IASB Meeting 22-25 July 2008

Tuesday 22 July 2008

Liabilities and Equity – EFRAG-PAAinE Working Group Education Session

General remarks

The EFRAG representatives highlighted that some issues have to be addressed before comparing any approaches to distinguish between liabilities and equity (for example, who are the users, what is the perspective – reporting entity vs. issuing entity, etc.) and others, although important, do not (measurement, disclosure and income statement classification). It was also noted that there is a high number of cross-cutting issues like the Framework project. The representatives made clear that the characteristics of liabilities and equity are multi-dimensional, which made the dichotomous distinction difficult. Any selection of criteria was considered somewhat arbitrary.

Some Board members expressed their concern that some instruments, particularly puttable instruments with a fixed repayment amount, are considered loss absorbing under the loss absorption approach as developed in the EFRAG Discussion Paper. It was noted that some might interpret loss absorption capability as far reaching, that is even trade payables could be deemed loss absorbing in some scenarios. The Board and the EFRAG representatives had a lengthy debate on this issue.

Principle of loss absorption

The EFRAG representatives then continued to explain the principle of loss absorption. It was noted that one of the key features of equity instruments was considered to be the loss buffer function, in this case loss as defined by the accounting framework. It was also noted that the loss absorption approach would provide for reclassification when the terms change or certain triggers are met and split accounting for instrument not fully loss absorbing.

The Board discussed certain aspects of the loss absorption approach in depth. One Board member made a general remark that it would have helped the Discussion Paper of EFRAG if it had also covered measurement and disclosure issues.

Another Board member again expressed concern with loss absorbing capabilities being the distinguishing criterion, as at least on (involuntary) liquidation all instruments on the equity/liability section of the balance sheet would participate in losses – whether this was part of the contractual agreement or not. This Board member also noted that the EFRAG presentation explained that loss absorption clauses must be 'operational', but it was not clear what it means, and that he considered the existence of an obligation more fundamental for the distinction.

Some Board members asked how the loss absorption approach would avoid structuring opportunities. In response to that, another Board member explained that there will always be structuring, but that the incentive to do so could be mitigated by requiring certain measurement attributes and/or disclosures. It was also mentioned that a major issue were hybrid instruments and what would be the answer provided by the loss absorption approach.

Application within a group context

The EFRAG representative very briefly presented what the view to be taken was when the classification is made – an entity view or a proprietary view? The Board shortly discussed this issue in the light of both the EFRAG and the FASB's preferred approach.

The Board then returned to the discussion of what were the defining features of equity and what features would be covered under both the loss absorption and the basic ownership approach.

The Chairman wrapped up the session and asked the EFRAG representatives to develop a comparison between the loss absorption approach and the basic ownership approach in the light of the features highlighted in the EFRAG presentation and bring it back at a later point.

Amendments to IFRS 5 – Discontinued Operations

FASB staff joined the meeting by video link.

The IASB considered issues that needed to be addressed before issuing an Exposure Draft to amend IFRS 5 Non-current Assets Held for Sale and Discontinued Operations. The ED's primary purpose is to align IFRS and US GAAP with respect to the definition of discontinued operations and to make other improvements to IFRS 5.

Additional criteria for the definition of a Discontinued Operation

In May 2008, the FASB indicated its preference to amend the previously agreed definition of discontinued operations to include in the definition subsidiaries that meet the criteria to be classified as held for sale on acquisition.

Subsequently, the staff prepared a memorandum for both Boards, which included a recommendation to include in the definition of discontinued operations subsidiaries that meet the criteria to be classified as held for sale on acquisition. In June, the staff was asked to perform additional analysis related to the various alternatives for the definition of discontinued operations discussed by the Boards and to present this analysis at a future meeting. This meeting discussed that analysis.

The Board considered four alternatives for an additional grouping of assets that would meet the definition of discontinued operations, in addition to those components that are operating segments. These were:

• View A: All components of an entity that meet the criteria to be classified as held for sale on acquisition

• View B: All subsidiaries (in their legal form) that meet the criteria to be classified as held for sale on acquisition

• View C: All businesses as that term in defined in IFRS 3 Business Combinations (revised 2008) that meet the criteria to be classified as held for sale on acquisition

• View D: No additional criteria, only an operating segment can meet the definition of a discontinued operation

After a brief discussion, the Board agreed that the proposed definition of discontinued operations be amended to include businesses as defined in IFRS 3 (revised 2008) that meet the criteria to be classified as held for sale on acquisition (View C).

The Board agreed that there should be no additional requirements that would limit the component of an entity, subsidiary, or business that meets the criteria to be classified as held for sale on acquisition to be reported in discontinued operations only when it is required by law or regulation (for example, as a result of a competition review). A Board member noted that classification as held for sale or discontinued would have to wait for the competition review: how could you classify something as held for sale when the entity did not know what it had to divest?

As a result of these decisions, a discontinued operation would be a component of an entity that:

• (a) meets the definition of an operating segment in accordance with IFRS 8 Operating Segments, and either has been disposed of or is classified as held for sale, or
• (b) is a business in accordance with IFRS 3 Business Combinations (revised 2008) that meets the criteria to be classified as held for sale on acquisition.

Disclosure exemptions

The Board agreed to provide certain disclosure exemptions for businesses that meet the criteria to be classified as held for sale on acquisition. These include certain items in IFRS 5.33 and 39; and IFRS 3 (2008).B64.

Financial statement presentation

The Board agreed that entities should provide reconciliations of 'income from discontinued operations' in the statement of comprehensive income and the assets and liabilities of operations held for sale in the statement of financial position. In providing these reconciliations, an entity would be permitted to:

• (a) aggregate the assets and liabilities of businesses that meet the criteria to be classified as held for sale on acquisition into total assets of a business held for sale on acquisition and total liabilities of a business held for sale on acquisition, respectively; and
• (b) aggregate the assets and liabilities classified as held for sale (other than those in (a)) that are not disclosed separately because they were not considered to be major into other assets and other liabilities, respectively.
• (c) aggregate the profit or loss of businesses that meet the criteria to be classified as held for sale on acquisition into profit or loss of a business held for sale on acquisition; and
• (d) aggregate the income and expense items (other than those in (c)) that are not disclosed separately because they were not considered to be major into other income and expenses.

Income Taxes

FASB staff joined the meeting by video link.

The Board discussed various 'sweep issues' arising from their review of a pre-ballot draft of an Exposure Draft (ED) that would replace IAS 12 Income Taxes. The pre-ballot draft had been sent to various external parties and tax accounting experts as well for their review and comment.

Income tax consequences of equity instruments issued

The Board confirmed that the ED will propose that equity instruments issued by an entity should not be regarded as having a tax basis that is compared with the carrying amount of the equity instrument to assess the tax consequences of repurchasing the instrument or derecognising the carrying amount in some other way. Rather the tax consequences related to equity instruments issued that will occur without any change to the carrying amount in equity should be regarded as the tax basis of those items.

Exception for foreign subsidiaries and joint ventures

In an extended debate, the Board disagreed with a staff proposal related to the exception brought in from SFAS 109 for foreign subsidiaries and joint ventures. The ED is likely to propose that a deferred tax liability shall not be recognised for a temporary difference arising from the difference between the carrying amount and the tax basis of an investment in a foreign subsidiary or a foreign joint venture to the extent that it is essentially permanent in duration. The phrase 'to the extent that' is intended to accommodate remittance of retained earnings to the parent (on which remittance the tax consequences would be recognised) without tainting the whole of the investment balance.

In addition, the exemption for deferred tax assets related to investments in foreign subsidiaries and foreign joint ventures will be based on the same principles as other deferred tax assets: that a deferred tax asset should be recognised (or a valuation allowance against a previously recognised deferred tax asset reduced) when it is probable (that is, more likely than not) that those benefits will be realised.

The Board agreed that specific requirements in SFAS 109 related to foreign subsidiaries ceasing to be subsidiaries or foreign investments becoming subsidiaries should be replaced by requirements consistent with the treatment of disposals and step-acquisitions in IFRS 3.

The wording of the requirements on tax allocation

The Board agreed to retain the approach proposed in the pre-ballot draft, essentially the approach in FAS 109 as reworded by the combined FASB and IASB staff. In doing so, the intra-period allocation would be subject to a practicability exception. Board members noted that attempting to do 'backwards tracing' was often complex and required scheduling of reversals of temporary differences, something the Boards were told frequently was impracticable. The Board wanted to be honest about how it phrased the exception and that it was a practicability issue.

Guidance on substantive enactment

The Board agreed that the Application Guidance on substantive enactment should be amended as follows:

An entity shall regard tax rates as substantively enacted when future events required by the enactment process historically have not affected the outcome and are highly unlikely to do so.

The Board rejected a staff proposal that substantive enactment was a matter on which national standard setters might usefully give guidance. No mention of this matter will be made in the ED, the Basis, or other accompanying documents. Any issues of what constitutes 'substantive enactment' in a given situation should be referred to the IFRIC.

Disclosures arising from the financial statement presentation project

The Board agreed to clarify that a balance sheet to balance sheet numerical analysis for each type of temporary difference, unused tax loss, and tax credit would be required.

Disclosures related to the effect of distributions

The Board confirmed that entities should disclose the entity's assumptions about future distributions and their effect on the tax rate used to measure deferred tax assets and liabilities.

Disclosures on tax uncertainties

The Board agreed not to extend the disclosures already agreed with respect to tax uncertainties.

Wording of the Core Principles

The Board noted that the staff was working with Board Members to develop a short paragraph that sets out a principle without discussing the methodology. A preliminary draft wording was presented to the meeting but not discussed.

Temporary differences that arise on the initial recognition of assets and liabilities

The pre-ballot draft application guidance included requirements for the treatment of temporary differences that arise on the initial recognition of assets and liabilities. Some Board members and subject matter experts expressed concern that the requirements were complex and confusing. The Board noted that there was no viable alternative to the approach in the ED other than immediate recognition in comprehensive income. No changes to the guidance were made.

The role of expectation in the recognition and measurement of deferred tax assets and liabilities

The Board noted that in accordance with the proposed amendments, the entity's expectations do not affect the tax basis. The proposed approach is justified on the grounds that the tax basis is a matter of fact that determines whether or not a deferred tax asset or liability exists. That is not affected by the entity's expectations about the manner of recovery or settlement of an asset or liability.

There was some discussion of 'sale versus use rate' assets and dual-use assets. The Board agreed that the Basis for Conclusions accompanying the ED should discuss the Board's reasoning on this matter and that the staff should discuss drafting issues with those who found them confusing to find ways of improving them.

The analysis between the recognition and measurement of deferred tax assets

The Board agreed to retain the 'two-step' approach (recognise the full amount of a deferred tax asset and a related valuation allowance against that asset to the extent that it is more likely than not that there will not be sufficient taxable profit to utilise the asset). However, they encouraged the staff to improve the drafting to clarify the approach.

Discounting deferred tax assets arising from unused tax losses and tax credits

The Board confirmed that discounting deferred tax amounts should be prohibited. Discounting implied detailed scheduling, something constituents repeatedly told standard-setters they could not do.

Allocation of the effect of changes in uncertain tax positions

The ED will propose that the effects of changes in uncertain tax positions should be recognised in continuing operations, regardless of the component of comprehensive income or equity in which the related tax assets and liabilities were originally recognised. The Board agreed to retain this approach, but to ask a question on this proposal in the Invitation to Comment.

Interest and penalties

By a very narrow majority (7-6), the Board agreed that the ED should be explicit that an entity has an accounting policy choice on how to classify interest and penalties payable to tax authorities. Those objecting felt strongly that interest and penalties imposed by the taxing authority should not be presented as a component of income taxes.

Transition for first-time adopters

The Board agreed that that first-time adopters with a transition date before the date of issue of the revised standard (but a first IFRS reporting period after the date of issue) should have the option to apply the revised standard to all periods presented in the financial statements to which the revised standard first applies.

Structure and internal references

The Board had a brief discussion about the structure of the ED and internal references in particular. The staff was instructed not to refer from the Standard part of the ED to non-mandatory guidance (for instance, draft Illustrative Examples); references from the draft Illustrative Examples to the draft Standard were permitted.

Description of the document

The Board agreed that the ED would be presented as a Draft IFRS rather than an amendment to IAS 12.

Alternative Views

Board members were asked whether any intended to present an Alternative View in the ED. Mr Garnett indicated that he might because he was concerned that the text of the pre-ballot draft had not reflected his understanding of what the Board had agreed.

Revenue Recognition

The Board discussed the project timetable and continued its deliberations on the measurement approaches of the forthcoming discussion paper (DP) on revenue recognition.

Way forward and project timetable

There was a broad consensus that a DP should be drafted and issued as soon as possible. One Board member expressed frustration about the progress made in the project and noted that the unresolved issues are more significant than the resolved issues. Among other things, this Board member noted that the scope is not clear (that is, the impact on accounting for leases, insurance contracts, and financial instruments), that there is no proper definition of onerous contracts, and that the treatment of rights to return and the measurement of contract rights are not addressed. This Board member raised the concern that because of these deficiencies constituents will find it difficult to respond to the DP as currently drafted.

Other Board members acknowledged that several issues are unresolved but noted that the DP is a 'high level document' that seeks input on the general revenue recognition approach.

Finally the Board agreed to the staff proposal to finalise drafting the DP and to publish it in October or November 2008.

The staff explained that it intends starting work on the exposure draft (ED) immediately. The staff was of the view that constituents will not fundamentally disagree to a contract-based recognition principle and the proposed measurement approach.

Consequently, developing the high-level model in the DP into standards-level guidance should begin in parallel to completing and redeliberating the DP. The ED would then be updated to reflect comments on the DP.

The Board agreed to the staff proposal. The Board tentatively decided to have a six-month comment period for the ED.

Eventually, the Board adopted the following timetable:

• October/November 2008: DP issued; six-month comment period.
• Up to September 2009: Development of the ED parallel to completing and redeliberating the DP.
• October 2009: ED issued; six-month comment period.
• March 2010: Roundtable discussions (if necessary).
• May 2011: Publication of final standard.

Measurement of performance obligations

At the May 2008 meeting the Board decided that the discussion paper should express a preliminary view in favour of the customer consideration approach. At this meeting the Board discussed the description of the measurement approach in the pre-ballot draft and when performance obligations should be remeasured under the customer consideration approach.

Measurement at contract inception

By majority vote the Board reaffirmed its decision that at contract inception performance obligations should be measured equal to the transaction price of the contract (customer consideration measurement approach).

The Board agreed to outline the two different views expressed by Board members why at inception a contract should be recognised in that way:

• View A: No revenue should be recognised before a performance obligation is satisfied. Because the transaction price represents the amount the customer is willing to pay for the goods and services to be provided in the contract, that price serves as a meaningful measure of the performance obligations in the contract.

  This view suggests that no matter how observable or costless to obtain a fulfilment price measurement might be the recognition of a contract asset and revenue at contract inception would not be favoured.

• View B: A fulfilment price is conceptually preferable but the costliness and complexity of estimating such a price is unjustified given that the transaction price in the contract is a relatively straightforward, observable, and reasonable proxy for a fulfilment price.

  This view suggests that the Board might decide at some future point that in situations in which a fulfilment price is observable and relatively inexpensive to obtain, that price would be used to measure the bundle of performance obligations, in particular, if the fulfilment price for those obligations materially departs from the transaction price.

Discussion will be continued on Wednesday 23 July at 13.15 UK time

Wednesday 23 July 2008

IFRS for Private Entities (formerly IFRS for SMEs) – Recognition, measurement and presentation

The Board continued its redeliberations of the proposals in the February 2007 Exposure Draft of a Proposed IFRS for Small and Medium-sized Entities (the ED). In this session the Board discussed the key issues relating to sections 13 to 19 excluding any disclosure issues and requests for additional implementation guidance. The main decisions are outlined below.

Investments in associates and joint ventures (sections 13 and 14)

The Board had a thorough debate regarding the options permitted in accounting for associates and joint ventures. Currently, the ED permits using the cost model, the equity method, proportionate consolidation (joint ventures only) or fair value through profit or loss.

The Board decided to add an exception to the use of the cost model. The cost model would not be permitted when the shares of the associate or joint venture have public price quotations.

The Board deferred its decision on elimination of proportionate consolidation for joint ventures but indicated that the requirements in ED 9 Joint Arrangements will be considered if the ongoing project on joint ventures results in elimination of proportionate consolidation and if the final standard of that project is issued before publication of the IFRS for Private Entities.

In addition, the Board decided to replace the requirement that the difference between the reporting date of the financial statements of the associate/joint venture and those of the investor must not be greater than three months by a general statement that the most current information should be used.

Investment property (section 15)

The Board decided to not to make any changes to the guidance in this section.

Property, plant and equipment (section 16)

The Board agreed the following:

• To retain the requirement for component depreciation in paragraph 16.14 but to rewrite the paragraph by addressing the normal case (being no component depreciation) first.
• To clarify in paragraph 16.17 that reassessing residual value, useful life and depreciation method should be performed only if there is a clear indication of change since the last reporting date. The additional guidance should also clarify that such an assessment does not require a full impairment test.
• To retain the option to use the revaluation model
• Not to add an undue cost or effort exemption to for the requirement to separate the land and building components when land and building are acquired in a single purchase transaction. This decision also applies to similar requirements in sections 15 Investment Property and section 19 Leases.

Intangible assets other than goodwill (section 17)

The Board agreed the following:

• Not to add a presumption that all intangible assets other than goodwill have a finite life, which would allow amortisation of indefinite-lived intangibles. Instead, as proposed in the ED, private entities will be required to distinguish between intangible assets with finite and indefinite useful lives. The Board noted that such a simplification would not be appropriate since private entities can have material intangible assets with indefinite useful lives (franchises, licenses, etc.).
• To include a clarification regarding reassessment residual value, useful life and depreciation method (same as for property, plant and equipment).
• To retain the accounting policy choice either to expense all development costs or capitalise that portion of development costs that is incurred after commercial viability has been assessed.
• To retain the option to use the revaluation model

Business combinations and goodwill (section 18)

The Board agreed the following:

• Not to amortise goodwill over its estimated useful life
• Not to add an undue cost or effort exemption regarding separation of intangible assets acquired and contingent liabilities assumed in a business combination
• To add the requirements in IFRS 3(2008) regarding the 'measurement period' to account for adjustments to the fair values of identifiable assets and liabilities after acquisition
• Not to permit the pooling of interests method

Leases (section 19)

The staff proposed to add an exemption to the application of the straight-line method for operating leases if payments to the lessor are structured to compensate for the lessor's expected cost increases. Some Board members raised the concern that such an exemption could open the door for earnings management by structuring lease arrangements. The Board deferred its decision and asked the staff to prepare a more detailed analysis focussing on inflation clauses.

In addition the Board decided to retain the guidance in the ED relating to classification of leases as either operating or financing but to include additional guidance regarding the application of the criterion 'major part of the economic life of the asset'.

Project Proposals

The purpose of this session was to get the Board's approval to move two projects from the research agenda to the IASB's active agenda:

• Liabilities and Equity
• Derecognition

The staff recommended adding both projects to the agenda despite the current length of the active agenda as in their opinion the projects meet the criteria set out in the IASB due process handbook.

Liabilities and Equity

The staff noted that both the IASCF Trustees and the Standards Advisory Council (SAC) have consented to add this project to the active agenda. One Board member highlighted that the Framework project covering the elements of financial statements has not been finalised. Constituents might complain that a project on liabilities and equity can only produce an interim solution as long as the issue of how a liability is defined is not resolved. Another Board member replied that the basic ownership approach as preferred by the FASB would not necessarily depend on the outcome of the framework project. It was also suggested to change the title of the project to clarify that only the distinction of financial instruments is within the scope of this project (not non-financial liabilities). The staff agreed to that proposal.

The Board agreed to move this project to its active agenda.

Derecognition

The staff noted that taking this project to the IASB's active agenda was agreed to by both the IASCF Trustees and SAC. Also, this has been one of the topics that the Financial Stability Forum considered a high priority item.

One Board member asked the staff to confirm that the FASB will contribute to this project. The staff answered that the FASB staff will report back on the derecognition project at the Joint Board meeting in October 2008. The Board agreed to move this project to its active agenda.

Revenue Recognition

The Board continued yesterday's discussion on measurement of performance obligations.

Subsequent measurement: Allocation approach

According to the preliminary view expressed by the Board, the transaction price used to measure the bundle of performance obligations at contract inception is allocated to individual performance obligations based on the entity's separate selling prices of the promised economic resources (that is, goods and services). The amount allocated to each performance obligation at inception is then recognized as revenue when that particular performance obligation is satisfied. This approach negates the need to remeasure the remaining performance obligations in subsequent periods to determine how much revenue to recognize in those periods.

By majority vote the Board modified this view by including a limited exception to the allocation approach. This exception applies when goods or services identical to those promised in the contract have a quoted price in an active market (corresponds to 'Level 1 Inputs' of the fair value hierarchy in SFAS 157) or the fair value can be determined using 'Level 2 Inputs'. In these situations the promise to transfer the good or service should be measured at the so determined fair value with any remaining balance of the contract transaction price is allocated to all other performance obligations on a relative selling price basis.

Remeasurement of performance obligations

At the May meeting the Board noted that performance obligations might be remeasured for circumstances other than the onerousness of the performance obligation. The staff identified the following additional circumstances that may trigger remeasurement:

• Availability of observable current exit prices
• Uncertain, long-term performance obligations

Regarding the first issue by majority vote the Board tentatively decided that observable current exit prices should not result in remeasuring the performance obligation. In this context several Board members noted that quoted current exit prices may exist in general but that very often it is difficult to determine the exit price goods or services identical to those promised in the contract with the customers.

Regarding the second issue the Board did not come to a conclusion. The Board noted that a thorough understanding of the onerous contract test would be required to answer this question, that is, to assess whether such an onerous contract test would be sufficient to cover the risk of 'surprise losses' related to these performance obligations.

Finally the Board deferred its decision on remeasurement of performance obligations. The staff was asked to develop a detailed description of the onerous contract test including the measurement of onerousness (in particular how to consider risk and profit margins in such a calculation).

Consolidations

Guidance on consolidation is one of the IASB's high priority items in the light of the credit crunch. The purpose of this session was to get the Board's input on the staff working draft for a revised consolidation Standard that ultimately would replace IAS 27 and SIC-12. The goal is to develop this staff draft to be discussed at round-tables later this year and finally, issue an exposure draft.

The staff started to talk the Board through the proposals based on a presentation that was not part of the observer notes. It was noted that the draft was developed working under the assumption that IAS 27 and SIC-12 were not fundamentally flawed and that any earlier decisions by the Board are still valid. The need for a revision resulted from inconsistent application of IAS 27 and SIC-12 and the inherent tensions of both documents due to the IAS 27 control model and the risk and rewards approach emphasised in SIC-12. Also, items that were 'close' to consolidation would be caught by introducing the notion of significant involvement triggering additional disclosures.

The staff informed the Board on the timeline for this project and highlighted that it would bring back papers between this meeting and September on certain topics with the aim to have roundtables in September and finally publish an exposure draft in Q4/2008. The Board agreed to the timetable.

The staff then turned to the working draft. It was noted that this is an early draft and that the staff would welcome any drafting comments offline so to focus on the principles at this session. One Board member highlighted that the draft would conclude that consolidated financial statements are the only relevant set of financial information. This Board member also expressed his concerns over the notion of significant involvement and noted that the definition of the reporting entity that is used in the draft would be an issue in the deliberations as this is still work in progress in the framework project.

The Chairman asked the Board members if the core principles and their thrust would be appropriate. The majority of the Board members seemed to agree. The Chairman also noted that the introduction of the significant involvement notion along with the additional disclosures would offer the opportunity to abandon the specific accounting for associates (that is, IAS 28). The Board members seemed to agree to include such a proposal in the ED.

Another Board member asked what would be the difference between significant influence and significant involvement. The staff answered that this would be made clear in the guidance.

The Board also had a lengthy discussion on what represented a subsidiary and why the notion of legal entity was used. Some Board members expressed their concerns over the subtlety of the draft. They asked the staff to make any principle as clear as possible. One Board member commented that a consolidation standard would be the worst place for subtlety.

The staff then turned to the notion of power and benefits as described in the staff draft. Again, some Board members struggled with the subtlety of the words used to describe the principle. Others were concerned over the application on securitisation transactions. It was also noted that benefits are usually defined as a 'net' term. The guidance on reputation risk was considered not appropriate as drafted by some Board members.

On the issue of de facto control, one Board member noted that the indicators of control once the reporting entity does not have the majority of the voting rights in the draft was not operational enough.

The guidance on the term 'expected return' was considered by one Board member as too close to the approach taken in FIN 46R. This Board member also asked what its actual relationship with the control notion was.

The staff informed the Board that it planned to skip the last part of the staff draft as it mainly consists of existing guidance, notably the guidance on separate financial statements. Also, the staff informed the Board that it asked for input on the five examples that were provided as part of the session's agenda papers. The goal was to understand how the principles in the staff draft would be applied to these scenarios and if the results are considered appropriate.

The disclosure section was considered work in progress and not discussed in detail. One Board member noted that there was no concept of aggregation of the disclosures for entities where the reporting entity has significant involvement, which might prove difficult in practice.

Another Board member asked whether the issue of accounting and consolidation for fund managers had been addressed. The staff responded that this will be considered as part of the agency section which will be brought back at a later point in time to the Board.

IFRIC Update

The Director of Implementation Activities gave an update on the IFRIC's current activities.

It was noted that two draft Interpretations have gone into their redeliberation phase and that IFRIC reconfirmed the need for an Interpretation on both issues.

Regarding D23 Distributions of Non-cash Assets to Owners the approach has been basically reaffirmed, but IFRIC asked the staff to conduct some research on the issue of the measurement mismatch between the asset (measured at cost) and the dividend liability (measured at fair value) once the entity is committed to make a distribution.

The redeliberations of D24 Customer Contributions proved somewhat more difficult, notably on the revenue recognition side. The Director of Implementation Activities highlighted that any Interpretation would give some guidance on if (and when) to recognise an asset that has been contributed, but that providing guidance on if (and when) to recognise revenue was difficult. The final Interpretation could be referring only to the existing guidance in IAS 18 Revenue.

Another project of the IFRIC involves amendments to IFRS 2 and IFRIC 11 covering group cash-settled share-based payments. The staff noted that the thrust of the amendments will shift from amending the scope to amending the definitions to avoid receiving submissions to provide guidance on specific scenarios on a recurring basis. The ultimate goal would be to cover all share-based payment transactions in group scenarios. The amendments would describe both the consolidated financial statements accounting as well as the accounting for the entity receiving goods/services in its separate financial statements. It was noted that any output from the staff work would go directly to the Board.

At the end of this session the Director of Implementation Activities informed the Board that IFRIC has published one agenda decision (on the application of the effective interest rate method in IAS 39) with a recommendation that the Board clarifies the applicable Standard and three tentative agenda decisions (on lease payments in an operating lease, revenue recognition for trailing commissions and equity transaction costs). Also, IFRIC has asked the staff to conduct further research on compliance cost in the context of the EU's Registration, Evaluation, Authorisation and Restriction of Chemicals (REACH) environmental regulation. The staff highlighted that it would try to incorporate the existing guidance in IFRIC 1 on how to account for obligations arising from the Waste Electrical and Electronic Equipment (WEEE) regulation of the EU, as well as guidance in other IFRSs.

Fair Value Measurements – Expert Advisory Panel on Valuing Financial Instruments in Inactive Markets: Meeting update

The project manager on the fair value measurement project gave an oral update on the activities of the expert advisory panel. The purpose of this panel is to assist the IASB in reviewing best practices in the area of valuation techniques as well as formulating any necessary additional guidance on valuation methods for financial instruments and related disclosures when markets are no longer active.

The panel or subgroup met three times. At the kick-off meeting the panel identified specific issues that panel members felt must be addressed (such as forced transactions, the use of pricing services, illiquid markets).

It was noted that there seemed to be consistency in applying the fair value measurement requirements in IAS 39 despite the use of different techniques.

The staff informed the Board that there will be a draft document to be discussed end of July on those issues, but that it is not clear yet who will publish it. The panel would then turn to appropriate disclosures with the aim to have an exposure draft published in Q4/08. It was noted that there would be ongoing communications with the consolidations project team.

Thursday 24 July 2008

IFRS for Private Entities (formerly IFRS for SMEs) – Disclosure

The Board continued its redeliberations of the proposals in the February 2007 Exposure Draft of a Proposed IFRS for Small and Medium-sized Entities (the ED). In this session the Board discussed the key issues relating to sections 20 to 27 excluding any disclosure issues and requests for additional implementation guidance. The main decisions are outlined below.

Provisions and contingencies (section 20)

The Board decided not to simplify the measurement requirements for provisions. However, the Board agreed to a staff proposal that most issues raised by respondents could be mitigated by adding examples to the implementation guidance.

Equity (section 21)

The Board decided to retain the requirement of split accounting for compound instruments, i.e. that equity and debt components of compound instruments need to be separated. However, the Board agreed to add examples as implementation guidance to assist entities in accounting for compound instruments.

The Board deferred its decision on debt-equity classification for certain types of entities, such as cooperatives and partnerships. The staff noted that comment letters and reports of the field tests were prepared before the changes made to IAS 32 Financial Instruments: Presentation regarding classification of puttable instruments and obligations arising on liquidation were finalised. The staff intends to present their recommendations in this regard at a future Board meeting.

Revenue (section 22)

The Board decided to retain the percentage of completion method and to add examples as implementation guidance.

Government grants (section 23)

The Board agreed to remove the option in paragraph 23.3(b) of the ED to apply IAS 20 Accounting for Government Grants and Disclosure of Government Assistance for those government grants not related to assets measured at fair value through profit or loss. Consequently, only the 'IFRS for SME model' will be allowed for these assets. Some Board members noted that IAS 20 is a standard that 'needs fixing' and that removing the option to follow IAS 20 would therefore be appropriate.

Borrowing costs (section 24)

The Board decided to retain both the expense model and the capitalisation model as accounting policy options. The Board noted that as a consequence of retaining the options there is no need for simplifying the capitalisation model, for example, by allowing the application of an average borrowing rate.

Share-based payment (section 25)

No decisions were made at this meeting because the staff is currently researching measurement of equity-settled share-based payments by private entities. The staff will present their recommendations at a future Board meeting.

Impairment of non-financial assets (section 26)

Several respondents and field test entities disagreed with the proposal in the ED requiring impairment to be measured by comparing the carrying amount to fair value less cost to sell and suggested reinstating the notion of 'value in use'. The Board decided that the approach for determining an impairment loss should be similar to IAS 36 Impairment of Assets and, consequently, Section 26 should include the concepts of 'recoverable amount' and 'value in use'. In addition, the Board decided to include the concept of 'cash generating units'.

The Board deferred its decision regarding the requirements for allocating goodwill to components of an entity. The staff was asked to further elaborate this issue by focussing on entities that do not manage their business based on cash-generating units.

Employee benefits (section 27)

The Board decided to retain the requirement in the ED that all actuarial gains and losses and past service costs should be recognised immediately in profit or loss.

Several constituents noted that in some cases information to apply the projected unit credit method (such as data about demographic and financial variables) would not be available. No decision was made whether private entities might be allowed to measure defined benefit obligation at a current liquidation amount rather than using the projected unit credit method in such situations. The staff was asked to prepare for discussion at a future meeting an analysis under which circumstances the use of a current liquidation amount would be appropriate.

Management Commentary

The purpose of this session was to finalise the Board's preliminary views on certain topics for the exposure draft to be drafted.

Conceptual Framework

The staff asked the Board if it agreed to benchmark management commentary against the outcome of Phase A of the Conceptual Framework project ('Objective and qualitative characteristics') instead of the existing Framework of the IASB.

The Board agreed.

Objective of management commentary versus the objective of financial reporting

The project staff continued to get the Board's view on the objective of management commentary. Firstly, the staff asked the Board whether management commentary should be subordinated of the framework (that is, is the Conceptual Framework the 'umbrella' for management commentary). The Board agreed

The Board also had a short discussion of where to draw the line of the information to be provided in management commentary. The project team then asked the Board whether the objective of management commentary should be the same as for financial reporting. The Board had a discussion of whether overemphasising neutrality would impair the 'through the eyes of the management' approach. The Board agreed to the staff recommendation to align the objectives.

The staff then went on to explain that although the objective of both financial reporting and management commentary are the same, but the purpose of management commentary is unique, which should be reflected in the wording used.

After a short debate on the distinction between objective and purpose, the Board agreed.

Users of management commentary versus the users of financial reporting

The staff asked the Board whether the primary users of management commentary should be both present and potential capital providers as defined in the ED on objective and qualitative characteristics of financial reporting.

The Board agreed.

Qualitative characteristics of management commentary versus qualitative characteristics of financial reporting

The project team noted that the use different terminology to describe the qualitative characteristics of management commentary as compared to the qualitative characteristics of financial reporting.

The staff explained that 'balance' can be subsumed within faithful representation. There was a short discussion in this topic and whether balance was interchangeable with the notion of 'neutrality'. It was agreed to use 'faithful representation' instead of 'balance'

The area of bigger concern for Board members was the difference between verifiability and supportability. It was argued that although much of the information in management commentary is forward-looking, the process for 'verifying' is essentially the same as for historical information. It was proposed to better explain what verifiability meant in the context of forward-looking information and management commentary in general instead of introducing a new term. The Board had a lengthy discussion on this topic.

In the end, the Board agreed to replace 'supportability' with 'verifiability', but asked staff write up what is the intended meaning of verifiability in this context and bring this back to the Board.

Content of management commentary

The staff presented the Board the information to be disclosed to meet the objective of management commentary. Some Board members wanted that list to be expanded to include management compensation (and how it aligns to the performance measures), segment information, financing and taxes.

The Board agreed subject to expanding the list.

Permission to begin drafting an exposure draft

At the end of the session the staff sought permission to begin drafting an exposure draft. One Board member asked what type of publication that would be - it has already been agreed that it will not be part of IFRSs. The staff replied that this is work in progress, but this would be resolved in due course.

The Board then granted permission to begin drafting.

Financial Statement Presentation - Phase B

The Board discussed a sweep issue identified in the pre-ballot draft of the forthcoming discussion paper.

A paragraph in the scope section clarifies that presentation and reclassification (recycling) of OCI items is outside the scope of the project. Another paragraph in the pre-ballot draft states that 'the Boards expressed a preference for eliminating the recognition and presentation of other comprehensive income items outside net income and profit or loss and therefore also eliminating the need to subsequently recycle those items into net income and profit or loss' and that '(i)n the future, the Boards plan to undertake projects to eliminate the separate presentation of other comprehensive income items and related reclassification adjustments by revising individual standards'.

One Board member had questioned whether there is such a preference for eliminating OCI and noted that the Boards currently have no future plans regarding OCI.

The Board acknowledged that the current Board cannot bind future Boards regarding which projects are to be undertaken. Finally, the Board decided to keep the paragraph in the scope section but to be less specific regarding elimination of OCI. It was agreed to describe the discussion on OCI during the deliberations and to be silent on future plans.

Leases

The Board discussed in detail the revised project plan. The staff noted that the revised project approach takes into account the 'mid-2011 completion goal' discussed at the April 2008 joint Board meeting for projects that are part of the Memorandum of Understanding between the IASB and FASB (MoU).

The key proposals of the revised project approach were:

• to address lessee accounting and defer consideration of lessor accounting,
• to apply the current finance lease model to leases currently classified as operating leases, which means that the current finance lease model will be applied to all leases, and
• to remove the requirement for lessees to classify leases as finance leases or operating leases.

In addition, the staff presented analyses on the following issues that arise if the current finance lease model is applied to operating leases:

• options to extend or terminate a lease,
• contingent rentals, and
• initial and subsequent measurement of the lessee's asset and liability under the lease.

Several Board members expressed their disappointment that lessor accounting was scoped out but acknowledged that the time constraints make it impossible to address both lessee and lessor accounting. Some Board members stated that lessor accounting should not disappear from the IASB's agenda but should be addressed in a subsequent phase of this project.

By majority vote the Board agreed to the revised project plan in full.

Some Board members noted that residual value guarantees and the nature of the right-to-use asset should also be addressed in the discussion paper. The staff responded that residual value guarantees will addressed at the exposure draft stage and that issues regarding the right-to-use asset will be addressed in the discussion paper.

The Board then started its deliberations on the technical issues that arise if the current finance lease model is applied to operating leases.

Options to extend or terminate a lease

Without detailed discussion the Board decided that options to extend or terminate the lease should not be recognised separately from the right of use asset but that the assets and liabilities recognised by the lessee should be based upon an assessment of the lease term.

The Board did come to a conclusion on how the lease term should be assessed. The discussion was based on an example of a five-year lease that incorporates an option to extend the lease for an additional three years. Some Board members favoured a probability weighted approach, i.e. if the probability that the lease will be extended is 50% the estimated lease term would be 6.5 years. Other Board members disagreed to this approach since there would be no continuous range of possible outcomes. In addition, Board members expressed mixed views on whether the estimated lease term should be trued up on a regular basis. The issue was pushed back to staff for further elaboration. However, there was a consensus that all contractual, non-contractual financial and business factors should be taken into consideration when determining the lease term. The Board also decided that any new lease accounting standard should provide detailed guidance on the factors to be considered.

Contingent rentals

The Board decided not to retain the current accounting treatment for contingent rentals but to estimate contingent rentals at inception of the lease. Also the Board decided that the best estimate of contingent rentals determined in accordance with the methodology in IAS 37 Provisions, Contingent Liabilities and Contingent Assets should be used.

The FASB staff informed the Board that the FASB tentatively decided to also have an upfront estimate of contingent rentals but to use the most likely outcome when determining contingent rentals.

Initial and subsequent measurement of the lessee's asset and liability under the lease

The Board made the following decisions:

• The lessee's right-to-use asset should be initially measured at the present value of the 'expected lease payments'. The Board noted that the expected lease payments differ from minimum lease payments if they include contingent rentals.
• Accordingly, the lessee's liability should be initially measured at the expected lease payments.
• The discount rate used in calculating the expected lease payments should be the secured incremental borrowing rate.
• The payments for the lessee's liability should be apportioned between a finance charge and a reduction of the outstanding liability, consistent with the treatment of finance leases currently in place.

Regarding the subsequent measurement of the right-of-use asset the staff recommended allocating the depreciable amount on a systematic basis consistent with the depreciation policy the lessee adopts for depreciable assets that are owned. The right-of-use asset would be depreciated over the shorter of the lease term or the economic life of the leased item and for leases of items in which it is reasonably certain that the lessee will obtain title at the end of the lease term, the 'period of expected use' would be the economic life of the leased item. The staff noted that this recommendation is consistent with the current finance lease accounting model and is consistent with the basic approach to the project.

The Board seemed to agree. However, one Board member strongly demanded that further research work on the nature of the right-to-use asset should be undertaken before answering this question.

Lease classification

The Board decided to remove the requirement for lessees to classify leases as operating or finance and to develop a single model of accounting for all lease contracts.

Way forward

The Board intends to publish a discussion paper in November 2008.

Friday 25 July 2008

Standards Advisory Council Meeting Summary

The staff gave a very brief update on the SAC meeting that took place 23-24 June 2008 noting that technical issues were allowed less time due to the constitution review of the IASCF.

Fair Value Measurements

At this session the staff asked the Board to decide on a definition of 'fair value' – what is the measurement object for items with a measurement basis currently referred to as 'fair value'? The staff acknowledged that some aspects of fair value have not been discussed yet, but will be brought to the Board at future meetings (for example, principal market and day-one gains/losses). Staff's view, however, is that whether fair value means an entry or exit price can be decided separately.

The staff then turned to the standard-by-standard review as requested by the Board. This review had been requested to help the Board to decide whether:

• To retain the term 'fair value' and define it appropriately, or
• To replace the term 'fair value' with more specific terms more appropriate in the individual context.

It was noted that a consistent definition of fair value might lead to fewer instances where the Board would require or permit its use. It was also highlighted that a precise definition of fair value would help to ensure proper application where it is required or permitted.

The Board had a lengthy discussion about whether entry and exit price would be the equal for the same item on the same date in the same market. Also, the Board discussed which market an entity should refer to in measuring fair value and whether an exit price could include exit by consumption of assets. Board members expressed a range of views on these issues. No clear consensuses were reached.

Some Board members observed that if the Board cannot clearly define what fair value means, it would be even more difficult for constituents in applying IFRSs. Board members said that some of the issues that are to be brought back for discussion at future meetings must be resolved before the Board can agree on a definition of fair value.

The staff also asked the Board to consider whether to keep the term 'fair value' or abandon it. The Board seemed to be split on that issue.

The Board discussed whether, in measuring the exit-price fair value of an asset the entity is using, the measurement should take viewpoint of the entity or of an independent market participant. Board members' views varied, and no decision was reached.

The staff distributed a flow chart which was not part of the observer notes that was intended to facilitate the discussion.

The Board decided that, once fair value is precisely defined, each reference to fair value in IFRSs should be assessed in relation to the definition. Where 'fair value' as used in an IFRS is not consistent with the agreed definition, the term should be replaced with a more descriptive term.

Sweep issues from this meeting: Reorganisation of IFRS 1

The Director of Implementation Activities informed the Board that the staff planned to update the restructured version of IFRS 1 First-time Adoption of International Financial Reporting Standards as published as part of the Annual Improvements 2007 to reflect changes made to IFRS 1 as consequential amendments after 30 June 2007. The staff recommended this to avoid revising restructured IFRS 1 immediately. Furthermore, the staff recommended that the restructured IFRS 1 reflecting the changes made to it after 30 June 2007 need not be balloted by the Board.

While there seemed to be broad support for the first question, many Board members were concerned over not balloting in the light of the IASB due process handbook. One Board member asked what a jurisdiction would do with the reorganised IFRS 1 where it has a formal endorsement process – would it formally endorse or just note that nothing had changed from a content perspective?

After discussion, the Board decided to ballot on the revised restructured version.

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