Monday 15 June 2009

Financial Instruments – Educational Session: Operational Challenges of an Expected Loss Provisioning Model

Four representatives from BNP Paribas appeared before the IASB 'as fellow thinkers' to discuss the operational challenges of the expected loss provisioning model. They based their assessment on the expected loss model put forward by the IASB staff in May 2009, and in particular Agenda Paper 5D. The BNP team attempted to illustrate how such a provisioning model might be applied in their circumstances.

A key question for financial institutions would be whether the expected loss method reduced pro-cyclicality in financial reporting or whether it would be counter-cyclical. Their initial reaction was that the expected loss model was less pro-cyclical than the incurred loss model, but was not counter-cyclical.

BNP Paribas had estimated that the cost of implementing an expected loss approach to loan loss provisioning would be significant and would extend for three years: one year for development of systems and two years for deployment. Variable rate assets were problematic, and the systems consequences of such instruments still needed to be explored. Speaking personally, one of the presenters thought that banks would be prepared to incur these significant costs if the approach reduced pro-cyclicality. However, the banks would probably not want to incur those costs if they also had to deal with an additional regulatory loss provision.

One problem with using the Basel II data is that it is very crude: the cut is short-term versus long-term, whereas the expected loss model would require more granularity in the data captured by the systems. Some operational efficiency could be achieved by being able to monitor portfolios of similar loans rather than individual loans, but that would also involve systems challenges, given the sheer volume of different types and maturities of loans involved. Again, this still needed to be explored.

Board members probed various aspects of the model with the presenters and clarified certain points. It was clear from the presenters that it would simplify their lives as preparers if there was a high degree of consistency between the data needed for loan loss provisioning for financial reporting and prudential regulatory purposes. However, it was also obvious that some Board members were still uncomfortable with some of the smoothing consequences of the expected loss model.

Both sides expressed a desire to continue to work collaboratively on exploring the expected loss model. The IASB staff reminded constituents that a Request for Views document is expected to be released later in June or very early in July 2009 and would explore the expected loss model in an attempt to gauge its feasibility.

Tuesday 16 June 2009

Financial Instruments – Comprehensive Project to Replace IAS 39

The staff opened the meeting by laying out the agenda which would consist of board discussion and vote on the seven items below relating to the proposed new classification structure and transitional provisions.

Embedded derivative accounting

The staff summarised their paper on the subject which contained three alternatives for the board to consider. They were as follows:

• Alternative 1A: Use the embedded derivative assessment as a filter for classification. Under this alternative embedded derivative assessment and any bifurcations would take place as under existing requirements in IAS 39, and in a second step the bifurcated derivatives, host contracts and hybrid contracts which had not been bifurcated would be classified using the new criteria.

• Alternative 1B: Use the embedded derivative assessment as currently exists in IAS 39 as the classification assessment itself. Under this approach embedded derivatives which are separated would be automatically classified at fair value, and the host at amortised cost. If no bifurcation takes place the instrument automatically qualifies for amortised cost in its entirety.

• Alternative 2: Eliminate the concept of embedded derivatives altogether. Under this approach a hybrid instrument would be classified according to the new criteria in its entirety. Thus a derivative embedded in a debt instrument, for example a commodity price indexation, could result in a cashflow stream which disqualified the instrument from being classified at amortised cost under the new criteria and the entire instrument would be classified at fair value. However features such as interest rate caps, floors or collars which would result in an instrument's yield being switched from fixed to floating rate or vice versa would not preclude an instrument from being classified at amortised cost. This is because, since both fixed rate instruments and floating rate instruments would qualify for amortised cost, the staff viewed an instrument which combined the two elements should also qualify for amortised cost accounting in the absence of any other features. Given that a potential weakness of this approach is that a relatively insignificant embedded feature could result in an instrument being classified at fair value in its entirety, the staff recommended the introduction of a materiality overlay to assess the significance of such features on the variability of cash flows from the instrument as a whole for classification purposes.

Two board members voiced strong support for alternative 2 as the cleanest and simplest approach, and therefore the approach most in line with the objective of reducing complexity. It was pointed out that there would be no interaction between the embedded derivative provisions laid out here and the proposed treatment of the fair value option since it was proposed that the latter would only be retained for elimination of accounting mismatches. One board member believed the materiality overlay suggested as part of alternative 2 should not be retained as materiality should be a consideration in interpreting all standards. Three other board members voiced support for this opinion.

In response to concerns that alternative 2 would lead to change on a large scale, one board member commented that there would be sufficient lead time if an adoption date of 1 January 2011 was adopted. One board member commented that there could be potential for financial engineering given that some instruments containing embedded derivatives would be measured at amortised cost. Another board member responded to this concern by stating that it would be doubtful that instruments containing complex or multiple embedded derivatives would qualify for amortised cost treatment.

11 board members voted in favour of alternative 2. A majority voted against inclusion of the materiality overlay, with 2 votes in favour.

Concentrations of credit risk

The staff summarised their recommendations in this area. The issue relates to concentrations of credit risk at the individual financial instrument level due to subordination, that is, the existence of a priority of payments structure for different instruments issued by the same debtor. The implication of this is that senior and secured creditors are not usually leveraged and thus would meet the criterion of 'having only basic loan features'. However junior instruments held within a waterfall structure would be contractually leveraged, providing credit protection for more senior tranches. Instruments which provide protection for other tranches would not be basic lending transactions and so would be required to be measured at fair value. However subordinated debt instruments within a general creditor structure which is not a waterfall would not be contractually leveraged since they reflect the default ranking established under commercial law. As such they would satisfy the criterion of having only basic loan features.

There was some discussion as to whether this would contradict the tentative agreement that basic loan features would be defined as having only principal and interest cashflows, since all tranches including junior instruments issued would satisfy this criterion. However the board agreed that the element of contractual leverage and consequent differential in credit risk between senior and junior debt adds another factor to cashflow profile and so there is no inconsistency.

The board agreed (13 votes in favour) that application guidance should be included on concentration of credit risk, and also concurred with the staff position differentiating waterfall structures and creditor ranking as a basis.

Fair value option

The staff presented their position that the fair value option should be restricted to the eligibility criterion that the designation eliminates or significantly reduces an accounting mismatch. As such two of the criteria currently permissible under IAS 39, namely:

• Where a group of financial assets or liabilities is managed and its performance evaluated on a fair value basis, and
• Where a hybrid contract contains an embedded derivative, unless that embedded derivative does not significantly affect the cash flows or is closely related to the hybrid contract

One board member, agreeing with the staff position, noted that it should be made clear within the literature that the two criteria which would be dropped were already dealt with elsewhere by the new measurement criteria.

The board voted in favour of the staff position.

OCI method for equity instruments

The staff referred to the board's tentative position that fair value changes for certain equity instruments would be allowed to be presented through other comprehensive income (OCI) but that and subsequent transfers to profit or loss, including on disposal, would be prohibited. The staff presented two possible approaches with regard to when OCI treatment would be permissible:

• Approach 1. An entity would have the option on initial recognition of designating any equity instrument as at fair value through OCI. The designation would be irrevocable and made on an instrument-by-instrument basis. On derecognition of an instrument the amount in OCI would be transferred to retained earnings. Disclosures would be required to make transparent why an entity has invoked the option and what the effect on the financial statements has been.

• Approach 2. Designation as at fair value through OCI would be governed by a principle. A possible starting point for such a principle would be as follows:

  An equity instrument that is held in a broader business context and not primarily for realising the financial benefits inherent in it shall be accounted for as at fair value through other comprehensive income.

The staff recommended the second approach, with reclassifications in and out of the OCI category required if the strategic relationship in relation to an equity investment changes, such that the principle no longer applies or only begins to apply at a date after initial recognition.

One board member disagreed with the staff position on the basis that the reclassification criteria would introduce added complexity. It was noted that the OCI category is a concession by the board and it would be inappropriate to introduce a new principle. Furthermore it was noted that reclassification criteria could be abused if entities anticipated gains or losses in certain instruments. There was some discussion as to whether a sufficiently robust reclassification model would prevent such abuse. Some board members also commented that the proposed principle lacked clarity.

One board member opined that the prohibiting of reclassifications would introduce sufficient discipline when entities designate which instruments to classify at fair value through OCI and limit the potential for abuse.

Another board member noted the example of an entity which is a venture capital company with a variety of investments. A free choice in designating some investments as at fair value through OCI and others as at fair value through the income statement would result in lack of transparency, and users would need to look at the entire statement of comprehensive income in order to understand results.

However several board members pointed out the fact that appropriate wording for any principle was problematic and may result in the need for copious guidance going forward.

The board voted against a principle-based approach in designating which instruments should be at fair value through OCI. 4 members voted in favour. The board also voted in favour of assessment on an instrument-by-instrument basis in designating.

The staff recommended that IAS 18 should be amended in order to exclude dividends receivable for equity instruments at fair value through OCI from the revenue recognition guidance. There was some discussion as to whether transfers to retained earnings for dividend income could be permissible and IAS 16.41 was cited as a parallel. One board member also noted that guidance would be required in relation to areas such as EPS disclosure and the statement of cash flows. The board agreed with the staff's view with regard to IAS 18.

Transition: retrospective application

The staff took the board through its recommendations around retrospective/prospective application in 12 different areas.

1. Classification model and assessment whether an instrument is managed on a contractual yield basis – the staff recommended retrospective application, however assessment of the contractual yield basis criterion should be based on facts and circumstances as at the date of transition to the new guidance. The board agreed with this approach.

2. Designation of equity instruments fair valued using the OCI method – the staff recommended full retrospective application. The problem of obtaining fair values for equity instruments held at cost is addressed in (8) below. There was no board disagreement to this recommendation.

3. Treatment of available-for-sale reserves for instruments measured at AFS under the current guidance – the staff recommended full retrospective application with amounts in OCI relating to AFS instruments should be reclassified to opening retained earnings if they relate to instruments shown at fair value through the income statement under the new guidance. For instruments treated as AFS under the current criteria which will be required to be measured at amortised cost under the new guidance, issues around impairment calculation are addressed at (7) below. The board agreed with the staff recommendation.

4. Hybrid contracts where an embedded derivative was separated under the old guidance and where the hybrid contract is required to be at fair value under the new guidance – the staff recommended full retrospective application. The fair value of the hybrid contract would be the sum of the FV of the previously separated embedded derivative and the FV of the host which had been disclosed previously under IFRS 7. For treatment of hybrids requiring amortised cost treatment under the new guidance and consequent impairment issues see (7) below. Two board members voiced the opinion that there should be consistency in application across the different areas to as great an extent as possible. The board agreed with the staff's recommendation (9 votes in favour).

5. Fair value option – the staff recommended that the assessment for designation and dedesignation should be required on the date of transition, and that the accounting consequences should be applied retrospectively. There was no board disagreement to this proposal.

6. Effective interest rate – the staff recommended retrospective application for instruments which are measured at amortised cost under the new criteria where there had been a different measurement basis previously. This would involve determining the estimated future cash flows considering all contractual terms of the instrument, fees, transaction costs and premium/discounts and generating an internal rate of return. The staff believed that this would be essential for the requirement to report financial instruments at amortised costs going forward. The board agreed with the staff recommendation.

7. Impairment – the staff recommended prospective application with a requirement for an impairment test at the date of transition, and any impairment charge recognised in profit or loss. The board considered whether retrospective application might be possible. One board member opined that a stream of cashflows would be available from previous fair value calculations in order to perform a retrospective impairment assessment, however it was pointed out that some fair values are derived from quoted prices where there is no stream of cashflows used in the calculation. Another board member noted that there may be a large adjustment if there is prospective application. Another board member suggested an alternative treatment whereby the fair value of an instrument as a proxy for the impaired amount for the purposes of recording impairment retrospectively. There was some discussion about whether cash flows should be used where available for a retrospective calculation and, where this was not possible, fair value should be used as a proxy. It was noted that reversals in periods prior to presentation would not cause problems as any current impairment calculation would override previous impairments. It was concluded that the staff should explore the possibility of using fair value in this context.

8. Financial instruments measured at cost – the board had already agreed that the exemption for unquoted equities from fair value measurement should not be retained under the new classification system. The staff suggested that the fair value for these instruments should be determined at the date of transition and the difference recognised in profit or loss on transition. The question was raised by two board members why the difference should not be taken to retained earnings on transition as an adjustment of the opening position as per an IAS 8 change in accounting policy. However it was pointed out that it would be too difficult to fix which periods the change in FV would belong to.

9. Hedge accounting – the staff proposed the view that any hedge relationship which has to be dedesignated under the new criteria should be treated as a discontinuation of hedge accounting. This would provide transitional relief for preparers as it would not be necessary to identify and reverse any hedge accounting effect retrospectively. One board member commented that it would be difficult to interpret this transitional provision given that the guidance on hedge accounting would not be out in July 2009. The staff noted that the fair value option was still available to eliminate mismatches in cases where hedges were discontinued and hedged items would otherwise have been required to be measured at amortised cost. There was no board disagreement to the staff proposal.

10. Disclosure – the staff proposed no transitional relief in the requirement to disclose comparative amounts under IFRS 7 relating to the new classification and measurement system. The board agreed and there were no dissenting opinions.

11. Disclosure on transition – the staff did not propose any requirements additional to the provisions already included in IAS 8.28 for initial application of an IFRS. The board agreed with the staff view and there were no dissenting opinions.

12. Comprehensive additional disclosures for early adopters – in order to ensure comparability between entities the staff proposed the following disclosure requirements for early adopters:
    • An additional statement of financial position in accordance with current IAS 39 for all periods presented
    • An additional statement of comprehensive income in accordance with current IAS 39 for all periods presented
    • A table comparing the carrying amount under the current version of IAS 39 with the carrying amount under the new guidance per class, for each period presented
    • Narrative information on how the entity applied the new classification model and how the model impacts the entity's financial position and performance in the current and preceding periods

All of the above disclosures would be required for each period until the new guidance becomes effective for all entities reporting under IFRSs.

The staff explained that there had been a high level of correspondence and consultation on the subject of disclosure for early adopters. The rules in effect would produce a high barrier to early adoption. On board member commented that the requirements appeared excessive; however, he understood the need for them.

The staff suggested an alternative view whereby disclosure requirements for early adopters would be limited to disclosure on the effect of choices made, as compared to the position pre-transition. The chairman suggested that this could be published as an alternative view within the exposure draft.

Another board member commented that, if the new requirements are superior, the board ought not to place high barriers to early adoption. This view was supported by another board member. The staff commented that comparability was the only reason for the proposed disclosure requirements. The chairman suggested that views should be passed to the staff in the week of 15 June 2009 in relation to the potential alternative view.

Consequential amendments to IFRS 1

The staff proposed some consequential amendments to IFRS 1 in relation to designation date option (that is, the option to designate financial instruments either at the date of initial recognition or the date of transition to IFRSs) and some implementation guidance-related issues, including guidance on embedded derivatives as well as classification and measurement issues. Board members asked whether it was necessary to include this in the first phase of the project, or whether it would be more sensible to postpone IFRS 1 amendments to the second phase.

Consequential amendments to IFRS 7

The staff presented consequential IFRS 7 amendments to reflect the new categories and eliminate disclosure for areas no longer relevant (such as reclassifications). There were no dissenting opinions from the board.

Sweep issues

The staff presented four other issues to the board as follows:

1. The staff did not propose to address the issue of scope of IAS 39 in this phase of the project. The board agreed with the staff suggestion.
2. The staff recommended that there should be no changes proposed to the requirements around day 1 gains and losses in the exposure draft. The board agreed with the staff recommendation.
3. The staff noted that two of the annual improvements to IAS 39 to be included in the forthcoming exposure draft, in relation to effective interest rate and bifurcation of embedded derivatives, may no longer be relevant. It was noted that the exposure draft for the annual improvements would have an effective date of 1 January 2011, and that the effective date for the revised classification and measurement requirements may be 1 January 2011 or 1 January 2012. One board member voiced support for an effective date of 1 January 2012, since all of the proposed amendments ought to apply at the same time. It was decided to include the question in the September exposure draft for annual improvements.
4. The staff did not recommend any changes to the IAS 39 measurement guidance in relation to financial guarantee contracts, loan commitments or financial liabilities with a demand feature. The board agreed with the staff position.

Final discussions

The chairman stressed that, if appropriate, alternative views could be expressed in the exposure draft in relation to the new classification and measurement rules. One board member held an alternative view which was supported by another board member. The chairman suggested that the alternative view should be discussed between the board member and the staff and that a further discussion would be held on Friday, 19h June 2009.

The board member gave a brief outline of the alternative view. This was that, for certain debt instruments which were not loans and receivables, income could be presented in the income statement but fair value movements through OCI. Thus fair value information would be given on the balance sheet and also an amortised cost-based income stream in the income statement whilst preserving the fair value basis. As such the amortised cost model would only be retained for loans and receivables. However the same criteria would exist for classification at amortised cost (i.e. managed on a contractual yield basis). It was concluded that a paper would be produced, summarising this view.

The chairman noted that this alternative view and that for disclosures on early adoption should be discussed on Friday, 19 June 2009.

Wednesday 17 June 2009

Liabilities – Amendments to IAS 37

Applying the proposed requirements to litigation liabilities

The Board discussed concerns raised by some constituents and Board members that defendants in some legal proceedings might encounter practical problems when applying aspects of the proposed amendments to IAS 37 Provisions, Contingent Liabilities and Contingent Assets.

Recognition would prejudice the outcome of the proceedings

The staff presented an analysis that concluded that:

• the proposed amendments to the recognition and measurement requirements do not significantly increase the risk of prejudicial information being disclosed; and
• some useful information would be lost if liabilities were instead either not recognised at all, or recognised at a less relevant amount, such as the minimum or maximum amount in the range of reasonably possible outcomes.

Some Board members were uncomfortable with requiring preparers to quantify the expected outcomes of a piece of significant litigation, preferring a disclosure approach. The numbers produced would be too variable to be useful. Other Board members were not content with that approach, fearing that that the disclosure would quickly reduce to boilerplate. Board members noted that the staff recommendation was not a great distance from the current situation in IAS 37 and as such was evolutionary not revolutionary, and was still subject to a 'prejudice' exemption. The result should be better information than was provided currently. The Board agreed (one opposed) that the standard should not make any exceptions to the proposed recognition and measurement requirements for litigation liabilities.

One-off litigation liabilities not capable of reliable measurement

The Board discussed the common concern that the outcomes of major one-off legal proceedings can be very difficult to predict and, consequently cannot be measured reliably.

The Board discussed the issues related to major items of litigation, but concluded that the standard should continue to describe the circumstances in which liabilities cannot be measured reliably as 'extremely rare' and that no guidance on how this should be interpreted should be provided.

Practical problems for US entities

The staff asked the Board for direction in light of comments made in the United States that IAS 37 might be 'incompatible with the legal environment in the US because preparers would be compelled to reveal potentially damaging information about their litigation.' Some Board members noted that while there is a 'prejudicial' exemption for disclosure, there is none for recognition and that items recognised in the financial statements are subject to 'discovery' under US legal procedure.

Board members noted that the problems identified exist in IAS 37 at present and that the Board should not delay the finalisation of the standard for this potential issue. Board members did not want to move towards existing US GAAP in this area. If, as part of a transition to IFRS, operational issues with respect to the application of this standard were identified, these could be raised with the IASB in the normal manner.

Reimbursement rights

The Board agreed that the standard should not include any measurement requirements for reimbursement rights. However, it should state explicitly that the assumptions used to measure a reimbursement right should be consistent with those used to measure the related liability.

There was some discussion about whether IFRIC 5 Rights to Interests arising from Decommissioning, Restoration and Environmental Rehabilitation Funds should be amended to remove the 'lower of the amount of the decommissioning obligation recognised and the reimbursement right' in paragraph 9. A majority of the Board favoured removing the asset ceiling test from IFRIC 5.

Disclosure of possible obligations

The Board discussed the circumstances in which an entity should disclose information about 'possible obligations' (that is, those for which there is uncertainty about whether an obligation exists, but for which based on current information, management has concluded that the recognition criteria are not met and no liability has been recognised).

The Board agreed that there should be disclosure of possible obligations (subject to materiality) whenever the possibility of the outflow of economic resources is other than remote.

The Board agreed that in such circumstances, an entity would disclose:

• a description of the circumstances;
• an indication of the financial effects;
• an indication of uncertainties relating to the amounts or timing of any outflow of economic benefits; and
• the possibility of any reimbursement.

Stand-ready obligations

The staff presented a 'refined analysis' of the attributes of stand-ready obligations and the circumstances in which they might arise. Board members were generally content with the revised analysis and supported its use in the drafting of the standard and related application guidance. In particular, some Board members thought it was very helpful to them in distinguishing stand-ready obligations and 'incurred but not reported' obligations. The Board agreed that the staff paper reflected correctly the Board's conclusions.

Conceptual Framework - Phase C – Measurement

The Board discussed a draft chapter on measurement that might form the basis of a joint IASB-FASB discussion paper. The sample chapter very basic; it did not include a basis for conclusions or other supporting material that would be included in an actual measurement chapter. In addition, the staff admitted that it did not include all the topics that the Boards might want to include in the Framework's measurement chapter.

No decisions were asked for or made, but Board members had some overall comments:

• There should be a discussion of measurement as a component of financial reporting; how the various measurement alternatives are assessed with respect to a particular asset or liability; and how measurement related to income and expense determination.
• Board members had concerns that the discussion of measurement of financial instruments might be contrary to the most recent decisions about those items, especially with respect to items that might be measured at amortised cost under the Board's forthcoming proposals on classification and measurement.
• There was no implicit ranking of the measurement alternatives, which would leave a preparer, using the measurement chapter via IAS 8, with no guidance on which of the measurement approaches was most appropriate in a given circumstance.
• The measurement chapter should not import ideas from individual IFRSs; thus rather than referring to 'Level 2' inputs, it should describe what those inputs are.

Overall, the Board thought that the sample chapter was a useful starting point, but that it could be made more succinct and direct.

Revenue Recognition

Noncash consideration

The FASB staff joined by video conference.

The staff began the discussion by reminding the Board of the previous tentative decisions made at the March and April Board meetings, including that:

• The entity should measure noncash consideration at fair value.
• If an entity cannot reliably estimate the fair value of noncash consideration, it should measure the consideration indirectly by reference to the selling price of the promised goods and services.
• Some exchange transactions should not be transactions that generate revenue but did not decide on which exchange transactions should be excluded from revenue. The Board had asked the staff to seek user input on this matter.

The staff talked to users, particularly in the oil and gas industry. The staff advised that the (almost unanimous) user input was that they preferred that transactions not be recognised as revenue. The users believed that exchanging assets in the normal course of business was more like the acquisition of inventory rather than a sale.

The staff then moved on to their first recommendations:

• that an exchange transaction should not be regarded as a transaction that generates revenue if the purpose of the transaction is to facilitate sales of an asset to another customer in the ordinary course of business.
• that the revenue standard not provide guidance on how to account for contracts whose purpose is to facilitate sales to customers.

One Board member noted that the proposals work well for similar assets, but not for dissimilar assets. Problems are likely to arise if different assets and different timing occurs. For example, what if tow oil companies sold oil to each other and exchanged cash? As long as there is economic substance the Board member though that there may be revenue recognised.

Another Board member noted that the current IAS 18 seemed to work in practice.

The Board agreed with the staff recommendations.

The staff then moved on to their recommendation that either the selling price of the asset surrendered or fair value of the asset received in an exchange transaction needs to be reliably estimable for the transaction to be considered a transaction that generates revenue. One Board member queried whether this is meant to be different to the current paragraph 12 of IAS 18 which refers to goods being dissimilar and measured revenue based on fair value received if able to be measured reliability, or those given up otherwise.

The staff responded by saying they thought it was consistent, but also if you can't measure either then it is revenue.

Another Board member responded to this by stating that they were concerned that the drafting is too broad. They would prefer not to have the reliable criteria, and would prefer to keep the requirements as currently included in IAS 18. Following discussion the Board supported the current requirements of IAS 18 and not the staff recommendation.

Presenting revenues for performance by third parties

The staff introduced the paper that considers whether in some cases an entity should recognise revenue as the gross amount billed to the customer, or the net amount retained by the entity after paying those other parties. The staff presented their first three recommendations:

1. The identification of performance obligations should determine the amounts at which an entity recognises as revenue.
2. The revenue recognition standard should provide indicators to assist entities in identifying performance obligations when it is not clear what goods or services an entity is obliged to transfer.
3. Indicators that an entity may have a performance obligation to provide a good or service to a customer include:
   • Primary responsibility for fulfilment
   • Inventory risk
   • Discretion in establishing prices
   • Customer credit risk.

The Board agreed with each of those recommendations.

The staff then proceeded to their fourth recommendation:

• If an entity transfers a performance obligation to another party, it should not recognise revenue with respect to that obligation.

The staff clarified that by transfer they intended legal transfer. The Board discussed whether any amount that may arise on the transaction (fir example, if an entity was paid by another entity for the transfer of the obligation) would be classified as a gain or revenue. The Board did not conclude on this point. There was general agreement by the Board with the staff recommendation.

The final two recommendations related to disclosure. The staff recommended that an entity:

• Disclose separately revenues in the same line of business from (a) providing goods and services on its own account and (b) arranging for the provision of goods and services.
• Disclose the basis for its assessment and any significant judgement when determining whether it is obliged to provide goods and services to a customer or to arrange the provision of goods and services on behalf of another entity.

The Board agreed with the first disclosure recommendation. A number of Board members thought that the second recommendation was already addressed by IAS 1 requirements. The staff was asked to reconsider this disclosure recommendation to avoid any redundancy in requirements.

Combination, segmentation and modification of contracts

The Board first considered the issue of combination of contracts. The staff recommended that when two or more contracts with the same customer should be combined into a single contract position if the price of those contracts are interdependent. The Board agreed with the staff recommendation. The Board discussed some issues relating to how the indicators for such principle may be expressed, but the Chair reminded the Board that the wording is not yet finalised, and that the staff were heading in the right direction so asked the Board to move on to the next issue.

The Board then moved on to discuss in what circumstances a contract should be segmented. The staff recommended that a single contract with a customer should be segmented into more than one net contract position only if each segment is priced independently. One Board member said that they did not fully understand the principle and would like to see the full picture before concluding. The staff noted that implicitly if the Board agreed with the first recommendation they should also agree with the second recommendation as it is the inverse. Another Board member noted that it is about getting the right allocation, and when contracts should be segmented. Following a brief discussion the staff were asked to reconsider and clarify the issue and bring it back to a future Board meeting.

Financial Instruments – Education Session by Bank of Spain (BdE) Representatives: the BdE Provisioning Model

Two representatives from the Bank of Spain (regulator of Spanish banks) presented the statistical provisioning approach which the BdE requires from entities regulated by them. The representatives explained that, in their opinion, the model incorporates losses incurred due to under-pricing of credit in times of boom in the lending cycle due to market over-optimism. The lending cycle per the model is closely correlated with the economic cycle as a whole.

The model is based on a statistical formula which incorporates an element of collective impairment relating to the point in the lending cycle ('alpha') and incurred losses relating to individual assets ('beta'). The alpha component is a collective assessment and applied to the change in the portfolio of assets at each date of assessment. Thus in times of boom in the lending cycle, the alpha component is high relative to the beta component, whereas this trend is reversed in times of slump as incurred losses relating to the general cycle are in effect transferred to individual assets; the alpha element can be negative, reflecting over-conservative pricing of credit. The representatives explained that they believe the advantage of the model is the early detection of credit losses.

The Bank has around 6 asset classes which it views as homogeneous, for each of which an alpha (effect on asset class of stage of the lending cycle) and beta (historical incurred losses relating to individual assets) are kept. In order to assess the lending cycle, the BdE holds data from the Spanish national credit register dating back to 1988 for each of the asset classes, which equates roughly to 2 full lending cycles. The representatives stressed that this is an incurred loss model as the inputs to the model are derived only from historic experience.

Board members asked questions around various aspects of the model. One member asked what approach the BdE takes for new products where there is little historic data. The representatives replied that this was not an issue that had caused much difficulty in Spanish banking given the relative absence of new products – for example, credit cards represented only around 1% of total lending in Spain. Another member pointed out that, for loans given out during periods of boom, the model effectively results in a large 'day 1'-type loss for lenders. The representatives replied that this was a necessary reflection of credit pricing in these times.

Another member asked whether BdE was aware of how much credit data other central banks held, and thus how practicable a system such as this would be for banks from other countries. The representatives replied that they were aware of some central banks holding extensive credit data; however it was unlikely that many would hold data in sufficient detail going back as far as 1988. Another board member asked whether, if an expected loss model were incorporated within IFRS, the bank would continue to use its model. The representatives replied that, in their opinion, it was possible to use the model to estimate expected losses, however it would be a relatively simple approach. The representatives agreed with board members' views that, were this model adopted more widely, more active involvement would be required from banking supervisors in assessing provisioning than is currently the case given the complex nature of the model and underlying data. The representatives put forward the view that, in times of economic difficulty such as the present time, banks would be less likely to voice the view that an approach such as their model would lead to competitive disadvantage. This had been their experience in Spain.

The chairman thanked the representatives for their presentation.

Thursday 18 June 2009

Joint Ventures – Exposure Draft 9

Parties to Joint Arrangements that do not share in 'joint control'

The Board discussed whether the final standard should refer in some manner to parties to joint arrangements that do not share in joint control and, if so, how such parties should account for their interests. Respondents to ED9 had suggested that there was diversity in practice and the Board wished to clarify what they thought the appropriate accounting should be.

After discussion, the Board agreed that the final standard should acknowledge that a party to a joint arrangement might not have joint control. Such participants should account for shall account for their assets, liabilities, revenues and expenses, including their share of any assets, liabilities, revenues and expenses arising from the joint operation. A cross-reference for investors in 'joint ventures' (as now defined) to guidance in IAS 39 (or IAS 28) might be necessary.

Clarification of the accounting requirements for 'joint operations'

Unit of account and nature of the assets and liabilities to be recognised

Respondents to ED9 had challenged the Board's conclusions on certain aspects of the unit of account, especially in relation to its decision to eliminate the proportionate consolidation method (ED9, BC8-BC10), when compared to its other conclusions on the unit of account (e.g. ED9 BC18).

The Board noted that BC8-BC10, and in particular BC9 were conclusions specifically related to its conclusions related to the unsuitability of the proportionate consolidation method. In determining the accounting for joint operations, the Board intended that participants in such arrangements would account for the assets, liabilities, revenues and expenses that were contributed to the joint operation. Such items would be defined in the terms of the joint operating agreement, which would specify the rights and obligations of the joint operating agreement parties. The accounting should follow those rights and obligations. The over-all effect might look like proportionate consolidation, but it was fundamentally different.

The Board agreed that the basis for conclusions accompanying the final standard should describe the Board's conclusions about when it is appropriate for an entity to account for its share of assets/ liabilities and when to account for an investment rather than focusing on the elimination of the proportionate consolidation method.

Nature of the assets and liabilities to be recognised

The Board agreed that the final standards should clarify the accounting requirements in relation to the nature of the assets and liabilities to be recognised by the parties in 'joint operations' to be 'shares of assets/liabilities' instead of 'rights. In doing so, the guidance in IAS 31 relating the classification of the share of assets according to their nature should be retained.

Next steps

The senior staff noted that, although the major items of ED9 had been redeliberated and resolved, the staff needed to undertake a careful review of the consequential amendments, in particular given that the consolidation standard was being redeliberated. There were potential conflicts between ED9 and other standards that needed to be analysed carefully and brought before the Board.

Financial Instruments with Characteristics of Equity

Measurement of equity instruments and separated hybrid instruments

The Board discussed several aspects of the measurement requirements for freestanding equity instruments and equity hybrids (that is, instruments that are separated into an equity component and a liability or asset component). The following decisions were, unless otherwise noted, agreed without significant detailed discussion.

Transaction costs

The Board agreed that transaction costs or fees incurred to issue freestanding equity instruments and equity hybrids should be expensed immediately.

One Board member was concerned that this principle is contrary to the notion of 'cost' in IAS 16. For example: an item of property, plant and equipment was acquired in exchange for shares (value 100) and additional costs of 10. If the 10 was related to the issue of the shares, it would be expensed; if it was directly attributable to bringing the asset to the location or condition necessary to use it, it would be included in the cost of the asset. No other Board members were concerned about this difference. In the example, the 10 was not a transaction with shareholders in their capacity as shareholders and should therefore be excluded from equity.

Initial measurement of freestanding equity instruments

The Board agreed that freestanding equity instruments should be measured initially at their transaction prices.

Separation of equity hybrids (that is, IAS 32 'compound instruments')

The Board agreed that the separated components of an equity hybrid should be measured as follows: first, the liability (or asset) component should be measured at the fair value as if it were a freestanding liability (or asset); second, the remainder of the transaction price for the hybrid instrument should be allocated to the equity component.

Subsequent measurement

The Board agreed that equity instruments and separated components that the entity cannot be required to redeem should not be remeasured. The Board agreed that at each reporting date, equity instruments and separated equity components with redemption requirements should be remeasured at current redemption value. (Current redemption value is a defined term: it is the amount that would result from applying the redemption formula as if redemption was required at the measurement date.) Changes in current redemption value should be recorded as a transfer between retained earnings and the redeemable equity instruments or components.

The Board also agreed that the liability or asset component of a separated instrument should be subsequently remeasured as if it were a freestanding instrument.

Measurement of liability and asset instruments

The Board discussed how instruments classified as a liability (or asset) under the IASB's classification approach would be measured using the current measurement requirements in IFRS and US GAAP.

Board members were uncomfortable with the staff recommendations, which they thought would be open to abuse, in particular the ease with which a liability could be structured to achieve equity classification. Some Board members would prefer to account for the instruments 'net', while others preferred the current IAS 39 requirements. Staff noted that the FASB's current view is to report the position 'net'.

A bare majority of the Board (8 in favour) agreed that physically settled forward contracts and written put options on an entity's own equity instruments should be (a) reported on a net basis and (b) measured consistently with the financial instruments recognition and measurement project's conclusions.

Insurance Contracts

Project timetable

The staff presented a revised project timetable, one that suggested that the exposure draft of the Board's proposals would be published in April 2010 for 120 days' comment, with redeliberation completed by June 2011.

This revised timetable was not well received by the IASB Chairman and several Board members. The staff was instructed to ensure that the exposure draft was published no later than December 2009.

Measurement approach for insurance contracts/ Using the updated IAS 37 model as a candidate for measuring insurance contracts

The Board agreed that sufficient progress had been made on the IAS 37 model for liabilities that a modified IAS 37 approach should be considered as a candidate for measuring insurance liabilities. At the same time, the 'current fulfilment value that includes a margin for the cost of bearing risk and a residual margin' approach was removed from consideration.

In proposing the IAS 37 measurement model, the Board noted that the objective in IAS 37 is to measure the amount that the insurer would rationally pay to be relieved of a liability. In the absence of an active market, the modified IAS 37 model clarifies that the insurer can estimate that amount by looking at the burden to the insurer of having to fulfil the obligation over time, or what it would rationally expect to receive from a third party to assume that liability. The margin would be calibrated such that there was no day one gain or loss, except that the insurer would recognise revenue at the inception of the contract to the extent that it provides recovery of the incremental acquisition costs incurred.

Although agreeing that IAS 37 should be added to the measurement candidate list, several Board members wanted greater assurance that the modified IAS 37 model was sufficiently robust to be applied to insurance liabilities. In addition, the Insurance staff team needed to provide further thoughts about how the IAS 37 model would be applied to insurance contracts and what additional Application Guidance might be necessary. Board members wanted a joint session with the insurance and IAS 37 teams to provide them with greater assurance and comfort on this fundamental issue.

One Board member also wanted greater comfort on the risk margin: was it a surrogate for the entity's cost of capital or was it compensation for bearing the insured risk. Some other Board members were not certain that there was a difference between the two. However, there was agreement that the Board should be explicit about the measurement objective inherent in the risk margin.

Current exit price

Subject to the modified IAS 37 model being articulated appropriately with respect to insurance, the Board agreed not to continue considering current exit price as one of the measurement candidates for insurance contracts.

Some Board members were concerned that the exit price provided a 'sanity check' for the measure of the insurance liability. Board members were reminded that the requirement to look at what the entity would rationally accept or demand to assume the liability from another provided a check on the 'would rationally pay' criterion in the measurement requirement.

Field tests

The Board agreed a staff proposal to undertake 'targeted field tests', to begin before the exposure draft is issued, to assess whether the proposals will achieve their objective and how the proposed approach would change current practice. The staff expects to engage approximately 15 insurers (preparers), with follow-up involvement from user groups.

The staff had hoped to complete their work in advance of the exposure draft being issued; however, given the explicit direction of the Board to have an exposure draft by December 2009, not all work might be completed prior to the exposure draft being issued.

Leases

FASB staff joined by video conference.

Impairment of right-of-use asset

The staff opened the discussion by reminding the board that they have previously tentatively decided to requite initial and subsequent measurement of a right-of-use asset on an amortised cost basis. Consistent with other assets measured on an amortised cost basis it needs to be determined how a right-of-use asset will be reviewed for impairment.

The staff noted that they believe there are four options for impairment accounting for right-of-use assets:

1. require all entities to use IFRS approach
2. require all entities to use US GAAP approach
3. develop specific approach for right-of-use assets
4. require entities to refer to existing applicable standards (IAS 36 for IFRS preparers, SFAS 144 for US GAAP preparers)

The staff recommended the last alternative. The Board agreed with the staff recommendation.

Revaluation

The staff introduced the topic by noting that the discussion was about whether an option for revaluations should be included for right-of-use assets, not a requirement to revalue. The staff recommended that revaluation of right-of-use assets should be permitted. The staff further added that their recommendation did not change regardless of whether the right-of-use asset was considered to be intangible or tangible in nature. The staff believes that permitting revaluation may provide users of financial statements with more relevant information about the revalued assets than amortised cost based measurement. They also believe that revaluation will ensure consistency with other non-financial assets in IFRSs. The FASB staff did not agree with the IASB staff recommendation; the FASB staff recommended that revaluation of right-of-use assets should not be permitted. At their Board meeting the FASB agreed with the FASB staff recommendation.

One Board member asked the staff whether they thought the revaluation criteria would be IAS 16 or IAS 38? The Board member thought that the Board needed to decide this first as revaluation under IAS 38 requirements would be impossible as there is no active market. The Board member would favour no revaluation.

Another Board member supported the IASB staff recommendation. They thought that the appropriate standard to look to would be IAS 16, not IAS 38. The Board member did not see why financing a non-current asset by leasing rather than by an outright purchase should change whether a revaluation should be allowed.

Some other Board members thought that the right-of-use was an intangible.

Another Board member said that they agreed with the IASB staff recommendation. The Board should not revisit the current requirements. Whether IAS 16 or IAS 38 is applied depends on the nature of the asset you are leasing. A number of other Board members agreed with this notion.

In response to a Board member's question, the staff said that the FASB made their decision as it was consistent with current US literature. The FASB staff member added that the FASB think that rights-of-use are intangible. This is a difference.

The Board voted, and all favoured the IASB recommendation.

The staff summarised the discussion by saying that we should look to the nature of the underlying asset and apply that revaluation model. In that case the remainder of the questions in the paper were not required.

One Board member asked whether the staff thought that the revaluation should be applied to classes or assets or individual assets, as in IAS 40. The staff responded by noting that they need to consider the interaction between IAS 40 and the leasing proposals and will bring this back for Board consideration at a future meeting.

Initial direct costs

The staff introduced the discussion by stating that there are three possible ways of addressing how initial direct costs should be accounted for:

• (a) add initial direct costs to the carrying amount of the right-of-use asset
• (b) allocate initial direct costs between debt issuance costs and asset acquisition costs
• (c) recognise such costs as an expense as incurred.

The staff recommended (a), and the FASB at their meeting agreed with (c).

One Board member agreed with the FASB. Another noted that if the asset is revalued the initial direct costs would be expensed anyway. Another Board member said that they would like to get to the FASB answer. Another added that if the initial direct costs are added to the costs to the asset, then the asset would not equal the liability on initial recognition. It would also be inconsistent with the definition of cost in the discussion paper. A number of other Board members supported the IASB staff view.

The Board voted. The vote was split: 7 Board members favoured (a) while 7 favoured (c) - expense. The Chairman used his 'casting vote' (paragraph 35 of the 2009 IASCF Constitution) to make the vote 7 for (a) and 8 for (c).

Transition

The staff initially considered four ways of addressing how the new lease standard should be applied:

• Option A - retrospective application
• Option B - prospective application to new lease contracts entered into after the effective date
• Option C - measure all leases at fair value on the transition date
• Option D - measure all leases at the present value of the lease payments, discounted using the lessee's incremental borrowing rate on the transition date.

The staff recommended Option D. At their meeting, the FASB agreed with the staff recommendation. The Board also generally supported the staff view, subject to some modification.

Sale and leaseback

The final issue to be addressed was to obtain preliminary views from the Board on how a seller/lessee should account for a sale and leaseback transaction under a right of use accounting model. Lessors are also discussed in the staff paper; however, the Board would not be asked to reach a preliminary view on lessor accounting at this stage. The staff noted that they were not attempting to develop a general theory of derecognition for non-financial assets. The staff also noted that they have assumed that the sale proceeds received by the seller/lessee equal the fair value of the property sold and that the leaseback is at a market rate.

The staff said that the FASB preferred an approach where the entire asset was derecognised. They preferred to look at whether a sale had occurred, regardless of the existence of a leaseback. They would look at the existing control based assessment and consider the use of some specific criteria in making this judgement.

The staff then turned to the first question; whether the Board agreed with the staff recommendation that a seller/lessee should consider whether the entire asset qualifies for derecognition. Following some discussion, the Board agreed with the staff recommendation.

The second question posed by the staff was whether the Board would support (a) always derecognising the leased asset or (b) developing criteria to differentiate between transactions that qualify for derecognition and those that do not.

A number of Board members thought that they should use the revenue recognition (control) model. Following discussion the staff summarised by noting that the Board would look to the control model as to whether there is a sale or derecognition and look to revenue recognition for indicators as to whether this has occurred. The Board agreed.

The staff then asked the Board if they would like additional criteria beyond the revenue recognition criteria? The Board indicated that they did not; the revenue recognition criteria should be sufficient.

As a final question, the staff asked the Board if a sale is recognised, would they want to defer any gain associated with this. The Board indicated that they would not want to defer any gain.

Question 4 of the staff paper was not discussed.

Friday 19 June 2009

Rate-regulated Activities

Recoverability of regulatory assets and impairment testing

The Board had previously determined that regulatory assets and regulatory liabilities should be measured at the present value of expected cash flows both on initial recognition and subsequently and therefore a discussion of recoverability and impairment was deemed unnecessary.

However, staff raised a concern about the combined effect on an entity's rates of all the regulator's decisions with respect to the recovery of individual costs.

In other words, the regulator may permit the entity to recover a variety of previously incurred costs without regard to their combined effect. However, when the total effect of those costs on future rates is considered, the entity might conclude that at the rates implied by the inclusion of those costs, its total revenue might still not cover the all the costs because of reduced demand.

The Board decided that:

• an entity should be required to consider the overall effect of regulatory assets on future rates and its ability to generate sufficient revenue to recover them;
• the cash-generating unit in which the regulatory assets are included should be tested for impairment in accordance with IAS 36 if recovery of the net regulatory assets and regulatory liabilities is not reasonably assured. Regulatory assets and liabilities must be tested for impairment as part of a CGU as they do not generate independent cash flows;
• any impairment loss should be allocated to individual regulatory assets based on the period and amount by which estimated future cash flows are affected; and
• in subsequent periods the amount and timing of the estimated cash flows used in determining the amount of the impairment loss should be used to measure the asset.

Presentation of regulatory assets associated with other assets

The Board concluded at its meeting in May that an entity should recognise a regulatory asset for amounts the regulator permits to be included in rates associated with self-constructed assets. Those amounts may relate to indirect overheads and financing costs that would not be recognised as part of property, plant and equipment in accordance with IAS 16. The issue is whether those amounts must be presented separately as regulatory assets or whether they may be included as part of the cost of the PP&E.

Some Board members and staff thought that on cost-benefit grounds it was reasonable to include these regulatory assets within the cost of the PP&E and therefore depreciate them over the same useful lives as the PP&E. Other Board members and staff argued that regulatory assets do not have the same characteristics as PP&E and therefore should be presented separately. Those Board members also questioned whether it was appropriate to depreciate the regulatory assets over the same period as the PP&E where the useful economic lives differed.

Overall, a majority of Board members agreed that an entity should include all the amounts the regulator permits to be included in the cost of self-constructed assets or internally generated intangible assets as part of the related asset. These costs would therefore not be re-measured at the present value of future cash flows but be treated as part of the total cost of the asset under IAS 16 or IAS 38. It was agreed that the basis for conclusions would explain that there is no conceptual basis for this decision; rather it is an exception that has been allowed on cost benefit grounds. For these reasons it would not be appropriate to analogise to this exception in other circumstances. Furthermore, the Standard would remind users of the requirements of IAS 16.57 that the useful economic life of an asset is defined in terms of the asset's expected utility to the entity and that the useful life of an asset may be shorter than its economic life.

Transition

The Board agreed that fully retrospective application would be too onerous and therefore decided that an entity should apply the requirements of the Standard to regulatory assets and liabilities existing from the beginning of the comparative period, that is, there would be an adjustment to opening retained earnings. In respect of the effective date, it was agreed that sufficient lead-time should be granted to allow entities to collate the required information for the comparative period.

First-time adoption

The Board agreed that a consequential amendment to IFRS 1 is required as part of this project. That amendment would permit entities not to restate PP&E to recognise separately amounts that would qualify for recognition as regulatory assets. There would no longer be a need for a definition of rate regulated operations in IFRS 1 or a separate impairment test.

Annual Improvements – four issues:

IAS 28 Investments in Associates – Venture capital consolidations and partial use of fair value through profit or loss

The issue under discussion was one in which an investor, at a consolidated level, has an investment in an associate, a part of which is held by a subsidiary that is an investment-linked insurance fund (or any entity potentially included within the scope exemption of paragraph 1 of IAS 28). The question raised was whether that part of the investment held by a subsidiary that is an investment-linked insurance fund is able to be designated at initial recognition as at fair value through profit or loss in accordance with IAS 39 Financial Instruments: Recognition and Measurement, while another part of the investment held by another group entity is accounted for in accordance with IAS 28.

The Board determined that there were 2 steps to this question:

• first to determine whether, at a consolidated level, there was significant influence; and then
• to conclude on the appropriate accounting.

The Board agreed with the staff recommendation that all direct and indirect interests held in the associate should be identified, but that the scope criteria in IAS 28 should be used to determine the allowed accounting treatments for the investment (or a portion of the investment). Therefore the scope of IAS 28 should be used to group the investment holdings into one of potentially two valuation models (equity method or fair value through profit or loss, or both).

IAS 28 Investments in Associates – Impairment of investments in associates

The issue under discussion was whether the Board agreed with the staff recommendation that impairment testing of investments in associates should be performed:

• for the consolidated financial statements in accordance with IAS 36 Impairment of Assets; and
• for the separate financial statements of the investor in accordance with IAS 39 Financial Instruments: Recognition and Measurement.

In respect of the consolidated financial statements, the staff believed that the guidance in IAS 28.31-33 is clear. In respect of the separate financial statements, the staff believed that paragraph BC66 of IAS 27 clearly explains the Board's intent that, in the separate financial statements of the investor, investments in associates should be accounted for consistent with the accounting for financial instruments. Given the Board's underlying rationale for separate financial statements, in the staff's opinion, in the separate financial statements of the investor, impairment testing of investments in associates should be performed in accordance with the provisions of IAS 39 for both investments 'at cost' and 'in accordance with IAS 39'. The Board agreed with the staff recommendation.

Contingent consideration of an Acquiree ('pre-existing contingent consideration')

The issue under discussion was to clarify the treatment of contingent consideration of an acquiree that an acquirer assumes in a business combination ('pre-existing contingent consideration' or 'PCC').

The staff presented 2 views:

1. Although PCC does not meet the definition of contingent consideration, it retains its nature in the subsequent acquisition. Accordingly, it should be accounted for in the same way as any contingent consideration in the subsequent business combination.
2. PCC does not meet the definition of contingent consideration in the subsequent business combination. Therefore, it should be accounted for as part of the acquired identifiable assets and liabilities in the subsequent acquisition.

The staff recommended the second view and the Board agreed.

IFRS 1 First-time Adoption of International Financial Reporting Standards - Accounting for privatisation

The issue under discussion was to clarify the accounting guidance for a continuing business restructured in connection with privatisation and subsequent initial public offering (IPO).

The first scenario presented was where an entity is about to undergo an IPO and its revaluation occurs at about the same time as the restructuring for privatisation and during the periods covered by its first IFRS financial statements.

The staff provided two views to support a possible conclusion that a privatisation-triggered revaluation would qualify for 'deemed cost' under IFRS 1, as follows:

• View A – The revaluation date falls within the periods covered by Newco's first set of IFRS financial statements even though that period includes predecessor periods of the restructured or carved-out business; or
• View B – The date of transition is Year 3 when Newco is formed because Newco cannot adopt IFRS before it was legally formed.

The Board agreed with the staff recommendation that the Board adopt View A and amend IFRS 1 to permit an entity to use the revaluation basis as deemed cost when the revaluation for a privatisation occurs during the period covered by its first set of IFRS financial statements, even if that revaluation date is after the entity's date of transition to IFRSs and before the entity's legal date of formation.

The rationale for this decision is that an SOE whose assets and liabilities are revalued contemporaneously with a privatisation and IPO is similar to a first-time adopter that established a deemed cost under previous GAAP. The similarity is also the same when such an SOE presents 'carved-out' financial statements because those financial statements related to a continuing business that was previously a portion of its predecessor's, was subsequently revalued by its predecessor, and is now transferred to be held by Newco. The staff therefore recommended that the Board should broaden the current exemption in paragraph D8 of IFRS 1 to cover such an SOE even though its revaluation was obtained during the period covered by its first set of IFRS financial statements and not prior to its date of transition to IFRS.

Comparative Period

The Board then discussed how, under View A above, comparative information should be presented. The staff had considered two alternatives:

• Option A – establish the deemed cost on the date of transition to IFRSs using the revaluation amounts obtained in Year 3, adjusted to exclude any depreciation, amortisation or impairment between the date of transition to IFRSs and the date of that revaluation; or
• Option B – establish the deemed cost on the date of revaluation, present historical costs or previous GAAP amounts as permitted by IFRS 1 for the comparative periods prior to revaluation date.

Some Board members supported option B on the basis that it would be impossible to apply option A without employing hindsight. Other Board members supported option A on the basis that they believed that option B did not provide meaningful information. Overall the majority of the Board agreed with the staff recommendation of option B.

Transition

The Board agreed with the staff recommendation that retrospective application of these proposed amendments to IFRS 1 should be permitted but not required.

Existing IFRS Preparer

The Board agreed not to address how an existing IFRS preparer should account for a one-off restructuring for a privatisation or whether the revaluation in relation to that restructuring results in a change in accounting policy.

IFRS 1 – Accounting policy changes in the year of adoption

The issue under discussion was to clarify whether a first-time adopter is exempt from all the requirements of IAS 8 for the interim and annual periods presented in its first IFRS financial statements. If IAS 8 does not apply, what, if any, requirements apply if an entity changes its accounting policies between the first interim financial statements it presents in accordance with IFRSs and the first annual financial statements? In addition, although this was not part of the clarification requested, a similar question arises with respect to changes an entity might make in the IFRS 1 exemptions it chooses to apply.

The staff recommended that:

• IFRS 1 should continue to specify the required disclosures relating to first-time adoption and an entity's transition to IFRSs rather than referring to IAS 8. IFRS 1.27 should be amended to explicitly state that:
  • (a) IAS 8 does not apply both to the entity's selection of accounting policies at the date of transition to IFRSs and to any changes to those policies made up to the date of the first annual IFRS financial statements, and
  • (b) all of IAS 8's requirements related to changes in accounting policies do not apply (rather than only its disclosure requirements); and
• that the reconciliations required by paragraphs IFRS 1.27 and 32 must be updated for changes the entity makes during the year of first time adoption in accounting policies and in transitional choices made in accordance with IFRS 1.

The Board agreed with the staff recommendation.

Financial Instruments Comprehensive Project to Replace IAS 39: Transition – Disclosure Requirements for Early Adopters

The staff noted that the Board's forthcoming proposed amendments to IAS 39 would be effective for annual financial years beginning on or after 1 January 2012, with early adoption permitted.

The Board considered staff proposals designed to address Board members' concerns that disclosures would be required for early adopters to increase comparability with entities that do not adopt early. The staff noted that IAS 8.28 already requires extensive disclosure in the year of initial application of an IFRS. However, they maintained their view that additional disclosures for early adopters were necessary to assist users in comparing the financial position and performance of entities adopting the amendments before the mandatory application date. However, they acknowledged a need for a balanced approach, so that any disclosure was not overly onerous so as to discourage early adoption.

The staff clarified that these proposed disclosures would not apply to first time adopters, and that an amendment to IFRS 1 would be made to clarify this (the disclosures address the transition from the current IAS 32/39 model to the proposed model, not adopting the new model from a previous GAAP).

The Board agreed (one opposed) that the following disclosures (additional to those required by IAS 8.28) should be made in the year of adoption if the final requirements are adopted before the mandatory application date.

• (a) A table displaying all financial instruments, aggregated by class as defined in IFRS 7, whose measurement basis or the presentation of gains or losses had changed as a result of applying the new guidance, disclosing:
  • (i) the original and new measurement basis
  • (ii) the original and new carrying amount
  • (iii) the reasons for the change in the measurement basis or presentation method.
• (b) a table displaying the reclassified amounts as a result of any:
  • (i) designations into the fair value option including the original measurement bases (and presentation method) and carrying amounts;
  • (ii) designations out of the fair value option distinguishing between permitted and required dedesignations including the original measurement bases (and presentation method) and carrying amounts; and
  • (iii) the reasons for any such designation and dedesignation.

One Board member thought that, while he understood the intention of the proposed disclosure, the result would be ineffectual boilerplate. The revised standard would permit changes in presentation and measurement, and a preparer might legitimately state in the footnote that the entity had adopted a new accounting policy because the IASB allowed it to do so! Other Board members thought that this position was extreme, and that a sensible application of the requirements would yield the appropriate disclosure.

There was some concern among Board members about how the proposed disclosure would apply to interim reporting. The staff agreed to confirm the implications of their proposals on interim reporting and revert to the Board if necessary. If no Board decision was necessary, the interim reporting consequences would be explained in the exposure draft.

Financial Instruments Comprehensive Project to Replace IAS 39: Description of Possible Alternative Features to the Exposure Draft Model

The Board discussed a proposal put forward by a Board member describing some additional features (variants) of the classification model developed by the Board. Under this variant:

• (a) Financial assets with basic loan features that are managed on a contractual yield basis would be measured at fair value in the balance sheet, unless they meet the definition of loans and receivables in IAS 39.
• (b) Such financial assets would:
  • (i) be measured on an amortised cost basis in profit or loss (including recognition of impairment using the incurred loss provision requirements in IAS 39); with
  • (ii) any difference between that amortised costs measure and the fair value change being recognised in other comprehensive income. There would be no recycling between OCI and profit and loss.

The effect of this proposal was that potentially more financial instruments would be measured at fair value on the balance sheet, but the value change would be allocated between profit and loss and other comprehensive income in the statement of comprehensive income.

Board members discussed this variant for a while, suggesting other possible variations. At least one member thought the variant as 'dead on arrival' and would not support it. Another Board member thought that it was unhelpful to mix the measurement of financial instruments between the statement of financial position and the statement of comprehensive income. If an item was reported on the statement of financial position at fair value, changes in that measure should be reported in profit and loss. A mixed allocation method, such as proposed with the amortised cost component being reported in profit and loss and the 'plug' between that amount and the value change being reported in other comprehensive income was likely to lead to problems and the Board developed other aspects of the revised financial instruments package.

In particular, some Board members were concerned about the consequences of this variant on hedge accounting, especially that the mixed allocation might add rather than reduce complexity in some situations. If hedging is designed to manage what is recognised in profit and loss, allocating some of the exposure being hedged to other comprehensive income would create challenges in hedge accounting, in particular assessing effectiveness.

While not commenting on its merits, the Board agreed that the variant should be discussed in the forthcoming exposure draft's Basis for Conclusions (as will all the alternatives considered in detail by the Board) and that comments should be invited on it.

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