are missing on CRUF's list of issues like pensions, leasing, and consolidation. It was made clear that the list was not meant to be exhaustive. On consolidation, the representatives explained that disclosures would help understanding the underlying risk.

An IASB member asked why many items of other comprehensive income (OCI) would be reclassified to net income for analysis purposes. The CRUF delegation made clear that components of OCI are used, but not the comprehensive income figure. A FASB member cited empirical evidence implying that comprehensive income is more relevant and that the financial statement presentation project addresses many of the issues raised. In response, one of the CRUF members explained that comprehensive income is too complex to apply multipliers to it and is too complex to have predictive powers.

The FASB Chairman highlighted that the financial statement presentation project aims to disaggregate income and expense with different degrees of risk.

Another IASB member said that many others have represented that comprehensive income is important to them and that many of the issues raised in the CRUF presentation result from misapplication of the relevant IFRSs. He asked the CRUF members how they define 'net debt'. The CRUF representatives were reluctant to go into the details of their definition and explained the real issue is the inability to reconcile net debt to the cash flow statement.

It was also noted by one IASB member that it is even less relevant to 'bury' intangibles in goodwill. She also noted that while CRUF seemed to urge both Boards to give higher priority to issues that are causing real life problems, CRUF also prioritises the conceptual framework project, which address no specific issues. Responding to the latter one CRUF representative said that the basis for developing principle-based standards (that is, the Framework) must be clear, as rules add complexity.

Another IASB member asked why CRUF did not consider segment reporting to be important and if they are satisfied with the current standard (IFRS 8). The CRUF delegation said that this is an issue, but not an urgent one.

An IASB member asked whether the request for more disclosures will lead to information overload. The CRUF delegates' response was that only certain additional key disclosures were required, not extensive additional items.

The next question by a FASB member was on the topic of financial instruments accounting and the use of fair value. The CRUF members agreed that they prefer fair value and are concerned about the fact that many entities seem to be unsure about the reliability of their valuation models. Additionally, it was admitted that fair value might be pro-cyclic, but that this would not be the real issue.

The IASB Chairman thanked the CRUF members and closed the session.

FASB and IASB – Standard setters' responses to credit crisis

The next item discussed was the standard-setters' response to the credit crisis. [Note: We have recently created a Credit Crunch Page on IAS Plus.]

The FASB Chairman encouraged both Boards to share information on the key issues that emerged during the credit crunch and discuss on the measures to be taken. He said that the three key areas of concern from an accounting perspective are:

• Derecognition (especially in the context of securitisations)
• Consolidation
• Fair value measurement

He continued that the US Senate is interested in some of the accounting issues. He also said that some problems are more compliance issues than problems with the standasrds, and that the reason for the crisis is mainly that the business models employed were flawed.

Derecognition and consolidation

On the issue of derecognition and consolidation, the FASB Chairman explained that the relevant US GAAP guidance (SFAS 140 and FIN 46R) will be revised to abandon the exemption from consolidation for qualifying special purpose entities (QSPE) – they would be consolidated in the sponsor's financial statements. He noted that the QSPE concept worked until the credit crunch, but with hindsight they have been ticking time bombs. FASB expects to publish changes to the US GAAP guidance by the end of 2008.

On the IASB side, a derecognition team has been formed to start with a clean sheet approach, and issues have been identified. The project team recognises the time pressure and will bring the issue back to the next Joint Board meeting in October 2008.

The IASB Chairman said that all three projects mentioned above have be prioritised and accelerated. The FASB Chairman supported approaching these projects jointly as far as possible, but that there were different time constraints.

One IASB member noted that IFRS 7 could be used at a starting point for enhanced disclosures. Assessments based on the first full year of application (2007) could be used. One FASB member expressed concerns over the ability to have a converged consolidation standard but thought it should be possible to have a converged disclosures standard.

The FASB Chairman then continued to elaborate on liquidity risk. He noted that many models didn't include liquidity risk and that many FIN 46R calculations did not either. He said that qualitative evaluation of facts and circumstances has to be improved and that the evaluation of whether an entity must be consolidated must be reassessed on an ongoing basis. In response to a question about the timing for the changes to US GAAP, he answered that an exposure draft (ED) is planned before end of June with the final amendments to be released at the end of the year.

On the IASB consolidation project, the project manager reported that the project has been accelerated and that the models in IAS 27 (control model) and SIC 12 (risk and rewards model) are currently being aligned, with improved disclosure. The IASB plans to publish an ED in summer 2008 with the goal of having the single source of guidance on consolidation.

A FASB member noted that it would probably be easier to disclose risky items then to find the right model for consolidation.

Fair value measurement

On fair value measurement the FASB Chairman said that both Boards have received a request from the IIF (Institute of International Finance) to address two issues (see related IIF Report on our 'Credit Crunch Page'):

• Allowing management to switch from mark-to-market to mark-to-model in certain situations where market values are not representative.
• Facilitate transfers from the trading book to the bank book for financial institutions.

The IASB Chairman underlined that the Financial Stability Forum (FSF) and the Basel Committee support the IASB's and the FASB's approach to use market values, as markets would be more confused by some sort of arbitrary measurement attribute. He also noted that the fair value measurement project will have a focus on accounting responses to illiquid and contracted markets.

The FASB Chairman informed the Boards that the US Securities Exchange Commission have issued a Paper Advising Registrants to Further Explain Fair Value in their management discussion and analysis.

One IASB member noted that a move from fair value would increase uncertainty in the markets.

The FASB Chairman closed this session with an appeal to share information and align any efforts as far as possible.

Update on the status of the Memorandum of Understanding Between the IASB and FASB, including current priorities

The Boards continued their discussion of recommendations of a working group of IASB and FASB Board members and staff tasked by the chairmen of the respective Boards with reviewing the 2006 Memorandum of Understanding (PDF 68k) and suggesting changes to it. The first part of this discussion took place on 21 April 2008, and our notes are Posted on IAS Plus.

Financial Instruments

This was one of the two projects for which the working group was unable to make a recommendation at this time. In their opinion, there is no single solution that would have broad-based Board support. The use of fair value for all financial instruments was the most obvious answer, but it did not command sufficient support in either the FASB or IASB to be viable.

In the meantime, the IASB has a Discussion Paper and the FASB has an Invitation to Comment on Reducing Complexity in Reporting Financial Instruments. The FASB also has a forthcoming ED on hedging. The working group thought it premature to make a recommendation until the comments on both have been received, as those comments might inform the Boards' decisions. The working group will revert to the Boards in October 2008.

Liabilities and Equity

The staff noted that FASB members had some deeply-held views on the liabilities/equity split, and the FASB Preliminary Views paper issued in 2007 reflected those views. It was the recommendation of the working group that the IASB concentrate its deliberations on two of the models included in the FASB document: the pure ownership and the ownership-settlement models. The working group did not think that there was sufficient support for the reassessed expected outcomes approach to make it a viable alternative.

An IASB member noted that one of the problems for the IASB was its own Framework's discussion of liabilities. An easy fix would be to state that a liability could be settled (extinguished) by the delivery of assets or the entity's own equity. There were other problems – for example perpetual preferred shares – but these were not insurmountable.

Another IASB member thought that the current bifurcation of compound instruments required by IAS 32 reflected economic reality and provided useful information. Other IASB members were also content to leave puttable shares in equity, provided the put feature is at fair value.

Short-term convergence

Earnings per Share: The working group sought guidance from the Boards as to whether this topic should be subsumed into the Liabilities/Equity project or whether the work done by the IASB, which is nearly ready for release as an ED, should be allowed to continue. Some were strongly of the view that it should be wrapped into the Liabilities/Equity project, but a majority of the IASB were of the view that there was the opportunity to make significant improvements and simplifications to financial reporting by issuing the ED.

Joint Arrangements and Income Taxes: The Board noted that the IASB should complete its project to replace IAS 31 Joint Ventures by the end of 2008. With respect to Income Taxes, the forthcoming IASB ED would be exposed as a 'replacement' for FAS 109; however, the issue of the status of FIN 48 on uncertain tax positions was still open. An IASB member expressed concern that the IASB's conclusions on uncertain tax positions were operational.

Investment Property: The FASB chairman noted that the US real estate investment trust organisation has asked FASB to adopt IAS 40, but to make fair value mandatory. That would work in the US, but the IASB had the problem that deep and liquid markets for real estate, and the necessary professional infrastructure, are not present in many emerging economies.

Cross-cutting issues

The staff suggested that the most critical 'cross-cutting issue' facing the IASB is how to define, recognise, and measure liabilities – issues the Board is currently facing in its project to revise IAS 37. Staff noted that the IASB has suffered because it has no common understanding of the definition of a liability and consequently no agreement on recognition and measurement. A Board member commented that this assessment was cynical but realistic. However, it tended to obscure the fact that, even when the IASB had a common understanding on some issues within the Liabilities project, Board members still came to different conclusions. Another IASB member expressed frustration that each time they discussed liabilities, they were prone to reach different answers, depending on the context of the discussion: insurance, pensions, financial liabilities, or non-financial liabilities. Part of the tension is that the IASB needs to identify clearly the recognition and derecognition issues and to separate those from measurement.

Wayne Upton (IASB staff) volunteered to prepare a memorandum that would attempt to tie together the various issues that continually trouble the IASB. However, he noted that subsequent measurement would be challenging – even given general agreement on the initial measurement attribute. He noted that it was highly unlikely that the Board would agree that all liabilities should be (re)measured at fair value. Board members were concerned that there was no common understanding of what they mean when they say 'a liability is remeasured' – what the measurement attribute should be. Any substantive progress on that issue would be a significant step forward.

Next Steps

The Boards agreed the general strategy summarised in the Working Group's Memorandum (PDF 81k), with limited dissents. The next steps would be to revise and reissue the 2006 Memorandum of Understanding, and for the staff to prepare and present at the June 2008 IASB meeting (and a June FASB meeting) a revised project timetable.

IASB members queried the effect on non-MOU projects of the IASB's decision. The IASB Chairman assured IASB members that non-MOU projects, including SMEs and Insurance, would be unaffected. The staff resources being devoted to those projects would not be diverted to MOU projects.

The IASB and FASB Chairmen thanked the Boards, staff and other participants for their contributions and closed the 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.