Monday 19 October 2009

Meeting of Representatives of IASB and EFRAG

Representatives of the EFRAG and IASB met for their regular meeting to discuss convergence-related issues.

The EFRAG Chairman started the discussion by expressing the support of EFRAG for the aim of achieving high-quality converged accounting standards as outlined by the G20. Nonetheless, he stressed that while EFRAG supported convergence, the high quality of those accounting standards had to be a priority that was not to be compromised.

The EFRAG praised the response of the IASB to the financial crisis related issues, especially the mixed measurement model proposed in the Classification and Measurement ED. Nonetheless, EFRAG was concerned by the potential decisions being made in the name of convergence. The Board responded that many constituents had shown their preference for a converged solution to financial instruments. In response, EFRAG reiterated its position that convergence should not be an one-way move to US GAAP but an improvement to quality of existing financial standards.

One member of EFRAG suggested that some changes of fair value of financial instruments not organised through an exchange or clearinghouse should be presented in OCI instead of profit or loss because:

• they represented 'soft earnings' in comparison to 'hard earnings' and thus have less predictive power, and
• they should not be used for profit distribution.

The EFRAG has expressed agreement with the overall direction of the expected loss model and hedge accounting proposals. Nonetheless, it articulated its position that a forward looking model for impairment should be developed and all convergence-related and implementation issues should be addressed before it was finalised. EFRAG stressed the importance of hedge accounting on a portfolio level.

The IASB Chairman responded by alluding to the timeline imposed by the G20. He noted that even though the classification and measurement IFRS was to be finalised the following month, if convergence was achievable after the FASB finalised its model, further changes to the model were probable.

On consolidation project, the Board noted that following changes to US GAAP, it planned to assess any need to change and discuss it with FASB. That could have impact on timing of the project.

On derecognition, the Board alluded to two approaches possible, an alternative approach and a more limited amendment to IAS 39 model (based on risks and not rewards). The Board expressed its view that a new ED on derecognition might be necessary.

On other proposals, the EFRAG commented that the amount of changes to IFRSs already issued and proposed is very large. It suggested that some projects could be deferred following unfavourable reaction from the constituents (for instance, income taxes) and some should be finalised in full and not split into phases (for instance, the employee benefits project). The IASB noted the the staff has recommended that the proposed amendment on IAS 19 on discount rates might not be finalised as constituents were polarised how to proceed. The EFRAG members showed their surprise on such a recommendation.

The EFRAG also showed its support to the full re-exposure the new liabilities standard in light of the significant time the IASB has taken to redeliberate the proposals in the ED. It noted that during period, opinions of constituents might have changed.

Finally, the EFRAG updated the Board on status of the pan-European projects.

Financial Instruments: Classification and Measurement

Gains and losses related to fair value measurements in level 3 of the hierarchy

The Board considered the requirement for separate presentation on the face of the statement of comprehensive income of the total gains and losses for the period related to fair value measurement in Level 3 of the hierarchy.

In the outreach related to the Classification and Measurement ED, the Board was told by some constituents (mainly regulators) that separate presentation of gains and losses related to unreliable fair value measurement was superior to a mere disclosure in the notes, as data presented on the face of the statement of comprehensive income were seen to carry more weight.

Most of the Board members disagreed, as they felt that such information was already available under the requirements of IFRS 7, and regulators had enough powers to require any disclosures desired in prudential reporting. Moreover, some Board members were concerned that such separate presentation would not address the true issues as valuation uncertainly as well as earnings volatility had less predictive power for future financial performance for users.

The Board finally decided not to require such separate presentation as part of Financial Instruments project. Some Board members suggested that Financial Statement Presentation project was the right place to address such an issue. Moreover, the Board agreed to discuss this issue together with the FASB during the October joint meeting along with the proposal to disclose both fair value and amortised cost of financial instruments on the face of the statement of financial position.

The IASB's plan is to publish a final IFRS on classification and measurement of financial instruments in November 2009

Tuesday 20 October 2009

Fair Value Measurement

Comment letter analysis

The staff presented a summary analysis of comment letters received in response to the IASB's Invitation to Comment and Exposure Draft of a proposed IFRS Fair Value Measurement. To date, 157 comment letters had been received. The staff noted that as issues are redeliberated, more detailed analyses of the comments received would be presented.

The staff noted that nearly all respondents were in favour of the project and that constituents generally identified the following:

• having a single source of guidance would reduce complexity and improve consistency in the application of fair value measurements
• the IASB and FASB should work together to develop fully-converged guidance for fair value measurement under both IFRSs and US GAAP
• an exit price notion is not relevant for assets when an entity does not intend to sell the asset (that is, when it is being used in the operations of the business or it is a financial asset not held for trading)
• a liability measure should reflect a settlement notion, not a transfer notion, if the liability cannot legally be transferred or if the entity does not intend to transfer it
• some of the guidance for measuring fair value in inactive markets in the Expert Advisory Panel's report should be added to the final IFRS on fair value measurement guidance.

Board members noted that some of these items reflected constituents' opposition to measuring an item at fair value (the 'when' question) rather than disagreement with the ED's proposals about 'how' to measure fair value when an IFRS required such a measure.

In addition, some Board members noted that the use of 'fair' in 'fair value' was an emotive issue for many constituents. Some constituents seemed to think that the Board had only two buckets, cost and fair value, and that there was no place in IFRSs for current measures other than fair value. It might be better that the IFRS be neutral and refer to 'exit price', 'entry price', etc. The confusion also extended to whether approximations/ estimations of fair value determined using present value techniques could be described as 'fair value'.

Another Board member was concerned about the application of the IFRS in less developed economies and economies in transition. In many such jurisdictions, hypothetical markets were 'beyond their experience and imagination'. As part of the Board's outreach activities during redeliberations, specific consideration should be given to engaging with these jurisdictions – either through activities in Africa, South America, and South-east Asia, or through meetings to be held as part of, or as an adjunct to, meetings of the SAC; or through remote meetings, utilising technology. There was support for such activities.

Preliminary project plan

The staff presented a preliminary project plan outlining their proposed approach to redeliberating issues in the exposure draft (ED) and for addressing developments in US GAAP (including Accounting Standards Updates 2009-5 and 2009-12) subsequent to the publication of the ED in May 2009.

While approving the project plan, Board members expressed concern that the plan gave the impression that the staff was concentrating on 'playing catch-up' with US GAAP and would not address IASB constituents' concerns and suggestions for joint improvement in the standards. The staff noted this concern and stated that such issues would be discussed at the forthcoming joint IASB-FASB meeting later in October 2009.

Consolidation - Definition of Control of an Entity

The activities of the entity

The staff reminded the Board that ED10 proposed the following definition of control:

A reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity to generate returns for the reporting entity.

The Board discussed a staff recommendation that the IFRS should clarify that 'the activities' in the control definition refers to those activities of an entity that significantly affect the returns.

Several Board members expressed concerns with this clarification: some thought it too narrow and some did not think it captured common securitisation structures. One Board member noted that the Board (and staff) was often schizophrenic when using the term 'power': at the entity level, the returns were for the entity; but when layering the 'so as to benefit' criterion when assessing whether the entity should be consolidated, the returns had to benefit the owner, not the entity.

That Board member agreed that if [a parent] had both power and benefits, consolidation of the entity would be required. In addition, other Board members noted that synergies were indicative of control – an entity could not take advantage of synergies without having control of another entity – but they came after control was obtained and need not be present.

Another Board member challenged the main definition, and urged that the well-established notion of power to direct the strategic financial and operating policies of another entity should not be lost.

The Board accepted the staff recommendation without a vote.

Returns for the reporting entity

The Board agreed the staff recommendation that the definition and description of 'returns' should be retained in a manner similar to that in ED10. However, the Board would clarify which returns are relevant when assessing control.

The staff recommend that the final standard should also clarify that:

• (a) to control another entity, a reporting entity must be exposed to variability of returns from its involvement with that entity. Without exposure to variability, a reporting entity is unable to benefit from any powers that it might have.
• (b) returns received in the past are not relevant when assessing control. If a reporting entity is not exposed to variability of returns in the future, it is unable to benefit from any power that it might have. In such situations, a reporting entity uses any powers that it might have solely for the benefit of others, and therefore, would be acting as an agent.
• (c) returns have the potential to be wholly positive, wholly negative or either positive or negative. Therefore, a reporting entity controls another entity if it has the power to direct the activities of that entity, and any of the following three possibilities exist:
  • (i) the reporting entity's future returns from its involvement could only ever be positive (e.g. a beneficial interest holder in an entity that has bought insurance to cover all potential losses).
  • (ii) the reporting entity's future returns from its involvement could only ever be negative (e.g. a reporting entity that provides a guarantee of payments to beneficial interest holders when assets default).
  • (iii) the reporting entity's future returns from its involvement could be either positive or negative (e.g. an equity shareholder in an entity)

A Board member was concerned about the use of 'variability in returns' and the opportunities for defeasance trusts and similar structures to be used once again to achieve off-balance sheet treatment for items. The staff acknowledged the potential difficulty, but was trying to avoid too definitive guidance.

Power to direct: protective and participating rights

The Board discussed a staff recommendation that the IFRS characterise 'power' as follows:

• Power refers to a reporting entity's current ability to enforce its will in directing the activities of an entity that significantly affect the returns. A reporting entity has that current ability if a mechanism is in place that ensures that the reporting entity has substantive decision-making rights that mean that it can enforce its will in directing the activities that matter as and when decisions are required to be taken or the reporting entity would like decisions to be taken.
• Power need not be exercised.
• Power need not be absolute.
• Power is assessed on the basis of current facts and circumstances.

A Board member noted that 'current ability' would be the tension point and that the staff's proposed wording would not resolve the tension that exists. The staff responded that much of that tension concerns the effect of options, a topic that would be addressed later.

The Board did not object to this clarification, subject to its forthcoming discussion of options.

Rights of a reporting entity

The Board discussed whether to:

• add guidance discussing participating rights as follows:
  • participating rights are rights that, if held by one party, are sufficient to give that party the ability to enforce its will in directing the activities of an entity that significantly affect the returns. If their exercise requires agreement by more than one party, participating rights prevent other parties from controlling the entity to which they relate.
  • participating rights must be substantive
  • rights that are exercisable only when specified circumstances arise or events happen are participating rights in some circumstances and protective rights in others
• include the guidance on protective rights included in B1 and B2 of ED10

A Board member thought that the discussion focussed too much on rights and omitted any discussion of obligations – if an entity has rights it must have obligations to another entity.

In addition, Board members were concerned that some of the discussion of operational barriers to exercising an entity's rights to exercise control over another might have significant unintended consequences for entities in administration/ bankruptcy protection and urged the staff to investigate this further.

Subject to other minor clarifications, the staff recommendations were agreed.

Sharing power

The staff prefaced this discussion by noting that they did not want to change the definition of 'joint control'. Rather, this discussion was about situations in which multiple parties had decision-making authority over the activities of an entity. In particular, the discussion focussed on situations in which entities have discrete and unilateral power over bundles of activities (sometimes called 'silos').

The Board agreed the staff recommendation that when two or more parties have discrete decision-making authority over the activities of an entity, the party that has the ability to direct the activities that most significantly affect the returns meets the power element of the control definition.

In doing so, several Board members expressed grave concern about how the discussion of shared power (the Consolidation IFRS) and joint control (the Joint Activities IFRS) were explained and distinguished, given that the expected release date of the two IFRSs were different and that the forerunner could not refer to conclusions in an IFRS that was not yet balloted: it could only refer to existing IFRS. The staff acknowledged that the two standards were not scheduled to be released at the same time and noted the concern raised.

Involvement in the design of a structured entity

The Board discussed a staff recommendation that the IFRS clarify that understanding the purpose and design of an entity was an important factor to consider when assessing control of that entity, and that involvement in the design of an entity is not, in isolation, sufficient to conclude that the reporting entity controlled that entity. The staff's intention was that involvement in the design of a structured entity was indicative but not determinative of control.

Board members were uncomfortable with the recommendation as drafted. Control of the risks and benefits was often the more crucial assessment to be made. It was necessary to understand the entity's purpose and who controls those policies.

The Board agreed that, in assessing control of any entity, including a structured entity, a full understanding of all relevant facts and circumstances was necessary. This could include who designed the structure and why, the source of assets and financing, as well as who controls the operating policies and which entity has the risks and benefits.

The staff agreed to rework its proposals and return at a subsequent Board meeting.

Continuous assessment of control

With little discussion, the Board affirmed that a reporting entity should assess control continuously and that the IFRS should clarify the application of that requirement.

Financial Statement Presentation

The statement of comprehensive income

The Board briefly considered the proposal to present a single statement of comprehensive income. The Board concluded that this topic would be addressed later this week as part of another project (proposed amendments to IAS 1) in response to a similar expected FASB proposal (as part of its financial instruments project).

The Board agreed to retain the requirement to identify and indicate on the statement of comprehensive income the category or section to which each item of other comprehensive income (OCI) (apart from a foreign currency translation adjustment on a consolidated subsidiary and proportionately consolidated joint ventures) related. The Board also discussed implications of this decision on some items in OCI (for example, cash flow hedge reserves) as it could mean that they might be split between the respective sections.

Income tax allocation and presentation

The Board agreed to propose in the forthcoming ED to retain the existing requirements on intraperiod tax allocation in the statement of comprehensive income. This may result in an entity presenting income tax expense or benefit in the discontinued operations and OCI sections in addition to determining the income tax effect for continuing operations (the income tax section).

The Board also tentatively agreed that existing requirement to disclose the amount allocated to each component of OCI should be retained. Nonetheless, the staff noted that this issue might be reconsidered following the decision on a single statement of comprehensive income later in the week.

Finally, the Board agreed that an entity should present current and deferred income tax assets and liabilities recognised and related cash flows in an income tax section on the statement of financial position and statement of cash flows.

Disaggregation by Function and Nature

The Board continued its discussions on the level of disaggregation in the financial statements. This was an educational session, and no formal decisions were taken.

The Board discussed a disaggregation principle that would require an entity to consider disaggregation by function, nature, and measurement basis in financial statements as a whole in a manner that provided transparency to that entity's business model and best representation how the entity used its resources to generate income and cash flows. This disaggregation principle would then apply not only to the statement of comprehensive income but also to the statement of financial position and the statement of cash flows.

Whilst the majority of the Board was contended with the overall direction of embodied in that principle, they expressed their concerns on how the principle was articulated. Some Board members were particularly concerned that the wording was too vague and a more rigorous wording would be required to ensure discipline to provide a proper level of consistency and comparability. Otherwise, they feared, it would give the preparers a carte blanche in determining the level of disaggregation. Especially, the representatives of analysts among the Board members were concerned that applying the proposed principle could lead to essential information not being disclosed. On the other hand, some other Board members felt that some level of flexibility was necessary and it reflected different characteristics of different industries (for example, financial institutions).

On balance, the Board saw merit in the proposed principle but asked the staff to reformulate it, articulate more clearly the objectives and accompany the principle with additional application guidance and examples how that principle might impact the presentation of primary financial statements. The Board will reconsider this principle on the joint meeting with the FASB next week.

The Board considered where in the financial statements the disaggregated information should be presented. Most of the Board members were concerned that the level of disaggregation would lead to the primary financial statement being too cluttered with data leading to reduction in relevance and understandability.

Whilst most of the Board members concurred with the proposal to present disaggregated information on the face of the financial statements for entities with one reportable segment and to present that information in its segment note for an entity with more than one reportable segment, they were concerned that segment note was based on a different measurement basis (non GAAP numbers). The presentation of disaggregated information would be reconsidered at the October joint meeting with the FASB. Nonetheless, the Board thought that the forthcoming ED might ask the question whether segment reporting note should be amended to reflect the GAAP measures.

Insurance Contracts

Unbundling

The Board considered when an insurance contract that contains insurance, deposit (financial) and service components should be accounted for as if they were separate contracts (unbundling). The Board considered the requirement to unbundle when the components were not interdependent.

After a long debate, during which the Board discussed consistency of this requirement with the proposed guidance for multiple segment contracts in the revenue recognition project, the Board asked the staff to redefine the conditions and guidance when the contract was interdependent and could not be unbundled (that is, valued separately).

Presentation of the performance statement

The Board continued with an educational session on presentation of insurance contracts in the performance statement.

The Board was presented with five presentation options:

• (a) Treat all premiums (including the portion that pays for the deposit component) for all insurance contracts as revenue.
• (b) Unbundle all (or specified) insurance contracts into an insurance component, as in (a) and a deposit component – a fee approach.
• (c) Treat all premiums for all insurance contracts as deposits, and all claims and expenses as repayments of deposits. Use the margin model for the margin.
• (d) For insurance contracts that meet specified criteria (for instance, life insurance contracts, or long duration contracts), treat all premiums for all contracts as deposits, as in (c). For all other insurance contracts, treat all premiums as revenue, as in (a).
• (e) Permit insurers to choose for each class of insurance contracts between a revenue presentation, as in (a), and a deposit presentation, as in (c).

After a thorough discussion, during which the Board considered the level of granularity required, the Board seemed to revert to unearned premium model for short term policies and (c) or (d) for other insurance contracts. The Board will reconsider these models at its November meeting, after received feedback from insurance working group.

Deposit floor for Insurance contracts

The Board rediscussed the issue of deposit floor for insurance contracts. The implication of usage of measurement model based on expected cash flows resulting from insurance contracts was that no deposit floor applied for measuring insurance contracts.

In the debate on this implication of the measurement model, the Board discussed the scope of an insurance contract as well as consistency of the deposit floor in banks and insurance.

The Board tentatively confirmed that no deposit floor applied in measuring insurance contracts. Nonetheless, the Board asked the staff to further analyse the implications of that decisions on more complex insurance products. Moreover, the Board directed the staff to analyse possible arbitrage opportunities arising from this decision in groups consisting of both a bank and an insurance company.

Timetable

Given the decisions taken on the previous sessions (including lack of final decisions on several subjects), the Board decided to reconsider the timetable for the project at its November meeting.

Wednesday 21 October 2009

Credit Risk in Liability Measurement

The Board continued its discussion of the comments received on its Discussion Paper Credit Risk in Liability Measurement and deliberated the next steps for this work stream.

There was broad consensus that on initial measurement credit risk should be included in the measurement of at least some liabilities.

Some of the respondents thought that credit risk should always be included, although those respondents would limit this answer to financial liabilities. A few respondents thought that credit risk should always be included in initial measurement of all liabilities. Very few respondents would never include credit risk in initial measurement.

On subsequent measurement, views were more divided. Many agreed that credit risk should be included sometimes, although a significant number thought that it should not be included. Only a few would include credit risk at all times – again, this was in the context of financial liabilities.

The Chairman sought to clarify the preference among respondents for the 'frozen credit spread' approach and whether this was consistent with fair value. Staff acknowledged that using a frozen spread approach could lead to a measurement that diverged from fair value. (If the risk-free rate declined and the margin on AA-rated debt increased, an entity would mark away from market/fair value.) The staff noted that the DP had attempted to observe that there were two bits to the frozen spread approach, but only a few respondents had commented on it (see, for example, HSBC's comments).

Many Board members were frustrated by the lack of response from constituents about how to measure the frozen credit spread – often spending more time commenting on what should or should not be measured at an amount reflecting credit risk.

Staff noted also that constituents' apparent support for a frozen credit spread approach was probably a product of profound dislike for the other possible approaches discussed in the DP. However, the approach needed to be put in the context of a particular standard to obtain better and harder data.

The Board moved to discuss staff recommendations for this work stream and the information gained from the DP and made the following decisions:

• The Board agreed that no further work on credit risk in liability measurement as a separate work-stream should be undertaken.

• The Board would be required to make decisions about liability measurement in individual standards-level projects.

• The Board agreed that the definition of 'fair value' should not be modified as a result of the DP. Decisions about how 'fair value' is applied belong properly in the Fair Value Measurement project and individual standards-level projects.

It was possible that, in any particular project, the Board might agree a measurement attribute as fair value 'as modified' (for example, fair value 'less costs of disposal'). Board members noted that this decision might be troublesome to constituents.

Should the notion that credit risk is inherent in the measurement of fair value be included in the IASB's Framework? The staff noted that most applications of fair value to liabilities occur in the context of financial instruments. Several other IFRSs require current information to be incorporated in liability measurement (but not fair value as defined), including IAS 19 and IAS 37. Board members seemed to think the idea of embedding the notion credit risk being included in liability measurement in the Framework as a general concept was the right approach. How the concept was applied would be left to the Fair Value Measurement standard and other IFRSs.

The Board discussed non-performance risk, and its interaction with credit risk. Non-performance risk was a notion introduced by the FASB in Statement of Financial Reporting Concepts No. 7 (CON 7) and was an attempt by the FASB to address the physical as well as the financial incapacity to discharge an obligation. The Board discussed this issue for some time, essentially coming to a common understanding of what CON 7 was saying and how its concepts might be applied in an IASB context.

The Board agreed with the staff's assessment that the interaction of non-performance risk and credit risk could not be addressed satisfactorily at a concepts level, but needs to be addressed explicitly in each project when a liability measure is at issue. (This approach would be applied to all future projects, not existing IFRSs or projects in an advanced state of deliberations.)

Liabilities – Amendments to IAS 37

Decision about re-exposure

The staff presented one issue to the Board: whether re-exposure of the IAS 37 amendments package was necessary or whether the Board could proceed directly to issue an IFRS. In doing so, they reviewed with the Board the criteria for re-exposure in the IASB's Due Process Handbook, paragraphs 46-48, and the decision summary of redeliberations.

Three options were proposed:

1. Issue an IFRS without re-exposure;
2. Undertake a limited-scope re-exposure of selected changes to the propels; or
3. Re-expose the entire standard.

After an extended debate, the Board agreed that it would:

• Ballot the IFRS and prepare the Basis for Conclusions for the IFRS other than the measurement guidance and release this as a Near-final Draft on the IASB's Website; and
• Expose for public comment its proposed clarification of the measurement requirements. Those requirements, in the Board's view, are a re-articulation of the current measurement requirements in IAS 37, not a new measurement basis. Based on decisions reached in July and September 2009, the revised standard would state that:
  • the requirement is to measure the amount that the entity would rationally pay on the reporting date to be relieved of the present obligation.
  • the amount that the entity would rationally pay to be relieved of the present obligation is the lowest of:
    • the value the entity would gain if it did not have to fulfil the obligation;
    • the amount the entity would have to pay the counterparty to cancel the obligation; and
    • the amount the entity would have to pay a third party to transfer the obligation to that party.
  • If there is no evidence that the entity could cancel the obligation or transfer it to a third party for a lower amount, the entity measures the liability at the value it would gain if it did not have to fulfil the obligation.
  • An entity estimates the value it would gain if it did not have to fulfil the obligation using expected present value techniques. The calculations take into account:
    • the outflows of resources expected to be required to fulfil the obligation (the probability-weighted average of the possible outcomes);
    • the time value of money; and
    • if the amount or timing of the outflows is uncertain, any additional amount the entity would rationally pay to be relieved of risk.
  • An entity should measure the resource outflows at their value, not cost. If the obligation is to provide a service at a future date, the entity measures the service outflows at the amount it would rationally pay a contractor at the future date to carry out the service on its behalf.
    • if a market exists for such services, the amount is the price that a contractor would charge.
    • if no market exists, the entity would estimate the amount.

  Board members stressed that the ED of the proposed clarification of the measurement approach and the near-final draft of the IFRS should be available at the same time.

At least five Board members indicated that they would dissent to the ED on the basis of the measurement approach being adopted.

Financial Instruments – Classification and Measurement

Scope

The Board revisited its earlier tentative decision on the scope of the forthcoming IFRS. Many Board members had become increasingly concerned that introduction of the frozen credit spread for financial liabilities would create severe unintended consequences (for instance, measurement of derivatives embedded in financial hosts and implications for fair value option). Moreover, this particular decision would make convergence with FASB increasingly difficult.

The Board expressed its desire to rediscuss this issue and consider additional outreach activities. Therefore, the Board unanimously decided to exclude financial liabilities from the scope of the forthcoming IFRS. The Board would rediscuss this issue immediately after the IFRS is issued and try to come with a common solution with the FASB on treatment of financial liabilities.

Effective Date

The Board discussed the proposed mandatory effective date for the IFRS. Some Board members thought that the IFRS should be mandatorily adopted only as a whole package at the same time (with all the other parts of the IAS 39 replacement) and preferably at the same time as the second phase of the insurance contracts project. On the other hand, some Board members felt that in this way comparability would be impeded for a relatively long period of time. Finally, the Board agreed that a mandatory effective date of the finalised guidance on classification and measurement of financial instruments would be for annual periods beginning on 1 January 2013 or later. The Board noted that until then, constituents should have sufficient time to prepare for all the phases of the IAS 39 replacement project. Nonetheless, the Board noted that if there was a need to delay further the mandatory effective date, for example due to the Impairment phase adoption, that would be possible.

The Board agreed without much discussion to permit early application of the final IFRS and to require the transition disclosures for all entities adopting the new IFRS (not just for entities adopting them early as proposed in the ED).

Nevertheless, some Board members expressed their concerns that permitting early adoption might lead to lack of comparability and consistency in financial reporting.

Transition

The Board discussed transition requirements. As the discussion progressed, some of the Board members become increasingly concerned that proposed transition could lead to a complete free choice and would lead to window-dressing of financial statements.

After a substantial discussion the Board agreed to permit determining the date of initial application of this IFRS at any date between issue of the IFRS and 31 December 2010. Thereafter, an entity could determine the date of initial application at the beginning of the reporting period only.

The Board agreed not to require restatement of comparative periods in 2009-2011 period. However, for all the periods after 1 January 2012 comparative information would have to be provided. The Board also agreed with the principle (consequential amendment to IFRS 1) that first-time adopters should not be in a more onerous position in restating comparative periods that entities already applying current IAS 39. The Board also decided not to require early adoption of subsequent guidance (other phases of IAS 39 replacement project) if any previous guidance was adopted. Nonetheless, the Board agreed to limit the number of choices by requiring early adoption of any preceding final guidance if subsequent guidance was early adopted.

Some Board members were concerned that requiring restating of comparative periods would lead to lower quality of the data as well as practical problems (for example, with financial instruments already derecognised). Nonetheless, the majority of the Board were of the opinion that such a requirement is necessary to ensure a basic level of comparability and consistency.

On the other issues the Board decided to finalise the guidance as proposed in the ED on impracticability of retrospective application and disclosure requirements.

The Board decided not to permit 'grandfathering' of the accounting for hybrid contracts with financial hosts given its decision on scoping liabilities out of the IFRS.

The Board also agreed to remove the provision for discontinuance of hedge accounting relationships that did not qualify under the new classification model as they would be effectively a null set.

Finally, the Board decided not to provide any guidance on potential transition relief for future phases of IAS 39 replacement project.

Transitional insurance issues

The Board considered the interaction between classification and measurement phase of the IAS 39 replacement project and Phase II of the project on insurance contracts. The Board agreed that if the effective dates of these projects are different, additional accounting mismatches might occur. Nonetheless, as the Board believed that mandatory adoption in 2013 might be achievable for both of these projects, it did not provide any additional relief for insurance companies (such as temporary exemption to maintain an AFS portfolio). The Board agreed that as part of the transitional requirements of the insurance contracts IFRS, a transitional option to reclassify financial assets on adoption of Phase II of insurance contracts should be considered. The Board also agreed to include such discussion in the Basis for Conclusions of the Classification and Measurement IFRS.

The Board also considered consequential amendment of IFRS 4 to modify shadow accounting for insurance contracts or financial instruments containing a discretionary participation feature (allow adjustment to the insurance liability to be recognised in other comprehensive income (OCI) if a realised gain or loss on an asset is recognised in OCI). The Board decided against such a change as it believed that OCI presentation for equity instruments was a choice, and thus an accounting mismatch might be avoided by not using the option.

Thursday 22 October 2009

Post-employment Benefits

Post-employment Benefits: IFRIC 14 – The Limit on a Defined Benefit Asset, Minimum Funding Requirements and their Interaction

The Board received a staff analysis of comments received as a result of its proposed amendment of IFRIC 14 Prepayment of a Minimum Funding Requirement (ED/2009/4). It also redeliberated its conclusions in that exposure draft (ED).

The staff briefly introduced its comment letter analysis. The staff noted that some respondents wished the IASB to extend its amendments to the measurement of surpluses, not only repayments, but the Board agreed with the staff that such an extension was beyond the scope of the project.

The Board agreed to proceed with the amendment to IFRIC 14 such that it address only the treatment of a prepayment of a minimum funding requirement.

The Board considered whether to provide additional guidance on the definition of 'unconditional right to a refund' in IFRIC 14. The Board agreed that no elaboration was necessary.

The ED proposed to delete IFRIC 14 paragraph 22. In response to concerns raised by respondents about whether the other amendments proposed replaced all the requirements of paragraph 22, the Board decided to retain the paragraph.

The Board agreed that the amendments should be applied from the beginning of the earliest comparative period presented in the first financial statements in which the entity applies IFRIC 14.

Post-employment Benefits – IAS 19 Discount Rate

The Board received a staff analysis of comments received on its proposed amendment of IAS 19 Discount Rate for Employee Benefits (ED/2009/10). It also redeliberated its conclusions in that exposure draft (ED).

The staff noted that 100 comment letters were received; in addition, there had been correspondence with constituents since the staff papers for this meeting had been released.

The staff said that the comments were polarised: those who were in favour of the change were strongly so; those against were equally strong in their opposition. In addition, it was apparent that the exposure process had highlighted a number of areas in which the proposal would create problems of which the staff were previously unaware. The Board's proposals could lead to greater diversity in practice rather than less. As a result, the staff presented three alternatives:

• Require government bond rates to be used when it is difficult to estimate a high quality corporate bond rate, rather than when there is no deep market in high quality corporate bonds. The staff would consider further what is meant by 'difficult' if the Board decides to proceed on this option;
• Continue with the ED proposal to eliminate the requirement to use a government bond rate; or
• Keep the existing requirement to refer to a government bond rate when there is no deep market in high quality corporate bonds – in other words, stop the project.

Board members engaged in a vigorous debate. Some challenged that staff analysis as simplistic and disingenuous. Others noted that the proposed amendment illustrated the danger of forcing an entity to use a measurement input that matched neither the currency nor duration of its defined benefit obligation.

Board members expressed dissatisfaction with all three alternatives. However, ultimately there was not sufficient support among Board members to ratify the amendments. Consequently, the requirement in IAS 19 paragraph 78 to use the government bond rate in the absence of a high-quality corporate bond rate would remain in force.

Next steps for proposed amendments to IAS 19 relating to termination benefits

The staff reminded the Board that it had published an Exposure Draft of proposed amendments to IAS 19 addressing termination benefits in June 2005 (this was issued in conjunction with the proposed amendments to IAS 37).

The Board had considered comments received and had concluded its redeliberations in May 2008. However, the amendments had not been balloted or published pending further deliberations on IAS 37. With the conclusion of redeliberations on IAS 37, the staff asked for the Board's intentions for the IAS 19 issues.

The Board directed the staff to prepare a ballot draft of the amendments and that the amendments should be issued as soon as they are ready. No Board members indicated their intention to dissent. Ms McConnell indicated that she would likely abstain, since all redeliberations occurred prior to her appointment as an IASB member.

Timing of effective date and transition

The staff proposed that the amendments to IFRIC 14 and IAS 19 for termination benefits should be effective for annual periods beginning on or after 1 January 2013, with early application permitted.

Board members reacted angrily to this suggestion, noting that the Board had been told that constituents wanted these amendments quickly and yet the staff was proposing an effective date several years in the future, while permitting early adoption. As such, the staff were suggesting that the Board promote non-comparability. IFRIC 14 was admittedly flawed, yet the staff were reluctant to require the improved version to be implemented.

In their defence, the staff suggested that they were trying to avoid multiple changes being inflicted on constituents. However, Board members noted that this defence was predicated on the Board completing its work on post-employment benefits accounting by 2013, something that the Board might not be able to achieve.

The Board directed that the amendments be effective for annual financial reporting periods beginning on or after 1 January 2011, with early adoption permitted.

Financial Statement Presentation – Other Comprehensive Income

The Board discussed a proposal for a possible limited scope amendment to IAS 1 Financial Statement Presentation. This amendment might be necessary to preserve a degree of comparability between the presentation of the statement of comprehensive income between IFRS and US GAAP, depending on the actions that the FASB might take in its Financial Instruments: Recognition and Measurement project.

Specifically, the staff presented a proposal to remove the option in IAS 1 paragraph 81 to present a statement displaying the components of profit or loss and a second statement beginning with profit or loss and displaying components of other comprehensive income (the 'two statement' option). The staff stressed that nothing in their proposal would change the items that could or should be presented in OCI, or whether an item should be reclassified upon derecognition.

Board members expressed surprise that the staff was bringing this proposal forward at this time. The latest version of IAS 1 had been in effect for less than ten months, and the last time the Board had suggested a single statement of comprehensive income it had faced near universal opposition. Now was not the time to reignite the embers of opposition and provide additional ammunition to those ill-disposed towards the IASB.

Noting the foregoing arguments, a Board member warned that, should they proceed with this proposal, all Board members voting in favour of the proposal before exposure must have the backbone to maintain their position afterwards: it was unlikely that the exposure process would raise any information or insight of which it was unaware already.

The Chairman noted that the proposal would need to be addressed carefully and as a true US GAAP convergence item. He noted also that the topic would be discussed with the FASB at its joint public meeting on 26-28 October, after which the IASB would be in a better position to judge whether the amendment would be needed.

The Board tentatively agreed to eliminate the alternative in IAS 1 paragraph 81 that permits the 'two statement approach' to presenting the statement of comprehensive income.

The Board also tentatively agreed to require that the single statement of comprehensive income be displayed with two sections: profit or loss and other comprehensive income.

By a majority (at least two opposed), the Board tentatively agreed that

• components of OCI that would not be reclassified into profit or loss in future periods should be displayed together, and
• components of OCI that would be reclassified into profit or loss in future periods should be displayed together.

The Board tentatively agreed to remove the option to permit an entity to display components of OCI net of tax. In addition, the Board agreed that income taxes related to items reported in OCI should be allocated between the two sub-classifications.

The Board will make a further determination about this possible project after the joint meeting with the FASB on 26-28 October 2009.

Financial Instruments – Classification and Measurement

Interaction between decisions on concentration of credit risk and other non-recourse instruments

The Board discussed the accounting for proportionate non-recourse instruments from the perspective of the holder. The majority of the Board agreed that the IFRS should include additional guidance that an entity had to ensure that any payments arising under the contract were consistent with the principle of all payments being payments of principal and interest (representing time value of money and credit risk). This required 'looking through' the non-recourse instruments to the underlying ring-fenced assets.

The Board discussed this principle in detail. Some Board members were concerned that the words did not reflect the principle that should have been articulated (in effect the difference between the credit risk and owner risk). The Board asked the staff to draft the principle to reflect that the holder always had to assess the repayment and its source. In case of non-recourse loans that meant that the promised return was evaluated for whether it represented compensation for credit risk or another economic substance.

One Board member in particular was concerned about this principle as he considered a non-recourse loan to be a loan with an embedded option. Consequently he would deny amortised cost accounting for all non-recourse loans as they did not exhibit basic loan features.

Summary of decisions

The Board considered the decisions taken during the process of redeliberation of the classification and measurement phase of the Financial Instruments project.

The Board clarified that with respect to underlying portfolio of investments in contractually linked instruments, additional credit protection (such as guarantees) for the underlying instruments would not prohibit amortised cost accounting.

With regards to reclassifications, the Board specified that following the identification of a change in the business model, an entity should reclassify the financial instruments in question from the start of the following period (including interim periods).

At least three Board members (and an additional Board member tentatively) indicated that they would dissent to the ED on the basis of the approach being adopted.

Friday 23 October 2009

Consolidation

Agency Relationships

The Board held a preliminary discussion of the effects of an agency relationship in consolidation. The topic will be discussed at next week's joint meeting between the IASB and FASB on 26-28 October 2009.

The staff noted that the FASB had recently amended its consolidation standards with respect to variable interest entities in which it addressed the effects on consolidation of the power to remove an agent ('kick-out' rights) and the remuneration of the agent. The IASB project seeks to address the same issues, but in a wider context, since the forthcoming IFRS would apply to all entities. Crucially, the IASB staff and the FASB are in slightly different positions at the moment. This discussion was intended to gain a preliminary understanding of why the two sides were where they were and what the key differences were.

No decisions were made at this session.

Removal rights

In SFAS 167, the FASB concluded that, in the context of variable interest entities, kick-out rights should be excluded from the determination of the primary beneficiary [that is, the accounting 'parent'] unless those rights are held by a single party. A Board member noted that it was highly unlikely that the FASB would revisit this conclusion, as the FASB was very concerned that to conclude otherwise would open the standard to structuring opportunities. However, the decision had been contentious and one not taken lightly.

IASB members were troubled by the absolute nature of this conclusion but acknowledged the difficulty in some circumstances of determining whether an entity acting in an agency capacity was in control of the entity it was managing. The Board seemed sympathetic with the staff view that kick-out rights could be held by more than one party; however, the greater the number of parties that held kick-out rights, the less likely it would be that those rights were substantive. At the same time, they wanted to hear from the FASB directly their thinking on removal rights, especially to understand their concerns about structuring opportunities and other possible abuses.

Remuneration

The staff presented three potential views of how remuneration of the agent might affect the determination of control. One view put forward by some respondents to ED10, that when (for example) a fund manager held anything less than 100% of the units if a fund should not be deemed to control the fund, was rejected by all Board members and was not discussed.

View 1 would apply the definition of control to conclude that a reporting entity controls another entity when it has decision-making authority to direct the activities, and receives a variable return from its involvement with the entity. This is the FASB's view, except that in issuing SFAS 167, the FASB viewed the issue from the agent's point of view.

View 3 would acknowledge that there are situations in which a reporting entity's returns might be more than insignificant and yet that reporting entity would still use the decision-making authority delegated to it to generate returns for other parties. When there is evidence that the reporting entity uses the delegated authority for its own benefit rather than for the benefit of other parties, it would be presumed to control the managed entity.

During the discussion, it was noted that the FASB would agree that a substantive kick-out right should be included in the determination of control; and that a substantial variable interest in the returns of an entity would be indicative of control.

The Board discussed examples distinguishing Views 1 and 3 and noted that in the IASB's analysis (that is, not considering SFAS 167) the control/consolidation decision would be different only when the manager acted in a dual capacity: as a manager and as an owner. The sense of the meeting (in the absence of any votes) was that a majority of the IASB favoured the approach in View 3. One Board member noted that he favoured View 3, but was also a 'single kick-out right' person because he did not think anything else would be operational.

Another Board member noted that he was becoming uncomfortable with using kick-out rights as an indicator of control in voting interest entities (that is, not structured entities, but operating entities). He was thinking in terms of joint ownership entities in which the owners appoint one of the owners to act as operator/manager under contract. He was still thinking about how such an arrangement might be analysed using the IASB's approach.

The IASB staff noted that they continued to work with the FASB to understand issues around the tension points that cause a different conclusion in the assessment of control.

Non-contractual agency relationships

The Board held a brief discussion of whether the forthcoming IFRS should include a list of examples of parties that often act for the reporting entity (without an assumption that they always act on behalf of the reporting entity). The Board seemed to agree that such a list might be helpful, but that any list provided should not be seen as definitive.

Derecognition of Financial Instruments

Bankruptcy remoteness concept

The Board analysed the legal isolation test with reference to the derecognition model. The Board discussed the issues that were connected with the application of the legal isolation test in US GAAP (a transfer must be bankruptcy-remote for an asset or component of an asset to be eligible for derecognition as a result of the transfer.

The Board decided not to include the legal isolation criteria in its derecognition approach as it believed that derecognition criteria should be driven by accounting principles and not specific legal rules. In the view of one Board member, determining what was and what was not a sale in financial statements should be based on accounting principles and not determined with reference to law. The Board was also concerned that introduction of the legal isolation test would be inconsistent with the Framework.

On the other hand, the Board stressed that bankruptcy remoteness concept should be reflected in measurement of the instruments and clarified by appropriate disclosures.

Accounting for repurchase agreements and similar transactions

The Board considered accounting for repo transactions in response to a very strong opposition among constituents to the proposals in the ED (which proposed to treat these transactions as sale transactions). The Board was told that these transactions were almost universally perceived as financing and that their treatment as sale transactions would increase volatility in profit or loss that had no economic substance. Moreover, several Board members noted that proposed treatment would be inconsistent with treatment of sale and leaseback transactions and might be contrary to substance over form principle embodied in the Framework.

On the other hand, other Board members preferred more conceptual arguments in favour of the proposed treatment (for example, differences to collateralised loans, existence of two sources of credit risk).

After an extended debate the Board acknowledged that some of the transactions, generally referred as repos, might have economic substance of a loan and some might have the economic substance of a sale. Consequently, the Board asked the staff to propose a criterion that would try to capture this distinction. In addition, the Board decided to discuss this question with the FASB in an attempt to coordinate views on this matter.

Accounting for retained interests

After a short discussion, the Board agreed to treat retained interests representing a proportionate interest in the asset previously recognised as part of the asset previously recognised. In all other cases, the Board decided to treat retained interest as a new asset and measure it at fair value on initial recognition. Subsequently retained interest should be accounted for on the basis of classification and measurement guidance on financial instruments.

The derecognition approach

The Board discussed two possible derecognition approaches, the amended IAS 39 approach and a modified alternative approach (modified by the accounting for repos and retained interests). The Board tentatively agreed with the alternative approach. Nonetheless, the Board agreed to discuss this approach with the FASB with the aim to achieve convergence. The Chairman noted that in light of this decision, re-exposure of the derecognition ED was probable.

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