Monday 19 June 2010
The IASB and the FASB met in London with the FASB joining the meeting via video link. The IASB Chairman welcomed two new Board members, Dr Elke König and Paul Pacter at their first Board meeting they attend as IASB members.
IASB-FASB Joint Meeting (13:00-19:00)
Application guidance on when to use the performance obligation or derecognition approaches
The Boards discussed the application guidance on when to use the two approaches for lessor accounting.
First, the Boards discussed the timing of the assessment which approach to use. The majority of both Boards agreed that a lessor should be required to determine at inception of the lease whether the lease exposes the lessor to significant risks and benefits associated with the underlying asset and that determination should not be subsequently reassessed. One FASB member suggested that one of the exceptions to the principle should be business combinations. The Boards agreed. Nonetheless, several Board members suggested that reassessment should be performed also in case of significant change in the economics of the contract. The staff clarified that the change in the economics would be accompanied by the change of the lease contract that would automatically trigger reassessment.
Subsequently, the Boards discussed clarification of the terms underlying asset in the context of the assessment. The Boards agreed that the term underlying asset in this context should refer to the asset itself and not to the credit risk. One Board member also noted that the risks and benefits associated with the underlying asset shall be determined at the inception of the lease but assessed over the life of the lease not just at the end of the lease.
Several Board members expressed their concerns over the articulation of the principle and expressed their preference to formulation of the principle based on transfer or retention of the risk rather than creation of exposure (as lessor is already exposed to the risks of the underlying asset).
The discussion focussed on the general criteria of the usage of performance obligation and derecognition approaches. Several Board members questioned the business model criterion and suggested that it could be expressed in a better way as it could lead to structuring opportunities. They also questioned whether risks and rewards were used as a proxy for existence of performance obligation. Some suggested that over the time of the lease performance obligation aspect could be dominant and at the end of the lease the transfer notion is dominant.
The Boards also noted that in the assessment of the risks and rewards the present value of the residual value at the end of the lease period should be considered.
The Boards will continue the discussion on this issue later this week.
After a short discussion, the Boards agreed that residual value guarantees provided by parties other than the lessee should be considered in determining whether a lessor is exposed to significant risks and benefits associated with the underlying asset. The Boards noted that such approach focuses on economics of the lease rather than legal form of the contract.
The Boards also agreed not to provide any additional guidance for the long-term leases of land and noted that the general principles should be applied for all type of contracts (based on significant risks and benefits).
Finally, the Boards considered the set of factors to be considered in determining whether a lessor is exposed to significant risks and benefits associated with the underlying asset. Some Board members expressed their concerns how operational the factors will be as interaction between the criteria to distinguish between the two approaches, short and long term leases and factors to determine between leases and sales/purchases of underlying assets. In addition some Board members expressed their concerns over the complexity of the hybrid approach for lessor and its inconsistency with the proposed guidance for lessees. Even though the Boards agreed in principle with majority of the factors suggested (business model, exposure to risks and benefits associated with the underlying asset at the end of the lease - i.e. lease terms and residual value guarantee, significance of contingent rentals, nature of the underlying asset, relation of fair value of lease payments and fair value of underlying asset and material non-distinct services), the Boards asked the staff to re-consider these factors and articulate them more clearly. The Boards will discuss these conditions later this week.
Revisited: Scope - Purchases/sales of the underlying asset
The Boards re-discussed the criteria for scoping the contracts that meet the criteria for classification as a purchase or sale of an underlying asset out of the new leases standard. Some Board members expressed their concerns that given the decisions taken on the hybrid approach, some criteria for classification as a purchase or sale and related to derecognition approach for lessor would overlap. Some Board members noted that the rationale for scoping of these contracts have been substantially narrowed by the decision to pursue the hybrid approach. Nonetheless, other Board members considered the two set of criteria necessary. In their view, the scope analysis related always to the whole asset and as such would better depict the lending nature of the transaction in some circumstances.
The Boards noted that the economic distinction between derecognition approach and purchase and sale is very small, but could have practical significance. Consequently, the Boards decided to retain the separate criteria for determining whether the contract should be classified as a purchase or sale of the underlying asset. Nonetheless, the Boards decided to retain only the criteria related to title transfer and bargain purchase option, as all other criteria would be already covered by the derecognition approach.
One IASB member asked whether the bargain rental option should not represent a separate criterion as it economically can equal to the bargain purchase option. The staff clarified that this condition would be already covered by the other proposed criteria.
Accounting for Arrangements with Service and Lease Components
The Boards considered accounting for arrangements that contain both service components and lease components.
After a short discussion, in which several Board members expressed their concerns with the appropriate revenue and profit recognition, the IASB agreed that lessor under the derecognition approach to lessor accounting should be required to bifurcate service and lease components in a lease arrangements for both distinct and non-distinct service components. Nonetheless, this proposal was narrowly defeated in the FASB, as three FASB members expressed their concerns over separation of non-distinct services based on practicability concerns and margin considerations. The IASB agreed to do the allocation based on the relative standalone selling prices of the service for both distinct and non-distinct services.
The Boards discussed the allocation of revenue for lessors between the various components. For many Board members it was contradictory to use the relative selling prices of the non-distinct services (as these are usually not separable) and noted that a kind of allocation based on cost-plus-margin approach might be necessary.
Some Board members questioned why the bifurcation is not required for lessees as well if it is possible to require it for lessor accounting. These Board members were concerned by the possible revenue recognition patterns of these contracts. The staff responded that such bifurcation would be too onerous for the lessees due to informational asymmetry.
The Boards continued to consider the accounting for the service component of a lease arrangement under the derecognition approach to lessor accounting, considering two possible approaches: accounting based on proposed revenue recognition requirements or by recognising a separate performance obligation for the service components. The second approach would lead to slightly earlier revenue recognition as well as grossing-up of the statement of financial position. The Boards remained split on the issue, with the IASB preferring to recognise a separate performance obligation, and the FASB preferring to refer to the proposed revenue recognition guidance.
As the Boards were split on the accounting, the Boards decided to ask questions to constituents in the forthcoming exposure draft on these issues (on bifurcation as well as on accounting treatment).
Business Combinations
The Boards discussed the recognition and measurement of the lease assets and liabilities in a business combination. After a short discussion, the Boards agreed that all lease assets and liabilities in business combinations should be measured in accordance with the proposed leases requirements and that an acquirer would measure those assets and liabilities as if the lease arrangement was a new lease arrangement. Based on that decision, the lessee would measure the right of use asset at the present value of remaining lease payments reflecting the acquirer's discount rate (that would equal the initial measurement of lease obligation) and any adjustment for the off-market rate. The lessor, under the performance obligation approach would adjust the initial measurement of the performance obligation (that would equal the initial measurement of lease receivable) for the off-market rate. Under derecognition approach, any adjustment for off market rate would adjust the lease receivable (that would be initially measured at the present value of the remaining lease payments reflecting the acquirer's discount rate).
Additional disclosures
The Boards agreed to add following proposed disclosures relating to the hybrid lessor model to the disclosure section of the forthcoming exposure draft:
- details on the accounting policy on which model(s) that the lessor applies,
- the types of risks/benefits of the underlying asset that the lessor considered when deciding which approach to apply, and
- separately for each type of lessor approach any impairment that occurred.
The Boards also agreed that an entity should disclose the existence and principal terms of any purchase options for the lessee to purchase the underlying asset.
The Boards will continue to discuss leases later in the week.
The IASB Chairman extended to FASB and FASB staff publicly the sympathy of all at the IASB on the death of Jeff Cropsey, who died suddenly in early July. He had been, Sir David noted, an extremely important part of the insurance contracts team and his contributions would be missed.
Unbundling insurance contracts
The Board discussed the results of the staff's additional research in developing the concepts behind a principle for when to separate ('unbundle') components of insurance contracts and discussed the proposed approach to unbundling to be included in the forthcoming exposure draft on insurance contracts.
The staff had explored both a 'significant interdependence' approach and a 'variability in the overall cash flows' approach, but had concluded that neither on its own was sufficient. Consequently, they proposed an approach that would limit unbundling to the particular components that the boards identified as the most relevant and prominent unbundling cases, namely policyholder account balances and embedded derivatives that are separated under existing bifurcation guidance.
The Boards had a thorough debate. Some supported the proposal; others wanted to identify either significant interdependence or variability in cash flows as the principle and then list what would reasonably be expected to be unbundled; at least one IASB member proposed an entirely different approach. A FASB member was concerned that the two principles identified by the staff worked with different components of the items that would be unbundled, but neither worked with all of them. He was concerned that the Boards were micro-managing the issue.
The FASB seemed more inclined to support the variability in cash flows principle, but a strong majority of the IASB favoured significant interdependence—a concept already in IFRS 4.
The Boards moved on to discuss the components that would be unbundled. A FASB member was concerned that a proposed requirement to use the market rate in certain circumstances would be unnecessarily onerous and would result, at least in the US environment, in a 'search and destroy mission' by entities seeking to ensure that all possible information had been taken into account when determining the rate. The Boards agreed that this was not the intent and that the crediting rate for the account balance should be determined by the investment performance of the underlying investments (similar to pension accounting).
After these clarifications, the Boards confirmed that the unbundling principle should be:
A component of an insurance contract should be unbundled if it functions independently from other components of that contract. A component functions independently if it is not significantly interdependent with other components of that contract.
In addition, application guidance would be provided such that:
An insurer shall unbundle the following components of a contract that are not closely related to the insurance coverage specified in that contract:
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(a) policyholder account balances that bear a crediting rate determined by the investment performance of the underlying investments (supplemented with additional guidance);
- (b) embedded derivatives that are separated under existing bifurcation guidance; and
- (c) goods and services provided under the contract that are not closely related to the insurance coverage, supplemented with the clarification that the intention is not to create or require an exhaustive search for goods and services that are not closely related but to deal with situations where goods and services have been combined with the insurance coverage for reasons other than economic.
Staff will work with Board members out of session to refine this guidance.
Unit-linked issues (follow-up)
The Boards discussed two follow-up issues for unit-linked contracts: the accounting mismatches that arise from the measurement of the assets backing unit-linked contracts; and the presentation of assets, expenses and income arising from those contracts.
Accounting mismatches
The Board noted that several issues arise in asset measurement for portfolios associated with unit-linked contracts, in particular when funds are consolidated or when the fund is an internally managed virtual fund. Three items were identified as posing problems: issuer's own shares held in the fund (in those jurisdictions in which this is permitted); real estate and investments in associates.
The staff proposed that these items should be added to the list of items that qualify for the application of the fair value option, in the interest of eliminating accounting mismatches. In addition, it would be necessary to specify that holdings of the insurer's own shares would qualify for recognition as an asset only in the circumstance in which the shares back unit-linked contracts (e.g., because they are in an index tracker fund or similar).
The Board had another vigorous discussion. One IASB member warned that the proposals were set the Board on a 'slippery slope', in particular with respect to own shares. Staff responded that the accommodation was being made only when there was a contractual link between the unit-linked insurance contract and the underlying fund.
In the end, the IASB voted (10 in favour) for the staff proposal, clarified to stress the contractual link between the unit-linked insurance contract and the underlying fund. The FASB was content with the modified proposal.
Presentation issues
With little discussion, both Boards agreed that an insurer should present the pool of assets underlying unit-linked contracts as a single line item and not commingle them with the insurer's other assets.
In addition, the Boards agreed that that an insurer shall present income and expense from the pool of assets underlying unit-linked contracts as a single line item, presented on the face of the statement of comprehensive income or disclosed in the notes, and not commingle them with income or expense from the insurer's other assets.
Simplified measurement (short-duration contracts)
The Boards have decided tentatively to require the premium allocation model for pre-claims liabilities of short-duration insurance contracts. This requirement puts some pressure on the line between short-duration contracts and other insurance contracts. This session was devoted to identifying the characteristics of a short-duration contract.
One related question facing the Boards was whether an insurance entity underwriting both short-duration and long-duration insurance contracts should use the same accounting model for all contracts; or whether all short-duration contracts should be accounted for using the premium allocation model and all other insurance contracts should use the building block approach. The staff's preference is the former approach.
The Boards ultimately agreed that the required application of the premium allocation model should be restricted to the pre-claims liability of short-duration contracts, which incorporate all the following features:
- (a) the coverage period is approximately 12 months or less;
- (b) the insurer is unlikely to become aware of events during the coverage period that could cause significant decreases in the expected cash out flows[*]; and
- (c) do not contain significant embedded options or guarantees
[*] The IASB was evenly split on this issue and the FASB wholly in favour of including it, so it will be included in the forthcoming exposure draft with a related question in the Invitation to Comment.
Treatment of acquisition costs
The Boards discussed the treatment of acquisition costs. The Boards were confused because it seemed that one option was to expense as incurred and the other was to defer and amortise over the contract period (i.e., 12 months). Board members thought that these two were essentially the same. No firm decision was made (or if there was one, it was not obvious).
Discount rate: locked-in or updated?
Some IASB members would prefer to stay silent on the issue of the discount rate, mostly on the grounds that for short-duration contracts the effects of discounting will not be material. However, the IASB did agree to use a current rate for the accretion of interest to an unallocated premium liability (subject to the usual materiality constraint).
The FASB will vote on this issue later in July.
Residual margin for Investment Contracts with a discretionary participation feature [IASB-only issue]
With almost no discussion, the IASB agreed that the residual margin of a discretionary participating feature should be recognised in profit or loss over the life of the contract in a systematic way that best reflects the asset management services, as follows:
- (a) on the basis of passage of time, but
- (b) if the insurer expects to provide asset management services in a pattern that differs significantly from passage of time, it shall release the residual margin on the basis of assets under management.
Confirmation of Alternative Views and Abstentions
Mr Smith confirmed his intention to present an Alternative View in the exposure draft, for the reasons given in June (see IASPlus.com notes for that meeting). Mr Engstrom also confirmed that he is considering presenting an Alternative View, for reasons expressed in June.
Dr Paul Pacter will abstain, given that he has not participated in the development of the exposure draft other than this meeting.
Dr Elke Koenig said that she would vote in favour of the exposure draft, having followed the project closely and benefitting from being an observer at the IASB table since her appointment earlier in 2010.
The meeting closed at about 1900.
Tuesday 20 June 2010
Based on the IASB and FASB's decision in June 2010 to amend their convergence workplan, the IASB's derecognition project has been removed from the current priority list to be reconsidered again sometime after June 2011. Instead, the Boards have agreed that their near term focus should be on increasing the level of transparency and comparability with respect to disclosures of transfers of financial assets between IFRS and U.S. GAAP. Additionally, the Board will be performing post implementation reviews of the FASB's recently adopted guidance for derecognition of financial assets within ASU 2009-16 (FAS 166) to help in determining the future direction of the project.
The IASB staff has performed an assessment of the disclosure requirements proposed within ED/2009/3 Derecognition and those within the FASB's new standard to identify any differences and if, and how, they could best be eliminated. After completing that assessment, the IASB staff believes that while differences may exist with respect to geography and that certain transactions may not be disclosed identically because of the differences with respect to the derecognition models, that broadly the disclosures between the FASB's standard and the IASB's ED are similar.
The one notable exception to the above is with respect to servicing assets and servicing liabilities in which the IASB ED does not require specific disclosures because the subsequent accounting for those assets and liabilities is not included within the scope of IAS 39. While the staff believes there may be some usefulness to such disclosures, it recommends that the Board address the disclosures as part of a more comprehensive consideration of the accounting for servicing assets and servicing liabilities. The Board agreed with the staff recommendation that addressing disclosures of servicing assets and servicing liabilities should not be done as part of the near term disclosures project.
The staff also addressed the question of to what extent the proposed disclosures within the derecognition ED would overlap with the proposed disclosures within the pending consolidation standard. With respect to transfers of financial assets to consolidated subsidiaries, the staff does not believe there would be any overlap as a transfer would not have occurred on a consolidated basis and derecognition would not have been achieved. For transfers to nonconsolidated entities, the staff believes there is the potential for overlap; however, this primarily stems from the consolidation disclosures focus on the entity while the derecognition disclosures focus on transactions. As a result, the staff believes that any overlap would still provide useful information regarding an entity's activities and risk exposures and recommends maintaining the proposed disclosures. The Board agreed with the staff recommendation.
The Board then proceeded to discuss the effective date and transition requirements for the derecognition disclosures. The staff proposed an effective date of 1 January 2011. The staff also discussed whether retrospective application or prospective application was more appropriate. The staff believes that retrospective information would provide the most useful information, but given the nature and lifecycle of derecognition transactions, applying retrospective disclosure requirements could be quite costly and difficult to apply. As a result, the staff recommended that the disclosure requirements would only apply to those derecognition transactions entered into subsequent to 1 January 2011. However, entities would not be precluded from applying retrospective application if they felt that it provided more useful information. The Board agreed with the staff recommendations regarding effective date and transition requirements.
The staff will now complete drafting in preparation for a ballot vote on the new requirements. Additionally, the staff mentioned that given the decision to move the reconsideration of derecognition until 2011, the staff would also begin the process of moving the current derecognition requirements within IAS 39 into IFRS 9.
At the February 2010 Board meeting, the Board requested the staff to perform additional research and analysis on the key issue of the recognition of regulatory assets and liabilities. The staff presented the Board with a detailed analysis of the various regulatory environments, an analysis of the scope, a comparison of the rate-regulated activities project to current IFRSs as well as to current IASB projects and a summary of the outreach efforts.
The staff reported back that the results of the additional research and analysis did not provide a clear direction for the project. That is, that all aspects of the staff's efforts resulted in some information that is supportive and some information that is not supportive of the recognition of regulatory assets and liabilities.
The Board was presented with two alternatives with regards to the future direction of the project:
- View 1 - recognition of regulatory assets and liabilities on a 'cost-plus aggregate contract' approach where the time delay required by regulations between incurring the unanticipated costs of the current period goods and services sold (not already included in current period rates) and invoicing the aggregate customers in a future period for this unanticipated variance is reflected as a regulatory asset or liability as at the current period end.
- View 2 - Disclosure only of the impact of regulations on the entity (i.e. no recognition of regulatory assets and liabilities).
Before opening the floor for the deliberation of the presented alternatives, the Chairman noted that key question the Board needs to consider is whether these regulatory activities give rise to assets that meet the definition of an asset as set out in the Framework.
There appeared to be significant confusion amongst the Board members as what the asset would be. A Board member wanted to know whether these 'regulatory assets' would be separately identifiable assets when acquired in a business combination or if they would just be included in goodwill. The staff responded that in North-America, these are likely to be recognised as separate assets, whereas in Europe they are generally included as part of the licence.
A Board member asked what constitutes 'the resource controlled by the entity'. The staff explained that any variance that exists between the beginning of period expected costs and the actual costs incurred in providing the goods or services that have already been delivered, is deemed an 'unbilled receivable'. Another Board member enquired if that would imply that a utility entity that has a recognised regulatory asset, controls the individual customers? The staff responded that although the 'unbilled receivable' technically is an intangible asset, the realisation of the economic benefits is more akin to a financial asset.
One Board member asked why there was an apparent inconsistency between the proposed recognition of regulatory assets and the recognition of the right to charge customers as described in IFRIC 12. Another Board member noted that in some circumstances it may also be possible to analogise the Regulator to an insurer/guarantor and that there is also an inconsistency with that treatment.
In general, the Board members were split between those believing that regulatory assets and liabilities should be recognised and those that don't believe the definitions in the Framework are met. Several Board members felt that the Board has not looked at the elements of a regulatory 'asset' close enough to conclude that an asset meeting the definition in the Framework exists.
The Board had an extended discussion on whether the definition of asset in the Framework is met, only briefly considering whether the definition of a liability would be met. A Board member expressed his surprise with the number of Board members focussing solely on the definitions in the Framework, whereas the Board has decided to recognise various other 'items' as assets or liabilities although the definitions were not clearly met, such as options and participation features.
One Board member summarised the position by concluding that there appears to be general agreement that there are assets that exist through the regulatory system. However, the key question to consider is whether these assets are recognised or not. It was suggested that by analogy to other intangible assets, it could be decided that unless these regulatory assets were acquired directly or through a business combination, they are not recognised.
Other Board members supported this on the basis that if it is decided that regulatory assets should be recognised, it will be very difficult to define the scope as there are other similar situations where entities are governed by regulation where these principles could equally apply. A Board member acknowledged that on the whole, it appears that the definition of an asset could be met, but questioned whether the recognition thereof would provide any decision-useful information for the general users of the financial statements.
One Board member noted that the Regulator in Brazil has issued a statement indicating that it will not influence any accounting decisions relating to the transitioning to IFRS, but that they will maintain and require information for regulatory purposes separately.
Some Board members were of the opinion that the conceptual framework question is being brought into a industry-specific question and that accounting principles should not be forced purely because there are principles under IFRSs that do not fit well with the current practice of a specific jurisdiction.
The Chairman noted that it seems unlikely for the Board to reach a decision that would allow solution to be found in time for the adoption of IFRSs by Canada. He provided the Board with three options to consider with regards to the matter:
- The Board does nothing and leave it put to the Canadian adopters to apply the principles in the Framework. This may result in a precedent being created that cannot be stopped once it has started and will open the door for many such situations by future adopters of IFRSs;
- Develop a short-term Standard to resolve the matter, similar to IFRS 6. It was acknowledged that this will not be a quick solution either;
- Formulate a 'quick-fix' solution for the short-term to assist Canada and Brazil in the transition to IFRSs.
The Chairman instructed the staff to contact the Canadian standard setter to determine what alternatives they may have as a solution.
The matter will be discussed during at a later session once the staff had time to liaise with the Canadian standard setter. The Board also asked the staff to prepare a paper that rationalise the approach adopted for service concessions in relation to regulatory activities.
The Board was reminded of the decisions taken at the February meeting with regards to the Income Tax project. At that meeting, the Board agreed to limit the scope of the project to two practice issues, being deferred tax on property remeasurement at fair value and uncertain tax positions, as well as five proposals from the exposure draft that were very popular with respondents.
Deferred tax on remeasurement of property at fair value
The staff presented the Board with two alternatives to achieve the required outcome with regards to investment property measured at fair value in accordance with IAS 40:
- An exception to the measurement principles based on the expected manner of recovery under IAS 12 paragraph 52 or
- Extending the guidance in paragraph 52 on the expected manner of recovery.
The Board considered whether to limit any amendment to IAS 12 to investment property measured at fair value, or to extent it to other non-depreciable assets measured at fair value. With a majority vote, it was agreed not to limit the amendment to investment property only, but to broaden it to other non-depreciable assets.
On the matter of an exception vs. an extension of the guidance, the Board decided through majority vote to amend IAS 12 by including an exception to the principles in paragraph 52.
Uncertain tax positions
The Board was presented with a proposed timeline in which to address the remaining proposals. In accordance with the proposed timeline, uncertain tax positions would have been discussed by the Board in October. Initially it was decided to only address uncertain tax positions once the amendments to IAS 37 have been finalised.
After a short deliberation, the Board agreed to dealing with uncertain tax positions separate from the other issues, in order to provide speedy relief to constituents. The Board instructed the staff to prepare an exposure draft for ballot. The exposure draft will be open for comment for a period of 60 days.
The remaining five issues on IAS 12 will be dealt with at the next Board meeting with an exposure draft expected by December 2010.
Wednesday 21 July 2010
The Board was provided an update on the activities of the IFRS Interpretations Committee including developments from the meeting on 8-9 July 2010. The Board held a brief discussion on the Committee's agenda topic of put options written over non-controlling interests as one Board member inquired why the Committee did not recommend bringing the issue before the Board, particularly given the ongoing project of financial instruments with characteristics of equity. The response the Board received was that the initial question raised to the Committee was narrow in scope; however, the Committee thought it most appropriate to consider the overall accounting under existing standards. The Committee is in the process of determining whether a consensus view will emerge such that an Interpretation can be issued. If the Committee does reach a consensus, but has concerns over the practical implications of the consensus, the Committee will then raise the issue to the Board.
The Board discussed the recommendation made by the IFRS Interpretations Committee on replacing the fixed date of 1 January 2004, relating to the derecognition exception (IFRS 1.B2) and the fair value measurement of financial assets or liabilities at initial recognition (IFRS 1.D20), with a more relevant date. The Board acknowledged that the cost for an entity of reconstructing transactions back in time to 2004 would likely outweigh the benefit to be achieved by doing so. The Board unanimously agreed to replace the fixed date with "the date of transition to IFRSs". The Board also agreed to amend IFRS 1 as a separate project, rather than through the Annual Improvements process, so that the relief offered by the amendment may be available in time for those jurisdictions planning to adopt IFRSs in the near future. The amendments will have a comment period of 60 days.
IFRS 1 - Clarification of borrowing costs exemption
The Board was presented with a recommendation from the IFRS Interpretations Committee with regards to a perceived lack of guidance in paragraph D23 of IFRS 1 with respect to the accounting for borrowing costs capitalised in accordance with previous GAAP for completed and under-construction projects at the date of transition.
The staff explained that there is current divergence in practice as to whether borrowing costs capitalised under previous GAAP should be eliminated or retained (grandfathered) at the date of transition. Furthermore, for qualifying assets under construction at the date of transition and for which the commencement date for capitalisation is before the transition date, there are divergence as to whether subsequent borrowing costs incurred should be capitalised under IAS 23 or remain accounted for in accordance with previous GAAP.
The Board unanimously agreed to include additional guidance in IFRS 1 through the annual improvement process to clarify that capitalised borrowing costs should be retained at the date of transition and that borrowing costs incurred after the date of transition should be accounted for in accordance with IAS 23.
A Board member questioned whether the Board will be opening itself to numerous other requests for the grandfathering of previous GAAP accounting in situations where the requirements are different to IFRSs. The Chairman responded that the amendment will be limited to this specific situation and that the Board will not be opening the floodgates for other assets as well.
Another Board member noted that the proposed amendment will also be of benefit to those jurisdictions that are transitioning to IFRSs in the near future and whether the amendment should be included as part of the separate exposure draft on amendments to IFRS 1 discussed earlier. The Chairman responded that although the final amendments following from the Annual Improvements ED will only be published towards May 2011, the effective date for this amendment can be backdated to annual periods starting on 1 January 2011. In that way the amendment can still be applied by jurisdictions that adopted IFRSs on 1 January 2011.
IAS 16 - Clarification of accounting for servicing equipment
The Board was asked to consider an apparent inconsistency in paragraph 8 of IAS 16 which states that spare parts and servicing equipment are usually carried as inventory but that major spare parts and stand-by equipment qualify as property, plant and equipment when they are expected to be used during more than one period. The matter was recommended as an annual improvement by the Committee.
The Board unanimously agreed that servicing equipment qualify as PP&E when used during more than one period, otherwise it should be classified as inventory. The Board also agreed to delete the requirement that spare parts and servicing equipment used only in connection with an item of PP&E be classified as such.
The Board considered the proposed amendments to IAS 16 presented by the staff and deliberated whether the make some editorial changes to ensure the proposed wording bring across the Board's intention. The Board finally accepted the proposed wording, subject to replacing the term 'usually' with 'often' in the proposed amended paragraph 8 of IAS 16.
IAS 32 – Tax effect of distributions to holders of equity instruments
The Board considered a conflict between IAS 12 and IAS 32 in respect of accounting for income tax consequences of distributions to holders of equity instruments, recommended as an annual improvement by the Committee.
The Board unanimously agreed to amend IAS 32 through the annual improvements process to require accounting for income tax in accordance with IAS 12 instead of addressing the specific accounting treatment on equity transactions within IAS 32 itself. A Board member pointed out that IAS 32 currently refers to 'distributions' whereas IAS 12 refers to 'dividends' and questioned whether the proposed amendment may have some unintended consequences in jurisdictions where not all distributions are treated as dividends. The Chairman clarified that all the proposed amendment will do is to clarify that users should refer to IAS 12 instead of IAS 32 for the tax treatment of distributions. The staff was asked to make sure that there are no unintended consequences while finalising the exposure draft.
IFRS 8 and IAS 34 - Consistency in disclosure of total segment assets
The Board considered a proposal to clarify the disclosure of total segment assets in the interim financial statements prepared in accordance with IAS 34. IFRS 8 was amended in April 2009 to only require disclosure of total segment assets when regularly provided to the chief operating decision maker, however no consequential amendments were made to IAS 34. The Committee recommended the matter to the Board to be clarified as an amendment to IAS 34 through the annual improvement process.
A few Board members noted that an amendment to IAS 34 is not required as IAS 34 only requires disclosure of material changes to information that has been previously disclosed. As total segment assets would not have previously disclosed where it is not regularly reported to the chief operating decision maker, nothing would need to be disclosed in accordance with IAS 34. However, the Board unanimously agreed to amend IAS 34 as part of the annual improvement process.
Issues recommended by the Committee not to lead to amendments within the scope of the Annual Improvements process
The Board considered the following three issues recommended not to lead to amendments by the Committee:
- IFRS 3 - Contingent consideration and first-time adoption;
- IFRS 8 - Determination of scope; and
- IAS 32 - Clarification of the puttable instruments criteria for income trust units
The Board confirmed that contingent consideration existing on first-time adoption should continue to be accounted for under IFRS 3 (2004) and that no amendment to IFRS 3 is required.
The Board confirmed the Committee's recommendation that matters regarding the scope of IFRS 8 should be addressed as part of the post-implementation review of IFRS 8 and that no amendments to IFRS 8 should be made during this annual improvement cycle.
The Board unanimously confirmed the Committee's recommendation not to amend IAS 32 as part of the annual improvement process as the requested exception to the definition of a financial liability is outside the scope of the annual improvements and that many of the arguments supporting the application of the fixed for fixed condition also apply in considering this request.
Measurement chapter
At the May 2010 joint meeting the Board decided to continue to develop preliminary views in the measurement phase of the Conceptual Framework project rather than produce a neutral discussion paper. The Board was presented with three questions posed in the May paper as the staff believes that these questions are the most important.
[The staff had a separate meeting with the FASB to consider these questions prior to the meeting with the IASB and the FASB views were highlighted throughout the discussion]
1. What are the implications of the objective of financial reporting for measurement?
The Board was reminded that the objective of financial reporting is the foundation of the Conceptual Framework and thus, the concepts and guidance of the measurement chapter should logically flow from that objective.
The staff presented three possible views of the implications for measurement of the objective of financial reporting. These views are expressed in terms what the best way is to maximize information for investment and credit decisions:
- View A: The balance sheet view - the selection of measurements for assets and liabilities that faithfully represent the entity's wealth with respect to those assets and liabilities;
- View B: The income statement view - the selection of measurements for assets and liabilities that result in persistent information about accrual-basis cash flows in the statement of comprehensive income;
- View C: The holistic view - consider information that would result in both statements from selecting a particular measurement for an asset or liability, or groups of assets or liabilities.
A large majority of Board members were supportive of View C, albeit for different reasons. In general, these Board members considered View C consistent with the Board's view in the objective chapter that the statement of financial position and statement of comprehensive income are equally important and that one does not take prominence over the other.
Several of Board members were of the opinion that the views have not been articulated well and that descriptions and rationalisation of the alternative views were not neutral and objective. The staff acknowledged that the views were only articulated in order to obtain preliminary thoughts on and that they will be developed further based on the comments received from the Board.
The staff indicated the FASB were unanimous in their support for View C.
2. What are the general implications of the fundamental qualitative characteristics of useful information for measurement?
The Boards considered two alternatives for the measurement chapter to built on fundamental qualitative characteristics of relevance and representation.
- View A: No additional discussion is needed about what the qualitative characteristics might imply for measurement;
- View B: An explanation of how relevance and faithful representation relate to measurement would be useful.
The Board members expressed very strong support for View B, although they were not all supportive for the explanations listed in the agenda paper. It was agreed that editorial suggestions would be discussed offline with the staff.
The staff indicated that the FASB was also supportive of View B. The staff also pointed out that the FASB was concerned that one of the explanations may create the impression that the selection of measurement bases related to the entity's business model. The Board agreed that the point should be clarified.
3. What should the measurement chapter accomplish?
The Board was presented with five alternatives with View A being the most basic specifications and each alternative thereafter, building onto the specifications of the previous alternative.
A Board member started the discussion with noting that the measurement chapter should not be neutral (view A), but should also not specify which assets and liabilities should be measured using a specific basis (view E). Most Board members were either supporting View B (discussing the relationship between qualitative characteristics and measurement bases on a conceptual level) or View C (expanding on view B by prescribing a hierarchy of measurement bases). One Board member was concerned that view C would 'box in' the Board with regards to future assets and liabilities and how they should be measured. Other Board members agreed that measurement should be based on principles and that the measurement chapter should not be too prescriptive. This was the main objection against view C.
The Chairman brought the discussion to an end by summarising the all Board members were completely in view B, but leaning towards view C. The staff indicated that the FASB was in the same position.
The staff indicated that they will take all the comments and recommendations on board and use view B as the starting point for the measurement chapter and incorporate some of the 'good' points of the other views, especially view C, in their analysis.
 Advisory Council update |
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The Chairman of the Advisory Council Paul Cherry provided a brief oral update from the recent Advisory Council meeting that was held in June 2010 in London. Mr. Cherry focused on the process of setting the post 2011 agenda as well as the criteria for the agenda setting process. Output of these deliberations would be presented to the Board and will be subject of public consultation later in the year.
Application guidance on when to use the performance obligation or derecognition approaches (cont.)
The Boards continued their discussion on the hybrid approach for lessor accounting. After a considerable debate, the Boards remained split on the cut between derecognition approach and performance obligation approach.
In general, the majority of the IASB members preferred more contracts to be accounted using derecognition approach, whereas the FASB members preferred more contracts to be accounted using performance obligation approach. The FASB suggested that contracts that expose the lessor to the risk of significant variability of returns over the lease term should be accounted for using the performance obligation approach, whereas several IASB members preferred a purer derecognition approach.
Finally, the IASB Chairman concluded that any of the discussed distinction criteria would not be operational and suggested that each Board develops a preferred default approach for which a set of exceptions would be developed. The IASB tentatively opted for the derecognition approach to lessor accounting whereas the FASB tentatively opted for performance obligation approach to lessor accounting. The Boards agreed to discuss the default preferred approach at separate sessions and to continue their discussions at a joint session on Thursday.
Preferred default approach to lessor accounting
The IASB discussed the derecognition model as its preferred default approach to lessor accounting. The Board agreed that there exist some leases for which derecognition approach would not be suitable and discussed possible criteria for the exceptions (i.e. criteria for accounting for the lease contracts under the performance obligation approach). Some Board members expressed their concerns focused on application of the performance obligation model to investment property and real estate industry.
After a lengthy discussion, the Board tentatively agreed (subject to further discussion with the FASB and subject to drafting) that the lessor should use the performance obligation approach if the lease term is insignificant (short term) in relation to the useful life of the underlying asset, with the lease term being defined as the minimum contractual term of the lease, and the lessor is exposed to the significant risk of obligation resulting from the non-integral services that could lead to non-performance (with non-performance possibly leading cancellation of the entire lease contract).
The Board discussed other possible criteria for the exception including removal of the asset risk for the lease period, residual value guarantee as well as business model of the lessor. Nonetheless, these criteria did not attracted widespread support among Board members.
The IASB will discuss the criteria for the performance obligation approach at a separate meeting on Thursday. Subsequently, it would discuss possible solutions to the divergent views on lessor accounting jointly with the FASB.
The project team presented the Board the results of the external review of the staff draft of the ED Financial Instruments with Characteristics of Equity. A small group of external commentators provided more than 600 individual comments on the draft. The reviewers concluded that the approach lacks principles and thus it would be very difficult to determine the classification of an instrument that was specifically not addressed by the draft. Consequently, these reviewers expressed doubts that the specific guidance in U.S. GAAP could be replaced by this draft. The reviewers also noted that the proposed approach provides in many instances inconsistent results and might lead to structuring opportunities. Finally, the reviewers questioned the proposed specified-for-specified criterion and questioned the relation between this criterion and the fixed-for-fixed criterion currently in IAS 32 Financial Instruments: Presentation.
The Board members noted that the most obvious criticism was the lack of principle, and as such the basic approach to this project needs to be reconsidered. Several Board members questioned whether it was still worth to continue trying to develop a new model and whether the current criteria in IAS 32 amended for the most pressing issues would not provide the appropriate classification. Moreover, several Board members noted that benefits of implementing new model of classification of these instruments would be limited as in majority of cases it would provide the same answers as the current guidance in IAS 32.
The staff noted that in some instances the criticism of IAS 32 was driven by the desire to classify more financial instruments as equity rather than unclear requirements of the Standard itself. On the other hand, the staff noted that such approach would not address one of the objectives of the project - convergence with U.S. GAAP.
The staff suggested that limited amendments of IAS 32 and relevant guidance in U.S. GAAP could lead to comparable outcomes by retaining the different approaches (more extensive guidance under the U.S. GAAP). One IASB member suggested that before the Boards jointly consider the next steps in this project the FASB staff should undertake an outreach in the U.S. regarding their reaction to the guidance in IAS 32 as a less prescriptive, more principle-based approach. Additionally, the IASB staff should identify the most pressing issues identified in relation to the current guidance in IAS 32 that could be addressed by a limited-scope project.
The Boards would discuss the project based on the additional outreach later in the year.
Thursday 22 July 2010
Application guidance on when to use the performance obligation or derecognition approaches
The Boards continued their discussion on when to use which approach to lessor accounting. The Boards discussed multiple variants of the model, either separately, or at a joint meeting, before agreeing on a converged solution to lessor accounting.
The Boards agreed that a lessor should account for a lease contract based on whether the lessor retains exposure to significant risks or benefits associated with the underlying asset
- either during the expected term of the current lease contract; or
- subsequent to the term of the current lease contract by having the expectation or ability to generate significant returns by leasing that asset multiple times subsequent to the current contract, or
- by selling the underlying asset.
The Boards also agreed that counterparty credit risk of the lessee should not be considered for this assessment. The Boards confirmed that this assessment should be made at the inception of the lease and not reassessed subsequently.
The Boards agreed that if the lessor retained exposure to significant risks or benefits associated with the underlying asset, the performance obligation approach should be used, otherwise the lessor should apply the derecognition approach.
The Boards agreed to provide additional factors that would indicate that significant risks or benefits associated with the underlying asset during the lease term have been retained. These would include the risks resulting from:
- Significant contingent rentals that are based on the use or performance of the underlying asset;
- Options to extend or terminate the current lease term; or
- Contractual material non-distinct services provided under the lease contract.
The Boards also decided that a lessor should consider whether the term of the lease is short in relation to the useful life of the underlying asset when determining whether the lessor retains exposure to significant risks or benefits associated with the underlying leased asset subsequent to the term of the current lease contract. The Boards noted that in making this assessment the lessor should consider the present value of the residual cash flows at the end of the lease term as well as effect of residual value guarantees provided at inception by the lessee or third parties.
Finally, the Boards concluded that the residual asset should not be re-measured as the asset risk is considered through the lessor's consideration of exposure to risks or returns through sale of the underlying leased asset.
The Boards also noted that the Basis for Conclusion should refer to the business model as a possible indicator of whether the derecognition or performance obligation model for lessor accounting would be appropriate.
Sale and leaseback
The Boards considered implications of the deletion of the reference of 'all but a trivial amount of the risks or benefits associated with the underlying asset' as well as two of the other criteria in determining whether a contract is a purchase or sale of the underlying asset. (Note: that tentative decision was made earlier on Monday).
The Boards decided to reinstate the reference to 'all but a trivial amount of the risks or benefits associated with the underlying asset' but confirmed deletion of the two criteria.
Some Board members still expressed some concerns with the purchase or sale criteria as they believed that these might be potentially confusing with the criteria for using the derecognition approach to lessor accounting.
In relation with sale and leaseback, the Boards decided not to change any proposed guidance, and acknowledged the possible effect that more transactions being accounted for as financings.
Support for the package of decisions
The Boards formally approved the package of decisions in the leases project. Mr. Finnegan indicated that he might present an alternative view related to derecognition and performance obligation approach to lessor accounting.
The Boards briefly discussed the scope of the Insurance Contracts Exposure draft. The FASB raised the issue of the employer providing health insurance to its employees on an ongoing basis being potentially within the scope of the new Insurance Contracts guidance. The IASB staff responded that such employer provided health insurance would meet the criteria of employment benefits under IFRS, thus being scoped out from IFRS 4 Insurance Contracts as well as from the forthcoming Exposure draft.
Presentation
During the September 2009 meeting, the Board had tentatively decided to replace fair value hedge accounting with a model similar to cash flow hedging with gains and losses on the effective portion of the hedging instrument recognised in other comprehensive income and any hedge ineffectiveness recognised in profit and loss.
During constituent outreach, the staff received concern regarding the artificial volatility created within equity as a result of this decision. Those entities expressing this concern included banks and certain non-financial entities who enter into foreign exchange contracts to hedge the risk associated with long term firm commitments, such as aerospace manufacturers and shipbuilders. These entities are concerned over the potential implications from adding the effective portion of hedging relationships into equity, including the possibility of having an overall negative balance within equity as well as the impact on leverage ratios.
The staff proposed three alternatives to address the concerns raised including:
- retaining the original decision of recognition in other comprehensive income,
- adding a separate balance sheet line item "valuation allowance" for recognition of the effective portion of the hedging relationship (rather than remeasuring the hedged item itself), or
- retaining the approach within IAS 39 of remeasuring the hedged item.
The staff recommended alternative 2 by creating a separate line item within the statement of financial position to reflect the effective portion of the hedge relationship.
The Board discussed the three alternatives focusing primarily on alternatives 1 and 2. One Board member expressed reservation on whether the separate line item would meet the definition of an asset or a liability while others felt that rather than needing to meet the definition of an asset or liability, it was strictly a valuation allowance for a recognised asset or liability or a recognised firm commitment in a hedge relationship.
A majority of the Board ultimately agreed with the staff recommendation to create a separate line item within assets or liabilities to recognise the effective portion of the hedge relationship.
The Board then discussed an alternate proposal brought by one staff member which recommended a linked presentation approach for fair value hedges of firm commitments. Discussion ensued over the difference between a linked presentation approach and offsetting (primarily that offsetting presents two items as a single item within the financial statements where linked presentation "links" two separate items (typically one asset and one liability) that have a natural connection and are beneficial to present together rather than in separate sections of the statement of financial position. While the suggested alternative was only to allow linked presentation for fair value hedges of firm commitments (as the hedged item is not recognised within the statement of financial position), many Board members discussed extending the approach to all fair value hedges. The Board tentatively agreed not to permit a linked presentation alternative at this point but to continue outreach on this issue.
Effectiveness Assessment
One of the issues constituents have recommended addressing during the project to reconsider hedge accounting is the effectiveness assessment to initially qualify and continually retain the eligibility for hedge accounting. Many belief the current effectiveness requirements are overly rules driven (the arbitrary 80 to 125 percent brightline), the testing requirements are too onerous (requirement to continually perform both prospective and retrospective effectiveness tests), the cliff effect of failing the effectiveness criteria is too severe (effectiveness outside the 80 to 125 band in any one period results in the loss of hedge accounting), and potentially most important - there is little to no correlation between the hedge accounting qualification requirements and the underlying risk management strategy.
The staff considered whether an approach of establishing a minimum level of effectiveness to allow certain hedges in or an approach of establishing guidelines such that hedges with accidental offsetting were kept out was preferable. The staff also considered the use of qualitative thresholds, quantitative thresholds, or some combination of the two as the effectiveness assessment criteria. The staff proposed four alternatives to the Board for effectiveness assessments:
- a quantitative threshold
- a qualitative threshold,
- rely solely on an entity's risk management policy, or
- a combination of qualitative thresholds with minimum requirements tied to risk management or supplementary tests.
The Board agreed with the staff recommendation for alternative 4 to incorporate a model for effectiveness assessment using both qualitative thresholds and risk management policies. Using this approach the staff further proposed an approach that would bifurcate hedging relationships into non-complex and complex hedging relationships.
Non-complex hedging relationships would be those where the critical terms are either matched or closely aligned such that the hedge is expected to be highly effective throughout its life. Because these hedges are expected to be highly effective, they would be qualitatively assessed for effectiveness prospectively at inception and on an ongoing basis unless events occur that would result in the hedge no longer being considered effective in which a quantitative assessment would be performed.
Complex hedging relationships would not have matching terms thereby increasing the uncertainty regarding the level of offset between the hedging instrument and the hedged item. Because of the level of uncertainty regarding their effectiveness, these hedging relationships would be quantitatively assessed prospectively at inception and on an ongoing basis.
The Board had mixed views on the staff proposal with some members supporting the proposal. However, other Board members expressed concerns ranging from operationalising the proposal for complex hedging relationships, the lack of convergence with the FASB's proposals and concerns that the criteria set for qualifying for effectiveness did not seem sufficiently stringent enough. One Board member proposed a model where effectiveness should be assumed to be very highly correlated and as part of the hedge designation, the entity would document those risks that would contribute to ineffectiveness of the hedge relationship from its risk management policy. Other Board members seem to support the underlying concept of this proposal and the Board asked the staff to further develop this approach.
The Board continued its discussion from earlier in the week regarding the accounting for rate regulated activities as no consensus had previously been reached. The staff provided the Board with four potential alternatives of how to move forward with the project.
Those include:
- a "fast-tracked" standard,
- an interim solution for those pending initial adopters of IFRS while later considering a longer term solution,
- an amendment to IFRS 1 to permit the continued use of previous national GAAP for rate regulated activities for first time adopters, and
- continue with the existing project under its current timeframe.
After deliberations of the four alternatives, the Board agreed to continue its current project under the existing timeframe without amending IFRS 1.
In the last step of the consolidation standard, the staff discussed with the Board various disclosure issues raised. One concern related to the disclosures for structured entities and why those disclosures were not required for risk exposure with all entities rather than just limited to structured entities. While the staff agreed with these disclosures could be relevant to all entities, including the disclosure requirement for all entities could involve expanding the scope of the standard and delay its issuance. The Board agreed to proceed with the disclosures only for the involvements with structured entities.
Another concern expressed was whether those disclosure requirements for structured entities was broader than those required under U.S. GAAP. The staff conducted a review of the proposed disclosure requirements with those in ASU 2009-17 (FAS 167) and outreach of U.S. constituents. The analysis determined that although there may be slight differences due to such definitions as "structured entities" versus "variable interest entities" or "involvements" versus "variable interests" the disclosure requirements are substantially similar and U.S. constituents generally agreed with the scope of the disclosures. The Board agreed to proceed with the disclosures as drafted.
In June 2010, the Board had agreed to include a disclosure objective requiring financial statements to include information that helps users understand the impact of noncontrolling interests on the entity. The staff has proposed to supplement the disclosure objective with specific disclosures similar to those exposed within ED 9 Joint Arrangements which includes the name of the subsidiary, their country of incorporation or residence, the method for allocating profit and loss and summarised financial information for the subsidiary (while considering a materiality threshold in preparation of these disclosures). The Board agreed with the staff's proposed disclosures.
The staff has also proposed additional disclosures for unconsolidated structured entities in which the reporting entity is the sponsor but no longer has continuing involvement as of the reporting date. In those instances, the reporting entity would disclose any income earned from its sponsorship and the carrying amount of any assets transferred to the structured entity during that period (carrying amount as of the time the transfer was made). The Board agreed with the staff's proposed disclosures.
The Board then voted for the staff to proceed with drafting in preparation for balloting of a final consolidation standard and a final disclosure standard (including disclosures for joint ventures, associates, etc.) and for drafting of an exposure draft on investment companies.
| IAS 29 – Reporting in accordance with IFRS after a period of chronic hyperinflation |
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The Board discussed the IFRS Interpretations Committee's request to consider clarifying how an entity should resume presenting financial statements in accordance with IFRSs after a period of severe hyperinflation, during which it had been unable to comply with IAS 29.
The request identifies an entity whose functional currency is that of a hyperinflationary economy and the entity is unable to comply with IAS 29 and prepare IFRS financial statements, because the general price index relating to the entity's functional currency is unavailable, and the functional currency lacks exchangeability. Once an economy ceases to be severely hyperinflationary, the question has been raised of 1) how the entity resumes preparing IFRS financial statements and 2) how the parent of a subsidiary in the above scenario would account for its involvement with the subsidiary. This issue is particularly relevant for those entities based in Zimbabwe or parents with subsidiaries based in Zimbabwe. The Committee recommended the Board to make amendments to IAS 29 as well as other standards including IFRS 1.
While the Board recognised the significance of the issue, they felt that they could not address the issue sufficiently with a complete review of IAS 29 under the time frame needed. The Board asked the staff to reach out to the South African Institute as well as groups in Mexico and Argentina who have been analyzing potential issues with regards to IAS 29 to discuss how best to move forward.
Friday 23 July 2010
Effectiveness – Method of Assessment
The Board continued its discussion on hedge effectiveness assessment from the previous day. This session focused on what method of assessment reporting entities should utilize in performing their effectiveness analysis and whether the IASB should prescribe or exclude any measurement techniques. The staff expressed concern with the use of percentage-based methods, particularly in respect of more complex hedging relationships as they felt the information provided was limited and did not provide economic meaning. However, the Board agreed that they should not proscribe any effectiveness methodology and would allow the percentage-based methods for effectiveness assessment.
Hedging Eligibility – Net Positions
IAS 39 currently prohibits the hedging of a net position requiring reporting entities looking to hedge a net exposure to either enter two offsetting derivative instruments or to hedge a portion of one side of the gross exposure. The Board had previously agreed to develop a model to permit hedge accounting for net positions. In the May 2010 meeting, the Board tentatively decided that gains or losses arising from hedging of net positions should be presented in a separate line item within profit or loss (because the hedging instrument is mitigating the risk of two separate financial statement line items, the question was which line should reflect the hedging instrument offset).
During this meeting, the staff expanded the previously discussed example of a net hedge of FX risk of two firm commitments to a net hedge of FX risk of two highly probable forecast transactions which impact profit and loss during separate reporting periods. The staff proposed that hedge accounting for a net position of forecast transactions should be permitted. Some members of the Board expressed reservations with applying hedge accounting to a net position of a forecast transaction, primarily around the linkage between the two items. The example of hedging FX risk on future sales and cost of sales used in the staff example was converted to hedging FX risk on future sales and advertising expenses and whether those two items would be correlated enough to be considered a net position. Some Board members felt that if the correlation was sufficiently documented within the initial designation documentation that would help support why the risk management policy links the two transactions as a net position. One Board member felt that the model needed enhanced discipline around what could be considered a hedge of a net position which received support from other Board members.
The Board also discussed how to identify the hedged item when hedging groups of items. This is one of the building blocks to begin future discussions around portfolio hedging. The staff recommended that the net position can be identified as multiple gross hedge items which may offset within and across reporting periods. The Board felt that the same issues discussed in the discussion of the net hedge of a forecast transaction were relevant in this discussion as well.
While no official decisions were made, the Board expressed agreement for the general direction the staff was heading but cautioned to incorporate the suggestions and concerns expressed throughout the meeting.
Comment Letter Analysis
The staff presented the Board with the analysis of comment letters on the Exposure draft ED/2010/4 Fair Value Option for Financial Liabilities. The Board did neither discuss the issues in detail nor did it take any decisions during this meeting. The Board will start the process of re-deliberations on one of the following meetings.
In general, the majority of constituents supported the general approach taken by the Board. Nonetheless, the comment letters expressed the following four concerns over the general approach:
- Meaning of the phrase 'changes in a liability's credit risk' (and lack of consistent definition of credit risk)
- Asymmetry between measurement of financial asset and financial liabilities;
- Interaction of the proposals with other projects (notably Financial Statement Presentation), and
- Lack of convergence between IASB and FASB.
Responding to a question, the staff clarified that despite expressing concerns about asymmetry in measurement, most constituents seemed to pragmatically accept the solution proposed.
The constituents agreed with the proposal that the effects of changes in a liability’s credit risk should not affect profit or loss unless the liability is held for trading. Nonetheless, some respondent noted that such approach could create additional mismatches in narrow circumstances when both assets and liabilities are subject of the same credit risk (e.g. state bodies that borrow from a market as state and grant the funds further to other state institutions). The Board members noted that although these circumstances should be sufficiently narrow and isolated, they would have material effect on particular entities and a targeted solution could be found to avoid those mismatches.
The majority of constituents agreed to present the effects of changes in a liability’s credit risk in the Other Comprehensive Income (OCI). The option to present these changes directly in equity did not attract sufficient support. Nonetheless, several constituents expressed their concern about the lack of principle on what items are presented in the OCI and asked the Board to undertake a comprehensive review of OCI as part of the Financial Statement Presentation project.
The staff also noted that some constituents (from one particular jurisdiction) supported the frozen credit spread approach.
Majority of constituents did not support the two-step approach or the prohibition of recycling from OCI to profit or loss on realisation. Many constituents noted that recycling would ensure consistency between early settlement of financial liabilities held at amortised costs and financial liabilities to which fair value option is applied. One Board member noted that constituents understand the OCI as distinction between realised and unrealised, a concept that was abandoned by the Board. Other Board member disagreed as he noted that currency transaction reserve is being recycled and thus the Board did not provide any concept or principle which to apply.
Finally, the staff noted that constituents supported using the default IFRS 7 method but suggested to the Board to make the objective clearer so that alternative methods could be used. In addition, constituents supported possibility to apply requirements of the ED early, but without adopting the rest of the requirements of IFRS 9 as the ED is built on IAS 39 requirements.
Comment Letter Analysis
The staff presented the Board with the analysis of comment letters on the Exposure draft ED/2009/12 Financial Instruments: Amortised Cost and Impairment. The Board did neither discuss the issues in detail nor did it take any decisions during this meeting. The Board will start the process of re-deliberations on one of the following meetings.
Based on the analysis, most constituents supported the move towards expected loss model for impairment. Nonetheless, some concerns were expressed over the possibilities for earnings management. Some Board members noted that a proposed disclosure package should alleviate these concerns. The Board also briefly discussed the concerns expressed over pro-cyclicality of the proposals and noted that accounting should provide a true and fair view of the situation at the year end and thus would reflect the effects of the cycle. In the view of some Board members that would not mean that the proposals are necessarily pro-cyclical.
Some constituents suggested that the wording of the ED is unclear whether the approach requires considering future expectations when estimating expected cash flows. The Board members noted that they do not see much difference between the objectives of the proposed IASB and FASB approaches. Nonetheless, they admitted that neither of the proposals is expressed clearly and thus the final guidance is likely to be in the middle between these proposals.
The constituents raised some concerns over operationality of the proposal and referred to the work of the EAP on Impairment in areas of open portfolios, lack of historical data, EIR calculation and tracking of losses and related requirement on maintaining of data.
Further concerns were expressed over the proposed catch-up adjustment (changes in estimates of expected losses to be recognised immediately in profit or loss), its consistency with the overall model as well operational challenges. The Boards also noted that concerns were expressed over the probability weighted average method for calculating expected losses (similar to concerns over probability weighted methods expressed in other projects, e.g. proposed revisions to IAS 37).
Finally, the staff noted that constituents expressed also concerns over the practical expedients, presentation and disclosure requirement that were perceived onerous and application of the proposals for non-financial institutions and non-interest bearing financial instruments.
Commenting on the due process, many constituents stated their concerns related to the status of the EAP work and the possibility to comment on the final standard arising from the EAP recommendations and Board re-deliberations.
Summary of work of the Expert Advisory Panel (EAP)s
The staff presented the Board with the summary of deliberations of the EAP prepared by the participating Board members and the staff. No decisions were taken at this meeting. The staff noted that the three most important issues for simplifications were:
- Use of estimated lifetime expected loss
- Decoupling of the contractual EIR calculation and expected losses calculation (e.g. by annuity approach or building block approach)
- Application of the guidance to open portfolios through using several possible approaches how to apply the guidance to 'good book' and 'bad book' portfolios.
This summary is based on notes taken by observers at the IASB-meeting and should not be regarded as an official or final summary.
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