The Boards discussed two sweep issues identified by the staff while preparing the pre-ballot draft of the forthcoming exposure draft.

Sweep issues: IFRIC issues related to the requirements for comparative information

Through the IFRIC the Boards have become aware that a diversity of views exists as to the requirements for comparative information when an entity provides individual financial statements beyond the minimum comparative information requirements. Those issues are a result, at least in part, of guidance added as part of the 2007 revision of IAS 1 Presentation of Financial Statements.

Comparative information

The Boards discussed the issue in the context of the following example. An entity provides selected financial statements in addition to those required as a minimum within a complete set of financial statements prepared in accordance with IFRSs. For example, a calendar year end entity provides the following financial statements for its year ended 31 December 2009:

1. Statements of financial position as at 31 December 2009 and 2008
2. Statements of each of the following for the years 2009, 2008, and 2007 (one more than the minimum required by IAS 1):
   • (i) Statement of comprehensive income
   • (ii) Statement of changes in equity
   • (iii) Statement of cash flows

With little discussion, the Boards agreed that exposure draft should clarify that only the minimum comparative periods are required for a 'complete set of financial statements'. Presenting selected additional comparative information is acceptable, provided it is not misleading. That is, the additional financial statements must be prepared in accordance with current IFRSs and presented with equal prominence as the other periods - but a 'complete set' is not required (in the example above, a 31 December 2007 statement of financial position is not required).

Opening statement of financial position

The Boards addressed the issue of what should be considered as the 'statement of financial position for the earliest comparative period presented' when additional selected comparative financial statements are presented for the comparative period.

Using the example from the previous issue, given that the entity has presented annual statements of comprehensive income, changes in equity and cash flows for the three years ended 31 December 2009, 2008, and 2007, and has presented two statements of financial position as at 31 December 2009 and 2008, what should be the 'statement of financial position for the beginning of the earliest comparative period'?

The Boards had a lengthy discussion, during which various alternatives were explored and modified or rejected. The two Boards noted that what was 'required' and what was 'optional' would often be driven, for publicly-listed companies at least, by securities market and other regulatory requirements. To comply with local regulatory requirements, an entity might have to provide information not required for the financial statements to 'comply with IFRS'. That additional information would be subject to the regulator's requirements, but would not ordinarily affect the statement of compliance with IFRSs.

The Boards finally agreed that, for the example under discussion, the 'statement of financial position for the beginning of the earliest comparative period' would be that of 1 January 2008. In addition, the footnote disclosure for that statement would not be required to claim compliance with IFRS.

The Boards discussed whether the January 1 2008 statement was the same as the statement prepared as of 31 December 2007. The Board agreed that it was, subject to the application of any retrospective adjustments for accounting policies adopted on 1 January 2008. Significantly, the Boards agreed that any adjustments to the statement of financial position between 31 December 2007 and 1 January 2008 should be explained in the footnotes.

Presentation of OCI items related to a discontinued operation

In October 2009, the Boards agreed that an entity must identify and indicate in the statement of comprehensive income whether an item of other comprehensive income relates to (or will relate to) an operating, investing, or financing activity. The staff noted that the requirement should logically be extended to include items related to a discontinued operation.

The Boards agreed with the staff and requested that the forthcoming exposure draft clarify this proposed requirement.

Measuring the fair value of financial instruments within a portfolio

The staff opened the discussion by noting that the topic was one of the most controversial issues in the fair value measurement project and was the main issue that financial institutions wanted to discuss with the IASB after the publication of the exposure draft (ED) Fair Value Measurement in May 2009. Those constituents were concerned that the proposals in the ED would:

• change practice significantly with respect to how entities measure the fair value of financial instruments managed within a portfolio;
• result in significant operational challenges and costs; and
• result in financial reporting being divorced from risk management systems.

The staff undertook intensive outreach activities with several large financial institutions to determine how entities measure financial instruments within portfolios in practice. The agenda paper noted two approaches to measurement - the individual instrument approach and the portfolio approach. The staff recommended that a portfolio approach be permitted. In that approach, the unit of account and the unit of valuation might differ. This is the approach currently used in practice for measuring the fair value of financial instruments that are managed within a portfolio.

Bid-ask

The staff recommended that the boards permit entities:

1. to use mid-prices as a basis for establishing fair values for offsetting (ie long and short) market risk positions (as market risk is defined in IFRS 7), and
2. to apply the price within the bid-ask spread that is most representative of fair value to the net open risk position.

Such an approach would be limited to circumstances in which:

1. the entity manages its financial instruments on the basis of the net open risk positions in accordance with the entity's documented risk management strategy (that is, it would not apply to entities that 'exit' a financial instrument by selling or transferring an individual financial instrument, but it would apply to entities that 'exit' a financial instrument by entering into an offsetting risk position).
2. the market risks (for example, interest rate risk, currency risk, or other price risk) that are being offset are substantially the same.
3. the financial instruments share common characteristics (for example, maturities).
4. the financial instruments are measured at fair value on a recurring basis.

There was much disquiet with this recommendation. Some Board members thought it was inviting inappropriate entity-specific measurements, in particular because of the way entities would be allowed to assemble the portfolios for measurement purposes. Those Board members criticised a staff comment that the value of the portfolio depends on the other instruments held by the entity and the entity's risk preferences. The use of 'depends' in this statement created a presumption of an entity-specific measure. Those Board members also thought that an entity's risk preferences had no bearing on measuring fair value.

Other Board members were more sympathetic: they saw it as a pragmatic approach that aligned financial reporting models with best practices in business.

The Boards eventually concluded that the staff proposal could be supported; however, it must be described as an exception to the general principle in the Fair Value Measurement standard. Board members continued to be concerned about establishing discipline around the net positions being measured. Both Boards supported the staff recommendations by majorities.

Counterparty credit

The Boards agreed to permit entities to consider offsetting counterparty credit risk positions when measuring the fair value of financial instruments when there is a legally enforceable right of offset (such as in a master netting agreement) with the counterparty in the event of bankruptcy (or other default).

Again, some Board members were unhappy with the staff recommendation - some seeing it as an inappropriate use of offsetting, compounding the measurement error. However, others were happier to see the measurement proposals used in this situation than in the bid-ask spread situation, above. The staff recommendations were agreed by majorities in both Boards.

Broad issues: Derecognition requirements

The Boards discussed how to reflect derecognition of convertible debt measured at fair value when that debt is converted. Conversion may be in accordance with the original terms of the instrument or may be initiated by the issuer before the conversion period (or early in the conversion period).

The debate was difficult to follow because the Boards discussed a question that was not in the agenda papers and because the debate became heated at times. Some Board members were adamant that any settlement of the liability component should result in a gain or loss recognised in profit or loss. Others would record the transaction using a carry-over basis (carrying amount of the call option recognised in equity) plus any cash received.

The Boards seemed to agree, by majorities in both Boards, that the settlement was a 'wealth transfer' and that the difference between the fair value of the shares on the settlement/conversion date and the carrying amount of the equity instrument should be displayed as a movement between components of equity.

Reassessment of classification

In a brief discussion, the Boards agreed that:

1. An instrument should be reclassified if events occur or circumstances change so that the instrument no longer meets the conditions for its existing classification. The reclassification should take place as of the date of the events that changed the classification.
2. An entity should remeasure a reclassified instrument according the requirements for the new classification as if it were a newly issued instrument on the date of the reclassification. An entity should report any difference in measurement on reclassification as an adjustment to a separate equity account and recognise no gain or loss in profit or loss.
3. There is no limit on the number of times an instrument may be reclassified.
   

Economic compulsion

The Boards discussed whether an instrument without an explicit settlement provision that would make it a liability should be classified as a liability if the issuer feels compelled to settle or redeem because not doing so imposes significant negative economic consequences.

The Boards agreed (by majorities in both Boards) to retain the principle in IAS 32 that 'economic compulsion' is not relevant to the classification of a financial instrument. If there is no [present] contractual obligation to deliver cash or other financial assets to the holder of the instrument at initial recognition, the instrument is not a liability.

Interaction with the fair value option

The IASB agreed to adopt the FASB conclusion that an entity may not avoid separation (bifurcation) of an instrument with a liability and equity component by electing the fair value option for the instrument in its entirety. However, the entity would be permitted to apply the fair value option to a separated liability component if a comparable freestanding instrument would be eligible for the fair value option.

Scope exclusions and additions

The Boards agreed that the scope of the financial instruments with characteristics of equity document should match that of IAS 32.

Transition

The Boards approved a limited retrospective application transition requirement. In the first financial statements following the effective date, an entity would apply the new requirements to all instruments outstanding at the beginning of the first period presented. Under this alternative, net profit or loss would be restated for all periods presented, but beginning retained earnings would not be adjusted.

Disclosure

The Boards agreed to propose the following disclosure requirements:

Entities with financial instruments within the scope of this [draft] Standard shall disclose the nature and terms of the instruments, including information about settlement alternatives-assets or equity instruments. That disclosure shall include:

1. The identity of the entity that controls the settlement alternatives
2. The amount that would be paid, or the number of shares that would be issued and their fair value, determined under the conditions specified in the contract if the settlement were to occur at the reporting date
3. How changes in the fair value of the issuer's equity shares would affect those settlement amounts (for example, "the issuer is obligated to issue an additional X shares or pay an additional Y dollars in cash for each $1 decrease in the fair value of one share")
4. The maximum amount that the issuer could be required to pay to redeem the instrument by physical settlement, if applicable
5. The maximum number of shares that could be required to be issued, if applicable
6. That a contract does not limit the amount that the issuer could be required to pay or the number of shares that the issuer could be required to issue, if applicable
7. For a forward contract or an option indexed to the issuer's equity shares, all of the following:
   • i. The forward price or option strike price
   • ii. The number of issuer's shares to which the contract is indexed
   • iii. The settlement date or dates of the contract, as applicable.
     

Additional statement and schedule for publicly-traded entities

The Boards agreed to include in the exposure draft a requirement that a publicly-traded entity should be required to present a 'statement of capitalisation at fair value'. The additional statement would show the beginning balance plus issuances less repurchases or expirations plus (or minus) changes in fair value for financing liabilities. This statement of capitalisation should be supplemented by a separate schedule that discloses all of the entity's outstanding equity derivatives, exercise prices, and settlement terms.

Transition for first-time adopters and reclassification disclosures [IASB only]

The IASB agreed a limited retrospective application approach. In the first financial statements following the effective date, an entity would apply the new requirements to all instruments outstanding at the beginning of the first period presented (any adjustments will be through opening retrained earnings).

When reclassification is specifically required, IFRS requires disclosures of the amount, timing, and reason for the transfer between liabilities and equity (IAS 1 paragraph 80A and IFRIC 2 paragraph 13). Those instances when reclassification is required will be replaced by the proposals in the forthcoming ED. The Board agreed that those disclosures should be required for share-settled instruments that are transferred from equity to liabilities because there are no longer sufficient authorised shares to settle those instruments.

Comment period

The Board agreed that the proposals should be exposed for 120 days.

Drafting and alternative views

The Boards requested the staff to prepare a pre-ballot draft based on the package of conclusions reached by the Boards.

Two FASB Members (Messrs Linsmeier and Siegel) and one IASB Member (Mr Smith) indicated that they would present Alternative Views in the Exposure Draft. Those Board members variously do not support the approach in the exposure draft and/or do not see the package as a whole as an improvement in financial reporting.