Monday 15 February 2010 (IASB Meeting)
 Derecognition of Financial Instruments
Transfer definition
The Board discussed the set of concerns raised by respondents to the Derecognition ED with respect to the definition of transfer. The Board agreed with the staff analysis that in the alternative approach, the link between the financial asset and the transaction transferring the economic benefits is of crucial importance. Therefore, the Board decided not to provide a transfer definition in the final Standard, but to deal with the individual issues raised by providing additional application guidance on application of the derecognition principle underlying the alternative approach.
Some Board members expressed their concerns how consistent would be this decision with the conclusions reached in other projects, especially with respect to the importance of legal form of the transaction in some cases (e.g. leases).
The Board continued to discuss the question whether 'economic' benefits were to be assessed in derecognition principle include voting or subscription rights. Most Board members agreed that inclusion of these rights in the definition of economic benefits is consistent with the general principle of the model, to the extent they were not recognised separately. Nonetheless, they expressed concerns relating to valuation, in particular, of the non-financial economic benefits and they suggested additional application guidance in this area.
Some Board members stated that in their opinion the impact of the recognition of differences between values of these rights in profit or loss would be limited, as in practice these rights being transferred would not have much value, unless connected with control premium.
Some Board members were concerned by the implication of such decision, especially for temporary transfer of non-financial benefits. The staff responded that such distinction between temporary and permanent transfer would contradict the principle of the model and they analogised it to passing of all interest for loans to a third party.
One Board member expressed his concerns that the alternative derecognition approach would lead to a free choice of classification of financial assets and suggested to be limited. Another Board members responded that these concerns do not relate to the derecognition principles but rather to classification criteria of IFRS 9.
Finally, by a large majority, the Board agreed that economic benefit concept shall include both financial and non-financial economic benefits.
Derecognition Principle - Access to economic benefits
The Board discussed other issues related to the derecognition principle raised by constituents. The Board briefly discussed and agreed with the proposed clarifications of terms of the alternative approach (definition of the derecognition principle, definition of present access and benefit).
The Board discussed in particular the issue of unit linked insurance i.e. whether does the sale of units in insurance fund in which the insurer has agreed to pass onto the policyholder the economic benefits of the underlying linked investment constitute a transfer. The Board acknowledged the links with the insurance projects and asked the staff to analyse the matter further beyond the simple answer that if such asset is outside of scope of IAS 39 it would not be subject to derecognition rules.
In a further discussion that referred to the 'empty SPEs' issue, some Board members emphasised the need for consistency between the consolidation and derecognition guidance and asked the staff to consider this in further analysis. One Board member pointed out that the issue of empty SPEs would be more pressing for the FASB as it would mean that even such empty shell would have to be consolidated under FASB consolidation rules.
The Board discussed the need for specific guidance for pass-through arrangements. Most of the Board members disagreed with the staff recommendation that the new Standard would not include guidance related to the pass-through test in IAS 39. Even though they acknowledged that the recognition principle might address all the issues intended to be addressed by the pass-through test it would represent useful application guidance, given that it is part of the guidance now.
Accounting for repurchase agreements
The Board discussed the accounting for repurchase agreements. Although most of the Board members expressed their conceptual preference for the sale approach, they acknowledged that such approach was not tenable given the level of disagreement from constituents.
Most Board members agreed that the guidance for repurchase agreement should be formulated as an exception from the general derecognition principle. Given this decision, most Board members agreed that this guidance should be as converged with the FASB as possible even though such solution might be prone to structuring.
Most of the Board members agreed that a transaction would be treated as secured financing, if the agreement both entitles and obligates the transferor to repurchase or redeem transferred financial assets from the transferee and all of the following conditions are met:
- (a) The financial assets to be repurchased or redeemed are the same or substantially the same as those transferred.
- (b) The agreement is to repurchase or redeem them before maturity, at a fixed or determinable price.
- (c) The agreement is entered into contemporaneously with, or in contemplation of, the transfer.
The Board decided not to include the requirements for collateral maintenance that are currently part of the U.S. GAAP to the proposed approach, due to the concerns about application of such guidance in the IFRS context.
The Board decided also to discuss these conditions with the FASB in order explore any potential differences.
Finally, following a brief discussion, when the Board discussed the possibility of the same asset being portrayed in financial statements of multiple companies the Board agreed that the resulting asset should be presented as the right to get the asset rather than the asset itself. The Board also did not agree with any 'linked' presentation of assets and liabilities in the Financial Statements.
Tuesday 16 February 2010 (IASB-FASB Joint Meeting)
Financial Instruments: Presentation
Education Session: Right of offset
The Boards were presented three short presentations from the International Swaps and Derivatives Association (ISDA), independent legal experts, and representative of large international banks to discuss the mechanics and conditions of master netting agreements and potential implications on offsetting principles for financial statement presentation.
he ISDA representatives described the 2002 ISDA Master Netting Agreement – its features, structure, components, and functioning. In particular, they explained the differences in functioning of close-out netting and payment netting. Most attention was paid to the termination and close-out netting provisions, and practical issues as calculation of the net amount and experience under current market conditions.
The legal presentation focused on three types of netting – set-off on insolvency of counterparty, close-out netting on insolvency of counterparty and settlement netting – as well as application of netting and insolvency rules in the international context.
Finally, the presentation by the large international banks highlighted the differences between the US GAAP requirements and IFRSs and stated arguments supporting net presentation of derivatives under IFRSs.
This was an education session only, no decisions were made. The Boards intend to use the input from these presentations and following brief discussion in their deliberation process.
Revenue Recognition
Scope
The Boards considered the scope of the proposed revenue recognition model. The staff presented a flow chart that provided the decision criteria to determine whether a contract is in scope of the proposed revenue recognition model.
The Board agreed that performance obligations for the transfer of goods and services that are within the scope of other standards should be accounted for in accordance with those standards rather than under the proposed model. Those performance obligations would include contractual obligations to provide the customer with financial instruments, insurance coverage, leased assets, or guarantees.
Some Board members questioned the application of the proposed scope when the contract is partly outside of scope of the proposed revenue recognition model, in particular using the 'residual method' (that is, allocate transaction price to all performance obligations equalled to fair value if those performance obligations are initially measured at fair value by the other standards, with the remaining balance allocated to all other performance obligations based on relative selling price).
Some Board members expressed concerns about how this principle would be operationalised and which guidance on bundling and unbundling is to be applied first if potentially inconsistent criteria are to be applied across some of the projects (such as revenue recognition and insurance).
Other Board members were concerned that the notion of interdependence was not properly defined within the project. A Board member raised the question of application of other Standards to some of the longstanding issues (such as volumetric optionality contracts) and noted that simply referring to another Standard would not solve those issues. Therefore, he argued that the staff should perform additional analysis.
An FASB member asked the staff for additional analysis how the interdependencies would be captured in interaction with other contracts. Finally, the Boards asked the staff for additional analyses on the definition of interdependencies and allocation method. These will be discussed at a future joint meeting.
Transition requirements
The Boards discussed the possible transition requirements for the new guidance. From the start of the discussion it was clear that a clear majority of the Boards preferred full retrospective application, given the importance of the revenue figures in the financial statements. Although, some Board members raised concerns about the potential use of hindsight, the Boards decided to propose a full retrospective application and to require transition disclosures in accordance with general requirements of IAS 8 (IFRSs) and ASC 250 (US GAAP).
Effective date
The Boards continued their discussion by considering whether or not to permit early adoption of the proposed Standard.
The FASB members made it clear that the FASB did not intend to allow early adoption because of the importance of the comparability of performance of various reporting entities. Nonetheless, as the IASB Chairman noted, the IASB was in a more difficult position. Even though the comparability argument was acknowledged, given the history of allowing early adoption, some IASB members were reluctant to prohibit early adoption of a Standard that was perceived as improvement to financial reporting. On voting, for existing IFRS users the IASB was evenly split whether to prohibit or allow early adoption.
One Board member noted that given the amount of new Standards and scope of the changes in financial reporting expected to result from the current convergence efforts, the Boards should align the transition requirements, effective dates, and application to first-time adopters among the new Standards. Another Board member highlighted the need for consistency by relating to the scope discussion and implied complexities when effective dates and transition requirements were not aligned.
The IASB proceeded to discuss the application for first-time adopters. The IASB Chairman noted that prohibiting early adoption for first-time adopters would be politically unsustainable, especially for jurisdiction that would have to change revenue recognition systems twice in a very short period of time. The Board discussed the possibility of allowing early adoption only to jurisdiction adopting IFRSs in the following years, but on balance the majority of the Board thought that such limitation would not be enforceable. Therefore, the Board agreed to allow early adoption of the proposed guidance for the first-time adopters.
Summary of proposed model
The staff presented a summary of the proposed revenue recognition model and asked the Boards for comments on the document that would be used as basis for writing of the Exposure Draft. Due to time constraints, it was decided that any comments Board members had would be dealt with offline.
Financial Statement Presentation
Analysis of changes in balances of assets and liabilities
The Boards were asked to deliberate three implementation issues related to the tentative decision, taken at the October 2009 joint meeting, to require the presentation of changes in the balances of all significant assets and liability line items in the notes to the financial statements. Without any discussion on the matter, the Boards agreed that the analyses of changes should be presented in the context of related information as long as the analysis is accompanied by adequate narrative and descriptive explanations. When asked whether the analysis should be presented for the current period only or for comparable period as well, the Boards agreed that the current period financials would drive the presentation of the financials for prior periods and that an exception from providing comparative information is, therefore, not needed.
As some Standards in both accounting frameworks already require a reconciliation of the beginning and ending balance of some items, staff presented three alternatives for handling the existing requirements for specific reconciliations:
- Alternative A: the requirement to present analyses set out in the Financial Statement Presentation (FSP) Standard would supersede any existing requirements;
- Alternative B: maintain existing requirements. However, guidance on how to present the reconciliation would be removed from existing standards and replaced with a reference to the new FSP Standard; or
- Alternative C: maintain existing requirements and guidance on how to reconcile specific line items with an additional requirement that those reconciliations should be consistent with the requirements of the new FSP Standard.
Some Board members expressed concerns that preparers will see this requirement in a negative light and regard it as 'pile-on' of disclosures. One Board member suggested asking constituents a specific question on what reconciliations should be deleted or what information they fear would be lost if these reconciliations are no longer provided. Another Board member noted that there is an expectation that the Boards will address the information overload required by the various Standards, but that will be better dealt with as part of the Disclosure Framework. When asked to vote on the matter, the Boards tentatively agreed with Alternative C and that the analysis should explain the nature of the transaction or event that gave rise to the change separately distinguishing within each component any elements of change that are different from the others.
Definition of a remeasurement
Following consultation between the staff and a subset of Board members on an appropriate definition of a remeasurement, the Boards considered the following proposed definition of a remeasurement
an amount recognised in comprehensive income that reflects the effects of a change in the net carrying amount of an asset or liability and is the result of:
- a. a change in (or transacting at) a current price or value;
- b. a change in an estimate of a current price or value; or
- c. a change in any estimate or method used to measure the carrying amount of an asset or liability.
Some Board members expressed their concern that by including all three changes listed above may be excessive disaggregation, although they also admitted that by only including changes (a) and (b), there may be inadequate disaggregation. One Board member questioned how an entity should distinguish between a change in estimate and a remeasurement if all changes in the measurement of an item are regarded as remeasurements. Another Board member went further by fundamentally disagreeing with the proposal on the grounds that the definition of a remeasurement does not clearly articulate what a remeasurement is. The Boards deliberated the proposed definition further and tentatively confirmed the proposed definition and related guidance, but agreed to include a specific question on the proposed definition in the ED.
The Boards further tentatively agreed to exclude the sale of inventory from the presentation of remeasurement information. However, other remeasurements that relate to inventory and receivables would not be excluded from the requirements.
The Boards were also presented with proposed application guidance on remeasurements to be included in the ED. Although the Boards did not express any general disagreements with the proposed guidance, they agreed that Board member comments on this guidance will be addressed outside the meeting.
New categories for 'financing arising from operating activities' and 'assets and liabilities arising from equity'
The Boards tentatively confirmed a proposal to include a subcategory for financing from operating activities in the operating category of the Statement of Financial Position and the Statement of Comprehensive Income for all liabilities (and assets bound to the related obligation for the purpose of settling the liability) that
- do not meet the definition of financing;
- are initially long-term; and
- have a time value of money component evidenced by either interest or an accretion of the liability due to the passage of time.
The Boards then considered how to present dividends payable or instruments entered into as part of an entity's capital raising activities that do not meet the definition of equity. Based on the outcome of consultations between staff and a small group of Board members, the Boards tentatively agreed to revise the definition of debt to include assets and liabilities that arise from transactions involving an entity's own equity, such as:
- dividends payable,
- written put options on an entity's own shares, and
- a prepaid forward purchase contract for an entity's own shares.
Statement of Cash Flows for an entity with funds held on deposit
The Boards continued their discussion from the January 2010 joint meeting on whether a direct method Statement of Cash Flows (SCF) should be required for financial services entities.
The Boards tentatively decided to include the existing guidance in IAS 7 and Topic 230 about the types of cash flows that may be reported net, without an exception for loans made to customers and principal collections of loans.
Some Board members commented that there is general opposition from financial institutions to their presenting a Statement of Cash Flows as the information provided is not considered useful. They would rather present liquidity tables than a statement of cash flows. Other Board members noted that making a fundamental change to the direction of project will further delay the issuing of the ED. The Boards tentatively confirmed the recommendation that financial institutions be required to present a direct method SCF, showing cash inflows and outflows between the entity and its depositors as if they were settled by external funds.
It was agreed to include, in the ED, a specific question to financial institutions on whether they prefer the direct method statement of cash flows or the indirect method along with more aggregation of information, as well as seek input on the costs and benefits of presenting cash flows in such a manner.
Divergent issues
The Boards attempted to resolve some of the differences in their tentative decisions on the presentation of certain items.
Analysing changes in specific line items
The IASB tentatively decided at its January meeting to require an analysis of all the line items in the debt category, cash, short-term investments and finance leases in a single note disclosure. The FASB indicated that they did not want to include a similar requirement, although it will ask constituents whether the information is considered relevant.
Minimum line items
The FASB indicated that it did not wish to require the inclusion of minimum line items, similar to the IASB requirements, in the Statement of Financial Position or the Statement of Comprehensive Income.
Presentation of remeasurement information
At previous meetings, the FASB indicated that it did not want to change its tentative decision to require presentation of information on remeasurements in the SCI, however, following the earlier discussion about remeasurements, the FASB tentatively decided to align its presentation requirements to that of the IASB.
Sweep issues
The Boards discussed several matters carried forward from the discussion paper that have not yet been discussed as respondents to the discussion paper had little or no concern about those particular proposals.
The Boards reconfirmed their intentions that a separate Statement of Changes in Equity must be presented and that only the components of changes in equity could be presented in the notes to the financial statements.
Some Board members questioned whether an accounting policy disclosure on the classification of assets and liabilities in operating, investing, financing assets and financing liabilities is still needed as the classification is based on the business model of the entity. It was confirmed that there has been a change in the Boards' position on classification from the discussion paper to the exposure draft as the various categories are now clearly defined.
Without further discussion, the Boards confirmed the staff recommendations with regards to:
- not retain the requirement to disclose information about the maturities of contractual long-term assets and liabilities, as other Standards already require similar information to be disclosed;
- clarify that cash inflows and outflows related to VAT may be netted in the SCF. In addition, the general offsetting principle in IAS 1 will be included in the ED;
- include guidance on the disaggregation of information in the SCF for purposes of preparing a direct method SCF;
- require the presentation of subtotals and headings.
Support for package of decisions
The Boards discussed the length of the comment period for the ED as the presentation model proposed in the ED retains the basic principles proposed in the discussion paper. The Boards agreed to provide a comment period of 5 months. The Boards also supported the drafting and publication of an ED based on the package of tentative decisions.
One FASB member indicated a possible dissent from the ED related to the direct method SCF. Three IASB members indicated that they would definitely dissent from the ED, with two more members indicating that they may also dissent. In general, the reasons for their dissent relate to the direct method Statement of Cash Flows, concerns that the project did not achieve improvement from existing requirements, and that the costs of providing the additional information outweigh the benefits achieved by users.
Fair Value Measurement
The Boards continued their discussions on fair value measurements in accordance with the project plan presented at the December 2009 joint meeting.
Measuring the fair value of a financial instrument
As part of their deliberations on measuring the fair value of a financial instrument, the Boards were asked:
- if the highest and best use concept is relevant for the measurement of liabilities and financial assets;
- if the valuation premise concept is relevant for liabilities and financial assets;
- how the fair value of a financial instrument should be measured when there are offsetting risk positions; and
- if valuation adjustments should be made in a fair value measurement using valuation techniques.
Without much deliberation the Boards tentatively agreed that the 'highest and best use' concept is only relevant for non-financial assets because financial assets do not have alternative uses, as changes in the terms of the financial asset will result in a different asset. A similar principle applies to liabilities where a change in the terms of a liability will result in a different liability. The Boards then also agreed that if the highest and best use concept does not apply to liabilities and financial assets, the valuation premise is not relevant either. This will avoid the need to determine a valuation premise for liabilities and financial assets when there is only one possible result.
The Boards then considered whether to provide a practical expedient allowing entities to measure fair value of a financial asset or a financial liability by considering offsetting market risk positions, including credit risk in Levels 2 and 3 of the fair value hierarchy. In considering the merits of the practical expedient, the Boards were presented with two illustrative examples prepared by the staff (these were not made public) dealing separately with credit risk adjustments and other market risk adjustments.
The Boards deliberated at length whether an adjustment should be made for credit risk when financial instruments are valued as part of a portfolio. Several Board members noted that they support the view in the illustrative examples where an adjustment for credit risk have been made, although they acknowledged that such a view is not in accordance with existing and proposed guidance on fair value measurement. The staff explained that this is the reason why a practical expedient has to be included in the guidance. By a very small margin, the Boards tentatively supported the adjustment for credit risk. One Board member reminded the Boards that such a significant change to the proposed guidance will require re-exposure of the guidance and may result in this Board member dissenting from the proposed guidance.
The Boards then considered the illustrative example dealing with offsetting other market risk positions. Both Boards indicated that such an adjustment would not be in accordance with existing guidance, with some members questioning why an entity would make adjustments for offsetting market risk positions when presentation in the statement of financial position will be on a gross basis. The majority of Board members did not support the staff recommendation to allow entities to measure fair value by considering offsetting market risk positions.
The Boards also deliberated the valuation adjustments that may be needed when measuring the fair value of a financial instrument when there is not a quoted price that instrument (that is, when a valuation technique is used). The Boards tentatively agreed to describe the type of valuation adjustments that might be needed in measuring fair value, without being too prescriptive.
It was also agreed to include a requirement that any valuation adjustments must be consistent with the objective of fair value measurement, that is, only including those adjustments that market participants would include.
Premiums and discounts in a fair value measurement
Comments received on the IASB's ED and at round-table discussions highlighted divergent interpretations of the term 'blockage factor'. The Boards were asked to clarify what a blockage factor is. The Boards agreed that is an estimate of the reduction in a quoted price that would occur if a market participant were to sell a large holding of instruments at one time. A blockage factor is, therefore, specific to the transaction and not to the instrument – for this reason it should not be included in a fair value measurement at any level of the fair value hierarchy.
The Boards also tentatively confirmed that this does not preclude the application of other premiums and discounts within Levels 2 and 3, such as control premiums, lack of marketability discounts, and minority interest discounts, because those are adjustments that a market participant would consider in pricing and asset of liability.
Valuation premise for non-financial assets
In the ED, the IASB asked whether the proposed guidance for the in-use and the in-exchange valuation premise is appropriate. Some respondents commented that they do not agree that an asset is sold individually in the in-use valuation premise because the assets are typically sold as a group. The Boards were asked to confirm their assumption that the asset is sold individually.
The Boards confirmed that the in-use valuation premise assumes that the individual asset's value is measured in the context of its use with other assets as a group and that the market participant buyer has the complementary asset – the right to manage or operate it. The Boards therefore tentatively agreed that the in-use and in-exchange valuation premise assume that the asset is sold individually and not as part of a group of assets or a business.
There appears to be confusion about the terms 'in-use' and 'in-exchange' as both relate to the use of an asset, and both rights are sold in exchange transactions. The Boards were presented with two alternatives for resolving the confusion:
- Approach 1: retain the existing methodology but better explain the meaning of the terms; or
- Approach 2: delete the terms and rather describe the objective each in the standard.
One Board member recommended that the guidance should be written in such a way that not only valuers will understand the meaning, and that the meaning of the terms should be made clearer in way that 'ordinary' people will be able to understand what the standard requires them to do. The Boards tentatively expressed support for Approach 2, subject to the understanding that the objectives are expressed in a better way.
Highest and best use
At their January 2010 joint meeting, the Boards tentatively confirmed that fair value measurement reflects market participant views. At this meeting, the Boards tentatively agreed that as market participant buyers will consider how they will use the non-financial asset when determining the price they are willing to pay – the price will reflect the asset's highest and best use by market participants.
In addition, the Boards were asked whether to include and describe the terms 'physically possible', 'legally permissible', and 'financially feasible' in the context of 'highest and best use' in the proposed standard. The Boards agreed to include a description of the terms and their impact on highest and best use in the proposed standard.
Incremental value
The IASB's ED referred to incremental value as the difference between the current use value of an asset and its fair value (highest and best use value). The Boards considered whether to require entities to separate the fair value of an asset into two components or only require the disclosure of relevant information when an entity uses an asset (recognised at fair value) together with other assets in a way that differs from its highest and best use.
Staff recommended that disclosures should only be provided when an asset is used in a way that is different from highest and best use, and this would be expected to occur only in rare circumstances. One Board member commented that the issue has been raised at the Hong Kong roundtable meetings, where it may be possible to operate a hotel on a site that can be of higher and better use as an apartment building; however, it would take a number of years to convert the hotel.
The Boards had a short discussion on whether assets should be componentised, but when asked to vote, the majority tentatively supported the staff's proposal to require disclosure only.
Wednesday 17 February 2010 (IASB Meeting)
Consolidation
Disclosures
The staff noted that as part of their preparations for joint IASB/ FASB deliberations (in March 2010) of proposed disclosures in ED 10 and those in FAS 167, they had identified issues to be decided by the IASB in advance of the March meeting:
- whether the proposed disclosures in ED 10 and ED 9 Joint Arrangements could be combined into a comprehensive disclosure standard for a reporting entity's involvement with other entities that is not in the scope of IAS 39 Financial Instruments: Recognition and Measurement and IFRS 9 Financial Instruments;
- whether a reporting entity should disclose information about its risk exposure from its involvement with unconsolidated entities; and
- whether those disclosures should be integrated into the proposed comprehensive disclosure standard for involvement with other entities.
A single disclosure standard
After a brief debate, the Board agreed that the proposed disclosure requirements in ED 10 and ED 9 should be combined with the disclosures in IAS 28 within a comprehensive disclosure standard that addresses a reporting entity's involvement with other entities that are not in the scope of IAS 39/IFRS 9. In addition, the Board agreed that such a combined disclosure standard should include the proposed disclosure requirements for joint operations that might not relate to an involvement with another entity.
Disclosures – Unconsolidated structured entities
The staff noted that ED 10 proposed disclosure requirements for both subsidiaries and unconsolidated structured entities. While there was general agreement among respondents that additional disclosures about subsidiaries would assist users in their understanding of consolidated financial statements, many questioned the proposal to require disclosures about the nature of, and risks associated with, the reporting entity's involvement with structured entities that the reporting entity does not control.
In another brief debate, the Board:
- Agreed that a reporting entity should disclose information that enables users of its financial statements to evaluate the nature of, and risks associated with, structured entities that the reporting entity does not control.
- Agreed that these disclosures should be integrated into the proposed combined disclosure standard for a reporting entity's involvement with other entities, rather than IFRS 7.
The Board resisted the temptation to address disclosures for separate financial statements as part of this project.
A Board member also noted that the proposed disclosure standard would also be the appropriate place for any disclosures arising from the Board's Derecognition project.
Rate-regulated Activities
Summary comment letter analysis
The staff presented a summary of their comment letter analysis of comments received on Exposure Draft ED/2009/8 Rate-regulated Activities. No technical decisions were made, but significant scheduling issues were addressed and it is now unlikely that the original timetable for redeliberation and approval of an IFRS can be sustained. Since many of the routes open to the Board would involve re-exposure of the proposals, the earliest that an IFRS could be issued is now estimated to be Q3 or Q4 2011.
The Observer Note for this meeting is available on the IASB's Project Page. It presents a comprehensive and balanced assessment of the key issues raised as a result of the ED. Outside the utilities sector respondents, respondents agreeing with the ED's proposals and those who did not support them were evenly balanced. The utilities sector, particularly from North America, was strongly supportive of the ED.
The staff were not satisfied that they had sufficient international consensus to recommend any direction for the Board at this time. They asked the Board to allow them to undertake further research and analysis on the fundamental issue of whether assets and liabilities arising as a result of the actions of a regulator exist in accordance with the current IASB Framework and consistently with other IFRSs.
While supporting the staff's desire to explore further the issues identified in the comment letters, several Board members were concerned that the results of that analysis would not lead them to come to a different conclusion on the fundamental issue identified by the staff.
At least one Board Member noted that in his discussions with national standard-setters and other constituents, it was obvious that the ED had not convinced those constituents. The IASB's model was not well understood and had not been accepted. Another Board member remained concerned about the inference that the ED was an 'industry-specific', almost jurisdiction-specific proposal. He was opposed to such standards and would seek to have the IFRS apply generally (that is, look at the fundamental issue broadly).
Another Board Member noted that having opened the debate, the IASB had to act in some way, or risk a lack of comparability in the future. He noted that some aspects of FAS 71 (the US standard) are incompatible with IFRSs, and the Board needed to make that clear in any IFRS or other communication.
The staff noted that they would require at least two months to conduct the additional analysis and consequently redeliberations of the ED could not begin until late Q2 2010.
The Board agreed the staff's request for more time to analyse the technical merits of the fundamental issue identified.
Transition relief for first-time adopters
The Board agreed to remove from the ED 2009/8 project and approve as an Amendment to IFRS 1 the proposal that an entity with operations subject to rate regulation be permitted to elect to use the carrying amount of items of property, plant, and equipment held, or previously held, for use in such operations as their deemed cost at the date of transition to IFRSs. This was exposed in September 2008; comments were received by 23 January 2009; and the Board completed its redeliberations in May 2009. Finalisation of the amendments was postponed with the intention that they be incorporated in the standard on Rate-regulated Activities. The staff was confident that all due process steps with respect to the 'deemed cost' exception had been completed and that the amendment could be issued without further delay. The Amendment would be included in the next omnibus Improvements to IFRS, due to be issued in April 2010.
Wednesday 17 February 2010 (IASB-FASB Joint Meeting)
Replacement of IAS 39: Hedge Accounting
Hedged items: Approach for determining what risk components are eligible for designation
The Boards discussed, primarily in the IASB context, possible conditions for bifurcation-by-risk. The discussion was a follow-up to the 2 February 2010 Discussion in which some IASB members expressed their concerns that the broad approach to risk components designation might lead to what would be a free choice in componentisation of item and could lead to situation that designation of a component would automatically result in accounting relationship being 100% effective.
The staff paper provided an analysis of the current requirements of IAS 39 with the emphasis on the criteria for eligibility of risk components to be designated as hedged items being separately identifiable and reliably measurable.
Based on application of the IAS 39 criteria to a set of risk components may or may not be explicitly specified in the contract, the staff concluded that IAS 39 criteria do not lead to a free choice of how to split an item into components and do not automatically lead to 100% effectiveness of hedging relationship. Nonetheless, the staff concluded that current requirements of IAS 39 are problematic as they are rule-based and internally inconsistent.
Following this discussion the Board agreed to explore a new criterion for the purpose of determining eligible hedged components. The staff will present such analysis at a future Board meeting.
In the following discussion about possible criteria, one Board member expressed his concerns whether, in case of non-contractually specified risk components, would the risk component be separately identifiable within the entire hedged items. He argued that application of IAS 39 in some of these cases do not result from the fact that the risk component was separately identifiable, but rather from the fact that IAS 39 allows it to be a hedged item. He expressed his concerns about interdependence of risk components in many of the cases.
Another IASB member reinforced this view, by expressing his doubt whether this proposed approach would be operational. He also expressed his view that hedge accounting as such is an exception to the classification and measurement principles of financial instruments. Therefore, in his view, it would be difficult to formulate a broad principle underpinning hedge accounting, and some rules would be necessary.
The staff responded that it was not their intention to formulate the principle behind hedge accounting but rather a principle-based approach for designation of risk components that, in their view, should be possible.
Another Board member supported the broad direction the staff had taken. He asked the staff whether, based on the preliminary analysis, the new criteria for designation of risk components would be broader or narrower in comparison with current requirements of IAS 39. The staff responded that the answer would depend on the usefulness of the information provided to the users of financial statements.
One FASB member noted that the criteria need to be fleshed out before it was possible to determine how operational would the guidance be.
The staff noted that more attention should be focused on the reliably measurable criterion, rather than separately identifiable criterion.
One IASB member stated an example of an AA rated fixed rate instrument. He noted that in the past the benchmark interest rate decreased by 50 basis points whereas the AA rate increased by 100 basis points. He asked the staff to apply any criteria to the example and assess whether the benchmark interest rate was eligible for risk component designation.
The discussion continued by focusing on the FASB approach to bifurcation-by-risk for financial instruments within the remits of the overall FASB model for financial instruments.
The FASB staff recommended the application of the current bifurcation-by-risk model in the ASC Topic 815 if the FASB retains the tentative classification and measurement model for financial instruments. Further, the staff recommended that if the FASB increases the amortized cost category to allow more financial instruments to be measured at amortized cost, the FASB should utilize bifurcation-by-risk guidance similar to that proposed in FASB ED Accounting for Hedging Activities, issued in June 2008, to determine if the relationship qualified for hedge accounting.
The FASB agreed with this staff recommendation. The FASB also agreed that the reasonable effective threshold for hedge effectiveness (also proposed in June 2008 FASB ED) should be carried forward into the new guidance, thereby allowing more hedging relationship to qualify for hedge accounting. The FASB members noted that given the FASB tentative model, the current US GAAP model is the least onerous. However, they noted that any drift to amortized cost category beyond own debt would mean that a more fundamental change was required.
The Boards discussed both models and concluded that it is very difficult to further specify the hedge accounting models until the classification and measurement guidance is finalised (the cut between the fair value and amortised cost). The differences between both models are based mainly on the fact that the FASB and IASB classification and measurement models are different, thus leading to different requirements for hedge accounting.
The FASB briefly discussed any need for fair value hedge accounting in the context of financial instruments held for the contractual cash flows. The Board members noted that it is more a synthetic accounting rather than a hedge accounting, that is, its purpose is in many cases to lock-in a cash flow in case of mismatch of fixed-rate financial assets financed by variable-rate financial liabilities (such as in the context of a financial institution).
The Boards summarised that the FASB hedge accounting model would portray all the risk in the financial statements whereas the IASB model consistently with the amortised cost notion would not portray all the risks in the financial statements. One IASB member noted that a paradoxical implication of the FASB model in the IASB context would be that financial instruments measured at amortised cost subject to hedge accounting rules would also portray effects of non-hedged risks in the profit and loss (fair value) whereas reporting entities not applying hedge accounting rules would not.
The FASB disagreed as they believed that their model provided a consistent measurement attribute and any inefficiency in the profit or loss portray the actual financial risks and their management by the reporting entity.
The IASB members noted that the IASB had previously decided to apply the cash flow hedge mechanics also to fair value hedges that would provide a consistent measurement attribute.
Finally, both Boards noted that the different position on hedge accounting is reflection of the differences of the classification and measurement models. Nonetheless, both Boards expressed their willingness to explore a set of criteria for designation of risk components and discuss them at one of the following Board meetings.
Replacement of IAS 39: Classification and Measurement – Financial Liabilities
This session was primarily an IASB session. The FASB will discuss measuring liabilities held to pay contractual cash flows together at a later separate FASB meeting.
Without much discussion the IASB agreed that financial liabilities held to pay contractual cash flows that have pain vanilla contractual cash flow characteristics should be measured at amortized costs unless the fair value option is elected.
Bifurcation methodology
The Board continued its discussion about the bifurcation methodology for the financial liabilities that are held to pay contractual cash flows and have non-vanilla contractual cash flows. (At the meeting on February 10, 2010 the IASB decided that such liabilities should be bifurcated into a host and the embedded features.)
The Board discussed two possible alternatives: maintaining the criteria of IAS 39 Financial Instruments: Recognition and Measurement or using bifurcation approach based on classification conditions in IFRS 9 Financial Instruments.
Although, many IASB members noted that IFRS 9 approach might be conceptually more sound (for instance, due to symmetry question), most of the IASB members agreed that retaining IAS 39 criteria to bifurcation would be less disruptive. Moreover, the IASB members liked the focus on the nature of the embedded feature rather than contractual approach.
The Board agreed that for most of the instruments the results of application of any of these bifurcation methods would be the same. However, one of the IASB members also expressed his doubts how operational would the IFRS 9 approach be for liabilities paying a market interest rate, but payment of the interest cannot be made unless the issuer is able to remain solvent immediately afterwards. He noted that valuation of compliance with prudential rules would be overly complex.
Finally, the IASB unanimously agreed to apply the IAS 39 bifurcation requirements for financial liabilities.
The FASB noted that the bifurcation methodology is very close with the FASB methodology for embedded derivatives.
Fair Value Option
The Board discussed the application of fair value option to financial liabilities.
The Board unanimously agreed to retain the fair value option for financial liabilities. As one of the IASB members noted, the fair value option was specifically designed for financial liabilities in the first place. In addition, the Board also confirmed all three eligibility conditions in IAS 39 for application of the fair value option (accounting mismatch, financial liabilities being managed at a fair value basis, financial liabilities containing one or more embedded features being accounted for in their entirety).
The Boards had a rather significant discussion on how to address the issue of the changes in own credit in the context of financial liabilities to which the fair value option is applied.
In effect, the Board discussed two alternatives of isolation of the effects of changes in own credit risk – either present the change in own credit risk a separate item directly in equity or in other comprehensive income.
The Board was relatively split in the discussion which solution was more appropriate. Some Board members preferred the presentation directly in equity as they believed that the change in credit risk represents a kind of a wealth transfer between creditors and owners. As one Board member noted, conceptually a debt instrument contains a put option on own equity and thus equity is the most appropriate place. On the other hand, other Board members stressed that nature of the changes in own credit risk does not represent a transaction between the entity and the owners and thus should not pre presented directly in equity but rather in a performance statement. They also cited potential problems with this approach – implication for company law in many jurisdictions (as this component might not be eligible to be 'equity' in some jurisdictions).
Finally, the Board narrowly approved the isolation of the changes in own credit risk in other comprehensive income.
Most of the Board members agreed that the mechanics of the isolation should include recognition of the total fair value change in profit or loss and separate recognition of the portion attributable in own credit risk in other comprehensive income with the offsetting entry to profit or loss. Some of the Board members questioned complexity of this mechanics, even though they acknowledged the benefits of enhanced transparency. The staff will provide additional analysis on the benefits of this approach to presentation.
The Board continued with a discussion whether to recycle the amount related to changes in own credit from other comprehensive income to profit or loss if the liability was derecognised before maturity. Even though some Board members noted that recycling might provide more useful information a narrow majority of the Board members agreed that the amounts should not be recycled.
Some Board members expressed their view that the approved model is overly complex and one of the objectives of the changes to financial instruments accounting was to reduce complexity.
One Board member said that isolation of the changes in own credit is not appropriate for all liabilities to which fair value option can be applied. According to this Board member, the presentation of the change in own credit in other comprehensive income is appropriate only for fair value option applied to a financial liability containing one or more embedded features being accounted for in its entirety. In the other two cases (accounting mismatch, management on a fair value basis), such separate presentation might exacerbate the mismatches that the fair value option was designed to minimise and would thus defeat the purpose of fair value option.
Leases
Accounting for Changes in Contingent Rentals
The Boards agreed that changes in amounts payable under contingent rental arrangements arising from current or prior periods should be recognised in profit or loss and all other changes should be recognised as an adjustment to the lessee's right-of-use asset.
One FASB member disagreed with that approach as he believed that contingent rentals are unlike other estimates and, thus, should be allocated between profit or loss and the right of use asset on the same basis as the right-of-use asset is amortised.
One IASB member raised his concerns related to granularity of the reporting period, especially in case of interim reporting. Nonetheless, other Board members believed that the issue is not limited to contingent rentals and, if necessary, should be addressed in a review of the interim reporting standard, that is, outside of scope of this project.
The Boards also agreed that all changes in amounts payable under residual value guarantees should be accounted in the same way as other contingent rental arrangements.
One IASB member noted that to he would prefer a formulation that would focus on booking of the changes in the current period unless they stem from the change of usage of the right-of-use asset.
The Boards also agreed that changes in the lessor's receivable should be treated as adjustment to the original transaction price and be allocated to the lessor's performance obligation. Further, if changes are allocated to a satisfied performance obligation, the effect should be recognised in revenues. On the other hand, if changes are allocated to an unsatisfied performance obligation, they will adjust the carrying amount of that performance obligation.
Although the Board agreed with the underlying principle of allocation, wording proved to be contentious. Therefore, the Boards decided to discuss the wording of the guidance offline.
Moreover, some Board members were unsure that time would be always appropriate criterion for allocation of satisfaction of performance obligation. The Boards agreed to find a formulation that would reflect the allocation based on the most appropriate factor (time, cost, usage).
Scope – Purchase or sale of the underlying asset
The Boards agreed that the principle that would determine whether a transaction represents a sale or purchase of the underlying asset (rather than a lease contract) should focus on control and, in particular, on transfer of residual benefits. The principle sought would ensure that no gain/loss at the end of the contract is possible.
Subject of drafting of the principle, the Boards agreed that a seller (lessor) shall not apply these requirements to contracts that will transfer all benefits associated with the underlying asset by the end of the contract. Conversely, the Boards agreed that a buyer (lessee) shall not apply these requirements to contracts under which the buyer/lessee will obtain all benefits associated with the underlying asset by the end of the contract.
The Board also agreed that the focus should be on all (but trivial) benefits rather than significant.
Based on these decisions, the Boards decided to include examples of transactions that would generally be considered to be purchases or sales of the underlying asset (including contracts that automatically transfer title, contracts that include bargain purchase option, and contracts where the return the lessor receives is fixed). The Boards discussed additional examples and noted that the decisive condition is existence of any residual benefits.
Finally, the Boards discussed the very long leases of land (for example, 99 years). The Boards were split whether to account for them as sales of underlying land or as leases. The Boards discussed various examples and noted different practices in various jurisdictions (including when the sale of land is legally prohibited). The Boards noted that none of the models is perfect and each has its shortcomings. After a rather lengthy discussion, it was clear that the Boards were split on the issue, with a narrow majority in favour of treatment as sales. Most Board members felt uncomfortable with, for instance, a 200-year revenue deferral, particularly when consideration is transferred at inception.
Initial Direct Cost
The Boards discussed the definition of initial direct cost and agreed that these should be defined as incremental costs directly attributable to negotiating and arranging a lease.
Despite agreement on this definition the Boards noted that the decision should be consistent with the treatment of the initial direct costs in other projects (Revenue Recognition, Insurance, and Financial Instruments). Subject to this caveat, the Boards agreed to include additional guidance to illustrate which costs are directly attributable to acquiring a lease.
Some Board members noted that definition of initial direct costs might vary if they are referred to from lessor or lessee perspective. Nonetheless, the main discussion by the Board focus on treatment of the unit of account of those costs and their treatment, for example, within the context of a lease origination department.
Consolidation
Investment Companies
The Boards discussed possible guidance for investment companies that would exempt them from the requirement to consolidate entities they control. The aim of the discussion was to consider the implications on accounting for an investment company (fund) that holds various investees. The discussion did not consider accounting by a fund manager for its interest in the investment company (fund). That issue is planned to be discussed by the Board at the March joint meeting.
The Boards received feedback from constituents that in a great majority disagreed with the requirement to apply the control principle in ED 10 Consolidated Financial Statements to investment companies. The industry organisations argued for an amendment to ED 10 that would require an investment company to account for all of its investments at fair value even if controlling interest is held. The industry representatives argued that the consolidation view is often ignored in practice as it does not provide useful information for users, particularly in cases when the investment is held only to receive income and capital appreciation (such as investments held by a mutual fund or unit trust).
The Boards argued that even if special requirements for investment companies are agreed, all entities should apply the requirements of the consolidation standard to assess control of an entity. Only if the control exists, the entity shall determine if it meets the criteria for an investment company and, therefore, is required to measure its investments using fair value with changes in fair value recognised in profit or loss.
Given the arguments of the industry, the majority of the IASB was prepared to consider that fair value measurement could be the appropriate measurement for all investments held by investment companies. Nonetheless, some IASB members argued that conditions for this exception should be extremely tight to avoid possible structuring opportunities. In addition, some IASB members thought that consolidation would be more appropriate when control exists despite the existence of self-imposed restrictions on the ability to direct assets and liabilities. Such restrictions could, in many cases, be revoked by the reporting entity.
The IASB then considered two possible criteria for investment companies: one based on the US GAAP requirements (ASC Topic 946, formerly the AICPA Investment Company Guide), or a second based on a new set of criteria that would capture the proposals by the industry.
Most of the Board members agreed that the US GAAP guidance is an established base that works in the practice. Some Board members were concerned with the US-specific requirements and definitions and how those could be carried forward in a standard in the international context. Finally, the IASB and the FASB agreed to develop a generic international guidance based on the current US GAAP requirements that would exclude US specific references (for example, to the Investment Company Act).
The Boards discussed also the application of this guidance by venture capital companies and some private equity funds, as those entities are within the scope of ASC Topic 946 by direct reference to Investment Company Act of 1940. The Boards discussed a set of potential criteria and directed the staff to provide additional analysis for the next joint meeting. The Boards noted that a possible solution could include a specific reference to genuine external investors.
Some Board members raised the possibility of structuring opportunities by creating an 'internal' venture capital structure to avoid consolidation. A way to prevent those structuring opportunities was a consideration that such fair value accounting would be reversed by the parent of the investment company, unless the parent is Investment Company itself. The staff would provide additional analysis of the issue at the next meeting.
Finally, the Boards agreed that investment companies required to report investments at fair value should provide additional disclosures. One Board member suggested that in addition to an overview of all individual investments, separate financial statements of the investees might be provided. The Boards agreed that such disclosures should be developed in the context of the overall disclosure package for consolidation. Nonetheless, the Boards noted that the focus should be on disclosures about the relationship between the investment company and the investee that are different from disclosures required for in a normal parent-subsidiary relationship.
One IASB member noted that the changes proposed to ED 10 are fundamental and therefore, in his opinion, would require re-exposure of ED 10. The IASB Chairman agreed.
Thursday 18 February 2010 (IASB Meeting)
Post-employment Benefits
Disclosure
The Board discussed a proposed disclosure package to accompany the forthcoming exposure draft of amendments to IAS 19 Employee Benefits.
Board members noted with approbation that the volume of disclosures was much more reasonable than previously suggested, but several continued to be concerned that repetitions and redundancies remained. It was also suggested that a limited field test should be conducted before the exposure draft is issued. A company with pension obligations in multiple jurisdictions should be asked to prepare the proposed disclosures. The goal would be to identify any aspects of the proposed disclosure package that may be difficult to understand or impracticable to implement.
The Board also asked for clarification about the extent of the interim reporting requirements suggested by the staff proposal. Although the staff responded that the forthcoming Improvements to IFRSs Standard would include improved language in IAS 34 that would clarify the general principle of 'tell users what has changed' since the last annual (or interim) report, it was clear that some Board members were not as confident as the staff that the Board's intentions would be understood.
A Board member was also concerned about the practicability of the staff's proposals with respect to sensitivity analysis, in particular that relating to the significant components of the actuarial assumptions.
The Board agreed that the staff should continue to work with the Board member project advisors to address the Board's concerns and proceed to the pre-ballot draft stage. Mr Yamada reserved his vote, indicating that he may dissent on the basis of the proposed presentation of pension expense in the statement of comprehensive income.
The Board also directed the staff to be clear in the exposure draft that the proposed exemption for pension plan assets from the disclosure requirements of the forthcoming IFRS on fair value measurement was an exemption from disclosures only (and not measurement). The staff noted this direction.
Thursday 18 February 2010 (IASB-FASB Joint Meeting)
Leases
Lessee accounting – Transition
The Boards discussed transition requirements for capital/finance leases from lessee's perspective. The Boards noted that for simple finance leases there would be no significant difference between the old model and new model apart from classification. For more complex leases with extension options and contingent rentals, no solution would ensure the benefits of complete comparability as well as simplicity of implementation.
Board members held various views. One Board member was particularly concerned that the implications of the new model would lead to an overall increase in expenses in the first years following transition (as costs allocated to first years under the new model are higher than those allocated to the following years, and after transition all the leases will be in their first year thus increasing the overall expense).
Finally, after a brief discussion, the Boards agreed that for simple leases, assets and liabilities under finance leases remain the same on the transition date with no change to the accounting for those assets and liabilities subsequently. Nonetheless, for leases containing additional features such as contingent rentals, residual value guarantees, or extension options, the proposed general transition requirements would apply to both assets and liabilities (that is, modified retrospective application).
The Boards agreed that the right-of-use asset should be recognised and measured at the present value of the lease payments discounted using the lessee's incremental borrowing rate on the transition date, subject to impairment review and any further adjustments for rentals prepaid or accrued.
Without much discussion the IASB agreed that if an asset acquired under a finance lease is accounted for using the revaluation model, the revalued amount of property, plant, and equipment should be carried forward as carrying amount of a right-of-use asset.
Lessee accounting – Definition of 'interest rate implicit in the lease'
The Boards agreed with the principle that the discount rate that should be used to calculate the present value of the lease payments is the rate that the lessor is charging the lessee. Some Board members felt that such principle would not be operational, and additional guidance would be required.
One Board member suggested that the principle should the objective for determining the discount rate (that is, a finance lease includes a financing element that reflects the uncertainty of the cash payments). He noted that in many circumstances the rates might be marginally different for lessor and lessee, but those differences would not be significant as they relate only to allocation method. The Boards agreed.
Financial Instruments with the Characteristics of Equity
Broad classification questions
The Board considered particular financial instruments and their desired classification in order to be able to determine a principle underpinning the model being developed.
Firstly, the Boards reaffirmed all their decisions already made during the project.
The Boards also agreed that nominally perpetual instruments issued by limited-life entities should be classified as equity in the separate financial statements of the issuer.
The Boards agreed that, consistent with the previous decisions, contracts that require issuance of specified number of puttable and mandatory redeemable equity instruments for a specified price (which are classified as equity in accordance with previous decisions) and contracts covering derivatives classified as equity would be classified as equity. On the other hand, contracts over puttable instruments that would be bifurcated when issued would be classified as a liability.
Contracts that require an entity to issue a specified number of equity instruments in exchange for no future compensation (prepaid instruments) would be classified consistently with contracts that require specified-for-specified issuance of equity instruments (see previous paragraph).
The Boards also agreed that mandatorily convertible preferred shares convertible into specified number of perpetual equity instruments or specified number of puttable or mandatory redeemable equity instruments would be classified as equity.
Finally, both Boards agreed that the classification of an instrument in a subsidiary's financial statements should be carried forward in the consolidated financial statements unless the nature of the instrument changes in consolidation because of arrangements between the instrument holder and another member of the consolidated group. If the nature of the instrument changes in consolidation, classification should be reconsidered in the consolidated financial statements.
Puttable shares and gross-up of freestanding written put options
The Boards decided that puttable shares should be separated into a share and a written put option, and that the written put option should be reported net as a liability even if the exchange is specified-for-specified. The Boards further decided that all freestanding written put options should be reported net as liabilities.
One Board member preferred grossing up of the separated put option as he believed that the agreed solution should facilitate structuring of the debt as equity. However, most Board members disagreed as they believed that any alternative that contains grossing up could be counterintuitive and extremely complex to implement.
The Boards agreed to add special provisions to prevent abuses (such as an example that issuing shares and an in-the-money put option at the same time to the same party should be linked as treated as a single debt instrument).
Convertible debt
The Boards considered bifurcation of convertible debt. The IASB preferred bifurcation of convertible debt as Board members believed that such treatment is more consistent with the overall IASB model. Moreover, the IASB members believed that the existing requirement for bifurcation of convertible debt is well understood, used in practice, and perceived as decision-useful. As one IASB member noted, even if convertible debt were classified as liability in its entirety under this project, it would be bifurcated under the proposed guidance for classification and measurement of financial liabilities, which would then require a new set of conditions for bifurcation and result in additional complexity.
On this basis the IASB decided to retain the conditions for bifurcation of convertible debt. Views of FASB members were divided, with some members preferring measurement of convertible debt at fair value through net income in its entirety, and others preferring bifurcation. Finally, the FASB narrowly decided to proceed with bifurcation.
The Boards also considered the methodology for bifurcation. Some Board members preferred a simplified bifurcation method by which the debt component would be allocated on the basis of a 'plain vanilla' instrument with the same maturity date, and the interest rate would be the rate of nonconvertible bond of comparable credit quality from the same issuer (with the remainder allocated to the equity component). Other Board members preferred to retain the IAS 32 bifurcation method, in which any interdependency is allocated to the liability component. Most Board members preferred the simplified method, subject to additional analysis by the staff that would consider potential consequences of such an approach.
Fair Value Measurement
Measuring the fair value of difficult-to-value assets and liabilities (including unquoted equity instruments)
Without much discussion, the Boards agreed not to provide specific guidance for measuring the fair value of difficult-to-value assets and liabilities (including unquoted equity instruments) in the converged fair value measurement Standard, as any guidance would be prescriptive and inconsistent with principle-based standards.
Nonetheless, the staff noted that it plans to develop educational material that should address potential concerns by constituents.
The Boards also agreed not to include guidance about when cost might be an appropriate estimate of fair value in the converged fair value measurement Standard. The IASB decided that such guidance will be retained in the individual standards (that is, in IFRS 9 and IAS 16). Some IASB members said that eventually all the guidance should be in the fair value measurement Standard or, if redundant, eventually withdrawn from IFRS 9 and IAS 16.
Insurance Contracts
Presentation from the Chair, IAIS Insurance Contracts Subcommittee
Robert Esson made a short presentation on behalf of the International Association of Insurance Supervisors. He stressed that the supervisors were increasingly concerned about the boards' approach to considering issues on theoretical grounds on an individual basis. He acknowledged that this was a necessary step; however, the IAIS believed that the boards should also consider the impact of their tentative decisions made on the totality of financial reporting by insurers. In his view, the boards ought consider the business structure for insurers and determine whether, in totality, the tentative decisions made so far would lead to useful information for users of the financial reports of insurers.
In particular, he stressed that any financial reporting model introduced by the boards would involve some degree of pragmatism. What was important is that the financial reporting should reflect the economics of the business and not introduce volatility that is not reflective of the economics of the business.
Throughout the presentation, Mr Esson noted that the IAIS had identified a key principle that should prevail: that a model using unbiased, probability-weighted cash flows would provide an answer to many of the problem in the insurance contracts project. In particular, he noted the problems created by forcing the residual margin to calibrate the profit or loss on inception of the contract to zero. If the model were permitted to weight acquisition costs as a '1.0' (that is, certain) cash flow, the residual margin would be lower, acquisition costs would still be expensed, but the deferred profit embedded in the residual margin would not be distorted. He acknowledged that unbiased probability-weighted cash flows were not perfect, but they were significantly better than the direction that the boards were taking.
Board members asked for clarification of certain issues, but it seemed that many of the more vocal board members were not persuaded by the presentation.
Insurance contracts - unbundling
The boards discussed whether an insurer should recognise and measure those components of a contract as if they were separate contracts (unbundling). The staff introduced the technical discussions by noting that the IASB and FASB staffs were split on the issue.
The IASB staff were largely supportive of the following positions:
An insurer should unbundle a component of an insurance contract if that component is not interdependent with other components of that contract. This would also apply to those components of insurance contracts that are embedded derivatives.
If components are interdependent, an insurer:
- should not be permitted to unbundle those components of the contract for recognition and measurement.
- should not separate any deposit element from the remainder of the premium for presentation in the performance statement.
The FASB staff had prepared an Alternative View:
- the notion of interdependency should apply only to situations in which the components cannot function independently, that is, only to those situations where a truly symbiotic relationship is necessary for the individual components to function;
- embedded derivatives in an insurance host contract should continue to be subject to existing guidance for derivative instrument accounting and bifurcated when appropriate. There should not be an exception from [IFRS] for insurance-the general notion in the insurance contracts project should be to address insurance specific issues; and
- contracts subject to unbundling should be presented on an unbundled basis on both the balance sheet and income statement.
The discussion that followed was often difficult to follow as board members flipped between agenda papers at will. However, it was clear that there was a lack of consensus between the FASB and the IASB – although some IASB members were supportive of the FASB staff view. One IASB member noted six significant problems with the proposed model and felt that the notion of 'interdependency' was at the root of all of them.
An IASB member noted that the notions of independence versus interdependence were difficult to analyse, but that he was sympathetic to using a unitary whenever possible: he was uncertain that it was worth the effort to separate the components of an insurance contract. What was important to users was the aggregate measure, not the individual components and he urged the boards not to over-engineer the IFRS. An IASB staff member noted also that the additional work implied by the FASB view would entail significant effort without much additional benefit (especially in jurisdictions outside the US and European Union).
In an attempt to achieve some direction, the IASB staff suggested a modified proposition:
Unbundling for recognition and measurement should not be required if the components are significantly interdependent.
Board members objected to this because there was no consensus on what 'interdependent' meant in this context. The meeting agreed on examples that demonstrated the extremes of the spectrum (for example, term life (interdependent) and investment contracts (unbundled)) but were uncomfortable with the contracts those two extremes. A bare majority of the IASB (8-7) supported this proposition; but none of the FASB members present did.
Embedded derivatives
The boards discussed the effects of the unbundling approach on the accounting for embedded derivatives. A major concern, particularly for FASB members, was that derivatives masquerading as insurance (e.g. credit default swaps) should not be treated as if they were insurance contracts.
The IASB staff noted that the definition and elaboration of the term 'insurance contracts' was critical to this issue and opted to defer further discussion and return to the boards with modified proposals at a later date.
Financial statement presentation
The Board discussed the presentation of insurance contracts in the statement of comprehensive income. The staff presented three examples:
- (a) the summarised margin presentation;
- (b) the expanded margin presentation; and
- (c) the 'traditional' premium allocation presentation.
These approaches were presented to the boards in December 2009.
The IASB staff noted that the measurement approach adopted by the project drives the fundamental structure of the presentation model. To achieve this, the statement of comprehensive income should give the following information (as a minimum) on the face of the statement:
- (a) the release of the expected margin during the period flowing from the measurement model, showing the release of the risk adjustment separately from the release of the residual margin either on the face of the statement of comprehensive income or in the notes
- (b) the difference between the expected and the actual cash flows
- (c) changes in estimates (remeasurements)
- (d) results from investments, showing separately
- (i) interest income; and
- (ii) interest on the insurance liability
The Boards discussed various aspects of these principles and the examples provided. All alternatives had supporters, although some thought that removing the notion of premiums written/ received from the statement of comprehensive income might be confusing to users, even if it was consistent with the measurement approach.
The IASB and the FASB agreed that the measurement approach should drive the presentation model for the performance statement. The boards also agreed that they should not select a 'traditional' premium allocation approach as the presentation model for all types of contracts (although it may still be used as a basis for the presentation for a simplified measurement approach based on premium allocation [e.g. for non-life contracts]).
In addition, the IASB had a strong preference for the 'expanded margin' presentation approach, while the FASB preferred the 'summarised margin' approach – although the FASB would want disclosure of 'key business drivers'.
Variable and unit-linked contracts-separate accounts
The boards discussed the accounting for account-driven contracts generically referred to as 'unit-linked' or 'variable insurance' and annuity contracts. In particular, they considered questions about whether the invested fund into which the premium is deposited represents an asset and corresponding liability of the insurance entity. The staff noted that the fundamental question to this discussion was identifying appropriately 'whose assets and liabilities' were involved.
The staff introduced and the boards discussed some of the models of separation and segregation that exist in various jurisdictions, noting that the US notion of 'separate accounts' was probably the most extreme example, because the account has a separate legal existence and is insulated legally from the general account liabilities of the insurance entity.
The boards agreed that assets and related liabilities associated with unit linked contracts, including those defined as separate accounts, should be reported as the insurer's assets and liabilities in the statement of financial position.
In addition, the boards agreed that issues involving the consolidation of investment funds associated with unit-linked contracts (including separate account contracts) be addressed in the consolidations project rather than in the insurance contracts project.
The boards did not discuss or vote on whether unit-linked contracts should be measured in the same manner as other account-driven contracts.
Friday 19 February 2010 (IASB Meeting)
Joint Ventures
At this meeting, the Board addressed scope section and loss of joint control section of the proposed Standard. In March, the Board will discuss transition provisions and disclosures. The Board expects publication of the final Standard at the end of the second quarter of 2010.
Scope
The Board briefly discussed a wording change in the scope paragraph of the proposed Standard that would require all entities to account for interests in joint arrangements using this Standard. The current scope exemption for investment company type venturers would be incorporated in the measurement section, that is, those entities would be still permitted to use fair value instead of the equity method.
The staff justified this change by tying to clean the standard as, currently under IAS 31, disclosures requirements of IAS 31 are required for these entities, even though they are scoped out from measurement requirements.
Some Board members felt uneasy and questioned why such a proposal is made at such a late stage. In addition they questioned the logic of consequential amendments to IAS 28, when an annual improvement is being deliberated at the same time and expressed their concerns that two changes will be made in the same 'scope' paragraph in a very short period time, potentially with two different effective dates.
One Board member expressed his preference for the current guidance as he preferred a scope exemption from two different measurement bases in the Standard.
Finally, with a bare majority of votes, the Board approved the proposed change. On the annual improvement issue, the Board noted that it would incorporate the annual improvement related to scope paragraph of IAS 28 into consequential amendments of IAS 28 when the final Joint Arrangements Standard is published, to avoid two successive changes to IAS 28 scope paragraph.
Loss of Joint Control
The Board briefly discussed the measurement requirements related to loss of joint control in particular, when a reporting entity has an investment that changes from being a joint venture to become an associate
The Board agreed that as the measurement method is maintained in this case (equity method), no remeasurement is required. One Board member suggested to clarify that this principle would apply in the reverse order as well (associate becoming a joint venture), but the Board decided to remain silent on this point and allow constituents to analogise the accounting treatment to the guidance provided.
The staff noted that partial disposal issues would be addressed at a later stage of the project.
The Board also agreed to redefine 'significant economic event' as an event that changes the nature of the investment and affects group boundaries and consequently remove all descriptions that associate loss of joint control and loss of significant influence in current standards to 'significant economic events'.
Finally, the Boards agreed that Joint Arrangement Standard should confirm that change from joint control to significant influence result in partial disposal in IAS 21 and explain the removal of 'significant economic influence' in Basis for Conclusion in IAS 21.
Fair Value Measurement
Measuring the Fair Value of Alternative Investments
The Board considered the requirements under US GAAP (ASU 2009-12 Investments in Certain Entities that Calculate Net Asset Value per Share (or its equivalent)).
The Board agreed not to provide a practical expedient by allowing entities applying IFRSs to use net asset value (NAV) as an estimate of fair value for alternative investments. The Board was concerned that such a practical expedient would be not operational as under IFRSs there are not specific accounting requirements how to calculate the NAV.
Some Board members noted that in many cases the NAV would be the best estimate of fair value as NAV would be the exit price of the investment. On the other hand, in different fact patterns NAV would be inconsistent which the objective of fair value measurement (for example, investment that could be redeemed at NAV, which consists of investment of that generates higher return). Therefore, the Board decided not to include the US guidance that is jurisdiction specific in the Fair Value Measurement Standard and explain its rationale in the Basis for Conclusions.
This summary is based on notes taken by observers at the joint IASB-FASB meeting and should not be regarded as an official or final summary.
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