• September 2004: Financial Instruments Working Group Appointed
• Discussed at March 2005 IASB Meeting
• Discussed at April 2005 Joint IASB-FASB Meeting
• Discussed at July 2005 IASB Meeting
• Discussed at October 2005 IASB Meeting
• Discussed at October 2005 Joint IASB-FASB Meeting
• 6 March 2006: Staff Questionnaire on users' views on fair value disclosures
• Discussed at April 2006 IASB Meeting
• Discussed at April 2006 Joint IASB-FASB Meeting
• Discussed at June 2006 IASB Meeting
• Discussed at September 2006 IASB Meeting
• Discussed at November 2006 IASB Meeting
• Discussed at December 2006 IASB Meeting
• Discussed at January 2007 IASB Meeting
• Discussed at March 2007 IASB Meeting
• Discussed at April 2007 IASB Meeting
• Discussed at October 2007 IASB Meeting
• Discussed at January 2008 IASB Meeting
• Discussion Paper published 20 March 2008. Comment deadline 19 September 2008.
• Discussed at June 2008 IASB Meeting – Discussion of FASB Hedge Accounting Project

Timetable

• Click for IASB Project Timetable

Discussion at the March 2005 IASB Meeting

This was an educational session. The Board was not asked to made decisions.

The aim of the education session was to present to the Board the project plan proposed for convergence with US GAAP and to ask for suggestions on the approach to the project. The list of convergence issues identified so far is:

• Accounting for securities sold but not yet purchased (short trading)
• Definition of a derivative
• Derecognition of financial assets
• Classification of financial assets - held to maturity
• Effective interest method
• Impairment
• Unquoted equity instruments

Generally the Board was supportive of the methodology used to identify differences and the analysis provided on these topics. The Board asked that cash flow hedge accounting be inserted into the paper as a convergence issue and that the FASB be asked to consider the IFRS requirements.

However, the Board expressed its frustration in that the differences highlighted indicated the need to not only improve the current financial instruments standards (IAS 39 and FAS 133 - the US GAAP equivalent) but also to simplify them. Some Board members believe the IASB and the FASB should work more closely and concentrate on the fundamental issues of financial instrument accounting and deal with those issues so as to eliminate the differences and inconsistencies that arise in the detail of the Standards. One of the fundamentals given as an example was whether or not all financial instruments should be measured at fair value; agreeing on this point would allow the Board to simplify the requirements of financial instrument accounting.

FASB staff agreed with the comments made (via video link) and indicated that the same issue would be discussed with the FASB on 16 March. The IASB suggested that these issues be discussed at the joint meeting of the two Boards in April.

Discussion at the April 2005 Joint IASB-FASB Meeting

The Boards discussed the best way forward in further developing the financial instruments models, and particularly eliminating differences and the mixed attribute model. Staff suggested the following alternative methods of proceeding:

• (1) Proceed with a project to introduce a full fair value model
• (2) Proceed with a project using a full fair value model with certain exemptions based on the cash flows of each instrument
• (3) Identify and deal with discrete areas of financial instruments accounting
• (4) Undertake a project to deal with 'small' issues which would eliminate reconciling items between US GAAP and IFRS.

It was noted that prior to making a final decision as to the agenda, the FASB would be likely to be required to discuss this with the Financial Accounting Standards Advisory Council (FASAC). There was a brief discussion on the role of the Financial Instruments Working Group. It was noted that this group is purely advisory and is not a decision making body.

The Boards expressed a view that the full fair value model is the ultimate goal. FASB members noted that in issuing FAS 133 the FASB stated that they were moving toward a fair value model subject to the resolution of certain practical difficulties. It was noted that the technical project to produce a full fair value option document will not take as long as the time needed to convince constituents of the value of this method. The existing fair value alternatives will need to be in operation for some time to enable constituents to better understand the benefits of such an approach before it will be possible to undertake a project to make fair value mandatory for all financial instruments.

The Boards noted that a project on de-recognition was also required, but that such a project should extend beyond only financial instruments. They briefly discussed whether it was possible to comply with IAS 39 and FAS 140. It was agreed that in some scenarios the outcomes might be the same, but in many a reconciling item would be required. The Boards noted that the justification for a project on derecognition was possibly more persuasive than that for further consideration of the fair value options as the magnitude of the differences between IFRS and US GAAP is much greater, and there is continuing public concern about off balance sheet financial transactions. The Boards agreed with the staff suggestion that this should, for the time being, be a research project rather than an agenda project, and acknowledged that it is unlikely to be in a form ready for discussion for some time.

The Boards noted that of the alternatives presented to them in respect of fair value neither alternative (3) nor alternative (4) appeared to be viable alternatives as they would consume hours of staff and agenda time for little improvement. The Boards agreed that they needed to consider the proposed timetable for each of the remaining approaches - alternative (2) should only be considered if it was likely to be completed in a shorter time frame and would then go another step in the direction of full fair value. Some members noted that alternative (2) may actually take longer due to the difficulties in crafting the appropriate exemptions for instruments for which the amortised cost model would be permitted. It was noted that if this approach was adopted the Boards should ensure that constituents understand this is considered to be an incremental step in the direction of a full fair value model.

The staff drew to the Boards' attention the fact that even if the full fair value options were implemented there would still be significant difficulties to be resolved in respect of cash flow hedging. The Boards agreed that simplification of cash flow hedging is desirable.

Staff noted that there appear to be three main issues:

• Scope (consistency and appropriateness of the definition of a financial instrument);
• Disaggregation of gains and losses in the income statement; and
• Disclosures.

The IASB acknowledged that while the FASB has a well-advanced project on the definition of fair value, the IASB do not. Accordingly before the project could proceed far the Boards would need to agree on the meaning of fair value, and the IASB agreed this would be a key part of their process to be followed. The Boards agreed a project should be added to the agenda to resolve the full fair value option, and that the first steps toward this should be for the staff to prepare a plan on how to address this topic. The plan would particularly address the first of the two issues above, but would be designed to ensure the overall objective (an eventual move to a full fair value model) is kept at the forefront of any developments. The plan will be developed by the joint project team and presented to each Board at its own meeting.

Discussion at the July 2005 IASB Meeting

The Board was updated on the July 2005 meeting of the financial instruments working group. The update included the following:

• Board members in attendance at those meetings had re-iterated that the working group was intended to assist the Board with work on financial instrument accounting that would ultimately replace IAS 39. It was pointed out that there should be no tinkering with the standard, instead only improvements should be explored and put through as a way of improving the Standard unless some direction is determined that could lead to a full review of the entire standard.
• Members of the working group had indicated concern about moving to a full fair value basis of accounting given where accounting is at present.

Discussion at the October 2005 IASB Meeting

This session covered preliminary discussions ahead of the joint meeting with FASB on 24-25 October 2005 to clarify objectives and status for the potential work program and a work trough of a paper that consider issues related to disaggregation of fair value. Board members discuss the IASB-FASB convergence project, and there seem to be agreement that this should be done by a long term convergence project, were the result should be to issue a new standard (not a revision of IAS 39 and the equivalent FASB standards) that is based on a 'full fair value model.' Board members stressed that this goal was a long way ahead. However, that long-term goal would not preclude standards being developed in the shorter-term on discrete aspects of financial instrument accounting. These short-term projects would only be undertaken if they were seen as consistent with the long-term project.

The paper on disaggregation of fair value was discussed very briefly as most members agreed on what the staff had proposed. In particular, the identification of those fair values derived with few or no market inputs ('mark-to-model') was seen as critical.

The Board agreed that there was a significant learning exercise underway between users and preparers of financial statements, with IAS 39 information being presented for the first time in many areas. This progressive education exercise needed to be built into the staff's plan to this topic. This would help the staff to work with users to determine the users' requirements for disaggregated information. Once these had been determined, whether it would be possible to provide this information would be investigated. This iterative process would be repeated as necessary. The staff were encouraged to use the national standard-setters as a means through which users could be engaged in this process.

Discussion at the October 2005 Joint IASB-FASB Meeting

The Boards considered their financial instruments projects, and how they should communicate their objectives to constituents. Staff recommended that the Boards communicate, via posting on their respective websites, their future plans. Those plans include:

• a commitment to full fair value measurement,
• improving the derecognition requirements,
• improving the hedge accounting requirements, and
• determining the appropriate treatment for a non-financial asset or liability that contains a hedged item.

The Boards noted that in stating their commitment to the development of a full fair value model, this would be a reaffirmation for the FASB who already stated this commitment some time back. It was noted that rather than an objective, development of a full fair value model is better considered as the long term vision. The Boards should clearly stipulate why they support full fair value, and what the obstacles to this vision are. (Board members cited issues in relation to scope, hedging, treatment of commodities, and definitional problems). The Boards hope to issue a due process document late in 2006 to suggest solutions to some of these obstacles.

Some IASB members noted that there will be a need to make changes to IAS 39 in the short term, and that each request must be considered on its own merits, rather than the current position of a stated blanket refusal to make minor amendments to the standard.

The Boards considered a paper in relation to the disaggregation of changes in fair value to provide the staff with guidance on how to proceed with the project. The staff had divided the decisions to be made into three categories:

• Those that should be left to be dealt with in the performance reporting project;
• Those that the Board should develop as requirements; and
• Items that should be discussed in semi-formal meetings with users.

The Boards noted that for the meetings with users to be effective, preparers would also need to be present to balance the competing needs. Board members were concerned that the project on disaggregation might delay the development of the full fair value model and strongly asserted their views that this must not be allowed to happen.

The Boards agreed that staff should develop a more detailed analysis on disaggregation. Concurrently the staff would draft a request for information to be sent to users.

March 2006: Joint IASB-FASB Questionnaire on Information about Changes in Fair Values of Financial Instruments

On 6 March 2006, the IASB and the US FASB jointly requested input from users of financial statements about the kinds of information about fair values of financial instruments, and changes in those fair values, that is useful to those making investment or credit decisions or advising others on investment or credit decisions. For this purpose, financial instruments include not only debt securities, equity securities, and derivatives, but also loans and accounts payable or receivable, and almost any other amount payable or receivable. The Boards issued a questionnaire and related background paper aimed at seeking users' views about whether current standards provide the information that investors and creditors need to analyse companies that report some or all financial instruments at fair value.

The Boards cite the following as examples of possible additional information that users may need:

• Quantitative information about the reasons why the fair values of financial instruments changed.
• Disclosure of exposures to future changes in the fair values of financial instruments.

The questionnaire has five questions with various sub-questions:

Responses are requested by 14 April 2006.

Click for:

• Press Release (PDF 28k)
• Questionnaire (PDF 39k)
• Background (PDF 38k)

Discussion at the April 2006 IASB Meeting

The staff presented a paper dealing with long-term objectives on how to simplify and improve financial reporting for financial instruments. The same paper will be discussed at the upcoming joint IASB/FASB Meeting 27 April 2006.

The paper addresses ways to simplify or eliminate the need for special hedge accounting. Both fair value hedging and cash flow hedging were addressed.

Several Board members commented favourably on the paper and suggested that the staff should explore the issues raised in the paper more extensively. One FASB member who was attending the meeting said that the paper was a good preliminary proposal but suggested that further consideration of the issues should await completion of the Fair Value Measurement project.

Board members expressed some general comments but no decisions were made.

Discussion at the April 2006 Joint IASB-FASB Meeting

The Boards discussed their long-term objective to eliminate or simplify hedge accounting in the broader context of the FASB/IASB Memorandum of Understanding's agreed objective to issue one or more due process documents relating to accounting for financial instruments by 1 January 2008. The Boards did not discuss the paper issued to Observers as Agenda Paper 1 for the joint meeting.

A FASB Member observed that the long-term objective of the Boards was the elimination of the current mixed attribute model for financial instruments. Therefore, the due process document should address why one basis is better than mixed attributes and why, in the Boards' view, fair value for financial instruments was the better answer for users, preparers and auditors. Members from both Boards commented that the due process document should address the measurement attribute rather than simply the calculation that is the result of that determination; that the document must articulate clearly what a financial instrument is and to which portions of a financial instrument (if any) a particular calculation might be applied. Board members stressed that this document would not seek to advocate (or otherwise) the extension of fair value measurement to assets and liabilities that are not 'financial instruments' as defined. In addition, the due process document would need to address both decision usefulness (relevance, reliability, and neutrality) and complexity issues.

The Boards discussed the shape and content of the due process document. The character of that document (that is, whether a Staff Paper or a Preliminary Views Document) could not be determined until the staff had prepared a outline and an estimate of the amount of Board involvement required. The amount of Board time necessary would also be a product of the amount of 'new thinking' vs synthesis of existing work in the document. Board members, especially IASB Members, stressed that a Preliminary Views Document would receive more and better attention from constituents and thus a higher-quality response.

The IASB and the FASB agreed to commit their staff to the next stage of 'the effort' (this was not an Agenda Decision). One FASB Member did not support this because the staff proposal was not sufficiently focused to enable him to make a properly considered decision.

The next stage is that the IASB and FASB staff will develop an outline of the due process document together with their assessment of Board time and involvement necessary if the document were to be released by 1 January 2008.

Discussion at the June 2006 IASB Meeting

Planning

No technical decisions were made during this session.

The Board discussed the primary objectives of, possible extent of IASB involvement with, a suggested outline of, and proposed timetable for the IASB-FASB Discussion Paper or Preliminary Views on financial instruments.

Primary objectives

The Board confirmed that the primary objectives of the Discussion Paper should be to:

• describe the major issues in current accounting standards and practice related to financial instruments;
• describe the boards' long term objectives with regard to accounting for financial instruments and the reasons that the boards established those objectives;
• present preliminary views on any individual issues on which a majority of the members of either Board have agreed, tentative conclusions supported by a significant minority of members of the boards, and any other results of the boards' deliberations that would aid constituents in preparing responses to the questions in the document;
• ask constituents for their opinions about the issues and possible alternative resolutions that may have been identified, and to request suggestions from constituents about possible ways to achieve the boards' long term objectives with the least cost and disruption in practice; and
• demonstrate to constituents the interaction between the issues related to the long-term objectives for financial instruments and other projects the boards are undertaking (such as the financial statement presentation project). The due process document should demonstrate the progress made on addressing issues relating to the accounting for financial instruments in the other projects.

Extent of Board involvement

The Board agreed that:

• the Discussion Paper should contain preliminary views, to the extent that the boards have reached them already either in this project (such as the long-term objectives of the boards and the decision not to undertake efforts with the single objective of eliminating reconciling items in SEC filings) or in other related projects;
• the Discussion Paper should contain the preliminary views of the boards on other issues to the extent that the staff and boards believe that it might be possible to reach those preliminary views in the timeframe we have; and
• to the extent that the boards have not discussed (or have not reached) preliminary views on specific issues, the Discussion Paper should include a neutral discussion of those issues (and state that no view has been reached).

Possible contents of Discussion Paper

The Board agreed that:

• The Discussion Paper should be drafted from a 'broad scope' position. That is that financial instruments (broadly defined) is the appropriate basis for the scope of the document, subject to whatever exceptions the boards think it desirable to make or additional items the boards wish to include. The board agreed with the staff that a scope that included all contracts requiring delivery or exchanges would be easier to describe and implement, as well as easier to justify conceptually.
• The Discussion Paper should not address derecognition issues relating to the transfer of financial assets: these should be included in a separate discussion paper. That DP should also include other derecognition issues (for example, relating to financial liability extinguishment or debt modification).
• In drafting the Discussion Paper, the long-term objective of fair value measurement should be assumed. The Board stressed that there might be some instruments for which a fair value measure would not be appropriate and that having this general principle would assist the boards to identify those contracts for which fair value was not an appropriate measure and to apply that principle consistently.

Timetable

The Board noted the current timetable, which plans for a Discussion Paper with Preliminary Views to be released in November 2007. Several Board Members noted the timetable was 'ambitious', but encouraged the staff to get on with it.

Presentation of Changes in Fair Value

The Board discussed an analysis of the results of a survey of the views of users responsible for making investment and credit decisions (or those advising others on investment and credit decisions), which asked what types of information in respect of financial instruments measured at fair value would be relevant to their analysis.

The staff had received responses to the questionnaire from 47 individuals covering 34 organisations, including many of the major sell-side and buy-side institutions. Six of the organisations who participated are based in the US with the rest based outside the US. The staff thanked these constituents for their assistance. Board Members noted that the survey was one of the most comprehensive and useful of its kind.

The questionnaire raised the following major points:

• Users require some disaggregated information for financial instruments that are measured at fair value. In particular, users continue to want information on bad debts (both in terms of bad debt charges and bad debt allowances) and interest. However, most users do not believe that further disaggregation of fair value changes and balances would provide information that would be of significant value given the current valuation methods that are used;
• There is little or no demand for interest income/expense to be reported on a 'fair value' basis. Most users express a preference for interest information to be presented on an accruals basis;
• There is support for the provision of more information on the exposure of an entity to future changes in the fair value of financial instruments (such as enhanced sensitivity analysis or stress tests)

It was noted that users had a general level of unease with the degree of optionality within IAS 39 and had difficulty tracking the reversal of value changes recognised in equity when these were subsequently recycled to profit and loss. In addition, it was noted that the survey was conducted before the effective date of IFRS 7, which requires some of the information currently sought by users.

The Board agreed that the next steps in the project should be to hold further discussions with selected users to:

• Ensure that the staff analysis as set out in this paper is appropriate; and
• Attempt to develop requirements for sensitivity analysis/stress tests that will provide useful information to users.

Discussion at the September 2006 IASB Meeting

The Board discussed issues raised by the staff about the scope of the proposed due process document on financial instruments.

Scope

After discussion, the Board agreed that the scope of the due process document should be based on a common definition of financial instruments, rather than instruments with similar probable outcomes. The latter alternative was seen as too wide and potentially would scope in items that the Board did not intend to.

The Board agreed that the Invitation to Comment should discuss whether noncontractual obligations to deliver cash (or other financial instruments) and rights to receive cash (or other financial instruments) should be part of the definition of a financial instrument.

Definition of a financial instrument

The staff proposed and then discussed a definition of financial instruments:

Ownership interests

The proposed definition is based on that in FAS 107 Disclosures about Fair Value of Financial Instruments, which refers to evidence of ownership interests with no reference to contracts. The Board agreed that the approach taken in FAS 107 is clearer and hence preferable. That is, to specifically include ownership interests and include contracts requiring the delivery and exchange of ownership interests with other delivery and exchange contracts.

Symmetry of contractual rights and obligations

The Board agreed that the contractual obligation of one entity to deliver creates another entity's contractual right to receive, and that exchange contracts create rights and obligations for both parties.

Reference to cash and financial instruments in contracts that are financial instruments

The Board agreed that a separate reference to cash was not needed. IAS 32 and Statement 107 explicitly refer to obligations to deliver cash or financial instruments and rights to receive cash or financial instruments-even though cash has previously been specified as a financial instrument.

Grouping of delivery and exchange rights and obligations

Statement 107 states that:

The Board agreed that it was both clearer and more logical to group the two sides of the contract (the right and obligation to deliver or exchange) together.

References to favourable and unfavourable contracts

The Board agreed that the reference to 'favourable' and 'unfavourable' was not necessary to ascertain whether something is an asset or a liability. The due process document could describe a financial asset as a financial instrument that is an asset (and similarly that a financial liability is a financial instrument that is a liability).

Right to require delivery or exchange

The Board agreed that the right to require receipt or exchange is what creates a right to an economic resource, and hence creates an asset (rather then the ability to simply receive or exchange).

Inclusion of components of non-financial contracts

The Board agreed that the definition of a delivery contract could be improved by stating that the right to receive a financial instrument in a delivery contract is the only form of consideration to be received in exchange for releasing the other party from its obligation.

Multiple element contracts

After discussion the Board agreed that they wished to view multiple element contracts as separate sets of rights and obligations. Some Board members were not convinced and would explore a 'whole instrument approach' with the staff.

Possible adjustments to scope

The Board agreed to exclude the following items from the scope of the due process document:

Matters being considered in other current projects:

• Investments in consolidated subsidiaries, consolidated variable interest entities (FASB only), and associates (equity method investees in FASB terms) or joint ventures
• Contingent consideration in business combinations
• Leases
• Royalty contracts and other contracts for rights to use assets (revenue recognition issues)
• Pensions and other post employment benefits
• Financial instruments classified as equity by the reporting entity
• Insurance and related contracts

• Financial instruments and derivatives related to share-based payments

The Board agreed to include the following:

• Contracts that are financial instruments by definition but are not recognized under current GAAP (for example, loan commitments, letters of credit)
• Intra-group balances [in the context of separate financial statements]
• Financial instrument servicing contracts

The Board noted that 'strategic investments' are within the scope of financial instruments generally and will not be considered as a separate type of financial asset.

The Board concluded that contracts that are very similar to related financial instrument contracts should not be included in the scope of the due process document.

Discussion at the November 2006 IASB Meeting

The Board continued their deliberations of Fair Value Measurements (FVM) and debated a number of key issues relating to recognition and measurement.

Reliability of fair value measurement

The Board discussed the question whether all financial instruments and related items can be measured with sufficient reliability at a reasonable cost. The Board indicated that particularly for some unquoted equity instruments and long-term derivatives subjective assumptions might be necessary. However, it decided that no exceptions should be allowed. The question whether costs might outweigh the benefits was not discussed at this meeting.

Unit of account for recognition

The staff paper considered the following possible units of account for recognition purposes:

• A portion of the individual instrument
• The individual instrument
• A linked (synthetic) instrument

The Board decided that the individual instrument should be used as starting point for recognition purposes. It noted that this approach might be overridden by a specific requirement in a Standard, e.g. by allowing the recognition of linked financial instruments.

Initial measurement

The Board discussed whether a financial instrument should be initially measured at:

• Market exit price
• Transaction price/market entry price

Some Board members noted that the transaction price/market entry price should not differ from the market exit price on initial recognition. Other Board members argued that there might be a difference depending on the evaluation model used by the entity at initial recognition. Finally, the Board was nearly equally split between market exit price model and entry price model and no final decision was made. However, it was noted that for subsequent measurement the exit price should be applied.

Unit of measurement

The staff paper considered the following possible units of measurement:

• Individual instrument
• Portfolio of instruments
  • a. Portfolios of identical financial instruments traded in an active market
  • b. Portfolios of non-identical financial instruments that share broadly similar risks
  • c. Portfolios of non-identical financial instruments with offsetting separately identifiable risks

Reporting of unrealized gains and losses

The Board considered how unrealised gains and losses arising from the remeasurements of financial instruments should be reported. The Board decided not to distinguish between realised and unrealised gains and losses and that all realised and unrealised gains and losses should be reported in profit and loss.

Measurement of guaranteed liabilities

The Board discussed whether a financial guarantee affects the measurement of a guaranteed liability and whether the guarantee should be considered separate from the liability (and hence not affect the fair value of the debtor's liability) or as part of the liability (and hence should be taken into account in measuring the fair value of the debtor's liability). No decision was made but the staff was asked to elaborate this issue further for discussion in a future meeting. Reporting of fair value changes arising from changes in an entity's own credit risk or own share price. No decision was made. The staff was asked to elaborate this issue further for discussion in a future meeting.

Measurement of certain options and embedded options

This issue relates to the question, what expected cash flows should be used in valuing the present contractual rights and obligations of an entity. As an example the Board discussed the option a credit card company writes to the holder of the credit card, under which the holder can either obtain a cash advance or use the card to purchase goods or services.

Two approaches were deliberated:

• Approach A: The cash flows used assume exercise of the option only in those circumstances in which a securities option would be exercised, that is, when the exercise price of an option to buy an item is less than the market price for the same item
• Approach B: All expected cash flows a market participant are considered in valuing the option contract, i.e. to use all the possible cash flows arising from the operation of the existing contract

Discussion at the December 2006 IASB Meeting

The Board continued its discussions on issues relating to recognition and measurement for its Due Process Document. Four main issues were addressed at the December meeting.

Loan with prepayment options and credit card agreements

First the Board discussed the issue on how a loan with a prepayment option should be characterised by the holder of the instrument.

Board members discussed whether the prepayment option is a non-financial component that the holder should recognise separately from the loan. The Board expressed reservations about this approach. The Board expressed a preliminary view that the entire asset should be recognised at fair value. The Board acknowledged that the prepayment option affects the fair value but that fact does not lead to recognising the non-financial portion of the value as a separate asset.

Secondly the Board discussed the issue on how credit card contracts should be assessed from the perspective of the issuer of the credit cards, and specifically whether the credit card company should separately report the portion of the value of a credit card contract with a cardholder that would not exist if the cardholder made his judgement solely based on interest rate considerations.

The paper presented to the Board identified two alternatives that had support from some Board members. One approach would recognise a single non-financial asset at fair value on the balance sheet. The other approach would split the contract into two portions, recognising a non-financial asset and a financial liability. Board members supporting the second approach said they would separate the two components of if the financial liability is material and separation is justified on a cost/benefit basis.

Bank deposit agreements

The Board discussed whether bank deposit agreements between a bank and the holder of the demand deposit would be within the definition of a financial instrument for the purposes of the Due Process Document. The Board's preliminary view was that since the bank did not have a stand-ready obligation to accept deposits from the depositor, bank deposit agreements should not be regarded as financial instruments. However, the Due Process Document should include a discussion of these agreements and seek views from constituents.

Liabilities with a demand feature

The Board debated how to remeasure liabilities that have a demand feature. The issue was whether the liabilities should be remeasured based on the immediate settlement value of the liabilities or whether it should be measured based on market expectations about the timing and amount of cash flows, the discount rate and incremental service costs on the liabilities.

The Board expressed a tentative view that these liabilities should be remeasured based on the market conditions, taking timing, discount rate and service costs into consideration.

Guaranteed liabilities

The Board discussed how third-party contractual guarantees would affect how a debtor should measure liabilities. Board members' views were divided. One view was that as long as the debtor was not released from its obligation if the guarantor has to settle the obligation, this should not affect measurement of the liability. The other view was that the existence of a guarantee always will affect the value of the liability.

The Board decided that it would need to assess specific examples before it would be able to express a tentative view on how contractual guarantees affect fair value measurement of liabilities for the debtor. The Board directed the staff to develop some examples which will be considered at a later meeting.

Note that the paper presented to the Board also includes a discussion on statutory guarantees, but in light of the conclusion regarding third-party guarantees this discussion was postponed.

Discussion at the January 2007 IASB Meeting

The Board continued its discussion of a due process document on measurement of financial instruments and hedge accounting.

Guarantees liabilities

Contractual guarantees

The Board discussed whether a third-party contractual guarantee affects the fair value to the debtor of the liability related to the contractual guarantee. The Board concluded that such a contractual guarantee does not affect the fair value unless payment of the guarantee by the guarantor to the creditor results in the release of the debtor from its obligation.

In addition, the Board agreed that if payment of the guarantee by the guarantor to the creditor results in the release of the debtor from its obligation, the debtor should recognize an asset as well as measuring the fair value of the liability based on the combined probability of cash flows from the debtor and cash flows from the guarantor.

Statutory guarantees (such as deposit insurance)

The Board agreed that statutory deposit insurance and similar non-contractual guarantees do affect the debtor's obligation and should be included in the valuation of the liabilities with statutory and similar non-contractual guarantees by the debtor. (Some Board members, while agreeing with this conclusion, disagreed with the staff's rationale. The rationale, some of which is included in Observer Note 7, will be revised.)

The forthcoming Discussion Paper would reflect these views.

Hedge accounting

The staff noted that the Due Process Document (DPD) treats hedge accounting as a departure from normal recognition, measurement and presentation principles. The staff then presented a number of situations and asked the Board which, if any, of the situations justified a departure from the general principles. The staff noted that hedges of the foreign currency exposure of a net investment in a foreign operation were not addressed in the DPD.

The Board then discussed each of the following issues:

• Exposures to changes in the fair value of a recognized item in the scope of the DPD
• Exposures to changes in the expected future cash flows of a recognized item in the scope of the DPD
• Exposures to changes in the expected cash flows of a forecast transaction to buy or sell an item that, when recognized, would be within the scope of the DPD.

The Board agreed that the Due Process Document should express a Preliminary View that there is no justification for an exception to normal accounting principles for these items. Board members noted that information about risk exposures required by IFRS 7 should address many of these items.

Exposures to changes in the fair value of assets or liabilities (including firm commitments) outside the scope of the DPD

The Board was sympathetic to permitting a 'fair value option' for exposures to changes in fair value outside the scope of the due process documents, for example, commodities traded other than for normal purchase and sale. Such an approach would permit both the hedged item (the purchase commitment) and the hedging instrument (presumably a derivative) to be marked to market through profit and loss. Designation would be required. Board members stated that components (that is, specific risks) of hedged items (for example, inflation risk) could not be hedged. A hedge need not be for the entire period of the commitment, nor for the entire quantity of the purchase commitment. Any gains and losses on such hedges would be recognised in profit and loss.

Some Board members were cautious, noting that they did not want to create additional accounting mismatches. Others were worried about the possibilities for obfuscation presented by permitting hedge accounting. These Board members were worried that there would be no disclosure of non-financial items exposed to economic risk (because they were not hedged). Again, it was noted that IFRS 7 should address much of these concerns.

It was also noted that the Due Process Document should acknowledge, although not necessarily resolve, the challenges posed by firm commitments denominated in a foreign currency. Although such transactions were outside the scope of the document, the Board noted that they were inextricably linked to the issues addressed in it.

Exposures to changes in the expected cash flows of a forecast transaction to buy or sell an item that, when recognized, will be outside the scope of the DPD

The Board expressed a preference that the Due Process Document should state a Preliminary View that there should be no exception to normal accounting principles for such items, provided that the document discussed the related presentation and disclosure issues. Some Board members suggested that, if the item eventually recognised was a fixed asset (for instance, an aircraft or a ship), the exposure to changes in cash flows should be presented as a Financing cash flow; if related to inventory, it would be an Operating cash flow.

Discussion at the March 2007 IASB Meeting

The staff prefaced the discussion by reminding the Board that the forthcoming Financial Instruments Due Process Document (the Document) was in two parts:

• the main components of the fair value model for financial instruments, and
• how the IASB and FASB might move to this model.

The staff advanced three possible approaches to advancing work on the project after consideration of comments on the Document.

The approaches advanced by the staff were:

• Move directly to a comprehensive exposure draft of the fair value model for financial instruments;
• Develop one or more interim steps that advance the use of the fair value model for financial instruments. Such an approach might seek to limit existing exceptions to the general principles in IASs 32 and 39 and, where possible, achieve convergence with US GAAP;
• Take a 'wait and see' approach.

Board members did not think the 'wait and see' approach was a viable alternative; it achieved nothing other than the status quo. The Board would continue to be in 'reactive' mode, making small changes to the standards, and IFRIC would continue to be faced with requests for interpretations. In addition, this approach would be contrary to the demands from constituents to remove complexity from the standards. This was unacceptable to many Board members.

Board members seemed to agree that the fair value model for financial instruments was the goal, but they disagreed about how best to get there. Some wanted to adopt the interim steps approach, seeing it as realistic and pragmatic. Others thought that the next step should be to develop an exposure draft, because that would force the Board to define what it means by the 'fair value model for financial instruments' and the accounting it thinks necessary to put that model into effect. Only then would constituents be able to evaluate the Board's position 'rationally and unemotionally.'

Several Board members thought it important to be clear about what the Board means by 'reducing complexity' and what alternatives that might appear to meet the objective of reducing complexity would not be candidates, because they would not advance the intention of the Board to move towards a fair value model. (Thus, introducing more options to measure financial instruments at cost would not be considered by the Board, even though it might reduce complexity.) This idea was termed 'directional consistency.'

The Board moved on to discuss the parameters (or constraints) that might determine the next step(s). Board members had differing views about the relative priority of the staff's suggestions, but the following were generally seen as ways to move towards the fair value model for financial instruments.'

• More financial instruments should be measured at fair value.
• The complexity of the standards should be reduced
• Accounting alternatives should be reduced and the role of management intent eliminated.

The Board agreed that short-term convergence with US GAAP was desirable but should not be a constraint, since the two Boards were starting from different positions. Thus, it would be acceptable to 'leap frog' each other. Also, Board members stressed that 'convergence with US GAAP' implied long-term convergence, not that the IASB would move to FAS 133. Some Board members noted that surrounding this approach was the issue of presentation. Constituents might accept the move to the fair value model for financial instruments provided that not all value changes were reported in operating income. The staff concluded the discussion by saying that they would return at a later Board meeting with examples of approaches that met the Board's objectives.

Discussion at the April 2007 IASB Meeting

At the March 2007 meeting the Board considered different approaches to moving towards the 'fair value model' which is the Board's long term objective in respect of the accounting for financial instruments. One approach discussed was the 'interim steps approach'.

At this meeting the Board discussed a model that could represent a possible interim step. The starting point of this model is the fair measurement principle rather than certain components of the existing standards (hedge accounting, derivatives, etc). The reason for choosing this approach was that the existing mixed cost-fair value measurement requirements were considered to be the main source of complexity.

The key features of the model are:

• Set fair value measurement as the default for financial instruments.
• As an exception, financial instruments with certain cash flow characteristics that are not traded in an active market can be designated on initial recognition to be measured at amortised cost.

The consequences of this model were discussed in detail for the component 'hedge accounting'. Further details and illustrative examples are outlined in Agenda Paper 10 and 10A available in the Observer Notes Section of the IASB Website.

No decisions were made in this session. However, there appears to be a consensus regarding the following issues:

• An 'interim steps approach' is in general a valid alternative to the one-step introduction of the fair value model and should be considered further.
• Any interim step should result in more financial instruments being measured at fair value as anything else is considered to be a step back.
• When considering 'complexity' the different forms of complexity should be taken into account. For example the reduction of complexity in applying (that is, understanding) the Standards might increase complexity in implementing the Standards in practice as new valuation models might need to be implemented.
• If an interim step provides exceptions from fair value measurement for certain financial instruments a subsequent move towards fair value measurement should be allowed for these instruments.

Discussion at the October 2007 IASB Meeting

The staff presented a summary to the Board on discussions between an IASB team (consisting of selected Board members and staff) and a number of banks in July and September 2007. Those meetings were an outcome of the deliberations between the European Banking Federation (FBE - a banking representative body) and the IASB team which resulted in a presentation by the FBE at the IASB Board meeting in December 2006.

The discussions were aimed at identifying any issues arising from the application of the cash flow hedge accounting model in IAS 39. The staff sought opinion as to whether any clarification of IAS 39 was necessary.

The main issues potentially requiring clarification are:

• What is meant by a 'hypothetical derivative' for testing effectiveness?
• Improvement of the documentation/effectiveness methodology applied to existing hedging relationships.
• Designation of sub-benchmark interest rate items.
• The period in which deferred gains/losses should be reclassified if a hedging instrument is dedesignated.

Staff indicated that three of the above items could potentially be clarified without consuming excessive staff resources. It was noted that the formal process of bringing these clarifications in the standard could (at least partly) be done via the Annual Improvements Process. It was suggested that the points should be addressed in order of priority.

One Board member noted that the banks had no application issues in relation to some of the points raised by the FBE. It was suggested that a possible solution to deciding whether the issues were widespread in the banking sector would be a further meeting with the banks. It was noted by one Board member that if some constituents struggle with applying the cash flow hedge accounting provisions in IAS 39 the Board should provide clarification.

One Board member reckoned that the true issue facing the banking sector was the designation of demand deposits within the cash flow hedge accounting model under IAS 39 (the treatment of those under the current IAS 39 model led to the 'carve out' of the respective sections within the EU). The Board reaffirmed its previous decision that they will not change that principle.

To gain a common understanding of what are problems for the banks, it was suggested that a letter would be sent to the banks listing all the issues raised by the FBE, including an analysis of why some issues were not addressed in the Agenda Paper, either because it is not an issue that emerged from the talks with the banks or the Board is of the opinion that the standard is clear.

The Board did not make any decisions.

Discussion at the January 2008 IASB Meeting

In the Memorandum of Understanding between the FASB and the IASB, the Boards agreed that one or more due process documents will be issued on financial instruments accounting. The IASB plans to issue a Discussion Paper Reducing Complexity in Reporting Financial Instruments in Q1/2008. This paper was discussed with members of the Financial Instruments Working Group (FIWG) on 17 January 2008.

The purpose of this session was:

• To discuss the content of the staff draft of the IASB Invitation to Comment
• To discuss the questions for respondents therein
• To provide an oral summary of the FIWG discussions on the 17 January 2008.

The staff started with the summary of the FIWG discussions. Two proposals emerged from those discussions:

• The focus of the paper should be less on fair value and more on the intermediate solutions to reduce complexity in financial reporting for financial instruments.
• The discussion should be expanded to the problems resulting from the extended use of fair value, especially where markets are non existent or illiquid.

On the first issue, the staff said it will look into structure and language of the paper, as FIWG members had the impression that Board members had already decided that fair value is the ultimate measurement attribute. One Board member noted that the FASB seemed also to propose a change in the tone of the paper, but in the opposite direction (that is to propose more clearly fair value as measurement basis).

Also, the FIWG proposed to add questions on the following topics:

• Presentation (including disaggregation) – especially, what users of financial statements want
• Whether a single measurement attribute is desirable
• Discussion on hedge accounting alternatives.

On the first point, the Board had a lengthy discussion whether this issue should be included. Supporters of its inclusion mentioned that if this is not included, the feedback on the Discussion Paper would probably be negative. Those board members who were not in favour of having references or questions on presentation in the Discussion Paper noted that this might distract readers from the scope of the document. One Board member proposed that there could be cross references to the sections on presentation in the Joint Working Group papers issued some years ago.

On the issue of hedge accounting, staff reported that FIWG members obviously do not want to abandon hedge accounting. The chairman proposed that one way forward could be to abandon hedge accounting but allow entities to explain the effects and put them in an economic context in the notes. Another Board member was concerned that constituents might want more deferral hedge accounting alternatives besides hedge accounting.

March 2008: Discussion Paper on Reducing Complexity in Reporting Financial Instruments

On 20 March 2008, the IASB published for comment a Discussion Paper (DP) on Reducing Complexity in Reporting Financial Instruments. The DP examines the main causes of complexity under IFRSs today – such as "many alternatives, bright lines, and exceptions that often obscure the underlying principles". The DP concludes that the long-term solution is a single measurement principle for all financial instruments within the scope of a standard, and explains why "fair value seems to be the only measurement attribute that provides relevant information for all types of financial instruments". However, many issues and concerns must be addressed before a general fair value measurement requirement could be introduced. Consequently, the paper suggests possible intermediate approaches that would improve and simplify measurement and hedge accounting requirements relatively quickly – including any or a combination of:

• Amending the existing measurement requirements in IAS 39, for instance, by reducing the number of categories of financial instruments
• Replacing the existing IAS 39 measurement requirements with a fair value measurement principle and some optional exceptions to fair value measurement
• Simplifying hedge accounting

The DP is the first step in an IASB project that would replace IAS 39. The DP is being published by the IASB. However, it will also be considered for publication by the US Financial Accounting Standards Board for comment by its constituents. The IASB requests responses to the DP by 19 September 2008. Click for Press Release (PDF 79k).

Discussion at the June 2008 IASB Meeting CLASS=sb>FASB Hedge Accounting Project – Education session

FASB staff gave a presentation on an exposure draft (ED) on simplifying hedge accounting under SFAS 133 recently published by the FASB. No decisions were made at this education session.

In an opening remark the staff noted that the objective of the ED is to simplify accounting for and to improve financial reporting of hedging activities. It was also noted that two of the FASB Board members dissented from the issue of the ED, mainly as the ED would not lead to convergence with IFRS and as some of the complex portion hedging would still be allowed. One Board member asked if the FASB considered requiring mandatory fair value measurement for financial instruments. The FASB staff replied that this has been considered but discarded due to time constraints which would have contradicted the idea of having a short-term solution.

The FASB staff then began to present the proposals of the ED. It was emphasised that the eligibility criteria for hedged items would not be changed. Furthermore, the ED would introduce what was called a 'fair value methodology' approach to hedge accounting. The consequences of that approach would be:

• No bifurcation of risk (with exceptions)
• Abolishment of shortcut method and critical terms match
• No quantitative effectiveness test required generally.

The FASB staff then turned to depict the major changes that would be introduced by the ED.

Hedge effectiveness

The FASB explained the new principles that would be established under the ED regarding the hedge effectiveness requirement. It was noted that the quantitative test that 'proves' the effectiveness of a hedging relationship would no longer be required if a qualitative analysis showed a 'reasonable' economic offset between hedging instrument and hedged item. If this is not obvious, however, a quantitative test would still be required. One Board member told the staff that some constituents would have the impression that not requiring an effectiveness test would result in not recognising any ineffectiveness at all. The FASB staff explained that although there would be no effectiveness test required, an entity would still have to measure any ineffectiveness.

Another Board member asked what was meant by the term 'reasonable'. The FASB staff answered that there is no quantitative threshold for this. It was also questioned whether an effectiveness assumption would still be required given that all ineffectiveness would be recognised in profit or loss anyway. The FASB staff responded that the FASB considered this, but that not requiring some notion of effectiveness would essentially result in a fair value option for non-financial items by way of designation. It was also noted that if circumstances suggest that the assumption of effectiveness no longer holds true, effectiveness would have to be reassessed.

Dedesignation

The FASB staff then presented the new dedesignation criteria. It was highlighted that voluntary dedesignation would no longer be permitted under the ED's approach. Instead a hedging relationship would be discontinued if the hedging instrument terminated, sold or expired or would no longer meet the criteria in SFAS 133.21 and .22. Also entering into a derivative contract offsetting the hedging derivative would be consideration effective termination. One Board member asked if this would also trigger recycling of the amount deferred in equity in a cash flow hedge of a forecasted transaction. The FASB staff explained that provided the forecasted transaction is still considered to be highly probable the amount would continue to be deferred until the hedged item affects profit or loss.

Hedged risk

The FASB staff then turned to the definition of hedged risk under the ED. It was noted that the general approach would be that only all risks can be designated with two exceptions:

• Foreign exchange risk
• Interest rate risk in hedge of an entity's own debt if designated at inception.

This would reduce the situations where bifurcation of risk would be possible. It was noted that the designation of a proportion would still be possible.

One Board member asked why these two exceptions were made. The FASB explained that changing the hedge accounting requirements for foreign exchange risk under SFAS 133 that had been carried over from SFAS 52 would have required redeliberating and amending SFAS 52. Regarding the second exception it was argued that this has been done for convenience reasons as entities have indicated they prefer issuing fixed rate debt and then swapping it into variable rate debt, in which case they would have to apply hedge accounting in the absence of invoking the fair value option for the debt instrument. That would have resulted in those entities being required to present changes in their own credit risk inherent in their issued debt. Another Board member asked why this choice would not be permitted for assets. The FASB staff responded that the FASB considered it useful information if users of financial statements would not only see what an entity has hedged, but also what it has not hedged. This would be implemented with the ED's hedge accounting model.

One Board member asked about the interaction of the 'all risks' approach and measuring ineffectiveness and, if necessary, any quantitative effectiveness testing. The FASB staff highlighted that if all risks are designated then all changes in value of the hedged item caused by these risk would be reflected in measuring ineffectiveness (or when testing effectiveness). This is, however, different in a scenario where the ED would still allow designating risk components.

Measurement of hedged items in a fair value hedge

The FASB staff noted that the ED would still require the hedged item to be adjusted for fair value changes. It was also noted that hedged item and hedging instrument must be measured separately and that all contractual cash flows must be included.

Measuring and reporting ineffectiveness in a cash flow hedge

The FASB then continued to present the accounting changes for cash flow hedges. It was noted that the ED would implement the hypothetical derivative method (which compared the actual hedging instrument with a hypothetical derivate that would perfectly offset the risks from the hedged item) and any difference in the value between this derivative and the actual hedging instrument would be reported in profit or loss as ineffectiveness. The FASB staff also highlighted that the approach set out in Implementation Guidance G20 which allows deferring changes in the time value of an option in a cash flow hedge would still be allowed under the ED, but would be moved to the main body of SFAS 133. It was also noted that the time value must be amortised using a 'rational basis'.

Disclosures

The FASB staff then explained the new disclosure requirements under the ED. It was noted that a reconciliation would be required that showed reported amount in the balance sheet, any hedge adjustment and other fair value changes. Furthermore, if an entity hedges the interest rate risk in issued debt, it would be required to disclose the impact of any derivatives on maturity and interest rate of the debt.

Partial-term hedging

At the end of the session, the FASB staff was asked if partial term-hedging would still be possible. FASB staff response was no.

The Chairman thanked the FASB staff for the presentation and closed the session.