Tuesday 24 August 2010
The IASB met in London for a special meeting related to the Financial Instruments and the Income Taxes projects. Some IASB members as well as the FASB staff joined the meeting via videoconference or phone.
User feedback summary
The staff presented the Board with a summary of feedback from outreach with users of financial statements. No decisions have been taken.
The staff noted that most of the feedback from users was consistent with the general feedback received (as discussed at the July Board meeting). In particular, most users supported the move towards an impairment approach based on expected losses but expressed concerns about its complexity and subjectivity. The main difference between the feedback from users and other constituents was the users’ focus on disclosure requirements. Users argued that extensive disclosure might help to counterbalance subjective management judgement and provide useful information.
General approach for re-deliberations
The Board discussed the general approach for re-deliberations. The Board agreed that the re-deliberations should focus on open portfolios. The staff noted that any model that is applicable and operational for open portfolios would be applicable and operational for closed portfolios.
The Board also noted that it will deliberate the impairment approach jointly with the FASB once the FASB comment period on the FASB Accounting for Financial Instruments ED ends at the end of September 2010.
Objective and Approach
The Boards discussed the objective of amortised cost measurement. The staff noted that constituents supported the overall objective but some respondents felt that the objective should be modified to address impairment specifically. The staff noted that the Board would need to reconsider a separate objective if it decides to pursue decoupling of credit losses from the effective interest rate calculation. The Board agreed to consider the issue at that point.
The Board considered four alternative impairment approaches:
- Expected loss approach
- Modified incurred loss approach
- Fair value based approach
- Impairment approach based on IAS 36 Impairment of Assets
Based on the strong support of the expected loss approach to impairment, the Board agreed to pursue the expected loss approach.
The Board discussed the modified incurred loss approach based on IBNR provision. Most Board members felt that the modified incurred loss approach would be subjective and the link between specific events and specific outcome might prove to be elusive.
Scope of Expected Loss: Outlook period and conditions
The Board discussed the length of the outlook period and conditions to consider when determining an expected loss. The discussion focused on high-level issues related to the outlook period and did not focus on practical implications of how to measure expected loss or practical expedients that could be used. These topics would be discussed at one of the future Board meetings.
The Board confirmed the decision from the ED that the expected loss approach should be based on lifetime expected losses. Nonetheless, as one Board member noted, estimate of lifetime losses should not mean explicit forecasting but should allow using long term averages as practical expedients. As one Board member noted, the lifetime approach is consistent with other proposed Standards and was also supported by banking supervisors.
The Board then discussed the conditions when calculating expected loss. The FASB in its Accounting for Financial Instruments ED proposed to determine the expected loss based on past and existing conditions whereas the IASB proposed in the ED to consider all reasonable and supportable information and conditions.
One Board member noted that the difference between the IASB and FASB approach was not that large, and both could be adjusted through wording. In his view, the FASB did not intend to ‘freeze the situation’ on current level and the IASB did not intend to allow ‘pick and choose’ the information – e.g. by allowing using future information. He suggested to work with the FASB on a common ground in this area and to base the assessment on the best available information.
One Board member suggested that the information should be limited to the best estimate of conditions that market participants would consider in the assessment, but not market participant view of credit risk. Another Board member suggested that the consensus forecast should be input to the consideration. He noted that in his view the correct conditions and management consideration of future conditions relate to two different issues that would diverge especially when a market has developed a specific opinion on performance of a specific class of assets.
Finally, the Board tentatively agreed that all reasonable and supportable information and conditions should be considered in determination of expected losses. As one Board member noted, even if the IASB rejected the through-the-cycle impairment approach, long term average loss rates would be one of the inputs to calculation of lifetime expected losses. The IASB will discuss the conditions to consider in determining an expected loss together with the FASB to try to come to a converged solution.
Effectiveness Assessment
The Board continued its previous discussions from the 3 August and July meetings on the development of a hedge effectiveness assessment method to qualify for hedge accounting. During those previous meetings the Board had developed a concept of seeking a hedge relationship that should have the intention of being highly effective at inception while understanding and documenting any potential sources of ineffectiveness as part of the designation process. The Board asked the staff to further build a model around this concept.
The model the staff developed and proposed at this meeting included the following:
- The objective of the effectiveness assessment is to ensure the hedging relationship has an unbiased result (e.g., no intentional over or under hedging) and to minimise ineffectiveness.
- Hedging relationships should also be expected to achieve other than accidental offsetting (a second screening criterion in addition to the unbiased hedge requirement above).
- Effectiveness assessment is a forward looking concept performed at inception of the hedging relationship and ongoing throughout the life of the relationship.
- The type of effectiveness assessment (whether quantitative or qualitative) will largely depend on the entities’ risk management system, the specific characteristics of the hedging relationship and the potential sources of ineffectiveness. No method will be prescribed.
- Changes in the method of assessing effectiveness are required when unexpected sources of ineffectiveness occur in the hedging relationship or if the relationship is rebalanced and is no longer capable of capturing the sources of ineffectiveness, the entity would be required to change the method for assessing effectiveness.
The incorporation of the neutral or unbiased result concept acknowledges that many hedging activities cannot eliminate all sources of ineffectiveness (either because the perfect hedging instrument is not available or is cost prohibitive to obtain); however, the hedging relationship should not be established in such a way as to include a deliberate mismatch in the weightings of the hedged item and of the hedging instrument.
One Board member expressed concern over the use of the term neutral hedge and preferred utilising the unbiased hedge terminology. Another Board member expressed concern over the example used in the Agenda paper discussing the additional effectiveness criteria regarding accidental offsetting. He used an example of hedging the price of whiskey by entering into a hedging instrument over the price of steel as an example where any level of offset would clearly be accidental in nature.
The Board tentatively agreed with the staff’s proposed model for hedge effectiveness assessment.
Hedging a Portion of a Group of Items
The Board continued its previous discussions from the 3 August meeting regarding designating a portion of an item (rather than a proportion) in a hedging relationship. The Board’s previous tentative decision to permit hedging of a portion of an item focused specifically on an individual item. Today’s discussion expanded the previous discussion to include a portion of multiple items, such as a specific portion (e.g., €700K) of multiple firm commitments to purchase multiple items of property, plant and equipment in the same foreign currency or a top layer portion (e.g., £50M) of two issued bonds.
Consistent with the previous discussion on single items, items with fixed term prepayment features (in which the hedged item would have a change in fair value from changes in interest rates) were excluded from the scope of the discussion and will be discussed separately at a later date.
The Board tentatively agreed to require, when hedge accounting is elected, part of a group of existing items to be identified and designated as a portion of the entire group of items when:
- the portion is identified and documented at inception of the hedge,
- the designation is in line with the entity’s risk management strategy,
- the entity can demonstrate that:
- the hedged items are existing items that can be clearly identifiable,
- each item in the group are exposed to the same hedged risk,
- it is possible to appropriately track the portion and entirety of items to measure hedge ineffectiveness and when to release amounts recognised in the balance sheet once the hedged item impacts profit and loss, and
- the hedged portion is clearly identifiable and reliably measurable, and
- the fair value of any prepayment or termination features is not impacted by the hedged risk.
Eligibility to Hedge Instruments Measured at FVOCI
As a result of the issuance of IFRS 9 and the ability to elect to measure certain equity investments at fair value with gains and losses recognised permanently in other comprehensive income (OCI), the question has been raised on whether (and how) an entity would be permitted to apply hedge accounting to such an investment. The current definition of both fair value and cash flow hedges refer to affecting profit and loss. Because the requirements of IFRS 9 do not permit recycling of gains and losses held within OCI when an investment is disposed of, there will naturally be a disconnect in the application of the hedge accounting principles (i.e., both with ineffectiveness during the life of the investment and with effectiveness at realisation of the investment - since the hedged item does not impact profit and loss the deferred amounts in the balance sheet would be realised in profit and loss upon settlement with no offset from the derecognition of the hedged item).
To address the issue of whether to permit hedge accounting for equity investments measured at fair value through OCI would require consideration of a separate hedge accounting model for these items. Additionally, the IFRS 9 provision to measure an equity investment at fair value through OCI is an election. As a result, the staff recommended the Board prohibit the application of hedge accounting to equity investments designated at fair value through OCI.
The Board agreed with the staff proposal. However, two Board members disagreed with the staff proposal to not permit hedge accounting for these items while another Board member expressed concern with the proposal but because of the elective nature of the designation ultimately did not vote against the proposal. One of the Board members who voted against the staff proposal felt that it was a valid hedging strategy to protect capital and therefore it should not be excluded simply because it did not fit within the existing hedge accounting model. Additionally, because of the pending standard which plans to create a single statement of comprehensive income where profit and loss and other comprehensive income would be shown together, they felt that no distinction should be made.
In preparation of the issuance of the exposure draft Deferred Taxes: Recovery of Underlying Assets, the staff shared a pre-ballot draft with certain constituents to obtain feedback. This process identified five primary issues the staff brought back to the Board for reconsideration.
The first issue identified related to the exception applying to deferred tax assets in addition to deferred tax liabilities as initially determined. Constituents mentioned it was inconsistent to measure deferred tax liabilities based on the exception while not also measuring deferred tax assets using a similar approach. The Board tentatively agreed to include deferred tax assets within the exception.
Similar to the first issue, constituents also expressed concern over consequential amendments to the scope of SIC 21 (applying only to deferred tax assets and not to deferred tax liabilities for non-depreciable assets that are revalued or fair valued) because SIC 21 would not be applied consistently. The Board tentatively agreed to withdraw SIC 21 in its entirety and incorporate the constituent concerns as part of issue four discussed further below.
The third issue raised by constituents was application of the exception to all temporary differences relating to an underlying asset rather than just to a temporary difference created by revaluation of the asset. This is because the unit of account in determining the manner of recovery is the underlying asset rather than the individual temporary difference. The Board tentatively agreed that the exception should apply to all temporary differences relating to the underlying asset and not just temporary differences created by revaluation.
The fourth issue identified by constituents relates to how deferred taxes should be measured when applying the exception. The Board’s original decision was to apply the exception based on the lower tax consequence of either sale or use of the underlying asset. However, constituents questioned why a “lower” approach was used instead of an alternative approach such as a higher or average. The Board tentatively agreed to require when utilising the exception that the measurement should reflect the underlying asset being recovered entirely through sale. This is because the approach:
- can be applied to both the measurement of deferred tax assets and deferred tax liabilities,
- is a more practical approach than the lower of approach,
- is consistent with the approach in SIC 21, and
- reflects at least one of the entities’ dual intentions (sale or use).
The fifth issue was whether the exception should be required to be applied. Constituents believed the exception should not be required when an entity’s intention to sell or use the underlying asset is unclear. The staff proposed addressing this concern by requiring the exception to be applied under a rebuttable presumption of recovery by sale unless the entity has clear evidence to prove it will consume the asset’s future economic benefit. The Board discussed the proposal and whether the suggested wording provided too high of a hurdle to overcome in order to apply the use approach (i.e., providing evidence). The Board agreed that other standards such as IFRS 9 apply management’s intent to the determination of accounting considerations. The Board tentatively agreed with the staff recommendation subject to wording revisions to focus on management intent or expectations rather than requiring evidential matter.
Constituents also raised certain other issues including:
- Should the exception be applied to other assets?
- Should the exception also be applied when assets are measured at fair value in a business combination and subsequently measured using a cost model?
- The computation of tax consequences of a sale may be complex
- Tax planning opportunity, and
- Retrospective application.
The Board tentatively decided not to make changes to the pre-ballot draft based on the concerns raised on these topics. However, the exposure draft will include a specific question on the retrospective application provisions, specifically in the context of a business combination and whether they are overly burdensome to apply.
This concluded this special meeting.
This summary is based on notes taken by observers at the joint IASB-FASB meeting and should not be regarded as an official or final summary.
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