Tuesday 15 September 2009

Mr Garnett chaired the meeting in the absence of the IASB Chairman. Mr McGregor joined the meeting via video link from Melbourne, Australia.

Post-employment Benefits – Next Steps

The Board discussed a timetable proposed by the IASB staff for the proposed Post Employment Benefits exposure draft. The staff suggested that, as the Board and the FASB expect to discuss the presentation of other comprehensive income at their joint meeting in October, publishing the ED in November was possible.

The Board was more cautious than the staff. Several Board members noted that there were too many 'moving parts' in projects related to the presentation of pension expense and that it was premature to commit to the publication timetable. In particular, the Board was receiving criticism about how it (and the FASB) used the 'other comprehensive income' category and whether items recognised (for whatever reason) in OCI should be reclassified through profit or loss.

The Board deferred any decision on publishing the exposure draft until the November meeting.

Board members encouraged the staff generally to develop principles that defined what was recognised in OCI versus profit or loss, but several also suggested that such principles may be elusive.

Conceptual Framework – Objectives and Qualitative Characteristics

The staff led the Board through a series of issues raised by Board members during their review of a pre-ballot draft of final chapters on the Objectives and Qualitative Characteristics of Financial Reporting.

Effective Date and Amendments to IFRS

The Board agreed that the revised chapters of the Framework should be effective on issue. Conforming terminology (especially in IAS 8) would be introduced, most likely through the Annual Improvements process.

Some Board members were concerned about both these matters, but agreed that the Framework is not an IFRS and that it would be inappropriate for the Framework to make consequential amendments to IFRSs – that was for the Board to do separately.

Structure and Introduction

The Board agreed that Chapters 1 and 2 of the revised Framework would replace existing paragraphs 12-22 and 24 to 46.

Paragraph 23, which addresses going concern, will remain, pending being incorporated in the measurement chapter.

The Introduction to the Framework, paragraphs 1-8 and 10-11 would be retained. Paragraph 9 (which addresses users) is now addressed in Chapter 1 (Objectives) and would be deleted.

Terminology

Throughout the Framework, the term 'standard setters' and 'boards' should be replaced by the term 'board' [meaning the IASB].

Objective – general issues

The staff was requested to provide more precision in the 'Objective of general purpose reporting' section to clarify that the cash flows being addressed in this situation are those from an investor's investment in the entity, not the cash flows of the entity itself.

The Board agreed that no amendment of the Framework was necessary to address a potential inconsistency with the IFRS for SMEs. The latter document should be amended if necessary.

The Board agreed to clarify in the section on 'Usefulness of financial reporting in assessing cash flow prospects' that the cash flows in question are the providers of capital's cash flows, not those of the entity.

Objective – Stewardship

The Board supported the staff's drafting for two paragraphs addressing management's stewardship responsibilities (although the term 'stewardship' is not used) and had no appetite for further elaboration. Board members noted that the words were very carefully crafted and should be left as they were.

Objective – 'Financial reporting' or 'financial statements'?

The Board agreed that the scope of the Framework – 'financial reporting' – is appropriate and that the narrower 'financial statements' is not appropriate, as it would be used as an excuse to resist any activity the Board might wish to undertake on matters outside the financial statements, such as management commentary.

Objective – Financial stability

The Board agreed that 'financial stability' should not be an objective of financial reporting. There was no clear consensus as to what 'financial stability' meant, other than perhaps as code for avoiding volatility in profit or loss.

However, the Board was sensitive to the work and report of the Financial Crisis Advisory Group and supported a suggestion that the themes in the FCAG Report should be incorporated in the Basis for Conclusions, since they supported the Board's conclusions in the Framework. Reference to the FCAG might be made via a footnote in the Basis.

Characteristics – Neutrality

The Board agreed that 'neutrality', in terms of the neutrality of the Board, should not be addressed in the Framework, but is a valid topic for discussion when the Board revises its Due Process Handbook. The discussion of neutrality of financial reporting in the Framework was appropriate.

Characteristics – Freedom from error

The discussion of faithful representation in the Framework would include an expanded discussion of the use of estimates. In particular, the Board discussed whether a particular sentence, 'Those representations would be considered to be free from error if they are based on appropriate inputs and estimation techniques that reflect the best available information' was too absolute and whether it should be modified or deleted. The Board concluded that the sentence was acceptable as drafted, but that the Basis for Conclusions should explain the Board's reasoning about what 'free from error' and 'appropriate inputs' meant in this context.

Characteristics – Enhancing characteristics

The Board agreed to retain the four enhancing characteristics of financial information: comparability, verifiability, timeliness, and understandability. There was no implied hierarchy among them.

Various other minor issues related to drafting were also addressed and direction given to the staff.

Conceptual Framework – Reporting Entity

The Board gave direction to the staff preparing the exposure draft of the Reporting Entity chapter of the Framework as follows. There was very little debate of these issues. The Board agreed:

• That concerns raised with regard to the Objectives chapter should not be discussed in the Reporting Entity chapter
• That it should proceed with the conceptual framework project without regard to whether there are conflicts with current standards-level projects
• That something less than a legal entity could be a reporting entity
• That a portion a group of entities could be a reporting entity
• To replace 'party' with 'entity', 'parent' with 'controlling entity', and 'subsidiary' with 'controlled entity' throughout the revised Framework
• Not to use the same wording as in ED10 for the definition of 'control of an entity'
• To explain that control of an entity includes a notion of risks and rewards but that risks and rewards by itself is not a workable criterion for identifying a group entity
• To add an explanation that joint control is an issue related to accounting for certain types of investments and not an issue of defining the reporting entity
• To clarify in the Basis for Conclusions an example that is intended to demonstrate that the concept of an area of economic activity need not be affected by the way in which entities are structured
• That the Framework should not discuss whether there are cases where parent-only financial statements could provide information that is more useful than consolidated financial statements
• That the Basis for Conclusions should discuss the role and usefulness of separate financial statements
• That combined financial statements might qualify as general purpose financial statements
• That there was no need to provide more explanation of the difference between combined and consolidated financial statements
• That an appendix illustrating the application of the reporting entity concept to various situations should be provided
• That, for the time being at least, the Reporting Entity chapter should retain references to and a brief discussion of proportionate consolidation
• That the phrase 'in this chapter' be replaced with 'in this conceptual framework'

The Board did not support a suggestion that a universal change be made to IFRSs to replace 'separate financial statements' with 'parent-only financial statements'.

The Board directed that the exposure draft should be issued when it is ready and should not wait upon any other IASB standards-level projects.

Revenue Recognition

FASB staff joined the discussion by video link.

Control

The Board focused on when an entity recognises revenue in the proposed revenue recognition model. In the Discussion Paper the Board proposed that an entity should recognize revenue when it transferred control of a good or a service to the customer.

The Board acknowledged that IASB's and FASB's literature contains definition of control on the level of an entity. Nonetheless, the Board agreed that control of a good or service would require a separate definition.

The staff proposed the definition that 'control of a good or service is an entity's present ability to direct the use and receive the benefit from that good or service'. Broadly the Board agreed with this definition. Nonetheless, several Board members raised important concerns regarding the application of the definition for the work in progress, distinction between a partially completed and a completed product, application of the proposed definition to a service contract and to situation when goods and services are provided continuously.

One Board member was concerned that the proposed definition is too vague and not clear. As a matter of fact, in the discussion it became clear, that several Board members had different understandings of the definition and would apply it differently in some situations. Some Board members were particularly concerned about application of the definition to construction contracts and its effects on the usage of the percentage of completion method.

The Board noted the need for consistency of the proposed model with the derecognition model proposed for the financial assets.

The Board concluded that on the high level the definition was suitable and could be adopted as a working definition. Nonetheless, it directed the staff to revisit the definition after the raised issues are addressed in other parts of the project.

The Board then addressed the issue from whose perspective the control should be assessed. Some of the Board members agreed that the notion of control was not symmetrical, that is, the fact that the vendor lost control over a product did not necessarily mean that the control had been transferred to the customer.

The staff proposal to assess the control from the customer perspective was not supported unanimously. Some Board members preferred that the staff explored the possibility of assessing control also from vendor perspective. In their opinion it could help to alleviate the some concerns about sales returns and application of the percentage of completion method. Other Board members proposed to assess the perspective based on facts and circumstances. The Board disagreed.

Some of the Board members were concerned how this decision would influence how much revenue should be measured. The staff explained that in this initial stage of deliberations this question was not addressed as it would be addressed as part of the measurement part of the next meeting. Nonetheless, the staff pointed out that assessing the transfer from the vendor perspective increased the risk that the revenues would be recognised based on activity.

The Board agreed with the staff view that control should be assess from the perspective of the customer. Nonetheless, it directed the staff to perform further analysis in connection with identification of performance obligation and consequences for complete and continuous delivery of products and services.

The staff than asked the Board to agree whether any indicators of control shall be specified and proposed eight such indicators. The Board agreed that indicators of control would indeed be helpful for constituents and clarity of guidance. Nonetheless, many Board members were concerned about the nature of these indicators, notably their relation to the contractual terms and conditions and their order of precedence. The staff agreed that it needed to further investigate and analyse the relationship with contractual terms and conditions. Moreover, further analysis is to be performed to determine how to define the need for comprehensive assessment of the indicators, their application to part-completed assets as well as identification of the situation when one/combination of indicators may be sufficient to determine control.

Several Board members seemed to support the idea that in case of uncertainty about the control, no revenues should be recognised.

Accounting for an Option for Additional Goods and Services in Contracts with Customers

The Board continued its deliberations in discussion how an entity would determine whether options to acquire additional goods and services are granted in a present contract with customer and how these shall be accounted for. The core of the discussion focused on distinguishing between an option granted implicitly as part of the contract and an offer. The Board agreed with the staff that the option should be accounted for as a performance obligation if that option provided a material right that the customer would not receive without entering into that contract. An entity should account for that performance obligation by allocating to it a portion of the transaction price relative to the standalone selling price of the option.

One Board member, although supporting the proposed principle, was particularly concerned about how operational this principle would be. Another Board member felt that the proposed guidance was not sufficient and was too open-ended. Nonetheless, as another Board member noted, the guidance related just to allocation of the already received consideration for further purchases. The staff agreed to provide more guidance in this respect.

Regarding measurement, the Board had a significant discussion over the staff proposal that the value of the option should be determined using an intrinsic value method if its value was not directly observable. Although, the Board supported simplification of the requirements, majority of the members felt that this principle would give a lot of discretion in the standards and as such would decrease the level of transparency for the users. Using only intrinsic value would be too restrictive as it may not capture many situations arising.

Therefore, the Board tentatively decided that the option shall be valued using observable data or calculated using an option pricing model. Only if determining of the value of the option by a model was impracticable would intrinsic value be used (that is, the time value component should be ignored).

Finally, the Board assessed valuation of renewal options. The staff proposed and alternative model of measurement for renewal options of contracts based on expected optional goods and services (probability-weighted basis) for the additional goods and services that were similar in nature to the other goods and services in the contract and were provided in accordance with terms and conditions of the contract (including pricing). The Board agreed.

One Board member raised the question if this 'expected basis' approach should not be conceptually consistent with the estimation of the standalone selling price of that option. The staff will analyse that issue further.

Leases – Comment Letter Summary

The Board was joined by video link by the FASB staff. The Board discussed the summary of 290 comment letters received to the discussion paper Leases Preliminary Views. The Board did not take any decision during this session.

The staff highlighted the following issues where the majority of constituents expressed different preferences from those articulated by the Board:

• Lessor accounting – the decision to defer consideration of lessor accounting
• Probability-weighted estimate of contingent rentals payable
• Inclusion of the contingent rental in the lessee's obligation

The staff also highlighted the need for further guidance for distinguishing service contracts and leases in addition to that included in IFRIC 4 as this distinction would become much more pertinent under the new rules.

In addition, most constituents seemed to prefer a derecognition approach for lessor accounting. The Board considered the comments by the investment property companies that new leases accounting should not apply to lessors currently applying the fair value model in IAS 40. The Board agreed that it would assess the need for a separate model for the industry on one of the future meetings.

The Board considered the proposed timing of the new standard. It reaffirmed the timetable for lessee accounting with the ED expected in June 2010 and final standard in June 2011.

Regarding lessor accounting, the staff will provide additional analysis for the October meeting. The Board noted that the timetable for the lessor accounting would be based on the outcome of the discussions on the basic features of the lessor's accounting model. At that time, the Board will decide how to proceed with the lessor accounting (whether to issue a separate discussion paper or exposure draft on lessor accounting) and will decide on timing of the project.

One Board member was particularly concerned about the consistency between derecognition model for lessor accounting and the overall derecognition model that would be adopted as part of the IAS 39 replacement project. The Board agreed to address this issue as part of its deliberations.

Wednesday 16 September 2009 (morning only)

Liabilities – Amendments to IAS 37

The Board discussed the details of the measurement guidance for service obligations. The issue was discussed on the July meeting when several Board members expressed their concerns regarding the earlier tentative decision.

The Board agreed with the staff that 'if a market exists for such services, the amount is the price that the contract would charge'. Most of the discussion concentrated on the attributes concerning the existence of market. The Board considered the notions of efficient, functioning, competitive, and active market, but significant differences arouse between the Board members. As each of the words describing the attributes of the market posed a specific challenge, the Board finally decided to drop any of them in the definition itself.

In addition, the Board considered an illustrative example provided by the staff. After a long discussion the Board agreed that calculation should be based on the estimation of how much a contractor would charge today, estimated outflows and associated probabilities, adjustment for risk and uncertainty (risk margin reflecting the uncertainty about the future assumptions) and time value of money. Some members were concerned that by adjustment for risk and uncertainty the Board would create a double counting, but the majority of the Board disagreed.

The Board continued its discussion with assessment of the requirements when efficient market does not exist. The staff proposed a new guidance based on direct costs, allocation of overheads and required return on capital employed. The Board decided not to develop a new guidance based on the staff proposal but to base the measurement on the estimate of what a (hypothetical) contractor would charge based on the guidance on building blocks included already in the standard and the guidance on probabilities, risk margin and time value of money agreed before.

The Board without much discussion approved the consequential amendments to IFRS 3 and IFRIC 5. The Board asked the staff to try to incorporate all the guidance contained in the related IFRICs (IFRIC 1, IFRIC 5, and IFRIC 6) in the amended standard. The staff replied that they would include the guidance as far as possible.

Consequently, the Board agreed that it would issue the amended standard as an IFRS rather than amendments to IAS 37 in order to adopt the structure of an IFRS.

Finally, the Chairman asked about the overall support for the new standard. Six Board members dissented, with one of those saying he might reconsider his dissent once drafting was complete.

Derecognition – Comment letter analysis

The Board was presented with a comprehensive analysis of comment letters and outreach to constituents on the derecognition project. No decisions were taken during this session. FASB Board members and staff joined the meeting via the video link.

Overall, constituents overwhelmingly disagreed with the proposed approach as described in the ED. A significant majority of the arguments presented was similar to the reasons stated in the Alternative View in the ED.

A majority of constituents seemed to favour a kind of alternative approach, mainly for the reasons described in the ED. Nonetheless, many constituents were concerned that the alternative approach was not sufficiently developed, might lead to misleading representation of some transactions, and created opportunities for earnings management. Some of the constituents noted also their concerns related to expansion of fair value measurement, transfer definition, and lack of convergence with the US GAAP.

Most respondents disagreed with the Board (and the approach in both proposed and alternative approach) for treatment of the 'repo transactions' and asked the Board to reconsider their decision. One Board member suggested that regulatory regime and usage of repo transaction by some of the central banks to provide liquidity to financial markets may have played a role. The Board agreed to revisit this area in the process of re-deliberations.

The staff then continued its presentation with listing the problems with current IAS 39 requirements (internal inconsistencies, conceptual weaknesses and practical difficulties) before presenting 4 alternatives to replacing the current IAS 39 guidance on derecognition:

1. Enhancing disclosures
2. Address the know issues with IAS 39 and enhance the disclosures
3. Develop a proposed approach
4. Develop an alternative approach

The staff expressed its preference for the forth approach. The staff pledged to prepare further analysis for the October Board meeting in order to facilitate the Board`s decision.

In response, several Board members expressed their concern with the lack on convergence with FASB and urged the Board to co-operate with FASB and to provide a converged standard, issue that was highlighted also by the comment letters. The FASB members noted that FASB had recently issued FAS 166 on derecognition but it considered replacing the concept of legal isolation as it was just a temporary solution.

One FASB member noted that the Board has two alternatives how to proceed – either analyse the differences between current IAS 39 requirements and FAS 166 and try to converge on that basis or to work on a new standard based on the alternative approach. Some IASB members clearly preferred the second alternative. This issue will be discussed further at the joint meeting in October.

Regarding timing, several Board members noted that of alternative approach was to be developed re-exposure would be required and thus issuance of the new standard would be delayed. FASB members also noted that as FAS 166 was issued only recently, longer period would be required before a new standard was adopted.

Thursday 17 September 2009

Classification of Rights Issues (proposed amendment to IAS 32)

Staff presented an analysis of comments received on the exposure draft Classification of Rights Issues: proposed amendment to IAS 32 issued in August 2009. The Board discussed the comments, made certain decisions, and directed the staff to proceed to preparing a ballot draft of final amendments to IAS 32.

Scope

The Board considered the suggestion made by several respondents to expand the scope of the ED to include equity warrants and convertible debt instruments issued in a foreign currency.

The Board decided not to expand the scope of the amendments to include convertible debt instruments issued in a foreign currency. In doing so, the Board also clarified that to be within the scope of the proposed amendment, the underlying instrument (the instrument on which the rights are offered) must be an equity instrument in its entirety and that conversion features in financial liabilities are not 'equity instruments'. Warrants for an entity's own equity would be within the scope.

Clarification of the term 'rights issues'

The Board agreed that the term 'rights issue' should be clarified in the context of the amendments to include 'rights, warrants, options or similar instruments provided to owners on a pro-rata basis'.

Several Board members were concerned that the amendment was not conceptually based-and called into question whether the 'pro-rata' component of the rights issue was critical. To some, whether a right was distributed on a pro-rata basis was irrelevant to whether an instrument was a liability; others were worried that without it, strain would be put on the 'fixed for fixed' criteria in IAS 32.11. The chairman of the meeting noted forcefully that the consideration of 'fixed for fixed' belonged in the project on Financial Instruments with Characteristics of Equity.

Pro-rata as a key concept

The Board agreed that pro-rata should be emphasised. The basis for conclusions would clarify that the amendment is an exception to the 'fixed for fixed' exception because of the embedded foreign currency features. In addition, the basis for conclusions would emphasise that the primary focus of the amendments was transactions with existing owners acting in their capacity as owners.

Continuing the previous discussion, the Board challenged the proposed changes, especially in the context of shareholders in jurisdictions in which equity holders would be unable to take up the rights and whether this would taint or even negate the notion of pro-rata to all shareholders.

In response to Board members' questions the staff confirmed that, in the case in which a class of equity instruments was denominated in more than one currency (say euro and US dollar) and the rights were offered pro-rata to only the US dollar-denominated shareholders, the rights issue would fall outside the proposed amendment.

Existing owners of the same class of equity

The Board agreed that the amendment should continue to require that the rights issue be made to all existing owners of a class of non-derivative equity instruments and that it should not require that the rights issue be made to all existing owners of non-derivative equity instruments of the entity.

One Board member wanted the amendment to be restricted such that the rights had to be offered to all shareholders of the most residual class of equity only. Others commented that in many multinational companies, there are often more than one class of common shares and that such a restriction might be a 'null set'. However, the staff did admit that by allowing rights to be offered 'by class', diluting other classes of equity was a possibility.

Timing

The Board agreed that this amendment should be issued even though the Board is discussing related matters in the Financial Instruments with the Characteristics of Equity project.

Re-exposure

The Board agreed that the triggers for re-exposure were not met.

Effective date

The Board agreed that the amendment should be effective for annual financial periods beginning on or after 1 February 2010, with earlier application permissible. The Board considered whether it should not require application from 1 January 2010, but noted that it was unlikely that the amendments could be issued in time to allow the 90-day minimum lead time required for endorsement or incorporation in the legal framework required in several IFRS jurisdictions.

Indications of dissent

Mr Smith indicated that he would dissent from the amendments on the basis that he considers the scope to be too broad (he would restrict the amendment to rights issues offered pro-rata to the most subordinated class of equity).

Next steps

The Board agreed that the staff should proceed to prepare a ballot draft of amendments to IAS 32 based on the Board's decisions.

Related Party Disclosures – Amendments to IAS 24

The Board reconsidered its tentative decisions with respect to the transitional requirements for the amendments to IAS 24.

In July 2009, the Board had agreed that the amendments would be applied prospectively from the effective date, 1 January 2011.

The Board noted that the main changes to IAS 24 were:

• A partial exemption from the disclosure requirements for transactions between a government-controlled reporting entity and that government or other entities controlled by that government; and
• Amendments to the definition of a related party.

The Board agreed that the partial exemption from the disclosure requirements should be required to be made retrospectively, because this should result in a reduction of 'clutter' in the footnotes and an identification of better information about the nature and extent of significant transactions with the government.

In addition, the Board agreed that the definition of a related party should also be applied retrospectively from the effective date.

In addition, the Board agreed that an entity should be permitted to adopt the partial exemption for government-controlled entities before the effective date even if it does not adopt the amended definition of related party until a later date.

Financial Statement Presentation – Field tests and FASRI study [education session]

Results of the FASRI Experimental Study

The IASB received a presentation from Professor Robert Bloomfied (Cornell University), Director of the Financial Accounting Standards Research Initiative (FASRI), of the results of a study that tested the decision-usefulness of two proposals contained in the October 2008 discussion paper Preliminary Views on Financial Statement Presentation. The study had focused on two particular proposals in the discussion paper:

• classifying the statement of financial position, statement of comprehensive income, and statement of cash flows into operating, investing and other categories, and
• the proposal to disaggregate expense items in the statements of comprehensive income and cash flows by function and nature.

In particular, the study tested whether the way in which the classification and disaggregation were presented influenced the behaviour of a sample of credit analysts.

The key finding of the study was that appropriate decisions were most likely to occur when the classification and disaggregation were effected in the same place – that is, if the classification and disaggregation were performed on the face of the financial statements; or were made in the footnotes. Sub-optimal decisions were more likely when classification was made on the face of the statements with disaggregation in the footnotes, or if disaggregation was presented on the face of the financial statements with classification information in the footnotes.

Professor Bloomfield suggested that one of the most important findings was that the disaggregation of cost of sales was crucial to many credit analysts.

Analysts Field Test Results

Regenia Cafini (FASB staff) reported on the analyst portion of the field tests performed by the FASB and IASB. The field testing was conducted to test the proposals in the 2008 Discussion Paper. Of particular relevance to the proposals in the DP were the following findings:

• Analysts ranked 'increased disaggregation' as the most useful aspect of the proposed presentation model and the management approach to classification as the least useful aspect.
• Most analysts agreed with the proposed definitions of operating and financing. They were split evenly regarding the definition of investing. Most of the respondents thought that financial statements prepared according to the DP were better at presenting the operating and investing results of the companies they reviewed; however views were not as favourable with respect to the results of the entity's financing activities.
• Cohesiveness enhanced the usefulness of the income statement and the cash flow statement the most.
• The direct method presentation of cash flows was ranked as the third most useful aspect of the proposed presentation model. For the sub-group that reviewed a financial institution's financial statements, this was ranked second in usefulness.
• About 70% of the respondents indicate that the reconciliation schedule enhanced the decision-usefulness of the financial statements they reviewed. The 'cash' and the 'accruals and allocations' columns were cited as the most useful on the proposed reconciliation schedule.
• The majority of respondents do not think that the recast statements present the entity's liquidity and financial flexibility any better than the non-recast statements.

Another key finding was that many analysts who participated in the field test considered 'nature' (at least in the statement of comprehensive income) to represent 'fixed' versus 'variable', rather than any other possible attribute.

The Board thanked both presenters for their presentations, and their research teams, for their time and efforts, which would be most useful as the Board considered its next steps on this project.

Financial Instruments with Characteristics of Equity

The Board considered the impact of the decisions made on Classification of Rights Issues on this project. The staff pointed out that the approved amendments to IAS 32 are inconsistent with the proposed classification approach. The Board decided to develop a new principle in the classification approach that would allow including some share-settled instruments to be classified as equity. Some Board members clearly did not feel comfortable with such outcome as they felt it was inconsistent with the principles in the approach. Some Board members noted that the staff would have to ensure that only transactions with shareholders acting in their capacity as shareholders were included in the principle to be developed. The staff pledged to provide additional analysis for October Board meeting.

The Board then discussed the details of the classification approach as presented by the staff (without reflecting the new principle). The staff presented a summary of the approach with examples reflecting the principles. The Board agreed with the basic idea behind those principles, which reflected and further articulated tentative decisions already taken by the Board.

The staff noted that accounting for share-based payments (and accounting for them until they vest) and subsidiaries' instruments in consolidation would have to be addressed on a next meeting. The staff also noted that the highlighted issue of classification of preferred shares that are mandatorily convertible to equity instruments may be solved by the new principle and would be addressed in that context. Detailed examples reflecting the changes would also be provided for the next meeting.

Credit Risk in Liability Measurement – Comment letter analysis

The Board discussed the feedback from constituents on this session. No decisions were made.

The main message from the constituents can be summarised as follows: Own credit risk should be included on initial recognition of financial liabilities, initial recognition of non-financial liabilities measured at fair value, and in cases when initial consideration is exchanged. On the other hand, on subsequent measurement own credit risk shall be included only when financial or non-financial liabilities are measured at fair value. The responses did not elaborate on the difference between measurement of credit risk via rating or credit spread.

Some constituents proposed a new measurement category, fair value adjusted for changes in own credit risk. Constituents observed that for a Level 1 instrument (observable market price), own credit risk was hard to extract, and for other instruments, it might be very difficult to be estimated.

The staff noted to the Board that many constituents stressed interaction between this analysis and conclusions reached (or to be considered) in the Classification and Measurement phase of the Financial Instruments project.

The staff will provide further analysis to the Board on October Board meeting, when the Board would be asked for direction on this project.

Financial Instruments: Replacement of IAS 39 – Impairment

The Board was joined by FASB staff and FASB Board members via video link. The Board discussed the responses to the Request for Information published in July and next steps.

The main message from respondents to the Request for Information was that the expected loss approach would pose significant operational challenges (especially in the area of cash flow estimates and complexity of required calculations) and would entail substantial costs and lead time to implement. Views of constituents on other issues were generally mixed. Constituents requested some additional guidance and clarification on specific issues, but on the other hand requested more prescriptive requirements on portfolio assessment of impairment. Moreover, in their view, further simplification of the approach would be desirable in order to make the principles operational.

The FASB members noted that the FASB did not discuss the impairment issue yet, but the range of interpretation of what was meant by expected loss model was wide. Some constituents understand expected loss in Basel II sense or, alternatively, as a possibility to include losses due to worsening of the economic conditions. This difference in opinion and expectations could pose a challenge in the deliberation process.

Several Board members raised the issue of application of the model to trade receivables of non-financial entities. There was a high degree of consensus that these instruments should not be excluded from the model, but additional application guidance for trade receivables should be included to alleviate the concerns raised by the industry.

Some Board members expressed their concerns over timing of the project. Given estimated lead time (2-4 year after publication of the final standard in order to adjust the systems), some Board members preferred a more thorough discussion, perhaps in the form of issuance of DP rather than ED. Other Board members were concerned that the model is not sufficiently developed for issuance of the ED. They were particularly concerned that additional guidance would be developed only after the ED has been published. Nonetheless, other members pointed to the political environment and the clear need for new guidance that was already pledged by the Board. Moreover, they pointed that alternative views were already explored by the Board in June and July and expected loss model was identified as the way forward.

The Board decided to provide a clear objective and emphasise principles that would be reinforced by clear and concise application guidance. It was felt that providing a comprehensive guidance was impossible as it could not provide guidance for all the issues. Some members of the Board expressed their concerns that if insufficient guidance was provided regulators would step in and impose additional requirements.

The Board decided to establish an Expert Advisory Group on Impairment that would assess the need for development of further guidance. FASB will participate in such discussion. The Board also considered the need for further outreach to constituents perhaps in a way of roundtables as part of deliberations on the ED.

The Board reaffirmed its decision to require one single impairment model to all financial instruments measured at amortised cost. Therefore, it did not support any exception for trade receivables, instruments trade in active markets, or individually significant assets.

The Board then considered possible simplifications of calculations required. The Board did not approve the proposed usage of the straight-line method for measurement of expected losses on initial recognition, as opposed to the effective interest rate method. It was felt that the issue was too technical in nature and should be first assessed by the Expert Advisory Group.

The Board also noted that additional discussion on application of the principles on portfolio level should be included in the ED. Some Board members noted that the application guidance should include also guidance on how portfolios should be identified.

Friday 18 September 2009

Financial Statement Presentation – Definitions, management approach, net debt, discontinued operations

Classification: Definitions and Management Approach

The Board began reconsideration of the classification of information within the financial statements as proposed in the 2008 Discussion Paper (DP) Preliminary Views on Financial Statement Presentation. In particular, this session focused on the management approach for classification of items in the financial statements as well as the section and category definitions proposed in the DP.

Generally, the discussion was difficult, with the Board divided about the level of specificity that any future IFRS should contain and the consequences of any decisions in this project (and even this topic) on other topics within the financial statement presentation project and other Board projects.

Management approach to classification of assets and liabilities

The Board agreed to continue to develop an approach to classification based on how a reporting entity organises its activities and uses its assets and liabilities on the basis that it would provide the most decision-useful presentation of financial information for users of the financial statements.

Separating business activities from financing activities

The Board reaffirmed its preliminary view expressed in the DP that, with respect to the statements of comprehensive income and cash flows, the financial statement should distinguish the business activities of an entity from activities that finance those activities. However, peeking ahead to a discussion to be held in November, they reserved the possibility that the statement of financial position might be presented on a basis similar to the current format, but with more disaggregation.

Defining the financing section

By a slim majority, the Board agreed that that the financing section should be defined narrowly as financial liabilities that have an agreed-upon schedule of repayment with an interest component (and that interest component is either explicit or implicit). Items directly related to those financial liabilities, such as fees would also be classified in that section. Derivatives held as part of an entity's non-equity sources of funding, regardless of whether it is an asset or a liability at the reporting date, would also be presented in that section.

There was a lengthy and somewhat confusing debate leading to this decision. Some Board members suggested that the financing section should also include financial assets if they are managed with related financial liabilities. Others were concerned about potential conflicts with the Board's decisions on the liabilities and equity project. Board members understood the frustration, but were not convinced that the liabilities and equity project should influence the categories presented on the balance sheet.

The staff will prepare a draft of the proposal and work with Board members off-line, returning to a public meeting if necessary.

Defining the business section

The Board was finely balanced between those who seemed to prefer being prescriptive about how activities were categorised and those who would not. There seemed to be consensus that the 'business' category should be the residual category, which placed strain on the financing category. The Board members with analyst backgrounds dominated the discussion, but did not agree. Some wanted structure without a great deal of prescription; others would err on the side of caution and would be more definitive about what should be categorised where.

A bare majority of the Board supported requiring no defined categories within the business section. Management would also have flexibility to devise groupings of information within the business section that assisted in communicating the relationships between groups of assets and liabilities.

Presentation of discontinued operations

The Board agreed that the forthcoming exposure draft should retain the DP proposal to present discontinued operations in a separate section in each financial statement. In addition, the exposure draft would not prescribe the level of detail that an entity should present about its discontinued operations or where that information should be presented.

Information about net debt

Whether to require information about net debt

The Board agreed that the forthcoming exposure draft should propose requiring information about net debt to be presented in the financial statements.

In the debate, it was apparent that how 'net debt' was defined would be critical. Several Board members were concerned that 'net debt' could be misleading if not presented and discussed carefully. For example, Board members were very concerned that inappropriate inferences about the ability to settle obligations with cash balances would be made. A common situation is that cash may reside in a favourable tax jurisdiction and could only be used to settle liabilities at the cost of a considerable tax penalty.

Defining 'net debt'

The Board discussed three alternative approaches to defining net debt. The concerns expressed in the previous discussion were again apparent as the Board sought to balance the need to develop a principles-based approach with the need to guarantee some degree of consistency among preparers. The Board concluded that 'net debt' should be defined to be the 'financing' category less the financial resources available to service those obligations.

How to present net debt information in the financial statements

The Board discussed several possible alternatives for presenting net debt. The Board indicated support for disclosure of net debt either on the face of the financial statement or in the footnotes, provided that it was not confused or mingled with the cash flow statement. In an indicative vote, the Board preferred a presentation that described net debt in a footnote, reconciling the movements in the components of net debt over the reporting period.

Financial Instruments: Replacement of IAS 39 – Hedge accounting

The Board considered possible approaches to hedge accounting during this session. FASB Board members and staff joined the debate via video link.

The staff presented a wide range of possibilities for the future of hedge accounting ranging from its complete elimination to retaining and amending the current conditions and criteria. The staff recommended replacing fair value hedge accounting by permitting recognition outside profit or loss of gains and losses on financial instruments designated as hedge instruments (an approach similar to cash flow hedge accounting). The staff further proposed some simplification of current cash flow hedge accounting model. A majority of the Board agreed with this basic approach. Several Board members focussed on the need for further simplification of the hedge accounting requirements and development of a single set of hedge accounting rules.

Nonetheless, some Board members were concerned with some detailed issues as well as interaction of the project with the Classification and Measurement phase of the financial instruments project.

One Board member was concerned with the proposed approach as he believed that it would create more questions and issues than it would solve. He was particularly concerned with evaluating the effectiveness of hedge accounting.

Several Board members were concerned by the lack of convergence with FASB. The FASB clarified that it had not yet considered (either publicly or privately) the hedge accounting standards. The FASB and several IASB Board members seemed to be particularly concerned with the application of fair value hedge accounting to financial instruments measured at amortised cost due to the application of business model. For them the intuitive argument would be to prohibit the usage of fair value hedge accounting for such instruments. The staff replied that that interaction must be fully analysed and would be addressed by both Boards at a later stage.

The Board generally agreed that initially general requirements for hedge accounting had to be developed and agreed (in the form of an ED) and, based on the adopted approach and public consultation, application for portfolio hedging should be developed.

The Board agreed that portfolio hedge accounting was a very complicated area that would need to be assessed at a later stage and would require significant time to be completed.

The Board continued with discussion on hedge accounting for net investments in a foreign operation. Most of the Board agreed that this issue should not be addressed at this stage as the issue did not relate as much to hedge accounting as to IAS 21 requirements. Nonetheless, some Board members stressed the need for a single hedge accounting model. The Board agreed that it would address this issue at a later stage, when basic model of hedge accounting was agreed.

One Board member suggested that definition of hedging instrument should be based on cash flow characteristics. The staff will investigate how to fit this suggestion into the model.

Financial Instruments: Classification and Measurement – Comment letter analysis

The Board was joined in its discussion by FASB Board and staff members via video link. The staff presented to the Board a preliminary comment letter analysis (as the comment deadline expired this week only and comment letters are still arriving). The Board did not take any decisions during this session.

Constituents seem to support the basic idea behind the Classification and Measurement ED requirements. Nonetheless, they raised significant concerns about speed of the project, interaction of the project with other projects of the Board, as well as lack of convergence with FASB.

Most of constituents support a mixed attribute approach for measurement of financial instruments and the proposed criteria for the measurement cut. Nonetheless, significant majority of constituents believe that the interaction between the criteria was not well defined and understood and there was a need for clearer articulation of both of the conditions.

Additional concerns were raised regarding accounting for hybrid contracts (especially application for liabilities), lack of recognition of dividends in income in the FVTOCI category, lack of reclassification, and elimination of the cost exception for unquoted equities. The Board briefly discussed the possibility of reclassification between the categories and noted that what could be understood as 'change in business model' varied greatly among constituents.

The Board will address all of these issues on later meetings. Regarding the plan for the project, the Board announced that from the next week on, the Board would deliberate on these issues on a weekly basis, with special meetings announced for 22 and 29 September.

Insurance Contracts

Timetable and items to be excluded from the exposure draft

The Board noted the proposed timetable for the remaining deliberations leading to the publication of the exposure draft and subsequent outreach activities, re-deliberations, etc.

One consequence of the proposed timetable is that policyholder accounting, with the exception of the accounting for reinsurance (both by cedants and reinsurers), would not be addressed in the ED. At least one Board member challenged this decision, noting that while it made the timing awkward, the accounting by the insured might provide useful insights on contentious issues in insurers' accounting.

In particular, the Board member was concerned that the cash surrender value of a life insurance policy had been excluded from the measure of a liability in the insurer's financial statements, while it was almost certainly a relevant measurement attribute for the policyholder. In addition, it was likely that the Board would require recognition of an asset for future policy renewals on long-term contracts; however, the Board was highly unlikely to require recognition of a liability in the financial statements of the policyholder. In both cases, the lack of symmetry was a concern.

Another Board member was concerned that the Board had not learned the lessons of the Leases project, in which it had been heavily criticised for addressing only lessee accounting and leaving lessor accounting until a later date. The Board member was concerned that IAS 8 would lead policyholders to the IFRS on insurance contracts and infer, perhaps inappropriately, symmetrical accounting.

Other Board members were also surprised by the inclusion in the timetable of the use of other comprehensive income (and hence the possibility of recycling): this was the first time the Board had been warned that this issue was on the table.

The Chairman closed debate on these matters.

Measurement approach

The Board discussed the remaining measurement approaches (both of which would be modified to exclude day one profits):

• measurement based on the approach being developed in the project to amend IAS 37 Provisions, Contingent Liabilities and Contingent Assets (the updated IAS 37 model).
• a current fulfilment value that includes a composite margin.

The Board was evenly divided. Some favoured the fulfilment value approach, noting especially that the FASB had made a tentative conclusion in favour of this measurement approach. These Board members also saw a degree of consistency between the fulfilment model and the Board's conclusions on revenue recognition. Others thought that there was too much to be resolved in the 'updated IAS 37 approach' to enable them to support it.

Others specifically rejected the fulfilment value approach, in particular the analogy to the revenue recognition model. Those who supported the 'updated IAS 37 approach' noted that the approach remeasures the margin and was consistent with the building block approach put forward in the exposure draft. While the 'updated IAS 37 approach' had 'warts and blemishes', it was better than fulfilment value.

The Board voted 8 to 7 in favour of the 'updated IAS 37 approach'. This was a key vote because the margin, if it were to be maintained in a vote on the ED as a whole, would be insufficient to issue the ED. The Board concluded that procedurally it could continue, since it was the whole package that was the subject of balloting.

In any event, the ED would include a thorough discussion of the fulfilment value approach and the Invitation to Comment would seek views on the alternatives.

Subsequent release of residual and composite risk margins

This discussion began with the staff admitting that they were unable to present the Board a recommendation, since they were split among themselves. Some staff members believed that the attribute (driver) selected for release of residual and composite margins should result in recognising those margins in income in a systematic way that best depicts the insurer's performance under the contract. The other view was that the attribute in all cases should be the release from risk. Not surprisingly, the Board was finely balanced between both views.

The staff noted that:

• The 'updated IAS 37 approach' includes a separate risk margin and that the residual margin should be released over the coverage period only because the risk margin under that approach is intended to capture the risk associated with the claims handling period.
• The fulfilment value approach includes only a composite margin which should be released over a period that includes the claims handling period because the period used should reflect the risk associated with the settlement of claims.

The Board debated the issue in considerable detail, but in the end voted (8 to 7 again) to support the first alternative. The risk margin should be released based on a 'release from risk' notion, while the residual should be released on a passage of time basis. Board members noted that in the 'updated IAS 37 approach' the residual margin was essentially a plug, and that this item should be run off over the shortest possible period.

Initial recognition: Day One losses

The staff noted that, because of differences in the way in which insurance contracts were priced compared to the measurement models under consideration, a day one loss might arise in some situations. The Board confirmed that should such a loss arise, it should be recognised in profit or loss.

Relationship between the residual and composite margins and subsequent changes in estimates

The staff presented three possible approaches to addressing the subsequent changes in the residual and composite margins.

• Approach A would result in subsequent changes in estimates being reported in profit and loss.
• Approach B would adjust the margin for changes in cash flow, resulting in no impact on profit and loss.
• Approach C, which the staff had found almost impossible to defend, would update the margin as a fixed proportion of cash flows, determined at exception.

The Board supported Approach A by a large majority. Many thought that Appoach B obscured too much information.

Discount rate

The Board agreed that the discount rate chosen should reflect the characteristics of the liability. It should not capture characteristics of assets held to back those liabilities if the liabilities do not share those characteristics. In addition, the Board agreed that it should not provide specific guidance on how to estimate a discount rate for insurance liabilities, beyond providing a cross-reference to the guidance for fair value measurement.

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