IASB-FASB Joint Meeting (13:15-18:45pm London Time)

• Leases
• Consolidation

Wednesday 21 April 2010

IASB-FASB Joint Meeting (10:30-18:45pm London Time)

• Leases
• Insurance Contracts
• Derecognition

Thursday 22 April 2010

IASB Meeting (10:00am-13:15pm London Time)

• Financial Instruments: Classification and Measurement
• Leases
• Financial Instruments: Hedge Accounting

IASB-FASB Joint Meeting (13:45-17:45 London Time)

• Financial Statement Presentation
• Insurance Contracts
• Leases

Friday 23 April 2010

IASB Meeting (09:00am-12:00pm London Time)

• Insurance Contracts
• 'Sweep Issues' (if needed)

Tuesday 20 April 2010

The IASB and the FASB met via video-link today due to the current flight restrictions. Several IASB members, FASB members, and staff joined the meeting via video link or teleconference.

In the absence of the IASB Chairman, the meeting was chaired by Mr McGregor. Mr Paul Pacter, appointed to the IASB from 1 July 2010, attended the meeting as an observer and was congratulated by the IASB and FASB members on his appointment.

Leases

Sale and leaseback transactions

As part of their discussion of whether a sale and leaseback transaction under the performance obligation model should be accounted for as a sale rather than a financing transaction, the Boards were presented with the following two approaches:

• Determine whether the transaction is a sale of the underlying asset. If not, then account for it as a financing transaction.
• Determine whether the leaseback is a lease. If the leaseback represents the repurchase of the underlying asset rather than a lease, it should be accounted for as financing.

Without much discussion, the Boards agreed that the most appropriate test to apply is whether the transaction represents the sale of the underlying asset. Having supported the sales approach, the Boards were then presented with the following two approaches to determine whether a sale has occurred:

• A: Apply the control criteria developed in the revenue recognition project.
• B: Determine whether control has been transferred and all but a trivial amount of the risks and rewards associated with the underlying asset have transferred to the buyer.

Several Board members supported approach B as they are of the opinion that it will ensure that most sale and leaseback transactions are accounted for as financing transactions, which is the substance of most such transactions. Those members also felt that considering the risks and rewards is the only approach consistent with the leasing model and that, when looking at the sale and leaseback transactions in combination, it will give the most appropriate answer. Some supporters of approach B questioned why such a high hurdle ('all but a trivial amount') should be cleared in order to recognise a sale.

Other Board members supported approach A. They questioned why the control criteria developed for the revenue recognition project are not applied to these transactions.

Another Board member did not support including any guidance on how to account for sale and leaseback transactions in the leasing standard as enough guidance have already been developed in other standards. The first test should be to determine whether a sale has occurred by applying the revenue recognition criteria. If the transaction is deemed to be a financing arrangement, then guidance on financial instruments should be applied. Lastly, if the transaction is deemed to be a lease, then the guidance on accounting for leases should be applied.

Following a long discussion on the merits of each approach, the majority of Board members supported approach B, although some members qualified their support for this approach by requesting that the same criteria be applied in the revenue recognition model.

The Boards then deliberated when a gain or loss arising on a sale and leaseback transaction should be deferred by considering two approaches:

• Defer gains or losses on sale and leaseback transactions that are not at fair value.
• Adjust the assets, liabilities, gains, and losses recognised to reflect current market rentals.

The FASB members indicated very strong support for the latter approach but questioned whether it is practicable. The staff responded that this approach is similar to the existing requirements of IAS 17 for sale and leaseback transactions and should therefore not be too difficult to apply in practice. Not all Board members agreed with this response.

One IASB member added another alternative by stating that when a sale and leaseback transaction is not established at fair value, the recognition of a sale, is precluded and the transaction should be accounted for as financing. Several other IASB members indicated sympathy with this alternative, while others favoured the same approach supported by the FASB members.

When put to a vote, Boards unanimously agreed that as long as the sale and leaseback transaction results in a sale and both the sale and leaseback are at fair value, gains or losses arising from the transaction should not be deferred. The majority of Board members also tentatively agreed that where either the sale or the leaseback is not established at fair value, the assets, liabilities, gains, and losses should be adjusted to reflect current market rentals.

Lessor accounting – Accounting for lessor's performance obligation, including consideration of recognising profit/loss at lease commencement

At their November 2009 meeting, the Boards tentatively agreed that the subsequent measurement of the performance obligation should depict the decrease in the entity's obligation to permit the lessee to use the leased item, but requested the staff to clarify how the performance obligation should be regarded as satisfied and revenue recognised. At this meeting, the staff recommended that the revenue should be recognised in a systematic and rational manner as the performance obligation is satisfied. This could be based on time, usage, or other measure that the economic benefit derived from the leased asset is provided to the lessee.

Some Board members questioned how the lessor is supposed to determine the rate of usage by the lessee. Another Board member remarked that this seems to imply that when a lessee is not using a leased asset properly, the lessor has not satisfied its performance obligation and does not get to recognise revenue. Other Board members also disagreed with the proposal as they deemed it inconsistent with the revenue recognition model where revenue is recognised as services are performed or goods transferred, regardless of usage by the customer.

In defence of the staff proposal, a Board member explained that the aim was to allow for a method of revenue recognition that is similar to the unit of production method of depreciation and usage by lessee does not refer to actual usage, but rather to usage agreed to as part of negotiating the contract. Following this explanation, the majority of Board members supported the staff's proposal.

The Boards then considered the following approaches in determining whether a lessor should be required/allowed to recognise a profit/loss at the commencement of the lease:

• A: Recognise profit/loss upon delivery of leased asset to the lessee.
• B: No profit/loss upon delivery of the leased asset to the lessee.
• C: Recognise profit/loss upon delivery of leased asset to lessee but only for some lessors.

Several Board members disagreed with the staff proposal to prohibit the recognition of a profit or loss at lease commencement and noted that it is not consistent with the revenue recognition or performance obligation model. Those Board members were of the opinion that once a performance obligation has been satisfied, revenue should be recognised and that the delivery of the leased asset to the lessee is one of the performance obligations of the lessor.

The Boards deliberated at length whether a lessor has more than one performance obligation. The FASB showed strong support for the staff proposal, but the IASB was split evenly. In the absence of the Chairman to cast a deciding vote, it was agreed that the staff should bring the matter back later in the week.

The staff then asked the Boards which lessors should be allowed to recognise a profit or loss. Again several Board members vehemently disagreed with the staff proposal that any lessor – whether the carrying amount of the underlying asset is different from its fair value – should recognise a profit or loss, as this approach focusses on the amount at which the lessor has recognised the underlying asset. In their view, this approach is consistent with the derecognition model and not the performance obligation model being discussed. Another Board member remarked that under the performance obligation model, the consideration receivable should be allocated to the various performance obligations based on their stand-alone selling prices, similar to the revenue recognition model. Other Board members questioned what the related cost would be for the revenue recognised.

The Boards tentatively agreed that the recognition of revenue on day one should not be limited to only dealer and manufacturer lessors, but that revenue recognised should not be based on the carrying amount of the underlying asset. With regards to how the revenue should be recognised, the Boards instructed the staff to explore the alternatives under the performance obligation model further, along with the earlier question on whether the lessor has more than one performance obligation. As this is likely to take the staff some time to prepare the necessary agenda papers, it was agreed that the matters be discussed at the special meeting in early May.

Accounting for subleases – performance obligation model

The Boards were asked to consider the accounting for subleases under the proposed new leases requirements under the performance obligation approach. Without any discussion, the Boards agreed that special recognition and measurement guidance is not needed for assets and liabilities arising under subleases.

The Boards discussed various alternatives for the presentation of assets and liabilities arising from a sublease. The FASB members preferred an alternative whereby the right-of-use asset, lease receivable, and the performance obligations of the lessor are presented gross with a subtotal as part of property, plant, and equipment in the statement of financial position, with the obligation to make rental payments presented separately as part of the liabilities (alternative C-prime). The IASB members initially expressed a preference to for the gross presentation of all amounts without any subtotals (alternative A).

The staff remarked that this will be totally inconsistent with the previous decision by the Boards with regards to the gross presentation with a subtotal for lessors and questioned whether the IASB is willing to accept the inconsistency and explain their reasoning in the basis for conclusions.

After careful consideration, the IASB members changed their preference to the gross presentation of all assets and liabilities excluding the obligation to pay rentals, with a net subtotal (alternative C). In order to achieve convergence between the Boards, the FASB members indicated that they can also support alternative C instead of C-prime as initially indicated.

The Boards further tentatively agreed to require the disclosure of the nature and amount of material subleases in the lessor's financial statements. The Boards will continue their discussions on lease accounting at later sessions.

Consolidation

Investment Companies

The Boards continued their discussions from the February joint meeting in assessing how an investment company should account for its investments that it controls. At the February joint meeting the Boards agreed that an entity that is considered an 'investment company' should be exempted from consolidating entities that it controls and, instead, should measure investments in such controlled entities at fair value through profit or loss.

The Boards started their discussion by determining what indicators should be used to identify an investment company.

The Boards agreed that an investment company is an entity that met all of the following conditions:

• Express Business Purpose. The express business purpose of an investment company is investing for current income, capital appreciation, or both. The entity shall make a commitment, to a group of unrelated investors, that the purpose of the entity involves investing in assets, usually in the securities of other entities not under common management, in order to generate and distribute income, and/or capital appreciation, or both. An exit strategy must also be included in the investment plans.
• Investment activity. To meet the express business purpose requirement, substantially all of the entity's activities shall be investment activities carried out for the purpose of generating current income, capital appreciation, or both. Operating activities related to services provided to the entity do not preclude an investment company from meeting this criterion. To be an investment company, an entity must not obtain benefits from its investees that would be unavailable to other investors or unrelated parties of the investee.
• Unit Ownership. Ownership in the entity is represented by units of investments, such as shares of stock or partnership interests, to which proportionate shares of net assets can be attributed.
• Pooling of Funds. The funds of the entity's owners are pooled to avail owners of professional investment management.
• Fair value. All of the investments of the entity are managed, and their performance evaluated, on a fair value basis. Information about the entity's investments is provided internally on a fair value basis to the entity's key management personnel and externally on a fair value basis to its investors.
• Debt. Any providers of debt to the investees of the entity shall not have direct recourse to any of the entity's other investees.

The staff originally proposed that the entity must be a separate legal entity. Nonetheless, at the start of the meeting, the staff noted that it proposed to change that requirement to the definition of reporting entity (as defined in the exposure draft on Reporting Entity chapter of the Conceptual Framework). Several Board members strongly disagreed with that suggestion as they believed that such interpretation could lead to structuring opportunities – for example, divisions of multinational conglomerates would qualify for the fair value exception from consolidation. Other Board members did not share those concerns as they believed that the remaining conditions are rigorous enough to preclude such structuring (especially the unit ownership condition).

Finally, after significant level of discussion, the Boards agreed with the suggestion of one Board member to tie the reporting entity condition with the unit ownership condition. For the staff the elimination of separate legal entity condition was important as the staff believed that such condition could preclude the usage of the exception by some unit trusts. On the other hand, some Board members were extremely concerned with unintended consequences of such change. One Board member even suggested that such a decision might lead to introduction of the legal isolation concept by the back door.

The Boards decided to include several additional requirements to the list of conditions for classification as an investment company. Those additional requirements included an explicit condition related to substantial investments by outside investors, prohibition of usage of call and put options, and better articulation of the range of companies that are considered to be affiliates to the entity.

The Boards also considered the scenario in which the parent company directly owns a share in an entity (such as 25%) and owns the remaining 75% through investment companies that are measured at fair value. The Boards considered how to adjust the balances on consolidation, or alternatively whether to scope out investment companies from the fair value exception proposed when the ultimate parent owns partial interest in the investments held by the investment company. Finally, the Boards decided that they needed to consider the consequences of the fair value exemption on consolidation adjustments more broadly (for example, intra-group sales, intra-group loans, etc).

Nonetheless, several Board members remained concerned that the new guidance would be subject to structuring and would not fulfil the objectives the Board expected.

The Boards also clarified that all investments that fulfil the criteria would be measured at fair value through profit or loss.

The Boards considered the consequences on the accounting by the parent of the investment company. Several Board members supported the guidance that parent entity would not be permitted to retain fair value accounting for any controlled investees of an investment company subsidiary in the parent's consolidated financial statements. Those Board members believed that only such restriction would eliminate the structuring opportunities.

On the other hand, the majority of the Board believed that it would be appropriate to retain the accounting for an investment company subsidiary if a parent has multiple separate activities (that is, report investment activities at fair value and consolidate operating activities). The Boards agreed that when the information is relevant and useful on the investment company level it would be useful also on the parent level.

Finally, the Boards clarified that involvement of the management company in management of the investees (for example, representation on the Board level) is consistent with the definition of the investment company.

The Boards agreed that an entity that previously was not considered an investment company, but met the revised definition of an investment company, should report the effect of the change in status as of the date that they first applied the revised consolidation requirements as an adjustment to retained earnings in the period in which the change occurred. The adjustment to retained earnings would represent the difference between the previous carrying amount of the net assets of the investee and the fair value of the investee as of the date of first applying the new consolidation requirements.

The staff noted that the IASB plans to publish a limited exposure draft of guidance related to investment companies. Even though the Board did not officially vote, several Board members indicated that they intend to dissent from that ED and would present an alternative view.

The Boards will continue their discussions on disclosure requirements at later sessions.

Wednesday 21 April 2010

Leases

Lessor accounting: Impairment of assets

The Boards were requested how impairment by lessors should be addressed under the performance obligation model where the lessor has two assets – the underlying leased asset as well as the lease receivable. In their deliberations, the Boards considered two approaches suggested by the staff:

• A: group the underlying asset and performance obligation as a single unit of account to assess for impairment in accordance with IAS 36, while the receivable is assessed for impairment in accordance with IAS 39.
• B: consider the underlying asset, lease receivable and performance obligation as a single unit of account in accordance with the requirements of IAS 36.

The Board members expressed mixed support for approaches A and B, with a few Board members indicating that they don't have a strong preference for either of them. Those Board members that supported approach A were of the opinion that the underlying asset and lease receivable are distinct assets with significantly different characteristics and need to be assessed separately.

The Board members supporting approach B were of the view that by entering into the lease contract, the underlying asset has been modified through the performance obligation and some of the economic benefits of the underlying are included in the measurement of the lease receivable. According to these Board members this is the purest form of a cash generating unit as defined in IAS 36 and should be assessed for impairment at that level.

Some Board members questioned why the performance obligation is netted against the underlying asset in approach A. In terms of the performance obligation model, the performance obligation arises as a result of the lease receivable and if the lease receivable no longer exists as a result from, for example, default by the lessee, the lessor no longer has a performance obligation and as such has recourse to the underlying asset. Some Board members regard this as economically similar to a secured loan and don't see enough reason to treat impairment on this differently to secured loans.

One Board member remarked that the proposed approaches highlight the weaknesses and problems with the performance obligation model and regarded the approaches as being overly simplistic. This Board member favoured an approach whereby the lease receivable is assessed for impairment first and if it is, to look at the rights and obligations of the lessor in terms of either recovering the outstanding receivable or repossessing the underlying asset. As several other Board members also favoured this approach above the other two presented, the staff was instructed to further articulate the alternative approach and develop a flowchart with the assistance of some FASB members to explore the interrelationship between the various components for discussion at a future meeting.

Long-term leases of land

At the February 2010 joint meeting, the staff was instructed to develop criteria for excluding very long leases of land from the scope of the proposed new leases requirements. The staff explained that they have requested input from constituents and do not think that an exemption should be provided from very long leases of land as criteria has already been developed to distinguish the outright sale or purchase of an asset from a lease. If the criteria for the recognition of an outright sale or purchase have not been met, then there would be no conceptual basis to differentiate these leases from other leases.

The Boards were supportive of the staff's proposal not to exempt very long leases of land from the requirements of lease accounting. One Board member did question whether a lessor would recognise a performance obligation at inception if it has undertaken to pay property taxes (for example) for a certain period of time. The Boards entered into a discussion on whether it will qualify as a performance obligation or as a period cost to the recognised in accordance with IAS 37. It was agreed to further discuss this question offline, however, the staff was requested to link this matter to the previous discussion on what the performance obligation of the lessor is and whether it is possible to have more than one performance obligation.

Lessor accounting for Purchase options

In the light of the Boards' tentative decision for lessee accounting that purchase options should be accounted for in the same way as options to extend or terminate the lease, the Boards deliberated how lessors should account for purchase options. The staff explained that although the Boards tentatively decided that there should be symmetry in the accounting by lessees and lessors, there may be a difference in measurement. However, the staff recommended that lessors should also account for purchase options in the same way as for renewal or termination options.

Some Board members questioned how gains or losses on purchase options will be treated as it is possible under the performance obligation model to recognise a gain on the purchase option prior to the option being exercised. These Board members wanted a part of the performance obligation to be allocated to the purchase option until the option is exercised.

After a short discussion on whether there is a difference between what was tentatively agreed on lessee accounting and what is proposed for lessor accounting, the majority of Board members supported the staff proposal but qualified their support on the basis that there need to be linkage with how the performance obligation is run-off.

Leases – information about total cash rentals paid

At the March 2010 joint meeting, the Boards tentatively agreed that cash payments of interest and principal amounts relating to leases should be presented separately as financing activities in the statement of cash flows. Some Board members noted that information on cash rentals paid are important, especially for users that used to have an operating lease payment included in the calculation of EBITDA. As the lease payments under the new requirements would be split between interest and prinicpal amounts, and would be grouped with interest and principal repayments on other borrowings, it may be difficult to reconstruct the total cash rentals paid.

The staff recommended that the cash rentals paid be disclosed in the roll-forward presented in the notes. The Boards agreed with this proposal.

The Boards were also asked whether they want the interest and principal cash payments on leases to be presented separately from other borrowings. After some confusion as to what was tentatively agreed to at the previous meeting, the Boards confirmed that such separate presented should not be required.

Derecognition

Proposed derecognition model

The Boards discussed the IASB derecognition model for financial assets and liabilities, focusing in particular on the issues identified by the FASB during the previous educational session as issues requiring clarification. The purpose of this session was to provide the FASB with information that would allow it to decide on the future steps in the project. No decisions were taken during this session.

From the start of the discussion it was obvious that the FASB had serious objections to the model being developed by the IASB. The FASB members did not seem to support the underlying principle of the model and they were more in favour of a model based on stickiness.

In particular, the Boards considered the proposed treatment of sale of an asset with an option to repurchase the asset in the future. On balance, the FASB seemed to be unconvinced that such transactions led to surrendering of control and thus should lead to derecognition of the financial asset. As such, the threshold for derecognition for the FASB would be much higher than proposed in the IASB model.

The Boards discussed the consistency of the application of the control model in derecognition and consolidation projects and application for the consolidation of entities and derecognition of assets. No clear consensus emerged.

One FASB member raised a particular issue that the IASB proposed an exception for repurchase agreements (that would be treated as financing) but no similar exception was to be granted for transactions with derivatives that achieve the same economic substance. The staff responded that the repurchase agreements exception was a limited exception that was tightly defined and limited to certain circumstances. They argued that otherwise the derivatives transactions would lead to grossing-up of the balance sheet (and ultimately based on this logic all derivatives would have to be grossed-up on the balance sheet).

One IASB member also challenged the staff on the role of stickiness in accounting for financial instruments. He noted that there is informational asymmetry in derecognition transactions and the real issue is that the entities did not recognise all the risks related to the derecognised asset (especially items like implicit guarantees). He urged the Board not to ignore the lessons from the recent financial crisis in the derecognition model. The FASB members agreed. They challenged the IASB and the staff how well it was possible to identify and recognise such components. The staff responded that the financial instruments accounting is based on current contractual rights and obligations. As one IASB member put it, this issue is rather a recognition issue accompanied with providing of proper disclosures.

The Boards continued with a discussion on the consistency of the model with the conceptual framework, difference in assessing of stickiness in financial and non-financial assets as well as possibilities for window-dressing. No conclusion was reached The Boards agreed to re-discuss the remaining issues jointly at the following joint meeting. There seems to be a tension point between the two Boards as the FASB would like to re-discuss all the features of the model, rationales for all the decisions taken and conclusions reached, whereas the IASB was prepared to proceed to drafting and balloting process. The Boards agreed that the technical directors should consider the way forward.

Insurance Contracts

Discount rate to be used for insurance contracts

Discounting is a significant issue for long-term insurance contracts. Some argue that insurers often price the policies using as a discount rate a rate of return on their investments, and to use a different rate, such as a risk free rate would lead to day one losses.

Taking account of past decisions to use 'building blocks' measurement model, not to fair value liability and specifically not to include own credit risk, the staff developed an objective for the discount rate. It is to adjust the estimated (probability-weighted) cash flows for the time value of money in a way that reflects the characteristics of the liability, and not those of the assets used to fund insurance liabilities, unless the cash flows to the policyholders are linked to the performance of such assets, as in the case of participating contracts. In particular, the discount rate should take into account the liquidity risk, as this is a risk present in the liability and is not reflected in the other 'building blocks'. Both the IASB and FASB members were unanimous in supporting this objective and liquidity risk was thought to address some of the 'day one loss' concerns.

There was some discussion about how best to estimate the discount rate. The staff suggestions were: 1) not to prescribe a detailed guidance beyond that of the measurement objective or 2) to suggest using a high quality corporate bond as an easy to use and comparable discount rate, that is consistent with the IAS 19 pension accounting. The first method would result in the discount rate being a risk free rate plus a liquidity premium. Using the high quality corporate bond was not supported, because while more practical, it seems to be a proxy for own credit risk, some countries do not have such bonds and it is less theoretically sound. The debate then focused on own credit risk, since it is not specifically addressed in the proposed objective. A number of FASB and IASB members wanted to include it. Including it would improve matching of the performance of insurance contracts and the insurance investments where investments are carried at fair value. However, referring to the recent IFRS 9 project decisions on own credit risk, the FASB suggested for discount rate to be based on the characteristics of the liability, being risk free rate plus liquidity risk and to include in the ED separate questions about an adjustment incorporating own credit risk. Both Boards voted unanimously. The Boards then voted unanimously to include specific guidance from the relevant IASB/FASB literature on the principles of how to estimate the discount rate to avoid double counting of risk.

On participating contracts the staff recommend considering the return on the linked assets where this influences, even if partially, the insurance contract cash flows. If the linked assets represent a 'replicating portfolio' that fully matches actual cash flows of insurance liability in all cases and can be measured directly, then no need to use a building blocks approach. If not, the return on linked assets should be considered in arriving at a discount rate that reflects characteristics of the liability, as per objective. The FASB members clarified that for assets the discount rate discounts contractual rather than expected cash flows. Need to avoid double counting of the risk of uncertainty of cash flows in both expected cash flows and discount rate. Using a replicating portfolio, if it exists, avoids this double counting. IASB – all but one member of FASB – unanimously supported the staff's suggestion, subject to seeing it clarified as above.

Thursday 22 April 2010

Financial Statement Presentation

Sweep issues from pre-ballot draft

The Boards discussed a number of sweep issues that arose during the review of the pre-ballot draft of the exposure draft. The FASB agreed to retain the existing requirements for the presentation and disclosure of unusual or infrequently occurring items. The IASB agreed to the same but also to include a specific question on the matter in its exposure draft.

The Boards agreed not to include the additional guidance proposed in the pre-ballot draft on the classification of short-term assets and liabilities in their respective exposure drafts. The FASB noted that its guidance on the classification of debt is not converged on the guidance of the IASB as it only focuses on the expection of what will happen, whereas the IASB guidance focuses on what was contractually agreed. The FASB express their commitment to converge with the IASB on the matter and agreed not to include the guidance in its exposure draft but to add the item to its agenda.

The Boards acknowledged that the guidance in IAS 1 on the mixed presentation of assets and liabilities in the statement of financial position has caused confusion in the past, but not agree with the staff to eliminate it. The Boards agreed to retain the guidance, but clarify the wording to resolve some of the confusion.

The Boards agreed to require both the reconciliation of operating income to operating cash flows and non-cash transaction information to be presented immediately following the statement of cash flows, but have requested the staff to amend the wording to require its presentation to be incorporated in the primary statement instead of being shown as a footnote.

The Boards acknowledged that the presentation of cash flows that represent increases in operating capacity separately from those required to maintain operating capacity has not been practical in the past and agreed to eliminate the requirement from the proposed disclosures. The IASB also noted that the presentation of cash flows arising from the activities of each reportable segment forms part of the segment review and need not be repeated in the FSP disclosure requirements. The Boards agreed that the amount of undrawn borrowing facilities should be required disclosures instead of encouraged.

The Boards agreed not to require entities to present the sections and categories in the same order in each of the primary statements, but to clarify that information should be presented in a way that provide meaningful information to users. The Boards also agreed to clarify that all sections comprising profit or loss, except the discontinued operation section, in the statement of comprehensive income be presented before the income tax section.

Financial Instruments: Classification and Measurement – Liabilities (IASB Only)

Disclosures for liabilities designated under the fair value option

The IASB discussed additional disclosures related to financial liabilities designated under the fair value option. The Board decided to require disclosure of how much of the accumulated OCI balance attributable to changes in own credit risk was realised during the current period.

The Board also discussed the issue whether and when the realised portion of the accumulated balance attributable to changes in own credit risk could/should be transferred within equity. There were different views expressed. Although the Board clearly favoured the transfer of realised accumulated OCI balance attributable to changes in own credit risk to retained earnings, no decision was taken as there might be different legal requirements in various jurisdictions on what represent retained earnings and how distributable earnings might be defined. The Board agreed with a level of flexibility on transfer of accumulated OCI balance to retained earnings (similar to guidance in IFRS 9: Financial Instruments for the gains/losses on equity instruments recognised in OCI).

Exposure logistics

The Board gave the staff the permission to proceed with drafting of the exposure draft that should be published in May 2010. No Board member indicated his/her dissent.

The Board decided to include in the exposure draft only the changes proposed to the fair value option. In order to mitigate the concerns indicated by some Board members the Board decided to draw the attention of constituents in the introduction of the ED to the fact that the only other change to the financial liabilities guidance relates to elimination of the cost exception for derivative financial liabilities over unquoted equity instruments. That change was exposed in the ED/2009/07 Financial Instruments: Classification and Measurement and deliberated together with guidance included in IFRS 9.

The staff clarified that the ED would be a standalone document, and after re-deliberations of the comments staff plans to include the whole financial liabilities guidance (the relevant guidance from IAS 39 Financial Instruments: Recognition and Measurement, guidance on elimination of cost exemption, as well as guidance related to fair value option related to own credit risk) in IFRS 9 and to delete the relevant sections of IAS 39.

The Board agreed with a 60-day comment period.

Finally, the Board decided to ask a question in the exposure draft on the proposal that if an entity decides to adopt early any finalised requirements in the IAS 39 replacement project, the entity must also adopt any preceding finalised guidance. This proposal was deliberated in the context of finalisation of IFRS 9 but was not yet exposed for public comments.

Leases (IASB Only)

First-time adoption of IFRSs

Without substantial discussion, the Board agreed that the same proposed transitional requirements should be applied to all leases for first-time adopters of IFRSs. That is, lease assets and liabilities should be recognised and measured at the present value of the leases payments for all leases and relief for simple finance leases should not be applied to a first-time adopter.

Consequential amendments

The Board considered the consequential amendments resulting from the lease guidance on the business combinations literature. Although the staff was focussing on the issue of the adjustments to the pre-existing intangible asset and/or liability associated with the acquired operating leases, the Board wished to consider the guidance in its entirety. In particular, some Board members were concerned by the requirement to revalue all leases to fair value at the date of acquisition. Those Board members noted that in the deliberations on the leases project the Board concluded that the requirement to use fair value on leases would be onerous and, therefore, questioned the conclusions reached on business combinations guidance.

Finally, the majority of the Board agreed that a specific exception for leases should be developed in the context of business combinations. Some members wanted to discuss the details of the exceptions (for example, related to the question whether the incremental borrowing rate should be reset on acquisition). Nonetheless, as the guidance on business combinations is joint guidance with the FASB, the Board decided to deliberate the issue at a later joint meeting.

The Board considered also the consequential amendments to IAS 40 Investment Properties, especially in the context of the intermediate lessor accounting.

The Board agreed that in the context of an intermediate lessor:

• If an entity elects to use the fair value model, its right-of-use asset classified as an investment property is subsequently measured at fair value in accordance with IAS 40. Therefore, the new lessee accounting requirements on subsequent measurement would not be required.
• If an entity elects to use the cost model, the new lessee accounting requirements for right-of-use assets would be required. Therefore, the requirement under IAS 40 to subsequently measure investment property at depreciated cost using the cost model in IAS 16 Property, Plant and Equipment would be replaced with the new lessee accounting requirements.

In addition the Board confirmed that:

• If the right-of-use asset is measured at cost, changes to the obligation to pay rentals should be accounted for under the proposed new leases requirements, and
• If the right-of-use asset is measured at fair value, the adjustments to the obligation to pay rentals arising from changes in the lease term or changes to estimated contingent rentals would be recognised in profit or loss.

Revaluation of the lessee`s right-of-use asset

The Board briefly discussed the issue of the revaluation of the lessee's right-of-use asset and the methodology of the revaluation. The Board was split on whether the appropriate requirements for revaluation of the right-of-use asset are in IAS 38 Intangible Assets (as that is the nature of the right-of-use asset), IAS 16 Property, Plant and Equipment (as right-of-use asset would be presented within PP&E), or alternatively use the forthcoming fair value measurement guidance. No consensus on methodology was reached. The Board decided to re-discuss the issue at a later meeting.

Nonetheless, the Board agreed in principle to permit revaluation of the lessee's right-of-use asset even if there is not active market in the right-of-use assets. The Board decided to permit a lessee to revalue its right-of-use assets only if the lessee chooses to revalue its owned assets in a class of property, plant and equipment; and to require a lessee to revalue the entire class (as defined in IAS 16) of property, plant and equipment (all owned and leased assets) to which that leased asset belongs if the lessee chooses to revalue its leased assets.

Financial Instruments: Classification and Measurement - Hedge Accounting (IASB Only)

Overview of items

The staff presented the Bard an overview of issues to be addressed as part of the hedge accounting project. No decisions were made.

The Board agreed to pursue the general hedge accounting approach and subsequently to consider the issues related to portfolio hedges. The staff also clarified that some issues related to both general approach and portfolio approach need to be addressed early in the deliberations (for example, groups of items and net positions).

Some Board members expressed some concerns with the tentative decision of the Board to apply cash flow hedge mechanics to fair value hedges. The staff noted that this issue will need to be re-deliberated to consider concerns expressed by several constituents in the outreach about possible unintended consequences of such decision.

The staff also clarified that based on the outreach, constituents prefer a comprehensive overview of the hedge accounting rather than a 'quick fix'. On the other hand, the FASB will publish its ED on Financial Instruments including proposed hedge accounting guidance in May.

The Board will continue in deliberations of hedge accounting at its May meeting.

Insurance Contracts

Discount rate to be used for insurance contracts

Discounting is a significant issue for long-term insurance contracts. Some argue that insurers often price the policies using as a discount rate a rate of return on their investments, and to use a different rate, such as a risk free rate, would lead to day one losses.

Taking account of past decisions to use 'building blocks' measurement model, not to fair value liability and specifically not to include own credit risk, the staff developed an objective for the discount rate. It is to adjust the estimated (probability-weighted) cash flows for the time value of money in a way that reflects the characteristics of the liability, and not those of the assets used to fund insurance liabilities, unless the cash flows to the policyholders are linked to the performance of such assets, as in the case of participating contracts. In particular, the discount rate should take into account the liquidity risk, as this is a risk present in the liability and is not reflected in the other 'building blocks'. Both the IASB and FASB members were unanimous in supporting this objective and liquidity risk was thought to address some of the 'day one loss' concerns.

There was some discussion about how best to estimate the discount rate. The staff suggestions were:

1. not to prescribe a detailed guidance beyond that of the measurement objective, or
2. to suggest using a high quality corporate bond as an easy to use and comparable discount rate, that is consistent with the IAS 19 pension accounting.

The first method would result in the discount rate being a risk free rate plus a liquidity premium. Using the high quality corporate bond was not supported because, while more practical, it seems to be a proxy for own-credit risk, some countries do not have such bonds, and it is less theoretically sound. The debate then focused on own-credit risk, since it is not specifically addressed in the proposed objective. A number of FASB and IASB members wanted to include it.

Including own-credit risk would improve matching of the performance of insurance contracts and the insurance investments where investments are carried at fair value. However, referring to the recent IFRS 9 project decisions on own-credit risk, the FASB suggested that the discount rate should be based on the characteristics of the liability, being the risk-free rate plus liquidity risk, that the ED should include separate questions about an adjustment incorporating own-credit risk. Both Boards agreed unanimously. The Boards then voted unanimously to include specific guidance from the relevant IASB/FASB literature on the principles of how to estimate the discount rate to avoid double-counting of risk.

On participating contracts, the staff recommend considering the return on the linked assets where this influences, even if partially, the insurance contract cash flows. If the linked assets represent a 'replicating portfolio' that fully matches actual cash flows of insurance liability in all cases and can be measured directly, then no need to use a building blocks approach. If not, the return on linked assets should be considered in arriving at a discount rate that reflects characteristics of the liability, as per the agreed objective. The FASB members clarified that for assets the discount rate discounts contractual rather than expected cash flows. There is a need to avoid double-counting of the risk of uncertainty of cash flows in both expected cash flows and discount rate. Using a replicating portfolio, if it exists, avoids this double-counting. IASB – all but one member/FASB – unanimously supported the staff's suggestion, subject to seeing it clarified as above.

Leases (IASB and FASB)

Lessor disclosures

The Boards discussed the disclosure requirements for lessors in accordance with the performance obligation model. The staff presented an analysis of proposed disclosures which have been structure in accordance with the Investors Technical Advisory Committee (ITAC) Disclosure Framework, setting out the requirements for the disclosure of the following:

• the lease disclosure principle;
• the nature of the lease arrangements distinguishing between the leased asset, lease receivable and performance obligation;
• the roll-forward;
• assumptions, uncertaintites and risks; and
• short-term lease arrangements

The Boards tentatively approved the proposed disclosure requirements subject to the following changes:

• with regard to contingent rentals, require the disclosure of the description and carrying amount of contingent rentals instead of the accounting policy; and
• require a level of disaggregation in the roll-forward so that information remains useful to the users.

The staff was also requested to liaise with the Financial Statement Presentation project staff with regards to incorporating a disaggregation principle into the lease disclosure principle, as this principle is broadly based on the principles agreed to in that project.

Lessor accounting – Impairment supplement

As a follow-up on the previous day's session on how to deal with impairment by lessors under the performance obligation model, the staff presented a supplement setting out the proposed flowchart and models for determining impairment, as requested by the Boards.

The flowchart summarised the process for assessing impairment as follows:

• assess whether lease receivable is recoverable in full;
• if it is, then assess whether the underlying asset is impaired using either option A or B as setout in the previous agenda paper;
• if the lease receivable is not recoverable in full, determine whether the lessor will/can repossess the underlying asset;
• if the underlying asset can be repossessed, the lessor may no longer have a performance obligation, in which case the performance obligation is derecognised and lease receivable impaired. The underlying asset is assessed for impairment on a stand-alone basis;
• if the underlying asset cannot be repossessed, the lease receivable as well as the underlying asset needs to be assessed for impairment using either option A or B as set out in the previous agenda paper.

Again, the Boards had a long discussion as to how impairment should be assessed and accounted for, especially whether either the underlying asset or lease receivable or both should be netted off against the performance obligation.

One Board member remarked that in essence the Boards seem to agree on the same approach; however, there seems to be difficulty in articulating the approach. This Board member recommended to withdraw the proposed flowchart and replace it with something that is more simplistic, setting out a pragmatic yet holistic approach.

Friday 23 April 2010

Insurance Contracts

Contact boundaries

The IASB discussed where the boundary of an existing insurance contract should be. The contract boundary determines which future cash flows are included in the measurement of the insurance contract. The staff noted that in May 2009 the IASB tentatively determined the boundary between existing and new contracts as the point at which the insurer can cancel the contract or change the pricing or other terms.

Since then, the International Association of Insurance Supervisors (IAIS) had suggested that the cash flows to be taken into account when measuring an insurance contract would be bounded by the earlier of (as applicable):

• the contractual termination date as extended by any unilateral option available to the policyholder, or
• the insurer having a unilateral right to cancel or freely re-underwrite the policy, or
• both the insurer and policyholder being jointly involved in making a bilateral decision regarding continuation of the policy.

The contract boundary is defined as including all cash flows arising under the contract as a result of events occurring during the period ending on the earlier of:

• the contract coverage period (as extended by any renewal options available to the policyholder) and
• the point at which the insurer has an unrestricted ability to cancel or re-underwrite and re-price coverage of the individual contract. For this purpose, restrictions would be ignored if they have no commercial substance (that is, no discernible effect on the economics of the contract).

After a long debate, the Board seemed to coalesce around the articulation of the contract boundary developed by the IAIS rather than the staff recommendation. They agreed that this should form the basis of the next steps in this part of the project, although the staff was asked to explore the effect of events arising from contractual terms. (The particular example will be the operation of a non-claims clause in a motor insurance policy in which renewing motorists are classified in 'classes' depending on claims experience under a contractual (or legal) formula; and whether moving from one class to another constitutes a new contract.)

Recognition

The Board discussed the recognition of rights and obligations arising under an insurance contract, including the treatment of the contract in the period (if any) between when the two parties (insurer and policyholder) enter into the contract and the start of the coverage period. The staff noted that the FASB had already tentatively decided that an entity should recognise an insurance obligation at the earlier of (a) the entity being 'on risk' to provide coverage to the policyholder for insured events and (b) the signing of the insurance contract.

Although Board members had some concerns about their understanding of 'on risk', it was evident that the vast majority (if not all) of the Board agreed that the principle could be re-expressed as 'as insurance obligation arises when the insurer has insurance risk'.

The Board agreed with the staff recommendation (as had the FASB), subject to drafting.

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.